Strategic Management

1. Abilene Christian University

Sarah Easter MGMT 439/Spring 2019

Strategic Management MGMT 439/Spring 2019 Sarah Easter Abilene Christian University

Table of Contents

Introductory Note on the Case Method...... 5 Netflix Inc.: Streaming Away from DVDs...... 11 Vietnam Handicraft Initiative: Moving Toward Sustainable Operations...... 21 Art Feeds: Scaling a Non-profit Organization...... 33 Namasté Solar...... 45 Hong Kong Disneyland...... 57 Apple and Its Suppliers: Corporate Social Responsibility...... 73 IMAX: Larger Than Life...... 83 LEGO Group: Building Strategy...... 101 Homelessness in Harvard Square: Multi-Stakeholder Collaboration in Action...... 113 The U.S. Postal Service: A First Class Disruption...... 137 Burro: Tools for a Better Life in Ghana...... 149 Tim Hortons Inc...... 155 Alice Saddy: Caring for the Community...... 171 The Espresso Lane to Global Markets...... 181

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AN INTRODUCTORY NOTE ON THE CASE METHOD

John Haywood-Farmer wrote this note solely to provide material for class discussion. The author does not intend to provide legal, tax, accounting or other professional advice. Such advice should be obtained from a qualified professional.

This publication may not be transmitted, photocopied, digitized or otherwise reproduced in any form or by any means without the permission of the copyright holder. Reproduction of this material is not covered under authorization by any reproduction rights organization. To order copies or request permission to reproduce materials, contact Ivey Publishing, Ivey Business School, Western University, London, Ontario, Canada, N6G 0N1; (t) 519.661.3208; (e) [email protected]; www.iveycases.com.

Much of the study of business administration is accomplished through the study of business cases, a method chosen for its effectiveness. This note’s goal is to help you learn how to deal with cases.

WHAT IS A CASE?

This note uses the term “case” to refer to a written description of a situation actually faced by a manager. Cases commonly involve a decision to be made, a problem to be solved or an issue to be settled. Although in some cases the authors might have disguised names, places, and other facts at the request of the organizations involved, most of the cases you will encounter are real situations that real people have faced. The objective of each case is to leave you at a point much like the one that the individual in the case actually confronted — you must make a decision.

In each case situation, the decision maker is expected to determine what problems and opportunities

existed, to analyze the situation, to generate and evaluate alternative courses of action, and to recommend Use outside these parameters is a copyright violation. and implement a plan of action. Except for the fact that you will not have the actual opportunity to implement the plan of action and see the results, you will be expected to go through this same process.

As they grapple with problems, decision makers encounter a number of common frustrations: a shortage of good information on which to base decisions, a shortage of time in which to make decisions, uncertainty about how plans will work out, and a lack of opportunity to reduce this uncertainty at a reasonable cost. You will experience these same frustrations because the cases try to give you the same information, time pressures, and so on that the decision maker had. In short, you will simulate the experience of decision making. However, cases do simplify the task somewhat: someone has already collected and sorted all the available data for you and presented it in a reasonably neat package. In real life the decision maker also faces the task of collecting the data that might be relevant for making a decision.

For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. THE CASE METHOD

The case method is not a single approach, but rather several variations. The general theme, however, is to learn by doing, rather than by listening. According to the Chinese scholar Confucius: “I hear and I forget. I see and I remember. I do and I understand.” This quotation illustrates the importance of hands-on

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experience in learning. Class sessions using cases are not lectures but discussions that emphasize the development of skills in problem solving and decision making. In a typical case discussion everyone in the room works toward a solution to the particular problem being addressed. Consequently, students will interact with one another as well as with the instructor. The student’s role, then, is one of participation and contribution — active listening and talking with others in the class. The instructor’s role is not to lecture the group but to guide the discussion by probing, questioning, and adding some input.

Cases can be used in several ways. You will probably be asked to deal with them in some or all of the following ways:

1. a. Individual preparation for a class discussion, followed by b. Small group discussion in preparation for a class discussion, followed by c. Class discussion. 2. A written report or in-class presentation of a case. 3. A written examination of your ability to handle a case.

Each of these methods is somewhat different and will require some variation in your approach. Also, your instructor will undoubtedly have his or her own comments to add to the following general remarks about approaches to cases.

INDIVIDUAL PREPARATION FOR CLASS

Cases can be complicated and controversial. In reality, they are unstructured problems. Watch out — the process of case preparation can be deceiving! Some students think they are on top of the situation without really having done much work. They read over cases casually once or twice, jot down a few ideas, go to class, and listen to the discussion. As points come up they think, “I touched on that,” or “I would have reached the same conclusion if I had pushed the data a little further.” However, when exam, report, or presentation time arrives and they must do a case thoroughly on their own, they find themselves in serious difficulty. These students spend all their time in the exam trying to learn how to deal with a case, rather than tackling the case issues on which they are being tested. Because this is the first case these students have really tried to do from beginning to end, this situation is not surprising. Their position is similar to Use outside these parameters is a copyright violation. that of someone who trained by watching others practise for a number of months and then entered a 100- metre race at an official track meet.

To help provide you with some structure, your instructor might assign specific questions to be addressed as you work on a case. You should consider such assignment questions as a means to assist you in getting started on the case and not as the limit of your preparation. When your instructor assigns no questions, it is up to you to develop the structure. In class, your instructor will still expect you to be ready to give a supported decision concerning what you would do as the decision maker in the case. Accordingly, you should regard each case as a challenge to your ability to:

1. Define a problem; 2. Sort relevant from irrelevant information; 3. Separate fact from opinion; For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. 4. Interpret and analyze information; 5. Come to a reasoned decision and course of action; and 6. Communicate your thoughts clearly and persuasively to others during class discussions.

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Cases also serve to communicate a good deal of descriptive information about a wide variety of institutions and business practices. Many cases are sufficiently complex to absorb all the preparation time you have — and then some! Therefore, it is extremely important that you develop skill in using your preparation time efficiently.

Much of your preparation time should be spent analyzing and interpreting information. In effect, the case presents facts and opinions. Your job is to become acquainted with those facts and opinions and to know how they relate to the decision. The following steps will help you in your individual case preparation:

1. Read the case once quickly to get an overview. 2. Skim any exhibits in the case just to see what type of information is available. 3. Find out — frequently from the few paragraphs at the beginning and end of the case — who the decision maker is (this will be your role); what his or her immediate concern, problem, or issue appears to be; why this concern has arisen; and when the decision must be made. 4. Read the case again, more carefully. This time highlight key information, make notes to yourself in the margin, and write down ideas as they occur to you. At this stage you are trying to familiarize yourself as thoroughly as possible with the case information. Having done so, you are ready to begin your analysis. 5. Try to answer at least the following questions: a. What business is the organization in? What are its objectives? What are its strengths and weaknesses? What opportunities and threats exist? Who are its customers? What does it have to do well to satisfy customers? How do you know? b. What is the decision to be made, problem to be solved, or issue to be resolved? How do you know — what is your evidence? (Let the case data guide you — most cases will have sufficient data for you to “solve” the problems and are unlikely to contain vast amounts of completely irrelevant data.) c. What facts are relevant and key to a solution? Are they symptoms? Causes? What is your quantitative and qualitative evaluation of the organization’s strengths and weaknesses? d. What do the facts mean for the problem? Here, learn to analyze — ask and answer lots of questions. e. What are the decision criteria?

f. What are the alternatives? Are they relevant to the problem at hand? Although it is usually Use outside these parameters is a copyright violation. unwise to ignore the obvious solutions, most instructors appreciate creative solutions, provided they are sensible and supported by reasonable data. g. What is your evaluation of the alternatives in view of the decision criteria? What are the pros and cons of each? h. Which alternative or combination of alternatives would you choose? Why? i. What is your plan of action? Outline your plan by answering the questions who, when, what, where, why, and how. j. What results do you expect? Why?

SMALL GROUP PREPARATION FOR CLASS

If possible, prior to class you should informally discuss your preparation of each case with some of your For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. classmates. Many students find such study group sessions to be the most rewarding part of case method learning. A good group session is a sharing experience in which you discover ideas you might have missed or to which you did not give enough weight. Your colleagues will also benefit from your input.

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The effectiveness of a small group case discussion can be increased substantially if you and the other members of the group adhere to the following guidelines:

1. Each student must come to the group meeting with a thorough knowledge of any assigned readings and analysis of the case. The small group session is not the place to start case preparation. 2. Each group member is expected to participate actively in the discussion — it is an excellent place to check your analysis before going into class. 3. It is not necessary to have a group leader. All members of the group are responsible for making their own decisions based on what is said plus their own case analysis. 4. It is also not necessary to have a recording secretary. Participants are responsible for their own notes. It is important to be able to recognize a good idea when you hear one. 5. Consensus is normally not necessary. No one has to agree with anyone else. 6. If it is important to you, work at clarifying individual disagreements after the small group discussion, especially if only one or two people are involved. 7. Set a time limit for discussion and stick to it. Effective small group case discussions can take less than 30 minutes and, because of your workload, 30 minutes will have to be adequate for most cases.

Remember, a group can be as small as two people. If you cannot get together in one place, spend some time on the phone with a classmate reviewing your respective case analyses. You will be more confident, feel better about your own preparation, and probably contribute more to the class discussion.

CLASS DISCUSSION

Cases are complex and there are never any completely right or wrong answers. Consequently, groups of managers who address the kinds of issues represented by cases nearly always express different views on how to interpret the data and what action could and should be taken. They see the world differently, and this diversity is one reason management is worth studying. You should expect something similar: during discussion of a case, your classmates will express several different views. The essence of the case method is the process of putting forward different points of view, defending your position, and listening actively to others in order to understand and constructively criticize others’ points of view. Only rarely will you leave

the classroom with your position or perspective unchanged after discussing a case; indeed, if you do so, it Use outside these parameters is a copyright violation. was a waste of your time to go to class.

However, despite the common interest of all class members in resolving the case issues, and regardless of guidance from the instructor, class discussions sometimes will seem repetitious and unorganized. This is unavoidable and natural, especially during the early stages of a course. Over time, as a group develops its group decision-making ability, case discussions will become more orderly, effective, efficient, rich, and satisfying to all.

The need to be a skillful communicator arises repeatedly in management. The case method presents an ideal opportunity to practise communication skills — both talking and listening. Some people, because they find talking in a group difficult and threatening, avoid talking in class even though they might realize that by being silent they are not getting full value out of the experience. If you are one of these individuals, the only way to overcome this problem is to jump in and begin. Make a habit of participating regularly in For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. class. Do not wait until you have a major presentation to make in which you will hold the floor for a lengthy period. You can add a key piece of information or question something in just a few sentences, and this might be the best way for you to begin active involvement. Your instructor and your classmates will support your efforts. Remember, the classroom is a place where we can learn from one another’s mistakes

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as much as, and often more than, from one another’s solutions. The cost of making a mistake in class is very small compared to making it in an actual situation. Other people have poorly developed listening skills. Some individuals do not listen: they simply wait for their turn to talk. The case method depends on the willing two-way interaction of the students. Without that essential ingredient, the cases become interesting stories rather than opportunities to develop the ability to make and argue for and against management decisions.

Not surprisingly, students are interested in finding out what actually happened in a case or what the instructor would do. Only rarely will you be provided with this information. Learning comes from the process and habit of making decisions, not from reviewing what others decided to do.

AFTER CLASS

After class take a few minutes to assess your preparation by comparing it with what happened in class. Were you in the ball park or completely off base? Did you spend enough time preparing on your own? Was your small group session effective? What can you do better next time? What general lessons did you learn? For example, although you might not be interested in remembering how the market for athletic shoes can be segmented, you should want to remember how to segment a market.

EVALUATING PERFORMANCE

In a typical class discussion of a case, exactly what gets done depends not only on the work done by the students — what preparation they did, who actively participated in the discussion, how well people related their comments to previous discussion — but also on the instructor’s pedagogical objectives and performance as a moderator and discussion leader. Instructors view case courses as sequences of problems that gradually foster the development of decision-making skills. With this longer time horizon, instructors often find it advisable to emphasize a specific analytical technique on one occasion, stress problem identification on another, and so on. Thus, it is possible that many class sessions will seem to be incomplete, unbalanced developments of a case analysis and plan of action. Although this might frustrate you, have faith that your instructor is trying to develop your skills over one or more terms. Use outside these parameters is a copyright violation.

How do instructors assess performance? The answer, of course, varies from one instructor to another. However, there are some common factors. Above all, instructors develop your ability to demonstrate that you can think logically and consistently by being able to:

1. Identify, prioritize, and deal with issues and problems; 2. Judge the quality and relevance of information — fact, opinion, hearsay, lies, and so on; 3. Make and assess necessary assumptions; 4. Relate the information to the issues, problems, and decisions in the case; 5. Resolve conflicting information; 6. Analyze by asking and answering the right questions and correctly using appropriate analytical tools; 7. Determine and rank appropriate criteria for making decisions; 8. Generate and evaluate alternative courses of action; For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. 9. Make a decision (take a stand) and defend it with persuasive, well-ordered, convincing argument; 10. Develop a reasonably detailed action plan showing an awareness of what might happen; 11. Build on other students’ arguments to advance the discussion toward a coherent conclusion rather than making unrelated points or repeating ones already made; and

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12. Generalize: in traditional lectures instructors expect students to take the general lessons from the lecture and apply them to specific problems; case method instructors expect students to go from the specific lessons in a case to more general lessons.

In addition to assessing performance in class on a daily basis, most instructors will provide some opportunities for more complete, balanced treatment of cases. Sometimes instructors allow extra preparation time and ask for an oral presentation of a case by an individual or group. Sometimes instructors require students to prepare a written report on how they would handle a particular situation and why. Frequently, case method courses have cases as examinations: students are given a case and asked to do whatever analysis and make whatever recommendations they deem appropriate.

In reports, presentations, and examinations, instructors expect a more complete, balanced argument for a particular course of action. Such exercises are not usually intended to result in a diary of how a student or group looked at a case or in a rewritten version of the case. A report, presentation, or examination is supposed to be a concise, coherent exposition of what to do and why — it usually starts where most students leave off in their regular individual preparation for a case class. Think of a report, a presentation, or an examination as an organized, more fully developed (and perhaps rewritten) version of your regular class preparation notes.

You will find that your audience — instructor, business executive, or whoever — has particular ideas about how a report, presentation, or examination should be organized. Try to find out as much as you can about format expectations before embarking on your task. You might use the following general outline:

1. Executive summary (written last but appearing first); 2. Statement of problem, opportunity, and objectives; 3. Analysis of the situation; 4. Identification and evaluation of alternatives; and 5. Decision, course of action, and implementation.

CONCLUDING REMARKS

Use outside these parameters is a copyright violation. Case teachers are less interested in the relatively straightforward problems typically found at the ends of chapters in most texts than in the unstructured problems more typical of real situations and exemplified by cases. The key to dealing with unstructured problems is to learn what questions to ask. Ironically, answering the questions is usually easier than asking them because the questions focus thinking. It is like trying to find your way in the wilderness. Almost anyone can follow a trail; the key skill is knowing which trail to follow.

Like many generations of business students, you will probably find case study a very rewarding way to learn. Good luck with it!

For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019.

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1 NETFLIX INC.: STREAMING AWAY FROM DVDS

David Wesley wrote this case under the supervision of Professor Luis Alfonso Dau solely to provide material for class discussion. The authors do not intend to illustrate either effective or ineffective handling of a managerial situation. The authors may have disguised certain names and other identifying information to protect confidentiality.

Richard Ivey School of Business Foundation is the exclusive representative of the copyright holder and prohibits any form of reproduction, storage or transmission without its written permission. Reproduction of this material is not covered under authorization by any reproduction rights organization. To order copies or request permission to reproduce materials, contact Ivey Publishing, Richard Ivey School of Business Foundation, c/o Richard Ivey School of Business, The University of Western Ontario, London, Ontario, Canada, N6A 3K7; phone (519) 661-3208; fax (519) 661-3882; e-mail [email protected].

The very concept of physical media is racing toward obsolescence. – Steven Levy, author of The Perfect Thing: How the iPod Shuffles Commerce, Culture, and Coolness2

On a clear summer evening in 2011, Reed Hastings, founder and chief executive officer (CEO) of Netflix Inc. (Netflix), decided to visit a friend near his home in Santa Cruz, California. During this visit, Hastings shared an idea that he had been considering for some time — splitting his company’s DVD rental business from the online streaming business. “That is awful, I don’t want to deal with two accounts,” replied the friend, who was also a Netflix subscriber.3

Unconvinced by his friend’s objections, on July 12, Hastings publicly announced his plan and a corresponding increase in fees (see Exhibit 1), both changes to take effect on September 1. The reaction

was swift and brutal. Over the next quarter, Netflix lost 805,000 subscribers, its first decline in Use outside these parameters is a copyright violation. membership in more than a decade. At the same time, the company’s stock dropped by more than 50 per cent from a high of $300 per share prior to the announcement.4

In an apologetic letter to subscribers, Hastings admitted that he had “messed up.” “I owe you an explanation,” he wrote (see Exhibit 2).

It is clear from the feedback over the past two months that many members felt we lacked respect and humility in the way we announced the separation of DVD and streaming and the price changes. That was certainly not our intent, and I offer my sincere apology.

1 This case has been written on the basis of published sources only. Consequently, the interpretation and perspectives For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. presented in this case are not necessarily those of Netflix Inc. or of any of its employees. 2 Steven Levy, “Young’s Frankenstein,” Wired, July 2009, p. 54. 3 Nick Wingfield, “A Juggernaut Stumbles,” The New York Times, October 25, 2011, p. B1. 4 Todd Wasserman, “Netflix Loses 800,000 Customers in Quarter,” Mashable Business, October 24, 2011, http://mashable.com/2011/10/24/netflix-loses-800000-customers-in-quarter/#314677-Netflix-Stock-Plummets-27-Following- Earnings-Report, accessed January 11, 2012.

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Although Hastings apologized for the way the plan was executed, he continued to defend the new structure.

Meanwhile, Netflix began to face new competition from a variety of video streaming services, including Apple iTunes, Amazon Video on Demand (VOD), Hulu and Google TV. Even YouTube, which had previously limited its service to amateur video sharing, began to offer advertising-supported films and television shows. In addition, cable and satellite providers started to roll out their own video streaming services at no extra cost to subscribers. Since most Netflix subscribers relied on cable and satellite to provide them with content not available on the Internet, such as sporting events and cable news programming, Netflix content was becoming increasingly redundant. Moreover, unlike the DVD rental service, the new streaming-only service did not offer recent films, due to the unwillingness of content distributors to enter into flat-fee contracts.

Streaming was not the only service where Netflix faced new competition. Redbox Automated Retail, LLC (Redbox) supplied DVD kiosks in high-traffic locations across the United States. Each of the 29,000 kiosks offered as many as 200 popular movie titles,5 which could be rented for as little as $1.00 per day ($1.50 per day for Blu-ray discs and $2 per day for videogames).6 Low rental fees, convenience and availability enabled Redbox to capture 18 per cent of the DVD rental market share in 2009, which grew to 25 per cent in 2010.7

Media analyst Michael Olson believed that for Netflix to remain competitive, it needed to expand its online catalog.

I understand why they’re making this move toward streaming from a long-term perspective, but the only way they will now be able to make investors believe in them, and subscribers continue to be attracted, is to have a waterfall of new content in the next few months.8

However, Hastings had always maintained that Netflix would not seek new releases from its content partners, who demanded pay-per-view rates. Instead, Hastings’ solution was simple — go to Amazon or iTunes. “Both of the services, iTunes and Amazon, are pretty comprehensive,” he said. “We’re focused on the subscription — unlimited for a flat fee.”9

Use outside these parameters is a copyright violation. On November 25, Netflix stock fell to $63 per share.10

BACKGROUND

Reed Hastings and Marc Randolph co-founded the Los Gatos, California-based company in 1997 to provide online rentals of DVDs. At a time when technology pundits saw online streaming as the future of

5 Redbook Automated Retail, LLC, “Media Center: Facts about Redbox,” https://www.redbox.com/facts, accessed March 21, 2012. 6 Redbook Automated Retail, LLC, “General Questions: Price Change,” https://www.redbox.com/pricechange, accessed March 21, 2012. 7 Erik Gruenwedel, “Analysts Downplay Redbox’s ‘Messy’ Quarter,” Home Media Magazine, July 30, 2010, http://www.homemediamagazine.com/redbox/analysts-downplay-redbox%E2%80%99s-%E2%80%98messy%E2%80%99- quarter-20180, accessed March 21, 2012. For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. 8 Ronald Grover and Cliff Edwards, “Can Netflix Find Its Future by Abandoning the Past?” Bloomberg Businessweek, September 22, 2011, http://www.businessweek.com/printer/magazine/can-netflix-find-its-future-by-abandoning-the-past- 09222011.html, accessed January 11, 2012. 9 Henry Blodget and Dan Frommer, “Netflix's Market Opportunity Is a Lot Bigger Than You Think,” Business Insider, April 4, 2011, http://www.businessinsider.com/netflix-ceo-reed-hastings-interview-2011-4?op=1, accessed January 11, 2012. 10 Google Finance, “Netflix Inc.” https://www.google.com/finance?client=ob&q=NASDAQ:NFLX, accessed January 11, 2012.

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content delivery, Netflix turned to a low-tech solution — the United States Postal Service. For a fee of $20 per month, members could select three movies at a time from a wide variety of available titles. Netflix mailed members the physical DVD discs and a postage-paid return envelope. Members could keep the DVDs for as long as they needed without incurring late fees. The only catch was that the DVDs needed to be returned in good condition before another movie could be rented.

“Compared with other VOD schemes, Netflix is slow,” observed Peter Lewis of Fortune, shortly after the service was launched.

But once the DVDs are in house, it’s video on demand: The movies can be watched when the user wants and as many times as he or she wants. There are no due dates or late fees. And Netflix has an advantage over other VOD schemes and rental stores when it comes to obscure movies. Try finding the Hindi classic Do Ankhen Barah Haath at your local video store, for example.11

In 2002, Netflix raised more than $82 million in a successful initial public offering (IPO) that relied largely on the company’s strong growth projections. The enthusiasm was warranted, as Netflix nearly doubled its subscriber base each year for the next several years. By 2004, Netflix had more than 4 million subscribers, compared with 600,000 in early 2002.12

In 2005, Netflix’s growth began to slow considerably. Between 2005 and 2008, U.S. per capita annual spending on DVDs fell from $60 to $43,13 as consumers increasingly turned to illegal downloads on file- sharing services such as The Pirate Bay and Megaupload.14 Most viewers did not seem to mind the security risks or video quality that was often inferior to the DVDs.

Netflix responded in 2007 by launching its own streaming service that provided members with unlimited movie rentals for a nominal monthly fee. It also lowered the cost of its subscription service, eventually settling on a $10 per month flat fee for both the streaming and mail-in services. Although Netflix paid a fixed cost to distributors for streaming content over the Internet,15 contracts tended to be for one or two years, after which fees were adjusted on the basis of subscriber numbers.16 Analysts hailed the new business model, which quickly returned Netflix toward a path of rapid growth.

In 2010, Netflix began to expand internationally, first offering its service in Canada and later in Latin Use outside these parameters is a copyright violation. America and the Caribbean. In 2011, the California-based company had 20 million subscribers, employed more than 4,000 people and received revenues of approximately $2.2 billion (see Exhibit 3 for additional financial data).17

11 Peter Lewis, “Netflix: Video on Delay,” Fortune, September 17, 2001, p. 230. 12 Netflix Inc., “Company Timeline,” http://signup.netflix.com/MediaCenter/Timeline, accessed January 10, 2012. 13 Dominic Rushe, “DVD Sales Slump Challenges Hollywood,” The Times Online, July 4, 2009, business.timesonline.co.uk/tol/business/industry_sectors/leisure/article6639171.ece, accessed July 13, 2009. 14 File-sharing services permitted users to upload digital media to a remote server where it could be shared with other users or distributed directly through peer-to-peer networks. In the United States, approximately 40 per cent of Internet users shared music, 14 per cent shared video content and 9 per cent shared games. Source: N, Van Eijk et al., “Legal, Economic and Cultural Aspects of File Sharing,” Communications & Strategies, No. 77, 2010, pp. 35–54. For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. 15 In 2010, Netflix had “over $1.2 billion in such contractual commitments covering payments due over the next several years. Furthermore, [Netflix planned] on increasing the level of committed content licensing” based on continued growth projections. Source: Netflix, Inc., 2010 Annual Report, Form 10-K, p. 6 16 Henry Blodget and Dan Frommer, “Netflix's Market Opportunity Is a Lot Bigger Than You Think,” Business Insider, April 4, 2011, http://www.businessinsider.com/netflix-ceo-reed-hastings-interview-2011-4?op=1, accessed January 11, 2012. 17 “Netflix, Inc.: SWOT Analysis,” Datamonitor, October 14, 2011, p. 4

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THE RISE (AND FALL) OF BLOCKBUSTER

Netflix’s main competitor was Blockbuster Inc. (Blockbuster), which was founded in 1985, when the video rental market was dominated by small, independently owned rental stores and convenience stores. Video stores offered VHS and Betamax tapes for a fixed nightly fee. These tapes were large, relatively expensive to produce and wore out quickly. Most stores required consumers to pay a large deposit to ensure that tapes were returned in working condition. If tapes were returned late or damaged, consumers had to pay fines, which, in some cases, could amount to more than the purchase value of the movie.

Blockbuster was widely lauded as a technological innovator for its use of computer databases to optimize inventory, track consumer movie preferences and consolidate its video rental business nationally.18 Customers were issued a membership card that could be used to borrow movies at any Blockbuster location in the United States without having to complete additional registration forms or provide additional deposits.

Over the next decade and a half, Blockbuster grew rapidly across the United States and internationally. By 1999, Blockbuster was the largest video rental company in the world with triple the market share of its next nearest competitor. At the time, “Blockbuster estimated that roughly 60 percent of the U.S. population lived within three miles of a Blockbuster store. The typical Blockbuster store carried 4,500 different movie titles, 500 of which were new release titles.” Approximately 78 per cent of the company’s revenues came from new release rentals.19

The introduction of DVDs in the mid-1990s radically altered the way movies were consumed. DVDs were lightweight, cheap to produce and offered significantly improved video and sound quality over VHS tapes. Also, unlike VHS tapes, DVDs could be economically mailed directly to consumers. By delivering movies directly to consumers through the mail, Netflix was able to provide its DVD rentals from a single location in San Francisco. In 2002, Netflix added 10 regional hubs to serve its rapidly growing membership, which at the time had grown to 600,000.20

When Blockbuster introduced its own DVD mail-in service in 2004, Netflix had already grown to 3 million members. However, Blockbuster’s unwillingness to eliminate late fees, which provided $300 million in annual revenues, allowed Netflix to continue to win market share.21 In 2010, Blockbuster filed 22 for Chapter 11 bankruptcy protection after losing more than $500 million in 2009. Use outside these parameters is a copyright violation.

ONLINE STREAMING

In 2000, Blockbuster partnered with Enron Broadband Services (Enron) to become one of the first companies to provide on-demand movie rentals. At the time, Blockbuster dominated DVD rentals with 4,800 video stores across the United States and 72,000 employees in 26 countries.23 However, after a brief trial run in four major U.S. cities, both companies abandoned the project, each blaming the other for the failure. Blockbuster argued that Enron had not been ready to provide the technology needed to reach

18 Stephen Gandel, “How Blockbuster Failed at Failing,” Time, October 11, 2010, pp. 38–40. 19 E. Scott Mayfield, “Netflix. Com, Inc.,” Harvard Business School Case 201-037, 2000, p. 5 20 Netflix Inc., “Netflix Announces Opening of 10 Regional Distribution Centers,” Netflix press release, June 20, 2002, http://ir.netflix.com/releasedetail.cfm?ReleaseID=83066, accessed January 24, 2012. For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. 21 Stephen Gandel, “How Blockbuster Failed at Failing,” Time, October 11, 2010, pp. 38–40. 22 David Lieberman, “Blockbuster Files for Chapter 11 Bankruptcy, Will Reorganize,” USA Today, September 23, 2010, http://www.usatoday.com/money/media/2010-09-23-blockbuster23_ST_N.htm, accessed January 24, 2012. 23 Blockbuster Inc., “About Us: The Company,” October 4, 2001, http://web.archive.org/web/20011004102053/http://www.blockbuster.com/bb/about/company/0,4440,,00.html, accessed January 10, 2012.

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consumers; and Enron blamed Blockbuster for not having offered content that consumers wanted. In reality, consumers were not ready for streaming services. Most Americans still did not have broadband service, and those that did were unwilling to pay $5 per rental, a price 20 per cent higher than renting a DVD from a local video outlet.24

When Blockbuster re-launched its streaming service several years later, it fared marginally better. Pricing was clearly a major issue since Blockbuster continued to require subscribers to pay for each movie download. However, technology also proved to be a barrier, despite rapid growth in broadband adoption. Customers who did not have access to personal computers or who wanted to view content on a big-screen TV had to purchase a $100 download module to attach to their television.

Apple offered a similar service, known as Apple TV, which could be integrated with iTunes for an upfront cost of $229. However, like most online streaming companies, it too followed a traditional model of charging a fee for each rental. The cost to download a television episode or movie ranged from $2.00 to $6.00, depending on the length, quality and release date of the program. High rental costs, long download times and limited viewing options were cited as reasons for the lack of interest in movie download services.25

By the mid-2000s, Netflix had begun experimenting with movie downloads on personal computers (PCs) with mixed success. Most PCs at the time had small screens that were poorly suited to home viewing. To take advantage of big-screen televisions, users either had to hook their computers up to their television or obtain a physical disc through the company’s mail-in service.

In 2008, Netflix began to enter into partnerships with Microsoft, Sony and others to offer direct streaming to game consoles and “smart” devices, such as web-enabled TVs.26 Since customers already had the hardware needed to stream movies directly to their television sets, they would only need to pay the additional monthly fee to access the on-demand video service. Netflix subscribers could download as much content as they wished for a flat monthly fee that started at only $10 per month. Direct streaming was not only more economical but it encouraged users to try content that they were unsure they would like. If the film wasn’t suitable, the subscriber could delete it and download something different. Online streaming to game consoles proved to be a boon to Netflix, which posted higher than expected earnings during the first quarter the service was available.27

Use outside these parameters is a copyright violation. Most viewers seemed to prefer the convenience and affordability of Netflix’s fixed-fee monthly plans. During the economic crisis of 2008, Netflix’s stock price surged 25 per cent even as the stock market as a whole fell by half. Apple shares outperformed the market on the strength of the iPhone, but its shares still experienced an overall decline of nearly 20 per cent. Over the same period, shares in Blockbuster fell by a spectacular 95 per cent on speculation that the company would soon file for bankruptcy protection.

PRICING CHANGE ANNOUNCEMENT

On July 12, 2011, Netflix emailed its U.S. subscribers to announce a pricing change from $9.99 per month to $15.98 per month. The company also announced it would be separating its DVD rental and online

24 R. Thomas Umstead, “Blockbuster-Enron Deal Fades to Black,” Multichannel News, March 19, 2001, p. 32. For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. 25 Samantha Clark, “PlayStation Store Movie Downloads Review, Part 2,” Variety, July 17, 2008, videobusiness.com/blog/1730000173/post/1420030142.html, accessed July 12, 2009. 26 “Xbox 360 and Netflix Team Up,” Xbox.com, July 14, 2008, xbox.com/en-US/community/events/e32008/articles/0714- netflixteamup.htm, accessed January 26, 2009. 27 Sue Zeidler, “Netflix says 1 Million Xbox Members Use Movie Service,” Reuters UK, February 5, 2009, uk.reuters.com/article/filmNews/idUKTRE5145SF20090205, accessed March 1, 2009.

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streaming services into two separate entities. The original DVD mail-in service would be renamed Qwikster, while the streaming business would continue to be known as Netflix.

Traditionally, changes to subscription models of any kind invited criticism. However, Hastings never anticipated the backlash elicited by the announced change. The company received more than 10,000 comments on its blog site. “Most of them lambasted him for making life more difficult for about 12 million customers who get both streaming and DVD rentals. Those people will have to visit two websites to make requests and update their billing information.”28

Others quipped that the Qwikster name was confusing. Technology journalist Harry McCracken noted the similarity of the name to at least seven other companies and entities. For example, the online store for Amway, a direct seller of personal care products, was previously known as Quixtar North America. “[Netflix is] dumping a great brand and beginning all over again with one that starts with absolutely no value whatsoever,” McCracken complained.29

Meanwhile, the United States Postal Service, facing its own problems, announced plans to eliminate one- day delivery services. The combination of slower delivery and more online competition led some to question whether DVD rentals had a future.30

Hastings eventually apologized for not doing a good enough job of explaining the reasons for the company’s restructuring. “We chose the name Qwikster because it refers to quick delivery,” wrote Hastings on the company blog. “We will keep the name ‘Netflix’ for streaming.” In his view, the problem was not so much with the changes to Netflix than the way those changes were being communicated.

But now I see that given the huge changes we have been recently making, I should have personally given a full justification to our members of why we are separating DVD and streaming, and charging for both. It wouldn’t have changed the price increase, but it would have been the right thing to do.31

Despite the uproar, some analysts saw the logic in Hastings’ decision to separate the DVD rental service, as DVD technology appeared to be quickly heading toward obsolescence.32 For them, Hastings was a visionary who foresaw a diskless future. Use outside these parameters is a copyright violation.

28 Michael Liedtke, “Netflix Says It's Sorry, Then Creates New Uproar,” Bloomberg Businessweek, September 19, 2011, http://www.businessweek.com/ap/financialnews/D9PRS58G2.htm, accessed January 12, 2012. 29 Harry McCracken, “Qwikster: Not to Be Confused with Quixtar, QuickStar, Kwikster, Quickster, Kwik Star, Quik-Star, or Kickstar,” Technologizer, September 19, 2011, http://technologizer.com/2011/09/19/qwikster-not-to-be-confused-with- quixtar-quickstar-kwikster-quickster-kwik-star-quik-star-or-kickstar/, accessed January 11, 2012. For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. 30 Robert McMillan, “Internet Braces for Stream-Only Netflix,” Wired Enterprise, December 16, 2011, http://www.wired.com/wiredenterprise/2011/12/netflix-internet/, accessed January 12, 2012. 31 Reed Hastings, “An Explanation and Some Reflections,” Netflix company blog, September 18, 2011, http://blog.netflix.com/2011/09/explanation-and-some-reflections.html, accessed January 11, 2012. 32 Rebecca Rosen, “The Case for the Netflix Split,” The Atlantic Monthly, September 19, 2011, http://www.theatlantic.com/technology/archive/2011/09/the-case-for-the-netflix-split/245323/, accessed January 12, 2012.

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Appendix A

TIMELINE OF KEY EVENTS

1985 Blockbuster is founded. 1997 Netflix is founded, provides mail-in DVD service to members for a fee of $20 per month. 2000 Blockbuster debuts streaming service. 2002 Netflix adds regional hubs. May 24, 2002 Netflix initial public offering (IPO) closes at $16.75 per share, raises a total of $82 million, has 600,000 members. 2004 Netflix reaches 4 million members; Blockbuster starts mail-in service. 2005 Netflix growth slows. Illegal file-sharing services begin to offer videos. 2007 Netflix introduces streaming service, drops membership fee to $10 per month. 2008 Economic crisis in full effect, Netflix stock price surges 25%. Blockbuster shares decline in value by 95%. 2009 Blockbuster posts loss of $500 million. 2010 Blockbuster files for bankruptcy protection. July 12, 2011 Netflix announces a price increase. November 25, 2011 Netflix stock falls to $63 per share. Use outside these parameters is a copyright violation. For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019.

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Exhibit 1

NETFLIX PRICE CHANGE ANNOUNCEMENT SAMPLE OF EMAIL SENT TO CASE WRITER

Netflix Tue, Jul 12, 2011 at 2:48 PM To: [subscriber email address]

Dear Luis, We are separating unlimited DVDs by mail and unlimited streaming into two separate plans to better reflect the costs of each. Now our members have a choice: a streaming only plan, a DVD only plan, or both. Your current $9.99 a month membership for unlimited streaming and unlimited DVDs will be split into 2 distinct plans:

Plan 1: Unlimited Streaming (no DVDs) for $7.99 a month

Plan 2: Unlimited DVDs, 1 out at-a-time (no streaming) for $7.99 a month

Your price for getting both of these plans will be $15.98 a month ($7.99 + $7.99). You don't need to do anything to continue your memberships for both unlimited streaming and unlimited DVDs. These prices will start for charges on or after September 1, 2011. You can easily change or cancel your unlimited streaming plan, unlimited DVD plan, or both, by going to the Plan Change page in Your Account. We realize you have many choices for home entertainment, and we thank you for your business. As always, if you have questions, please feel free to call us at 1-888-357-1516.

–The Netflix Team

SRC: US_20110712_PC_C0_M1 Use outside these parameters is a copyright violation. For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019.

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Exhibit 2

REED HASTINGS APOLOGY SAMPLE OF EMAIL SENT TO CASE WRITER

Reed Hastings, Co-Founder and CEO of Netflix Mon, Sep 19, 2011 at 3:21 AM

To: [subscriber email address]

Dear Luis, I messed up. I owe you an explanation. It is clear from the feedback over the past two months that many members felt we lacked respect and humility in the way we announced the separation of DVD and streaming and the price changes. That was certainly not our intent, and I offer my sincere apology. Let me explain what we are doing. For the past five years, my greatest fear at Netflix has been that we wouldn't make the leap from success in DVDs to success in streaming. Most companies that are great at something – like AOL dialup or Borders bookstores – do not become great at new things people want (streaming for us). So we moved quickly into streaming, but I should have personally given you a full explanation of why we are splitting the services and thereby increasing prices. It wouldn’t have changed the price increase, but it would have been the right thing to do. So here is what we are doing and why. Many members love our DVD service, as I do, because nearly every movie ever made is published on DVD. DVD is a great option for those who want the huge and comprehensive selection of movies. I also love our streaming service because it is integrated into my TV, and I can watch anytime I want. The benefits of our streaming service are really quite different from the benefits of DVD by mail. We need to focus on rapid improvement as streaming technology and the market evolves, without maintaining compatibility with our DVD by mail service. So we realized that streaming and DVD by mail are really becoming two different businesses, with very different cost structures, that need to be marketed differently, and we need to let each grow and operate independently. It’s hard to write this after over 10 years of mailing DVDs with pride, but we think it is necessary: In a few weeks, we will rename our DVD by mail service to “Qwikster”. We chose the name Qwikster because it refers to quick delivery. We will keep the name “Netflix” for streaming. Qwikster will be the same website and DVD service that everyone is used to. It is just a new name, and DVD members will go to qwikster.com to access their DVD queues and choose movies. One improvement we will make at launch is to add a video games upgrade option, similar to our upgrade option for Blu-ray, for those who want to rent Wii, PS3 and Xbox 360 games. Members have been asking for video games for many years, but now that DVD by mail has its own team, we are finally getting it done. Other improvements will follow. A negative of the renaming and separation is that the Qwikster.com and Netflix.com websites will not be integrated. There are no pricing changes (we’re done with that!). If you subscribe to both services you will have two Use outside these parameters is a copyright violation. entries on your credit card statement, one for Qwikster and one for Netflix. The total will be the same as your current charges. We will let you know in a few weeks when the Qwikster.com website is up and ready. For me the Netflix red envelope has always been a source of joy. The new envelope is still that lovely red, but now it will have a Qwikster logo. I know that logo will grow on me over time, but still, it is hard. I imagine it will be similar for many of you. I want to acknowledge and thank you for sticking with us, and to apologize again to those members, both current and former, who felt we treated them thoughtlessly. Both the Qwikster and Netflix teams will work hard to regain your trust. We know it will not be overnight. Actions speak louder than words. But words help people to understand actions.

Respectfully yours, -Reed Hastings, Co-Founder and CEO, Netflix p.s. I have a slightly longer explanation along with a video posted on our blog, where you can also post comments.

SRC: 1578.0.US.en-US For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019.

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Exhibit 3

NETFLIX SUMMARY FINANCIAL DATA, 2006–2010

Year ended December 31, 2010 2009 2008 2007 2006 (USD in thousands, except per share data) Revenues 2,162,625 1,670,269 1,364,661 1,205,340 996,660 Total cost of revenues 1,357,355 1,079,271 910,234 786,168 626,985 Operating income 283,641 191,939 121,506 91,773 65,218 Net income 160,853 115,860 83,026 66,608 48,839

Net income per share: Basic 3.06 2.05 1.36 0.99 0.78 Diluted 2.96 1.98 1.32 0.97 0.71

Weighted-average shares outstanding: Basic 52,529 56,560 60,961 67,076 62,577

Diluted 54,304 58,416 62,836 68,902 69,075

Source: Netflix Annual Report, filed February 18, 2011, Netflix Investor Relations, http://ir.netflix.com/sec.cfm, accessed January 12, 2012.

Use outside these parameters is a copyright violation. For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019.

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VIETNAM HANDICRAFT INITIATIVE: MOVING TOWARD SUSTAINABLE OPERATIONS

Sarah Easter and Mary Conway Dato-on wrote this case solely to provide material for class discussion. The authors do not intend to illustrate either effective or ineffective handling of a managerial situation. The authors may have disguised certain names and other identifying information to protect confidentiality.

Richard Ivey School of Business Foundation prohibits any form of reproduction, storage or transmission without its written permission. Reproduction of this material is not covered under authorization by any reproduction rights organization. To order copies or request permission to reproduce materials, contact Ivey Publishing, Richard Ivey School of Business Foundation, The University of Western Ontario, London, Ontario, Canada, N6A 3K7; phone (519) 661-3208; fax (519) 661-3882; e-mail [email protected].

In January 2010, a 25-year-old MBA graduate, Sarah McKenzie, boarded an international flight from the United States bound for Vietnam. McKenzie had just received her one-year business assignment to work with the Vietnam Handicraft Initiative (VHI), a vocational training and employment center for people with disabilities, located in Central Vietnam. In her role as business development and marketing advisor, McKenzie was tasked with improving VHI’s business and marketing plans in an effort to increase VHI’s productivity, to enable it to become sustainable and to strengthen the overall capacity of the organization. Within the first four weeks of her arrival, McKenzie needed to provide a report to the international non- governmental organization (INGO), Volunteer Opportunities Abroad (VOA), which was responsible for her global assignment. In the report, she was to detail her assessment of VHI and to provide both key recommendations and focused work objectives for the remaining 11 months of her placement. McKenzie

was apprehensive about the report. She expected that the many cultural differences encountered along the Use outside these parameters is a copyright violation. way would provide a real challenge in accurately assessing VHI and developing a detailed work plan — especially within a few short weeks of her arrival. She would need to hit the ground running and would need to have a game plan in place within the first day or two after arrival. She was ready to work hard and implement change to improve VHI.

PRE-DEPARTURE PREPARATIONS

Prior to departing for Vietnam, McKenzie had received a cultural briefing from VOA. From this cultural briefing, she had learned that the Vietnamese people were very relationship-oriented and that building strong rapport was a prerequisite to effectively conducting business. The Vietnamese culture was deeply rooted in Confucianism values, which emphasized the importance of relationships, responsibility and

obligation. Additionally, McKenzie had learned that a very important aspect of Vietnamese culture was For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. the idea of saving face. The Vietnamese people, she learned, would do anything to prevent loss of face, even if doing so meant avoiding confrontation or telling others what they wanted to hear rather than dealing with issues inhibiting organizational success.

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McKenzie knew that the information obtained in this cultural briefing would be very helpful to her as she worked to quickly acclimate herself to VHI’s operations and staff. She also realized that her steep cultural learning curve would be amplified by the fact that no one at the organization spoke English and that she would be using an interpreter for all work-related communications and interactions.

To prepare herself for this adventure, McKenzie had reviewed key concepts from her MBA courses and work experience. Although she had not yet set foot in Vietnam, based on her interviews for the position, she anticipated VHI would require assistance with developing long-term plans for organizational sustainability. Many of the articles she had read emphasized the difficulties of working in an emerging market, such as Vietnam, where environmental conditions could impede business flow. She was unsure how business and marketing concepts could be adopted to a socially focused entity, such as VHI.

MCKENZIE: THE BUDDING SOCIAL ENTREPRENEUR

McKenzie first became interested in the idea of social entrepreneurship — defined as recognizing opportunities to solve problems in society and utilizing entrepreneurial concepts to create, organize and manage an enterprise to make improvements1 — while pursuing her master’s degree in Business Administration (MBA) in Florida in 2007. There, she had enrolled in an international marketing course, where she was exposed to new ideas concerning how business practices could be utilized for the greater good. Readings in the class included C.K. Prahalad’s The Fortune at the Bottom of the Pyramid: Eradicating Poverty through Profits,2 which discussed the ability of businesses to be both profitable and to bring about societal improvements in developing countries, and David Bornstein’s How to Change the World: Social Entrepreneurs and the Power of New Ideas, 3 which focused on how social entrepreneurs have implemented innovative solutions to effectively address systemic social and economic challenges around the world. The teachings in this class had greatly influenced McKenzie and helped her to realize that she wanted to pursue this path in the future.

After completing her MBA degree and obtaining two years of professional experience at a U.S.-based international corporation, McKenzie sought an opportunity to apply her business skills in a way that would help bring about sustainable social change. Through VOA, she found the perfect opportunity to

utilize her business skills to generate change within a local, social enterprise in Vietnam. Use outside these parameters is a copyright violation.

Although McKenzie had not previously lived abroad for an extended time, she had extensive experience traveling internationally. She had traveled to Honduras and Jamaica with her church on short-term mission-related endeavors. During her MBA program, McKenzie had traveled with her classmates to Argentina for a week-long global immersion course and to Italy for a global consulting assignment. She had also spent a summer studying abroad in Oxford, England, during her undergraduate studies. These international experiences, while relatively short in comparison to her upcoming one-year assignment overseas, had helped McKenzie to gain a limited understanding of culture and of how other countries operated in comparison with the United States. It had also given her a love for other cultures and a desire to experience more of the world outside of the U.S. borders.

1 W. G. Rowe and M. Conway Dato-on, “Social Entrepreneurship,” Introduction to Nonprofit Management: Text and Cases. Sage Publications, Thousand Oaks, CA, 2012, pp. 399-432. For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. 2 International best-selling book that makes a case for the fastest growing markets and entrepreneurial opportunities being found among the billions of poor people at the bottom of the financial pyramid; C.K. Prahalad, The Fortune at the Bottom of the Pyramid: Eradicating Poverty through Profits, Wharton School Publishing Upper Saddle River, NJ, 2005. 3 Well-known book in social entrepreneurship which documents how social entrepreneurs around the globe are finding innovative solutions to a variety of economic and social issues in their respective fields; David Bornstein, How to Change the World: Social Entrepreneurs and the Power of New Ideas, Oxford University Press, New York, NY, 2004.

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VIETNAM

The developing country of Vietnam shared its borders with China to the north, Laos and Cambodia to the west and the South China Sea and 3,000 kilometers of coastline to the east. Upon arrival in Vietnam, McKenzie visited the Vietnam Museum of Ethnology in Hanoi, where she learned that more than 85 million people from 54 different ethnic minorities lived in Vietnam’s vast geographic landscape, from mountainous regions to arid wilderness.4 She also learned through her study of Vietnam’s history and through stories told by the Vietnamese people, that the Socialist Republic of Vietnam had been plagued by brutal wars throughout much of the 20th century, first by France’s colonization and then by U.S.- backed, South Vietnam. The country became unified again in 1975, when Communist North Vietnam seized the south.5 Since 1986, when political and economic reforms known as Doi Moi were enacted, Vietnam’s economy had grown rapidly and had transformed the country from one of the poorest nations worldwide with per capita income below US$100 to a lower middle-income nation with per capita income of US$1,130, as of the end of 2010.6 Likewise, the percentage of people living in poverty had been reduced significantly from 58 per cent in 1993 to 14.5 per cent in 2008. As McKenzie walked around Hanoi and drove her motor scooter around Hue, she was continually impressed with the high-end commercial and residential buildings that seemed to be popping up by the day, serving as a symbol of Vietnam’s rapid economic improvements. After demonstrating its commitment to liberating market forces and to producing more competitive export-focused industries, Vietnam became a member of the World Trade Organization (WTO) in 2007.7 Due to its incredible economic successes over the last two decades, Vietnam had achieved middle-income status and was on track to achieve nearly all of the United Nations’ Millennium Development Goals by the 2015 deadline.8

TOURISM IN CENTRAL VIETNAM

Upon arrival in Vietnam, McKenzie came to understand why, in 2011 alone, more than 6 million international visitors came to the country as a tourist destination;9 and why Hue, located in Central Vietnam, was one of the most popular tourist destinations within the country due to its cultural and historical significance. McKenzie often observed and socialized with some of the more than 600,000 international visitors who flocked to Hue each year to see the 19th century imperial monuments and the

elaborate tombs of the Nguyen dynasty emperors. Because of its rich history and culturally significant Use outside these parameters is a copyright violation. monuments that comprised the Citadel, UNESCO had recognized Hue as a World Cultural Heritage Site in 2003.10 Unfortunately, due to military interference, which had occurred during the French and Vietnam wars, the Hue Citadel had received considerable damage to its structure and little of the original forbidden city remained, although ongoing reconstruction efforts were attempting to help maintain and attract more visitors to this key tourist destination.

Due to Hue’s popularity as one of Vietnam’s key tourist destinations, its tourism industry had built up considerably in recent years, especially within the more modern area of the city, south of the Perfume River. As a result, visitors could choose from a wide array of lodging options in this part of town complete with restaurants that catered to Western tastes, and tourist shops that sold a diverse range of

4 UNICEF, “Vietnam Overview,” www.unicef.org/vietnam/overview.html, accessed June 24, 2012. 5 BBC News, “Vietnam Profile,” www.bbc.co.uk/news/world-asia-pacific-16567315, accessed June 24, 2012. 6 www.worldbank.org/en/country/vietnam/overview, accessed June 24, 2012. For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. 7 Central Intelligence Agency, “Vietnam,” The World Fact Book, www.cia.gov/library/publications/the-world- factbook/geos/vm.html, accessed June 24, 2012. 8 UNICEF, “Vietnam Overview,” www.unicef.org/vietnam/overview.html, accessed June 24, 2012. 9 Vietnam National Administration of Tourism, “Tourism Statistics,” www.vietnamtourism.gov.vn/english/index.php?cat=0120, accessed June 24, 2012. 10 UNESCO, “Complex of Hué Monuments,” http://whc.unesco.org/en/list/678, accessed June 24, 2012.

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Vietnamese handicrafts, including recycled jewelry. While most handicraft sellers were located within this prime tourist area, VHI was located north of the Perfume River, several blocks north of the historic Citadel. Only the most adventurous international tourists ventured to this section of the city. McKenzie did not think she would have stumbled across VHI were it not for her involvement in the organization.

VOLUNTEER OPPORTUNITIES ABROAD (VOA)

Volunteer Opportunities Abroad (VOA) was an international development organization with 50 years of experience working with long-term, on-site volunteers to fight poverty in developing countries. Volunteers shared their skills and knowledge with local partnerships — usually local non-governmental organizations (NGOs) positioned in developing economies — with the goal of assisting the local organizations to become sustainable and to be more effective once the volunteers had completed their placements. VOA defined sustainability in terms of building local individual skills and institutional capacity so that local organizations would be better equipped to repeatedly care for their beneficiaries in the long term and to help reduce global poverty. VOA worked with partner organizations in each respective country through field offices where volunteers were matched to the locations where their skills were needed most. The organization worked in 41 of the most disadvantaged countries around the globe throughout Africa, Asia and South America. The Vietnam VOA field office, established in the mid-1990s, placed international volunteers in local organizations that served people who had disabilities and those who were HIV-positive, two significant social challenges for Vietnam. The Vietnam Handicraft Initiative was one such organization.

VIETNAM HANDICRAFT INITIATIVE (VHI)

Vietnam Handicraft Initiative (VHI) was established in November 1999 in Hue, Vietnam, as a vocational training and employment center for disadvantaged and disabled people. The disabilities of those at VHI ranged from severe mental disabilities to physical disabilities, such as hearing impairment and the loss of leg use. The two VHI founders, friends Lan Nguyen and Trang Tran, were inspired to create the organization after having witnessed the inefficiency of the existing vocational training programs. As of

2010, VHI was owned by Tran, and Nguyen was the VHI on-site director. Use outside these parameters is a copyright violation.

In the first five years of operation, VHI focused its training on tailoring and industrial sewing. Since its inception, VHI had provided nearly 20 training courses ranging from three to nine months in length and had aided more than 500 disadvantaged and/or disabled people in the local area. In addition to offering training and work opportunities for disadvantaged people, VHI provided food, housing and health care for the individuals in its programs. Once trainees completed the respective garment and/or handicraft courses, they became employees at the organization. The garment-manufacturing portion of the business supplied Hue and the surrounding areas with uniforms for schools, hospitals and businesses.

In 2004, a handicraft division was added to VHI. Artisans working on this portion of the business produced a variety of handmade products ranging from jewelry made from recycled telephone wire to basketry to woven silk bowls and accessories. These products were traditionally sold locally to tourists and to a few small retail clients in Hong Kong and Japan who regularly purchased handicrafts. Even For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. though VHI produced both garments and handicrafts, the garment portion of its business had historically accounted for approximately 90 per cent of all sales, producing 25,000 garments annually and bringing in VND900,000,000 (US$45,918)11 in revenues. In 2010, VHI employed 12 professional salaried

11 Currency conversion shown as of September 2010.

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employees, 40 garment workers and eight handicraft artisans (see Exhibit 1 for VHI organizational chart). The average monthly salary of a VHI worker was VND1,000,000 (US$51).12 From McKenzie’s conversations with community leaders and members in Hue, this salary seemed much lower than the average monthly salary in Hue.

While VHI generated some revenues from the sale of its handicraft products and garments, the amount was not enough to cover the significant costs involved with operating a training and employment center for people with disabilities. In addition to providing jobs for the people with disabilities, VHI provided its artisans with food, shelter (as needed) and insurance. Many times, VHI artisans, especially those with severe mental disabilities, could not complete their jobs as quickly as able-bodied individuals, resulting in high employee costs with less than optimal output. Consequently, Nguyen explained, VHI relied on numerous partnerships to cover its operating costs, including local and international NGOs and the local government. With the onset of the global recession in 2008, VHI faced increased financial difficulties, including fewer sales of its products, which hindered the organization significantly in terms of covering its operating costs and building its capacity.

VHI EMPLOYEES: PEOPLE WITH DISABILITIES IN VIETNAM

Although Vietnam’s economy had grown rapidly within the last quarter of a century and had been successful in terms of overall poverty reduction, McKenzie heard from VHI and many community leaders that some groups had been marginalized, including ethnic minorities and people with disabilities. Stigma and discrimination were some of the major problems that people with disabilities faced in Vietnam, even in large cities such as Hanoi, the capital.

According to Vietnamese cultural beliefs, when a child with a disability was born into a family, it was because family members had done something wrong in a previous life. As such, the family focused on making amends for previous wrongs by tenderly caring for and protecting the disabled family member. This cultural mindset culminated in the dominant attitude toward people with disabilities in Vietnamese society: to care for and protect them rather than to help them overcome their existing situation to become fully productive members of society. These beliefs helped perpetuate the feelings of dependence,

exhibited by many employees at the center. VHI struggled to motivate some of its disabled workers since Use outside these parameters is a copyright violation. the prevailing social norm dictated that they could not (and should not) be expected to actively contribute to society through work. As a result, some of VHI’s disabled artisans struggled, from day to day, to produce a consistent number of products, whether garments or handicrafts, in a reliable manner and of dependably high quality. The inherent inconsistencies of their work greatly affected both the marketability of the products and the numbers of items produced.

McKenzie wondered whether either the employees or the management staff fully understood the connection between the social attitude and the prevailing issues of lack of employee motivation. Regardless, she knew that if the organization wanted to reverse the two problems noted by Nguyen — the slide in both production numbers and sales — that all parties would need to understand the importance of consistent product quality. She struggled with how to inculcate such a market-centric and sustainable attitude in the socially focused organization. Such a change was crucial not only for the employees themselves and the social implications of having productive, disabled workers but also because For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. competition was intense for both the handicraft and garment markets.

12 VHI documents supplied to McKenzie by Nguyen; currency conversion shown as of September 2010.

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REFOCUSING VHI

When McKenzie arrived at VHI, the staff and artisans welcomed her with open arms. The staff seemed happy to have a foreigner working with them, and the artisans were eager to show off their garment and handicraft projects. McKenzie’s interpreter, Chung Le was very kind and eager to learn. Le had recently graduated from university, and this job was her first professional position. McKenzie knew she would initially need to spend a great deal of time working with Le to ensure that they were on the same page in terms of business knowledge and work expectations, especially since Le was to be her primary means of communicating with the VHI staff and artisans. McKenzie felt this was an important first goal to articulate in the report to VOA.

Upon meeting McKenzie, Nguyen, who was both her supervisor and VHI’s director, commented that she had expected someone much older. McKenzie remembered from her training that the Vietnamese society was very hierarchical and perceived age as an indication of experience and knowledge. McKenzie quickly realized that she would need to work hard to prove that, in spite of her young age, she was capable of completing the assigned work.

During McKenzie’s first week, an opening ceremony took place to publicize VHI’s new garment training course. Attendees at the ceremony included local media and government officials. After a representative from the government finished his speech, Nguyen turned to McKenzie and told her, through Le, that it was her turn to give a speech. McKenzie managed to muster the appropriate words for the occasion, but was surprised that she had been asked to actively participate during this special, high-profile event without having had any prior notice or time to prepare. At that point, McKenzie began to grasp more accurately that her new working environment was much different from the long-term and planning- oriented business climate in which she had become accustomed to working in the United States. McKenzie was again struck by the reality that she had a steep learning curve to overcome to acclimate herself to the Vietnamese business culture so she could become effective and help bring about sustainable change while at VHI.

ASSESSING THE CURRENT SITUATION THROUGH OBSERVATION AND RESEARCH

Use outside these parameters is a copyright violation. In McKenzie’s first few weeks at VHI, she gathered as much information as she could about the organization’s internal operations to aid her in writing the major report she needed to provide to VOA in a very short time. McKenzie spent a great deal of time observing employees in their work environments, engaging in conversation with staff and interacting with some of the organization’s key partners. She organized her observations into five areas.

Previous Western Business Support

During the employee interviews McKenzie had learned that VHI had previously received business support from an international NGO. Trade International, a European-based organization that focused on fighting poverty through trade, had assisted VHI with business planning and product design consultation

in the spring of 2009. Representatives from Trade International had spent a few days with VHI to assess For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. its internal operations and to provide management with guidelines needed to develop a long-term, holistic business plan. Trade International representatives had also worked with VHI’s handicraft artisans and product development team to help them to understand trends in Western handicrafts and to continually develop new products that would appeal to international clients.

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In addition to providing VHI with hands-on business consulting support, Trade International invited the organization to participate in an international trade fair it was hosting for a variety of handicraft producers in Central Vietnam. At the trade fair, VHI received interest from several international buyers who liked the materials that the organization was using to make its handicrafts but felt the designs were not aligned with foreign tastes and the prices were a little high. VHI received all suggestions for improvement from the international buyers in attendance, and Trade International made numerous additional suggestions to improve the organization’s handicraft products and to make them more marketable to global customers. Despite Trade International’s substantial support, however, McKenzie discovered that VHI still had not developed a long-term business plan and had not implemented new product designs or worked to adjust the prices. She also discovered that Trade International had not followed up with VHI after the business training and trade fair activities in the spring of 2009.

Limited Business Experience or Training

From McKenzie’s one-on-one interviews with each staff member, she learned that the employees possessed little knowledge concerning marketing strategies or how to position their products effectively in the local, national and international markets. While most of the garments were produced based on customer requirements, VHI also designed and produced handicrafts that managers or artisans believed would appeal to the local and international markets, where they then tried to sell them.

Investigations and interviews also revealed that VHI employees had received little formal training concerning basic business practices or how to work effectively among people with disabilities. Most employees simply attempted to acquire necessary skills while on the job. VHI staff worked very hard to perform their job duties, but the primary focus was short-term or task-oriented activities such as taking care of day-to-day operations rather than long-term, sustainable strategies.

Limited International Appeal

Trade International had noted that while most Western-based clients appreciated functionality when

purchasing handicraft products, the Vietnamese people tended to create handicrafts that were very Use outside these parameters is a copyright violation. decorative and appealed to their own, individual tastes. VHI followed this Vietnamese trend when creating handicrafts, For example, VHI developed a wide range of decorative products such as bowls and vases that were not highly functional. McKenzie suspected that making such a wide variety of products was also difficult for the artisans. Her initial thoughts were to redirect production to fewer, more usable products that required the same basic skills.

In terms of marketing its products and services on an international scale, VHI used a very basic website that was not updated regularly and could not easily be maintained by the administrative staff. An additional challenge VHI faced when attempting to market its products internationally was extremely limited English language skills. Without a regular staff member who could communicate in English, VHI stood little chance of successfully marketing itself or its products globally. While McKenzie’s interpreter, Le, was available to help VHI during McKenzie’s assignment, she was a temporary staff member employed by VOA and would be leaving the organization upon McKenzie’s departure. For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019.

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Resistance to Change

VHI’s senior administrative and leadership team included three individuals — the organization director, who was also a co-founder of VHI, the operations manager and the accounting manager — who oversaw all strategic and tactical operations of VHI. While the director and the accounting manager were open to change and wanted to make improvements to VHI, the operations manager was largely focused on the garment manufacturing side of the business. The operations manager felt that, rather than trying to expand the handicraft side, VHI should focus on the portion of its business that comprised the majority of its sales — garment manufacturing. McKenzie noted that because of this attitude, the operations manager was not concerned with investing in strategic planning and development. If McKenzie wanted to refocus VHI she would need to convince the operations manager of the importance of both the handicraft segment and the need for market planning.

The operation manager’s sentiment was shared by many of VHI’s other administrative staff members, including the garment manufacturing teachers and the quality manager. The senior leadership team, the garment-manufacturing teachers and the quality manager had all worked at VHI since its establishment in 1999. In addition to the senior-level staff, VHI employed four younger administrative workers who had been with the organization for three years or less including two administrative assistants and a human resources assistant. The younger workers were open to change and eager to increase their knowledge and skill sets. However, the thoughts and opinions of the younger, more inexperienced group of employees were often overshadowed by those of the senior, experienced workers.

Lack of Trust and Transparency

While VHI staff treated McKenzie kindly, they viewed her as a Westerner who would work at the organization for only a relatively short time. Since the employees did not know McKenzie, many were hesitant to share information with her, which became clear to McKenzie when she conducted one-on-one interviews with staff members. When asked to provide constructive criticism regarding VHI’s activities, most staff members were afraid to say anything negative or to offer any feedback. Many simply discussed positive aspects of VHI even though it became clear through McKenzie’s observations that all staff

members were not completely satisfied with the current state of VHI. McKenzie began to comprehend the Use outside these parameters is a copyright violation. meaning of the pre-departure training she had received regarding the importance of saving face. She needed to discover a way of gathering feedback without causing loss of face.

McKenzie worked hard to understand VHI’s inner workings, but she felt a hesitation from the staff. They were reluctant to be fully open and honest about VHI’s business dealings. For example, McKenzie recalled asking the accounting staff for copies of the organization’s financial statements to review. She was told the documents were not available for review and her director seemed slightly taken aback that McKenzie had taken the initiative to ask the staff directly without having first discussed the matter with her. McKenzie felt frustrated at the lack of disclosure, as it would be difficult to fully assess the organization’s current needs and business situation if she could not clearly understand VHI’s financial position. The emphasis on hierarchy seemed to outweigh the need for organizational improvement and goal accomplishment, which contradicted everything McKenzie had learned in her MBA program.

For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019.

GARMENT INDUSTRY IN HUE, VIETNAM

While McKenzie’s placement at VHI focused primarily on the handicraft portion of the organization’s business, she understood that the sewing and garment manufacturing industry within Hue city was

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intensely competitive. Nguyen informed McKenzie that the vast majority of competitors were from the local area and many factories produced in large volume to offer goods that were priced lower in comparison to VHI products. Most competitors employed able-bodied workers that could work very efficiently. The fact that VHI employed people with disabilities was an added challenge, as many could not work as quickly in comparison to able-bodied individuals, thus lowering overall efficiency of VHI’s production. In this fiercely competitive environment, VHI felt forced to continually lower its prices and reduce profit margins in an effort to maintain many of its existing clients. In one instance, a competitor who also employed people with disabilities undercut VHI’s prices, even below cost, in an effort to win future contracts. With the competition even willing to undercut costs and forsake current profits in hopes of future sales, VHI did not see how it could successfully and sustainably operate in this space in the long term.

VHI IN THE HANDICRAFT INDUSTRY IN VIETNAM AND BEYOND

The Vietnamese handicraft industry, targeted toward the international market, remained very competitive, locally, nationally and globally. The barriers to entry were relatively low as startup costs were minimal. Extensive copying of product and design concepts permeated the sector. Many other handicraft producers were active within Hue, as it was a popular tourist destination within Vietnam, although, as mentioned previously, most of the major competitors within the city were well located in the key tourist area of town. McKenzie believed that for a handicraft producer to be effective locally, it needed to have a prominent retail location in a high-traffic area or strong branding and marketing to help drive traffic to a location off the beaten path. Through McKenzie’s conversations with key industry players, she did note that prime retail space could be very expensive and high revenues difficult to achieve over time, even for the most well-known and experienced players.

Nationally, Vietnam had an abundance of handicraft producers. International visitors that traveled across the country had their choice of handicraft items — from high-end, wooden furniture and lacquer wear to purses, handbags and jewelry made from hand-woven cloth produced by ethnic-minority groups scattered throughout the country. VHI itself worked with the Aloui ethnic-minority group located just outside of Hue. Aloui produced beautiful hand-woven cloth that VHI workers sewed into handbags and purses.

However, VHI struggled to craft the cloth into finished handicrafts that international buyers would find Use outside these parameters is a copyright violation. attractive. As Trade International noted, international handicraft buyers appreciated items that were reflective of the Vietnamese culture and yet desired sleekly packaged functional products. Many larger handicraft producers in bigger Vietnamese cities were much more in tune with international buyer wants and needs. However, VHI was unique in its dual business model. VHI was both a handicraft/garment producer and a service-oriented training and employment organization for people with disabilities.

Additionally, Vietnamese handicraft makers competed globally with other low-cost producers in Southeast Asia including in Thailand, Cambodia and the Philippines. On a larger scale, they also competed with handicraft producers in Africa and South America. For a Vietnamese handicraft manufacturer, the greatest opportunities for profit margins existed overseas, but finding and securing the right buyers was very difficult given the communication barriers and lack of both international business knowledge and resources. While VHI obtained some small orders from retail handicraft stores in Hong

Kong and Japan, the organization did not have a consistent inflow of revenue from this portion of its For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. business.

Based on a preliminary review of the organization and its competitors, McKenzie felt that the biggest international potential for VHI rested in obtaining international wholesale contracts. Such relationships

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could secure large orders whereas international retailer’s orders tended to be much smaller. Wholesalers also offered to help producers with the customs process, including the paperwork. Once wholesalers chose to work with given producer groups, they were much more willing to offer support and guidance in terms of new designs that would cater to the international buyer. The major downside of pursuing a wholesale distribution strategy was that the prices needed to be competitive since the wholesaler, who acted as the intermediary, then needed to competitively sell the product to retailers in their given market. As noted, VHI had received previous feedback from Trade International that its prices were high and uncompetitive when compared with other handicraft exporters in similar product categories; this pricing issue would need to be revisited, especially if VHI wanted to pursue this distribution strategy. If VHI expanded its business and placed greater emphasis on producing and selling handicrafts abroad, it could reap larger profit margins than it currently obtained through its local garment manufacturing.

SOCIAL ENTREPRENEURSHIP: A WAY FORWARD OR CONFLICTING VISIONS?

On one hand, VHI was a nonprofit, mission-driven, service-oriented training center for people with disabilities to learn new skills in an effort to overcome their existing disadvantaged situations. On the other hand, VHI was also a revenue-seeking business trying to operate and sell its products in an effective manner. McKenzie quickly learned that the former mission was dominated in the minds of the VHI employees.

In McKenzie’s initial conversations with the director, Nguyen had mentioned several times that she would like McKenzie to raise funds so that VHI could support additional trainees. McKenzie tried to explain to Nguyen that a focus on strategic planning, product excellence and employee training could help VHI to bring in more revenues in a sustainable manner and could ultimately provide VHI with the resources needed to support more people with disabilities in the long term. However, Nguyen kept returning to the idea that McKenzie, being a native English speaker, could help VHI with a multitude of international grant applications.

McKenzie recalled that VHI’s mission was “Giving disabled and disadvantaged people a beautiful future.” McKenzie wondered how VHI could grow in a sustainable manner to give its beneficiaries a

bright future when the current overriding focus of the organization was that of a nonprofit mindset. She Use outside these parameters is a copyright violation. also wondered how she could help VHI to understand the relationship between means and ends. For example, by focusing on operational excellence, the means, the organization could effectively support more people with disabilities, the ends.

THE BEST WAY FORWARD

After four weeks working at VHI and living in Hue, McKenzie sat down at a local coffee shop to reflect on her time thus far in Vietnam and write her report that was due to VOA the following day. She had learned a great deal about VHI in terms of challenges and obstacles to overcome, but she was unsure what would be the most effective way forward. She knew she wanted to be sensitive to the fact that Vietnam was a very different culture than her native U.S. culture yet she desired to help the organization implement a plan that would be most effective for it in the long term. As McKenzie enjoyed her For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. Vietnamese coffee and tried to map out a plan to communicate to VOA, she began writing down ideas concerning the best way to proceed. Her first step was to set work objectives for the first few months at VHI. From there she needed to set realistic goals the organization could accomplish in her 11 remaining months in Vietnam.

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Exhibit 1

VIETNAM HANDICRAFT INITIATIVE ORGANIZATIONAL CHART

Use outside these parameters is a copyright violation.

Source: Based on information provided by Vietnam Handicraft Initiative to McKenzie.

For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019.

9B14M159

ART FEEDS: SCALING A NON-PROFIT ORGANIZATION

Colleen Sharen and Tess Widdifield wrote this case solely to provide material for class discussion. The authors do not intend to illustrate either effective or ineffective handling of a managerial situation. The authors may have disguised certain names and other identifying information to protect confidentiality.

In early June 2013, Meg Bourne-Hulsey, executive director of Art Feeds, located in Joplin, Missouri, received a request to expand the organization to Moore, Oklahoma. On May 20, 2013, an EF5 tornado had struck Moore, killing 24 people, injuring 240 people, and destroying five schools. Upward cost estimates placed the damage at US$6 billion.1 The people of Moore were looking for ways to help their children deal with this trauma. Given Art Feeds’ experience in delivering therapeutic art education to at- risk children, expanding Art Feeds to Moore seemed logical.

Bourne-Hulsey realized that this request was an opportunity to help a devastated community, and to begin building Art Feeds into a national organization. What was the best way to expand to Moore? She needed to develop a plan quickly to present to the board of Art Feeds. The needs of the City of Moore were pressing.

MEG BOURNE-HULSEY Use outside these parameters is a copyright violation.

Twenty-four-year-old Bourne-Hulsey was born and raised in Joplin. She graduated from Missouri Southern State University with a liberal arts degree. At the age of 19, while still in college, she realized that she had the power to help change the lives of youth through art. She created Art Feeds to provide therapeutic art and creative education to at-risk youth in Joplin.

Meg dreamed up Art Feeds as a 19 year old & still fearlessly guides the direction and vision of this creative not-for-profit. She is a 2012 Do Something Award Finalist and a 2013 recipient of the Missouri Arts Award in Arts Education. She spends her time telling the Art Feeds story, seeking funding opportunities & driving the path of Art Feeds organizational growth. Her dream is a nation filled with creative and expressive children — where creativity is valued in education and children are recognized as the most valuable members of society. When she’s not working her tail off for the kids, she’s loving on her niece & nephew, eating red sour patch kids, giggling For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. at her husband’s jokes or creating wildly.2

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To achieve her dream, Bourne-Hulsey worked long hours and lived a modest lifestyle. By 2012, she had set her heart on expanding into communities nationwide, helping as many children as possible. She believed that regardless of background, all children needed art in their lives.

ART FEEDS

Art Feeds provided therapeutic art and creative education to elementary school children to help them achieve mental and emotional well-being. Research showed that of the children who experienced a traumatic event, 70 per cent would maintain mental and emotional health if they consistently expressed themselves.3 Art Feeds worked to provide an outlet for expression for all students and attempted to locate the 30 per cent of students who needed extra help processing their trauma.

Art Feeds believes all children are artists. We exist to feed creative development and facilitate emotional expression in children through art and community. To do this, we provide free therapeutic art and creative education programs within schools & children’s organizations by mobilizing teams of community members to bring all forms of art into classrooms.4

Bourne-Hulsey created Art Feeds after working with one student in a high-needs classroom. After weeks of working with him, she discovered that he was not being fed at home, which explained his lack of academic success. She began to work with the boy using various artistic media to give him a sense of comfort and expression, and worked with other professionals to address his malnourishment. Bourne- Hulsey’s activities quickly grew from one little boy to more classrooms and more children. To fund her activities, she designed and sold Art Feeds t-shirts,5 which provided funds and increased awareness for her new initiative.

Teachers and administrators began to see the positive effect Bourne-Hulsey’s efforts were having with the students, spreading it through the school system. Brooke Hines, who had expertise in both dance and international development, also saw the positive impact of these efforts and volunteered to help meet the growing demand for therapeutic art programming.

Bourne-Hulsey branded her project Art Feeds, using the little boy’s handprint as its logo. The name Art Use outside these parameters is a copyright violation. Feeds came from Bourne-Hulsey’s realization that art was feeding that little boy emotionally, just as food fed him physically. According to Bourne-Hulsey, Art Feeds began because she was “foolish enough to think we could make change, and reckless enough that we did.”6

ART EDUCATION

The United States spent 23 per cent more than an average Organization for Economic Co-operation and Development (OECD) country (as a proportion of gross domestic product [GDP]) on primary and lower secondary education.7 Average state and local government spending on education in the United States had been declining over time, from 5.61 per cent of GDP in 2004 to a projected 5.53 per cent in 2014.8 State and local spending in Missouri during the same period had declined at roughly twice the national average, 9 from 5.53 per cent to 5.11 per cent of state GDP. For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019.

Data on arts education spending were difficult to find,10 although many advocates claimed that arts education was underfunded and continued to experience budget cuts.11 Nationally, students received minimal exposure to dance and theatre arts. Only 15 per cent of primary school students received music

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instruction at least three times per week.12 Visual arts offerings at elementary schools had decreased from 87 per cent of schools providing access in 1999/2000 to 83 per cent in 2009/2010.13 Arts education was least available in schools with the highest poverty rates.14

According to a 2014 study from the Missouri Alliance for Arts Education, schools with higher arts participation showed a 1 per cent increase in average daily attendance.15 Increased numbers of arts courses offered and enrollment in these courses were related to lower rates of student behavioural infractions, removal of students from the classroom and school suspensions.16 Student performance in math and communication arts standardized tests was positively related to the number of students enrolled in fine arts classes.17 Graduation rates were also shown to be higher in districts with higher arts class participation.18 Other research suggested that “arts-engaged low-income students tend to perform more like average higher-income students.”19

Political actors realized the importance of arts education. Former United States Secretary of Education William Bennett stated, “The arts are an essential element of education, just like reading, writing, and arithmetic . . . music, dance, painting, and theater are all keys that unlock profound human understanding and accomplishment.”20

The United States federal government had announced its support of arts education in its report from the President’s Committee on the Arts and the Humanities.21 Senior executives of major corporations agreed. For example, Joseph M. Calahan, director of corporate communications at Xerox Corporation, noted, “Arts education aids students in skills needed in the workplace: flexibility, the ability to solve problems and communicate, the ability to learn new skills, to be creative and innovative, and to strive for excellence.”22

Bourne-Hulsey believed that philanthropists, corporations, foundations and non-profit organizations were more open to funding arts education than ever before. Child-based charities in particular were attracting more support from funders. To date, Art Feeds had chosen not to pursue government funding or grants.

JOPLIN, MISSOURI AND THE 2011 TORNADO

Use outside these parameters is a copyright violation. Joplin, a small city of 50,000, was located in the southwestern corner of Missouri. It reported a per capita income of $22,458 in 2011, 19 per cent lower than the U.S. national average.23

In May 2011, Joplin was hit by an EF5 tornado. The tornado struck the poorest area of the city, destroying 7,500 homes. It injured 900 people and left 161 people dead.24 The home that Bourne-Hulsey and Hines shared at the time was destroyed, along with the Art Feeds supplies stored there.

In October of 2011, ABC’s television show “Extreme Makeover: Home Edition” came to Joplin to help restore the city. Bourne-Hulsey and Hines were nominated by community members to have their home rebuilt. Instead, they asked the show to help Art Feeds. ABC gave the organization a customized bus full of art supplies. This bus, fitted with kid-sized workspaces, became Art Feed’s mobile art center. Art Feeds was also featured on “Extreme Makeover,” giving it national exposure.

For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. Before the tornado, Joplin had a well-supported network of non-profit organizations. After the tornado, a local businessman asked community advocate Renee White to create a coordinating committee of local non-profit leaders, including Bourne-Hulsey, which met regularly to ensure that organizations were not fighting for the same funding.

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White noted that after the tornado, donors were more open to giving money to the community. Financial support was given through government and state-based organizations to many of Joplin’s non-profits. The Restore Joplin fund was created to support families, individuals, businesses, and organizations that were affected by the tornado. The fund continued to raise money for Joplin and other cities affected by natural disasters well past 2011, providing ongoing financial support to Art Feeds.

INSIDE ART FEEDS

Staff

Art Feeds consisted of four full-time staff, several unpaid interns, several part-time paid lead educators, and many ever-changing volunteer educators who delivered programs in the classroom. The full-time staff members were Bourne-Hulsey, Hines, Marissa Fahrig, and Johanna DeLong.

Bourne-Hulsey, 24, founder and executive director, handled all programming, branding, grant applications, and general relationships with school administrators, community organization leaders, and the Art Feeds board. She also managed volunteers and community art activities. In the early years of Art Feeds, Bourne-Hulsey involved herself heavily in classroom programming; however, over the years she moved away from program delivery, providing strategic direction and leadership to the venture.

Hines, 24, the director of visual content, was responsible for social media and external relationships between Art Feeds and the community. She created all social media campaigns and managed online voting grant applications for the organization. Before holding this position, Hines was the director of creative education. She was a founding employee of Art Feeds and a close friend of Bourne-Hulsey. Hines graduated from Missouri Southern State University with an international studies degree.

Fahrig, 25, chief financial officer, held a master of business administration from Missouri State University. She managed donations, program budgeting, intern coordination, office management, and merchandise sales. Fahrig began working with Art Feeds in 2010. Part of her role was to ensure that programming was achievable and financially feasible.

Use outside these parameters is a copyright violation. DeLong, 23, the newest member of the staff, joined Art Feeds in 2013. As director of creative education, she recruited, trained, hired, scheduled, and supported educators in the classroom. She developed lesson plans, planned events, and ensured that all lessons were approved by a volunteer art therapist. She also managed relationships with the teachers, and scheduled lessons at participating schools. She brought a wide range of teaching experience and a passion for teaching to the organization. DeLong received a degree in elementary education with minors in French and fine arts from Loyola University Chicago. She was also certified in teaching English as a second language.

To deliver classroom programming, Art Feeds hired several part-time paid lead educators. They were the onsite leaders of each educational activity in the schools, supervising the volunteer educators in the classroom. One hundred and fifty volunteer educators delivered programs in schools and assisted with various events each year. All volunteer educators received training by an art therapist and psychologist in

the Art Feeds method and in mental health issues. Art Feeds insisted upon a ratio of one educator to every For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. four students, which allowed educators to work closely with the students to facilitate emotional expression and invest deeply in each child.

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Art Feeds also engaged six to 10 unpaid interns from across the United States and Canada year-round. Interns assisted staff members with projects and day-to-day operations at the Art Feeds office, and helped deliver arts programming.

Four Distinctive Features of the Art Feeds Approach

Art Feeds delivered its programming in four distinct ways. First, it was a mobile organization that brought therapeutic art and creative education to the students instead of having the students come to it. By meeting the children where they were, the program was able to ensure accessibility no matter a child’s background, finances, or needs. Second, the organization engaged students in expression and creativity, prioritizing creativity in education and in their day-to-day lives. Each student was provided with an art pack at the beginning of the school year filled with the essentials necessary to be creative throughout the year. Third, Art Feeds helped schools foster creative learning, leveraging existing resources, knowledge, and skills. The organization did not add art back into schools, but rather supported existing programs. Finally, Art Feeds was consistent. The organization came to each school or community group on a weekly basis to create stability and long-term relationships with the children, fostering each child’s personal growth.

Programs

Art Feeds offered free programming throughout the regular and summer school terms to elementary school students (kindergarten to grade five) at local schools, libraries, and community organizations. Lessons were delivered by one lead educator, volunteer educators, and available interns. Each 30-minute lesson was conducted in a common space such as an auditorium or library in the child’s school or community organization.

Designed using a mix of nine teaching approaches25 (see Exhibit 1), Art Feeds used multiple forms of creativity throughout its programming, from storytelling to multimedia art. If a child did not want to participate in an activity or if they found it too difficult, the Art Feeds educator provided them with an

alternative activity, ensuring that every child in the class could benefit. Art Feeds engaged the community Use outside these parameters is a copyright violation. in its programming by hosting various community guests and bringing programming into the broader community.

Art Feeds also offered various paid workshops. The profits earned from these workshops were used to fund the organization’s free in-school programming. These workshops were the only programming for which Art Feeds charged participants.

Making a Difference: Outcomes

In program evaluation surveys, 100 per cent of participating schools invited Art Feeds to return. In addition, 96 per cent of teachers agreed that the Art Feeds curriculum was valuable, decreasing fear,

stress, and anxiety in their students. Finally, when students were asked, 86 per cent said that they loved For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. Art Feeds more than recess and lunch. Since 2009, the organization had worked in 15 schools and 32 children’s organizations.

The organization had worked with child trauma specialists at the Ozark Center (a comprehensive mental health services provider) and Missouri Southern State University to develop a program evaluation tool.

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The tool used a 10-question survey and a creativity challenge before and after the therapeutic art intervention. Joplin students experienced a 33 per cent decrease in fear, stress, and anxiety, and a 115 per cent increase in creative fluency.

Dale Benfield’s story of his daughter Ellie was representative of the effectiveness of Art Feeds’ approach:

I will forever be grateful for Art Feeds. After the Joplin tornado, Art Feeds brought therapeutic art to Ellie’s class. I remember the project where she was able to help design and rebuild her town and how that brought hope and optimism to an otherwise tragic situation (Ellie lost her great- grandma). From then on, she has fallen even more in love with art as a way of expression, and I love watching her grow and mature through Art Feeds.26

Governance and Decision-making

Art Feeds was a federally registered 501c3 non-profit corporation in the United States, which required it by law to have an independent board of directors. In 2012, Art Feeds had three outside board members. Fahrig and Bourne-Hulsey were inside voting members. In early 2013, four new outside members joined the board, and Fahrig and Bourne-Hulsey stepped down (see Exhibit 2).

The board met monthly. Bourne-Hulsey set the agenda and led the board meetings. Art Feeds’ incorporation bylaws dictated which decisions were the purview of the board. If it was a decision not included in the bylaws, the executive director had decision-making rights.

Fundraising, Revenue, and Expenses

Art Feeds operated on what it called the “100 per cent model.” All overhead costs, such as salaries and building costs, were covered by donors who wanted to ensure the long-term operation of Art Feeds. This group of donors was called The Palette, who donated a minimum of $1,000 each annually. In 2013, The Palette consisted of 14 members, 11 of whom were commercial sponsors. Many of Bourne-Hulsey’s

friends and family were major donors. As a result of The Palette, the organization was able to direct 100 Use outside these parameters is a copyright violation. per cent of any donations over and above The Palette directly to programming. Art Feeds asked donors for $1 per child per lesson, an easy to communicate and understand fundraising proposition.

In 2012, the organization reported $151,741 in revenue. Art Feeds experienced 35 per cent revenue growth from 2011, partially as a result of tornado relief donations.27 In 2012, Art Feeds employed Bourne-Hulsey, Fahrig, and Hines, who worked 40 hours a week, receiving a yearly salary of $10,000 to $12,500. Art Feeds’ largest expense was for art supplies, which accounted for roughly 40 per cent of its 2012 expenses (see Exhibit 3).

Organizational Resources

Art Feeds had few tangible assets (see Exhibit 4). It rented space in Joplin, with three offices: one for For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. Bourne-Hulsey, one shared by the three directors, and one shared by the interns. The office also held donated and purchased art supplies, which arrived on a daily basis.

Art Feeds owned a mobile art studio/bus used for events, workshops, and transportation of supplies, and as a mobile marketing vehicle. Art Feeds owned the web domain ArtFeeds.org, which was used as a

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promotional and fundraising vehicle. Once Art Feeds expanded, Bourne-Hulsey hoped to share lesson plans, curricula, and branding through the website.

Bourne-Hulsey believed that the Art Feeds brand was a key contributor to its success. Art Feeds was very well known in southern Missouri, although not as well known outside the state. The brand had been built through word of mouth, successful public relations activities, events, and a strong social media presence. All social media posted through Art Feeds’ Facebook page, Twitter, and blog followed the same format and used consistent language, colours, and fonts, and professional-quality photographs and videos.

Bourne-Hulsey continued to be the face of the brand, representing Art Feeds in the community, in grant applications, in social media and on the website. Bourne-Hulsey was nominated in 2012 for the VH1 Do Something Awards, which catapulted Art Feeds into the national spotlight. In addition to national and state recognition, Art Feeds was featured in magazines such as Fast Company, Teen Vogue, and Forbes.

Bourne-Hulsey’s Vision

Bourne-Hulsey’s vision was driven by her recognition of a need in the community. She created Art Feeds to fill it. She communicated this vision constantly in video and multimedia and through public relations initiatives. She and the board were strong advocates of the current funding model featuring The Palette, and were equally strong in their decision not to accept government funding. She believed that Art Feeds could address a need in schools nationally and internationally. Whether expanding programming to Ghana or to the rest of the United States, Bourne-Hulsey jumped at the opportunities available and figured out how to implement them as she went along. Because she had successfully grown Art Feeds, she was confident that there was both a need and demand for children’s arts programming.

Since the organization’s creation, she had actively engaged in all decision making, from the smallest detail to the biggest strategic decisions. She believed that a strong central organization in control of decisions and programs was essential to ensure quality programming.

Bourne-Hulsey recognized that the behaviour of staff members and interns reflected on the brand. It was stressed that staff, interns, and educators must behave in a manner consistent with the brand when in public. For example, they were trained to consistently position Art Feeds as a provider of therapeutic art Use outside these parameters is a copyright violation. — not art therapy. She spent considerable time training staff and volunteers about the organization’s brand, values, mission, and beliefs.

THE CITY OF MOORE

Moore, Oklahoma, a city of 55,000 people, located in northern Oklahoma, was only three and a half hours drive outside of Joplin. Both Joplin and Moore had strong church and non-profit networks that supported their communities. The 2013 tornado in Moore had killed seven and injured 70 children inside local schools. The tornado was recorded as the deadliest tornado in the United States since the 2011 tornado in Joplin. Several Moore community members were concerned about the emotional effect of the storm on their children, so they had approached Art Feeds about expanding to Moore. For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019.

THE DECISION

Bourne-Hulsey and her board had to decide if growth was a viable option for Art Feeds and needed to determine whether there were any risks to growth. Bourne-Hulsey could think of three ways to grow.28

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The first option was to disseminate the Art Feeds concept. Art Feeds could provide information, curricula, and technical assistance to the people of Moore. They could use this information to start an organization completely independent from Art Feeds, responsible for its own brand, fundraising, training, and development.

The second option was an affiliation model. Much like a franchise model in the business world, affiliation involved a formal, legal agreement between affiliates that governed the use of a shared brand name, mission, program content, program delivery, funding relationships, guidelines, and reporting requirements. While separate entities, the organizations were legally bound, sharing the same name and mission. These separate entities were often referred to as chapters. The degree of relationship varied from a very loose affiliation with very few limitations on local chapters to very tight control by the central organization.

The third alternative was branching, where one national organization managed multiple local sites. This model was similar to the structure of a large bank, where bank branches delivered services locally, while the head office managed, controlled, and coordinated all aspects of mission, strategy, branding, human resources, structure, and funding.

Each of these options required different resources to implement. They would result in different degrees of control for the central organization and different levels of autonomy for the outlying organization. They would also result in different rates of growth. Bourne-Hulsey’s initial preference was for an affiliation model, which would allow her to control branding and programming while still growing the organization; but she wondered whether the board would agree. Was Art Feeds ready to grow? Given the crisis in Moore, did it matter whether they were ready? If they were ready, how should they implement growth?

Use outside these parameters is a copyright violation. For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019.

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EXHIBIT 1: ART FEEDS NINE TEACHING APPROACHES

• Self-reflection: Careful thinking about their own behavior and beliefs is important in helping students increase their self-awareness and to process through their experiences in healthy ways. • Creative problem solving: In order to help students grow in their independence and self-efficacy, it is essential that they are given opportunities to be challenged to solve a problem on their own and in a way that makes sense to them without a prescribed outcome. • Storytelling: Storytelling gives students an opportunity to personally express and invest themselves in the creative process as well as helps them know that their voice and story are valued and worth hearing. • Unconventional art forms: Unconventional art forms are those that would not traditionally be used in a fine arts setting (painting, drawing, etc.) and could include anything from photography to sculpting with trash! These art forms help emphasize the idea that Art Feeds is all about wonder, whimsy, freedom of creating and outside of the box thinking. • Multimedia art: Multimedia art involves using more than one art form for expression in a project. This is valuable in helping facilitate expression by all students and their differing learning styles and enriches the creative experience as a whole. • Performing arts: Performing arts are important in engaging those students who best express themselves kinesthetically or linguistically. These art forms also help develop self-esteem, self- awareness and interpersonal skills in all students. • Installation: The purpose of doing an installation is to provide students with a broader sensory experience. These are typically larger projects that are done as a community, are on display in a community space once completed, and address a specific issue. • Community guests: This is an opportunity to connect students with artists & projects in their own community, helping build awareness & appreciation of students’ own regional culture. • Exploratory route: Because our goal is for every child to have a creative experience while in Art Feeds class, we created the Exploratory Route. Each lesson has an alternate activity designed to reach the same goals using a different medium to engage students more responsive to alternate

activities. Use outside these parameters is a copyright violation.

Source: Art Feeds, http://artfeeds.org, accessed November 29, 2013. For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019.

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EXHIBIT 2: ART FEEDS 2013 BOARD OF DIRECTORS

Board Occupation Community Experience Education Member Leah Willcoxon • Stay-at-home mother • Board member, Leffen Center for • B.A. Marketing, University • Part-time lead Autism of Missouri educator at Art • Board member, Children’s Haven • Marketing Feeds • Board member, Bramlage Foundation Vicky Mieseler • Licensed • 2012 Most Influential Woman by • B.S. Psychology, psychologist, Ozark the Joplin Tri-State Business Missouri Southern State Center Journal University • Led behavioural health response • M.S. Psychology, following the tornado Pittsburg State University Heather Collier • Past experience: • Dana-Farber Cancer Institute • B.A. Marketing, Auburn public relations and • Freeman Health Systems University fundraising • Virginia Leffen Center for Autism • Current: stay-at- home mother Renee White • Manager, Project • Active community volunteer • B.A. Social Work, Hope, Joplin Schools • Extensive non-profit experience Pittsburg State University • Master of Social Work, University of Arkansas • Doctorate in Educational Leadership Leadership and Policy Analysis Kim Lewis • Former production designer, ABC’s

“Extreme Makeover: Use outside these parameters is a copyright violation. Home Edition” • Motivational speaker Michael • Accountant, CPA • Board member, Big Brothers/Big • BSc Accounting, Baker Compton Sisters University • President, Neosho Chamber of • CPA Commerce • President, Lions Club Neosho • Past Treasurer, Lions Club Neosho

Source: Art Feeds, http://artfeeds.org, accessed December 9, 2013. For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019.

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EXHIBIT 3: ART FEEDS 2012 REVENUE AND EXPENSES

Revenue US$ Fundraising 12,500 Contributions, gifts, grants 139,241 Gross sales of inventory (T-shirts) 4,470 Less cost of goods sold 5,456 Net loss on sales of inventory (986) Total Revenue 150,758 Expenses Grants and assistance to governments and organization in the United States 2,500 Compensation of current officers, directors, trustees, and key employees 34,965 Payroll taxes 2,703 Legal fees 430 Advertising and promotion 1,168 Office expense 7,167 Occupancy 5,570 Travel 3,590 Insurance 851 Art supply expenses 48,205 Fundraising expenses 5,810 Volunteer expenses 6,487 Shipping expenses 2,798 Total Expenses 122,240 Revenue Less Expenses 28,518

Note: Wages and payments to employees of less than $10,000 were not required to be reported on IRS form 990. As a result, wages for part-time lead educators are not available. M. Delong joined the organization in 2013; thus, her salary was not included in this statement. Use outside these parameters is a copyright violation. Source: 2012 Art Feeds IRS form 990, http://artfeeds.org, accessed December 7, 2013.

EXHIBIT 4: ART FEEDS 2012 BALANCE SHEET

Beginning of Year (US$) End of Year (US$) Cash 9,973 40,392 Savings and temporary cash investments 4,803 946 Inventories for use or sale 2,949 4,905 Land, buildings, and equipment net of depreciation 56,840 56,840 Total assets 74,565 103,083

Liabilities 0 1,175 For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. Total liabilities 0 1,175 Net assets 74,565 101,908

Source: 2012 Art Feeds IRS form 990, http://artfeeds.org, accessed December 7, 2013.

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ENDNOTES

1 All currencies are in US$ unless otherwise stated; C. Gillam and I. Simpson, “Whole Neighborhoods Razed by Oklahoma Tornado That Killed 24,” Reuters, May 21, 2015, www.reuters.com/article/2013/05/21/us-usa-tornadoes-idUSBRE94J0TK20130521, accessed November 29, 2013. 2 Art Feeds, http://artfeeds.org, accessed November 29, 2013. 3 L. Chapman, D. Morabito, C. Ladakakos, H. Schreier, and M. Knudson, “Effectiveness of Art Therapy Interventions in Reducing Post Traumatic Stress Disorder (PTSD) Symptoms in Pediatric Trauma Patients,” Art Therapy: Journal of the American Art Therapy Association, 2001, 18(2). 2001. 4 Art Feeds, op. cit. 5 Ibid. 6 VH1, “VH1 Do Something Finalists Video,” VH1, www.vh1.com/video/misc/827783/do-something-award-finalist-meg- bourne.jhtml, accessed November 29, 2013. 7 OECD, “Education at a Glance 2012: OECD Indicators 2012 United States,” www.oecd.org/edu/EAG%202012_e- book_EN_200912.pdf, accessed January 10, 2014. 8 C. Chantrill, “Comparison of State and Local Government Spending in the U.S. Education 2014 Estimates,” www.usgovernmentspending.com/compare_state_spending_2014p20c, accessed January 10, 2014. 9 Ibid. 10 M. C. Dwyer, “Reinvesting in Arts Education: Winning America’s Future through Creative Schools,” President’s Committee on the Arts and the Humanities, May 2011, www.pcah.gov/sites/default/files/photos/PCAH_Reinvesting_4web.pdf, accessed January 10, 2014. 11 Ibid. 12 B. Parsad, J. Coopersmith and M. Spiegelman, “Arts Access in U.S. Schools (2009-10 FRSS),” U.S. Department of Education and its Institute of Education Sciences (IES), http://nces.ed.gov/pubsearch/pubsinfo.asp?pubid=2012014rev, accessed November 29, 2013. 13 Ibid. 14 Ibid. 15 L. Scheler, “Arts Education Makes a Difference in Missouri Schools,” Missouri Alliance for Arts Education, March 2010, https://www.missouriartscouncil.org/graphics/assets/documents/b657d9f1adfc.pdf, accessed January 10, 2014. 16 Ibid. 17 Ibid. 18 Ibid. 19 Dwyer, op. cit. 20 Art Feeds, op. cit. 21 Dwyer, op. cit. 22 Art Feeds, op. cit. 23 United States Census Bureau, “City of Joplin,” “State & County Quick Facts, City of Joplin,” United States Census Bureau, http://quickfacts.census.gov/qfd/states/29/2937592.html, accessed November 29, 2013. 24 Reuters, “UPDATE 1-Death Toll from Joplin Tornado Rises to 142,” May 28, 2011, www.reuters.com/article/2011/05/28/usa-tornadoes-joplin-idUSN2814172620110528, accessed November 29, 2013. 25 Art Feeds, op. cit. Use outside these parameters is a copyright violation. 26 Ibid. 27 Form 990, IRS, http://artfeeds.org, 2011, accessed December 7, 2013. 28 Personal conversation, June 2011; J. G. Dees, B. Battle-Anderson, and J. Wei-Skillern, “Scaling Social Impact: Strategies for Spreading Social Innovation,” Stanford Social Innovation Review, Spring 2004, pp. 24–32. For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019.

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9B10M049

NAMASTÉ SOLAR

Professor Anne T. Lawrence and Anthony I. Mathews wrote this case solely to provide material for class discussion. The authors do not intend to illustrate either effective or ineffective handling of a managerial situation. The authors may have disguised certain names and other identifying information to protect confidentiality.

On a warm day in July 2008, Namasté Solar president and chief executive officer (CEO) Blake Jones gathered the company’s employee-owners for an all-hands meeting in a warehouse behind their headquarters in Boulder, Colorado. Photovoltaic panels, installation tools and a discarded wooden sign displaying an image of the sun were piled haphazardly around the edge of the space. A window above the industrial-sized garage door threw a shaft of light across the concrete floor. The group, which had been temporarily displaced while their offices were undergoing a green renovation, had assembled an odd assortment of thrift-shop furniture to create makeshift seating. At the front of the room, they had set up easels, poster boards and markers to record their deliberations.

The group — made up of more than three dozen installers, designers, salespeople and office staff (most of whom were under the age of 40) — had come together to consider a potentially game-changing decision

for the young firm. Namasté Solar’s business was designing and installing solar electric systems for Use outside these parameters is a copyright violation. residential, commercial, non-profit and government customers. Despite the emerging recession, the company had been growing at breakneck speed: incentives for the purchase of renewable energy had created a market for solar electric systems in Colorado and beyond, and investors had become increasingly interested in opportunities in the new green economy. Over the past few months, Jones had been fielding a number of inquiries from private equity and venture capital firms, as well as from other strategic players interested in buying the company. Two investors, in particular, had put serious offers on the table. The company needed to decide whether to sell, and if so, to sell in whole or in part.

From the time of its founding, Namasté Solar had been committed to building a democratic, employee- owned and high-engagement culture. All employees, whether or not they held equity, were encouraged to participate in strategic decisions facing the firm. This decision was certainly the most momentous one the group had faced, and various conflicting interests and perspectives were in play. A series of half-day

retreats over the previous month had narrowed the choice to three possible options, which the group had For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. started calling Path A, Path B and Path C. The group had yet to choose among them, and the decision- making process seemed to be at an impasse. Nerves were frayed and tension was high as people gathered in the warehouse to try to reach a consensus on how best to move forward.

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BLAKE JONES

Jones and two partners had founded Namasté Solar in late 2004. Jones, then 30, had trained as a civil engineer. After college, he went to work for the engineering and construction firm Brown & Root, then a subsidiary of Halliburton, where he worked on many oil and gas projects, including a large gas field development project in Egypt. Although he was fascinated by energy and enjoyed working in a developing country, Jones was beginning to have concerns about the environmental impact of fossil fuels. He recalled:

My older brother was a big influence on me. He was saying, “Hey, you shouldn’t be in oil and gas, you should be in renewable energy instead.” I hadn’t thought much about environmental issues and society’s over-dependence on fossil fuels until he started sharing those ideas with me. As I started to see these things for myself, I began to have a gradual awakening that I wanted to get out of oil and gas and into renewable energy. In particular, I wanted to work with renewables in a developing country.

Jones left Brown & Root in 2001 and took a position with a 120-person renewable energy company in Nepal. A small, mountainous country wedged between India and China, Nepal had no fossil fuels; however, it did have a fast-growing demand for electricity and many sources of renewable energy. Jones described the opportunities and challenges he faced there:

Nepal was a playground for clean energy technologies, not just solar, but electric vehicles, biogas, hydro, wind and more. You’re talking about harsh and remote environments in the hills and mountains where the design and installation has to be perfect. You can’t afford to have things break down. We learned to do things right the first time.

Although Jones was happy in Nepal, events converged to draw him back to the United States. While living abroad, Jones had returned periodically to visit his brother and sister-in-law in Boulder, Colorado. He met and fell in love with a woman there who was not interested in a permanent move to Nepal. Jones laughed: “Colorado was where I wanted to come back to, because that was part of the deal for getting my wife to agree to marry me!”

Use outside these parameters is a copyright violation. NAMASTÉ SOLAR

An opportunity soon presented itself. In November 2004, voters in Colorado passed a ballot initiative that established a renewable electricity standard (RES). The RES required large, investor-owned electric utilities in the state to purchase at least 10 per cent of their supply of electricity by 2015 from renewable sources such as solar, wind, biomass or geothermal. This figure was to rise over time to 20 per cent by 2020. The standard also included a “solar carve-out” that mandated that at least four per cent of the renewable energy come from solar (sun-produced) electricity. Of this, half had to be generated on-site by customers, such as individual homeowners or businesses. The utilities were required to provide whatever incentives were necessary in order to get enough homeowners and business owners to purchase and install solar electric systems. For the first time, the RES created a real economic incentive for the installation of solar systems in newly constructed buildings and retrofits in Colorado. Jones immediately saw an opportunity to apply the skills he had learned in Nepal — and, at the same time, to follow his heart to For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. Boulder.

Back in Colorado, Jones got married and brought in two partners to start a new business. Wes Kennedy, a friend of a friend, had experience in solar installations and was looking for an employment change. Ray

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Tuomey, a friend of Jones’ wife, had a long-time association with community organizations in Boulder and many local contacts. The three men found they had much in common, as well as complimentary talents: they decided that Jones would handle business planning, Kennedy would lead the technical design and installation activities and Tuomey would head up marketing.

Just as important, the three founders also shared a vision of the kind of company they wanted to build. To some extent, their views were shaped by negative experiences in prior jobs. Jones explained:

Wes had worked for a sole proprietor who never shared anything with his employees. Then, the owner sold out and made a lot of money — without sharing any of it, and all the employees were stuck in an acquisition they didn’t choose to be a part of. In Nepal, the company I worked for had a problem with very high turnover. I learned from that how not to treat people. So, we had all these ideas for what we did and didn’t want to do.

At the same time, they knew they wanted to build a business in which risk and reward were shared, and decision-making was decentralized. In an effort to understand how to do this, they began reading and discussing books, including Jack Stack’s Great Game of Business and A Stake in the Outcome and his co- author Bo Burlingham’s Small Giants, as well as books and research about companies such as New Belgium Brewing Company, South Mountain Company, Chroma Technology Corp., ClifBar, Equal Exchange, Patagonia and others that provided ideas and possible models.

To fund their fledgling venture, Jones, Kennedy and Tuomey each contributed significant portions of their own savings, but it was not enough. When they approached local banks for a loan, however, they ran into resistance. Jones recalled:

The banks basically didn’t want to lend to the company. They were willing to lend to us as individuals, but not to the company. Furthermore, they wouldn’t do a non-recourse loan. They had to have a personal guarantee. But for our structure, we didn’t want anybody to give a personal guarantee because that meant that person was putting in significantly more risk than others, and we wanted to decentralize everything, share ownership, share the risks, share the reward. So that didn’t work for us.

Use outside these parameters is a copyright violation. Eventually we decided that if people wanted to loan the company money, they could get a personal bank loan, for example, and then they could turn around and loan these funds to the company. We figured out a way to compensate people for taking that additional risk in a way that still kept the structure intact. Because those loans were non-equity, they didn’t affect the ownership structure.

The founders incorporated their business in February 2005, selecting the name Namasté, a traditional Sanskrit greeting that Jones used on a daily basis while living in Nepal and that Kennedy used on a daily basis in his yoga practice. To them, the word’s meaning was significant: “A greeting of great respect that celebrates the interdependence of all living things.”

BUILDING A TEAM For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019.

Recruiting employees was a challenge: at the time, the fledgling solar electric industry was growing by leaps and bounds, and competition for experienced or skilled workers was intense. Jones commented:

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In a fast-growing industry like solar, people are being pirated left and right. And it’s a relatively new field, so if you’ve got a year of experience, you’re considered a veteran. All of these companies are trying to grow fast and keep pace with the booming market. It’s very expensive and time-consuming to train people on your own. It’s much cheaper to go and pirate employees from other companies.

Namasté Solar’s strategy was to recruit very carefully and to hire people who were a good fit with the company, both in terms of skills and philosophy, and who were prepared to make a long-term commitment. Jones explained:

We’re hiring business partners. When we hire people, we tell them, “Things in life can change, but we want your ideal situation to be staying with the company for five years or more.” We want people who are here for the long-term, because the company’s business model depends on long-term thinking. If you have people thinking short-term, but the company’s got a long-term vision, it won’t work out. So, we have a very lengthy interview process. At the beginning, we were worried that we wouldn’t be able to find any like- minded folks who wanted to join our hare-brained venture, but in the end, we were happily surprised. Our business model has attracted an amazing group of people.

During its first four years, Namasté Solar’s staff grew to 55 people. The company’s retention rate was extraordinarily high: by 2008, Namasté Solar had only three unplanned departures, out of more than 50 hires. One of these departures was Kennedy, who left in early 2008 to take a position with a larger solar company.

The company had an unusually non-hierarchical salary structure for its employees. At first, it had a two- tier salary structure. In 2008, this changed to a 10-tier wage scale, with an average of five per cent between tiers. No one, including the CEO, made more than two times the salary of the lowest-paid person.

EMPLOYEE OWNERSHIP

A critical part of the founders’ vision for Namasté Solar—and a strategy for attracting and retaining Use outside these parameters is a copyright violation. employees—was a commitment to employee ownership. Under the terms of a carefully crafted restricted stock plan, all employees had an equal opportunity (but not obligation) to buy shares in the company at any time, at the then-current value. Full vesting occurred over a period of five years. Jones explained the founders’ logic:

Some companies make employees wait five years before they are even able to buy stock. We wanted people to be able to enjoy the benefits of ownership from day one. So, at Namasté Solar, you can buy stock on your first day at the company, and you get to enjoy the benefits of ownership, including dividends if they’re paid. But, we want our employees to be here for the long-run. Since we’ve been growing so fast, our stock price has been increasing at a similar rate. If you come and join the company and then leave six months later with significant stock price appreciation, we don’t want you to be able to take advantage of that kind of short-term plan. For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019.

Employees who left the company were required to sell back their shares. Vested shares were bought back at their fully appreciated (or depreciated) value; non-vested shares at their original purchase price (or the depreciated price, whichever was lower). The restricted stock plan contained provisions designed to strike

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a balance between the redeeming stockholder and the company in terms of how quickly the company had to pay out the value of the redemption. The goal was to pay out departing stockholders as quickly as possible without harming the company, which was achieved by setting annual redemption payments according to a percentage of annual revenue.

As a privately held firm in a dynamic industry, Namasté Solar had considerable difficulty valuing its stock. Jones explained:

It is one of our biggest challenges. We use multiple methods, primarily market- comparable multiples, based on what other companies have sold for. But, in the solar industry, those multiples are so high, they are ridiculous. So we add a huge dose of conservative caution. One of the charges of our finance committee is to continually talk with investment bankers and other solar companies to find out what other companies have been acquired for. They also look at what normal multiples are for, say, electrical contractors or HVAC (heating, ventilation and air conditioning) contractors. At the end of the day, our goal is to share long-term ownership using a conservatively and fairly determined stock price.

In 2008, 37 employees (about two-thirds of the total) held equity in the firm. No single shareholder owned more than 50 per cent, not even the two remaining founders combined. Most of the co-owners owned between one to three per cent of the company, depending on when they joined the company and how many shares they decided to purchase. Over time, everyone’s ownership percentage, including the founders’, was declining through dilution, as was their intention.

ORGANIZATIONAL MISSION, VALUES AND CULTURE

Namasté Solar’s stated mission was “to propagate the responsible use of solar energy, pioneer conscientious business practices and create holistic wealth for our community.” According to the company’s brochure, holistic wealth was wealth that “benefits all stakeholders equally — customers, employees, investors, communities and the environment — as opposed to inequitably benefiting any stakeholders at the expense of any others” (see Exhibit 1). Use outside these parameters is a copyright violation.

With respect to care for the earth, the company’s core activity was designing and installing solar energy systems. In 2008, it remodelled its building in Boulder to be LEED-gold certified (indicating energy and environmental excellence in design), including — of course — a solar electric system. The company pursued zero-waste operations by recycling all of its waste materials, and its installers used a fleet of hybrid and biodiesel vehicles. The firm provided everyone with annual bus passes, encouraged carpooling and biking to work, and maintained showers and locker rooms in the building.

With respect to care for the customer, the company committed to “the best possible” customer experience. It offered a 10-year warranty on all residential installations, and reimbursed customers for lost energy production when equipment was out of service for repairs.

With respect to care for the community, Namasté Solar annually donated one per cent of its revenues in the For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. form of solar system installations to community non-profits. It also employed one person whose sole job was to perform educational outreach in the community about solar energy. Jones and other employee- owners were actively involved in policy discussions at the local and state levels, particularly regarding energy legislation.

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With respect to care for the company, Namasté Solar was committed to creating a collaborative and equitable culture. It supported open-book management, democratic decision-making and a meritocratic system in which employees assumed responsibility based on demonstrated competence.

Finally, with respect to care for ourselves, the company strove to “create a work environment where we can be healthy, learn continuously, laugh, have fun and LOVE what we do,” according to the firm’s brochure.

BIG PICTURE MEETINGS

Soon after establishing Namasté Solar, the founders initiated a process called the “big picture meeting” or BPM. Held weekly, BPMs brought together all employees for a full discussion of the issues facing the company, both large and small. These meetings were typically held on Wednesday mornings in a large, open conference room in the headquarters building. Every employee, whatever their role—and whether or not they owned stock—was expected to attend the BPM and encouraged to participate. Jones stated the rationale:

When you put amazing people in a room, the more diverse perspectives you have, the better chance you have [of finding] the optimal solution. I have a little plaque on my desk that my grandfather originally had on his desk that reads, “No one of us is as smart as all of us.” The more people you bring in, the more creativity you get. Through our group discussions, we look under rocks and in nooks and crannies, and find amazing new ideas. It builds on itself, and it ends up being something way beyond what you ever could have thought of by yourself.

At all times, and especially at the BPMs, the company strove for “frank, open and honest” communication — or, as it was known among Namasté Solar employees, “F.O.H.” This meant that “one person provides a frank and honest opinion, [and] the other [person] is open to receiving that opinion.” Jones commented:

F.O.H. is something that we take very, very seriously. It’s a verb. It’s a noun. It’s a regular

part of our vocabulary. We want everyone to truly speak their minds, and we have to Use outside these parameters is a copyright violation. create a culture where people feel comfortable to do so. We also have to trust that when a fellow co-owner F.O.H.’s you, they’re doing so with good intentions and aren’t trying to hurt you. At the end of the day, F.O.H. is a critically important part of our company’s culture — and, I might add, it works very, very well. It reduces the potential for grudges, harmful gossip and wasted energy as a result of not being able to get things off your chest.

Although democratic decision-making was time-consuming, Jones believed that people who had participated in making a decision would be more committed to implementing it:

Making these decisions in a big picture meeting can often be more laborious and time- consuming than they would otherwise be if you were just a sole proprietor or had a small ownership group or management team. But once you decide which direction the ship is going to head, everybody rows with full fervour and intensity because they’ve bought into For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. the decision. Changing directions can take time, but once you change the direction, you can reach top speed faster and go longer distances.

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FROM CONSENSUS TO DELEGATION

As the company grew and its operations became more complex, it gradually moved away from direct to more delegated forms of democracy. Initially, decision-making worked by consensus: Namasté Solar could move forward only when everyone agreed with a particular course of action. Referring to the company’s early period, Jones explained: “We used to make our decisions by consensus, absolute consensus. To us, consensus means everybody must give a ‘thumbs up.’ They must actively say ‘yes.’”

Later, when the group grew beyond 20 people, Namasté Solar changed to a process they called “consent,” meaning the company could proceed as long as no one voted “thumbs down.” Individuals could consent— or acquiesce—to decisions they did not feel strongly about one way or the other.

In early 2008, the company faced an issue for which neither consensus nor consent seemed to work. Namasté Solar’s new director of marketing and communications, Heather Leanne Nangle, along with several other employee-owners, felt that the firm needed to rebrand itself, including choosing a new logo. The company commissioned several designs and needed to choose among them. The group became completely bogged down. Jones recalled:

For three, three-and-a-half years, through hundreds of difficult, painful subjects, we had always reached consensus or consent. It was miraculous. And then to have something come up where it didn’t work — it was like, “Whoa!” It was all because the logo decision was so subjective. It was similar to, “Do you like this painting?” Trying to get 50 people to agree on their favourite logo design out of a dozen possibilities seemed impossible.

The marketing director and her team asked the BPM — and received permission — to make the logo decision on their own, without BPM review, and the company was able to proceed with its rebranding campaign. This process gradually became a model for other issues that came before the company.

From early on, the company was organized into functional teams whose members were determined by job role; for example, there were sales, installation, project management, operations and strategy teams. For everything else, the company was organized into committees, which differed from teams in that members were volunteers with a wide variety of daily job roles. Committees were empowered via BPM votes to Use outside these parameters is a copyright violation. address certain issues. These included, for example, marketing, human resources, finance, fun (social events), harmony (resolving interpersonal conflicts), education (of employees and the community) and canine (many Namasté Solar employees brought dogs to the office, which required that policies be created). The BPM continued to deal with some issues as a group; it delegated others to specific teams or committees. The empowered team or committee would then research the issue, deliberate and report back to the BPM with recommendations to be voted on; alternatively, it might be empowered by a BPM vote to make a decision on its own (as had happened with the logo decision, which prompted the evolution of this alternative). Through trial and error, the group continually developed expectations about what kinds of issues were appropriate for the BPM, for the teams and committees, or for individual roles.

Namasté Solar was formally governed by a five-person board of directors. All directors were required to be employees, but not necessarily owners. Each year, three directors were elected (or re-elected), so board turnover was rapid. All shareholders were eligible to vote for members of the board. Co-owners were For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. allocated votes based on the number of shares they owned and how many positions on the board were open. They could then cast their votes any way they wished, including casting all their votes for a single candidate. This variation on a cumulative voting method was intended to allow minority groups to pool their votes and allocate them to a single seat, to make sure they had at least one representative on the board.

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Throughout the company’s history, shareholder votes had been rare — mostly for board elections; however, the BPM undertook its discussion of a potential sale of the company knowing that the ultimate decision to sell would require the approval of a super-majority of at least 60 per cent of the shareholders.

INVESTMENT OFFERS

By 2008, Namasté Solar had become the largest solar electricity company in Colorado. The firm had installed more than 750 solar systems, more than any other company in the state, with a total capacity of 4,000 kilowatts. The company had a share of between 20 and 25 per cent of the state’s residential and small commercial solar photovoltaic markets, and had been profitable in every year except its first, with revenue growth of more than 2,250 per cent. More than half of its sales came through customer referrals and repeat customers. In 2008, the company was on target to earn revenue of more than US$14 million.

At the same time, the industry itself was growing at a breakneck pace. In 2007, installations of photovoltaic solar systems tied to the electrical grid in the United States grew by 45 per cent. Colorado ranked fourth in installed capacity (after California, New Jersey and Nevada). Growth was also brisk in the related areas of solar water heating and concentrating solar power (a technology used by utilities to generate solar electric power on a large scale). Much of the growth was driven by state-level public policies that incentivized renewable energy generation.1 In Colorado, Namasté Solar faced competition from both national and local firms; these included REC Solar, Standard Renewable Energy, Real Goods Solar, SolSource, Bella Energy and Akeena Solar.

As the industry grew, it attracted the attention of investors. Venture capital and private equity firms had acquired stakes in a number of Namasté Solar’s competitors, and several solar companies had gone public. Jones felt considerable pressure: “I was thinking, oh crap, our competitors have millions of dollars in their coffers, and they’ve got huge growth mandates from their investors. They’ll probably be willing to lowball and drive prices down and buy up competitors.”

At the same time, Jones himself was getting telephone calls:

I was getting multiple phone calls every week. It’s so-and-so from such-and-such private Use outside these parameters is a copyright violation. equity firm. It’s so-and-so from such-and-such investment bank. It’s so-and-so angel investor saying, “Can I take you out to lunch?” It’s so-and-so saying, “Hey, how would you like to be a part of our company? How would you like to join the next Starbucks of solar?” It was ridiculous how many phone calls we were getting.

Eventually, we starting thinking, let’s listen to what these folks have to say. Part of our motivation was we wanted new perspectives to help us with our stock valuations. So we thought, let’s never hang up on someone who thinks they’re interested in investing in us. Let’s hear what they’ve got to say. We had lots to learn from them, including what kind of prices they paid or bid for other companies.

But, as we started to talk to them, we started to take some of those conversations more seriously. The numbers we were hearing—it was like, wow, that’s five times what we For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. were internally valuing our company at. That’s a lot of money.

1 Solar Energy Industries Association, “US Solar Industry Year in Review, 2007,” www.seia.org/galleries/pdf/Year_in_Review_2007_sm.pdf, accessed June 3, 2010.

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At the same time, we were all exhausted from multiple years of non-stop, breakneck growth. At this particular time, we were going through an intense turn on our ongoing roller coaster ride and many of us were approaching burnout and overload. We all had our life savings in the company and were feeling more scared than normal that summer about the financial risks we were all taking. Our only exit strategy was to sell internally, but we didn’t know if that would work. So the end seemed nowhere in sight and we kept having to double-down on our bets.

Last but not least, one of our founders had just left the company. Wes, who everyone looked up to as a founder and a steward of our company vision, had just decided to leave the company, which came as a surprise to all of us. So, you combine all of this together and we were in a very vulnerable place from a morale perspective.

As Jones began fielding inquiries, he shared them immediately in the BPM, so employees were fully briefed on these conversations.

In mid-2008, two particular firms emerged as serious bidders. Jones considered both entities the best candidates among all of the rest, and they were both offering a range of opportunities from a sale of a minority equity stake all the way to a complete acquisition.

“SITTING IN THE CRUCIBLE”2

Over the course of the next two months, the company held a series of Wednesday morning mini-retreats to consider these two offers, and had narrowed its possible response to three options. Now, sitting in thrift- shop chairs and couches in the mid-summer heat, the group felt it needed to move to some closure. Both firms wanted to take the next steps, and the company perceived their window of opportunity to be limited in duration.

Path A was, in Jones’ words, to “sell the whole kit and caboodle.” Path B was a hybrid, involving the sale of a portion of the company, with employees retaining partial ownership. Path C was to recommit to

Namasté Solar’s original vision of being a privately held, 100 per cent employee-owned firm, with or Use outside these parameters is a copyright violation. without some changes in strategy.

The discussion of the pros and cons of the three paths was frank and wide-ranging. Path A and Path B would both bring a fresh infusion of capital into the company. The company had been growing faster than it was able to generate capital internally, and found it difficult to obtain non-recourse bank loans. “We were growing so fast, we kept needing more money. Where’s the money going to come from? Investors could supply that.”

Others agreed, saying the company needed to grow at least as fast as the market, and that they could not do so without accepting external capital.

We were worried that it was against the natural laws of business. Is it true that “you’re either growing or you’re dying?” If your market is growing 100 per cent a year, and you’re For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. only growing at 10 per cent a year, is that sustainable?

2 All quotations in this section are from Blake Jones, in a discussion of his recollection of various views expressed at the meeting (not necessarily his own), unless otherwise noted.

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It was the fear of big fish gobbling up the small fish. People said we’re going to get clobbered unless we do something. We’d better take on some money. We’d better keep growing. We’d better keep the triple-digit percentage growth every year.

Selling the company appealed to some who wanted to spread the “gospel” of solar power as widely as possible. Additional capital would enable the firm to hire more people, reach more customers and install more solar panels. Nangle, Namasté Solar’s director of marketing and communications, later recalled this view: “Some people work here because they want to propagate solar as much as possible and therefore have a greater global effect. It’s all about impact. Some people said, ‘think of all the solar we could do all over the world.’”

Chris Fox, an installer, recalled, “There was this sense that bringing in investor capital was necessary at the time. Some people were very persuasive, saying we have a great opportunity in this fast-growing market. Let’s talk about trying to maximize our profit and our growth curve in order to reap the benefits of that.”

For some employee-owners who were vested or close to vested, the matter was more personal: the offers provided an opportunity for a handsome return on their investment in the company. “[To some people], the offers were tempting. As much as we like to say, “It’s not about the money,” when you get a stack of hundreds slapped in your face, you’re kind of like, “Hmm, yeah, that’s a lot of money.” The numbers we were looking at were five times what we were valuing the company at internally.”

Another personal factor was burnout. Many of the employees sitting around the warehouse that day felt tired and overworked. The buyout offered a chance to take the money and move on to a less stressful job.

That summer was really hard. We had had triple-digit growth for several years in a row. We had just opened a new office in Denver, the building here in Boulder was being renovated, and we were all spread out. It was crazy. People felt really burned out, against the ropes. Their idea seemed to be that if we sold the company, we wouldn’t have everybody’s life savings on the line. We could take our chips off the table, and we wouldn’t have to be on the hook anymore.

On the other hand, many expressed grave reservations about the impact of an acquisition on Namasté Use outside these parameters is a copyright violation. Solar’s carefully crafted culture. “There was the problem of complete loss of control. Culture was just out the window with Path A, unless we felt we could really trust [the acquiring company]. What do we think it’s going to be like to work for this company? Are they going to respect our culture? No one has the same values as we do.”

Nangle pointed out: “I’m passionate about our grant program. We have an incredible grant program where we give one per cent of revenue, regardless of our profit, to the community. To me, that makes us one of the coolest companies on the planet, let alone in Colorado. I felt a private investor would say, ‘What the heck are you doing that for? Stop that. Don’t give your money away.’”

She also expressed concern about a possible loss of the family feeling at the company:

I was a strong voice for wanting to keep the family quality that we have. I want to be able For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. to sit in a big picture meeting and know every single person there. I don’t need to know every detail, but I want to be able to sit next to someone and ask, “How’s your child . . . how’s this or that?” If I’m sitting in a room with 500 people, there’s no way you’re going to know me, or I’m going to know you. The family element would be lost.

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Others expressed the concern that a private equity investor would be unlikely to support the firm’s concept of “holistic profit.”

The appeal of Path B, to some, was that it seemed to offer a way to bring in external capital to support growth, while maintaining control over the culture. Nangle recalled:

Some people passionately advocated for Path B. They thought we could bring a private equity investor on board, and still be in complete control and stay true to our values. Because they [equity investors] don’t have majority ownership, we would still be in control. Other people said, “No, they’ll want warrants for eventually purchasing the majority of the company.”

The supporters of Path C, for their part, argued that it was the only path consistent with the company’s values.

Our founding vision was to be a 100 per cent employee-owned company, with no external investors, where we’re in complete control. Some people were like, “What? I came into this company thinking that Path C was the only path, what the heck are we doing even discussing Path A and Path B? What’s going on here? I wouldn’t have joined this company if I thought you guys were thinking of doing this.”

Fox recalled that others called Path C “too idealistic.”

Jones recalled the scene:

I just remember that the decision was taking such a long time. I kept thinking, let’s not succumb to this frustrated feeling. Let’s just sit in the crucible, sit in the fire a little bit longer until we’re able to make the right decision. We might just be caught in the perfect storm of stress, fear, doubt, burnout and low morale . . . and somehow we need to allow ourselves to make a decision that we’ll be happy with . . . and that we won’t look back on and regret. Use outside these parameters is a copyright violation. For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019.

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Exhibit 1

NAMASTÉ SOLAR: OUR VALUES

1) Care for the Earth: Leave the environment a better place than we found it;

2) Care for our customers: Provide the best products, services and overall customer experience;

3) Care for our community: Be a good neighbour and actively engage with our community;

4) Care for our company: Cultivate a collaborative, equitable and fun company culture;

5) Care for ourselves: Strive to live balanced, healthy and fulfilling lives.

Use outside these parameters is a copyright violation. For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019.

56 7.

9B07M013

HONG KONG DISNEYLAND

Michael N. Young and Dong Liu wrote this case solely to provide material for class discussion. The authors do not intend to illustrate either effective or ineffective handling of a managerial situation. The authors may have disguised certain names and other identifying information to protect confidentiality.

September 12, 2006 marked the one-year anniversary of the opening of Hong Kong Disneyland (HKD). Amid the hoopla and celebrations, media experts were reflecting on the high points and low points of HKD’s first year of operations, including several controversies that had generated some negative publicity.

At a press conference and interview to discuss the first year of operations, Bill Ernest, HKD’s executive vice-president, acknowledged that the park had learnt a lot from its experiences and that the problems had made it stronger. Ernest also announced that HKD attendance for the year had been “well over” five million visitors. Still, this figure was short of the 5.6 million visitors that had earlier been projected by park officials. Ernest stated that the park was on sound financial footing but would not release the details.1 He also announced the appointment of two non-executive directors; Payson Cha Mou-sing, managing director of HKR International, and Philip Chen Nan-lok of Cathay Pacific would be joining the board of directors

in a move calculated to counter charges of a lack of transparency. The criticisms were, in part, coming Use outside these parameters is a copyright violation. from members of the Hong Kong Legislative Council as HKD was 57 per cent owned by the Hong Kong Government, which had invested HK$23 billion.2

Since plans for the high-profile HKD project were first announced, there had been criticisms of a lack of transparency from Hong Kong government officials, the Consumer Council and members of the public. The dissatisfaction was reflected in a survey conducted by Hong Kong Polytechnic University in March 2006.3 Although 56 per cent of the 524 respondents believed the government’s HK$13.6 billion (about US$1.74 billion) investment to be of a “fair” value, 70 per cent of respondents had a negative impression of the public investment in HKD. This response was a considerably more pessimistic result than previous surveys. It was in the interests of HKD to turn this situation around.

HKD was the third park that Disney had opened outside of the United States, following the Tokyo Disney

Resort and Disneyland Resort Paris. The Tokyo Disney Resort was the most successful of all of the Disney For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019.

1 Linda Choy and Dennis Eng, “5 Million Visit Disney Park, Short of Target,” South China Morning Post, electronic edition, September 5, 2006, available at http://scmp.com, accessed December 3, 2006. 2 In 2006, the Hong Kong dollar was pegged to the U.S. dollar at approximately US$1 = HK$7.80. 3 May Chan, “Disneyland’s Image Has Soured Since Its Opening,” South China Morning Post, p. CITY3.

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parks worldwide, and indeed one of the most successful theme parks in the world; the Disneyland Paris Resort was much less successful.4 Pundits had begun to wonder whether the outcome of HKD would more closely resemble that of its successful Far Eastern Japanese cousin or whether it would more closely resemble that of the French park. That outcome depended in part on how well Disney would be able to translate its strategic assets, such as its products, practices and ideologies, to the Chinese context.

COMPANY BACKGROUND

The Walt Disney Company (Disney) was founded in 1923, and was committed to delivering quality entertainment experiences for people of all ages. As a global entertainment empire, the company leveraged its amazing heritage of creativity, fantasy and imagination established by its founder, Walt Disney. By 2006, Disney’s business portfolio consisted of four major segments: Studio Entertainment, Parks and Resorts, Consumer Products and Media Networks. Exhibit 1 summarizes the details of the company’s holdings and their respective financial performance in 2005.

Other Disney Parks and Resorts

Disney opened the first Disneyland, Disneyland Resort, at Anaheim, California, in July 1955. The company’s second theme park, Walt Disney World Resort, was opened at Lake Buena Vista, Florida, in 1971. After the establishment of these two large theme parks in the United States, Disney sought to expand internationally. Disney’s international expansion strategy was straightforward, consisting of “bringing the original Disneyland model to a new territory, and then, if feasible, adding a specialty theme park.”5 Tokyo Disney Resort was Disney’s first attempt at executing this strategy.

Tokyo Disney Resort

Disney opened its first non-U.S. park in Tokyo, Japan, in 1983. The scope and thematic foundation of the Tokyo park was modeled after the Disney parks in California and Florida. The US$1.4 billion cost to

develop Tokyo Disney Resort was financed solely by Oriental Land Co., a land-reclamation company Use outside these parameters is a copyright violation. formed under a joint-venture agreement between Mitsui Real Estate Development Co. and Keisei Electric Railway Co.6 Disney did not assume any ownership of Tokyo Disney Resort to minimize risks. The contract signed in 1979 spelled out Oriental Land as the owner and licensee, whereas Disney was designated as the designer and licensor. Although Disney received a US$100 million royalty every year, this amount was less than would have been the case if Disney were the sole owner or even a co-owner of Tokyo Disney Resort. By 2006, the 23-year-old Tokyo Disney Resort, along with the addition of Tokyo DisneySea, at an additional cost of US$3 billion in 2000,7 was a huge success, with a combined annual attendance of more than 25 million visitors and an operating income of ¥28,957 million (about US$245.47 million) generated in 2005 alone.8

4 Mary Yoko Brannen, “When Mickey Loses Face: Recontextualization, Semantic Fit, and the Semiotics of Foreignness,” Academy of Management Review, October 2004, pp. 593–616. 5 Sara Bakhshian, “The Offspring,” Amusement Business, May 2005, pp. 20–21. For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. 6 Eva Liu and Elyssa Wong, “Information Note: Tokyo Disneyland: Some Basic Facts,” Research and Library Services Division of the Legislative Council Secretariat, Hong Kong, 1999, retrieved March 10, 2006 from www.legco.gov.hk/yr99- 0/english/sec/library/990in02.pdf. 7 Ibid. 8 Oriental Land Co., 2005 Annual Report, retrieved March 10, 2006 from http://olc.netir-wsp.com/medias/1656486483_OLCAR2005final.pdf.

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Tokyo Disney Resort was well received by the Japanese, owing in part to the Japanese interest in Western cultures and the Asian love of fantasy and costume. The secret underlying this success was to provide the visitors with “a slice of unadulterated Disney-style Americana,” proclaimed Toshio Kagami, president of Oriental Land Co. Tokyo Disney Resort had attracted wide support from the local Japanese, who accounted for more than 95 per cent of the annual attendance. Moreover, around 15 per cent of the total visitors had visited the park 30 times or more, making Tokyo Disney Resort one of the world’s most popular theme parks in terms of annual attendance.9 The Tokyo Disney Resort also had the highest sales of souvenirs of all the Disney land resorts, in part, because it was the only Disney property to give special admission just for the purpose of purchasing souvenirs.

Disneyland Resort Paris

France was the largest consumer of Disney products outside the United States, particularly in the area of publications, such as comic books.10 However, this status did not provide much help to Disneyland Resort Paris (formerly named Euro Disney), Disney’s second attempt at international expansion. Disneyland Resort Paris came into operation in 1992, after two and a half years of negotiations with the French Government. Disney was determined to avoid the mistake of forgoing majority ownership and profits as had been the case with Tokyo Disney Resort. Thus, Disney became one of the partners in this project. Under the initial financial arrangement, Disney had a 49 per cent stake in the project. The French Government provided cash and loans of US$770 million at interest rates below the market rates, and financed the majority of the US$400 million infrastructure.

However, cost overruns pushed overall construction costs to US$5 billion — five times the previous estimate of US$1 billion. This increase was due to alterations in design and construction plans. This higher cost, coupled with the theme park’s mediocre performance during its initial years of operation and other factors, caused the park severe difficulties between 1992 and 1994. The park did not report a profit until 1995, which was largely due to a reduction of interest costs from US$265 million to US$93 million and the rigorous financial re-engineering efforts in late 1994.11

Despite poor results between 1995 and 2001, Disney added a new park, Walt Disney Studios, which brought Hollywood-themed attractions to the French park. At its opening in 2004, the second park attracted Use outside these parameters is a copyright violation. only 2.2 million visitors, 5.8 million short of its original projections. At the end of the fiscal year on September 30, 2004, Disneyland Resort Paris announced a loss of €145.2 million (about US$190 million).12

Part of the problem with the Paris resort was the resistance by the French to what they considered American cultural imperialism. French cultural critics claimed that Disney would be a “cultural Chernobyl,” and some stated publicly a desire for the park’s failure. For example, critic Stephen Bayley wrote:

The Old World is presented with all the confident big ticket flimflam of painstaking fakery that this bizarre campaign of reverse-engineered cultural imperialism represents. I like to

For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. 9 James Zoltak, “Lots of Walks in the Parks the Past Year,” Amusement Business, December 2004, pp. 6–7. 10 Mary Yoko Brannen, “When Mickey Loses Face: Recontextualization, Semantic Fit, and the Semiotics of Foreignness,” Academy of Management Review, October 2004, pp. 593–616. 11 James B. Stewart, Disney War, Simon & Schuster, New York, 2005. 12 Jo Wrighton and Bruce Orwall, “Mutual Attractions: Despite Losses and Bailouts, France Stays Devoted to Disney,” Wall Street Journal, January 26, 2005, p. A1.

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think that by the turn of the century, Euro Disney will have become a deserted city, similar to Angkor Wat [in Cambodia].13

Disney had to assure the French government that French would be the primary language spoken within the park. Even the French president, Francois Mitterand, joined in the fray, declining to attend the opening-day ceremony, dismissing the expensive new investment with Gallic indifference as “pas ma tasse de thé” (“just not my cup of tea”).14

Robert Fitzpatrick, the first chairman of the Disneyland Resort Paris, was a French-speaking American who knew Europe quite well, in part because of his French wife. Fitzpatrick did not, however, realize that Disney could not approach France in the same way as it had approached Florida when setting up its second theme park. For example, the recruitment process and training programs for its staff were initially not well- adapted to the French business culture. The 13-page manual specifying the dress code within the theme park was apparently unacceptable to the French; the court had even ruled that imposing such a dress code was against the labour laws.

The miscalculations of cultural differences were found in other operational aspects as well. For instance, Disney’s policy of banning the serving of alcoholic beverages in its parks, including in California, Florida and Tokyo, was unsurprisingly extended to France. This restriction outraged the French for whom enjoying wine during lunch and dinner was part of their daily custom. In May 1993, Disney yielded to the external pressure, and altered its policy to permit the serving of wines and beers in the theme park. With the renaming and the retooling of the entire theme park complex to better appeal to European taste, Disneyland Resort Paris finally began to profit in 1995.

Why Such Different Outcomes for Tokyo and Paris?

Why was Disney so successful in Tokyo but largely a failure in Paris? Professor Mary Yoko Brannen maintains that it may, in part, have been due to the way that Disney’s strategic assets — such as products, practices and ideologies — were translated to and interpreted in the Japanese and French contexts.15 According to Brannen, the “Americana” represented by Disney was an asset in Japan, where a trip to Disney was seen as an exotic, foreign-like experience. However, this association with the pure form of all Use outside these parameters is a copyright violation. things American was a liability in France, where it was seen as a form of reverse cultural imperialism. The result was a “lost-in-translation” effect for many of Disney’s most valued icons and established business practices. For example, Mickey Mouse was seen as a squeaky-clean, all-American boy in the United States, and he was viewed as conservative and reliable enough to sell money market accounts in Japan. However, in France, he was seen as a street-smart detective because of the popularity of a comic book series Le Journal Mickey.

Likewise, Disney’s service training, human resource management (HRM) practices and training required to achieve the “happiest place on earth” were quite easy to implement in Japan, where such practices represented the cultural norm. In France, however, the same training practices were perceived as invasive and totalitarian. Exhibit 2 summarizes how other strategic assets of Disney were recontextualized to the Japanese and French environments. For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019.

13 James B. Stewart, Disney War, Simon & Schuster, New York, 2006, p. 128. 14 Ibid. 15 Mary Yoko Brannen, “When Mickey Loses Face: Recontextualization, Semantic Fit and the Semiotics of Foreignness,” Academy of Management Review, October 2004, pp. 593–616.

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In 2006, it remained to be seen how Disney’s strategic assets would translate to, and be interpreted in, the Chinese culture of Hong Kong, the topic to which we turn next.

Mickey Mouse Goes to China

We know we have an addressable market just crying out for Disney products. —Andy Bird, Walt Disney International president, discussing China’s potential16

The Chinese “have heard so much about the parks around the world, and they want to experience the same thing,” said Don Robinson, the former managing director of HKD. Chinese consumers wanted to connect with the global popular culture and distance themselves from their previous collective poverty and communist dictate. Kevin Wong, a tourism economist at the Hong Kong Polytechnic University, remarked that the Chinese “want to come to Disney because it is American. The foreignness is part of the appeal.” The Chinese needed Disney, and Disney needed China. For example, Ted Parrish, co-manager of the Henssler Equity Fund, an investment fund house, said, “If Disney wants to maintain earnings growth in the high teens going forward, China will be a big source of that.”17

Because the Chinese economy was booming, Disney thought it would be a good time to set up a new theme park there. China’s infrastructure was still substandard by world standards. In addition, the Chinese currency, the renminbi, was not fully convertible. These and other factors increased the attractiveness of Hong Kong — a Special Administrative Region of China since the handover of sovereignty from the United Kingdom in 1997. Hong Kong had world-class infrastructure and a reputation as an international financial center. Most importantly, Hong Kong had always been a gateway to China. These factors gave Hong Kong an edge as a location for Disney’s third international theme park.

THE HONG KONG TOURISM INDUSTRY

Hong Kong, with its unusual blend of East and West, of Chinese roots and British colonial heritage, of ultramodern sophistication and ancient traditions, is one of the most diverse

and exciting cities in the world. It is an international city brimming with energy and Use outside these parameters is a copyright violation. dynamism, yet also a place where peace and tranquility are easily found.18

Tourism was one of the major pillars of the Hong Kong economy. In 2005, the total number of visitors was more than 23 million, a new record and approximately a 7.1 per cent increase over 2004 (see Exhibit 3). Visitors came from all over the world, including Taiwan, America, Africa, the Middle East and Macao (see Exhibit 4). Mainland China was the biggest source of visitors, accounting for 53.7 per cent of the total in 2005.19 The dominance of this group was, in part, supported by the Individual Travel Scheme20 introduced in 2003.

16 Jeffrey Ressner and Michael Schuman, “Disney’s Great Leap into China,” Time, July 11, 2005, pp. 52–54. 17 Paul R. La Monica, “For Disney, It’s a Small World after All,” CNNmoney.com, September 12, 2005, retrieved March 10, 2006 from http://money.cnn.com/2005/09/12/news/fortune500/hongkongdisney/. For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. 18 Hong Kong Tourism Board, www.discoverhongkong.com, accessed August 17, 2007. 19 Hong Kong Census & Statistics Department, “Hong Kong Monthly Digest of Statistics,” Hong Kong Census & Statistics Department, Hong Kong, March 2006. 20 The Individual Travel Scheme was a policy that permitted urban residents from selected cities in Mainland China to apply for visas from the Public Security Department to visit Hong Kong. In 2006, the Scheme covered 38 mainland cities. Until the implementation of this policy, mainlanders could only visit Hong Kong through business or travel groups.

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Local Attractions

Popular tourist attractions in Hong Kong included, but were not limited to, Victoria Peak, Repulse Bay, open-air markets and Ocean Park. Hong Kong’s colonial heritage provided several attractions, such as Cenotaph, Statue Square and the Government House. Traditional Chinese festivals, such as Tin Hau Festival, Cheung Chau Bun Festival and Temple Fair, added local flavor. Visitors often took part in the celebration of these annual festive events during their stay. The Hong Kong Tourism Board had designated 2006 as “Discover Hong Kong Year” to attract more travelers and encourage them to extend their stay. Furthermore, the AsiaWorld-Expo opened in early 2006, and it was expected to attract more business travelers. Other initiatives included a sky rail to the world’s largest sitting Buddha statue and Hong Kong Wetland Park. In addition, the Dr. Sun Yat-sen Museum was being renovated and was scheduled to reopen in early 2007.

Ocean Park

Ocean Park was another prime attraction in Hong Kong and was well-recognized worldwide. Prior to Disney’s entry, Ocean Park occupied a quasi-monopoly position as the only local theme park. Founded in 1977, Ocean Park was located near Hong Kong’s Central district, the heart of the bustling city. Ocean Park had an annual attendance of more than four million visitors and had been ranked recently as one of the top 10 amusement parks in the world by Forbes magazine.21 Ocean Park sought to blend entertainment with educational elements, thus offering the dual experience for its guests termed as “edutainment.”

For the 2004/05 fiscal year, Ocean Park’s gross revenue was HK$684 million (US$87.8 million), which represented a 12 per cent increase over the previous year. The surplus of HK$119.5 million (US$15.3 million) was the best performance ever achieved at the Park.22 In 2006, Ocean Park received necessary financing for a HK$5.55 billion (about US$0.71 billion) makeover, including a government-guaranteed portion of HK$1.39 billion (about US$0.18 billion).23 Ocean Park’s redevelopment was expected to bring HK$23 billion (about US$2.95 billion) to HK$28 billion (about US$3.59 billion) over the first 20 years of operation, with visitors projected to increase to more than five million annually by 2011.

Use outside these parameters is a copyright violation. HONG KONG’S VERY OWN DISNEYLAND

Hong Kong Disneyland will be the flagship for the Disney brand in this huge and growing country and play a pivotal role in helping to bring entertainment to this . . . part of the world . . . . It is our first destination opening in a market where [there] isn’t a very deep knowledge of Disney culture and stories. —Jay Rasulo, chairman of Walt Disney Parks and Resorts24

Disney initiated a conversation with the Hong Kong Special Administrative Region (SAR) government in August 1998 about the possibility of setting up a Disney theme park. To avoid a situation like the one

21 Norma Connolly, “Top 10 Accolade a Boost to Ocean Park,” South China Morning Post, electronic edition, June 3, 2006, http://www.scmp.com, accessed December 3, 2006. For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. 22 The Walt Disney Company, Annual Report, 2005, retrieved March 10, 2006 from http://corporate.disney.go.com/investors/annual_reports/2005/index.html. 23 Charis Yau, “Ocean Park Eyes $4.1B Loan to Finance Makeover,” South China Morning Post, April 13, 2006, p. BIZ1, retrieved May 3, 2006 from WiseNews Database. 24 Greg Hernandez, “Mickey Gains Recognition in Hong Kong,” Knight Ridder/Tribune Business News, September 8, 2005, p. 1, retrieved March 10, 2006 from Lexis-Nexis Academic Universe Database.

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encountered by Disneyland Resort Paris, Disney initially planned to simply run the park on a management fee and licensing contract basis. After extended talks and negotiations, however, Disney agreed to take an ownership stake as well.

HKD was expected to bring a number of economic benefits to Hong Kong. First, approximately 18,400 jobs would be created directly or indirectly at HKD’s opening, and this number was expected to increase to 35,800 in 20 years. Plus, 3.4 million visitors, mainly from Hong Kong and Mainland China, would be attracted to the park, and attendance was projected to increase to 7.3 million after 15 years. The additional spending by tourists would amount to HK$8.3 billion (about US$1.1 million) in Year 1, rising to HK$16.8 billion (about US$2.2 billion) annually by Year 20 and beyond. There would be “soft” benefits as well, such as with the acquisition of first-class technological innovations and facilities and gaining hands-on experience with quality service training. Over a period of 40 years, it was forecast that HKD would generate an economic benefit equivalent to HK$148 billion (about US$19 billion). This forecast sounded promising during the 1998/99 period when negotiations were taking place, when Hong Kong was still feeling the effects of the 1997 Asian financial crisis.

The Concluded Deal

This is a happy marriage between a world-class tourism attraction and a world-class tourist destination. We hope that Hong Kong Disneyland will not just bring us more tourists, but also wholesome quality entertainment for local families as well.25

After a year of negotiations, the final contract was signed in December of 1999. The theme park and hotels would cost US$1.8 billion to construct over six years. In addition, US$1.7 billion would be spent for land reclamation as no other suitable location was available in the densely populated territory. The park would be situated on Penny’s Bay of Lantau Island, the largest of Hong Kong’s outlying islands. The Hong Kong Government and Disney would invest US$416 million and US$314 million, respectively. In return, Disney held a 43 per cent stake in HKD, and the government held the remaining 57 per cent, which could later be increased to 73 per cent by converting subordinate shares. A further US$1.1 billion was put up in the form of government and commercial loans.

Use outside these parameters is a copyright violation. Hong Kong International Theme Park Limited (HKITP), the joint venture formed between Disney and the Hong Kong Government in December 1999, oversaw the construction and running of HKD. While the government developed the infrastructure, Disney provided master planning, real estate development, attraction and show design, engineering support, production support, project management and other development services. Disney also set up a wholly owned subsidiary, Hong Kong Disneyland Management Limited, to manage HKD on behalf of HKITP.

A Rocky Start

There was a palpable excitement when the new Disneyland theme opened, but the skeptics and critics were not so easily impressed. Press reports described the first few months as a

“rocky start.” Some locals called the park’s management policies “absurd.”26 For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019.

25 Stephen Ip, Hong Kong secretary for Economic Services, press release from Hong Kong government, “Hong Kong Disneyland Final Agreement Signed,” www.info.gov.hk/gia/general/99912/10/1210286.htm, accessed August 17, 2007. 26 “Mousekeeping,” South China Morning Post, December 28, 2005, features section, page 12.

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Four weeks prior to the official opening, HKD invited 30,000 selected individuals per day to visit the park to test the rides and other attractions. During the trial period, a thick haze hovered over the whole park, a result of the air pollutants passing down from Mainland China. This problem was well-recognized by Hong Kong authorities and was particularly acute during low wind periods, which trapped all of Hong Kong in smog.27 Smog virtually engulfed Sleeping Beauty’s Castle.

The first problem noticed was that the capacity limit of 30,000 visitors may have been too high. For example, on September 4, 2005, approximately 29,000 local visitors went to the park. The average queuing time was 45 minutes at the restaurants and more than two hours for the rides. The park faced pressure to lower the daily capacity limit. Instead, the park proposed other measures, such as extending the opening time by an hour and encouraging visits during weekdays by offering discounts, as opposed to reducing the actual limit.28

The park faced another problem when inspectors from the Hygiene Department were asked to remove their badges and caps prior to carrying out an official investigation of a food-poisoning case. Park officials later apologized and pledged to operate in compliance with all local regulations and customs. But problems continued. The police could not get into the park — even when deemed necessary — unless pre-arranged with the park’s security unit.29

OPERATIONS

Product Offerings

HKD, like its counterparts in the United States, Japan and France, symbolized happiness, fantasy and dreams, and sought to offer an unparalleled experience to its visitors. The admission price was initially set at HK$295 (US$38) during the weekdays and HK$350 (US$45) on weekends and peak days, the lowest pricing among the five Disney theme parks. A day pass for a child was HK$250 (US$32), while it was HK$200 (US$27) for seniors aged 65 and above. Tickets were sold primarily via the company’s website (www.hongkongdisneyland.com), which allowed three-month advance bookings. Tickets were sold through travel agencies. These two measures aimed to control the daily number of visitors and avoiding

long queues at the entrance. Only a small portion of tickets were available for walk-in customers. Use outside these parameters is a copyright violation.

HKD, like other Disney theme parks, was divided into four parts, including Main Street, U.S.A.; Fantasyland; Adventureland and Tomorrowland. Disney’s classic attractions, such as Space Mountain, Mad Hatter Tea Cups and Dumbo, were included in the park. In Main Street, U.S.A., guests could ride a steam train to tour the park. A large part of Fantasyland was the Sleeping Beauty Castle, which included Dumbo and Winnie the Pooh. Guests could find Mickey, Minnie and other popular Disney characters available for photos in the Fantasy Garden, which was unique to HKD. Adventureland was home to Tarzan’s tree house, the jungle river cruise and the Festival of the Lion King show. Tomorrowland featured science fiction and space adventures.

To cater to the time-pressed Hong Kong residents, HKD offered a Fastpass ticketing system, which provided a one-hour window to bypass queues for favored rides. Guests preferring an extended stay could For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. 27 Bruce Einhorn, “Disney’s Not-so-magic New Kingdom,” Business Week Online, September 13, 2005, retrieved March 10, 2006 from http://www.businessweek.com/bwdaily/dnflash/sep2005/nf2005/nf20050913_9145_db046.htm?chan=search. 28 “HK Disneyland Considers Longer Opening Hours to Beat Long Lines,” The Associated Press, retrieved March 10, 2006, from http://english.sina.com/taiwan_hk/p/1/2005/0906/44951.html. 29 Jonathan Hill and Richard Welford, “A Case Study of Disney in Hong Kong,” Corporate Social Responsibility Asia Weekly, November 16, 2005, retrieved March 10, 2006 from http://www.csr-asia.com/index.php?p=5318.

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check in to one of the two hotels, HKD Hotel and Disney’s Hollywood Hotel, which offered on-site lodging services.

Marketing

HKD collaborated with the Hong Kong Government to jointly promote the theme park. It was estimated that one-third of the visitors would come from Hong Kong, one-third would come from Mainland China and the remaining third would come from Southeast Asian countries.30 The free-to-air TV program, The Magical World of Disneyland, was broadcast in Hong Kong, and could be received in various regions across Southern China. In each episode, famous pop stars from the region (for example, Jacky Cheung, who was also the official ambassador of HKD) would introduce some behind-the-scene stories about HKD, such as interviews with rides designers. Disney believed that the widespread popularity of Jacky Cheung would connect well with the audience in Asia. HKD also launched a special TV channel on local cable TV. This channel included background stories on founder Walt Disney, information about The Walt Disney Company and its evolution, interesting facts about the company’s state-of-the-art animated films, and regular updates on the construction progress of the park.

The theme park also introduced a line of Disney-themed apparel at Giordano, a Hong Kong-based clothing retailer with more than 1,500 outlets in Asia, Australia and the Middle East.31 Giordano featured low-price fashionable clothes similar to The Gap in the United States. The Disney line featured adult and children’s T-shirts and sweatshirts with popular Disney cartoon characters, such as Mickey Mouse and Nemo. The T- shirts were about HK$80 (US$10) at Giordano, much less expensive than comparable items at HKD for HK$380 (US$49).

HKD outsourced part of its marketing effort to Colour Life, a Guangzhou-based magazine. In September 2005, 100,000 extra copies were printed, featuring the grand opening of HKD that month. It was hoped the extra publicity would increase awareness of the theme park among the residents of Guangzhou, the major metropolitan area of southern China, just north of Hong Kong. The company also donated 200 HKD umbrellas to key newsstands in Guangzhou to provide even more publicity. In addition, HKD partnered with the Communist Youth League of China to run special events for children, such as Mickey Mouse drawing contests. Use outside these parameters is a copyright violation.

Human Resource Management

The magical experience of a HKD visit depended upon the quality of service. HKD treated human resource management (HRM) as one of the cornerstones of its competitive advantage. To fill the remaining positions at the park, in April 2005, HKD launched one of the city’s largest recruitment events ever. The park screened job candidates according to qualities such as service orientation, language capabilities, passion for excellence and friendliness. Employees were referred to as cast members because “they are For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019.

30 Suchat Sritama, “HK Disneyland to Boost Thai Visitor Numbers,” The Nation, September 13, 2005, retrieved March 10, 2006 from http://www.nationmultimedia.com/2005/09/13/business/index.php?news=business_18587589.html. 31 “Hong Kong Disneyland Rolls out Fashions: Hong Kong Disneyland Takes Publicity Blitz to Masses with Fashion Line,” The Associated Press, retrieved March 10, 2006 from http://abcnews.go.com/Business/wireStory?id=963083&CMP=OTC- RSSFeeds0312, archived at http://news.ewoss.com/articles/D8BFNL1O0.aspx.

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always on stage when interacting with guests, and therefore represent a very important element of the show,” said Greg Wann, vice-president for HRM at HKD.32

In January 2005, HKD sent the first cohort of 500 cultural representatives to Walt Disney World in Orlando for a six-month training program. The cast members would learn about the magical Disney culture and would have a platform to share their Chinese cultural experience with other cast members at Walt Disney World. During their stay at Orlando, the Hong Kong crew was trained according to standards set by The Walt Disney Company worldwide. They also had the opportunity to work in other divisions, including merchandising, food and beverage operations, park operations, custodial services and hotel operations. In addition to training, HKD provided handbooks to each cast member, which literally detailed the regulations from head to toe. For example, male cast members could not have goatees or beards, and female cast members were not allowed to have fingernails longer than six centimetres.

Local Cultural Responsiveness

Given the cultural faux pas that occurred with Disneyland Resort Paris, Disney paid special attention to cultural issues pertaining to HKD. Because the prime target customer segment was the growing group of affluent Mainland Chinese tourists, feng shui33 masters were consulted for advice on the park layout and design. New constructions often began with a traditional good-luck ceremony featuring a carved suckling pig.34 One of the main ballrooms was constructed to be 888 square meters since eight was an auspicious number in Chinese culture, signifying good fortune. The hotels deliberately skipped the fourth floor because the Chinese associated four with bad luck. Other finer details were incorporated throughout the park to better fit the local culture. For example, the theme park sold mooncakes during the Chinese Mid- Autumn Festival. Phyllis Wong, the merchandising director, stated that green hats were not sold at the park because they were a symbol of a wife’s infidelity in Chinese culture.35

Cast members at HKD were expected to converse proficiently in English, Cantonese and Mandarin, and signs in the park were written in both Chinese and English. Another local adaptation was the squat toilets, which were popular throughout China. “These toilets benefit those Mainland Chinese who prefer squatting and those who don’t want to see muddy footprints on toilet seats,” commented a Hong Kong visitor.36

Use outside these parameters is a copyright violation. Restaurants offered a wide variety of food, ranging from American-style burgers and French fries to Chinese dim sum and sweet and sour pork. Although some animal activist groups initially protested, shark fin soup was on the menu as “it is what the locals see as appropriate,” said Esther Wong, a spokeswoman of HKD.37

32 Based on: Steven Knipp, “The Magic Kingdom Comes to the Middle Kingdom: What It Took for Hong Kong Disneyland to Finally Open in 2005,” Fun World, February 2005, retrieved March 10, 2006 from http://www.funworldmagazine.com/2005/february05/features/magic_kingdom/magickingdom.html. 33 Feng shui is the Chinese art and practice of positioning objects in accordance to the patterns of yin and yang, and in flow with chi, the energy source that resides in all matter. 34 Jeffrey Ressner and Michael Schuman, “Disney’s Great Leap into China,” Time, July 11, 2005, pp. 52–54. For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. 35 “Disney Uses Feng Shui to Build Mickey’s New Kingdom in Hong Kong,” The Associated Press, retrieved March 10, 2006 from http://english.sina.com/taiwan_hk/1/2005/0907/45097.html. 36 “Disneyland with Chinese Characteristics,” Letters from China: China and Independent Travel, July 22, 2005, retrieved March 10, 2006 from http://voyage.typepad.com/china/2005/07/disneyland_with.html. 37 “HK Disneyland Draws Fire over Soup,” Chinadaily.com.cn, May 24, 2005, retrieved March 10, 2006 from http://www.chinadaily.com.cn/english/doc/2005-05/24/content_445139.htm.

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NEGATIVE PUBLICITY

The Lunar New Year Holiday Fiasco

The park faced several public relations problems during its first year of operations, none bigger than that which occurred during the popular Chinese Lunar New Year holiday period. HKD had introduced a new, discounted, one-day ticket that could be used at any time during a given six-month period. These tickets could not be used on “special days” when the park anticipated an influx of visitors. The first period of special days was the Lunar New Year holidays.38 In Hong Kong, the 2006 Lunar New Year period started on January 28 (Saturday) and ended on January 31 (Tuesday). However, HKD failed to take into account that the following two days (i.e. February 1 and 2) were still public holidays in Mainland China. Mainland tour agencies had purchased large batches of the discounted tickets and escorted large groups of Mainland tourists to HKD during those two days.

This influx created a major problem for HKD as thousands of mainland tourists clinching their tickets swarmed the front gates of the park. The park could not accommodate the additional guests, and the steel gates were locked shut. Many of these Mainland Chinese tourists had saved all year for this trip and had accompanied their extended families to Hong Kong to experience the Disney magic. Needless to say, they were understandably upset. The crowd turned into an angry mob, and, brandishing their tickets, started shouting profanities and hurling objects at the police and security guards. Some tourists even tried to climb over the gates, which were topped with sharp spikes. The front page of the local paper the next morning showed a Mainland tourist throwing a young child over the closed gates to his parents who had managed to get inside the park. As one disgruntled customer commented on that fateful day, “I won’t come again, even if I am paid to.”39

To China observers, the behavior was not entirely surprising, given that Mainland Chinese consumers can be very vocal when they are dissatisfied with a product or service. For example, in 2001, the dissatisfied owner of a Mercedes Benz SLK230 had his car towed to the center of town by a pair of oxen, where workers with sledgehammers demolished the car in front of media crews, creating a publicity nightmare for DaimlerChrysler.40

There was plenty of finger-pointing for the fiasco. Fengtan Peiling, the commissioner of the Hong Kong Use outside these parameters is a copyright violation. Consumer Council, claimed that Disney had failed to learn about the cultural traditions and consumption habits of Chinese people. Wang Shuxin, from the Shenzhen Tourism Tour Group Centre, blamed HKD of falsely accusing the travel agents for the predicament. His center, which oversaw Mainland tourists traveling to Hong Kong, had more than 300 claims for compensation through travel agencies. Some agencies wanted to sue HKD for a possible breach of contractual terms.41 Soon afterwards, the Hong Kong government released a statement requesting the park to improve its ticketing and guest-entry procedures. Bill Ernest, HKD’s executive vice-president, later apologized, stating “every market has unique dynamics that must be taken into consideration and must be learned over time,” and that Disney was still learning.42

38 The Lunar New Year Holiday, or Chinese New Year, was one of the most important traditional Chinese festivals. A series of celebrations usually took place during the period, starting from the first day of the first month on the Chinese calendar. 39 Helen Wu, “Queues Take the Magic out of a Crowded Kingdom,” South China Morning Post, February 4, 2006, p. CITY1. For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. 40 “Luxury Car Under Hammer,” Herald Sun, December 28, 2001, retrieved May 3, 2006 from Lexi-Nexis Academic Universe Database. 41 Meng Chu, “Disneyland Suffers Crowd Problems in Hong Kong,” Voice, February 10, 2006, retrieved March 10, 2006 from http://bjtoday.ynet.com/article.jsp?oid=7653476. 42 “HK Disneyland Underestimates Lunar New Year Holiday Potential,” Asia Pulse, February 6, 2006, retrieved March 10, 2006 from Lexis-Nexis Academic Universe Database.

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Customer Complaints

Customers also complained that the park was too small and that it had too few Hong Kong-themed attractions. HKD had only 22 attractions, 18 fewer than the other Disney theme parks. Other guests claimed that they were mistreated during their stay at the park. Some guests even planned to take legal action against HKD. For example, a park visitor from Singapore alleged negligence and discrimination of Disney’s staff because they refused to call an ambulance for her mother who later died of heart failure at an HKD hotel. A spokesperson for HKD denied the allegations, saying that the staff handled the case in the “most appropriate” manner.43 In another case, a guest and his daughter were in a bakery shop on Main Street, U.S.A. when they were hit by falling debris. The guest stated “the park does not seem to regard customers’ safety as its priority” and threatened to take legal action against HKD, adding that they tried to placate him with a Winnie the Pooh for his daughter.44

Working Conditions

The character performers at HKD complained that they were overworked and underpaid. The spokesperson of the staff union stated that workdays of more than 12 hours and inadequate rest breaks had overwhelmed many workers, causing work-related injuries, such as joint and muscle strain. In response, Lauren Jordan, the theme park’s vice-president of entertainment, claimed that “there are a few cast members who have found this work to be less rewarding than others and perhaps more physically challenging than they anticipated.”

In addition, the character performers, who performed in the daily parade and met visitors, were petitioning for the same salaries as stage performers. The entry salaries for parade performers averaged about HK$9,000 per month (US$1,153) per month compared to about HK$11,000 (US$1,409) for stage performers.45 In response to the staff’s concerns, management announced extended breaks of 40 minutes for every 20-minute session with guests during the hot and humid summer season. Cooling vests, designed for the character performers, were also being tested.

Complaints were not limited to the line staff; there was also turnover among the executive staff. As one disgruntled executive complained: Use outside these parameters is a copyright violation.

The Americans make all the key decisions and often the wrong ones. Finance is also king here, and when things go wrong, they look for local scapegoats. The mood and morale is very low here. I know a lot of us are actively looking for jobs [and many of us] are totally disillusioned.46

HKD’S RESPONSE

To combat problems highlighted through the media, such as low park attendance, limited attractions, long queues, disgruntled employees and guests’ accounts of rude treatment, HKD implemented several recovery strategies. For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. 43 Patsy Moy and Ravina Shamdasani, “Call for Inquest into Disney Visitor’s Death,” South China Morning Post, February 20, 2006, p. CITY1. 44 May Chan, “Disney’s Pooh Unable to Mollify Irate Father,” South China Morning Post, December 8, 2005, p. CITY4. 45 Dennis Eng, “Mickey and Friends Call for a Better Work Environment,” South China Morning Post, April 10, 2006, p. CITY3. 46 Dennis Eng, “Two More Executives Quit Disney Park,” South China Morning Post, p. CITY1.

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New Promotion

To boost attendance, HKD adjusted its pricing strategy. In November 2005, the park offered ticket discounts in which the price for local residents was reduced by HK$50 (US$6.41). Moreover, HKD promoted a ticket express package: guests could purchase a one-day rail pass for an extra HK$6.4 over the admission price. This pass gave unlimited rides to and from the park plus a souvenir showcase of the popular Disney characters. Many believed that these new policies were intended to boost attendance, but park spokespersons dismissed such a claim.

In mid-2006, 50,000 taxi drivers were invited to HKD free of charge. Every taxi driver who took up the offer was given free admission to the park between May 15 and June 11, 2006. In addition, a 50 per cent discount was provided to up to three family members or friends who accompanied each driver. The aim of this promotion was to give taxi drivers a personal experience of the park that they could share with others. The Urban Taxi Drivers Association Joint Committee welcomed this scheme, but it was not clear whether it was successful.

HKD also introduced a “one-day trip guide” in Chinese during November of 2005.47 This initiative was intended to explain HKD to local travel guides. Furthermore, special VIP treatment was extended to local celebrities in the form of a Dining with Disney program. Local TV commercials also featured testimonials of previous guests and enticing scenes from inside HKD.

External Liaison with Mainland Travel Agents

Since Mainland visitors were a primary target of HKD, more proactive and collaborative moves were made with Chinese travel agencies, some of which were reluctant to sell HKD tickets in view of their slim profitability and extensive hassles: “When there are problems, [travel agencies] have to eat the cost and other troubles.” To overcome this resistance, HKD offered Chinese travel agents a 50 per cent discount on visits to the park and hotels. Incentives of approximately US$2.50 per adult ticket were also given to tour operators who incorporated an HKD visit into their package tours. HKD also changed the sales packages to open-ended tickets, from just fixed-date tickets, which offered greater flexibility for visitors and minimized 48 the number of returned tickets. Use outside these parameters is a copyright violation.

SETTING THE COURSE FOR EVENTUAL SUCCESS

The performance of HKD during its first year of operation had not turned out as good as had been hoped, with some potentially devastating mistakes. Tour operators further complained that HKD was not big enough to keep the guests occupied for a whole day. Worse still, HKD had faced much negative publicity: from overcrowding, to customer lawsuits, to chaotic incidents during the Chinese Lunar New Year that were front page news in Hong Kong. Further, a survey of current visitors to HKD revealed that 30 per cent of guests opted not to revisit the park, which did not bode well for HKD’s future.49

Disney had experience in operating parks internationally in both good and bad conditions. Inevitably comparisons had begun being made between HKD and Disneyland Resort Paris in France, which attracted For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019.

47 Geoffrey A. Fowler and Merissa Marr, “Hong Kong Disneyland Gets Lost in Translation,” The Wall Street Journal Asia, February 9, 2006, p. 26. 48 Ibid. 49 “Feature: Concerns Growing over HK Disneyland’s Future,” Knight Ridder/Tribune Business News, October 20, 2005, p. 1. retrieved March 10, 2006 from Lexis-Nexis Academic Universe Database.

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a mere 1.5 million visitors by the end of its second month of operation and nowhere could it match Disney management’s original projection of 15 million in the first year. However, some academics believed that it might take another five years to determine whether HKD could be judged as an economic success or failure.

Although maintaining an optimistic public face, the management team at HKD was facing pressures to turn things around. How could HKD steer through the cultural minefield to ensure Hong Kong Disneyland’s success? How well had Disney achieved its goal of translating its strategic assets to the Chinese cultural context? What could HKD do to ensure a successful outcome along the lines of Tokyo Disney and avoid the type of embarrassment experienced with Disneyland Paris? What could the company do to rescue the park from the onslaught of continuing negative publicity? The park’s management certainly had its challenges cut out for it.

The initial research and a first draft of this case were completed by Edwina H. S. Chan, Lutricia S. M. Kwok, John C. M. Lee, Jacky W. Y. Shing and Sally P. M. Tsui as an assignment under the direction of Professor Michael Young. Use outside these parameters is a copyright violation. For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019.

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Exhibit 1

CURRENT HOLDINGS OF THE WALT DISNEY COMPANY

Business Segments Performance (2005) Studio Entertainment This segment had the greatest decrease of 69%, which the company attributed to the overall decline in unit sales in worldwide home entertainment and at Miramax Consumer Products This division reported decrease in operating income of 3% due to lower revenue generated from the sales of Disney goods and merchandise Media Networks The higher rates paid by cable operators for ESPN and the Disney Channels and higher advertising revenue at ESPN and ABC were the primary factors driving the 27% growth in revenue at the media network unit. Parks & Resorts The Parks and Resorts division also enjoyed a 5% increase in revenue, largely due to the higher occupancy at the resorts, theme park attendance, and guest expenditure. Source: Annual Report 2005, The Walt Disney Company.

Exhibit 2

HOW DISNEY’S ASSETS AND PRACTICES RECONTEXTUALIZE TO JAPAN AND FRANCE

United States Japan France Products Mickey Mouse Squeaky-clean, all- Safe and reliable (used to Cunning, street-smart American boy sell money market detective epitomized in Le representing wholesome accounts) Journal Mickey — squeaky American values clean version is boring Cowboy Rugged, self-reliant Quintessential team player Carefree, somewhat dim- individualist witted anti-establishment individual Souvenirs Fun, part of the Legitimating mementos that Tacky, waste of money experience fit into the formalized system of gift giving, Use outside these parameters is a copyright violation. known as sembetsu

Practices Service Orientation Hypernormal Cultural norm Abnormal Personnel Management Hypernormal Cultural norm Invasive/illegal Training Hypernormal Cultural norm Totalitarian

Ideologies Disneyland Modernist theme Translated modernist theme Postmodernist theme - fun, clean, wholesome - fun, clean, safe foreign - resistance to Disney’s entertainment vacation meta narrative Foreignness • Fantasized European • Keeping the U.S. exotic • Politicized repatriation roots • Marginalizing the Asian • Schizophrenic

• Marginalized native other relationship with the U.S. For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. and minority others

Source: Mary Yoko Brannen, “When Mickey Loses Face: Recontextualization, Semantic Fit and the Semiotics of Foreignness,” Academy of Management Review, October 2004, p. 593.

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Exhibit 3

ANNUAL VISITOR ARRIVALS IN HONG KONG

(millions) 25

0 2001 2002 2003 2004 2005

Source: Hong Kong Tourism Board (2006).

Exhibit 4

VISITOR ARRIVALS BY COUNTRY/TERRITORY OF RESIDENCE

Australia, New Zealand, & Macao South Pacific Europe, Africa, & 2% the Middle East 3% 6% Use outside these parameters is a copyright violation. America 5%

North Asia 7%

South & Southeast Asia 8% The mainland China 61% Taiwan 8% For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019.

Source: Hong Kong Monthly Digest of Statistics (March 2006).

72 8.

9B16M040

APPLE AND ITS SUPPLIERS: CORPORATE SOCIAL RESPONSIBILITY

Sun Hye Lee, Michael J. Mol, and Kamel Mellahi wrote this case solely to provide material for class discussion. The authors do not intend to illustrate either effective or ineffective handling of a managerial situation. The authors may have disguised certain names and other identifying information to protect confidentiality.

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Will it ever be good enough? That was the key question facing Apple Inc., (Apple) the California-based multinational technology company that was known for its innovative hardware, software, and online services. Apple had been accused of having allowed labour rights violations in China at Foxconn, a major supplier of its products in 2009, but the company had worked hard to overcome these issues to avoid any negative ramifications for its corporate image. Yet on December 18, 2014, new evidence was presented in a British Broadcasting Corporation (BBC) documentary that showed that labour rights violations continued to occur in China, this time at Pegatron, another large Apple supplier that specialized in the assembly of Apple’s iPhones 1 This documentary questioned Apple’s repeated statement in its 2014 supplier responsibility progress report that “Each of those workers has the right to safe and ethical working conditions.”2

Jeff Williams had been promoted to the role of senior vice president for Operations only 15 days earlier, when he was put in charge of what Apple called “end-to-end supply chain management . . . dedicated to Use outside these parameters is a copyright violation. ensuring that Apple products meet the highest standards of quality.”3 Given the huge progress that Apple had achieved, was the company simply being singled out unfairly because of its size, visibility, and earlier problems? Indeed, Apple now had an excellent reputation in terms of corporate social responsibility (CSR) and, in 2014, had been ranked fifth on Forbes’ “best CSR reputations” list.4 As Apple’s stock market value moved ever closer to US$1 trillion,5 did outside observers hold Apple, the most valuable company ever, to a higher level of corporate social responsibility? Alternatively, had the company still not fully come to terms with the nature and magnitude of its CSR challenges?

It had indeed proven to be difficult to maintain control over Apple’s vast operations, particularly when most activities were undertaken through outsourcing to independent suppliers that were mostly situated in offshore locations, such as China, far from Apple’s base in California. Perhaps the most important question of all was what Williams and Apple could do to tackle the allegations. Would it suffice to adopt a defensive strategy, by simply denying that the problem was structural in nature and pointing to Apple’s many and For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. costly efforts? Or should Apple’s management instead engage with the issue and instigate further CSR changes in its sourcing strategy? If so, what changes should be implemented? In short, how should Apple and Williams respond?

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THE SMARTPHONE INDUSTRY

In 2014, more than 1.2 billion smartphone devices were sold worldwide, for combined revenues of more than $380 billion.6 The competition among the major players — Samsung, Huawei, HTC, Nokia, and Apple — had started to take a toll on the industry’s profitability, which led industry experts to suggest that the smartphone industry was reaching its maturity stage, with year-on-year growth set to gradually decline. Apple was the largest player in the industry, accounting for more than 90 per cent of profits in the fourth quarter of 2014 and the first quarter of 2015.7 Samsung dominated the low end of the smartphone market, while Apple dominated the more lucrative high end. The low-cost players, Lenovo and Xiaomi, which were introduced to the smartphone market in 20128 and in 20119 respectively, broadened the reach of the smartphone market to lower-income countries and intensified competition among the key players in the market.10 The smartphone market had reached a saturation point in western markets, but was still expanding in emerging and low-income countries, providing new emerging-market multinationals such as Xiaomi with a potential competitive edge over traditional players such as Samsung, Apple, and LG.11

Besides its superior aesthetic design and cutting-edge features, Apple’s products were differentiated from those of its competitors by its use of a proprietary operating system (iOS) and its connection to Apple’s successful iTunes website that offered multimedia content for the iPhone and other Apple products. Because of its differentiated position, Apple’s iPhone commanded a premium price, which drove up Apple’s profitability and market value.12

APPLE, THE IPHONE, AND CUSTOMER LOYALTY

Apple was not only the world’s most valuable company but also a hallmark of how information technology could change lives. The company was founded in 1976 and started to encroach into the personal computer market from the late 1980s and early 1990s onward. After the company nearly experienced a total collapse, it convinced co-founder Steve Jobs to return in 1997 to revive the company. Jobs and his team succeeded with great verve, launching such innovative products as the iPod and the iPad.13

However, Apple’s greatest success (as of the writing of this case) came from its debut in the smartphone market.14 Ever since the introduction of the first-generation iPhone in 2007, Apple was recognized as the Use outside these parameters is a copyright violation. market leader of the smartphone industry with its cutting-edge technology and design, enabling it to charge a premium price and obtain a very high profit margin. In 2013, Apple’s sales revenue reached $170 billion and its net income was more than $37 billion. In 2014, Apple’s revenue rose to nearly $183 billion, with net income reaching $39.51 billion. Apple experienced exponential growth since 2008 (see Exhibit 1), and the iPhone was the biggest contributor to its success (see Exhibit 2)

Apple customers were extremely loyal to Apple products, often also buying its computers and tablets alongside the iPhone. For example, a survey conducted by Simonlycontracts.co.uk found that nearly 60 per cent of 3,000 iPhone owners declared that they had “blind loyalty” to their iPhones, and 78 per cent said they couldn’t “imagine having a different type of phone.”15

The Foxconn Affair For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019.

Foxconn, headquartered in Taiwan, was one of Apple’s biggest and oldest suppliers. In 2014, Apple contributed more than 40 per cent of Foxconn’s revenue. It was the biggest privately owned company in Taiwan with $131.8 billion sales revenue in 2013, and operations that stretched around the globe. Despite

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its large size, Foxconn, as an original design manufacturer (ODM) had long been an unfamiliar name in the public eye, chiefly because it did not produce its own branded goods.

In 2009, however, the Foxconn name suddenly came to prominence when a factory worker reportedly committed suicide after losing a prototype of the iPhone 4. It was later alleged that the employee’s treatment during questioning came close to being torture. One year later, another 18 Foxconn workers attempted to kill themselves, and 14 died at the manufacturing company’s facilities.16 Various explanations were offered for these deaths. Poor labour practices and working conditions were considered to be the main motivations for the employee attempting to commit suicide. Ever since the 2010 incidents, the company had been under increased scrutiny and pressure to improve its working conditions from various stakeholders, including non- governmental organizations (NGOs), the media, and customers such as Apple.

The Pegatron Crisis

After the Foxconn scandal, Apple and its suppliers were under more scrutiny than ever before. Apple made various promises to improve its practices. One of Apple’s responses was to move some of its business away from Foxconn to Pegatron, a Taiwanese electronics manufacturing company that mainly assembled the iPhone 4, 4s, 5, and 5c, along with Apple’s iPad. The company’s factories were located in Taiwan, mainland China, the Czech Republic, and Mexico, while its customer service centres operated in the United States and Japan. Since it started producing Apple products in 2011, Pegatron showed remarkable increases in revenue that mirrored those of Apple itself, from TW$599.9 billion in 201117 to TW$881.2 billion in 201218 to TW$949.8 billion in 2013.19

In 2013, China Labor Watch (CLW), a U.S.-based NGO, whose mission was to increase the transparency of factory labour conditions in China, published Apple’s Unkept Promises, a report based on an undercover investigation into working conditions at Pegatron factories. The situation was even more serious than at Foxconn. According to the report, three Pegatron factories in China had violated 86 Chinese regulations, including 36 legal and 50 ethical violations, ranging from use of a juvenile workforce, to violations of women’s rights, excessive working hours, and environmental pollution. 20 In response to the public disclosure of the report, Apple again promised its full dedication to addressing those issues.21 Jason Cheng,

Pegatron’s chief executive officer (CEO), also stated, “We will investigate the allegations fully and take Use outside these parameters is a copyright violation. immediate actions to correct any violations to Chinese labour laws and our own code of conduct.”22

Nonetheless, on December 19, 2014, the global news media again accused Apple and Pegatron, alleging that Apple had “broken its promises.” The previous day, the influential BBC Panorama program had broadcast a documentary based on an undercover investigation of the actual practices and working conditions at a Shanghai factory owned by Pegatron. The factory specialized in producing Apple products, including the iPhone. A variety of poor practices were exposed. For example, workers had to hand in their identification cards before entering the factory, were given no basic health and safety training, and had to work excessive hours — up to 16 hours a day, which would sometimes continue for 18 consecutive days. According to the documentary, workers’ requests for a day off were routinely ignored. Another scene in the documentary showed workers who could not help but fall asleep in the middle of a busy production line. The quality of life outside the factory was also criticized. Dormitories were overcrowded, and 23 consisted of nothing but 12 tiny beds placed end to end. For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019.

Apple did not comment on camera for the BBC documentary, but the next day, Jeff Williams clearly expressed what he and Apple CEO, Tim Cook, felt about the documentary. Their “deeply offended” feelings were delivered to the 5,000 U.K. Apple employees in the form of a letter, which became public when it was published by the Daily Telegraph.24 In the letter, Williams said, “We know of no other company

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doing as much as Apple does to ensure fair and safe working conditions, to discover and investigate problems, to fix and follow through when issues arise, and to provide transparency into the operations of our suppliers.”

CSR CHALLENGES

In its 2014 progress report, Apple confidently remarked, “At Apple, we believe in making complex things simple.”25 This statement was an apt description of its products’ appeal to consumers and in the area of product design. Apple retained firm control to ensure it could deliver on this promise, but when it came to supply chain management, an approach of simplification could have its limitations. Given the global nature of Apple’s supply chain, the various products it produced, and the technological complexity of these products, Apple needed to work with a wide array of suppliers. To fulfill its “promise,” Apple needed to be aware of and appropriately manage all these relationships. Doing so raised various challenges.

Some of these challenges related to the various formal and informal national institutional regimes that applied to various offshore locations. Apple and its suppliers operated in very different cultural, legal, political, social, and economic environments. For example, its two key suppliers, Foxconn and Pegatron, conducted their manufacturing operations mostly in mainland China. The top 200 suppliers on Apple’s supplier list were scattered around the world, ranging from Korea, Japan, and Taiwan, through to Ireland and the Czech Republic.26 As much as Apple may have wanted to make complex things simple, it could not single-handedly change these diverse national environments to suit its own purposes. Apple and its suppliers faced completely different stakeholders with different expectations. Apple needed to deal with high expectations from consumers, employees, investors, NGOs, and governments in the United States and other developed countries, while most of the suppliers were located in emerging countries that had much lower expectations and different social values and norms. Forbes, for instance, commented on the Panorama documentary:

While these issues are faced by every manufacturer, only Apple was specifically named in the programme. More than any other company, Apple has been the leading target for campaigners on working conditions, but it seems unfair to single out one manufacturer for the alleged sins of an 27

industry. Use outside these parameters is a copyright violation.

No solitary manufacturer can walk into the supply chain and demand working conditions far in advance of the prevalent conditions of the country. Change will be gradual, and measured over years, if not decades.28

A second set of challenges related to maintaining close buyer-supplier relationships. Apple was notorious for its price policy, squeezing suppliers to produce products at lower and lower costs.29 An executive from one of Apple’s iPad producers stated that “the only way you make money working for Apple is figuring out how to do things more efficiently or cheaper . . . and then they’ll come back the next year, and force a 10 per cent price cut.”30 Companies such as Foxconn dealt with conflicting demands: meeting higher working standards, which included paying higher wages, reducing working hours, investing in safety programs, and providing training, while also accepting lower and lower prices from Apple.

For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. Foxconn appeared to have made an effort to improve working conditions and meet the required labour standards. This effort was recognized by the Fair Labour Organization, which announced improvements in labour practices in Foxconn factories. Ironically, however, Foxconn started losing orders from Apple around the same time that it had improved its labour practices, perhaps due to the increased per unit costs.31 Apple began to give more and more volume to rival supplier Pegatron. Apple argued that Tim Cook, himself a supply

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chain management expert, realized the need for supply chain diversity to reduce the dependence on a single supplier and to spread risks.32 Furthermore, some had hinted that the close relationship between Apple and Foxconn was partly built on the personal relationship between Steve Jobs and the president of Foxconn; when Jobs passed away, so did some of the inter-organizational relationship.33

However, the reason for the switch from Foxconn to Pegatron might have been less straightforward. It was suggested that Pegatron was willing to accept thinner margins than Foxconn,34 which in turn allowed Apple to produce a cheaper version of the iPhone 5 series, the iPhone 5c, while not undermining its profitability. According to the Wall Street Journal, Pegatron accepted a margin of 0.8 per cent, while Foxconn had been seeking 1.7 per cent.35 Interestingly Apple’s own gross margin was 38.6 per cent as of 2014 and 37.6 per cent in 2013.36 Some observers argued that with such small margins it was little wonder that suppliers breached costly regulations in the area of labour rights.37

A third set of challenges arose from differences in the companies’ objectives, particularly their objectives in terms of CSR. However, because of Apple’s huge size, stock market value, visibility, and (partly self- created) image, it faced more scrutiny than perhaps any company in the world. Writing in alphr, Barry Collins argued:

Apple doesn’t outright deny any of those allegations. Yet, it does pose the question: why pick on us? . . . It’s not the only tech company using cheap labour in Asian factories: in fact, show me one that isn’t. Panorama could equally have substituted Apple for Microsoft, Samsung, Sony, or even a British firm such as Tesco, which has its Hudl38 tablets made in the same factories as Apple does. Picking on Apple because it’s the only company that’s made a public commitment to improving worker welfare seems a little perverse.39

Simon Rockman of The Register commented, “while Apple may well be right . . . the difference lies in the gap between what the richest company in the world has said it would do, and what it has achieved in reaching the standards it set for itself.”40 According to Brad Reed:

The point of all this isn’t to say that Apple is an “evil” company or that anyone should feel guilty buying an iPhone or a Mac. I’m also not calling on Apple to pull manufacturing operations out of

China since I know how important these jobs are to people who work at them. Use outside these parameters is a copyright violation.

However, there’s nothing wrong with insisting that our favourite companies — whether we’re talking Apple, Samsung or Google — do better on issues of worker treatment, especially when they’ve repeatedly vowed to do so. Apple makes insane profit margins on its iPhones and it can certainly afford to commit more resources for ensuring that the people who manufacture them aren’t forced to work 18 days in a row.41

Reed’s comments in fact seemed to resonate with the company itself because even Williams mentioned in his letter that Apple “can still do better.”42

Finally, it was important to acknowledge that individuals differed in their assessment of how much attention should be paid to these labour rights issues and what constituted an acceptable level of working conditions.

According to a New York Times article, Richard Locke, a professor at Brown University, “had studied working For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. conditions for many companies, and Apple has gone beyond standard practices.”43 But at the same time, Li Qiang, the executive director of CLW, said, “Apple is always finding excuses for its unrealized commitments. We are focused on what Apple does, not what it says.” 44 Such differences in perception were almost

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impossible to avoid in cases like this, but they did pose a fourth set of challenges faced by Apple: Did it want to satisfy its harshest critics, or was it enough to please a mainstream Apple consumer?

APPLE AND OFFSHORE OUTSOURCING

“Designed by Apple in California” and “Assembled in China,” read a statement imprinted on the back of Apple’s iPhones and iPads and on the bottom of its Mac products, neatly capturing Apple’s strategy of offshore outsourcing. As of 2004, with the closure of its very last U.S. manufacturing line, Apple was outsourcing all of its production and assembly lines to global suppliers, mainly in China.45 Prior to that, Apple was rather proud of its products being produced in America. But like other western companies, Apple found it difficult to resist the lure of offshore outsourcing.

It was estimated that around 90 per cent of the iPhone’s parts were manufactured overseas. German and Taiwanese contractors provided advanced semiconductors, while Korean suppliers provided memory and display panels. Those components, coupled with chipsets supplied from Europe and elsewhere, were ultimately assembled in China.46 Apple’s sophisticated supply chain offered the needed flexibility to meet fluctuating demand. Just before the debut of the first iPhone in 2007, Steve Jobs realized that the screen material needed be changed from plastic to glass so it would not get scratched. He was quoted as saying, “I want a glass screen. . . . I want it perfect in six weeks.”47

While no American company could produce the glass screens in a month, a Chinese company was able to make them. To meet Apple’s last-minute changes and orders, thousands more workers were needed overnight, leading to work shifts being increased at short notice.48 As put by Jennifer Rigoni, Apple’s former worldwide supply demand manager, “They [the suppliers] could hire 3,000 people overnight. . . . What U.S. plant can find 3,000 people overnight and convince them to live in dorms?”49

It also helped that wages in the Chinese factories were very low. According to CLW’s 2013 report, the base wage of Pegatron factory workers in Shanghai was the equivalent of approximately $1.50 per hour.50 The same report disclosed that most workers wanted to leave the factory after having experienced such harsh working conditions. In one of the Pegatron factories, AVY in Suzhou, more than a quarter of the new workers left within a two-week period.51 Use outside these parameters is a copyright violation.

Offshoring, however, was not looked upon favourably in the United States because it was considered to amount to a loss of job opportunities. In February 2011, when the president of the United States, Barrack Obama, asked Jobs, “Why can’t that work come home?” Jobs answered conclusively, “Those jobs aren’t coming back.”52 An anonymous executive of Apple gave a sullen response saying, “We shouldn’t be criticized for using Chinese workers. . . . The United States has stopped producing people with the skills we need.”53 The company overtly announced that moving work overseas was an inevitable choice and the continuing relocation of jobs was driven not only by lower costs.54

Despite the public controversy about Apple’s choices and the loss of domestic job opportunities in the United States, the relocation seemed to make perfect sense. Offshore suppliers in China, India, and elsewhere had a proven ability to produce what was needed, whereas the United States did not have enough 55

capable and skilled workers. To some extent, it was simply a numbers game. But Apple also argued that For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. it could produce more jobs in the United States through offshoring because American workers could then focus on higher value-added activities such as research and design.56

Offshore outsourcing might have significantly reduced Apple’s operating costs. At the same time, however, it also decreased Apple’s level of control and monitoring over manufacturing processes and practices.

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Although Apple prepared codes of conduct and enforced its suppliers to comply with those standards, in the absence of day-to-day monitoring, compliance was difficult to ensure. Of course, this problem was faced not only by Apple; Samsung and other smartphone producers often sourced from these same factories. But doing so represented a fundamental trade-off that any such firm would need to deal with.

SHOULD APPLE CARE?

The CSR failures did not seem to affect Apple’s business performance. In 2015, it topped the Forbes list of “The World’s Most Valuable Brands,”57 and ranked 12th in the “Global 2000” list,58 and 55th among America’s Best Employers.59 Furthermore, it still had unshakable customer loyalty that did not seem to have been negatively affected by the alleged socially irresponsible actions of its key suppliers. This situation invited the question: How much should Apple really care about socially irresponsible actions of its suppliers?

THE ROAD AHEAD

Given the circumstances, Apple and Williams still had several options available. But what option would give Apple the best outcomes? Should Apple continue as it was and take for granted the occasional bit of negative publicity? The company had perhaps already done more than its fair share to tackle CSR problems in its supply chain.60 On the other hand, maybe Apple could, and should, do more to tackle what had turned out to be a complex issue. Should Apple seek to work more to improve working conditions, such as by working with NGOs and transnational organizations? Should it engage in even more monitoring? Perhaps it could even go so far as to bring production in-house, in an attempt to regain control. A more radical solution would be to bring manufacturing back to the United States, which might become possible in the future, given increased levels of automation and robotization. But how would such changes affect Apple’s profit margins — and perhaps even more importantly, would Apple’s many customers in China respond negatively to such a move? Use outside these parameters is a copyright violation. For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019.

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EXHIBIT 1: APPLE’S NET SALES AND NET INCOME, 2008–2014 (IN US$ MILLIONS)

200,000 Net sales Net income 180,000 160,000 140,000 120,000 100,000 80,000 60,000 40,000 20,000 - 2008 2009 2010 2011 2012 2013 2014 Net sales 37,491 42,905 65,225 108,249 156,508 170,910 182,795 Net income 6,119 8,235 14,013 25,992 41,733 37,037 39,510

Source: Apple Inc., “Form 10-K: For the Fiscal Year Ended September 27, 2014,” EDGAR Online, accessed December 17, 2015.

EXHIBIT 2: APPLE’S NET SALES BY PRODUCT, 2011–2014 (IN US$ MILLIONS)

Net Sales 120,000

100,000

80,000 Use outside these parameters is a copyright violation. 60,000

40,000

20,000

‐ iPhone iPad Mac iPod iTunes, Accessories Software and services

2011 2012 2013 2014

Source: Apple Inc., “Form 10-K: For the Fiscal Year Ended September 27, 2014,” EDGAR Online, accessed December 17, 2015. For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019.

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ENDNOTES

1 BBC News, “Apple Accused of Failing to Protect Workers,” YouTube video, 3:03, December 18, 2014, accessed December 17, 2015, www.youtube.com/watch?v=kSvT02q4h40. 2 Supplier Responsibility 2014 Progress Report, Apple Inc., January 2014, 4, accessed December 17, 2015, www.apple.com/supplier-responsibility/pdf/Apple_SR_2014_Progress_Report.pdf. 3 Supplier Responsibility 2015 Progress Report, Apple Inc., January 2015, 5, accessed December 17, 2015, www.apple.com/supplier-responsibility/pdf/Apple_Progress_Report_2015.pdf. 4 Kathryn Dill, “The Companies with the Best CSR Reputations,” Forbes, December 8, 2014, accessed January 10, 2016, www.forbes.com/sites/kathryndill/2014/12/08/the-companies-with-the-best-csr-reputations/. 5 All figures are in US$ unless otherwise specified; Graham Ruddick, “Apple Could be Worth $1 Trillion, Says Wall Street,” Telegraph, March 23, 2015, accessed October 16, 2015, www.telegraph.co.uk/technology/apple/11490367/Apple-could-be- worth-1-trillion-says-Wall-Street.html. 6 Adeyemi Adepetum, “Smartphone Industry Earns $380b Revenue 2014,” The Guardian, June 3, 2015, accessed October 16, 2015, www.ngrguardiannews.com/2015/06/smartphone-industry-earns-380b-revenue-in-2014/. 7 Rob Price, “Apple Is Taking 92% of Profits in the Entire Smartphone Industry,” Business Insider UK, July 13, 2015, accessed October 16, 2015, http://uk.businessinsider.com/apple-92-percent-profits-entire-smartphone-industry-q1-samsung-2015-7. 8 Simon Sharwood, “Lenovo Tops China’s Smartphone Market in Just Six Months,” The Register, October 30, 2012, accessed February 26, 2016, www.theregister.co.uk/2012/10/30/lenovo_chinas_number_one_smartphone_maker/. 9 T. Florin, “This Is Xiaomi’s Impressive Army of Smartphones,” phoneArena, January 31, 2015, accessed January 10, 2016, www.phonearena.com/news/This-is-Xiaomis-impressive-army-of-smartphones_id65427. 10 David Gilbert, “Chinese Brands, Huawei, Lenovo, Xiaomi and More Dominate Global Smartphone Industry,” International Business Times, February 9, 2015, accessed January 7, 2016, www.ibtimes.com/chinese-brands-huawei-lenovo-xiaomi- more-dominate-global-smartphone-industry-2078834. 11 Eva Dou, “Xiaomi, China’s New Phone Giant, Takes Aim at World,” The Wall Street Journal, June 7, 2015, accessed January 7, 2016, www.wsj.com/articles/xiaomi-chinas-new-phone-giant-takes-aim-at-world-1433731461. 12 Lior Ronen, “Xiaomi a Threat to Apple, Samsung Smartphone Dominance,” Amigobulls, November 12, 2014, accessed February 20, 2016, http://amigobulls.com/articles/xiaomi-a-threat-to-apple-samsung-smartphone-dominance. 13 Owen W. Linzmayer, “30 Pivotal Moments in Apple’s History,” Macworld, March 30, 2006, accessed January 7, 2016, www.macworld.com/article/1050112/30moments.html. 14 Henry Blodget, “In Case You Had Any Doubts about Where Apple’s Profit Comes From,” Business Insider, August 2, 2012, accessed 7 January, 2016, www.businessinsider.com/iphone-profit-2012-8?IR=T. 15 Matthew Sparkes, “iPhone Owners Admit Having ‘Blind Loyalty’ to Apple,” The Telegraph, February 12, 2014, accessed December 17, 2015, www.telegraph.co.uk/technology/apple/10632787/iPhone-owners-admit-having-blind-loyalty-to-Apple.html. 16 Malcolm Moore, “‘Mass Suicide’ Protest at Apple Manufacturer Foxconn Factory,” The Guardian, January 11, 2012, accessed December 17, 2015, www.telegraph.co.uk/news/worldnews/asia/china/9006988/Mass-suicide-protest-at-Apple- manufacturer-Foxconn-factory.html. 17 TWD = Taiwanese dollar; US$1 = TW$30.29 on December 30, 2011. 18 TWD = Taiwanese dollar; US$1 = TW$29.03 on December 31, 2012. 19 TWD = Taiwanese dollar; US$1 = TW$29.83 on December 31, 2013. 20 China Labor Watch, Apple’s Unkept Promises: Investigation of Three Pegatron Group Factories Supplying to Apple, July Use outside these parameters is a copyright violation. 29, 2013, accessed December 17, 2015, www.chinalaborwatch.org/report/68. 21 Paul Mozur, “Apple’s Response to Latest Supplier Labor Abuse Allegations,” The Wall Street Journal, July 29, 2013, accessed January 7, 2016, http://blogs.wsj.com/chinarealtime/2013/07/29/apples-response-to-pegatron-worker-allegations/. 22 Associated Press reporter, “Chinese Workers’ Group Accuses Apple of Ignoring Pledges to Protect Staff and Continuing to Use Sweatshops to Make iPhones,” Daily Mail, July 29, 2013, accessed February 3, 2015, www.dailymail.co.uk/news/article- 2380881/Chinese-workers-group-accuse-Apple-ignoring-pledges-protect-staff-continuing-use-sweatshops-make- iPhones.html. 23 Richard Bilton, “Apple ‘Failing to Protect Chinese Factory Workers’,” BBC News, December 18, 2014, accessed January 7, 2016, www.bbc.co.uk/news/business-30532463. 24 Rhiannon Williams, “Read: Apple’s Letter to UK Staff over Chinese Factory Conditions,” The Telegraph, December 19, 2014, accessed December 20, 2014, www.telegraph.co.uk/technology/apple/11303406/Read-Apples-letter-to-UK-staff-over- Chinese-factory-conditions.html. 25 Supplier Responsibility 2014 Progress Report, op. cit. 26 Apple Inc., “Supplier List 2015,” 2015, accessed January 7, 2016, www.apple.com/supplier- responsibility/pdf/Apple_Supplier_List_2015.pdf. 27 Ewan Spence, “BBC Attacks Apple over Familiar Allegations in Panorama Investigation Over Working Conditions,” Forbes, December 18, 2014, accessed December 17, 2015, www.forbes.com/sites/ewanspence/2014/12/18/bbc-attacks-apple-with- For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. familiar-allegations-in-panorama-investigation-over-working-conditions/. 28 Ewan Spence, “Apple Loop: iOS 8.2 Details, Apple’s Working Conditions Attacked, Ignore Apple Watch,” Forbes, December 18, 2014, accessed December 17, 2015, www.forbes.com/sites/ewanspence/2014/12/19/apple-news-digest-ios-8-2-preview/. 29 Noel Randewich and Reiji Murai, “GT Advanced Bankruptcy Offers Warning to Apple Suppliers,” Reuters, October 8, 2014, accessed January 7, 2016, www.reuters.com/article/us-apple-gt-advanced-tech-idUSKCN0HX0XV20141008.

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30 Charles Duhigg and David Barboza, “In China, Human Costs Are Built into an iPad,” The New York Times, January 25, 2012, accessed December 17, 2015, www.nytimes.com/2012/01/26/business/ieconomy-apples-ipad-and-the-human-costs- for-workers-in-china.html. 31 Eva Dou, “Apple Shifts Supply Chain Away From Foxconn to Pegatron,” The Wall Street Journal, May 29, 2013, accessed March 7, 2016, www.theinquirer.net/inquirer/news/2271769/apple-shifts-production-from-foxconn-to-pegatron 32 Mikey Campbell, “Apple Reportedly Looking to Pegatron in Supply Chain Diversification Away From Foxconn,” Apple Insider, May 29, 2013, accessed January 7, 2016, http://appleinsider.com/articles/13/05/29/apple-reportedly-looking-to-pegatron-in- supply-chain-shift-away-from-foxconn. 33 Dou, “Apple Shifts Supply Chain Way from Foxconn to Pegatron,” op. cit. 34 Neil McAllister, “Apple Says ‘Zai Jian’ to Foxconn, Taps Pegatron for New iPhones,” The Register, May 30, 2013, accessed January 7, 2016, www.theregister.co.uk/2013/05/30/apple_taps_pegatron_for_cheaper_iphones/. 35 Dou, “Apple Shifts Supply Chain Away From Foxconn to Pegatron,” op. cit. 36 Apple Inc., “Form 10-K for the Fiscal Year Ended September 27, 2014,” accessed March 7, 2016, http://investor.apple.com/secfiling.cfm?filingid=1193125-14-383437. 37 Aditya Chakrabortty, “The Woman Who Nearly Died Making Your iPad,” The Guardian, August 5, 2013, accessed January 7, 2016, www.theguardian.com/commentisfree/2013/aug/05/woman-nearly-died-making-ipad; Sarah Mishkin, “Overtime Work at Foxconn Still Beyond China’s Legal Limits,” Financial Times, December 12, 2013, accessed January 7, 2016, www.ft.com/cms/s/0/af799a06-6334-11e3-a87d-00144feabdc0.html#axzz3wZbqcdNt. 38 The Hudl was a tablet computer produced by Pegatron for the British supermarket chain Tesco. 39 Barry Collins, “Bad Apple or the Best of a Bad Bunch? The Sad Reality about Apple’s Broken Promises From BBC Panorama,” Alphr, December 19, 2014, accessed December 17, 2015, www.alphr.com/smartphones/1000196/bad-apple-or- the-best-of-a-bad-bunch-the-sad-reality-about-apples-broken. 40 Simon Rockman, “Apple v BBC: Fruity Firm Hits Back over Panorama Drama,” The Register, December 19, 2014, accessed December 17, 2015, www.theregister.co.uk/2014/12/19/apple_vs_beeb_fruitier_hits_back_on_worker_rights_wrongs_issue/. 41 Brad Reed, “Apple’s Response to the BBC’s Sweatshop Labor Report Is Completely Tone Deaf,” BGR, December 19, 2014, accessed December 17, 2015, http://bgr.com/2014/12/19/apple-china-factory-conditions-response/. 42 Williams, op. cit. 43 Brian X. Chen, “BBC Documentary Shows Harsh Conditions for Workers in iPhone Factories,” The New York Times, December 19, 2014, accessed December 17, 2015, http://bits.blogs.nytimes.com/2014/12/19/bbc-documentary-shows-harsh- conditions-for-workers-in-iphone-factories/. 44 China Labor Watch, “Apple’s Unkept Promises on Working Conditions Continue,” press release, December 19, 2014, accessed December 17, 2015, www.chinalaborwatch.org/newscast/421. 45 Marcelo Prince and Willa Plank. “A Short History of Apple’s Manufacturing in the U.S,” The Wall Street Journal, December 6, 2012, accessed January 7, 2016, http://blogs.wsj.com/digits/2012/12/06/a-short-history-of-apples-manufacturing-in-the-u-s/. 46 Charles Duhigg and Keith Bradsher, “How the U.S. Lost out on iPhone Work,” The New York Times, January 21, 2012, accessed February 21, 2016, www.nytimes.com/2012/01/22/business/apple-america-and-a-squeezed-middle-class.html?_r=0. 47 Henry Blodget, “Steve Jobs Freaked out a Month Before First iPhone was Released and Demanded a New Screen,” Business Insider, January 22, 2012, accessed February 20, 2016, www.businessinsider.com/steve-jobs-new-iphone-screen- 2012-1?IR=T. 48

Ibid. Use outside these parameters is a copyright violation. 49 Duhigg and Bradsher, op. cit. 50 China Labor Watch, “Apple’s Unkept Promises: Investigation of Three Pegatron Group Factories Supplying to Apple,” op. cit. 51 Ibid. 52 Duhigg and Bradsher, op. cit. 53 Ibid. 54 Josh Ong, “Apple’s Overseas Manufacturing Operations Offer Flexibility, Not Just Savings — Report,” Appleinsider, January 22, 2012, accessed October 16, 2015, http://appleinsider.com/articles/12/01/22/apples_overseas_manufacturing_ operations_offer_much_needed_flexibility_not_just_savings. 55 Drake Baer, “Steve Jobs and President Obama Had a Dinner Together in 2011 That May Have Changed the Course of US History,” Business Insider, January 8, 2015, accessed February 20, 2016, http://uk.businessinsider.com/when-steves-jobs- and-barack-obama-dined-2015-1?r=US&IR=T. 56 Ryan Avent, “Apple and the American Economy,” The Economist, January 23, 2012, accessed February 20, 2016, www.economist.com/blogs/freeexchange/2012/01/supply-chains. 57 “The World's Most Valuable Brands,” Forbes, 2015, accessed January 7, 2016, www.forbes.com/powerful-brands/list/. 58 “The World’s Biggest Public Companies,” Forbes, 2015, accessed January 7, 2016, www.forbes.com/global2000/list/#tab:overall. 59 “America’s Best Employers,” Forbes, 2015, accessed March 7, 2016, www.forbes.com/sites/clareoconnor/2015/03/25/ For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. americas-best-employers-2015/#157418596ceb. 60 Richard Welford, “Media Misreporting and Apple’s CSR,” CSR Asia, accessed February 20, 2016, www.csr- asia.com/test/home/csr-asia-weekly-news-detail.php?id=11962.

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9B09M019

IMAX: LARGER THAN LIFE1

Anil Nair wrote this case solely to provide material for class discussion. The author does not intend to illustrate either effective or ineffective handling of a managerial situation. The author may have disguised certain names and other identifying information to protect confidentiality.

FLASHBACK 2004

In Daytona, Florida, John watched a racecar going at more than 100 miles per hour crash into a concrete barrier. John ducked to escape the debris that appeared to be flying straight at him. A few moments later John was virtually within a racecar, next to the driver, zooming at more than 120 miles per hour around the racetrack. For the next half an hour, John experienced in three dimensions and on a larger-than-life scale crashing cars, dizzying turns, efficient pit crews, shining metal, burning rubber, swirling gas fumes and screaming fans. Finally, as the overhead lights at the theater gradually lit up, the audience sitting around John started applauding. John had just witnessed a screening of the IMAX movie NASCAR.

NASCAR set a box-office record as an original IMAX 3D film with the highest grossing opening weekend

and the highest per-screen average. At $21,579, NASCAR’s per-screen average was higher than that of the Use outside these parameters is a copyright violation. weekend’s top 10 films.2 Reports of NASCAR’s box-office success would have surely pleased Richard Gelfond and Bradley Wechsler, the co-CEOs of IMAX Corporation.

INTRODUCTION

Gelfond and Wechsler had bought IMAX along with Wasserstein Perella Partners from the original owners in 1994 for $80 million. They took it public the same year to raise capital to fund IMAX’s growth. For investors in IMAX, the years since then had been like a ride on a rollercoaster in the IMAX film Thrill Ride: exciting peaks when movies achieved commercial and critical acclaim, and scary drops when analysts questioned whether a niche player such as IMAX would be able to achieve consistent growth or even survive.

For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. NASCAR’s success at the box office was evidence that the co-CEOs’ efforts to reach a new audience — distinct from those typically attracted to IMAX’s educational documentaries — might work. Another movie that was indicative of IMAX’s emerging strategy was The Polar Express. The Polar Express was the first time a Hollywood movie would be released simultaneously in commercial multiplexes and IMAX

1 This case has been written on the basis of published sources only. Consequently, the interpretation and perspectives presented in this case are not necessarily those of IMAX or any of its employees. 2 IMAX press release, March 14, 2004.

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theaters. NASCAR and The Polar Express were symbolic of the direction in which Gelfond and Wechsler had pushed the company to achieve faster growth and higher margins. The two-pronged strategy involved expanding the reach of IMAX by (a) going beyond its cloistered museum environments into multiplexes and (b) presenting Hollywood films in IMAX format.

Despite the success of NASCAR and The Polar Express, IMAX faced several questions about its future:

 Could IMAX thrive as a niche player that made large format films and systems?  Would increasing the number of Hollywood movies released in IMAX format save the firm or dilute the IMAX brand?  Should Hollywood movies be released simultaneously in regular and large format?

THE BACKGROUND SCORE

Since the first moving images flickered in a dark theater, movies have captivated audiences around the world. About the time that people were getting familiar with programming their VCRs and learning to enjoy movies on the small television screen, a small group of people was developing a technology to project movies on giant screens. The idea for IMAX originated in 1967 when the success of a multi-screen theater system at the Montreal Expo led filmmakers Graeme Ferguson, Robert Kerr and Roman Kroitor to create a large format movie system. IMAX was founded as the only company in the world that was involved in all aspects of large format films. The first IMAX film premiered in 1970 at the Fuji Pavilion in Osaka, Japan.

IMAX was listed in the NASDAQ exchange in 1994 and achieved a market capitalization of $196 million in the first year itself.3 As of December 12, 2008, market capitalization was down to $125 million. There were about 295 theaters showing IMAX movies in 40 countries, with almost 60 per cent of the theaters in North America.4 Almost 50 per cent of the theaters were located in museums, aquariums, zoos and other institutions, and about the same percentage had the IMAX 3D technology. The IMAX movie library at the end of 2007 stood at 226 films; some produced by IMAX, many others produced by independent filmmakers or studios such as Time Warner. In 2007/2008, some of the well-known films to be released in IMAX included Harry Potter and the Order of the Phoenix, Shine a Light — a film about the Rolling Use outside these parameters is a copyright violation. Stones by the famous film director Martin Scorcese — and The Spiderwick Chronicles.

THE IMAX STORY

Scope of IMAX

The company’s main sources of revenues were long-term theater system lease and maintenance agreements, film production and distribution, and theater operations. Given its scope of operations, IMAX could be considered a part of three different industries: Photographic Equipment and Supplies (SIC code 3861), Motion Picture and Video Tape Production (SIC code 7812), and Motion Picture and Video Distribution (SIC code 7822). IMAX was a relatively small firm compared to a rival studio such as Disney/Pixar or a theater chain such as Regal Entertainment. For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019.

3 S. N. Chakravarty, “A really big show,” Institutional Investor, 35:10, October 2002, p. 20. 4 Hoover’s, www.Hoovers.com.

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In 2007, it generated $59.12 million (51.04 per cent of total revenue) from IMAX systems sales, $36.57 million (31.57 per cent of total revenue) from films and $16.58 million (14.31 per cent of total revenue) from theater operations.5 Order trends suggested that newer agreements were for 3D systems. The theater leases were generally for 10 to 20 years and renewable by the customer. As part of the lease, IMAX advised customers on theater design, supervised the installation of the system, trained theater staff and maintained the system.6

Inside IMAX

Hardware: The Film Technology

IMAX films were printed on films that were 10 times larger than the 35 mm films that were used in traditional multiplexes and were projected on screens that were (on average) eight stories high (approximately 88 feet) and 120-feet-wide, or in domes that were 81 feet in diameter. See Exhibit 1 for a comparison of 35 mm and IMAX film sizes.

IMAX theaters were designed so that projected images stretched up to the peripheral vision of the viewer, thus the viewer was completely immersed in the scene. Each frame of an IMAX film had 15 sprocket holes to guide it through projectors (compared to four in each frame of a 35 mm film). The films were projected onto screens by IMAX-designed projectors that had special features — a higher shutter speed, rolling loop motion and vacuum to hold the film to the lens.7 IMAX projectors used 15,000-watt bulbs, whereas the regular 35 mm projectors used bulbs between 3,000-4,000 watts. The projectors were cooled by circulating more than 50,000 cubic feet of air and nine gallons of distilled water per minute. These features of the IMAX projection system produced images on-screen that were brighter and sharper than those found in conventional movie theaters.

IMAX had developed the skills, knowledge and capabilities to design and assemble the critical elements involved in its projector and camera systems, though most of the components were purchased from vendors with whom it maintained long-term relationships. Strict quality control of components and end products had ensured an average service time of 99.9 per cent for its equipments installed in theaters.

Company personnel visited each theater for servicing the systems; the projection systems were serviced Use outside these parameters is a copyright violation. every three months and the audio systems were serviced once a year.

In 2007, IMAX spent almost five per cent of its sales revenue on Research and Development, and 50 of its 318 employees were involved in it. The company had spent about $12.6 million in R & D in the past three years.8 It had also received grants from Ontario Technology Fund for its R & D, and held 46 patents and had seven patents pending in the United States.9 IMAX had successfully developed 3D cameras and projection systems to produce realistic 3D images. The audience used polarized or electronic glasses that split the images for the left and right eye by using liquid crystal shutter lenses that were controlled by an infrared signal and opened and shut 48 times per second in coordination with the projector to create a 3D effect. Another example of the firm’s technological capabilities was a lightweight 3D camera that it had developed to shoot a movie about the International Space Station in space. IMAX worked with MSM Design, a small firm owned by Marty and Barbara Mueller, and developed a camera that weighed only 90 For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019.

5 Annual Report, 2007. 6 Annual Reports. 7 Computer-Aided Engineering, 15:8, 1996, pp. 8-9. 8 Annual Report, 2007. 9 Annual Report, 2007.

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pounds, compared to the traditional IMAX 3D cameras that weighed 228 pounds.10 IMAX 3D projectors were also capable of projecting 2D images. The visuals were supported by six-channel digital audio that typically produced 12,000 watts of realistic, distortion-free sound. The sound systems were developed by Sonics Associates Inc., a subsidiary in which IMAX had 51 per cent ownership. The company had even developed a 3D directional sound technology that offered location and depth to the audio. A testament to IMAX’s technological prowess was the 1997 Oscar Award it received for Scientific and Technical Achievement.11

Because of its larger size, printing and distributing IMAX films was costlier than 35 mm films. IMAX had developed digital cameras and projectors that it planned to install in theaters starting in 2008 so that it could produce and distribute its movies in digital format. While the conversion to digital format required substantial upfront investment, it was expected that this shift would allow IMAX to lower its operational costs (of film production and distribution) significantly.

Software: IMAX Films

The motion picture industry produced several types of movies: horror, adventure, comedy, romantic comedy, family, drama and documentaries. Of these, the documentary segment was considered so significant that the Motion Picture Association of America (MPAA), in its annual Oscar Award ceremony, gave out separate awards for these films. While the large format film itself was a unique feature of IMAX, it had also differentiated itself by its library of films and locations. IMAX films were often educational and entertaining, and involved documentaries of natural and scientific wonders such as the Grand Canyon, space stations, etc. An IMAX film, Fires of Kuwait, was nominated for an Academy Award in 1993.

By locating itself in prestigious venues such as the Smithsonian Institution in Washington, Liberty Science Center in New Jersey, Museum of Science and Industry in Chicago, and Port Vell in Barcelona, Spain, the firm had created a unique brand image. In an interview with CNN, co-CEO Gelfond noted IMAX’s advantage: “IMAX is also a brand, so we don’t have to pay the same kind of talent that Hollywood has to pay, which is really a huge percentage of the costs. Once you take those costs down and you look at just making the film with the world around you as the talent, you get into much more manageable budget ranges. A typical two-dimensional film at IMAX is about $5 million; a typical 3D film at IMAX is about Use outside these parameters is a copyright violation. $10 million.”12 Hollywood studios would have to pay a major star (such as Tom Cruise or Eddie Murphy) more than $10 million for a movie. While top movie stars were celebrities and drew huge compensation, many others involved in the production, distribution and marketing of a film were neither well-known nor highly paid. In 2007, according to the Bureau of Labor Statistics (BLS), the median salary for an actor in the motion picture and video industry was about $17 per hour.13 Some of these talents had formed unions, such as the Screen Artists Guild, to negotiate higher wages for their labor. The disruption of TV programming in spring 2008 caused by the brief Writers Guild strike was suggestive of the power such groups had on studios.

Besides stars, the other major cost of movie-making was the marketing. It was estimated that a studio spent almost 30-50 per cent of the total cost of production and distribution of a movie on its marketing.

10 “Cam programming helps design 3d IMAX movie camera for NASA,” Computer Aided Engineering, 19:3, March 2000, p. For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. 10. 11 W. C. Symonds, “Now showing in IMAX: Money!; The giant-screen technology will even bag an Oscar,” Business Week, 3520, March 31, 1997, p. 80. 12 D. Michael, “Bigger is better: IMAX knocking competition down to size,” CNN, November 6, 1998, www.cnn.com/SHOWBIZ/Movies/9811/06/imax/index.html?iref=newssearch, accessed March 23, 2008. 13 www.bls.gov/oes/current/naics4_711500.htm, accessed December 23, 2008.

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According to the Motion Picture Association of America (MPAA), the average cost of making and marketing a movie rose to more than $106 million in 2007, with marketing budgets averaging $36 million.14 The marketing of the movie was done through several channels, such as TV, the press, theaters, websites and promotions with retailers. See Exhibit 2 for average spending in each media. For example, most kids’ movies released by studios, such as Disney and SKG Dreamworks were promoted through tie- ups with restaurants, such as McDonald’s and Burger King, and also toy manufactures and other retailers. The Hollywood business model used the awareness created by the presence of stars and substantial marketing budgets to draw large audiences into theaters in the opening weekend itself.15 To achieve high ticket sales on opening weekends, large numbers of prints of the movie were distributed. In contrast, traditionally, IMAX had not marketed its films aggressively. The company did have a sales force and marketing staff at its offices in Canada, the United States, Europe, Japan and China to market its theater systems. The movies were sold to theaters separately; as such, there was no national marketing or advertising.16 Unlike Hollywood movies that had short lifespans in the theater circuit and were then withdrawn for release on DVD and pay-per-view format, IMAX films were often shown in theaters for years after their release. In recent years, IMAX films had received some marketing support. For example, for IMAX movie Everest, producer Greg MacGillivray spent $2 million in marketing and reportedly saw a 20-45 per cent increase in box-office revenues at each theater. Moreover, IMAX’s alliances were helping in cross-promoting its movies. For example, for its T-Rex: Back to the Cretaceous 3-D movie, it had a month-long promo on Showtime that was also shown in Imaginarium stores in malls across the United States.17 The increasing number of Hollywood movies that were released in IMAX format allowed IMAX to ride on the coat tails of marketing campaigns launched by the studios.

IMAX films were often produced by the firm, or partially or fully financed by other parties. The firm hired the talent for the film on a project-by-project basis. Most of the post-production work was performed at David Keighley Production, a wholly-owned subsidiary of IMAX. IMAX (and any investors or sponsors) shared the ownership rights for a film, while usually IMAX controlled the distribution rights. As a result, IMAX had the distribution rights to the largest number of large format films. The distributor received a percentage of the theater box office revenues. IMAX films often remained in distribution for four or five years. (See Exhibit 3 for box office revenues for IMAX films.)

Generating Growth Use outside these parameters is a copyright violation.

IMAX used a two-pronged strategy to maintain its growth. First, it had sought to expand beyond its institutional environment by opening IMAX theaters within multiplexes or converting existing multiplexes’ screens to IMAX format. Second, it had launched Hollywood films in IMAX format.

An IMAX Near You

While early IMAX theaters were mostly located in institutional settings such as museums and aquariums, to reach a wider audience IMAX had engaged in alliances with commercial movie theater owners.18 It

14 M. Marr, “Now playing: Expensive movies; Average cost of a film tops $100 million for first time; Valenti set to leave MPAA,” The Wall Street Journal, March 24, 2004, p. B. 4, www.mpaa.org/researchStatistics.asp, accessed December 23, For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. 2008. 15 Adam Leipzig, “How to Sell a Movie (or Fail) in Four Hours,” The New York Times, November 13, 2005. 16 D. Oestricher, “IMAX hopes for big run with Matrix,” The Wall Street Journal, June 18, 2003, p. b5c. 17 T. L. Stanley, “IMAX lands showtime, GTE for 1st X-Promo,” Brandweek, July 13, 1998, 39:28, p. 5. 18 L. Gubernick, Hollywood Journal: Hollywood think bigger — your favorites, only taller: Can re-released movies breathe life into IMAX,” The Wall Street Journal, February 15, 2002, p. W. 5.

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grew rapidly during the late 1990s as theater owners, such as AMC, Cinemark and Regal, went on a building spree and bought IMAX systems to install in their multiplexes. According to Wechsler, this strategy backfired when IMAX could not escape the crisis that hit the theater industry in the late 1990s because of the overbuilding during that decade. As many theater-owners filed for bankruptcy, IMAX had to engage in belt-tightening of its own because of its receivable problems. Moody’s downgraded IMAX’s debt of $200 million senior notes from Ba2 to B2 and a $100 million note from B1 to Caa1 because of the risk of default by customers. In response, IMAX cut $14 million in overhead, laid off 200 employees and bought back $90 million of its debt.19 Debt remained a critical problem for IMAX (See Exhibits 4, 5 and 6 for IMAX financials).

In recent years, IMAX entered into partnerships with AMC and Regal Cinemas to screen IMAX films in multiplexes using its MPX technology. MPX technology allowed IMAX and theater-owners to convert traditional theaters to IMAX format.20 It was estimated that it now cost only $175,000 to retrofit a multiplex and another $500,000 to install the IMAX system.21 Regal Cinemas had built IMAX theaters in several markets and waited to see how they performed before adding more.22 In March 2008, it signed another agreement with IMAX for 38 more theaters, bringing the total number of Regal IMAX theaters to 52 by 2010. Regal theaters would charge $2.50-5.00 more than their regular feature admission for IMAX films. 23 In December 2007, IMAX signed a deal with AMC to install 100 IMAX digital theaters systems in 33 markets, thereby substantially increasing its presence in the U.S. market. IMAX had identified 655 multiplexes without an IMAX nearby.24 However, IMAX co-CEO Wechsler had stated that he did not expect IMAX theaters to be ubiquitous but exclusive, like flying first-class; while co-CEO Gelfond had suggested that the IMAX experience would be so unique that it could not be replicated at home. Consistent with this vision, the theater agreement that it recently signed gave AMC territorial exclusivity.25 Unlike past agreements where theaters chains bought the system from IMAX, the newer agreements required the partner theater chain to make the investment for retrofitting the theater, while IMAX paid for the system installation in return for revenue-sharing on future ticket sales. Analysts expected that such agreements (and digital conversion) would lower IMAX’s capital requirements and help it pay off its debt.26

Go West IMAX!

Use outside these parameters is a copyright violation. Another strategic move by IMAX to ensure its growth was the conversion of Hollywood movies into IMAX format. IMAX had developed a patented digital re-mastering (DMR) technology that allowed it to convert traditional 35 mm films, such as Harry Potter, Spiderman, Antz and The Simpsons, into the large- screen format and even develop 3D versions of such movies. The development of this technology was critical because merely projecting a 35 mm film on the large IMAX screen would have produced a grainy picture. According to co-CEO Gelfond, the firm invested millions of dollars to sharpen the resolution of

19 Z. Olijnyk, “One giant leap,” Canadian Business, 75:17, September 16, 2002, pp. 46-48. 20 D. Oestricher, “IMAX hopes for big run with Matrix,” The Wall Street Journal, June 18, 2003, p. b5c. 21 Katy Marquardt, “Imax Parlays a Huge Screen and 3-D Tech into an Experience You Can’t Duplicate at Home. Coming soon to a multiplex near you,” US News and World Report, Feb. 6, 2008, www.usnews.com/articles/business/2008/02/06/imax-parlays-3-d-tech-into-an-experience-you-cant-duplicate-at-home.html, accessed December 23, 2008. 22 The Wall Street Journal, 2000. 23 B. Pulley, “The really big screen,” Forbes, 172:13, December 22, 2003, p. 222.; The Wall Street Journal, 2003. For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. 24 D. Oestricher, “IMAX hopes for big run with Matrix,” The Wall Street Journal, June 18, 2003, p. b5c. 25 Katy Marquardt, “Imax Parlays a Huge Screen and 3-D Tech Into an Experience You Can’t Duplicate at Home. Coming soon to a multiplex near you,” US News and World Report, February 6, 2008, www.usnews.com/articles/business/2008/02/06/imax-parlays-3-d-tech-into-an-experience-you-cant-duplicate-at-home.html, accessed December 23, 2008. 26 Ibid.

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the converted pictures and it took more than five years to develop the technology.27 The re-mastering of Apollo 13 took 16 weeks, while The Matrix Revolutions was re-mastered as it was being produced, allowing for near-simultaneous theater and IMAX releases. As IMAX had worked out the teething problems with this technology, the costs of conversion had come down. For each print, it now cost $22,500 to convert a standard two-dimensional film and $45,000 to convert a 3-D film. It was expected that moving to a digital format would further lower the conversion costs. If the conversion succeeded at the box office, more studios might be willing to spend the extra money to convert their standard 35 mm films to IMAX format.28 This would also attract theater chains to open new IMAX screens. Though IMAX made only seven per cent of the box office revenue from reformatted films by other studios, compared to the nearly 30 per cent that it made on its own movies,29 the conversion of Hollywood movies might allow IMAX to survive, according to co-CEO Gelfond.30 An announcement to launch the Harry Potter movie on IMAX resulted in an almost 11 per cent surge in its stock price that day. Gelfond noted that IMAX could continue making educational films that could be screened in theaters during daytime for families, students and tourists, while its reformatted Hollywood movies could be screened in the evening. In an interview with Amusement Business, co-CEO Wechsler noted that the IMAX strategy of moving into the commercial movie business would hopefully expand the core audience.31 “Our research tells us that a lot of people will pay that extra $3 to $5,” Gelfond said in an interview with USA Today.32

The first full-length Hollywood movie released on IMAX was Fantasia 2000 in January 2000.33 The classic Beauty and the Beast, which had a 20-week show on 67 IMAX screens in 2002, generated $32 million in revenue.34 The first live action commercial movie to be launched in IMAX format was Apollo 13, which generated an additional $2 million in revenue. Later, Star Wars was released on IMAX followed by The Matrix Reloaded, which generated $11.7 million. 35 These movies were released in IMAX after their theatrical release.36

As more Hollywood movies were converted to IMAX format, the studios had to decide whether these should be released simultaneously in theaters and IMAX format. Could the expansion into IMAX theaters cannibalize the traditional theatrical revenues? It was found that almost 90 per cent of The Matrix Reloaded IMAX viewers had seen the movie in theaters earlier. The Polar Express, which was released simultaneously in IMAX and traditional theaters during the 2004 Christmas season, was a big hit with $45 million in revenues in the IMAX format.37 On December 12, 2008, the movie The Day the Earth Stood

Still was released simultaneously on IMAX and multiplex screens. At $31 million, the movie had the Use outside these parameters is a copyright violation. highest box office gross over a weekend. More than $3.8 million (about 12 per cent) of the total revenue came from IMAX theaters. Notably, the average revenue per IMAX theater was $30,800, compared to the

27 S. N. Chakravarty, “A really big show,” Institutional Investor, 35:10, October 2002, p. 20. 28 The Wall Street Journal, 2000; Institutional Investor, 2002. 29 D. Lieberman, “IMAX supersizes its plans for future flicks,” US Today, December 16, 2002, www.usatoday.com/tech/news/techinnovations/2002-12-16-IMAX_x.htm, accessed December 23, 2008. 30 Z. Olijnyk, “One giant leap,” Canadian Business, 75:17, September 16, 2002, pp. 46-48. 31 N. Emmons, “IMAX may turn toward mainstream,” Amusement Business, 112:49, December 4, 2000, p. 1, pp. 20-21. 32 D. Lieberman, “IMAX supersizes its plans for future flicks,” US Today, December 16, 2002, www.usatoday.com/tech/news/techinnovations/2002-12-16-IMAX_x.htm, accessed December 23, 2008. 33 R. Ricklefs, “IMAX hopes to take cast screen into mainstream — a new ‘fantasia’ tests film strategy of Canadian firm,” The Wall Street Journal, December 10, 1999, p. 1. 34 D. Oestricher, “IMAX hopes for big run with Matrix,” The Wall Street Journal, June 18, 2003, p. b5c. 35 T. Lowry, “Now playing at IMAX: Hit movies” Business Week, 3807, November 11, 2002, p. 46.; N. Sperling, “IMAX For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. executives hoping Warner’s ‘The Matrix’ is ‘the one’,” Amusement Business, 115:46, 2003, pp. 24-25. 36 T. King, “Hollywood Journal: When a ‘Sure thing’ Isn’t — Even the $20 million stars can’t guarantee a hit; trying to ignore ‘Pluto’,” The Wall Street Journal, October 11, 2002, p. w11. 37 W. D. Crotty, “IMAX’s screen gets bigger,” The Motley Fool, September 15. 2005, www.fool.com/investing/general/2005/09/15/imaxs-screen-gets- bigger.aspx?terms=Imax+screen+gets+bigger&vstest=search_042607_linkdefault, accessed December 23, 2008.

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national average theater revenues of $8,100.38 Such track records should give more studios the confidence to release their movies simultaneously in commercial and IMAX theaters.

INDUSTRY DYNAMICS

Motion picture production and distribution was part of the service sector of the economy and included firms such as Disney/Pixar, MGM, Regal Entertainment, Lions Gate and Carmike. Many of the production and distribution companies were now part of other, larger, diversified firms. For example, Columbia Pictures was now part of Sony, Warner Brothers was a subsidiary of Time Warner, Paramount Studios was part of Viacom and Pixar and Miramax were part of Disney. Over the years, media firms had sought to vertically integrate their operations by owning not only the production facilities but also distribution networks.

Film production remained a risky business. Only one in 10 films ever recovered its investment from domestic theater release; and only six out of 10 movies ever recouped the original investment. Competition among movies within the same genre was so high that studios scheduled releases carefully to avoid direct competition. Thus, release dates were announced several years in advance and production was designed around preferred holiday release dates, such as Thanksgiving, July 4th, Memorial Day weekends or the first weekend of May.

IMAX films faced competition from other films produced by studios such as Pixar/Disney that were targeted for families or children. Within the large format film segment, Iwerks was the only rival to IMAX.39 Iwerks was founded in 1986 and continued to be involved in all aspects of large format films and simulation rides. It produced films in the 15/70 and 8/70 formats; however, the focus of the firm was more on ride simulation packages located in theme parks, zoos, museums and other destinations. Iwerks had received two Academy Awards for Scientific and Technical Achievement. In 2002, Iwerks merged with SimEx (a firm founded in 1991), which was involved in ride simulation and animation production. Another firm, Megasystems, which was involved in the development of large format projection systems, production and consulting in marketing, operations and technical services, had discontinued its projection system production and was renamed Pollavision. Pollavision was now only involved in consulting (and 40 maintenance) services for large format film theaters. Use outside these parameters is a copyright violation.

Technology Trends

Potential IMAX viewers could consume many alternative sources of entertainment, such as live plays, sport events, TV programs, the Internet, etc. See Exhibits 7 and 8 for admissions, prices and time spent on alternative entertainment sources. Viewers might choose to watch a movie on DVD, pay-per-view or video on demand rather than at the theater. The development of high-definition DVD recording, big-screen TVs and cheaper home theater projection and sound systems posed an even bigger threat to box office ticket sales. See Exhibit 9 for DVD sales trends in the United States. According to one estimate, almost 85 per cent of a film’s revenue now came from home viewing through various channels such as DVD/VHS, cable and TV.41 Yet, it had been found that the success of secondary sources such as DVD sales and rentals was a For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019.

38 “Imax rises as consumers embrace large screens,” Associated Press, December 16, 2008, http://biz.yahoo.com/ap/081216/imax_mover.html?.v=1, accessed December 23, 2008. 39 C. Booth, “IMAX gets bigger (by getting smaller),” Time, June 29, 1998, 151:25, pp. 48-49. 40 www.pollavision.com, accessed December 23, 2008. 41 E. J. Epstein, “Hollywood’s death spiral,” Slate, July 25, 2005.

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function of the movie’s box office success.42 According to Jack Valenti, former president of MPAA, 50 per cent of DVD viewers and almost 38 per cent of VCR movie-users were frequent moviegoers. He said, “People who love movies are eager to watch them again in different environments.”43

The development of new technologies, such as cheaper high definition camcorders, as well as the proliferation of new distribution channels, such as cable, satellite and the Internet, had also created opportunities for new independent firms to enter the industry. One such firm that leveraged its knowledge of computer technology to develop blockbuster animated films was Pixar. New firms might enter one or more parts of the film industry value chain — talent management, production, post-production, distribution, etc. Specialists in post-production processes had emerged who were responsible for editing, special effects, media transfers, subtitling, etc. However, entry into all aspects of the value chain simultaneously had been rare. A recent example of such an entry was SKG Dreamworks, a studio that was started by film industry veterans Spielberg, Katzenberg and Geffen.

Such technological changes had also increased the potential for piracy. According to the Motion Picture Association of America, the U.S. film industry lost more than $3 billion annually because of piracy. Section 8, Article 1 of the U.S. Constitution offers Congress the power to offer copyright protection. The Copyright Act of 1976 that was amended in 1982 offers strong penalties for copyright violations. (See www.copyright.gov/title17 for recent development in copyright law.) Violations were considered felonies and were subject to federal criminal charges and civil lawsuits. The Motion Picture Association was working closely with the U.S. Congress to enforce sentencing guidelines and improve copyright protection as newer technologies emerged and posed fresher challenges. According to Karen Randall of Vivendi, whose production The Hulk was released on the Internet by pirates before its theatrical release, the FBI was very cooperative and aggressive in pursuing the case.44

Other Trends

IMAX had to cease screening its movie Volcanoes of the Deep Sea in some parts of the United States, as certain religious groups were offended by its position on, and depiction of, evolution.45 Concerns about violence and sex in movies had generated considerable efforts to organize and lobby political action to regulate the industry. For example, Tipper Gore and Lynn Cheney (spouses of former vice-presidents Al Use outside these parameters is a copyright violation. Gore and Dick Cheney, respectively) had worked hard to curtail the levels of violence, sex and vulgar language found in popular media.46

Another trend that might help firms such as IMAX was the increased consumption of educational entertainment. Ever since Sesame Street succeeded in educating and entertaining kids simultaneously, the “edutainment” market had grown as parents increasingly sought out play activities for their children that were educational. This trend had been attributed to increasing belief among parents that in a knowledge economy, their kids’ success might depend on education. The widespread popularity among parents of the concept of the “Mozart effect” — a finding that babies that listened to Mozart recordings in the womb or at early stages after birth had richer cognitive development — was seen as evidence of their desire to produce

42 Bruce Orwall, “A Dud at Theaters Will Be a Dud DVD,” The Wall Street Journal, November 26, 2005, p. A2. For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. 43 J. Valenti, MPAA Press Release, 2002. 44 S. McBride and B. Orwall, “Movie industry steps up drive against pirates,” The Wall Street Journal, January 27, 2004, p. B1. 45 Cornelia Dean, “A new test for IMAX: The Bible vs. the volcano,” March. 19, 2005. 46 Richard Goldstein, “Scary Move: When Both Parties Team Up to Target Hollywood, Be Afraid. Be Very Afraid!” Village Voice, October 3, 2000 p.20.

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smart kids.47 Other trends that were driving this growth could include higher education levels of parents and overscheduled kids and parents.48 As a result, zoos, museums, software, TV shows and toys were all redesigning their products to entertain and educate.

According to IMAX, more than 20 per cent of IMAX audiences were school groups. About 70 per cent of IMAX viewers were between 19 and 65 years of age, and the majority were college- or university- educated, with an average household income of more than $70,000, and with 33 per cent earning more than $100,000.49 MPAA offered a more fine-grained analysis of demographic data on movie attendance. It reported that 12-24 year olds (38 per cent of admissions) had the largest attendance for feature films in theaters in 2007, followed by the 25- to 39-year-olds group (29 per cent of admissions).50 The 12-24-year- olds were also frequent moviegoers (at least one movie per month), representing 41 per cent of frequent moviegoers. IMAX needed to figure out a way to attract this demographic.

U.S. and Global Market

In 2007, 603 movies were released in the United States and collected revenues of $9.6 billion.51 According to the MPAA, there were 1.4 billion movie theater attendances in the United States in 2007.52 Jack Valenti, former president of the MPAA, noted that Americans had the highest per capita movie attendance in the world at 5.3 films a year. By excluding those who did not see at least one movie a year, the per capita attendance rose to 8.6 films per year.53 Exhibit 10 displays theater revenues, average U.S. ticket prices, attendance annual growth rate, consumer price index (CPI) and growth of the U.S. economy. Theater-owners realized that ticket prices could not go up forever, as this might drive away more viewers; so they tried to generate revenue by screening more commercials before showing the feature film. According to some experts, release of big budget franchise movies or sequels of popular movies attenuated the adverse impact of the economy on theater attendance.

Movies were now increasingly becoming a global industry. More than 5000 films were released worldwide in 2007, with seven billion attendances and annual global box office revenues estimated at $26.7 billion.54 The Asia-Pacific region had the largest share of the global market. While Hollywood movies had always enjoyed an international audience, with globalization and the increased movement of people across national borders, movies from other regions such as Hong Kong and India were also finding Use outside these parameters is a copyright violation. an international audience. For Hollywood movies, a significant part of the revenues now came from outside the United States. See Exhibit 11 on domestic and foreign sources for the top 10 films in 2007.

THE LARGER ISSUES

At this point in its evolution, IMAX faced two critical questions. Would IMAX lose its differentiation if it exhibited too many Hollywood movies? Greg MacGillvray, who had made several films in the IMAX

47 Jeffrey Kluger and Alice Park, “The Quest For A Superkid,” Time, April 22, 2001 www.time.com/time/nation/article/0,8599,107265-1,00.html, accessed December 23, 2008. 48 R. White, “That’s Edutainment,” White Hutchinson Leisure & Learning Group, 2003. 49 www.IMAX.com. 50 J. Valenti, MPAA Press Release, 2002. For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. 51 US Entertainment Industry: 2007 MPAA statistics. See also, M. Marr, “Now playing: Expensive movies; Average cost of a film tops $100 million for first time; Valenti set to leave MPAA,” The Wall Street Journal, March 24, 2004, p. B. 4. 52 James Jaeger, The Movie Industry, www.mecfilms.com/moviepubs/memos/moviein.htm, accessed December 23, 2008. 53 2007 movie attendance study, MPAA. 54 2007 International Theatrical Snapshot, MPAA;www.mpaa.org/International%20Theatrical%20Snapshot.pdf, accessed March 4, 2009.

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format, including the highly successful Everest, argued that IMAX ran the risk of losing its brand identity as it moved into non-educational entertainment films. He said: “There’s also been a slight brand erosion given that these films have not been really educational experiences, but more entertainment experiences.” According to MacGillvray, IMAX’s own research showed that the brand’s trustworthiness was rooted in the fact that IMAX grew up in institutional settings.55

Another question that the present co-CEOs had faced for several years was: Should IMAX be sold to a larger studio, such as Sony, Disney or Time Warner? That is, was it too small to survive on its own? Some analysts had speculated that IMAX was ripe for acquisition. Co-CEO Gelfond had once stated, “Someday it will make sense for IMAX to be part of a studio.”56

The author would like to thank Professors Barbara Bartkus, Alan Eisner, Jim Key, participants at a case writing workshop organized by the Society for Case Research, and students at Old Dominion University for comments on earlier versions of the case. Thanks also to Lee-Hsien Pan for his research assistance.

Use outside these parameters is a copyright violation. For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019.

55 P. Waal, “Call in the barbarians,” Canadian Business, 73:17, September 18, 2000, pp. 85-87. 56 P. Waal, “The plot quickens,” Canadian Business, 71:11, June 26-July 10, 1998, pp. 51-57.

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Exhibit 1

IMAX FILM SIZE

Use outside these parameters is a copyright violation. For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019.

Source: IMAX, with permission.

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Exhibit 2

AVERAGE MARKETING SPENDING ON VARIOUS MEDIA, 2007

Newspapers 12.9 % Network TV 16.1 % Spot TV 13.7 % Internet 5.3 % Trailers 4.9 % Other Media (cable TV, radio, magazines, billboards) 24.5 % Other Non-media (production/creative services, exhibitor services, promotion & 22.6 % publicity, market research)

Source: www.mpaa.com.

Exhibit 3

BOX OFFICE REVENUES FOR IMAX MOVIES (IN MILLIONS OF $)

Rank Title Studio Gross-to-date Year 1 Everest MFF $87.18 1998 2 Space Station 3-D IMAX $77.10 2002 3 T-Rex: Back to the Cretaceous IMAX $53.14 1998 4 Fantasia 2000 BV $52.26 2000 5 Mysteries of Egypt IMAX $40.59 1998 6 Deep Sea 3-D WB $37.09 2006 7 Magnificent Desolation IMAX $26.67 2005 8 Beauty and the Beast BV $25.49 2002 9 NASCAR 3D: The IMAX Experience WB $21.58 2004 10 Sea Monsters: A Prehistoric Adventure NGC $20.05 2007

Use outside these parameters is a copyright violation. Source: www.boxofficemojo.com. IMAX box office receipts have only recently started being tracked.

For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019.

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Exhibit 4

IMAX CORPORATION ANNUAL BALANCE SHEET (in thousands of dollars)

Period Ending 31-Dec-07 31-Dec-06 31-Dec-05 31-Dec-04 Assets Current Assets Cash and Cash Equivalents 16,901 25,123 24,324 28,964 Short-Term Investments - 2,115 8,171 - Net Receivables 25,505 26,017 89,171 19,899 Inventory 22,050 26,913 28,294 29,001 Other Current Assets 2,187 3,432 3,825 2,279 Total Current Assets 66,643 83,600 153,785 80,143 Long-Term Investments 59,092 65,878 - 59,492 Property Plant and Equipment 23,708 24,639 26,780 28,712 Goodwill 39,027 39,027 39,027 39,027 Intangible Assets 4,419 3,782 6,030 3,931 Accumulated Amortization - - - - Other Assets 10,928 6,646 9,756 7,532 Deferred Long-Term Asset Charges 4,165 3,719 10,806 12,016 Total Assets 207,982 227,291 246,184 230,853 Liabilities Current Liabilities Accounts Payable 74,267 69,720 62,057 62,724 Short/Current Long-Term Debt - - - - Other Current Liabilities - - - - Total Current Liabilities 74,267 69,720 62,057 62,724 Long-Term Debt 160,000 160,000 160,000 160,000 Other Liabilities - - - - Deferred Long-Term Liability

Charges 59,085 55,803 44,397 50,505 Use outside these parameters is a copyright violation. Minority Interest - - - - Negative Goodwill - - - - Total Liabilities 293,352 285,523 266,454 273,229 Stockholders’ Equity Common Stock 122,455 122,024 121,674 116,281 Retained Earnings (213,407) (184,375) (144,347) (160,945) Other Stockholder Equity 5,582 4,119 2,403 2,288 Total Stockholder Equity (85,370) (58,232) (20,270) (42,376)

Source: Annual Reports. For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019.

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Exhibit 5

IMAX CORPORATION ANNUAL INCOME STATEMENT (in thousands of dollars)

Period Ending 31-Dec-07 31-Dec-06 31-Dec-05 31-Dec-04 Total Revenue 115,832 129,452 144,930 135,980 Cost of Revenue 74,673 76,902 73,005 70,062 Gross Profit 41,159 52,550 71,925 65,918 Operating Expenses Research & Development 5,789 3,615 3,264 3,995 Selling General and Administrative 44,705 42,527 39,503 36,066 Non-recurring 562 1,073 −859 −639 Others 547 1,668 911 719 Total Operating Expenses 51,603 48,883 42,819 40,141 Operating Income or Loss (10,444) 3,667 29,106 25,777 Income from Continuing Operations Total Other Income/Expenses Net (933) 1,036 1,004 265 Earnings Before Interest and Taxes (11,377) 4,703 30,110 26,042 Interest Expense 17,093 16,759 16,773 16,853 Income Before Taxes (28,470) (12,056) 13,337 9,189 Income Tax Expense 472 6,218 934 (255) Minority Interest 0 0 0 0 Net Income from Continuing Ops (28,942) (18,274) 12,403 9,444 Non-recurring Events Discontinued Operations 2,002 1,425 1,979 800 Extraordinary Items 0 0 0 0 Effect of Accounting Changes 0 0 0 0 Other Items 0 0 0 0 Net Income (26,940) (16,849) 14,382 10,244

Use outside these parameters is a copyright violation.

Source: Annual Reports. For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019.

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Exhibit 6

IMAX CORPORATION CASH FLOW STATEMENT (in thousands of dollars)

Period Ending 31-Dec-07 31-Dec-06 31-Dec-05 31-Dec-04 Net Income (26,940) (16,849) 14,382 10,244 Cash Flows Provided By or Used In Operating Activities Depreciation 17,738 16,872 15,867 14,947 Adjustments to Net Income (3,520) 10,349 (8,678) (4,577) Changes in Accounts Receivables 675 (11,106) (8,324) (6,673) Changes in Liabilities 4,781 4,399 (11,749) (6,830) Changes in Inventories (1,603) 57 (383) (283) Changes in Other Operating Activities 2,648 (9,659) (1,545) 4,583 Total Cash Flow from Operating Activities (6,221) (5,937) 1,786 11,411 Cash Flows Provided By or Used In Investing Activities Capital Expenditures (2,150) (1,985) (1,597) (320) Investments 2,115 6,396 (7,818) 393 Other Cashflows from Investing Activities (702) 2,105 (1,301) (1,435) Total Cash Flows from Investing Activities (737) 6,516 (10,716) (1,362) Cash Flows Provided By or Used In Financing Activities Dividends Paid – – – – Sale Purchase of Stock 420 286 3,633 558 Net Borrowings (1,714) – – (29,769) Other Cash Flows from Financing Activities – – 786 800 Total Cash Flows from Financing Activities (1,294) 286 4,419 (28,411) Effect of Exchange Rate Changes 30 (66) (129) 44 Change in Cash and Cash Equivalents ($8,222) $799 ($4,640) ($18,318)

Use outside these parameters is a copyright violation. Source: Annual Reports.

Exhibit 7

SUBSTITUTE ACTIVITIES TO MOVIES IN 2007

Activity Attendance Average Ticket Price (in millions) (in $) 1 Movies 1400 6.88 2 Theme Parks 341 35.30 3 Ice Hockey/NHL 21 44.60 4 Basketball/NBA 22 46.75 For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. 5 Football/NFL 17 65.25 6 Baseball/MLB 77 23.50

Source: MPAA, www.mpaa.com.

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Exhibit 8

MEDIA CONSUMPTION BASED ON HOURS PER PERSON PER YEAR

Filmed Entertainment 2003 2004 2005 2006 2007

Cable & Satellite TV 886 909 980 997 1,010 Broadcast TV 729 711 679 676 676 Consumer Internet 153 164 169 177 181 Home Video (DVD & VHS) 60 67 63 62 64 Box Office 13 13 12 12 13 In-flight Entertainment & Mobile Content 5 8 10 13 18

Subtotal 1,846 1,872 1,913 1,937 1,962 Other Entertainment

Broadcast & Satellite Radio 831 821 805 778 769 Recorded Music 187 196 195 186 171 Newspapers 195 192 188 178 172 Consumer Magazines 122 125 124 121 119 Consumer Books 108 108 107 108 108 Video Games 76 78 73 76 82 Subtotal 1,522 1,520 1,492 1,447 1,421

Source: MPAA, www.mpaa.com.

Exhibit 9

DVD CONSUMPTION IN THE UNITED STATES (in millions of units)

Use outside these parameters is a copyright violation. Rental DVDs Sell-through Total DVDs Avg. Price DVDs of DVD 2007 171.2 1,084.6 1,255.8 22.11 2006 180.2 1,129.0 1,309.2 22.29 2005 179.0 1,114.5 1,293.6 21.20 2004 149.3 1,063.3 1,212.6 20.32 2003 105.4 768.3 873.6 20.15

Source: MPAA, www.mpaa.com. For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019.

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Exhibit 10

THEATER BOX OFFICE REVENUES, AVERAGE U.S. ATTENDANCE, PRICE AND ECONOMY

Year Revenue Ticket price Attendance GDP CPI (in billions $) (in $) (in billions) Growth Inflation (in %) (in %) 1990 5.02 4.22 1.19 1.9 5.4 1991 4.80 4.21 1.14 -0.2 4.2 1992 4.56 4.15 1.10 3.3 3.0 1993 4.89 4.14 1.18 2.7 3.0 1994 5.18 4.08 1.24 4.0 2.6 1995 5.27 4.35 1.21 2.5 2.8 1996 5.81 4.42 1.32 3.7 3.0 1997 6.21 4.59 1.35 4.5 2.3 1998 6.76 4.69 1.44 4.2 1.6 1999 7.31 5.06 1.44 4.5 2.2 2000 7.46 5.39 1.38 3.7 3.4 2001 8.12 5.65 1.44 0.8 2.8 2002 9.27 5.80 1.60 1.6 1.6 2003 9.16 6.03 1.52 2.5 2.3 2004 9.21 6.21 1.48 3.6 2.7 2005 8.83 6.41 1.38 2.9 3.4 2006 9.14 6.55 1.39 2.8 3.2 2007 9.63 6.88 1.40 2.0 2.8

Source: National Association of Theater Owners (NATO), www.natoonline.org; Bureau of Economic Analysis, www.bea.gov; and Bureau of Labor Statistics, www.bls.gov.

Exhibit 11

Use outside these parameters is a copyright violation. DOMESTIC AND OVERSEAS REVENUES FOR 2007 (in millions of dollars)

Rank Title Domestic Overseas World 1 Pirates of the Caribbean: At World’s End 309.4 649.0 958.4 2 Harry Potter and the Order of the Phoenix 292.0 645.0 937.0 3 Spider-Man 3 336.5 548.9 885.4 4 Shrek the Third 321.0 470.4 791.4 5 Transformers 319.1 382.0 701.1 6 Ratatouille 206.4 409.5 615.9 7 I Am Legend 256.4 327.6 584.0 8 Simpsons Movie, The 183.1 342.4 525.5 9 300 210.6 246.0 456.6 For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. 10 National Treasure: Book of Secrets 220.0 234.0 454.0

Source: www.worldwideboxoffice.com.

100 10.

S w

9B11M086

THE LEGO GROUP: BUILDING STRATEGY

Paul Bigus wrote this case under the supervision of Professor Darren Meister solely to provide material for class discussion. The authors do not intend to illustrate either effective or ineffective handling of a managerial situation. The authors may have disguised certain names and other identifying information to protect confidentiality.

On February 15, 2011, world-famous toy maker the LEGO Group (LEGO) assembled an internal management team to create a strategic report on LEGO’s different product lines and business operations. Over the past two years, numerous threats had emerged against LEGO in the toy industry: the acquisition of Marvel Entertainment by The Walt Disney Company created major implications for valuable toy license agreements; LEGO had lost a long legal battle with major competitor MEGA Brands — maker of MEGA Bloks — with a European Union court decision that removed the LEGO brick trademark; new competition was preparing to enter the marketplace from Hasbro — the second-largest toy maker in the world — with the company launching a new rival product line called Kre-O. It was critical for the management team to identify where to expand LEGO’s product lines and business operations in order to develop a competitive strategy to continue the organization’s financial success and dominance in the building toy market.

Use outside these parameters is a copyright violation.

COMPANY HISTORY1

LEGO first began during the Great Depression in 1932, when Danish carpenter Ole Kirk Kristiansen and his sons started making wooden toys after the demand for building houses and furniture declined. Some of the first toys they made included yo-yos, wooden blocks, pull-along animals and wooden vehicles. Kristiansen believed that “only the best is good enough” in manufacturing children’s toys; this motto was so important to him that it was carved on a sign and hung on the workshop wall to serve as a reminder to always produce top-quality products. He used the highest quality materials and workmanship to produce toys that were designed to last through years of play. In 1934, the company name LEGO was created when Kristiansen held a friendly competition among the workshop employees to help name the company, with a bottle of wine as the prize. Kristiansen won the competition himself by creatively combining the

first two letters of the Danish words leg and godt, meaning “play well,” to form the name LEGO, which For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. also meant “I put together” in Latin. In 1942, disaster hit the small company of only 12 employees as the entire workshop burned to the ground. Not willing to quit, Kristiansen rebuilt the factory and painstakingly remade all of the lost designs from memory in order to keep the company going.

1 Daniel Lipkowitz, The LEGO Book, Dorling Kindersley Publishing, New York, 2009, pp.10-49.

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Following the end of World War II, LEGO became the first company in Denmark to purchase a plastic- injection molding machine in 1947; however, the new machine came at a high cost, requiring the company to risk a large portion of revenues and face the additional financial risk of plastic toys being expensive to manufacture. With the acquisition of the new machine, one of the first plastic toys to be created by LEGO was a baby rattle that was shaped like a fish. It did not take long before the investment in the machine proved to be a success, as LEGO quickly expanded its business operations to produce over 200 varieties of plastic and wooden toys. Using the new technology, the first plastic LEGO bricks — named Automatic Binding Bricks — were created and sold in sets in 1949; however, this name did not last long as it was changed to LEGO Bricks in 1953, with the addition of the LEGO name being molded onto every brick manufactured.

Godtfred Kirk Christiansen, one of Kristiansen’s sons, had grown up with the family company and eventually became the junior managing director of LEGO. Upon returning from a toy fair in 1954, Godtfred and a co-worker had a conversation during which they realized that no system existed to connect different products or items in the toy industry. To Godtfred this represented a key opportunity to design a new structured system of toy products, selecting the LEGO brick as the best company product with which to create what he referred to as the “LEGO System of Play.” The idea behind the LEGO System of Play was that each and every LEGO brick should connect to each other — not just within one set but across multiple sets. A ‘Town Plan’ series with 28 building sets and eight vehicle sets was developed and released. The strategy was simple but important: each additional LEGO set obtained by a child increased the amount of LEGO bricks that the child had available to build with, thus more sets equalled more creative opportunities. The different Town Plan models included LEGO bricks as well as various plastic people, trees, vehicles and road signs. In order to help market the product to children and parents, the sets were creatively designed in collaboration with the Danish Road Safety Council to help teach children about traffic safety. Godtfred commented on the LEGO System of Play: “Our idea is to create a toy that prepares the child for life, appeals to the imagination and develops the creative urge and joy of creation that are the driving force in every human being.”2

The development of the LEGO System of Play lead Godtfred to realize that improvements were needed to the LEGO brick design so that bricks could lock together firmly yet come apart easily: he referred to this as the brick’s ‘clutch power.’ Finding the correct clutch power would allow for more stable and secure

LEGO brick models that would not easily fall apart. With such a brick design and building capability, Use outside these parameters is a copyright violation. Godtfred believed that it would be possible to create anything out of LEGO bricks. In attempting to find such a design, LEGO experimented with different plastic-injection molding designs that included various shapes and connection methods before finally selecting a brick design that added hollow connection tubes to the bottom of the existing LEGO brick design. With the improved design, when two bricks were placed directly on top of each other, the hollow tubes on the underside of the top brick connected firmly between the existing circular studs on the top of the bottom brick, providing the perfect amount of clutch power. Pleased with the results, Godtfred submitted an application in Denmark on January 28, 1958, to officially patent the improved LEGO brick design. The year signified a historical event for LEGO; unfortunately, it also represented a major loss with the death of LEGO founder Kristiansen. This left Godtfred in charge of the company, which had grown to 140 employees.

The 1960s For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019.

During the 1960s, LEGO had experienced rapid success with the new brick design, expanding sales to many European countries as well as new markets in the United States, Canada, Japan and Australia. After

2 Daniel Lipkowitz, The LEGO Book, Dorling Kindersley Publishing, New York, 2009, pp.18.

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another fire destroyed the workshop where LEGO wooden toys were made, the company decided to stop selling wooden toys altogether and focus completely on the LEGO brick and System of Play. By 1967, more than 18 million LEGO sets had been sold in 42 different countries, with LEGO employing over 600 people. The company had also expanded the LEGO brick design to include over 200 different shapes such as wheels, flat bricks, train tracks, windows, doors and flags; this added further detail and allowed more creative possibilities to the System of Play sets. In an effort to help children and parents with the variety of bricks and the increased complexity of building sets, LEGO introduced building instructions as a standard feature of each building set. The increased success and popularity of LEGO around the world lead to the development of the first LEGOLAND theme park, opening in LEGO’s home country of Denmark in 1968. During the same year, LEGO continued to experiment with new products, introducing a brick called DUPLO which was eight times the size of an original LEGO brick and safe for children under five.

The 1970s

By 1975, LEGO had grown to over 2,500 employees and continued to develop new innovative sets that included a series for girls involving doll houses and furniture, ships made out of LEGO that could float in water and a LEGO Technic series which created models with mechanical moving parts. In 1978, LEGO continued to transform the building toy industry by introducing the first miniature figures with painted faces and movable arms and legs. LEGO incorporated the mini-figures into the launch of three new play themes: LEGO Castle featuring medieval knights and castle sets, LEGO Town featuring city characters and modern buildings and LEGO Space featuring astronauts and spacecraft. The company changed leadership again in 1979, when third-generation Kjeld Kirk Kristiansen, Godtfred’s son, became president and chief executive officer (CEO) of LEGO.

The 1980s

With LEGO celebrating its 50th anniversary in 1982, the company continued to expand operations, launching an educational line for schools as well as a DUPLO Baby series. Over the years, LEGO

continued to experiment by combining LEGO bricks with technology, introducing a Light & Sound series Use outside these parameters is a copyright violation. in addition to a LEGO Technic series — that allowed motors to be controlled by a computer — in 1986. Success of the LEGO play themes continued with new Castle, City and Space sets being released each year, in addition to a new LEGO Pirates theme being launched. With many children building their own LEGO creations without instructions, buckets full of assorted LEGO bricks were also made available to purchase for creative building. LEGO had become established around the world as the building toy of choice, with many fan clubs being created and building competitions taking place. To stay connected to an ever-growing market, a LEGO magazine was also made available in many countries to keep members up to date on new product information and creative building ideas.

The 1990s

LEGO had grown to become one of the top 10 largest toy manufactures in the world by 1990. Global For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. operations employed over 7,000 people and included over 1,000 injection molding machines in five LEGO factories. LEGO utilized its strong brand image by opening LEGO stores to exclusively sell LEGO products and merchandise. The use of television advertising also helped the company to build a familiar “LEGO Maniac” slogan. With the increase of home computer use and the rise of the Internet, LEGO launched the official LEGO website (www.LEGO.com) in 1996. Following soon after in 1997,

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LEGO expanded into a new business area with the release the first-ever LEGO computer game. The combination of LEGO and computers continued with the LEGO MINDSTORMS line, which allowed users to build and control complex sets with the use of desktop computers and remote controls.

LEGO also diversified its product line by launching many new creative play themes such as LEGO Western, LEGO Adventurers, LEGO Aquazone, LEGO Iceplanet, LEGO Time Cruisers and LEGO Space Insectoids. The company had even created a LEGO brick vacuum device to help children do their least-favourite LEGO activity — picking up the bricks. LEGO advanced again in 1999, as for the first time the company acquired the licensed rights to famous movies and children themes, which lead to the launch of LEGO Star Wars and DUPLO Winnie the Pooh product lines. Combining Star Wars licensed property with LEGO bricks allowed for constructible sets to be created, featuring various well-known characters and vehicles from the widely-popular franchise films. The LEGO Star Wars theme was a huge success, quickly developing into one of LEGO’s most profitable product lines.

2000 and Beyond

Following the success of LEGO Star Wars, other popular licensed rights were obtained for new product lines. Harry Potter, Spiderman, Batman, Indiana Jones and SpongeBob SquarePants were all developed into LEGO series sets. Licensed rights were also obtained for DUPLO sets including Bob the Builder, Dora the Explorer and Disney themes. The licensed agreements did not stop there as LEGO viewed professional sports as new opportunities, subsequently launching series sets with LEGO NBA Basketball, LEGO NHL Hockey and LEGO Soccer. Lego also continued to develop products internally, offering new play themes such as LEGO Knights’ Kingdom, LEGO Alpha Team, LEGO Bionicle, LEGO Discovery, LEGO Clikits Jewelry, LEGO Studios, LEGO Mars Mission and LEGO Exo-Force. As LEGO was also popular with many adults, special edition sets were created for advanced LEGO builders and collectors, featuring such famous structures as the Statue of Liberty, Taj Mahal, Eiffel Tower and the Star Wars Death Star. Some sets proved to be more successful than others; as a result, some product lines were only sold for a few years before being discontinued in order to free valuable shelf space, production and advertising resources to produce LEGO sets that were in high demand.

With the successful acquisition of many licensed rights, LEGO partnered with video game design Use outside these parameters is a copyright violation. companies to develop video games for both computers and video game consoles: this resulted in over 30 LEGO video games being released between 1997 and 2009, featuring the popular LEGO licensed product lines of Harry Potter, Batman, Indiana Jones and Star Wars. LEGO had also developed video games based on its own successful product lines and themes. Overall, many of the video games were highly popular with both children and adult age groups, as they featured LEGO characters and famous movie storylines to play and explore in LEGO-designed environments. At a time when many video games were seen as too violent — with content inappropriate for children — LEGO provided non-violent video games with content that parents could trust.

LEGO continued to expand beyond traditional video games to develop a virtual online LEGO Universe in 2010. After paying online to register, players could design their own personalized LEGO mini-figures to be used to explore online environments and interact with other online players. LEGO was also constantly updating and improving the LEGO website, which was receiving over four million visitors per month For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. from over 200 countries by 2003. All LEGO items were made available to purchase online, and the website also provided interactive games, animated videos and comics. One of the most popular additions to the LEGO website was the introduction of software called LEGO Digital Designer: this allowed a user to design a LEGO set online, using the enormous catalog of LEGO bricks available. After users finished building their own personal designs, the site would automatically calculate the cost for the materials,

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providing users with the option to buy their unique creations. If purchased, LEGO would package the physical bricks needed to build the online design and ship them directly to the user’s home. Users could also share their designs online, with contests taking place from which winning designs were turned into official LEGO sets.

THE FIRST TIME MANAGEMENT SAVED THE COMPANY3

The threats in the toy industry did not represent the first time LEGO management had faced serious issues. Between 1998 and 2004, the company had lost money four out of seven years. Revenues had dropped 30 per cent in 2003, and continued to fall another 10 per cent in 2004. Problems existed not with the LEGO products but behind the scenes in how the company manufactured and distributed LEGO around the world. Years of continuous growth added layers of complexity to LEGO’s operations. Knowing that the company needed to change directions, Kjeld stepped down as company CEO in 2004. He was replaced by Jorgen Vig Knudstorp, who had started at LEGO as the director of strategic development in 2001. In his first actions as CEO, Knudstorp assembled a leadership team of senior executives and managers to start analyzing every part of LEGO’s supply chain operations as a whole: this included everything from new product development to materials sourcing, production and distribution.

The leadership team discovered that over the years, as new products represented a larger amount of annual revenues, newer-generation LEGO sets had become more elaborate while providing less profit in return. Product designers were creating new sets without giving full consideration to the costs of materials or production: this resulted in LEGO dealing with over 11,000 suppliers, as designers often selected their own vendors. Not considering production costs resulted in serious waste. If a designer created a new brick or selected a rare colour, manufacturing would often be left with extra materials or costly resin colours that would never be used again. Inefficiencies were also revealed from the poor organization of LEGO’s plastic-injection molding machines, with each one capable of producing every type of LEGO brick: this required costly retooling and created long downtimes, translating into production facilities only operating at 70 per cent of capacity. Upon producing a finished product, the leadership team traced additional high costs to distribution operations. Logistics represented a web of 26 different providers that shipped products from multi-levelled distribution networks: this created a backlog of orders and inefficiencies in

inventory levels. The leadership team continued to uncover damaging business practices at the final retail Use outside these parameters is a copyright violation. level. Overall, LEGO was spending the same amount of time dealing with thousands of smaller independent stores that represented one-third of revenues as it did with 200 larger chain and big box stores that generated two-thirds of revenues. Smaller stores also added extra costs for LEGO in shipping, labour and inventory, as they often ordered less than a full carton of product. In turn, the disproportionate amount of time with chain and big box stores equalled inaccurate forecasting and inventory shortages that decreased sales.

In order to make LEGO profitable again, the leadership team introduced numerous changes across the organization. Cost-saving measures were found by cutting the selection of LEGO brick colours in half, while also reducing the number of different mini-figures available. The production cost for each individual LEGO brick shape helped identify and reduce expensive items: this resulted in an 80 per cent reduction in the amount of suppliers needed. With better production costs, designers could be shown the impact of using existing brick shapes compared to creating new molds and colours. Further down the For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. supply chain, the leadership team increased production capacity by assigning certain machines to make only specific LEGO bricks on scheduled production cycles: this reduced the amount of downtime and

3 Keith Oliver, Edouard Samakh and Peter Heckmann, “Rebuilding Lego, Brick by Brick,” Strategy and Business, August 29, 2007, www.strategy-business.com/article/07306?gko=99ab7, accessed on August 27, 2011.

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costly retooling for each machine. The leadership team also realized that revenue could increase by moving more inventory; therefore, using greater economies of scale they reduced the number of logistic suppliers from 26 to four, improving structure and communication. Smaller distribution centres were replaced by larger hub centres that were strategically located closer to retailers, providing better control over inventory and fewer stock shortages. Due to the contrast in revenue between small and large retailers, changes were introduced to create value and optimize sales: discounts were offered to smaller stores in exchange for placing orders early, and LEGO would no longer ship cartons that were not full. In order to maximize business opportunities with large chain stores and big box retailers, LEGO worked closely to provide joint forecasting, inventory management and marketing support.

The significant changes to design, production, distribution and sales resulted in LEGO increasing its inventory turnover by 12 per cent in 2005, earning a profit of $72 million. This continued with an inventory turnover increase of 11 per cent in 2006, as well as profits increasing by 240 per cent. Knudstorp’s leadership had successfully modernized LEGO’s business operations while placing his mark on the company. He commented on the company’s progress: “It has allowed us to again focus on developing the business.”

LEGO IN 2010

As of 2010, LEGO remained a privately-held company by the Kirk Kristiansen family. Annual sales reached an all-time high at DKK16.014 billion (Danish kroner), equaling over US$3.7 billion (see Exhibit 1).4 Overall, the company’s strongest-selling product lines were LEGO Star Wars, LEGO City and LEGO DUPLO. The high sales figures translated into seven LEGO sets being sold each second around the world.

With over 9,000 employees, LEGO had grown to become the fourth-largest toy manufacturer in the world.5 The company had developed a global brand that spread across numerous business operations (see Exhibit 2). As a household name and icon in the toy industry, LEGO had received the distinction of being named ‘Toy of the Century’ by the British Association for Toy Retailers.6 Since first starting to manufacture LEGO bricks back in 1949, the company had produced over 400 billion bricks, with 19

billion new bricks being made each year — translating to over two million bricks made every hour, or Use outside these parameters is a copyright violation. 36,000 each minute.7 Starting with one patented brick design in 1958, over the span of 50 years LEGO had developed over 2,400 different brick shapes, which were available in 53 different colors.

The LEGO mission stated, “Our ultimate purpose is to inspire and develop children to think creatively, reason systematically and release the potential to shape their own future — experiencing the endless human possibility”8, such a vision could be started with a handful of LEGO, requiring just six original shaped LEGO bricks to build over 915 million different creations.9

4 Andrew Couts, “Lego Systems’ sales surpassed $1 billion mark in 2010,” Digital Trends, February 14, 2011, www.digitaltrends.com/gaming/lego-systems-sales-surpassed-1-billion-mark-in-2010/, accessed on August 27, 2011. 5 “LEGO 2010 Annual Report,” LEGO, 2011, http://cache.lego.com/upload/contentTemplating/AboutUsFactsAndFiguresContent/otherfiles/downloadE994290D230BFB0E For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. 2A914F4DC3B6531C.pdf, accessed on August 27, 2011 6 Daniel Lipkowitz, The LEGO Book, Dorling Kindersley Publishing, New York, 2009, pp.30. 7 Jesus Diaz, “LEGO Brick Timeline: 50 Years of Building Frenzy and Curiosities,” Gizmodo, January 28, 2008, http://gizmodo.com/349509/lego-brick-timeline-50-years-of-building-frenzy-and-curiosities, accessed on August 27, 2011. 8 “Mission and Vision,” LEGO, 2011, http://aboutus.lego.com/en-us/group/vision.aspx, accessed on August 27,2011. 9 Daniel Lipkowitz, The LEGO Book, Dorling Kindersley Publishing, New York, 2009, pp.7.

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COMPETITION

Over a span of 50 years selling plastic bricks LEGO had faced a variety of competitors, as other companies entered the building toy market hoping to capitalize on LEGO’s success. Some companies introduced products based on their own unique design: one example was introduced by toy company Fisher Price, with a plastic construction toy called Construx. It used plastic beams and connector nuts to form different structures, but only lasted in production from 1983-1988.10 Another attempt was seen as a new company entered the building toy market in 1992, introducing a product called K’NEX that used flat plastic gear shapes and thin straw-shaped beams to build different designs.11

Some companies introduced plastic brick products that were compatible with the LEGO brick design: this meant that competitors’ bricks fit together and could be built with LEGO bricks. Toy manufacturer TYCO introduced TYCO Super Blocks in 1984, with a plastic brick design that was almost identical to LEGO bricks.12 In addition, TYCO also made reference to LEGO in its advertising, communicating to consumers that TYCO Super Blocks connected to LEGO, providing slogans such as, “If you can’t tell the difference, why pay the difference.”13 In response, LEGO launched a lawsuit that lasted four years (1984- 1988); the outcome was LEGO being successful in forcing the removal of the advertisements and product reference; however, the U.S. Supreme Court denied LEGO’s claim on the building block design as the LEGO patent expired in 1988.14

Upon the LEGO plastic brick design patent expiring in 1988, the barriers of competition were lowered in the building toy market.15 In 1991, Canadian toy manufacturer MEGA Brands, which had been selling plastic brick building products called MEGA Bloks since 1984, introduced a smaller-sized line of MEGA Bloks that were compatible with LEGO bricks.16 By 2003, MEGA Bloks had seen 17 straight years of sales growth with annual revenue of over US$188 million to become the world’s second-largest building toy producer behind LEGO.17 MEGA Bloks continued to quickly expand to different countries around the world. In 2010, MEGA Bloks had developed successful product lines that included license agreements with the popular HALO video game franchise, Marvel Comics, Disney, Thomas the Train, Hello Kitty, Nickleodeon and Caterpillar Construction Equipment.18 Although MEGA Bloks had significantly smaller sales with annual revenue of over US$368 million, it represented the largest competition to LEGO.19 It had also proved that other companies could carve out a percentage of the building toy market, with Use outside these parameters is a copyright violation.

10 “Construx Main Index,” This Old Toy, 2007, www.thisoldtoy.com/fisher-price/dept-7-playsets/f-construx/a-construx- index.html, accessed on August 27, 2011. 11 “About K’NEX,” K’NEX, 2011, www.knex.com/About_KNEX/, accessed on August 27, 2011. 12 “TYCO Super Blocks Resource,” Tony Cook’s HO-Scale Trains Resource, 2011, www.ho- scaletrains.net/tycosuperblocks/index.html, accessed on August 27, 2011. 13 Barbara Demick, “Judge Blocks Tyco Ads Claiming Blicks Are Like Lego’s,” The Philadelphia Inquirer, September 2, 1987, http://articles.philly.com/1987-09-02/business/26207754_1_tyco-toys-lego-systems-plastic-bricks, accessed on August 27, 2011. 14 “Tyco wins lawsuit over Lego,” HighBeam Research, May 6, 1988, www.highbeam.com/doc/1G1-6653339.html, accessed on August 27, 2011. 15 “Patents that changed the world: Lego,” New Legal Review, June 23, 2010, www.cpaglobal.com/newlegalreview/widgets/notes_quotes/more/3123/patents_that_changed_the_world_lego, accessed on August 27, 2011. 16 “Mega Bloks, Inc.,” Funding Universe, 2011, www.fundinguniverse.com/company-histories/Mega-Bloks-Inc-Company- For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. History.html, accessed on August 27, 2011. 17 Ibid. 18 “Shop,” MEGA Bloks, 2011, www.megabloks.com/Shop/MEGA_Bloks/, accessed on August 27, 2011. 19 “MEGA Brands Inc.: Consolidated Financial Statements December 31, 2010 and 2009,” a PricewaterhouseCoopers report, March 16, 2011, MEGA Brands, www.megabrands.com/media/pdf/corpo/en/reports/Financial_Statements_2010- 2009.pdf, accessed on August 27, 2011.

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MEGA Bloks management estimating that the company had a 25 per cent share of the North American building toy market and a 12 per cent share of the international building toy market.20

NEW BUSINESS THREATS

Over the past two years, LEGO had faced new threats emerging in the toy industry from company acquisitions, court battles and new product competition.

Company Acquisitions

In a strategic move to strengthen its position in the global entertainment industry, the Walt Disney Company (Disney) acquired Marvel Entertainment (Marvel) for US$4 billion in 2009.21 This provided Disney with control over Marvel’s vast catalogue of over 5,000 comic book characters to be used in future publishing, movie production and licensing operations. Movies based on comic book characters had proven to be extremely successful and profitable in the film industry, with Spider-Man earning over US$821 million in 2002,22 and The Dark Knight earning over US$1 billion in 2008.23 On top of producing massive movie revenues, comic book characters also generated huge revenues in the toy industry with the Spider-Man film generating over US$100 million in related toy sales in 2002.24 Mattel and Hasbro were the two largest toy manufactures in the world. Mattel had the highest revenue of any toy company with US$5.8 billion in 2010.25 It manufactured popular products such as Hot Wheels and Barbie, as well as a large selection of toys based on licensed rights. Behind Mattel but still significant in size, Hasbro operated as the world’s second-largest toy maker with a revenue of US$4 billion in 2010.26 The company produced many long-running successful toy products including Transformers, Mr. Potato Head, Play-Doh and Board Games, in addition to licensed toy products.

Although licensing arrangements often varied, many involved a foundation in which the licensee toy company paid the licensor a large advance of money. This advance guaranteed the licensor a large profit regardless of the licensee successfully selling its product; however, the licensee would often also be required to pay the licensor a percentage of the net sales for a licensed product, called a royalty. Licensing

agreements also specified numerous details including the amount of time a licensee could produce a Use outside these parameters is a copyright violation. product, the type of products to be created and in which countries the products could be sold. The acquisition of Marvel by Disney represented a significant move, as it placed a large amount of entertainment licensing under the control of one organization.

20 “MEGA Bloks Inc.,” Industry Today, 2010, www.usitoday.com/article_view.asp?ArticleID=1495, accessed on August 27, 2011. 21 “Disney Completes Marvel Acquisition,” Marvel, December 31, 2009, http://marvel.com/news/story/10809/disney_completes_marvel_acquisition, accessed on August 27, 2011 22 “Box Office History for Spider-Man Movies,” The Numbers, 2011, http://www.the- numbers.com/movies/series/SpiderMan.php, accessed on August 27, 2011. 23 “The Dark Knight,” The Numbers, 2011, http://www.the-numbers.com/movies/2008/BATM2.php, accessed on August 27, 2011. For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. 24 “Box Office History for Spider-Man Movies,” The Numbers, 2011, http://www.the- numbers.com/movies/series/SpiderMan.php, accessed on August 27, 2011. 25 “Mattel 2010 Annual Report,” Mattel, 2011,http://corporate.mattel.com/annualreport2010/pdfs/2010%20Mattel%20Annual%20Report(Bookmarked).pdf, accessed on August 27, 2011. 26 “Hasbro Annual Report 2010,” Hasbro, 2011,http://investor.hasbro.com/annuals.cfm, accessed on August 27, 2011.

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Mattel, Hasbro and LEGO all had individual licensing agreements with Disney to produce toys; however, Disney had a long and favourable history of licensing toys with Mattel. Hasbro on the other hand had an existing license agreement to produce Marvel toys and games until 2017.27 This created speculation in the toy industry as to which direction Disney would proceed in with future toy licensing agreements. Disney Chief Financial Officer Tom Staggs commented on this topic to the media: “As many of these deals conclude over time, we will have the flexibility to either bring them in-house or pursue third-party licensing agreements depending on how we feel we can create the most value.”28

Court Battle

LEGO had also been facing competition in the courtroom. In 1999, LEGO registered its classic eight-stud plastic brick shape as a trademark with the European Union, causing objection from rival competitor MEGA Brands. LEGO argued that its brick shape was distinctive and that consumers were often misled, believing that they were purchasing a LEGO product even when viewing a different company name on the box. The result was an 11-year court battle that came to a final decision in September 2010. The European Court of Justice ruled in favour of MEGA Brands, stating that shapes used for a technical result did not qualify for a trademark, thus revoking the LEGO brick trademark.29 This decision represented a major loss for LEGO. The company still held trademarks with the LEGO logo and popular mini-figure, but opportunities and business conditions existed for competition to increase.

New Competition

In 2011, new competition was set to emerge as Hasbro was planning to launch a new building block line called Kre-O that would be compatible with LEGO bricks. Although many different plastic brick building toys had been launched to compete with LEGO over the past 50 years, most did not succeed and eventually became discontinued; however, this product had serious threat potential due to the size and brand power of Hasbro. The new Kre-O line was set to be released in the spring of 2011, with the introductory Kre-O product line featuring the popular Transformers characters. Each set would include two sets of instructions that would allow builders to create a vehicle and a robot with the same building

pieces. The launch was designed to take advantage of the release of the third installment in the Use outside these parameters is a copyright violation. blockbuster Transformers movie franchise, Transformers: Dark of the Moon. Hasbro was hoping to tap into a licensed theme in the building toy market that had not been used before. The Transformers Kre-O line was scheduled to launch with 12 sets, with Hasbro planning to release additional product lines soon after.30

27 Aarthi Sivaraman, “Disney-Marvel deal casts web of issues for toymakers,” Reuters, August 31, 2009, www.reuters.com/article/2009/08/31/us-hasbro-analysis-sb-idUSTRE57U63C20090831, accessed on August 27, 2011. For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. 28 Ibid. 29 Sean Farrell, “Lego loses 11-year trademark battle,” The Telegraph, September 14, 2010, www.telegraph.co.uk/finance/newsbysector/retailandconsumer/8002268/Lego-loses-11-year-trademark-battle.html, accessed on August 27, 2011. 30 Mark Lennihan, “Hasbro pushes into Lego's land with new blocks,” USA TODAY, February 12, 2011, http://www.usatoday.com/money/companies/2011-02-12-hasbro-transformers_N.htm, accessed on August 27, 2011.

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FUTURE STRATEGY

Global toy sales represented over US$83.3 billion in 2010.31 One of the fastest-growing categories was building sets, with an increase of 13 per cent in 2010.32 The future in the building toy market held both opportunity and uncertainty, with new threats emerging from increased control over licensing agreements, loss of trademark protection and competition from new and existing sources. It was important for the LEGO management team to identify where to expand current product lines in order to help the company formulate a strategy to ensure that LEGO maintained market dominance in the building toy market and financial success in the years ahead.

Use outside these parameters is a copyright violation. For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019.

31 “Global Toy Sales in 2010 Increased by Nearly 5%, NPD Reports,” International Council of Toy industries, June 27, 2011. http://www.toy-icti.org/news/globaltoysalesin2010.html, accessed on August 27, 2011. 32 Mae Anderson, “Hasbro to challenge Legos with 'Transformers,'” Msnbc.com, February 13, 2011, www.msnbc.msn.com/id/41561886/ns/business-consumer_news/t/hasbro-challenge-legos-transformers/, accessed on August 27, 2011.

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Exhibit 1

FINANCIAL HIGHLIGHTS (in millions of DKK)

2010 2009 2008 2007 2006 Income Statement: Revenue 16,014 11,661 9,526 8,027 7,798 Expenses (10,899) (8,659) (7,522) (6,556) (6,393) Operating profit before special items 5,115 3,002 2,004 1,471 1,405 Special items (142) (100) 96 (22) (80) Financial income and expenses (84) (15) (248) (35) (44) Profit before income tax 4,889 2,887 1,852 1,414 1,281 Net profit for the year 3,718 2,204 1,352 1,028 1,290 Balance Sheet: Total assets 10,972 7,788 6,496 6,009 6,907 Equity 5,473 3,291 2,066 1,679 1,191 Liabilities 5,499 4,497 4,430 4,330 5,716 Cash Flow Statement: Cash flows from operating activities 3,744 2,712 1,954 1,033 1,157 Investment in property, plant and equipment 1,077 1,042 368 399 316 Investment in intangible assets 123 216 75 34 - Cash flows from financing activities (3,477) (906) (1,682) (467) 597 Total cash flows (871) 558 128 592 1,925 Employees: Average number (full-time) 8,365 7,286 5,388 4,199 4,908 Financial ratios (in %): Use outside these parameters is a copyright violation. Gross margin 72.5 70.3 66.8 65.0 64.9 Operating margin (ROS) 31.1 24.9 22.0 18.1 17.0 Net profit margin 23.2 18.9 14.2 12.8 16.5 Return on equity (ROE) 84.8 82.3 72.2 71.6 147.1 Return on invested capital (ROIC I) 161.2 139.5 101.8 69.7 63.6 Return on invested capital (ROIC II) 157.9 138.0 113.8 77.1 67.4 Equity ratio 49.9 42.3 31.8 27.9 17.2 Equity ratio 49.9 42.3 39.5 46.2 33.2

Source: The Lego Group: Annual Report 2010,” LEGO, 2011, http://cache.lego.com/upload/contentTemplating/AboutUsFactsAndFiguresContent/otherfiles/downloadE994290D230BFB0E

2A914F4DC3B6531C.pdf, accessed on August 27, 2011. For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019.

111 Page 12 9B11M086

Exhibit 2

BUSINESS OPERATIONS (2010)

Source: LEGO, 2011, http://www.lego.com/en-us/default.aspx, accessed on August 27, 2011. Use outside these parameters is a copyright violation. For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019.

112 11. HKS782 Case Number 2009.0

Homelessness in Harvard Square: Multi‐Stakeholder Collaboration in Action

In the summer of 2012, Ayala Livny, Program Manager for Youth on Fire (a drop‐in center for homeless and street‐involved youth in Harvard Square) came together with several others in Harvard Square to form the Harvard Square Homeless Coalition. Some of them, like Livny, represented nonprofit organizations that serve the homeless. Others represented Harvard Square churches that work with homeless people. A recent meeting convened by the Harvard Square Business Association (HSBA) had helped to catalyze this coalition: concern among Harvard Square business owners about aggressive panhandling, increased shoplifting and the absence of public bathrooms had reached a crescendo. It was clear that Harvard Square service providers needed a shared platform for discussion, exchange and collective action. Christ Church Cambridge, the 247‐year old Episcopal church that was once saved from decay by George and Martha Washington, hosted the first meeting of the Harvard Square Homeless Coalition. Ayala Livny stepped forward to be the informal leader of the coalition.

Harvard Square’s “Latrine Ministry” Closes Its Bathroom Doors

Harvard Square, in Cambridge, Massachusetts, is a cultural, academic and commercial center that takes pride in its inclusiveness and diversity. Each year, over 8 million people visit Harvard Square.1 In the 1970s, anti‐war protesters found support and solidarity in Cambridge, and camped out over an extended period of time on the Cambridge Common. The then pastor of Christ Church Cambridge (across the street from Cambridge Common), reflecting the wishes of his liberal congregation, opened the church bathrooms to these protesters and began what affectionately became known as “the latrine ministry.” Even after the departure of anti‐war protesters from Cambridge Common, Christ Church continued its posture of openness to people living on the streets. Over the years, the configuration of the bathrooms changed from a series of stalls to lockable bathrooms.

In May 2012, Reverend Joe Robinson, Pastor of Christ Church, faced a dilemma. He had been at Christ Church

for the past seven years and the church had intermittently faced difficulties with misuse of its bathrooms. This Use outside these parameters is a copyright violation. year, however, the situation had become dangerous. Heroin was cheap and plentiful on the streets, and the lockable bathrooms were being used to prepare and inject drugs. “We were dealing with overdoses every month – sometimes an overdose every week,” said Robinson.2 Cambridge Police Commissioner Robert Haas had requested a meeting with Reverend Robinson to discuss his concern that the Christ Church bathrooms were becoming a hotspot for drug overdoses. Most recently, the Cambridge Police Department had responded to four overdoses at

1 http://www.harvardsquare.com/about.aspx, (accessed July 4, 2013). 2 Reverend Joe Robinson. Interview with author. Cambridge, MA, October 17, 2012. This case was written by Sherine Jayawickrama, Senior Research Fellow, under the guidance of Julie Boatright Wilson, Harry S.

Kahn Senior Lecturer in Social Policy at Harvard University’s John F. Kennedy School of Government. HKS cases are developed For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. solely as the basis for class discussion. Cases are not intended to serve as endorsements, sources of primary data or illustrations of effective or ineffective management.

Copyright © 2014 President and Fellows of Harvard College. No part of this publication may be reproduced, revised, translated, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means without the express written consent of the Case Program. For orders and copyright permission information, please visit our website at ksgcase.harvard.edu or send a written request to Case Program, John F. Kennedy School of Government, Harvard University, 79 John F. Kennedy Street, Cambridge, MA 02138.

113 Christ Church in the span of one month. Haas urged Reverend Robinson to close the bathrooms to the public. Concerned that the church was unwittingly providing a place to facilitate destructive behavior that could lead to fatalities and worried about the safety of the preschool that the church housed, Robinson decided to do so.

After the closure of the Christ Church bathrooms to the public, homeless people in Harvard Square were left with few options. The Cambridge Police Department began receiving complaints from business owners that alleyways and sidewalks adjacent to stores were being used for defecation overnight. Tension on the streets intensified, especially between chronically homeless individuals who were “regulars” in Harvard Square and “travelers” who hitchhiked or train‐hopped across the country and stayed on Harvard Square streets for a few days or weeks at a time. Business owners perceived the chronically homeless as “our homeless” who were part of colorful, eclectic Harvard Square and had a stake in the welfare of the square; however, they saw the travelers as more aggressive, violent and rebellious.

The Cambridge Police Department had, over the years, developed effective strategies to engage with the chronically homeless and establish norms of behavior that would preserve a safe, comfortable atmosphere in Harvard Square. Dealing with travelers, however, was much more challenging. In general, travelers did not tend to respect authority and rejected the boundaries set by police. If arrested and charged, they would leave Cambridge and not appear in court. Many travelers had animals with them and fear of losing their animals (when asked to produce a license) was one of the only ways to secure their cooperation.

The Landscape of Homelessness in Harvard Square

Homelessness in the United States has been a persistent challenge exacerbated in a recessionary environment. According to the Department of Housing and Urban Development, some two million people in the United States were homeless at some point in 2009. A small proportion of these people were “chronically homeless” (defined by the federal government as being continuously homeless for one year or more, or experiencing at least four episodes of homelessness in three years). On any given day, about 112,000 people fit the definition of being chronically homeless.3 The rise in homelessness in the United States is driven by two major Use outside these parameters is a copyright violation. trends: the growing shortage of affordable rental housing and the increase in poverty.4

The situation in Cambridge, Massachusetts mirrors this landscape, with Central Square and Harvard Square being the main centers where homeless individuals congregate. The 2013 Cambridge Homeless Census5 counted 537 people experiencing homelessness. Over the years, Harvard Square (and “the pit,” the sunken area next to the Out of Town News stand and the entrance to the T station) has become a place where many homeless and street‐ involved people congregate. Their presence is seen as part of the landscape and texture of Harvard Square. Denise Jillson, Executive Director of the Harvard Square Business Association (HSBA), explained: For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019.

3 Dennis Culhane, “Five Myths About America’s Homeless,” The Washington Post, July 11, 2010. 4 National Coalition for the Homeless, “Why Are People Homeless,” July 2009. 5 The U.S. Department of Housing and Urban Development requires communities across the country to conduct an annual census of individuals and families experiencing homelessness during the last ten days of January. The census includes a count of unsheltered individuals, and a count of sheltered and transitionally housed families and individuals.

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114 Harvard Square should always be a place that welcomes everyone – from homeless people to global leaders. This is an authentic urban space comprised of mostly locally‐ owned, independent businesses. The consensus is there is room for everyone here. We never strive to rid the Square of homeless people. We do strive to help them.6

In fact, Massachusetts state law provides protection for panhandling as a First Amendment right, and declares the homeless a special needs group that cannot be held to the same rules as the general population because they are disadvantaged. For example, homeless people in Cambridge cannot be charged with loitering because, by definition, they have no home to return to.

There are several sub‐groups of homeless in Harvard Square. Among them are:

 The chronically homeless, some of whom have been on the streets of Harvard Square for long periods and are well known to the police, business owners and service providers. Some of these individuals struggle with mental health challenges.  Young people from Cambridge or surrounding towns who either live on the street or are involved with life on the street. These young people have left home for a variety of reasons: drug use, economic recession, domestic violence, intra‐family conflict, or gay, lesbian, bisexual, transgender or queer lifestyles. Others have homes but spend considerable periods on the streets.  Travelers who come to Harvard Square for relatively short periods of time. These young people move from city to city in a nomadic way (and connect with other travelers on social media), often train‐hopping or hitchhiking in small groups, along with animals. A 2011 survey conducted by Youth on Fire indicated that travelers are more likely (than general homeless youth) to: be male, white, heterosexual and more educated; use more alcohol and drugs; engage in more high‐risk sexual behavior; and report higher levels of sexually transmitted infections and Hepatitis C.7 Travelers tend to move around seasonally and Harvard Square has been a popular summer destination on the traveler circuit for years. Over the past five years,

Harvard Square has attracted increasing numbers of travelers in the warm months. In 2011 and 2012, the Use outside these parameters is a copyright violation. travelers’ aggressive behavior, open drug use and criminal activity caused intense concern – not only among residents, business owners, the police and service providers but also among other homeless people who were more rooted in Harvard Square.

A variety of actors engage with and served the homeless in Harvard Square: city agencies, nonprofit service providers, churches, ambulance services, and emergency room doctors, to name a few. Together they reflect the considerable resources of the City of Cambridge.

Cambridge Police Department

The Cambridge Police Department employs a community policing approach which seeks to proactively prevent and resolve law enforcement problems by working in partnership with various parts of the Cambridge community. For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. When Robert Haas became Police Commissioner in 2007, the Cambridge Police took a traditional law enforcement

6 Denise Jilson. Interview with author. Cambridge, MA, October 30, 2012. 7 Traveler Survey Findings, Youth on Fire, undated.

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115 approach to the homeless population. Haas reflected: “Typically, we would wait until there was a breach of the law and arrest them. Because many of them have severe mental or medical issues, we would wind up taking them to the hospital. They would end up in court, be released and be out on the street again. It was a vicious cycle.”8

Realizing that this approach was ineffective, Haas sought to connect with other government agencies and nonprofit service providers in order to understand and address homelessness in a more holistic and effective way. The Homeless Outreach Program was established in 2007 within the Community Relations Unit of the Cambridge Police Department. Officers Eric Helberg and Matt Price were assigned to the Homeless Outreach Program in recognition of their interest in working with the homeless population and their skill in relating to homeless individuals. This reflected the understanding that the police are often the first to interact with homeless individuals, and if they can build a respectful rapport, they are much better able to establish parameters for acceptable behavior as well as refer needed services. Since 2008, Officers Helberg and Price have had full‐time assignments with the Homeless Outreach Program, and are widely known and respected by both the chronically homeless on Cambridge streets and the service providers working with the homeless.

A December 2012 column in The Boston Globe9 chronicled Officer Eric Helberg’s work – how he knew homeless individuals and their stories personally, and how he watched out for them and avoided unnecessary hospitalizations and arrests with his vigilance. The column also described how closely the Cambridge Police Department worked with social services and medical facilities. Helberg reflected: “Before we started [the Homeless Outreach Program], we were islands: EMTs, the shelters, the police. We all took care of the same people, but no one talked. Now we’re a network of community services.”10

The progressive and respectful stance of the Cambridge Police Department makes the city, and Harvard Square, in particular, a relatively hospitable place for homeless individuals, including travelers.

Nonprofit Service Providers

Of more than 150 registered nonprofits in Cambridge, a few focus solely on homelessness. Other nonprofits Use outside these parameters is a copyright violation. with a broader geographic focus include Cambridge in their scope.

Youth on Fire, led by Ayala Livny, is a prevention program of the AIDS Action Committee, serving homeless and street‐involved youth in Harvard Square. It was established in 2000 following a survey of 100 youth showing that most of them were not connected to social services and did not want to be, and were at high risk for HIV and other sexually transmitted infections (STIs). Youth on Fire runs a daytime drop‐in center that takes a harm reduction approach. That means they make no judgment about risk‐taking behaviors, only trying to help youth be as safe as possible while engaging in those behaviors and building trust over time. Youth on Fire provides a range of services (hot meals, showers, laundry, computers), supports (mental health services, medical care, HIV/STI/hepatitis screening, housing search, referrals to other services), and opportunities (peer outreach program, youth advisory boards, speakers’ bureau, art and talent shows, community give‐back days). It is one of the few Cambridge For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019.

8 Commissioner Robert Haas. Interview with author. Cambridge, MA, October 10, 2012. 9 Joan Wickersham, “The Homeless Beat,” The Boston Globe, December 14, 2012. 10 Quote drawn from Joan Wickersham, “The Homeless Beat,” The Boston Globe, December 14, 2012.

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116 organizations that serve the travelers largely due to the fact that they provide safe, non‐judgmental space that is animal friendly. Some 40 percent of travelers have dogs with them, and Youth on Fire has become known on the traveler circuit as a place that welcomes animals.

The Harvard Square Homeless Shelter has been continuously run by Harvard students for thirty years. It is open from November to April each year and, for seven weeks in the summer, the shelter (housed in the basement of the University Lutheran Church) is used for the St. James Shelter, also run by students. Harvard Square Homeless Shelter offers 20 men’s beds and four women’s beds, roughly proportional to the gender breakdown of the homeless population. Beds are assigned through a lottery; people must call in the morning to request beds. Since it is an emergency shelter, stays of more than two weeks are not permitted. Harvard Square Homeless Shelter is a dry shelter, meaning that people under the influence of drugs or alcohol are not permitted.

CASPAR, a nonprofit serving Cambridge and Somerville, provides an array of outreach, shelter, stabilization, aftercare and prevention services to individuals struggling with substance abuse. It runs one of only three “wet shelters” (accepting individuals with active substance abuse disorders) in Massachusetts. This shelter, located in Central Square, provides services to 107 people nightly. Homeless individuals using Harvard Square as a base can access the shelter using the subway (red line on the T). CASPAR’s FirstStep street outreach program (on foot and in mobile vans) engages homeless people with substance abuse disorders where they are and tries to connect them with services.

Bread & Jams is a day shelter and drop‐in center located near Harvard Square. It provides a range of services such as case management, referrals for health and substance abuse problems, support with legal problems that preclude homeless individuals from obtaining housing or employment, and food, clothing and hygiene supplies. In 2008, Bread & Jams merged with Eliot Community Human Services, a large nonprofit human services organization serving people throughout Massachusetts, becoming a component of Eliot’s homeless outreach program.

Local Churches Use outside these parameters is a copyright violation. Since 1982, Christ Church Cambridge has hosted the Harvard Square Churches Meals Program every Thursday. It typically serves approximately 100 meals an evening; volunteers from local churches, schools and neighborhoods serve guests restaurant‐style, taking the meals to their tables. Being across the street from Cambridge Common, Christ Church welcomed anti‐war protesters to use its bathrooms in the 1970s. These bathrooms remained open to the public until June 2012, when a string of overdoses in the lockable bathrooms precipitated their closure.

Since 1987, First Church Shelter has provided accommodation to 14 homeless men each night. The shelter must be accessed on a referral‐only basis and does not accept walk‐ins. Shelter staff also help guests to negotiate the process of applying for public benefits or subsidized housing.

Business Owners For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019.

For more than 100 years, the Harvard Square Business Association (HSBA) has convened and represented the business community in Harvard Square, and helped advance the commercial and public interests of the square. Of the more than 330 businesses in Harvard Square, 78 percent are locally owned or independent. Denise Jillson has

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117 been Executive Director of HSBA since 2006 and is well networked not only within the Harvard Square business community but also more widely with the Cambridge Police Department, Harvard University and with nonprofit organizations and churches serving Harvard Square. Jillson serves as a node to which information relevant to the business community is transmitted and from which alerts are communicated. For example, relevant images and information from security cameras on the premises of HSBA members are shared with HSBA, and Jillson and her staff alert HSBA members to anything for which they need to be vigilant. Jillson was proactive in her engagement with the Cambridge Police and with nonprofit organizations on the issue of homelessness, especially the new challenges posed by a larger‐than‐usual influx of travelers in the summers of 2011 and 2012.

The Harvard Coop is a bookstore that has traditionally served Harvard University and the Massachusetts Institute of Technology (MIT). Its Harvard Square location is one of the largest retail spaces in the square. The Harvard Coop’s storefront, featuring a generous space that offers protection from the elements, is a popular area for homeless individuals to sleep or panhandle. The store also has bathrooms that are essentially open to the public. Jerry Murphy, President of The Harvard Coop, noted:

When there are people sitting in front of the store and asking for money, and particularly when they have animals like pit bulls with them, there is an intimidation factor that may discourage customers and visitors from going in. We have to make sure the front of our store and our bathrooms are clean and inviting for our customers and visitors.11

Many other business owners engage with and are affected by homelessness in Harvard Square. For example, given its location adjacent to the Harvard Square T station and “the pit,” Au Bon Pain is a café that has many homeless patrons. In addition, its ample outside seating is a draw for panhandling and its bathrooms are among a few in the square that can be used by homeless people. Given the number of aggressive young homeless people congregating and generating an atmosphere that visitors, residents and business owners find intimidating, the area outside CVS, Bank of America, Otto Pizza and T‐Mobile (on Massachusetts Avenue near the intersection with Use outside these parameters is a copyright violation. Church Street) has come to be known as “the gauntlet.” When the presence of travelers is at a peak, the “regular” homeless in Harvard Square steer clear of “the gauntlet,” seeking to avoid confrontation with travelers.

City Agencies

The Department of Public Works builds and maintains much of the public infrastructure of the City of Cambridge. To the extent that the homeless population in Harvard Square utilizes public infrastructure or reveals the need for additional infrastructure, the Department of Public Works needs to be involved. The lack of accessible public bathrooms in Harvard Square (with the exception of a bathroom at the Harvard Square T station) has become a contentious issue among homeless individuals, service providers and business owners.

The Department of Human Services runs a range of programs for homeless individuals and families. The Multi‐ For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. Service Center for the Homeless provides services to people living on the street, in transitional housing or at risk of losing their housing.

11 Jerry Murphy. Interview with author. Cambridge, MA, October 17, 2012.

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118 Platforms for Collaboration

Cambridge has no shortage of city agencies, medical professionals and nonprofit service providers serving the homeless. It also has a police department with a strong commitment to community policing led by a commissioner who places a premium on preventing the need for law enforcement solutions. In Harvard Square, business owners and residents view people living on the street as part of the diversity of the area. Harvard University students run a homeless shelter during the cold months and have street outreach teams that distribute food and blankets each night to homeless individuals on the street.

In 1999, after a study on homelessness conducted by the City of Cambridge, major actors engaging with the homeless came together to form the Senior Policy Group on Homelessness. This group became inactive over the years and was reactivated in 2007. Since then, the group has been convened by Claude Jacob, Chief Public Health Officer for Cambridge, and meets on a quarterly basis. Other members of the Senior Policy Group on Homelessness include the Assistant City Manager for Human Services, the Cambridge Police Commissioner and senior representatives of Healthcare for the Homeless, CASPAR, HomeStart, Professional Ambulance Services and the Emergency Department of Cambridge Hospital. The quarterly convening of this group – together with the preparatory and follow‐up work done by staff – enables the sharing of information among key actors engaging with homelessness in Cambridge and provides a forum for planning collaborative approaches and activities, where possible.

While the Senior Policy Group on Homelessness offered an effective platform for collaboration and coordination at the city level, localities like Harvard Square were not organized in similar ways. When new challenges arose or existing challenges were exacerbated, mechanisms for coordinated decision making and action were not in place. The summer of 2011 saw travelers arriving in Harvard Square in greater‐than‐usual numbers. A strong drug culture was associated with their presence. Fights broke out between travelers and “regulars” in Harvard Square. In the summer of 2012, two other factors converged to further escalate the situation. First, the

Cambridge Police response to a homicide in East Cambridge shifted police resources away from Harvard Square in Use outside these parameters is a copyright violation. the early part of the summer. Second, the closure of the public bathrooms at Christ Church left homeless individuals with no options to relieve themselves in the night.

This led to a situation where business owners found evidence of open defecation and urination in alleyways and outside storefronts when they opened for business in the mornings. Public consumption of drugs and alcohol was not uncommon, panhandling was turning aggressive, and incidents of shoplifting and break‐ins were on the rise. HSBA had long been a platform for business owners to discuss issues related to the welfare and safety of Harvard Square and its inhabitants. The association’s meetings were regularly attended by senior representatives of the Cambridge Police Department, who consistently urged business owners: “if you see something, say something.” They explained that the police could do very little unless residents or business owners reported aggressive behavior that made them fearful or uncomfortable. Such reports give the police the impetus to arrive For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. on the scene, investigate and address the situation. The police encouraged business owners and residents to dial 911 in an emergency, and dial 349‐3000 if not an emergency but the presence of a police officer was necessary. As a result of the police department’s proactive engagement with HSBA, a matrix of current problems together with

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119 the appropriate police response and community (business owners) response was developed to create a shared understanding of the situation.

As the situation escalated in Harvard Square, business owners began to get impatient about why the police were not acting more assertively. Although there was widespread appreciation of the work of Officers Eric Helberg and Matt Price (in homeless outreach), there was frustration that the City of Cambridge’s welcoming and respectful posture toward homeless individuals – including travelers – was combined with a lack of public infrastructure (i.e. public bathrooms) to meet their basic needs. This frustration was captured by Reverend Joe Robinson of Christ Church, who received some criticism after the church’s decision to close its bathrooms to the public after a series of drug overdoses occurred there:

This city has a very open policy toward people living in the streets and panhandling – much more open than Boston, which is why people gravitate here. The city doesn’t see the connection between the policy of openness and the responsibility to provide basic services for people who come here. For example, all the conversations have been about private bathrooms being made available to the homeless. Why is the city depending on the private sector providing bathrooms for the public, especially when there is such an open policy toward people living on the street?

In a June 2012 community meeting convened by the HSBA – and attended by the Police Commissioner, Reverend Joe Robinson, Ayala Livny and others – the lack of public bathrooms in Harvard Square became a flashpoint for frustration and collaboration.

Organizing for a Place to Go

When leaders of nonprofit service providers like Youth on Fire and Bread & Jams met at the HSBA meeting, some of them didn’t know each other – and, as a group, they had no forum in which to share information and

lessons, to jointly consider issues that were obviously interconnected, or to plan for collective action. In June 2012, Use outside these parameters is a copyright violation. when these service providers met at the HSBA‐convened meeting and took part in the discussion, securing a public bathroom that homeless people could use emerged as their top priority. They formed the Harvard Square Homeless Coalition12 with one immediate goal in mind: to press the Department of Public Works for a portable toilet at Cambridge Common.

The organizing for a portable toilet proceeded swiftly under the leadership of Ayala Livny, who mobilized a diverse group of Cambridge stakeholders to email or write to Lisa Peterson, Commissioner of the city’s Department of Public Works (DPW), each stating their distinctive case for a portable toilet. Parents who used the playground at Cambridge Common urged DPW to install a portable toilet so that their children could have easier access to a bathroom. Student groups who used the soccer fields at Cambridge Common mirrored that request. HSBA members and members of the congregations of Christ Church and First Church did the same. A member of Youth For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019.

12 The Harvard Square Homeless Coalition includes: Youth on Fire, Bread & Jams, the Harvard Square Homeless Shelter and the First Church Shelter. Christ Church Cambridge is not formally a member but provides meeting space and convening support. Notes of coalition meetings are shared with the Cambridge Police Department.

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120 on Fire wrote about how young homeless people often do not eat after 4 pm because the MBTA restrooms close at night. This organizing effort indicated both that the lack of public bathrooms affected a broad range of Cambridge stakeholders and that solving the problem was an urgent need.

The Harvard Square Homeless Coalition met with Lisa Peterson in September 2012 to discuss their request, and Peterson went away having committed to exploring what a feasible solution might be. A month later, a portable toilet was installed in the Cambridge Common. Charlie Hobbs of the Harvard Square Homeless Shelter recalls his surprise at the speed of DPW’s response: “I thought this was supposed to be way harder… that we would have to really fight to get something done.”13

After their rapid advocacy victory, the Harvard Square Homeless Coalition lost no time in pressing to keep the portable toilet open during the winter. The DPW’s policy was generally to remove portable toilets during the winter. After another round of mobilizing letters and emails, the coalition was successful in securing the DPW’s agreement to keep the portable toilet open throughout the winter. The DPW has service providers’ support in maintaining the portable toilet clean and functional: CASPAR’s FirstStep outreach team checks the toilet regularly and notifies the DPW when it needs cleaning or maintenance.

The Road Ahead

With a quick victory under their belt and recognizing the obvious value of a shared forum, members of the Harvard Square Homeless Coalition continued to meet regularly. Ayala Livny continued to provide leadership and coordination to the coalition, which met once a month (every third Wednesday of each month) and identified a topic to explore at each monthly meeting. Christ Church Cambridge became a regular meeting venue. While Christ Church was not part of the coalition itself, Reverend Robinson sought to support the coalition and help it cohere. The existence of the coalition also provided a convenient mechanism for the Cambridge Police Department and HSBA to engage with nonprofit service providers focused on homelessness in Harvard Square.

In June 2013, HSBA held its annual community meeting focused on keeping Harvard Square businesses, Use outside these parameters is a copyright violation. visitors and workers safe during the summer season. In addition to HSBA members, the meeting included several officers from the Cambridge Police Department and several service providers working in Harvard Square. Just one year since the HSBA meeting in which frustration about the lack of public bathrooms spilled over and concerns surrounding the travelers in Harvard Square reached a crescendo, the tone of the discussion was starkly different. Service providers who may not have known each other the previous year were now knit together in the Harvard Square Homeless Coalition. HSBA members and the Cambridge Police acknowledged that the summer of 2013 was, thus far, a slower season (in terms of the influx of travelers) than the summers of 2011 and 2012. However, given the collaborative relationships that had been built and strengthened, all these actors were better prepared and equipped to face new challenges.

The previous year, under Denise Jillson’s leadership, HSBA had produced a brochure titled “Help for the For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. Homeless” (see Exhibit 2) meant to provide information both to people in need of help and people wishing to help. This brochure briefly described the services and hours of six agencies/programs serving the homeless in Harvard

13 Charlie Hobbs. Interview with author. Cambridge, MA, October 11, 2012.

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121 Square. In the course of the year, HSBA had also set up a series of tablets in various shops so visitors could donate instantly to these agencies/programs using a credit card. Youth on Fire had organized a series of Clean‐Up Days for its members (homeless youth) to help clean up Harvard Square, and HSBA had supported this effort by buying pizza for the volunteers. Speaking at the June 2013 meeting, Ayala Livny asked if HSBA members would be willing to contribute toward a small stipend for peer leaders that could be trained by Youth on Fire to engage with travelers about the norms established by homeless young people who are in Harvard Square year‐round. Livny introduced a Youth on Fire member, who had been living on the street in Harvard Square for a few years. He eloquently described the state of tension that existed between travelers and chronically homeless individuals in Harvard Square: “We have the same problems with travelers that you do. They don’t care if things get bad because they can leave. We local kids have some norms. We scold each other for tossing trash about or being public with illicit activities or getting overly aggressive.”14

The meeting was attended by several police officers, including Superintendent Steve Williams, Commander of the Patrol Operations Division, and Deputy Superintendent Steve Ahearn, who underscored how important the partnership of the business community had been in managing the situation in Harvard Square the previous year. Various officers – from those assigned the day shift and night shift in Harvard Square to the Director of Outreach and Community Programs to one of the department’s Crime Analysts – were introduced to HSBA members and service providers. Although Officers Helberg and Price have had much success in their outreach roles, several officers acknowledged that engaging with travelers remained challenging. Toward the end of the meeting, some frustration spilled over from police officers assigned to Harvard Square, who urged that Youth on Fire collaborate more closely with the Cambridge Police Department when travelers suspected of crimes are at the Youth on Fire day shelter. Livny explained: “We work really hard to get these young folks to trust us. If we are seen to be in cahoots with the police, that doesn’t help us. Our primary obligation is to our members.”15

In addition, in the aftermath of the marathon bombings in Boston in April 2013, some new security concerns arose among HSBA members. A representative of Trademark Tours, a business that offers tours of Harvard, MIT and other Boston‐area landmarks, asked about security concerns surrounding unattended bags. Tour guides Use outside these parameters is a copyright violation. frequently see unattended backpacks but know that they belong to certain homeless individuals, and feel bad to report it to the police. What should tour guides do in these situations? While Trademark Tours was urged by the police to report it, Livny also offered to spread the word among young people on the street that they should not leave backpacks unattended.

Since June 2012, the Harvard Square Homeless Coalition’s mobilization for a portable toilet on Cambridge Common had grown into a fully‐fledged campaign catalyzed by members of Christ Church to press the city to include a public bathroom in its planned $4 million renovation of Cambridge Common. Advocates for a Common Toilet (or ACT) counted Youth on Fire, St. James Episcopal Church, HSBA, the Outdoor Church of Cambridge, Cambridge Youth Soccer, First Church and First Parish in Cambridge among its members (see Exhibit 3 and 4). For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019.

14 Drawn from remarks at the annual community meeting of the Harvard Square Business Association, June 12, 2013. 15 Ayala Livny. Interview with author. Cambridge, MA, June 4, 2013.

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122 Despite a plethora of public agencies and nonprofit organizations serving the homeless, a police department committed to community policing, and an association of business owners supportive of the rights of homeless individuals, Harvard Square continues to face challenges in relation to both “regulars” and travelers on its streets. How should the City of Cambridge more effectively reconcile its openness to homeless people – and its growing reputation on social media as an attractive destination to travelers – with public infrastructure and services to meet their needs? How should the rights of business owners and residents (e.g. to create a welcoming climate for customers, to feel safe and comfortable in Harvard Square) be balanced with the rights of homeless people (e.g. to fulfill basic needs with dignity, to panhandle)? What will it take for mechanisms for joint problem solving and collective action to be sustained over time, as some problems are resolved and new challenges emerge? As collaboration between police and service providers increases in breadth and depth, how are the boundaries of collaboration negotiated to allow each party to serve its clients while working toward a shared goal? What new strategies could be developed to incentivize travelers to respect accepted norms for homeless individuals in Harvard Square?

Use outside these parameters is a copyright violation. For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019.

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123 Exhibit 1: Map of Harvard Square Use outside these parameters is a copyright violation. For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019.

Source: Courtesy of Scott Walker, Harvard Map Collection

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124

Exhibit 2: HSBA brochure

Use outside these parameters is a copyright violation.

Source: Courtesy of the Harvard Square Business Association. For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019.

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125

Exhibit 2, Continued

126

HKS Case Program 14 of 24 Case Number 2009.0

For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. Use outside these parameters is a copyright violation.

Exhibit 3: ACT website (factsheet) Use outside these parameters is a copyright violation. For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019.

Source: http://www.cambridgeact.com/uploads/9/3/1/4/9314770/fact_sheet.pdf

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127 Exhibit 4: DPW letter re public bathroom

Use outside these parameters is a copyright violation. For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019.

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128 Exhibit 4, continued

Use outside these parameters is a copyright violation. For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019.

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129 Exhibit 4, continued

Use outside these parameters is a copyright violation. For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019.

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130 Exhibit 4, continued

Use outside these parameters is a copyright violation. For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019.

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131 Exhibit 4, continued Use outside these parameters is a copyright violation. For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019.

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132 Exhibit 4, continued Use outside these parameters is a copyright violation.

For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019.

HKS Case Program 21 of 24 Case Number 2009.0

133 Exhibit 4, continued

Use outside these parameters is a copyright violation. For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019.

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134

Exhibit 4, continued

Use outside these parameters is a copyright violation. For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019.

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135 Exhibit 4, continued Use outside these parameters is a copyright violation.

For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019.

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136 12.

9B15M004

THE U.S. POSTAL SERVICE: A FIRST CLASS DISRUPTION1

Allen H. Kupetz and Martin Suter wrote this case solely to provide material for class discussion. The authors do not intend to illustrate either effective or ineffective handling of a managerial situation. The authors may have disguised certain names and other identifying information to protect confidentiality.

In late 2013, the first correspondence from the United States Postal Service (USPS) to the team of advisors in Florida arrived, ironically, via an email. Facing declining revenues, huge fixed costs, bloated employee unions, an inflexible regulatory environment and a generation of millennials that virtually never used its product; the USPS was looking for help. The advisors all came from entrepreneurial backgrounds, unlike many of the large consulting firms that the USPS had used in the past. Their mandate was clear: challenge the status quo, help to frame the magnitude of the disruption that the USPS was facing, educate the leadership on the nature of innovation and technological ecosystems, identify opportunities for the USPS to enter new markets for new sources of revenue, and develop a solution immediately.2 The senior leadership of the USPS and some of the best consulting companies in the world had grappled with these issues and were now looking to break the mold with some fresh — maybe even unconventional — thinking. Was an entrepreneurial approach more likely to be successful? Or would this approach only involve niche ideas that would not produce significant results for an enterprise that had US$67billion3 in revenue in 2013? Many other developed countries were facing the same disruption; were there lessons to be learned from these other postal services? The advisors gathered together in a small Use outside these parameters is a copyright violation. office with a whiteboard and a PC projector to create a slide deck to share with the U.S. postmaster general later that month. Fueled by coffee, caffeinated soft drinks and protein bars, they settled into a task that, at first blush, seemed impossible.

THE USPS: A NATIONAL INSTITUTION

The USPS was older than the United States. Benjamin Franklin was appointed as the first postmaster general in 1775, 12 years before the U.S. Constitution was signed and 14 years before George Washington was elected as the first President.4

The Postal Clause of the U.S. Constitution empowered the U.S. Congress “to establish [p]ost [o]ffices and 5 post [r]oads.” Over 200 years later, congressional approval was still required on most things related to For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. the USPS, including postal rates, new products and services, and changes to its service obligations (e.g., Saturday delivery, post office closings, etc.). The role of Congress in the oversight of the day-to-day operations of the USPS meant that the postmaster general had far less autonomy to implement change than a chief executive officer (CEO) of a similarly sized corporation.

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Congress gave the USPS a monopoly on the delivery of “letter mail” (i.e., first-class mail), and was the only business allowed to use residential mailboxes. In return for this monopoly, the USPS had a service obligation commonly referred to as the “universal service obligation” (USO). A key element of the USO was residential delivery of letter mail to all U.S. residences six days per week.6

THE SCOPE OF THE PROBLEM

The size and scope of the USPS was enormous. At the end of 2013, the USPS: 7  Held a monopoly on first-class mail delivery and had an obligation to deliver mail to every home in the United States six days per week.  Had over 485,000 career and 137,000 non-career employees8 (see Exhibit 1).  Had over 31,000 retail locations and over 150 million delivery points; a larger footprint in the United States than McDonald’s, Starbucks and Wal-Mart combined9 (see Exhibit 2).  Delivered more mail to more addresses in a larger geographical area than any other post in the world.  Provided postal products and services to all residents of the United States and its territories; customers paid the same postage regardless of their location.10

According to its website,11 in 2013, the USPS:  Processed 158.4 billion pieces of mail.  Handled 40 per cent of the world’s mail volume.  Paid $1.8 billion every two weeks in salaries and benefits.  Maintained a fleet of over 211,000 vehicles — one of the largest civilian fleets in the world.  Processed 38.8 million address changes.  Had 1.1 billion visits to its website.  Accepted 5.3 million passport applications.  Sold almost 95 million money orders.  Supported 70,000 stores, banks and self-service kiosks that sell stamps.  Received absolutely no tax dollars to cover operating costs.

The challenges were equally enormous. The USPS: Use outside these parameters is a copyright violation.  Lost almost $16 billion in 2012 and $5 billion in 2013, hit its legal borrowing limit and defaulted twice on required payments to the federal government12 (see Exhibit 3).  Lost $2 billion in the second quarter of 2014, compared with a net loss of $740 million in the same period in 2013, and a $1.9 billion loss in the first quarter of 2014.13  Lost $25 million each day as more Americans communicated by email. In 2011, first-class mail (i.e., letters, large envelopes, small packages, etc.) was down 6.4 per cent — the sixth decline in six years. Further, fewer than half of all bills were paid through the mail in 2012.14  Slated almost 4,000 post offices for closure; almost two-thirds of these offices earned less than $27,500 in annual sales. Nearly 90 per cent were located in rural areas, where shrinking populations and dwindling businesses meant that the post offices simply cost more to operate than they earned. However, closing all of the post offices under consideration would save only about 15

$295 million a year — i.e., 0.4 per cent of the USPS’s annual expenses of $70 billion. For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019.

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THE BUSINESS OF THE USPS

The USPS was in the business of delivering mail, six days per week, to every residential address in the United States, for the price of a first-class stamp. It derived its revenue from mailing services and ancillary services.

Mailing services were broken down into sub-segments: first-class mail, standard mail, periodicals and package services, including completing the package delivery area for private companies like FedEx and UPS. Collectively, mailing services accounted for the vast majority of USPS revenue.

Ancillary services were tightly coupled to letter mail and included such services as certified mail, return receipts, delivery confirmation, P.O. Box rental and insurance. Distinct from letter mail was the USPS money order line of business, which accounted for $165 million in revenues in 2012, or approximately 0.3 per cent of total revenues.16 Collectively, ancillary services accounted for approximately 6 per cent of total USPS revenue.

ATOMS TO BITS: A DANGEROUS TREND FOR THE USPS

In his 1996 book, Being Digital, Nicholas Negroponte wrote: “The change from atoms to bits is irrevocable and unstoppable. Why now? Because the change is also exponential — small differences of yesterday can have suddenly shocking consequences tomorrow.”17

Virtually no industry had been untouched by the monumental shift from atoms — i.e., physical materials — to bits — i.e., computerized data. Entire industries, including advertising, music, television, photography, publishing, retail and education, had seen incumbents mortally wounded or disappear depending on their ability to adapt. The USPS had been sliding down an unsustainable fiscal path for years. Since 2007, the organization had been in dire financial straits. One article noted:

Like many large, once successful organizations, the USPS failed to adapt to sweeping technological changes that have altered how Americans do everything from paying bills to

communicating with friends and family. The USPS is scrambling to cut costs and legislators are Use outside these parameters is a copyright violation. debating a new law that would transform the organization. The question now is whether the overhaul of the USPS will position it to survive in the decades ahead, or whether instead it will continue on its current path to irrelevance.18

How had the atoms-to-bits disruption manifested itself in the context of the USPS? First-class mail volumes declined 25 per cent from 2008 to 2012, as traditional uses of first-class mail — like bill presentment and bill paying — shifted online. Standard mail, mostly in the form of advertising flyers, had declined nearly 20 per cent as local advertisers had embraced digital advertising — primarily search and social media — for their local advertising spend. Revenue from periodicals was down almost 25 per cent, as content consumption shifted from print to digital because of the emergence of smartphones and tablets.19

The team of advisors all agreed that none of these trends were going to stop. A more likely scenario, as For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. described by Negroponte, was that this change would continue to be exponential with the declines accelerating. The advisors agreed that future revenue from traditional mail was destined to approach zero in their lifetimes.

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A WAY TO DELIVER PROFITABLITY?

In 1899, postmaster general Charles Emory Smith called the USPS the “greatest business concern in the world.”20 However, with fixed costs largely resulting from bloated and inflexible employee unions, unprofitable physical locations across the country, and the lack of flexibility to change congressionally mandated prices and service terms, the USPS had not made money since 2006.21

Getting to breakeven could be achieved either by increasing revenues and/or reducing expenses, both of which presented unique challenges for the USPS.

The USPS relied almost entirely on revenue generated from its mailing services to cover its costs, but had to seek approval to raise the price of postage. Further, the postal service was required to charge the same rate regardless of the distance a letter or package was being shipped.22 Thus, despite a huge cost difference in delivering a letter from New York to New Jersey, as compared to from New York to a home in Alaska, the USPS charged the same rate for both deliveries. Mail volumes had continued to decline and rate increases had not offset this trajectory.

The atoms-to-bits disruption was hitting each of the USPS lines of business. Reversing the revenue trend, in any of the existing mail services, was not going to happen. Backfilling lost revenue with new services was the only option, but with multi-billion dollar declines every year, finding additional sources of revenue was the primary objective.23

Reducing expenses was also non-trivial. The USPS had massive fixed and operating costs associated with its national infrastructure and headcount, which were required to deliver against its USO.

Headcount costs (e.g., compensation and benefits, retiree health benefits, and workers compensation) had declined more slowly than revenue, due in large part to the political power of the four postal worker unions. These unions were among the largest donors to the Democratic Party, had been able to keep the USPS from ending Saturday mail delivery, and had done a masterful job of building opposition to a plan of opening post offices inside Staples stores.24

In February 2010, the USPS commissioned a study25 to investigate what the postal services of other countries26 were doing to offset reduced revenue from traditional mail delivery. This study identified five Use outside these parameters is a copyright violation. key categories to examine:

Transportation  Express parcel services  Logistics (including warehousing, freight forwarding, contract logistics and customs brokerage)

Retail services  Retail (sale of mail and non-mail-related convenience products)  Banking (money transfer, bill payment, retail and commercial banking, resale of financial services)

Mailed-related services  Integrated marketing (data, media, print and production services, and customer response For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. management)  Document management (document digitization, physical and digital mail room management, data processing, and archiving services)

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 Hybrid mail (electronic postage, multi-channel mail distribution, email certification and digital mailbox management)

Emerging services  Telecommunications (provision of Internet and/or telephone services)  eCommerce (online shopping and associated trade-facilitation services including e-payment)  Business services (consulting and outsourcing services)

Government services  Basic services (identification, enrollment, tax and fine payment, benefits distribution, certification, and license processing)  Other services (non-mail-related outsourced public services, such as environmental services)

The advisors viewed each of these five categories from a strengths and weaknesses perspective, and in the context of the macro-level trends facing them.27

Diversifying into transportation was likely the easiest, as the parcel delivery component was already largely in place. Logistics could be expanded with the USPS’s current physical locations and equipment, but there was little international experience among the workforce.

Diversifying into retail was easy too, but would not lead to significant incremental revenue. Banking stood out as a potential opportunity, if the USPS could compete against the payday loan companies that targeted the under-banked and poor. According to a 2013 Pew Charitable Trusts research project, “The average payday loan of $375 costs consumers an average of $520 over the life of the loan. A postal loan for the same amount could cost just $48, leaving already cash-strapped borrowers with more money in their pockets.”28

Mail-related services did not seem to offer significant revenue opportunities, and seemed destined to decline inexorably to zero.

Diversifying into emerging services like telecommunications and eCommerce would require the Use outside these parameters is a copyright violation. organization to hire very different employees from those currently working for the USPS. It would also mean competing against private companies that had already achieved economies of scale with vast physical and digital networks.

Government services had already proven to be a good source of revenue for the USPS with fees earned for processing more than five million passport applications. The advisors thought the cost needed to expand this branch relative to its potential revenue looked quite favourable.

CAN THE USPS BE SAVED?

Armed with reams of data (see Exhibit 4) and years of personal entrepreneurial experience, the team of advisors wrestled with a chicken-or-the-egg dilemma: small changes in either increasing revenue or reducing expenses would be insufficient to have a material impact on the USPS, but big changes required For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. congressional and employee union support — two sides that seemed unlikely to agree. With respect to the upcoming presentation to the U.S. postmaster general, the team did not plan on presenting a solution necessarily, but perhaps a path that could generate multiple solutions. As the smell of fresh coffee filled the room, the advisors set to work on what seemed like the most difficult project of their careers.

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EXHIBIT 1: NUMBER OF USPS EMPLOYEES, 1926 TO 2013

Source: Danielle Kurtzleben, “Amazon is One of the Only Things Keeping the U.S. Postal Service Afloat,” Vox, September 24, 2014, www.vox.com/2014/9/24/6829335/us-postal-service-post-office-charts-amazon-fedex-UPS, accessed November 1, 2014.

EXHIBIT 2: NUMBER OF U.S. POST OFFICES, 1789 TO 2013

Use outside these parameters is a copyright violation. For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019.

Source: Kurtzleben, op. cit.

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EXHIBIT 3: USPS INCOME MINUS EXPENSES, 2003 TO 2013 (IN 2014 DOLLARS)

Source: Kurtzleben, op. cit.

Use outside these parameters is a copyright violation. For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019.

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EXHIBIT 4: USPS OPERATING STATISTICS FOR THE PERIOD 2008 TO 2012

USPS Operating Statistics in millions of units indicated

Mailing Services 2012 2011 2010 2009 2008 First Class Mail Revenue $28,867 $30,030 $32,111 $33,848 $36,156 Pieces, number 68,696 72,522 77,592 82,727 90,671

Standard Mail Revenue $16,428 $17,175 $16,728 $16,707 $19,939 Pieces, number 79,496 83,957 81,841 81,763 98,350

Periodicals Revenue $1,731 $1,821 $1,879 $2,038 $2,295 Pieces, number 6,741 7,077 7,269 7,901 8,605

Package Services Revenue $11,596 $10,670 $10,156 $10,193 $10,529 Pieces, number 3,502 3,258 3,057 3,077 3,346

Total Mailing Services Mail Revenue $58,622 $59,696 $60,874 $62,786 $68,919 Pieces, number 158,435 166,814 169,759 175,468 200,972

Ancillary and Special Services 2012 2011 2010 2009 2008 Certified Mail Revenue $663 $708 $791 $731 $718 Number of articles 227 251 283 267 269 Return Receipts Revenue $399 $478 $557 $544 $550 Number of articles 170 195 223 221 230 Delivery Confirmation Use outside these parameters is a copyright violation. Revenue $228 $244 $224 $166 $147 Number of articles 1819 1482 1371 1063 961 P.O. Box Rent Revenue $837 $808 $816 $817 $897 Money Orders Revenue $165 $172 $182 $190 $205 Number of articles 109 116 123 135 149 Insurance Revenue $109 $117 $128 $129 $145 Number of articles 30 35 40 44 52 Shipping & Mailing Supplies Revenue $118 $112 $107 N/A N/A Number of articles 70 62 62 N/A N/A Other Mailing Services Revenue $1,266 $791 $985 $417 $971

Total Ancillary & Special Services Revenue $3,785 $3,430 $3,790 $2,994 $3,633 For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. TOTAL USPS Operating Revenue $65,223 $65,711 $67,052 $68,090 $74,932

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EXHIBIT 4 (CONTINUED)

USPS Operating Statistics % of Total Revenue

Mailing Services 2012 2011 2010 2009 2008 First Class Mail Revenue 44.3% 45.7% 47.9% 49.7% 48.3% Pieces, number 43.4% 43.5% 45.7% 47.1% 45.1%

Standard Mail Revenue 25.2% 26.1% 24.9% 24.5% 26.6% Pieces, number 50.2% 50.3% 48.2% 46.6% 48.9%

Periodicals Revenue 2.7% 2.8% 2.8% 3.0% 3.1% Pieces, number 4.3% 4.2% 4.3% 4.5% 4.3%

Package Services Revenue 17.8% 16.2% 15.1% 15.0% 14.1% Pieces, number 2.2% 2.0% 1.8% 1.8% 1.7%

Total Mailing Services Mail Revenue 89.9% 90.8% 90.8% 92.2% 92.0% Pieces, number 100.0% 100.0% 100.0% 100.0% 100.0%

Ancillary and Special Services 2012 2011 2010 2009 2008 Certified Mail Revenue 1.0% 1.1% 1.2% 1.1% 1.0% Number of articles Return Receipts Revenue 0.6% 0.7% 0.8% 0.8% 0.7% Number of articles Delivery Confirmation Use outside these parameters is a copyright violation. Revenue 0.3% 0.4% 0.3% 0.2% 0.2% Number of articles P.O. Box Rent Revenue 1.3% 1.2% 1.2% 1.2% 1.2% Money Orders Revenue 0.3% 0.3% 0.3% 0.3% 0.3% Number of articles Insurance Revenue 0.2% 0.2% 0.2% 0.2% 0.2% Number of articles Shipping & Mailing Supplies Revenue 0.2% 0.2% 0.2% N/A N/A Number of articles Other Mailing Services Revenue 1.9% 1.2% 1.5% 0.6% 1.3%

Total Ancillary & Special Services Revenue 5.8% 5.2% 5.7% 4.4% 4.8% For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019.

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EXHIBIT 4 (CONTINUED)

USPS Operating Statistics Period over Period Growth

Mailing Services 2012 2011 2010 2009 First Class Mail Revenue ‐3.9% ‐6.5% ‐5.1% ‐6.4% Pieces, number ‐5.3% ‐6.5% ‐6.2% ‐8.8%

Standard Mail Revenue ‐4.3% 2.7% 0.1% ‐16.2% Pieces, number ‐5.3% 2.6% 0.1% ‐16.9%

Periodicals Revenue ‐4.9% ‐3.1% ‐7.8% ‐11.2% Pieces, number ‐4.7% ‐2.6% ‐8.0% ‐8.2%

Package Services Revenue 8.7% 5.1% ‐0.4% ‐3.2% Pieces, number 7.5% 6.6% ‐0.6% ‐8.0%

Total Mailing Services Mail Revenue ‐1.8% ‐1.9% ‐3.0% ‐8.9% Pieces, number ‐5.0% ‐1.7% ‐3.3% ‐12.7%

Ancillary and Special Services 2012 2011 2010 2009 Certified Mail Revenue ‐6.4% ‐10.5% 8.2% 1.8% Number of articles ‐9.6% ‐11.3% 6.0% ‐0.7% Return Receipts Revenue ‐16.5% ‐14.2% 2.4% ‐1.1% Number of articles ‐12.8% ‐12.6% 0.9% ‐3.9% Delivery Confirmation Use outside these parameters is a copyright violation. Revenue ‐6.6% 8.9% 34.9% 12.9% Number of articles 22.7% 8.1% 29.0% 10.6% P.O. Box Rent Revenue 3.6% ‐1.0% ‐0.1% ‐8.9% Money Orders Revenue ‐4.1% ‐5.5% ‐4.2% ‐7.3% Number of articles ‐6.0% ‐5.7% ‐8.9% ‐9.4% Insurance Revenue ‐6.8% ‐8.6% ‐0.8% ‐11.0% Number of articles ‐14.3% ‐12.5% ‐9.1% ‐15.4% Shipping & Mailing Supplies Revenue 5.4% 4.7% N/A N/A Number of articles 12.9% 0.0% N/A N/A Other Mailing Services Revenue 60.1% ‐19.7% 136.2% ‐57.1%

Total Ancillary & Special Services Revenue 10.3% ‐9.5% 26.6% ‐17.6% For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019.

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EXHIBIT 4 (CONTINUED)

USPS Financial History Summary $ millions Income Statement 2012 2011 2010 2009 2008 Operating Results Operating Revenue $65,223 $65,711 $67,052 $68,090 $74,932 Operating Expenses Compensation and benefits $47,689 $48,310 $48,909 $53,154 $53,585 Retiree health benefits $13,729 $2,441 $7,747 $3,390 $7,407 Workers' compensation $3,729 $3,672 $3,566 Transportation $6,630 $6,389 $5,878 $6,026 $6,961 All other operating expenses $9,187 $9,822 $9,326 $9,260 $9,785 Total Operating Expenses $80,964 $70,634 $75,426 $71,830 $77,738

Operating Loss ($15,741) ($4,923) ($8,374) ($3,740) ($2,806) Interest and investment income $25 $28 $25 $26 $36 Interest Expense ($190) ($172) ($156) ($80) ($36) Net Loss ($15,906) ($5,067) ($8,505) ($3,794) ($2,806)

Balance Sheet 2012 2011 2010 2009 2008 Current Assets Cash and cash equivalents $2,319 $1,488 $1,161 $4,089 $1,432 Net Accounts Receivable $918 $1,041 $1,079 $824 $729 Supplies, advances & prepayments $126 $120 $114 $138 $193 Total Current Assets $3,363 $2,649 $2,354 $5,051 $2,354 Noncurrent Assets Property and equipment (net) $18,863 $20,337 $21,595 $22,680 $23,193 All other assets $385 $427 $377 $387 $439 Total Noncurrent Assets $19,248 $20,764 $21,972 $28,118 $25,986 Total Assets $22,611 $23,413 $24,326

Current Liabilities Total Current Liabilities $14,121 $16,729 $18,676 $32,109 $19,037 Noncurrent Liabilities Total Noncurrent Liabilities $19,410 $10,929 $19,523 $25,348 $23,316 Total Liabilities $33,531 $27,658 $38,199 $57,457 $42,353

Net Deficiency

Capital Contributions of US government $3,132 $3,132 $3,132 $3,087 $3,034 Use outside these parameters is a copyright violation. Deficit since 1971 reorganization ($37,978) ($22,072) ($17,005) ($8,500) ($4,706) Total Net Deficiency ($34,846) ($18,940) ($13,873) ($5,413) ($1,672) Total Liabilities & Net Deficiency $22,611 $23,413 $24,326 $28,118 $25,986

Source: Content created by case advisors; obtained via interview with the advisors (October 2014). Similar information is available via the United States Postal Regulatory Commission FORM 10-K for the fiscal periods ended September 30, 2008- 2013 via www.sec.gov.

For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019.

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ENDNOTES

1 This case has been written on the basis of published sources only. Consequently, the interpretation and perspectives presented in this case are not necessarily those of The U.S. Postal Service or any of its employees. 2 Interview with the advisors (October 2014). 3 All currencies are in US$ unless otherwise stated. 4 “About,” USPS website, https://about.usps.com/who-we-are/postal-history/significant-dates.htm, accessed January 5, 2015. 5 The United States Constitution, Article I, Section 8, Clause 7, www.archives.gov/exhibits/charters/constitution_transcript.html, accessed December 16, 2014. 6 “Report on Universal Postal Service and the Postal Monopoly,” USPS website, October 2008, https://about.usps.com/universal-postal-service/usps-uso-report.txt, accessed January 5, 2015. 7 “By the Numbers,” USPS website, https://about.usps.com/who-we-are/postal-facts/size-scope.htm, accessed November 1, 2014. 8 “By the Numbers,” op. cit. 9 Cezary Podkul and Emily Stephenson, “Post Office Closings Isolate Small Towns and Poor,” MSNBC, April 18, 2012, www.businessweek.com/articles/2012-04-18/can-the-postal-service-be-saved, accessed November 1, 2014. 10 “By the Numbers,” op. cit. 11 “By the Numbers,” op. cit. 12 Elvina Nawaguna, “Postal Service Looks to New Congress for Rescue,” Huffington Post, January 4, 2013, www.huffingtonpost.com/2013/01/04/us-postal-service_n_2410441.html, accessed November 1, 2014. 13 Elvina Nawaguna, “The Post Office Lost $2 Billion in Just 3 Months,” Huffington Post, August 11, 2014, www.huffingtonpost.com/2014/08/11/post-office-losses-usps-losing-money_n_5669173.html, accessed November 1, 2014. 14 Rick Hampson, “Bell Tolls for the U.S. Mail as We Know It,” USA Today, February 7, 2012, http://usatoday30.usatoday.com/news/nation/story/2012-02-08/postal-service-mail/53002066/1, accessed November 1, 2014. 15 Cezary Podkul and Emily Stephenson, “Post Office Closings Isolate Small Towns and Poor,” MSNBC, April 18, 2012, www.businessweek.com/articles/2012-04-18/can-the-postal-service-be-saved, accessed January 13, 2015. 16 Annual Report to Congress, USPS website, 2012, http://about.usps.com/publications/annual-reports/2012/annual-report- 2012.pdf, accessed January 5, 2015. 17 Nicholas Negroponte, Being Digital, Vintage Books, New York, 1996, pp. iii. 18 “First-class Mess: Saving the U.S. Postal Service,” Knowledge at Wharton, June 20, 2012, http://knowledge.wharton.upenn.edu/article/first-class-mess-saving-the-u-s-postal-service/, accessed November 1, 2014. 19 Annual Report to Congress, op. cit. 20 Richard R. John, “How the Post Office Made America,” New York Times, February 8, 2013, www.nytimes.com/2013/02/09/opinion/how-the-post-office-made-america.html, accessed November 1, 2014. 21 Danielle Kurtzleben, “Amazon is One of the Only Things Keeping the U.S. Postal Service Afloat,” Vox, September 24, 2014, www.vox.com/2014/9/24/6829335/us-postal-service-post-office-charts-amazon-fedex-UPS, accessed January 13, 2015. 22 “First-class Mess: Saving the U.S. Postal Service,” op. cit. 23 Interview with the advisors (October 2014). Use outside these parameters is a copyright violation. 24 Leonard, Devin, “Four Reasons the Government Isn’t Going to Sell off the Post Office,” Businessweek, March 25, 2014, http://origin-www.businessweek.com/articles/2014-03-25/the-u-dot-s-dot-postal-service-will-not-go-private-anytime-soon, accessed November 1, 2014. 25 “Is Diversification the Answer to Mail Woes? The Experience of International Posts,” February 2010, obtained directly from the U.S. Postal Service. 26 Those countries were: Australia, Austria, Belgium, Canada, Czech Republic, Denmark, Finland, Germany, Greece, Hungary, Ireland, Italy, Japan, Luxemburg, New Zealand, Netherlands, Norway, Portugal, Spain, Singapore, Sweden, Switzerland, South Africa and the United Kingdom. 27 Interview with the advisors (October 2014). 28 Danielle Kurtzleben, “Amazon is One of the Only Things Keeping the U.S. Postal Service Afloat,” Vox, September 24, 2014, www.vox.com/2014/9/24/6829335/us-postal-service-post-office-charts-amazon-fedex-UPS, accessed November 1, 2014. For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019.

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BURRO: TOOLS FOR A BETTER LIFE IN GHANA

Amy Lin, Caleb Chan, and Michelle Yick wrote this case under the supervision of Professors Nicole Haggerty and Francis Ayensu solely to provide material for class discussion. The authors do not intend to illustrate either effective or ineffective handling of a managerial situation. The authors may have disguised certain names and other identifying information to protect confidentiality.

As country manager of Burro in Ghana, Carol Brown had led the company to profitability in February 2015, after seven years of operation. Having achieved her primary goal, in May 2015, she was focused on her next objective: developing the Burro team. With demand for Burro’s sustainable products growing quickly in the booming Ghanaian market, Brown needed to determine a direction for growth to maximize the success of Burro’s future.

GHANA

Located in West Africa along the Gulf of Guinea and the Atlantic Ocean, Ghana had a growing population of 27 million people and English was its official language. Ghana had one of the most developed educational systems in West Africa, with tertiary education growing in enrolment and infrastructure over the past two decades.

Ghana was the largest cocoa producer in the world and had the ninth-largest economy in Africa. Its Use outside these parameters is a copyright violation. economic prosperity was credited to the production of petroleum and natural gas; Ghana had more than 5- trillion cubic feet of offshore natural gas deposit.1 With its booming economy, local purchasing power had grown with the increase of the minimum daily wage from GH₵2.30 in 2012 to GH₵7.002 in 2015.3 Unemployment rates had also dropped from 12.9 per cent in 2006 to 5.2 per cent in 2015.4

KOFORIDUA

As the capital of the Eastern Region, Koforidua was the eighth-largest city in Ghana with a population of 130,000 people. The city was famous for hosting West Africa’s largest bead market and oldest cocoa

1 Samuel K. Obour, “Atuabo Gas Project to Propel More Growth,” Graphic Online, May 13, 2013, accessed October 27, For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. 2013, https://www.graphic.com.gh/business/business-news/atuabo-gas-project-to-propel-more-growth.html. 2 GH₵ = GHC = Ghanaian cedi; all currency amounts are in GH₵ unless otherwise specified; GH₵0.3062 = CA$1 as of June 1, 2015. 3 “Minimum Wages in Ghana,” Mywage.org/Ghana, last updated December 27, 2017, accessed May 14, 2015, www.mywage.org/ghana/home/salary/minimum-wages. 4 “Ghana Unemployment Rate,” Trading Economics, accessed May 14, 2015, www.tradingeconomics.com/ghana/unemployment-rate.

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production centres. Koforidua’s economy thrived on local entrepreneurs and small businesses. Despite being less urbanized than other major cities in Ghana, Koforidua had become a major hub for education, with more than 70 primary schools, prominent high schools, Koforidua Polytechnic, and All Nations University College. More than 3,000 students were enrolled at All Nations University College, and many graduates sought careers in Accra (Ghana’s capital city), Nigeria, or overseas in North America and Europe.

HISTORY OF BURRO

Burro was founded in 2008 by Whit Alexander, the inventor of Cranium, a popular board game in North America. Burro was a privately owned American company focused on providing innovative products that specifically addressed the local needs of Ghanaians. While spending his twenties living in Africa, Alexander had discovered the need for a distribution channel to connect people with the best products from various industries to improve their quality of living. With this goal in mind, Alexander had founded Burro, with the vision to profitably and sustainably deliver tools for a better life. Burro began as a rechargeable battery rental business that helped locals save money by eliminating the need to constantly purchase new batteries.

Burro’s motto, “Do More,” embodied its mission to help people save more, earn more, and do more. With the majority of its consumers being low-income agricultural workers, its products needed to be affordable. To achieve this goal, Alexander set a benchmark: every tool sold needed to have a six-month payback period. Although Burro got its start by renting rechargeable batteries, the service was discontinued due to macroeconomic factors. Its bestselling products were solar-based although Alexander wanted to boost sales in other products. Burro measured success through its number of resellers, number of stock-keeping units in stores, revenues, and profits. With the company becoming profitable in February 2015, Burro had finally found a business model that worked in Ghana.

CAROL BROWN

Brown was one of Burro’s first employees. She grew up in the United States and completed her

undergraduate studies in mathematics, but also had a keen interest in business. As a close friend of the Use outside these parameters is a copyright violation. daughter of Whit Alexander, Burro’s founder, Brown had spent the summer of her junior year as a marketing intern at Burro’s office in Koforidua. She performed market research and promoted Burro’s rechargeable battery rental business to locals. She enjoyed her internship and became passionate about improving the lives of communities in the developing world through equipping people with tools for a better life.

When she returned to the United States, she continued to work part-time for Burro to promote its brand through social media and used crowdfunding to raise more capital. Upon graduation, she returned to Burro as the full-time acting country manager in June 2013. Brown’s top priorities were to maintain Burro’s profitability, build and develop her team, and continue to grow Burro’s brand. She also worked closely with Alexander, Burro’s founder, to pioneer the company’s expansion plans. Brown wondered how she could find a suitable candidate to succeed her, so she could begin establishing Burro in another

African country. For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019.

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CURRENT ISSUES

The Demand for Power

For the past three years, citizens and businesses in Ghana had been heavily impacted by inconsistent power supply. The crisis was caused by the country’s inability to produce enough power to meet the national demand. Although many industries were affected by inconsistent power supply, Burro’s sales had skyrocketed due to the booming demand for alternative power sources, particularly solar energy. With the imminent federal elections in 2016, Brown wondered how the new government would handle the national power crisis, and whether its actions would affect Burro’s business.

Competition

Burro’s wide network of partnerships had created a unique non-competitive environment. Instead of competing with manufacturers to produce similar products, Burro initiated partnerships to sell third-party products through its distribution channels. This strategic decision was partially influenced by Burro’s limited resources for conducting internal research and development. On the retail side, Burro distributed its products to many resellers. However, Brown was concerned that her partners would become competitors if they decided to bypass Burro in their distribution chain. Alternatively, she wondered whether Burro would benefit from increased vertical integration.

Shipping and Delivery

Ghana’s underdeveloped infrastructure also created challenges for Burro’s operations. Burro employees frequently drove across the country to deliver products and collect payments from its resellers, many of whom were based in remote communities. Due to the poor condition of many roads, delays and detours were unpredictable and resulted in common issues such as late deliveries, extra expenses, and dangerous driving conditions.

Another prominent issue was inventory stockouts caused by delayed shipments from Burro’s suppliers in Use outside these parameters is a copyright violation. China. Without a company representative in China to communicate with suppliers and oversee operations in person, Burro had limited control over its supply chain. When shipments finally arrived at the port in Ghana, the products still needed to go through customs, which took days to weeks. Consequently, Burro had damaged many customer relationships due to constant delivery delays.

Talent Acquisition

To expand Burro, Brown needed to find the right people to build her team. Despite Ghana’s high unemployment rate, suitable talent was difficult to attract and retain because top candidates often went abroad to pursue higher education or careers. Without the competitive salaries and international opportunities offered by larger companies, Brown struggled to convince qualified candidates to commit to

furthering Burro’s social mission and growth. Without new hires to grow the company, Brown was For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. unsure of Burro’s future.

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OPTIONS FOR GROWTH

When Burro became profitable, Brown was focused on growing the company. She considered two opportunities: geographic expansion and in-house product development.

Option One: Geographic Expansion

Burro had 24 resellers in Ghana, located primarily in Greater Accra. Brown believed that partnering with more resellers across different regions of Ghana would spread Burro’s brand presence, expand its customer base, and further the company’s mission. For the long term, she considered expanding into other African countries once she had developed an established and scalable business model. Brown had budgeted ₵30,000 for the current geographic expansion plan.

Revenue collection was the primary challenge for geographic expansion. Before Burro could expand, Brown needed to increase the effectiveness of its revenue collection system. Currently, Burro collected revenue through a remote distribution system that allowed employees to make purchases, distribute orders, and operate the business from the Koforidua office. Brown was deliberating between two ways of improving the revenue collection process.

The first solution was to build or rent a new office. This option would shorten the payment period from 90 to 75 days. It would also enable Burro to provide better service to its resellers, such as shorter delivery times. Brown estimated that a new office would attract 10 more resellers annually, resulting in a 10 per cent increase in sales. In 2014, Burro had ₵198,000 in revenues. Building a new office required several investments and expenses, including three additional full-time employees (see Exhibit 1).

The second solution was to hire more regional representatives without renting another office. The representatives would collect payments and feedback from resellers, and promote new products. This option would also shorten the payment period from 90 to 75 days. Each representative would be expected to find two new resellers annually, resulting in a 2 per cent increase in sales. With the high level of responsibility entrusted to the representatives, Brown wondered how she could build relationships and

develop their skills while minimizing costs (see Exhibit 1). Use outside these parameters is a copyright violation.

As Brown weighed both options, she knew that she needed to hire the right people regardless of her decision. She also wondered which solution would yield higher profits.

Option Two: Product Development

Brown also had the option to invest in product development to expand Burro’s product catalogue. By creating its own products, Burro could rely less on foreign suppliers. In-house product development would also further the company’s mission by catering to the unique needs of the Ghanaian market.

If she chose this option, Brown wanted to produce kits of edible insects. During her years in Africa, she

had discovered that insects were a common menu item. Africa was home to at least 527 types of edible For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. insects,5 many of which were high in protein, fat, and minerals. Edible insects were also eaten by

5 “Edible Insects: Food for Thought,” Modern Ghana: News Blog, February 21, 2008, accessed May 16, 2015, www.modernghana.com/blogs/158221/31/edible-insects-food-for-thought.html.

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livestock and were important contributors to the incomes of the locals.6 Brown believed that developing a starter kit for locals to harvest edible insects would be profitable while helping customers support their families and provide food for their communities.

In-house development required time, capital, and skill. Given Burro’s steady availability of funding, Brown’s primary concern was finding a suitable product developer, as she lacked the expertise to develop the kits. To recruit the right talent, Brown thought of two options.

The first solution was continuing to hire local graduates. Burro valued its Ghanaian employees because they were familiar with the local culture and needs. The salaries of local graduates were also generally lower than foreign hires. However, many local employees had left Burro in the past to pursue higher education or find careers abroad.

The second solution was to partner with North American or European universities to offer placements for bright engineering students. Burro would provide basic accommodations, meals and minimal pay in exchange for the engineers’ project work. Foreign workers would be unfamiliar with Ghanaian culture and needs, but Brown believed that they would be able to come up with solutions once they became adjusted to the new environment.

MOVING FOWARD

As Brown pondered these decisions, she knew she had to make a decision quickly. With Burro’s future on the line, she wondered how she could live up to the company’s motto of “Do More.”

Use outside these parameters is a copyright violation. For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019.

6 Sandra Chao, “Eat Insects, Scientists Urge Hungry Africa,” Africa Review, July 18, 2013, accessed May 16, 2015, www.africareview.com/Business---Finance/Eat-insects-scientists-urge-hungry-Africa/-/979184/1918534/-/juoi95/-/index.html.

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EXHIBIT 1: NEW OFFICE INVESTMENTS AND EXPENSES (IN GHANAIAN CEDI—GH₵)

Building a New Office One–Time Investments Office supplies 700 Renovations 1,000

Expenses Rent 1,150 per month Salaries per month 300 per employee Utilities 100 per month

Hiring Representatives Expenses Salaries 300 per month Fuel 250 per month Transportation 90 per month Miscellaneous 50 per month

Note: GH₵0.3062 = CA$1 as of June 1, 2015. Source: “Rent,” GIPC: Ghana Investment Promotion Centre, accessed May 17, 2015, www.gipcghana.com/invest-in- ghana/doing-business-in-ghana/cost-of-doing-business/rent.html; “Cost of Living in Accra,” Numbeo, accessed May 17, 2015, www.numbeo.com/cost-of-living/city_result.jsp?country=Ghana&city=Accra.

Use outside these parameters is a copyright violation. For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019.

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TIM HORTONS INC.1

Karin Schnarr and W. Glenn Rowe wrote this case solely to provide material for class discussion. The authors do not intend to illustrate either effective or ineffective handling of a managerial situation. The authors may have disguised certain names and other identifying information to protect confidentiality.

It would be a year of dramatic change for Tim Hortons Inc. On August 26, 2014, the company’s board of directors had agreed to be acquired by 3G Capital, the investment firm that owned Burger King. The new company would become the third-largest fast food restaurant chain in the world with 18,000 locations in 98 countries and combined international sales of $23 billion dollars.2 The new company would be headquartered in Oakville, Ontario, Canada and largely operate as two separate entities.

The deal still had to be approved by Tim Hortons’ shareholders and potentially by Canadian and American regulatory authorities. It was believed that this deal would help Tim Hortons with its plans for international expansion. 2013 had been an ambitious year. Tim Hortons had opened 261 new locations and refreshed more than 300 existing locations in Canada and the United States. While Tim Hortons was almost synonymous with the Canadian identity, its brand and products were far less known outside of Canada’s borders; to hit ambitious growth targets, international expansion was a must, and Burger King’s global experience could provide expert advice. Marc Caira, Tim Hortons’ president and chief executive officer (CEO), commented, “We are very, very confident that we can grow much quicker in this must-win Use outside these parameters is a copyright violation. battle called the United States with our partners than we would have otherwise done on our own.”3

Even with the acquisition, Tim Hortons would need to make clear strategic choices to achieve its aggressive growth and financial goals. Inconsistent economic growth was fostering increased competition and consumer tastes were evolving, making menu innovation an important priority. Achieving the returns shareholders expected would be challenging. 2014 would be the 50th year of operations for Tim Hortons. Even with Burger King’s help, the company would need to have clear competitive advantages and make smart strategic choices for the next 50 years to be as successful as its first half century.

THE RESTAURANT INDUSTRY

With over 900,000 locations, the restaurant industry in the United States was projected to reach US$683.4 billion in 2014, up 3.6 per cent from 2013.4 While this would be the fifth consecutive year of real growth, For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. it was lower than expected for post-recession recovery.5 The restaurant industry’s share of the overall food dollar was up to 47 per cent, almost double the 25 per cent it held in 1995.6 It was expected to employ 13.5 million people in 2014. The industry was highly fragmented, with the 50 largest companies accounting for only 20 per cent of the revenue.7

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In Canada, revenues from commercial food service were projected to be $57.5 billion in 2014, an increase of 4.7 per cent over 2013. Growth was expected to come from higher average bills rather than from additional food traffic in restaurants.8 In 2012, there were approximately 1.1 million employees in the Canadian restaurant industry at more than 81,000 restaurants, bars and catering businesses.9

The restaurant industry in North America was divided into two categories: full-service and limited- service. Full-service included family, casual and fine dining where patrons would be seated and food was ordered at the table. Customers paid after eating, and the average bill was the highest for any of the segments at $13.66 in 2013.10 Full-service dining restaurants incorporated all types of cuisines and included Boston Pizza, Red Lobster, and Ruth Chris’ Steak House, among others. However, the majority of restaurants in this segment continued to be individual or family-owned establishments.

The limited-service restaurant sector differed from full-service dining in that consumers were not waited on at the table. Instead, customers went to a central counter where they ordered, paid before receiving their food and either ate in the restaurant or had it “to go.” The limited-service restaurant sector in the United States was expected to post total revenues of US$195.4 billion in 2014, a 4.4 per cent increase over 2013.11 Customers in this category looked for good service, good value, convenience to their home or work place, favourite types of food and healthy menu items.12 Limited-service restaurants were divided into fast-casual restaurants and quick-service restaurants. While limited-service restaurants felt that competition was most intense within their category, fast-casual restaurants also competed with full- service restaurants, and quick-service restaurants competed with grocery and convenience stores.13

Fast-casual was a growing segment in the overall restaurant market, accounting for about 5 per cent of the limited-service category;14 in 2013, it saw an 11 per cent increase in sales15 and was the only category to experience an increase in customer visits.16 Fast-casual was differentiated from quick-service restaurants in that menu items were higher priced based on a perceived value by consumers (e.g., higher quality, customizability, handmade and/or locally sourced); as a result, average bills were higher than quick- service restaurants at $7.40 compared to $5.30, respectively.17 Ninety-five per cent of the fast-casual segment was made up of chains, including Panera Bread, Chipotle Mexican Grill and Five Guys Burgers.

Restaurants such as Tim Hortons and McDonald’s fell into the quick-service category — often called “fast food.” Their menu items were fast to prepare, offered at a low cost to the consumer and easy to

consume. The average bill at quick-service restaurants was the lowest of all of the categories; as such, the Use outside these parameters is a copyright violation. quick-service sector was largely recession proof. There was also customer loyalty, as 39 per cent of quick-service restaurant customers visited more than once a week compared to 19 per cent for fast-casual restaurants.18 In Canada, the quick-service restaurant market represented 64.7 per cent of all meals and snacks sold in the food service industry and generated $22.6 billion in sales in 2013.19

The restaurant industry overall was facing challenges. The number of visits to restaurants was stagnant in the United States and Canada in the year ending June 2014.20 Future forecasts predicted that food service industry traffic would grow at less than 1 per cent for the next few years. In addition, in the 12 months prior to July 2014, wholesale food prices rose 7.1 per cent while menu prices rose only 2.4 per cent.21 Food and labour costs were typically the largest general cost categories for restaurants, with each accounting for approximately one-third of every sales dollar.22 Occupancy costs were generally 5 per cent and net profits after tax from 3 per cent to 6 per cent.

For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. CONSUMER TRENDS

There were a number of consumer-related trends in the food industry. From a food perspective, this included consumer preferences for locally sourced meats, seafood and produce as well as natural ingredients. Restaurants, both quick-serve and full-serve, were increasingly looking to ethnic menu items

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and flavours to differentiate their product offerings as consumers became more aware of ethnic cuisines. There was a desire for more gluten-free cuisine and non-wheat noodles and pasta. Finally, more attention was being placed on children’s meals with a focus on catering to children’s healthy nutritional needs.23

Behavioural and demographic shifts were changing restaurant trends. In North America, the aging population was growing and consisted of individuals who were healthier and wealthier than any generation before them. They did not eat out more frequently than younger generations, but they were more likely to visit full-service restaurants. Younger generations (in particular, millennials who were 18 to 34 years old) were gaining increased purchasing power and, given their busy lifestyle, were more likely to grab food at quick-service restaurants. In particular, the morning snack, afternoon snack and evening snack were the fastest growing day segments.24 According to Robert Carter, the executive director of food service at The NPD Group, “the overarching trend . . . is that Canadians of all ages are having more sit- down meals at home and grabbing quick bites from fast food restaurants while on the go.”25 Mobile and digital technologies were driving consumers’ desire for information and offering companies new ways to attract consumer engagement. Consumers, particularly in quick-service restaurants, wanted the convenience of paying for purchases or accessing rewards through their mobile devices.26

TIM HORTONS: A HISTORY

Tim Hortons’ restaurants, commonly called “Tims or Timmy’s” by devoted customers, had become part of the Canadian identity. Internationally, the stores had been branded as Tim Hortons Cafe and Bake Shop. The chain was first opened in Hamilton, Canada in 1964 by hockey legend Miles G. “Tim” Horton. Ron Joyce was the franchisee of Restaurant #1, also located in Hamilton. By 1967, he and Horton had become full partners in the company. After Horton’s tragic death in a car accident in 1974, Joyce purchased Hortons’ shares from his wife for $1 million, becoming the chain’s sole owner. At the time, there were 40 stores, and an independent audit had appraised the business at $1.7 million.27

Using a franchisee model (99.5 per cent of the stores were franchised-owned), Tim Hortons became the largest quick-service restaurant chain in Canada, specializing in coffee, baked goods, breakfasts and homestyle lunches. Its commitment to maintaining a close relationship with franchisees and the communities where it operated generated immense guest loyalty and built the company into one of the most widely recognized consumer brands in Canada. The company was originally incorporated as Tim Donut Ltd. Then, in 1990, it changed its name to The TLD Group Ltd. In 1995, it merged with Wendy’s Use outside these parameters is a copyright violation. International Inc.; however, on September 28, 2006, it was spun off as a separate public company incorporated in Delaware, trading on the Toronto Stock Exchange and the New York Stock Exchange under TSI. Three years later, in September 2009, the company reorganized its corporate structure and became a Canadian public company named Tim Hortons Inc., effectively repatriating itself to Canada.

Tim Hortons was the fourth-largest publicly traded quick-service restaurant chain in North America, based on market capitalization, and the largest in Canada. It had more than 100,000 employees, the majority of whom worked in franchised locations. The head office was in Oakville, with smaller regional offices located across Canada and in the United States.

ORGANIZATIONAL STRUCTURE

Tim Hortons’ head office in Oakville employed more than 1,800 people who performed corporate For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. functions in the main and regional offices, distribution centres and manufacturing facilities. The head office buildings included Tim Hortons University (a training centre for franchisees), corporate restaurants and an innovation centre. There were five regional offices in Canada and two in the United States.

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The central team supported all facets of the business, including operations, finance, human resources, information technology, legal services, research and development, training, real estate acquisitions, franchising, purchasing and marketing. Marc Caira became president and CEO in July 2013. Caira had extensive food experience, having been the CEO of Nestlé Professional and the president and CEO of Parmalat North America. Caira led an executive team of nine individuals. Tim Hortons also had a Franchisee Advisory Board made up of 16 restaurant owners from across the chain and management. This board met quarterly to discuss issues impacting the industry or the chain.28

Mission and Vision Tim Hortons’ guiding mission was “to deliver superior quality products and services for [its] guests and communities through leadership, innovation and partnerships.”29 Its vision was “to be the quality leader in everything [it] did.”30

Foundation Created in 1974, the Tim Hortons Children’s Foundation (the Foundation) supported several charitable events, but its main focus was a summer camp program for underprivileged children. Since 1975, more than 150,000 children and youth had attended one of six summer camps at no cost to them or their families. While donations were collected year-round through counter and drive-thru coin boxes located at Tim Hortons’ stores, once a year on “Camp Day” the proceeds from coffee sales and related activities at the majority of Tim Hortons’ locations were given to support the summer camp program.

STORE LOCATIONS

As of the end of August 2014, there were 3,588 Tim Hortons’ restaurants in Canada, 859 in the United States and 38 in the Gulf Cooperation Council (GCC).31 With a few locations in Europe, this resulted in a total of 4,546 restaurants globally. In Canada, operations originally were focused in Ontario and Atlantic Canada. This expanded over time to include Quebec and western Canada.

The most unique Tim Hortons’ location was the Canadian Forces (CF) operations base in Kandahar, Afghanistan. It opened on Canada Day in 2006 and served four million cups of coffee, three million donuts and half a million iced cappuccinos and bagels to over 2.5 million customers from more than 37 countries. More than 230 Canadians travelled overseas to work at this Tim Hortons and served approximately 30,000 CF members over 11 rotations. The Kandahar Tim Hortons was operated by the Canadian Forces Personnel and Family Support Services, with proceeds benefitting military community and family support programs. Tim Hortons waived all fees and operating costs typically associated with a Use outside these parameters is a copyright violation. franchise and the Kandahar operation ended in November 2011 when all CF troops left Afghanistan.

Some analysts believed that Tim Hortons had reached its saturation point in Canada.32 In 1984, the company opened its first international store in Tonawanda, New York. During the 1990s, it expanded into other states including Ohio, Kentucky, West Virginia and Michigan. By 2004, the acquisition of 42 Bess Eaton restaurants allowed the company to gain a foothold in New England, the traditional stronghold of Dunkin’ Donuts. Tim Hortons’ locations in this area did not perform well, leading to the closing of 36 stores in the northeastern United States in 2010.33 U.S. locations close to the Canadian border seemed to perform the best, due to brand awareness. In 2014, Tim Hortons’ locations continued to be focused in the northeastern United States with 859 stores in Michigan, Maine, Connecticut, Ohio, West Virginia, Kentucky, Pennsylvania, Rhode Island, Massachusetts and New York.34

Tim Hortons had also expanded into the GCC. By August 2014, there were 38 stores in the United Arab For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. Emirates, Oman, Qatar and Kuwait.35 There were further plans for expansion into Bahrain with a goal of opening an additional 120 locations in the GCC region by 2018.36 Tim Hortons had a small number of European locations as a result of a partnership with the Spar convenience store chain in 2007. By the end of 2013, Tim Hortons’ coffee and donuts were available at approximately 255 locations in Ireland and the United Kingdom; the majority of these locations (252) were self-service kiosks.37

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PRODUCTS

Tim Hortons’ biggest drawing card was its legendary coffee. It was so popular that the company constantly battled rumours that it added nicotine to make it addictive.38 The coffee was a blend of 100 per cent Arabica beans grown in the world’s coffee producing regions. To ensure the coffee was always fresh, Tim Hortons served it within 20 minutes of being brewed; after 20 minutes, it was thrown away. The premium blend was sold in tins at most Tim Hortons’ locations and at supermarkets. Its coffee was also available in pods compatible with at-home single-cup coffee brewing systems such as Tassimo and Keurig. A number of Tim Hortons’ locations sold branded mugs and seasonal merchandise.

The chain focused on continuous product innovation—as consumer tastes grew, so did choices. The original menu included coffee and donuts but expanded to include tea, a small selection of cold beverages and baked goods (e.g., donuts, “timbits” and pastries). Originally, the baked goods were produced in- store. In 2003, the company switched from in-store preparation to preparing them centrally in Brantford, Ontario and then shipping them frozen to franchised stores to be baked and finished with fillings or glazes. This was initially controversial with franchisees and consumers, but the outrage dissipated quickly.

During the 1980s, the baked goods offering expanded to include muffins, cakes, pies and cookies. This was followed by more substantial items, including soups, chili and sandwiches. In 2006, Tim Hortons introduced breakfast options, including breakfast sandwiches on biscuits, bagels and English muffins, as well as oatmeal. These items became wildly popular with Canadian customers. According to NPD research, by May 2011, Tim Hortons held 57 per cent of the hot breakfast sandwich market in Canada compared to McDonald’s 29 per cent domestic share.39 To gain more of the lunch and dinner crowd, Tim Hortons aggressively expanded its food choices. It heavily promoted its soups, chili and cold sandwiches by offering combos, which included a traditional baked good and a coffee. It further expanded to include more hot offerings such as paninis, crispy chicken sandwiches and wraps. The company continued to invest in product innovation to keep the menu fresh and responsive to consumer trends.

Consumer tastes were also shifting as almost half of all Canadians and Americans surveyed stated that their last coffee was a dark roast.40 In order to compete with other retail outlets such as Starbucks, which offered a bolder base coffee taste, Tim Hortons officially launched a dark roast coffee in its North 41

American stores in August 2014. This was the first time in the company’s history that it had offered a Use outside these parameters is a copyright violation. coffee flavour other than its original premium blend. Caira commented on the launch, saying:

Tim Hortons prides itself on serving best-in-class coffee and responding to the evolving tastes of our guests, and our new Dark Roast blend speaks to that commitment. We know that our guests want choice when consuming their daily coffee and we applied our passion for coffee and brewing expertise to develop a superior tasting Dark Roast blend our guests will love.42

In recent years, it had expanded its hot and cold beverage offerings to compete with McDonald’s McCafé menu; this included lattes, cappuccinos, iced teas and coffees, smoothies and iced lemonades, which were offered at a price point similar to or lower than McDonald’s and much less than Starbucks.

FRANCHISE SYSTEM

The cost to acquire a Tim Hortons’ franchise was approximately $500,000. This included all furniture, For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. equipment and signage; a seven-week training program; staff assistance opening the store; the right to use trademarks and trade names; and support from the corporate office. The corporate office assumed all of the costs associated with the development of the land and the building. Given the demands of running a franchise, Tim Hortons required franchise locations to have two partners, both of whom had to be

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permanent residents of Canada. Individuals granted a Tim Hortons’ franchise were not allowed to operate any other business without the written approval of the company.

Licences were usually provided for 10 years with the option of extending for an additional 10 years. For the term of the licence, franchisees were obligated to provide a weekly royalty fee of 4.5 per cent of gross sales and a monthly advertising levy of 4 per cent of gross sales. They also had a monthly rental fee, which was the greater of a fixed minimum rent or 8.5 per cent of gross monthly sales.43 Even with these stipulations, there was a high demand for Tim Hortons’ franchises in Canada. While almost all of Tim Hortons’ restaurants in Canada and the United States were franchised, corporately owned and operated restaurants were used for the purposes of training and product/market development.

STORE OPERATIONS

Most standard Tim Hortons’ locations were open 24 hours. Guests could eat in the dining areas, take the food out or use the drive-thrus, which catered to consumers on the go. Additionally, the company’s “we fit anywhere” strategy led to a number of non-traditional locations in gas stations, convenience stores, universities, hospitals, office buildings and airports. A number of the locations were unionized.44

Tim Hortons also co-located with other franchise restaurants. In Canada, there were a number of combo unit locations, which housed both a Tim Hortons and a Wendy's. In 2007, Tim Hortons partnered with Cold Stone Creamery, a franchise that sold customizable, single-serve ice cream, jointly locating stores in selected Canadian locations. This partnership ended in 2014, and Cold Stone Creamery counters were removed from Tim Hortons’ locations. 2014 also saw the closure of a number of underperforming locations in the United States.45

Sourcing Tim Hortons sourced coffee from the world’s coffee producing regions. In 2005, it created the Tim Hortons Coffee Partnership in Brazil, Guatemala, Honduras and Columbia to help local coffee farmers improve their lives economically, socially and environmentally. The program had assisted 3,400 farmers. This approach was different from Starbucks, which had aggressive targets for responsibly grown and ethically sourced coffee through its Coffee and Farmer Equity (C.A.F.E) practices.

Production and Distribution Three manufacturing facilities, six warehouse distribution centres and one

warehouse serviced Tim Hortons’ restaurants across Canada and the United States (see Exhibit 1); Use outside these parameters is a copyright violation. corporate-owned trucks delivered food and supplies from the distribution centres to the restaurants.46 It was a highly sophisticated operation; over 50,000 to 60,000 cartons of baked goods per week were 47 shipped worldwide from the Guelph Distribution Centre alone.

Marketing On a chainwide basis, Tim Hortons advertised on television, radio, outdoor (billboards, transit shelters) and in some print vehicles (magazines). On a regional or restaurant basis, Tim Hortons also utilized newspaper advertising.48 Commercials in Canada were used to introduce new products, but a number of them also reinforced the connection between Tim Hortons and Canadian culture. Its wildly successful “Roll up the Rim to Win” promotion, which started in 1986, gave away millions of prizes, including cars, gift cards and Tim Hortons’ products and was eagerly anticipated by its customer base.

GOALS

For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. Tim Hortons had strong short- and long-term goals. As stated in the company’s 2013 Annual Report:

Our number one imperative is to deliver profitable growth, measured by same-store sales, operating profit improvement and sustainable earnings per share [EPS] growth. In 2014, while

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continuing our growth agenda, we plan to make transitional investments and further position our business for success.49

From 2015 to 2018, Tim Hortons had goals of an 11 to 13 per cent compounded annual growth rate, cumulative free cash flows of approximately $2 billion, operating income generated through the U.S. segment of up to $50 million, and opening 800 or more new locations in North America and the GCC.50

FINANCIAL PERFORMANCE

From a financial perspective, Tim Hortons grew overall revenues by 4.7 per cent to $3.3 billion and operating income by 4.5 per cent to $621 million in 2013. It had an operating margin of 19.1 per cent and a net profit margin of 13.0 per cent. Finally, the company’s dividend per share had increased for the seventh year in a row from $0.24 to $0.32.51 However, on the balance sheet were a number of issues, including a current ratio of 1.0, a quick ratio of 0.4 and a debt to equity ratio of 132.9 per cent.52

Even though the company experienced its 22nd consecutive year of same-store sales growth in Canada and 23rd year in the United States, the growth in 2013 was very modest at 1.1 per cent in Canada and 1.8 per cent in the United States.53 This was below the 2013 target of 2 to 4 per cent in Canada and 3 to 5 per cent in the United States.54 While the company’s EPS rose from $2.59 in 2012 to $2.82 in 2013 (an 8.9 per cent increase), it was below the targeted EPS of $2.87 to $2.97.55 As of its second quarter in June 2014, Tim Hortons was tracking well on a number of key financial indicators.56 It had a return on assets of 20.5 per cent, a return on equity of 53.0 per cent and a return on invested capital of 24.9 per cent. The debt to equity ratio had also improved to 3.7 per cent. Exhibits 2 and 3 provide additional details.

THE COMPETITION

In Canada, Tim Hortons led its competition with 27 per cent share of dollars and 42 per cent share of traffic in the quick-service industry; this was more than the next 15 chains combined.57 However, competition was heating up in all categories, particularly at breakfast, as noted by Canaccord Genuity analyst Derek Dley who stated, “Now you’ve got a number of chains in the breakfast category all looking to capture more market share. Where is that going to come from? Well, it’s going to be Tims.”58

Use outside these parameters is a copyright violation. Tim Hortons had traditionally competed with the typical coffee and baked goods chains. However, with its stronger presence in the breakfast and lunch market, it faced increasing competition with restaurants in the broader quick-service category (e.g., hamburgers, submarine sandwiches, pizzas and tacos). Its main competition in Canada and the United States came from Starbucks, McDonald’s and Dunkin’ Donuts.

McDonald’s McDonald’s was founded in 1955 in Des Plaines, Illinois by Ray Kroc. The company went public in 1965 with 700 restaurants. In 1967, the first international location opened in Richmond, British Columbia. McDonald’s quickly became the world’s leading quick-service retailer with more than 35,000 local restaurants in over 119 countries. At the end of 2013, 80 per cent of these stores were franchise- owned. There were approximately 1,400 McDonald’s restaurants in Canada; 80 per cent were franchise stores. Franchise/licence agreements were generally for a 20-year term.

McDonald’s products included distinct breakfast and lunch/dinner options. Menu items included egg- based sandwiches, muffins, hamburgers, French fries, salads, wraps and ice-cream-based desserts along For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. with beverages such as soda, milkshakes, fruit-based smoothies and coffee. McDonald’s was very aware of the competition in the coffee category. In 2011, it launched McCafé, an espresso-based beverage to compete with Starbucks. McCafé was offered at a much lower price than Starbucks beverages, but they

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were not as customizable. From a strategy perspective, McDonald’s was focused on balancing core menu items with new product innovation, improving customer service and strengthening its value platform.

In 2013, McDonald’s globally increased its revenues by 3 per cent in constant currencies to US$28.1 billion and experienced a 0.4 per cent growth in comparable store sales. It also increased operating income by 3 per cent in constant currencies and its EPS by 4 per cent.59 The company’s financial performance in 2013 just met its system-wide sales growth target of 3 to 5 per cent but did not meet its operating income growth target of 6 to 7 per cent.60 In addition, its return on incremental invested capital (ROIIC) of 11.4 per cent in 2013 did not meet its target of achieving a ROIIC in the high teens. The U.S. market had revenues of US$8.8 billion in 2013, roughly the same as the previous year.

Starbucks Starbucks was founded in 1971 with a single location at Seattle’s Pike Place Market. It incorporated in 1985 and went public in 1992. By June 2014, there were approximately 23,305 locations in 62 countries. This included 13,493 stores in the Americas (United States, Canada and Latin America), of which 8,078 were company-owned and 5,415 were licensed. Worldwide, Starbucks employed approximately 182,000 people in 2013, with 13,000 of the employees working in the United States.61 The majority of Starbucks’ employees were not represented by a union. The company owned its own roasting facilities and leased the majority of its warehouse and distribution centres.

Starbucks’ products included more than 30 blends and single-origin coffees; blended, customizable beverages; fresh food (sandwiches, pastries, salads, oatmeal, yogurt and fresh fruit); consumer products, including ready-to-drink coffees, teas and juices; and merchandise including mugs, music, books and seasonal products. Starbucks was committed to ethical sourcing, environmental stewardship and community involvement. It offered generous compensation packages and supplementary benefits to its employees and invested in ongoing employee training.

In 2013, Starbucks had global revenues of US$14.9 billion, a 12 per cent increase over 2012 revenue. This was driven by a 7 per cent increase in global comparable store sales; the 7 per cent increase was also achieved in the U.S. market.62 It was believed that this increase was due to a 5 per cent increase in the number of transactions and a 2 per cent increase in the average bill. Globally, Starbucks achieved a non- GAAP operating margin of 16.5 per cent based on a non-GAAP operating income of US$2.5 billion. However, due to the conclusion of litigation with Kraft Foods Global, Inc., Starbucks globally ended

fiscal 2013 with an operating margin of −2.2 per cent as compared to 15 per cent in 2012. Use outside these parameters is a copyright violation.

Dunkin’ Donuts Founded in 1951 in Quincy, Massachusetts, Dunkin’ Donuts franchises were established across the United States by 1955. By 2012, it had 10,083 in 32 countries worldwide, including 7,015 franchised restaurants in the United States and over 3,100 stores in international locations. The typical franchise agreement in the United States had a 20-year term, and initial franchise fees ranged from US$25,000 to US$100,000, depending on the location.63 From a product perspective, it offered 52 varieties of donuts as well as coffee, baked goods and breakfast sandwiches. The majority of stores were franchisee-owned, predominately located in the northeastern United States. It had expanded into Canada, but by the early 2000s, it had largely exited the Canadian market except for four locations in Quebec.

Dunkin’ Donuts was a wholly owned subsidiary of Dunkin’ Brands, which also included Baskin Robbins. For the full year 2013, Dunkin’ Donuts’ restaurants had global franchisee-reported sales of approximately US$7.4 billion.64 This was driven by revenues in the United States of US$6.7 billion.65 Dunkin’ Donuts United States experienced a 3.4 per cent comparable store sales growth in 2013, down from 4.3 per cent For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. in 2012. Dunkin’ Donuts International experienced a comparable store sales decline of 0.4 per cent in 2013. It planned to aggressively expand in the western United States, targeting California, and in Europe (in particular, Germany and the United Kingdom), the Middle East and Southeast Asia. Exhibits 4 and 5 provide a comparison of Tim Hortons, McDonald’s, Starbucks and Dunkin’ Donuts.

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TIM HORTONS’ STRATEGIC PLAN 2014 TO 2018

Tim Hortons was facing tough competition domestically and internationally. In 2014, the company had unveiled a five-year strategic plan called “Winning in the New Era.” Caira stated:

We envision a rejuvenated Canadian business that is the growth engine during our Strategic Plan time period. By 2018, we are working to have a profitable U.S. business that is ready to be aggressively scaled. We are looking to build on our established, growing international presence. We are building new capabilities and talent to execute flawlessly against our plans, and we are working to create above-market-average total shareholder returns.66

The plan focused on four core ideas: (i) driving same-store sales by targeting specific segments of the day category and marketing opportunities, (ii) investing to build scale and brand in new and existing markets, (iii) growing in new ways, and (iv) leveraging its core business strengths and franchise system.

(i) Same-store growth was not performing as well as had been forecasted. There was a desire to grow the hot and cold beverage category and market share, as well as to take advantage of the growing trend of snacking between meals. In addition, Tim Hortons was branded differently in the United States than in Canada; there was an opportunity to use product innovation to further differentiate the company in the U.S. market. This could involve new advertising and marketing campaigns.

(ii) While Tim Hortons was primarily located in Canada, there were still growth opportunities in western Canada, Quebec and major urban markets. Strategically, the U.S. market was considered to be a must win battle which would require aggressive and rapid expansion.

(iii) Tim Hortons had been considering changing the standard design of its restaurants to increase capacity and throughput. This could involve different interior and exterior features, equipment and menu items. The goal was to maximize throughput and not have patrons linger in the store. This was different than the Starbucks model of creating a third living space for customers outside of their homes and offices.

(iv) The franchise system worked very well for Tim Hortons, and there was an opportunity to build on the success of the system. Over the next five years, the company could pursue additional vertical integration and supply-chain opportunities to maintain control over more facets of the business.

Use outside these parameters is a copyright violation.

ACQUISITION

The strategic plan was now linked to the likely acquisition of Tim Hortons by 3G Capital, a Brazilian private equity firm that was Burger King’s majority owner. The deal, announced in August 2014, would pay current Tim Hortons’ shareholders approximately $94 a share, structured as $65.50 cash for each existing Tim Hortons’ share in addition to 0.8025 shares in the new company for each Tim Hortons’ share.67 Shareholders had the flexibility to select an all-share or all-cash option. The $94 share price was 39 per cent higher than the average price Tim Hortons’ shares had traded at in the month prior to the announcement of the merger. 3G Capital would own 51 per cent of the combined company in the $12.5 billion merger, which would create the world’s third largest quick-service restaurant company; $3 billion of preferred equity financing for the deal was to come from Warren Buffet’s Berkshire Hathaway.

3G Capital owned two-thirds of Burger King and the deal had already been approved by its board and had For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. been unanimously accepted by Tim Hortons’ board. However, it still had to be approved by Tim Hortons’ shareholders and likely Canadian and U.S. regulators. The new company would be headquartered in Oakville, Ontario along with Tim Hortons’ corporate office. Burger King’s head offices would continue to be in Miami, Florida. It was expected that Tim Hortons and Burger King would continue to operate as separate organizations and that the franchisee relationships would be managed independently by the

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separate brands.68 Financial analysts felt this move benefitted both parties in that the location of the company headquarters in Canada allowed the new company to take advantage of Canada’s lower corporate tax rates while Tim Hortons would benefit from Burger King’s global expansion experience. Caira was very positive about the growth potential this merger offered for Tim Hortons, stating: “As an independent brand within the new company, this transaction will enable us to move more quickly and efficiently to bring Tim Hortons’ iconic Canadian brand to a new global customer base.”69

PATH FORWARD: STRATEGIC CHOICES

While the merger talks were exciting, Tim Hortons had to continue implementing its strategic plan. There were important options to consider. Its recent crispy chicken sandwich was beginning to resemble products found at McDonald’s. Menu innovations to target the dinner market could include more complex items. This would change the food operation of the kitchen and the length of time required to prepare the food. Were there other menu innovations Tim Hortons should consider to drive customer traffic to stores?

Geographic expansion opportunities seemed limitless. Canadian and U.S. expansion were a priority, but where should it occur and in what order? All of Tim Hortons’ competitors were either already present or were expanding into Europe; should this market share just be ceded to them? Tim Hortons had a different brand presence in each of its three existing jurisdictions — Canada, the United States and the GCC. Should the company be positioned the same way in each area with the same marketing, menu and pricing? And how could the partnership with Burger King help with this expansion?

Finally, how could Tim Hortons take advantage of food trends? Food trucks were becoming popular, and Starbucks was experimenting with coffee trucks on university and college campuses. Tim Hortons had experience using semi-mobile retail space while stores were undergoing renovations. Was this type of alternative store format something it should try, recognizing that it was outside the franchise model?

To have an international presence, Tim Hortons would need financial resources, organizational capabilities, store saturation, product innovation and brand recognition to compete with some of the world’s largest and best known quick-service companies. The potential merger with Burger King would help, but would it be enough to create a competitive advantage on a global scale?

Use outside these parameters is a copyright violation. For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019.

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EXHIBIT 1: TIM HORTONS’ PRODUCTION/DISTRIBUTION FACILITIES

Type Location Ownership Approximate Square Footage Manufacturing (U.S. coffee roasting facility) Rochester, New York Leased 38,000 Manufacturing (Fondant and Fills Facility) Oakville, Ontario Owned 36,650 Manufacturing (Canadian coffee roasting facility) Hamilton, Ontario Owned 76,000 Distribution/Office Guelph, Ontario Owned 191,679 Distribution/Office Calgary, Alberta Owned 35,500 Distribution/Office Debert, Nova Scotia Owned 28,000 Distribution/Office Langley, British Columbia Owned 27.500 Distribution/Office Kingston, Ontario Owned 135,080 Distribution/Office Montreal, Quebec Leased 30,270 Warehouse Oakville, Ontario Owned 37,000

Source: Adapted from Tim Hortons Inc., “2013 Annual Report,” www.timhortons.com/ca/en/pdf/Tim_Hortons_2013_AR_full.pdf, p. 33, accessed August 22, 2014.

EXHIBIT 2: TIM HORTONS’ INCOME STATEMENTS (2009 TO 2013) (in thousands of Canadian dollars, except for weighted average number of shares)

Fiscal Years 2013 2012 2011 2010 2009 Sales $2,265,884 $2,225,659 $2,012,170 $1,755,244 $1,704,065 Franchise revenues: Rents & royalties $821,221 $780,992 $733,217 $687,039 $644,755 Franchise fees $168,428 $113,853 $107,579 $94,212 $90,033 Total revenues $3,255,533 $3,120,504 $2,852,966 $2,536,495 $2,438,853 Corporate reorganization expenses $11,761 $18,874 – – – Debranding costs $19,016 – – – – Asset impairment and related closure costs $2,889 $(372) $372 $28,298 – Other costs and expenses $2,600,772 $2,507,477 $2,283,119 $1,997,034 $1,913,251 Total Costs and Expenses $2,634,438 $2,525,979 $2,283,491 $2,025,332 $1,913,251 Gain on sale of interest in Maidstone – – – $(361,075) – Bakeries

Operating Income $621,095 $594,525 $569,475 $872,238 $525,602 Use outside these parameters is a copyright violation. Interest expense, net $35,466 $30,413 $25,873 $24,180 $19,184 Income before income taxes $585,629 $564,112 $543,602 $848,058 $506,418 Income taxes $156,980 $156,346 $157,854 $200,940 $186,606 Net income after income taxes $428,649 $407,766 $385,748 $647,118 $319,812 Net income attributable to non-controlling $4,280 $4,881 $2,936 $23,159 $23,445 interests Net income attributable to Tim Hortons Inc $424,369 $402,885 $382,812 $623,959 296,367

Diluted Earnings per Share $2.82 $2.59 $2.35 $3.58 $1.64 Weighted average number of shares 150,622 150,676 162,597 174,215 180,609 Dividends per common share $1.04 $0.84 $0.68 $0.52 $0.40

Source: Tim Hortons Inc., “2013 Annual Report,” www.timhortons.com/ca/en/pdf/Tim_Hortons_2013_AR_full.pdf,” p. 38, accessed August 22, 2014. For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019.

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EXHIBIT 3: TIM HORTONS INC. AND SUBSIDIARIES — CONSOLIDATED BALANCE SHEET (in thousands of Canadian dollars)

Dec. 29, 2013 Dec. 30, 2012 ASSETS Current assets Cash and cash equivalents $50,414 $120,139 Restricted cash and cash equivalents 155,006 150,574 Accounts receivable, net 210,664 171,605 Notes receivable, net 4,631 7,531 Deferred income taxes 10,165 7,142 Inventories and other, net 104,326 107,000 Advertising fund restricted assets 39,783 45,337 Total current assets 574,989 609,328 Long -term Assets 1,858,834 1,674,851 Total assets $2,433,823 $2,284,179

LIABILITIES AND EQUITY Current liabilities Accounts payable $204,514 $169,762 Accrued liabilities 274,008 227,739 Deferred income taxes - 197 Advertising fund liabilities 59,912 44,893 Short-term borrowings 30,000 - Current portion of long-term obligations 17,782 20,781 Total current liabilities 586,216 463,372

Long -term obligations Long-term debt 843,020 406,320 Capital leases 121,049 104,383 Deferred income taxes 9,929 10,399 Other long-term liabilities 112,090 109,614 Total long-term obligations 1,086,088 630,716 Equity

Equity of Tim Hortons Inc. Use outside these parameters is a copyright violation. Common shares $2.84 stated value per share, Authorized: unlimited shares, Issued: 141,329,010 and 153,404,839 shares, respectively 400,738 435,033 Common shares held in Trust, at cost: 293,816 and 316,923 shares, respectively (12,924) (13,356) Contributed surplus 11,033 10,970

Retained earnings 474,409 893,619 Accumulated other comprehensive loss (112,102) (139,028) Total equity of Tim Hortons Inc. 761,154 1,187,238 Non-controlling interests 365 2,853 Total equity 761,519 1,190,091 Total liabilities and equity $2,433,823 $2,284,179

For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. Source: http://annualreport.timhortons.com/downloads/Balance-Sheet.xls, accessed August 21, 2014.

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EXHIBIT 4: COMPARABLES OF QUICK-SERVICE RESTAURANTS

Company Global Revenues (2013) Number of Number of Number of Locations (Total) Locations (United Locations (Canada) States) Tim Hortons Cdn$3.3 billion 4,546 859 3,588 McDonald’s US$29.1 billion 35,429 14.278 1,400 Starbucks US$14.9 billion 23,305 13,049 1,555 Dunkin’ Donuts US$7.4 billion 10,083 7,015 4

Source: Compiled by case authors.

EXHIBIT 5: AVERAGE COST COMPARISON OF SELECT MENU ITEMS (in Canadian dollars before tax as of August 28, 2014)

Tim Hortons McDonald’s Starbucks Coffee (Medium) $1.52 $1.54 $1.85 Latte (Medium) $2.69 $2.99 $3.45 Muffin $1.29 $1.19 $2.00 Breakfast Sandwich $2.99 $3.19 $3.95

Source: Compiled by case authors.

Use outside these parameters is a copyright violation. For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019.

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ENDNOTES

1 This case has been written on the basis of published sources only. Consequently, the interpretation and perspectives presented in this case are not necessarily those of Tim Hortons Inc. or any of its employees. 2 All dollars in the case are stated in Canadian dollars unless otherwise noted. 3 David Hains, “Six Things You Need to Know About the Tim Hortons Deal,” August 26, 2014, www.theglobeandmail.com/report-on-business/six-things-you-need-to-know-about-the-tim-hortons-deal/article20208297/, accessed August 28, 2014. 4 National Restaurant Association, “2014 Restaurant Industry Forecast,” www.restaurant.org/Downloads/PDFs/News- Research/research/2014Forecast-ExecSummary.pdf, accessed August 10, 2014. 5 Ibid. 6 National Restaurant Association, “2014 Restaurant Industry Pocket Factbook,” www.restaurant.org/Downloads/PDFs/News-Research/research/Factbook2014_LetterSize.pdf, accessed August 20, 2014. 7 First Research, “Restaurant Industry Profile,” www.firstresearch.com/industry-research/Restaurants.htm, accessed August 20, 2014. 8 Jeff Dover, “11 Trends and Factors Affecting Canada’s Food Service Industry,” May 1, 2014, www.restaurantcentral.ca/trendsfactorsCanadasfoodserviceindustry.aspx, accessed August 20, 2014. 9 Restaurant Central, “Canada’s Restaurant Labour Force: 16 Employment Facts and Figures,” www.restaurantcentral.ca/Canadasrestaurantlabourforce.aspx, accessed August 20, 2014. 10 NPD Group, “Fast-casual Is Only Restaurant Segment to See Traffic Growth in 2013, Reports NPD,” www.npd.com/wps/portal/npd/us/news/press-releases/fast-casual-is-only-restaurant-segment-to-see-traffic-growth-in-2013- reports-npd/, accessed August 21, 2014. 11 National Restaurant Association, “Restaurant Industry 2014: Limited-Service Trends,” www.Restaurant.org, accessed August 10, 2014. 12 Ibid. 13 Alicia Kelso, “Report: Limited-service Restaurants Fighting Harder for Customers,” June 17, 2013, www.qsrweb.com/articles/report-limited-service-restaurants-fighting-harder-for-customers/, accessed August 21, 2014. 14 NPD Group, “Fast-casual Report,” www.npd.com/latest-reports/fast-casual-restaurants-foodservice-report/, accessed August 21, 2014. 15 Daniel Campbell, “How QSRs and Fast-casuals are Fighting for Market Share,” July 29, 2014, www.qsrweb.com/articles/how-qsrs-and-fast-casuals-are-fighting-for-market-share/, accessed August 21, 2014. 16 NPD Group, “Fast-casual Is Only Restaurant Segment to See Traffic Growth in 2013, Reports NPD,” op.cit. 17 Ibid. 18 Campbell, op.cit. 19 A&W, “A&W Revenue Royalties Income Fund,” www.awincomefund.ca/aboutfund/indicators.asp, accessed August 22, 2014. 20 QSR Web, “Consumer Traffic, Unit Growth Low in 2014,” www.qsrweb.com/news/consumer-traffic-unit-growth-low-in- 2014/, accessed August 21, 2014. 21 National Restaurant Association, “Economist's Notebook: Restaurant Indicators a Mixed Bag in 2014,” www.restaurant.org/News-Research/News/Economist-s-Notebook-Restaurant-indicators-a-mixed, accessed August 21,

2014. Use outside these parameters is a copyright violation. 22 National Restaurant Association, “Restaurant Operations Report,” www.restaurant.org/News- Research/Research/Operations-Report, accessed August 20, 2014. 23 National Restaurant Association, “2014 Culinary Trends: Top 10 Trends,” www.restaurant.org/Restaurant/media/Restaurant/SiteImages/News%20and%20Research/Whats%20Hot/What-s-Hot-Top- Ten.jpg, accessed August 22, 2014. 24 Dover, op.cit. 25 NPD Group, www.npdgroup.ca/wps/portal/npd/ca/news/press-releases/fast-food-still-king-in-canada/, accessed August 22, 2014 26 Tim Hortons Inc., “2013 Annual Report,” http://annualreport.timhortons.com/winning.html, accessed August 22, 2014. 27 CBC Digital Archives, “Tim Hortons: Ron Joyce Has a Story to Tell,” www.cbc.ca/archives/categories/economy- business/consumer-goods/tim-hortons-coffee-crullers-and-canadiana/ron-joyce-has-a-story-to-tell.html, accessed August 26, 2014. 28 Tim Hortons Inc., “Company Facts,” www.timhortons.com/ca/en/about/media-company-facts.html, accessed August 21, 2014. 29 Ibid. 30 Ibid. 31 Tim Hortons and Burger King, “Creating a Global QSR Leader,” Investor Call Presentation. August 26, 2014. For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. 32 Jeff Beer, “Fresh Trouble for the Double Double?,” January 16, 2013, www.canadianbusiness.com/companies-and- industries/tim-hortons-sales-slow/, accessed August 20, 2014. 33 James Cowan, “Why Tim Hortons Can’t RRRoll into the United States,” February 19, 2013, www.canadianbusiness.com/blogs-and-comment/tim-hortons-american-expansion-failure/, accessed August 21, 2014. 34 Tim Hortons Inc., “About Us: The Story of Tim Hortons,” http://shopus.timhortons.com/info/about, accessed August 20, 2014.

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35 Tim Hortons and Burger King, op.cit. 36 Madhavi Acharya-Tom Yew, “Tim Hortons Opens in Oman,” November 12, 2012, www.thestar.com/business/2012/11/12/tim_hortons_opens_in_oman.html, accessed August 19, 2014. 37 Tim Hortons Inc., “2013 Annual Report,” op.cit. 38 Tim Hortons Inc., “Frequently Asked Questions,” www.timhortons.com/ca/en/about/faq.php, accessed August 21, 2014. 39 Jason Buckland, “Tim Hortons’ Greatest Success Stories,” November 17, 2011, http://money.ca.msn.com/savings- debt/gallery/tim-hortons%e2%80%99-greatest-successes?cp-documentid=31401616&page=5, accessed August 21, 2014. 40 Tim Hortons Inc., “Tim Hortons Goes Dark Across North America,” August 14, 2014, www.timhortons.com/ca/en/corporate/tim-hortons-goes-dark-across-north-america.php, accessed August 24, 2014. 41 Ibid. 42 Ibid. 43 Tim Hortons Inc., “Frequently Asked Questions,” op.cit. 44 CBC News, “First Quebec Union at Tim Hortons Approved,” December 4, 2003, www.cbc.ca/news/business/first-quebec- union-at-tim-hortons-approved-1.380806, accessed August 21, 2014 45 Tim Hortons Inc., “2013 Fourth Quarter and Year-End Conference Call,” http://files.shareholder.com/downloads/ABEA- 333FKS/3412937430x0x727310/46189b5c-fbb3-4dcb-8de8-6aa6bf55f681/THI%20Q4- 2013%20Conference%20Call%20Slides%20(FINAL-FINAL).pdf, accessed August 21, 2014. 46 Tim Hortons Inc., “About Us: Company Facts,” op.cit. 47 Guy Broderick, “Tim Hortons’ Trucking Recipe,” June 12, 2012, www.todaystrucking.com/tim-hortons-trucking-recipe, accessed August 26, 2014. 48 Tim Hortons Inc., “Frequently Asked Questions,” op.cit. 49 Tim Hortons Inc., “Winning in the New Era: Tim Hortons 2014-2018 Strategic Plan,” http://annu alreport.timhortons.com/winning.html, accessed August 22, 2014. 50 Ibid. 51 Tim Hortons Inc., “Dividend History,” www.timhortons.com/us/en/corporate/dividend.php, accessed August 20, 2014. 52 Tim Hortons Inc. “2013 Annual Report: Financial Highlights,” http://annualreport.timhortons.com/2013-highlights.html, accessed August 21, 2014. 53 Tim Hortons Inc., “2013 Annual Report,” op.cit. 54 Tim Hortons Inc., “2013 Fourth Quarter and Year-End Conference Call,” op.cit. 55 Ibid. 56Tim Hortons Inc., “Q2 2014: Investor Fact Sheet,” www.timhortons.com/ca/en/pdf/THI_Q2_2014_Investor_Fact_Sheet.pdf, accessed August 21, 2014. 57 Tim Hortons Inc., “2013 Annual Report,” op.cit. 58 Canadian Business, “Fresh Trouble for the Double Double,” January 16, 2013, www.canadianbusiness.com/companies- and-industries/tim-hortons-sales-slow/, accessed August 21, 2014. 59 McDonald’s Corporation, “2013 Annual Report,” www.aboutmcdonalds.com/content/dam/AboutMcDonalds/Investors/ McDs2013AnnualReport.pdf, accessed August 21, 2014. 60 Ibid. 61 Starbucks Coffee, “Starbucks 2013 Annual Report,” http://investor.starbucks.com/phoenix.zhtml?c=99518&p=irol-irhome,

accessed August 21, 2014. Use outside these parameters is a copyright violation. 62 Ibid. 63 Dunkin’ Donuts, “2013 Annual Report,” http://files.shareholder.com/downloads/ABEA- 68SCR9/3419859776x0x737142/968D8A70-6911-43A5-AE59-791BF8FD6504/DNKN_Annual_Report_Final_.pdf, accessed August 21, 2014. 64Dunkin’ Donuts, “About Dunkin’ Donuts,” http://news.dunkinbrands.com/Content/Detail.aspx?ReleaseID=190&NewsAreaID=29&ClientID=3, accessed August 21, 2014. 65 Dunkin’ Donuts, “2013 Annual Report,” op.cit. 66 Tim Hortons Inc., “2013 Annual Report,” op.cit. 67 CBC.ca, “Tim Hortons Agrees to Burger King Offer for $94 a Share,” http://news.ca.msn.com/top-stories/tim-hortons- agrees-to-burger-king-offer-for-dollar94-a-share/?ocid=binganswers, accessed August 26, 2014. 68 Tim Hortons and Burger King, op.cit. 69 Eric Atkins and Jacqueline Nelson, “Burger King, Tim Hortons Ink Merger Deal for $12.5 billion,” August 26, 2014, www.theglobeandmail.com/report-on-business/burger-king-tim-hortons-ink-merger-deal-for-125-billion/article20203522/, accessed August 26, 2014. For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019.

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15.

9B08C016

ALICE SADDY: CARING FOR THE COMMUNITY

Colleen Sharen wrote this case solely to provide material for class discussion. The author does not intend to illustrate either effective or ineffective handling of a managerial situation. The author may have disguised certain names and other identifying information to protect confidentiality.

Ken MacLellan, executive director at the Alice Saddy Association, sighed as the door of his office closed. He had just finished a long meeting with the organization’s human resources manager, Kathie Wolcott. Wolcott had just presented some feedback from the support workers at the Alice Saddy Association (referred to in the case as “Alice Saddy” or “the Association”).

The Alice Saddy Association, a non-profit agency in London, Ontario, supported people with developmental disabilities, which allowed them to live independently in the community, rather than in more restrictive group homes. Support workers provided the in-home assistance to the people with developmental disabilities. As executive director of the Association, MacLellan was the most senior paid staff member.

At a regular employee human resources committee meeting, support workers shared with Wolcott their Use outside these parameters is a copyright violation. concerns about the current organizational structure. They felt that the structure caused confusion, slowed decision-making and created potential risk for the people served by Alice Saddy.

MacLellan knew that there was an issue with the current organizational structure. Since the structure reflected the philosophy of Alice Saddy, any changes would be resisted by the management team because it passionately believed in the organization’s mission and would see any changes as a threat to that mission.

Management had committed to the human resources committee that it would respond to issues raised within a week of its most recent committee meeting. MacLellan didn’t have much time to decide his next steps.

For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019.

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ALICE SADDY ASSOCIATION

History

Alice Saddy was well known in London, Ontario, for her volunteer work assisting adults with disabilities. When she passed away in her early forties, a committee from her church was formed to honour her memory. Funds were raised to establish an “apartment training” program for people with developmental disabilities. This initiative became known as the Alice Saddy Association.

The Association’s first group home opened in 1973. The concept was to teach daily living skills enabling people to live independently rather than in an institutional environment. Once the concept was proven, the Ontario Ministry of Community and Social Services provided program funding. A husband and wife team ran the group home.

In early 1976, the Supported Independent Living (SIL) program was established in London by Alice Saddy to assist developmentally disabled people in their own apartments. By 1980, there were nine people living at the group home, and 15 people living on their own with support.

In 1980, the husband and wife team running the organization resigned, and a new professional staff was hired for the Association, including MacLellan, executive director, and Kathy Peters, supervisor of support services. By the end of the 1980s, Wolcott, the human resources manager, a financial manager and several support service workers had been hired. By 1989, the group home had been discontinued, consistent with the association’s philosophy of independent living. Alice Saddy experienced moderate growth through the 1990s. By the end of 1999, there were 37 full-time employees who supported people with developmental disabilities in the community.

Alice Saddy grew to a staff of 96 at the end of 2007, more than doubling in size in seven years (see Exhibit 1). In 2007, Alice Saddy:

• supported 100 people with developmental disabilities in London wherever and with whomever they wished to live;

• supported 50 people in nursing homes; Use outside these parameters is a copyright violation. • supported a limited number of individuals with a brain injury; • provided a drop in centre offering social and recreational activities; • facilitated a collective kitchen; • coordinated a computer lab open to people of all disabilities; and • provided a volunteer program.

Alice Saddy’s Statement of Philosophy

The Alice Saddy Association was guided by its statement of philosophy:

“The Alice Saddy Association believes that all persons have the right to be respected as valued members of their community and society in general. Thus all people must: For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019.

• have the opportunity to be active, contributing members of their community; • be recognized as individuals with a unique and valued contribution; • be treated with dignity and respect;

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• have the opportunity to develop skills and/or be provided with supports enabling them to choose to live in an independent or shared home environment in the community/neighborhood of their choice.

Our vision is that in our society mutual respect will enhance each person’s sense of self-worth and equality. The uniqueness of each person is to be celebrated, supported and acknowledged as essential to the completeness of the whole community.”

The day to day operations of Alice Saddy were a reflection of the statement of philosophy. Clients were referred to as “people supported” because the staff at Alice Saddy believed that the term “client” was dehumanizing and did not acknowledge the individuality and contributions of the people that the agency supported. Alice Saddy focused on enabling independent living, personal choice and providing individualized service for the people that they supported.

“People supported first” was the rule at Alice Saddy, in contrast with a typical group home, where the residents of the home were often forced to live in a regimented way, with little or no say in how they lived, or what activities they engaged in. Employees at Alice Saddy passionately believed in this philosophy, which was ingrained in the organizational culture.

Role of Support Workers

Support workers worked in the residence of a person supported, assisting them with daily living skills, personal care and health-related needs. They ordered and administered medications, facilitated regular medical and dental care, provided financial management and helped in areas related to personal and apartment safety. They also worked with the person supported to obtain appropriate employment or volunteer opportunities. Finally, they communicated with the families of the person supported where appropriate.

Support workers worked independently outside of the office environment. They worked evenings and weekends when support service managers were not available to consult. The position required independent professional judgment, attention to detail, strong communication skills and experience working with

people with developmental disabilities. There was a mix of full-time and part-time support workers. Most Use outside these parameters is a copyright violation. of the support workers possessed a Developmental Services Worker (DSW) diploma from Fanshawe College. Support workers also received ongoing training at the Association, including first aid, CPR, incident prevention and back care seminars.

The position of support worker was highly demanding, both physically and mentally. Working with high- needs people was especially difficult, often resulting in stress and burnout among support workers.

Matching Support Workers to the Needs of People Supported

The Association attempted to reflect the individual uniqueness of each person supported by providing customized support; for example, matching skills and personalities of the support workers to the needs of

the person supported. For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019.

People supported had different levels of needs, from a few hours a week to 24 hours per day, seven days per week. Those receiving 24-hour care were considered high-needs individuals, and only certain support workers had the ability, patience and personal connection to effectively work with those people. About 20

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per cent of the people supported had high needs. Because working with high-needs individuals could be particularly challenging and result in burnout, the Association assigned more support workers for fewer hours each to high-needs individuals. They had learned that this strategy reduced burnout among support workers. Depending on the needs of the person supported, anywhere from five to 15 support workers would work on a team supporting an individual.

As well, Alice Saddy faced the needs of an aging population. Many of the people supported who began their relationship with Alice Saddy in the 1970s and 1980s were starting to experience health issues associated with aging. These concerns increased the amount of time that was spent on each case, the number of urgent care decisions and the risk to both the person supported and to Alice Saddy. These challenges were expected to increase as the large group of baby boomers supported by the Association aged.

Organizational Structure — The Early Years, 1980-1997

By the end of 1989, the management team was in place, comprising the executive director, supervisor of support services, finance manager and a part-time human resources manager.

In the early years of Alice Saddy it was a simple matter to ensure individualized support. When a new person supported was accepted by the Association, an extensive needs assessment was conducted. The support service supervisor then assigned a team of support workers whose skills best matched the needs of the person supported.

If a person supported needed a change the support worker informally discussed it with the supervisor of support services and a plan was developed. The process was ad hoc. With a relatively small case-load, it was possible for the support service supervisor to spend a great deal of time in the field working with support workers and interacting with the people supported.

Organizational Structure Evolution, 1998-2007

Use outside these parameters is a copyright violation. As Alice Saddy grew, it became clear that the supervisor of support services could no longer directly manage all of the support workers in the organization. In 1998, two managers of support services were hired, each reporting to the supervisor of support services. One more manager was hired in each of 2000 and 2002, creating a total of four managers of support services. These managers were recruited from the most experienced support workers, all of whom began working at Alice Saddy in the 1980s or early 1990s.

The managers had three main responsibilities. They 1) managed a case-load of people supported (as “case manager”), 2) managed the performance of a group of support workers, and 3) acted as a support worker in the field.

As case manager, the support service managers were responsible for the planning and delivery of service to the person supported.

For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. Support workers reported to one of the four support service managers for performance management purposes. The manager provided coaching, performance management, performance evaluations, scheduling, training and other supervisory functions.

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Each manager of support services worked 10 hours a week as a support worker and a further 25 hours per week in their managerial role. Support workers respected the fact that the managers were still active support workers. They believed that the managers had a better understanding of the issues faced by support workers because of the time that they spent working with people supported.

Assigning Work, 1998-2007

When a new person supported was taken on by the agency, the supervisor of support services conducted a needs assessment. The person supported was then assigned by the supervisor of support services to a case manager based on current case-loads and the skills of that particular manager.

Independent of the choice of case manager for the person supported, a team of support service workers was assigned to the person supported by the supervisor of support services, based on the needs of the person supported and the skills and personalities of the support workers. The support workers assigned to a person supported could report to any of the four support service managers. The Association believed that by having the best fit between the support worker and the person supported, the person supported received better care. Also, by increasing the number of workers and reducing the time each worker spent on any one case, the Association reduced the likelihood of burnout among support workers. As well, it was easier to accommodate vacations and sick coverage if the managers were able to draw upon all support workers across the organization (see Exhibit 2).

As a result of this “cross-reporting” structure, support workers often worked on the cases assigned to two, three or even all four support service managers (see Exhibit 3).

At the same time, each support worker reported to one single manager of support services for performance management purposes. Alice Saddy had an ongoing performance evaluation process, with managers meeting with each support worker every six to eight weeks to discuss performance and the needs of people that the worker supported. The evaluations were not used to determine pay increases, although they were considered when deciding whether to move a support worker from part-time to full-time status.

The Association believed that this structure provided the most flexibility, ensuring individualized service Use outside these parameters is a copyright violation. for the person being supported and staff coverage of all of the hours needed to support an individual. However in the late 2000s, as the agency grew, there began to be some drawbacks to the structure.

Impact of Growth on the Organizational Structure, 2008

In 2002, each support service manager managed an average of nine support workers and 22 people supported. By 2007, each support service manager managed an average of 22 support workers and 31 people supported. In addition, there was a significant increase in the number of high-needs people supported. The combination of the increased numbers of 1) people supported, 2) support workers, and 3) high-needs people supported resulted in a doubling of workload.

As the Association’s case-load grew and the needs of the people supported changed due to aging, it For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. became more challenging for the support service managers to deal with unusual situations. This required a great deal of coordination of activity, because each support worker on a team for a particular individual might have a different manager. This meant that the managers met regularly to discuss case strategy and individual staff performance.

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Scheduling also became more complex. Each support service manager scheduled support workers for their cases. However, because the support workers worked with people supported on the case-loads of all four managers, ensuring both adequate coverage and no scheduling conflicts took a great deal of time.

Support workers sometimes received conflicting feedback on their performance from the support service managers. A case manager might give different feedback than the support worker’s manager. Sometimes a case manager would report performance concerns to a support worker’s manager, who might choose to dismiss the concerns and not provide feedback to the employee in question. Managers sometimes disagreed about the appropriate way to manage employees. As well, with the increased number of support workers, MacLellan wondered whether the regular bi-monthly performance appraisals that were part of the performance management process were being completed. Employees were feeling confused and frustrated. They also worried that a person supported might be at greater risk due to these communication and decision-making issues.

The support service managers were also frustrated. They were working long hours. New manager positions had not been added in the past five years, in spite of the increased number of people supported by Alice Saddy and the increased needs of those supported. The managers felt that they were working well as a team to address many of the issues that arose. They had taken on a number of additional responsibilities for the development of individual service agreements with the people supported, the development of technology to improve reporting procedures and for the training and orientation of new support workers. It became very difficult for the managers to spend time in the field with the support workers to provide coaching, direction and support, given the allocated 25 hours per week to complete their managerial tasks.

As the Association grew, the support service managers were challenged by requests for direction on cases from support workers. Whenever a request was less than clear-cut, the relevant managers would meet to discuss the issue and develop a direction for the case. Then the support service managers would present their recommendations to the supervisor of support services for approval, and communicate the direction back to the support workers in question. In the past, when Alice Saddy was smaller, this informal coordination was easily accomplished, but with more managers, people supported and support workers, this coordination was more challenging.

Use outside these parameters is a copyright violation. In the mid-2000s, the volume of requests for direction increased with the number of people supported and the complexity of the issues. Although most of the requests were quickly dealt with, some of the more complex issues were beginning to take more time to resolve. Since these requests were often related to important or urgent issues for the care of a person supported, delay increased risk for both the people supported and for the Association. Support workers started to approach two or three support service managers individually in order to speed up the process. Sometimes they received contradictory direction. MacLellan knew that further growth would only increase the possibility of a tragedy occurring due to delay or confusion.

THE DECISION

MacLellan reflected on his 28 years at Alice Saddy, “You know, our cross-reporting structure worked well For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. until recently. We’ve been able to deliver on our philosophy of individual support and independent living for the people we support in the community. We’ve grown from supporting nine people to over 100 people. With our growth, our structure isn’t working as well as it used to.”

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Given case-load and related staffing growth in the agency, increased administrative and project loads, the support service managers were spending less time in the field managing, training, coaching and directing the support workers. It had been over five years since Alice Saddy had increased its complement of managers. While it might be time to add an additional manager or two, it was clear that decision also meant that support workers might end up working on the cases of up to six managers, creating even more inconsistency, confusion and frustration.

There were mixed opinions on the issue of the cross-reporting structure at Alice Saddy. Some of the management team felt that the current structure didn’t work well, but couldn’t think of another way of organizing themselves that would deliver on Alice Saddy’s philosophy and provide the organization with the flexibility it needed. Others felt that the cross-reporting structure was working well and did not need to change. In fact, they felt that a change would negatively impact the strong organizational culture of “people supported first.” Some members of the management team were concerned because some of the people supported were deeply attached to their support workers, with relationships that had lasted more than 20 years. This was particularly true for the high-needs people supported. Any change to a stable relationship could be disruptive in their lives. Still others felt that although the current structure wasn’t optimal, other structures would not work either, so the employees would just have to tough it out, because the people supported were of primary importance.

MacLellan started to think about what structures would enable Alice Saddy to deliver individualized support to developmentally challenged people in the community, while minimizing the risk to the people supported and to the agency. How would he convince the management team that a change in organizational structure didn’t necessarily mean a change in the “people supported first” philosophy of Alice Saddy? MacLellan needed to have a response for the human resources committee next week. He had a lot of thinking to do. Use outside these parameters is a copyright violation. For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019.

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Exhibit 1

HISTORY AND GROWTH OF ALICE SADDY ASSOCIATION, 1980 TO 2007

End of Management Staff Number Number People Supported Period Support Workers 1980 Director 6 9 Group Home Residents 15 Independent Living People Supported (SIL Program) 1989 Executive Director 12 Group Home Program Supervisor Support Services discontinued Manager Financial 45 SIL Program Manager Human Resources (part-time) 1998 Executive Director 29 70 SIL Program Supervisor Support Services 30 Nursing Home Program Manager Financial (newly launched) Manager Human Resources 2 Managers Support Services 2000 Executive Director 34 80 SIL Program Supervisor Support Services 40 Nursing Home Program Manager Financial Manager Human Resources 3 Manager Support Services 2002 Executive Director 36 90 SIL Program Supervisor Support Services 40 Nursing Home Program Manager Financial Manager Human Resources 4 Managers Support Services 2007 Executive Director 87 125 SIL Program Supervisor Support Services 50 Nursing Home Program Manager Financial Manager Human Resources 4 Managers Support Services 1 Administrative Assistant (part-time) Use outside these parameters is a copyright violation.

Notes: The number of support workers was not reported in full-time equivalents. The ratio of full-time to part-time workers changed over the period shown, although exact numbers were not available. The number of people supported was a rough representation of the work undertaken by the Association, since each person supported was assigned different hours of support based on their individual needs. Over time, the number of high-needs individuals had increased substantially to approximately 20 per cent of the case-load by 2007. This required an increased number of hours of support provided by the Association. Although the number of people supported in the SIL program increased from 2002 to 2007 by 39 per cent, the hours of support increased by significantly more, requiring substantially more support workers (a detailed history of hours of support was not available). For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019.

178

Use outside these parameters is a copyright violation. copyright a is parameters these outside Use For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. 2019. 06, May to 2019 14, January from Easter Sarah by taught University Christian Abilene at Management Strategic course the in only use For

Page 9 9B08C016

Exhibit 2 Persons Supported Jane SUPPORT TEAM FOR A SINGLE PERSON SUPPORTED (EXAMPLE) Sue John Carrie Persons Supported JaneMujdah Sue

GaryJohn TaraCarrie Sean Mudjah Matthew

Andrew Dennis TheresaGary PaulTara PeterSean MaryMatthew KenAndrew KateDennis KayTheresa RobertPaul PeterCourtney 179 M

Laurie Tricia Deb Renee Support Services Mgr Support Services Mgr Support Services Mgr Support Services Mgr

Support Workers Managed Support Workers Managed Support Workers Managed Support Workers Managed Peter M Jack A John M Scott P May F Anna K

Frances M Margaret E Tammy E Mary F Melissa K

Sue E Erika E Theresa K Linda K Paula K George L Paul L Don L

Dominick L Single Line Arrow=Performance Management Relationship Dotted Line Arrow=Membership on a Support Team for a Person Supported Thick Line Arrow=Manager’s Case-load

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Exhibit 3 Persons Supported Persons Supported Jane SIMPLIFIED ORGANIZATIONAL STRUCTURE ALICE SADDY ASSOCIATION Jane Sue Sue John John Carrie Persons Supported Persons Supported Carrie Peter Jane Mujdah Carl Sue Dennis

Mark John Tara Carrie Gary Sean Sam Kate Tara MatthewMudjah Kay Sean Andrew Lorna Matthew Andrew Dennis Melissa Renee Theresa Dale Theresa Paul Harris Paul Peter Tim Robert Mary Mary Courtney Ken Sean Kate Ashley Kay Colton Kate Robert Alisha Courtney Jessica Kay Laura Robert

Thomas 180 Ken Barb Courtney

Laurie Tricia Deb Renee Support Services Mgr Support Services Mgr Support Services Mgr Support Services Mgr

Support Workers Managed Support Workers Managed Support Workers Managed Support Workers Managed Scott P Peter M Jack A May F Anna K John M Frances M Margaret E Tammy E Melissa K

Mary F Erika E Theresa K Sue E Paula K George L Linda K Don L Paul L Dominick L

Single Line Arrow=Performance Management Relationship Dotted line Arrow=Membership on a Support Team for a Person Supported Thick Line Arrow=Manager’s Case-load

16.

9B12M058

THE ESPRESSO LANE TO GLOBAL MARKETS

Ilan Alon and Meredith Lohwasser wrote this case solely to provide material for class discussion. The authors do not intend to illustrate either effective or ineffective handling of a managerial situation. The authors may have disguised certain names and other identifying information to protect confidentiality.

“Espressamente is all about a perfect shot of dark elixir . . . Espresso is a miracle of chemistry in a cup.” Andrea Illy, CEO of Illycaffé S.p.A.

The global coffee industry was booming. From October 2010 to September 2011, world coffee exports increased by 9.4 per cent to 103.1 million 60-kilogram bags.1 The International Coffee Organization stated, “Demand prospects for coffee continue to be promising, particularly given the growth of niche markets in traditional consuming countries and the arrival of new consumers in emerging markets and exporting countries.”2 Christophe Reale, managing director of Espressamente at Illy, contemplated Espressamente’s place within the global market and the company’s future growth opportunities. He knew that a global route to market meant prioritizing markets, but where did the greatest potential for success lie? And what kind of strategy should he pursue to take Espressamente to market?

Use outside these parameters is a copyright violation. ILLY

Founded in Trieste, Italy, and inventor of the precursor to the espresso machine, Illy marketed a unique blend of coffee drinks in over 140 countries and in more than 50,000 high-end restaurants and coffeehouses. Over six million cups of Illy espresso were consumed every day. In Italy, Illy coffee is widely recognized as the best coffee and is a “must have” in Italian restaurants. Over time, Illy became known as a company based on quality and espresso culture. The company focused on premium travel, business-to-business operations, fashion and culture.3

Illy was well-known for producing the world’s finest tasting coffee, which it accomplished through quality obsession and knack for innovative design. After beans were purchased, Illy-branded 60-kilogram bags of coffee beans were shipped to Italy; bags were placed in shipping containers to maximize air circulation, which reduced the risk of mould, condensation and unwanted odours. In Italy, the bags were handled by an For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019.

1 International Coffee Association, “Monthly Coffee Market Report,” www.ico.org/documents/cmr-0911-e.pdf, accessed on February 13, 2012. 2 Ibid. 3 Espressamente Illy Company Report, 2011.

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automated system and sophisticated machinery. “The last selection is conducted by six bi-chromatic systems that electronically photograph each bean, detecting and eliminating any that do not meet strict color standards — an indication that the bean is not fully ripe, or is a ‘stinker,’ a fermented bean that can ruin a whole batch.” If a bean was defective, it was removed, as were the beans that surrounded it. Illy’s approach was one of zero defects.4

Illy built its brand upon its decadent coffee but expanded its product lines over time to include espresso machines, cups and mugs.

ESPRESSAMENTE

Born in Illy’s unique Italian heritage, Espressamente was the company’s own franchised coffee bar with 200 locations in over 30 countries. It served transit retail markets and began to expand to premium retail markets. Espressamente, meaning “clearly” or “expressly” in Italian, was meant to “purvey the original Italian cult of espresso.” CEO Andrea Illy wanted to create “an exclusive destination with an emphasis on quality and aesthetics. The Espressamente experience will be oh-so-Italiano, focused on coffee served short and dark with the perfect crema, or foam, in a designed demitasse.”5 (See Exhibit 1.)

In its 2010–12 strategic plan, Espressamente stated that its goals were to be “recognized as the only authentic Italian bar chain delivering superior customer satisfaction to premium transit coffee lovers,” to be profitable and to become a strong stand-alone brand. To achieve these goals, the company first focused on premium transit, retail and service partners instead of private dealers, as well as consistency development. In addition to premium transit locations, the company added luxury retail stores.

THE GLOBAL COFFEE INDUSTRY

Coffee, after oil, was the most heavily traded commodity in the world.6 As of 2005, coffee sales each year amounted to over US$70 billion. The International Coffee Organization emphasized that “the importance of coffee to the world economy cannot be overstated.” Recently, demand had grown in both developed and emerging markets. Specialty coffee was projected to increase worldwide; in the United States alone, 7 specialty coffee sales were forecasted to increase by 20 per cent each year. Use outside these parameters is a copyright violation.

Coffee sales across the globe were greatly affected by disposable income and the general economic environment: “Coffee manufacturers depend on a healthy economy and strong consumer spending to drive sales, as consumer spending drives demand for higher priced specialty products.”8 As the middle class grew in emerging markets, so did prospects for a successful coffee market where the expectation for a premium product was particularly strong. Additionally, the coffee market was characterized by high saturation and aggressive competition. In developed nations, there were thousands of coffee shops, both chains and independents, that competed for space. As a result, many of the larger retail chains looked to international expansion for growth. Emerging markets with growing middle classes, such as in China and India, were experiencing high competition among coffee retailers as Western companies expanded. Although there was

4 www2.illy.com/wps/wcm/connect/us/illy/, accessed February 17, 2012. 5 “Basta with the Venti Frappuccinos,” Bloomberg Businessweek, 2006, www.businessweek.com/magazine/content/06_32/b3996057.htm, accessed February 13, 2012. For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. 6 Global Exchange, “Coffee FAQ,” www.globalexchange.org/fairtrade/coffee/faq, accessed February 14, 2012. 7 NACS Online, “Fact Sheets: Coffee Sales,” www.nacsonline.com/NACS/News/FactSheets/MerchandiseandServices/Pages/Coffee.aspx, accessed February 14, 2012. 8 First Research, “Industry Profile: Coffee Shops,” http://search.proquest.com.ezpprod1.hul.harvard.edu/abicomplete.docview/192463238/fulltextPDF/1321075EF8488208B4/1 1?accountid=11311, accessed February 14, 2012.

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still room for growth in these markets, competition was aggressive. High levels of competition in the premium coffee industry forced players such as Starbucks, the Coffee Bean & Tea Leaf, Costa Coffee and independent coffee shops to continually innovate and adapt their products and offerings to compete in these concentrated and saturated markets.

A variety of environmental and legal issues surrounded the coffee industry as well. Sustainable coffee production and human rights issues that affected the supply side of coffee became essential to the future of the industry. The world coffee market was characterized by a coffee paradox: there was a “coffee crisis in producing countries with trends towards lower prices and declining producer incomes,” while there was a coffee boom in consuming countries characterized by rising sales and profits for retailers. Suppliers had very limited power; in 2005, when coffee sales amounted to over $70 billion, producers only received about $5 billion.9 Some legal issues arose as a result of increased coffee sales in emerging marketplaces. For example, developing nations had fewer laws related to copyright and other regulatory measures.

COMPETITORS

The coffee industry was highly competitive. Espressamente’s main competitors worldwide included Starbucks, McDonald’s McCafé, Costa Coffee, Lavazza, Tchibo, Segafredo and the Coffee Bean and Tea Leaf. Each had different competitive advantages, and all continued to expand internationally (see Exhibit 2).

Reale considered international expansion and, based on an analysis of Illy sales (see Exhibit 3), internal analysis of documents, executive knowledge of external markets and sales potential, decided to focus on the markets with the highest potential: Brazil, China, Germany, India, Japan, the United Kingdom and the United States.

BRAZIL

Brazil, the largest grower of coffee in the world, was the second-largest consumer coffee market behind the United States. Coffee consumption in Brazil rose rapidly “in line with increased interest in premium varieties and the opening of new, American-style coffee shops,” which presented opportunities for coffee Use outside these parameters is a copyright violation. retail companies. Brazil was one of the fastest growing markets by sales in the specialty coffee shops industry, with growth rates always exceeding 30 per cent.10 Additionally, the coffee market in Brazil was one of the most dynamic in the world and increasingly attracted foreign direct investment.11 Starbucks was highly successful in Brazil, highlighted by the growing demand for higher value gourmet coffee varieties. It was projected that the continuation of this trend meant that value sales would increase at a faster rate than volume sales over the next five years.12

Although consumption was rising due to a larger and wealthier middle class, consumption per capita was still quite low compared to mature markets. Despite this, it was possible that Brazil would overtake the United States in terms of overall coffee consumption sometime in the next few years as increased wealth in Brazil drove a rise in locals’ thirst for espressos and cappuccinos.13 As the eighth-largest economy in the

9 Geoff Riley, “Market for Coffee,” http://tutor2u.net/ economics/revision-notes/as-markets-coffee.html, accessed February For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. 17, 2012. 10 Business Monitor International, “Brazil: Food & Drink Report Q4,” http://search.proquest.com.ezproxy.rollins.edu:2048/abicomplete/docview/904728262/fulltextPDF/1338989D72E3BF732FE/ 11 Ibid. 12 Ibid. 13 Ibid.

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world, Brazil weathered the global economic crisis well and positioned itself as a regional and global power; it is expected to grow to become the fifth-largest economy in the next five years. Growth in exports and social programs lifted tens of millions of Brazilians out of poverty, and a majority of the population became a part of the middle class. As a result, purchasing power parity increased dramatically, and domestic consumption became a driver of Brazilian growth.

Brazil’s franchise sector was growing on a large scale: in 2010, 1,855 franchises operated 86,365 units and employed 777,285 people.14 Only 11 per cent of franchises were foreign-based franchisors and there was “natural fierce sector competition.”15 Entering the Brazilian market meant localizing products and services to better compete in a market in which the strength of local brands was a major challenge. Foreign-based franchisors developed relationships with non-competing businesses because of the challenge of finding suitable master franchisees in Brazil; additionally, joint-venture partnership tended to appeal to Brazilian partners because it meant risk was divided between the two partners.16 “Breaking into this market requires thorough research on the viability and uniqueness of the services and products.”17

Brazil’s capital, Brasilia, was approximately 9,054 kilometers away from Rome, Italy. The flight time from Brasilia to Rome was approximately 12 hours.

CHINA

China’s beverage industry was one of the country’s fastest growing sectors. Tea and coffee were established product categories there and were expected to experience modest growth between 2011 and 2015; coffee consumption was projected to increase at a compound annual average growth rate of 10.7 per cent. “The relatively modest growth forecasts can be attributed to the saturated and mature nature of the market.”18 Despite saturation and maturation, large coffee industry players such as Starbucks, China Resources Enterprise and Gourmet Master had plans for aggressive expansion “to capitalize on the growing café culture in China.”19 Coffee drinkers in China often enjoyed food while they drank coffee, which resulted in minimal to-go sales. However, on-the-go consumption of coffee was increasing.

Historically a tea drinking culture, coffee had become an established product category as well. China

boasted a huge population, 43 per cent of which lived in urban areas. After the economic downturn, Use outside these parameters is a copyright violation. “consumption’s role in the economy declined even though real wages increased in China 12.5% a year for a decade . . . “20 As a result, the country experienced decreasing rates of consumption. Despite the threat of decreased consumption, “rising consumer income and increasing standards of living, as well as the awareness of better-off lifestyles, especially among the growing number of middle-class consumers, have boosted the demand for high-quality products.”21

14 Brazilian Franchise Association, “Economic Impact in Brazil Reaches New Heights in 2010,” www.franchise.org/uploadedFiles/Economic%20Impact%20in%20Brazil%20Reaches%20New%20Heights%20in%202010.p df, accessed February 17, 2012. 15 Paulo Rodrigues, “Brazil: Franchising,” http://franchise.org/ IndustrySecondary.aspx?id=45562, accessed February 17, 2012. 16 Ibid. 17 Bachir Mihoubi, “Dealing with the Complexities of International Expansion,” www.franchise.org/Franchise-Industry-News- Detail.aspx?id=53325, accessed February 17, 2012. 18 Business Monitor International, “China: Food & Drink Report Q1,” For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. http://search.proquest.com.ezproxy.rollins.edu:2048/abicomplete/docview/887119018/13245EC23682C2987CC/20? accountid=13584, accessed February 14, 2012. 19 Ibid. 20 Ibid. 21 International Trade Centre, “The Coffee Sector in China,” www.intracen.org/WorkArea/DownloadAsset.aspx?id=37584, accessed February 17, 2012.

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The complex nature of conducting business in China resulted in the establishment of foreign companies through partnerships or master franchising. In 2007, the Chinese Ministry of Commerce changed and clarified many laws that made doing business difficult for foreign companies. Importantly, the “two-plus- one-requirement stipulating that prospective franchisors own at least two directly operated outlets in China for at least a year” was amended.22 Although China was slowly changing, franchising there was still complicated: “The concept is still new to China with many Chinese unfamiliar with it. Moreover, collecting royalty payments from your mainland franchisee and ensuring that the franchisee maintains the integrity of your brand is also a challenge.”23 Additionally, foreign franchisors were not allowed to directly purchase real estate property located in China unless it was for personal use. In 2008, China had 3,500 franchised businesses and more than 300,000 franchisees.24

As a result of the complexities of running a business in China, importance was placed on establishing different regional partners to successfully and respectfully navigate the Chinese coffee market. Partnerships also allowed companies to gain insights into Chinese tastes and preferences. Additionally, cafés were frequented by young, affluent, fashion-conscious, urban Chinese, as well as expatriates and foreign travelers. Chinese patrons of premium coffee shops preferred lattes, cappuccinos and mochas to espressos, which they considered bitter. Finally, Chinese frequented coffee shops for music and ambience, branded wares and the variety of fresh pastries and cookies offered and were usually business people in meetings, friends meeting or couples on dates.25

China’s capital, Beijing, was approximately 8,147 kilometers away from Rome, Italy. The flight time from Beijing to Rome was approximately 11 hours.

GERMANY

Coffee was an established product in Germany, which ranked second in the world in pounds per coffee consumed per person. Per capita consumption of coffee in Germany had been in decline over the past 15 years, in part due to the “unfashionable and unhealthy” product reputation it held. This trend had recently begun to change due to the rise in popularity of specialty coffee and an increase in U.S.-style coffee chains. “The German Coffee Association reported a shift in consumer behavior, with a clear trend toward the fresh preparation of specialty coffee.” In 2010, average German coffee consumption was 150 litres per person.

Business Monitor International predicted that the coffee industry in Germany would grow by 10.5 per cent Use outside these parameters is a copyright violation. between 2011 and 2015. It was possible that this growth will be inhibited by continued world economic difficulties; however, it was not affected in 2009 when espresso drinks and single portion coffee drinks demonstrated strong growth.26 The German coffee industry was characterized by fierce competition and high concentration.

Germany had about 1,000 franchise systems that operated 64,000 units with the help of 470,000 employees.27 The German Franchise Association had a great deal of power; although it was only partly

22 U.S. Commercial Service, “Country Commercial Guide, China,” www.buyusainfo.net/docs/x_8054544.pdf accessed May 13, 2012. 23 Ibid. 24 Beijing Tian Yuan Law Firm, “Franchise 2011: China,” www.franchise.org/uploadedFiles/Franchise_Industry/F2011Chinachapter.pdf, accessed February 17, 2012. 25 International Trade Centre, “The Coffee Sector in China,” www.intracen.org/WorkArea/DownloadAsset.aspx?id=37584, accessed February 17, 2012. For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. 26 Business Monitor International, “Germany: Food & Drink Report Q4,” http://search.proquest.com.ezproxy.rollins.edu:2048/abicomplete/docview/888214090/13516D7A0CB767B9CA9/4?accounti d=13584, accessed February 14, 2012. 27 Heiko Stumpf, “Franchising in Germany,” www.franchise.org/uploadedFiles/Franchise_Industry/International_Development/Country_Profiles/GTAI_FranchisinginGerm any2011.pdf, accessed February 24, 2012.

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recognized by the courts, membership in the association was regarded as an indication of quality for a reputable franchise business.28

Germany’s capital, Berlin, was approximately 736 kilometers away from Rome, Italy. The flight time from Berlin to Rome was approximately two hours.

INDIA

Although historically known for its tea culture, India was the sixth-largest producer of coffee in the world. Interest in coffee in India, particularly the transition to sophisticated coffee bars, began in the 1990s. Specialty and gourmet coffee shops increased in prominence for a few important reasons: first, Indians had increased exposure to international lifestyles and global trends; second, income rose and a middle class emerged; third, there was an increase in disposable incomes as well as in the number of working women; and fourth, the number of young people grew significantly.29 “Historically, Indians showed little interest in coffee, but changing lifestyles and the rise of high-end coffee shops increased consumption. Companies such as Café Coffee Day, one of the best known coffee shop brands in India, extended upward to target upper income consumers. Coffee consumption was likely to expand at a rapid rate . . .”30 In 2002, there were 200 cafes in India holding sales of $10 million compared to 1,500 shops in 2011. Coffee consumption in India had increased by 6 per cent in five years.31 The Indian coffee market was much more attractive than the tea market due to lower levels of saturation and “continued industry dynamism.”32

Coffee retailing was one of the fastest growing organized retail segments in India and had room for an additional 5,000 cafés. Illy CEO Andrea Illy saw potential in the Indian market: “I think specialty coffees in India are at the beginning. There is a good opportunity for growth, particularly through espresso, which is totally consistent with the Indian taste because it is a high body, strong flavor taste, and mixes with local food and tradition.”33

While the rest of the world dealt with an economic slowdown, India experienced unprecedented growth and was the second fastest growing economy in the world. As a result, the country boasted 300 to 350 million middle-income earners who had relatively high disposable incomes. India’s franchise sector expanded as the economy did. Franchising grew at a rate of 30 per cent and was India’s second fastest growing industry. As of 2009, over 70 international franchise operations operated in the country, while it Use outside these parameters is a copyright violation. became the “business model of choice” for the food and beverage industry.34 Although India represented a lucrative market in terms of the rising middle class and interest in Western culture and way of life, the franchising sector was still young. The country’s banking system and bureaucracy had the potential to

28 Noerr LLP, “Franchise 2011: Germany,” www.nacsonline.com/NACS/News/FactSheets/MerchandiseandServices/Pages/Coffee.aspx, accessed February 17, 2012. 29 Y. Aparna, “Coffee Parlours in India – Hotting Up,” 2003, IMCR Center for Management Research. Hyderabad, 2003. 30 Shalini Hasan, “Costa Coffee in India,” IBS Case Development Center, Hyderabad, 2006. 31 Boby Kurian and Reeba Zachariah, “Starbucks Coffee Company Set for Café Joint Venture with Tatas,” Economic Times, October 11, 2011, www.search.proquest.com.ezproxy.rollins.edu:2048/abicomplete/docview/896965090/1325AC9D3E66B29BB4/1?accountid =13584, accessed February 14, 2012. 32 Business Monitor International, “India: Food & Drink Report Q4,” 2011, http://search.proquest.com.ezproxy.rollins.edu:2048/abicomplete/docview/893679875/1327917278F1BD5F09 For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. 3/8?accountid=13584, accessed February 14, 2012. 33 Eduardo Silva, “Can Starbucks Brew Instant Success in the Indian Market?” www.coffeeclubnetwork.com/redes/form/post?pub_id =2774, accessed February 17, 2012. 34 Manjushree Phookan, “India: Legal and Regulatory Aspects of Doing Business in the Franchising Industry,” http://franchise.org/uploadedFiles/Franchise_Industry/International_ /Country_Profiles/India_Franchise%20Sector_July%202009.pdf, accessed February 17, 2012.

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hinder business and successful partnerships. Dividing India into individual markets for expansion was strongly recommended.35

India’s capital, New Delhi, was approximately 5,929 kilometers away from Rome, Italy. The flight time from New Delhi to Rome was approximately eight hours.

JAPAN

Japan was the world’s third-largest coffee importer, over countries such as Italy and France.36 Although the hot drinks sector in Japan was expected to have lower demand in 2011 and after, coffee sales were expected to grow at a compound annual average growth rate of 5.4 per cent to 2015, which outpaced the country’s traditional drink, tea. “The outlook for the country’s hot drinks sector is considerably brighter than that of the alcoholic drinks sector . . . this is due to a continued emphasis on product innovation by major producers and continued strong consumer interest, particularly from older consumers.”37 Innovation, in terms of products and packaging, and convenience were key to growth. “Modern coffee shops will continue to influence customers’ preferences, although ready-to-drink-coffee is also fast gaining popularity in Japan.”38

While the popularity of coffee shops grew in Japan, the value consumers placed on convenience made “off- trade sales” a stronger potential growth channel. Starbucks expanded its number of store locations in Japan and worked with Suntory “to develop new products for retail distribution, such as its new take-home coffee brand, Via.” Additionally, there were opportunities in healthier and weight-conscious beverage alternatives. Another trend was taste innovation: “Manufacturers are striving to provide novelty in terms of health, mellow taste, and added-values, through the addition of traditional ingredients such as black bean and ginger.”39

The franchising sector in Japan had flattened out, in part because of poor economic conditions. As a result, it was important for companies to adjust their concepts to local tastes and expectations in order to ensure success. Another important aspect of franchising in Japan was the identification of the right business partners.

Japan’s capital, Tokyo, was approximately 6,138 kilometers away from Rome, Italy. The flight time from

Tokyo to Rome was approximately 13 hours. Use outside these parameters is a copyright violation.

UNITED KINGDOM

The coffee industry in the United Kingdom grew stronger. In 2010, U.K. coffee drinkers increased their visits to coffee shops. In fact, coffee shops were a ₤5 billion industry.40 Growth of branded coffee outlets remained stable at 6.1 per cent in 2010. Managing director Jeffrey Young of Allegra Strategies was

35 Bachir Mihoubi, “Dealing with the Complexities of International Expansion,” www.franchise.org/Franchise-Industry-News- Detail.aspx?id=53325, accessed February 17, 2012. 36 Oliver Strand, “Coffee,” The New York Times, November 30, 2009, http://topics.nytimes.com/top/reference/timestopics/subjects/c/coffee/index.html?scp=4&sq=starbucks&st=cse, accessed February 12, 2012. 37 Business Monitor International, “Japan: Food & Drink Report Q3 2011,” http://search.proquest.com.ezproxy.rollins.edu:2048/abicomplete/docview/876624562/13516DD8B0B3F5C00F2/11?account For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. id=13584, accessed February 17, 2012. 38 Ibid. 39 Ibid, 40 Caterer and Hotelkeeper, “Coffee Drinkers Defy the Downturn,” http://search.proquest.com.ezproxy.rollins.edu:2048/abicomplete/docview/873820700/fulltextPDF/1322CDAEB4B599015C7/ 12?accountid=13584, accessed February 24, 2012.

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optimistic about market growth as well: “I have never seen such exciting developments in the UK coffee shop market. This year the market grew by more than 12% compared with 2.5% for the UK retail sector, adding more than 800 outlets in 2010 in challenging economic times. The market is poised for significant further growth over the next 3–5 years.”41 Even the credit crunch of 2008–09 did not stymie coffee shop growth in the United Kingdom; from October 2008 to October 2009, 164 new coffee shops opened, which represented an increase of 60 per cent. This was attributed to the ability of companies to secure premium locations at lower prices.42 “Nearly every street has been impacted and the coffee sector defies all the recessionary gloom that has been seen elsewhere. Caffeine really has been the most significant stimulus to the UK high street in this recession.” Independent coffee shops represented another important part of the U.K.’s coffee industry, accounting for 71 per cent of outlets.43

Historically a tea-drinking nation, coffee has taken up permanent residence in the United Kingdom. A study by Glasgow University found that “the young and old, homeless and upper class, taste conscious and tasteless have all taken coffee shops to their hearts and created a new kind of socializing.”44

There were 842 franchise systems in the United Kingdom, represented by 34,800 franchise units. There were few restrictions to franchising, which made it one of the easiest places in Europe in which to set up and run a business. The UK Trade and Investment Agency helped foreign businesses invest and locate in the United Kingdom, and there were no restrictions on foreign, as compared to domestic, franchisors.45

The United Kingdom’s capital, London, was approximately 893 kilometers away from Rome, Italy. The flight time from London to Rome was approximately two hours.

UNITED STATES

Statistically, the United States was the global leader for coffee; it consumed about 25 per cent of the world’s market.46 Over 50 per cent of Americans 18 and over consumed coffee every day. A 2009 study of the coffee shop industry in the United States revealed that although there were 20,000 stores with annual revenues of about $11 billion, the top 50 companies held over 70 per cent of industry sales.47 The U.S. coffee market was characterized by high consumption, high saturation and concentration, a diverse

demography and premium coffee as an affordable luxury good. Young adults drank more coffee, while the Use outside these parameters is a copyright violation. specialty coffee market was growing. Between 2000 and 2005, the specialty coffee market grew over 40 per cent, while improved roasting methods, better brewing equipment and higher grade coffee beans improved quality and raised customer expectations.48 Coffee was a cultural obsession in the United States; almost 20 per cent of adults drank gourmet coffee daily. The “third place” atmosphere of coffee shops had

41 Ibid. 42 Patrick Clift, “Caffeine Stimulates High Street as More Cafes Open,” http://search.proquest.com.ezproxy.rollins.edu:2048/abicomplete/docview/223771840/fulltextPDF/1322CDAEB4B599015C7/ 20?accountid=13584, accessed February 24, 2012. 43 Ibid. 44 Miki Moore and Ken Moore, “Coffee Culture in the UK,” http://cafecrem.wordpress.com/2008/11/09/coffee-culture-in-the- uk/, accessed February 17, 2012. 45 Hamilton Pratt, “Franchise 2011: United Kingdom,” www.franchise.org/uploadedFiles/Franchise_Industry/International_Development/United%20Kingdom.pdf, accessed February 17, 2012. For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. 46 Strand, “Coffee.” 47 Nina Samaldi, “IBISWorld Industry Report 72221b: Coffee & Snack Shops in the US,” http://clients.ibisworld.com.ezproxy.rollins.edu:2048/industryus/default.aspx?indid=1973 accessed May 14, 2012. 48 First Research, “Industry Profile: Coffee Shops,” http://search.proquest.com. ezpprod1.hul.harvard.edu/abicomplete.docview/192463238/fulltextPDF/1321075EF8488208B4/11?accountid=1131, accessed February 17, 2012.

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become a place for students, businesspeople and friends. The Starbucks phenomenon created high demand for specialty coffee. Coffee was enjoyed in coffee shops as well as on-the-go, and there were thousands of chain and independent coffee shops around the country. “The typical customer for a coffee shop is 25–45, affluent and educated. Specialty coffee appeals to a diverse adult demographic, including college students and young adults.”49

The U.S. coffee industry was strengthened by the growing perception of the health benefits of coffee drinking, as well as increased popularity and demand for specialty coffee. Despite the relatively concentrated and saturated nature of the U.S. coffee franchising market, there were still opportunities for development. For example, although there were many coffee shops, the number of coffee shops per person in the United States was far lower than that of Italy. Customers in the United States looked for a number of different attributes in their coffee experience, including a unique retail experience, access to wi-fi, product innovation and health trends.

The capital of the United States, Washington, DC, was approximately 4,497 kilometers away from Rome, Italy. The flight time from Washington, DC to Rome was approximately nine hours.

INTERNATIONALIZATION: WHAT SHOULD ESPRESSAMENTE DO NEXT?

As part of the market selection process, Reale looked for key success factors in each market that would determine the best market selection (see Exhibits 4 and 5). The criteria included:

 Coffee consumption  Coffee shop concentration  Income per capita of the top 10 per cent of the population  Urbanization rate  GDP per capita  Ease of Doing Business rank  Most attractive segments  Coffee sales.

Use outside these parameters is a copyright violation. While market selection was critical, mode of market entry was important as well (see Exhibit 6). Reale could pursue a number of different expansion strategies, including direct franchising, area franchising, master franchising, multi-unit franchising, sequential franchising, joint venture and wholly owned subsidiary.

 Direct franchising: A franchisor provides materials, training and other forms of support to a franchisee, who pays a fee to license the company’s trademarks, products, and/or services. A well-functioning franchise provides a win-win arrangement for both parties: the franchisor gets to expand into new markets with little or no risk and investment, while the franchisee gets a proven brand, marketing exposure, an established client base and management expertise to help it succeed.  Area franchising: Area franchising allows a franchisee, or area developer, to enter into an agreement to develop a minimum number of outlets within a specified territory.50 For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019.

49 Ibid. 50 Ibid.

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 Master franchising: Master franchising allows franchisees to extend sub-franchise rights within a specific territory.51  Multi-unit franchising: Multi-unit franchising allows the franchisee to operate more than one unit, which are usually acquired at a reduced rate per unit. The franchisee would be involved in the day-today operations.52  Sequential franchising: Sequential franchising occurs when a franchisee must prove capable of operating one franchise before being granted a second and capable of operating two franchises before being granted a third, etc.53  Joint venture: A joint venture is created when two or more companies share ownership of a third commercial entity and collaborate in the production of its goods or services.54  Wholly owned subsidiary: Establishing a wholly owned subsidiary involves buying an existing business or building new facilities in a target country. It is the most capital intensive mode of entry, and is typically viable for only large, internationally experienced corporations.55

The mode of entry also weighed heavily on which market Espressamente chose to enter first. In markets that were incredibly different from Italy’s, it would be beneficial to pursue joint ventures or partnerships to help the company navigate local culture, trends and norms. This may not be as important in markets more similar to Italy’s.

Reale also recognized the importance of timing. As companies looked to international markets for expansion, pace, rhythm and scope had to be considered in order to plan, strategize and organize the company for success; determining the appropriate levels of pace, rhythm and scope were necessary for Espressamente’s expansion.

 Pace: “The rate of opening new stores abroad.”  Rhythm: “The regularity by which stores were opened abroad.”  Scope: “The number of new countries entered.”56

“How do I prioritize these markets and determine the best mode of entry for each?” Reale thought to himself. There was so much information to consider. He looked out the window of his Trieste office, took a sip of perfect coffee and then turned his head back to his computer to contemplate the future expansion of Espressamente. Use outside these parameters is a copyright violation.

51 Don Daszkowski, “Different Types of Franchise Ownership,” http://franchises.about.com/od/buyingafranchise/tp/different- types-of-franchise-o.htm, accessed February 27, 2012. 52 Ibid. For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. 53 Callum Floyd, “Different Types of Franchising,” www.franchise-chat.com/resources/franchise_forms.htm, accessed February 27, 2012. 54 Ilan Alon, “Global Marketing: Contemporary Theory, Practice and Cases,” McGraw Hill, New York, 2013, p. 212-218. 55 Ilan Alon, “Global Marketing: Contemporary Theory, Practive and Cases,” p. 220. 56 Rob Alkema, Mario Koster and Christopher Williams, “Resuming Internationalization at Starbucks,” Ivey Publishing, product #9B10M073, 2010.

190 Page 11 9B12M058

Exhibit 1

ESPRESSAMENTE THROUGH PICTURES

Use outside these parameters is a copyright violation.

Source: Company files.

For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019.

191 Page 12 9B12M058

Exhibit 2

COMPETITORS

Country Core competencies Geographical dispersion Main market of Expansion/contraction in recent years affiliation operation Starbucks United People, real At the close of fiscal 2010, there United States In 2008–09, Starbucks scaled back its international States estate/location, roasting were 16,858 company stores, expansion and even closed stores in the United and selling coffee, the 11,131 of which were located in States, although it is currently expanding once Starbucks Experience. the United States. again. McDonald’s United Premium coffee at International: McCafe’s had their United States McDonald’s realized its lackluster coffee offerings States McDonald’s prices, own store fronts in markets other were harming its competitive edge and introduced market strategy, than the United States. premium coffee in 2006; today, McDonald’s sales internationalized have outpaced many of its peers in the United infrastructure States, a result credited to the McCafé beverage line. Costa Coffee United Flexibility, adaptability 25 countries worldwide, first United Kingdom In January 2011, Costa reported 35 consecutive Kingdom and localization in coffee company to enter India; 30 (largest coffee quarters of positive like-for-like growth. international markets, 40- countries by 2015. chain in the United 192 year roasting heritage, Kingdom) marketing Lavazza Italy Tradition of quality and Foreign subsidiaries and Italy/international Acquisition of companies/production facilities in innovation, acquisitions; distribution in 80 countries. India have allowed it to take advantage of new Lavazza as a coffee markets. company, not a coffee shop company. Tchibo Germany Diversification/product Market leader for roasted coffee in Germany and Diversified, exports to over 40 countries. development, distribution Germany, Austria, Poland, Czech Europe (99 per cent system. Republic; exports to over 40 brand recognition countries. rate in Germany) Segafredo Italy Acquisition of brands, 70,000 clients worldwide; Italy Over 600 franchised locations around the world supply chain. operations in Europe, North and and growing. South America, Asia and Australia with roasting plants in Italy, Austria, Brazil, Finland, France, Poland and the Netherlands. The Coffee Bean United Technology, incorporation 750 stores in 22 countries. United States The company franchised internationally, and Tea Leaf States of tea. particularly in Asia.

Source: Ilan Alon. “The Internationalization of Espressamente,” 2012.

For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019. Use outside these parameters is a copyright violation. Page 13 9B12M058

Exhibit 3

ILLY COMPANY DATA

Use outside these parameters is a copyright violation.

Source: Company files. For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019.

193 Page 14 9B12M058

Exhibit 4

COUNTRY INFORMATION

194

Source: *Data year: Italy 2012 (http://coffee-statistics.com/coffee_statistics_ebook.html); Brazil unavailable; China 2009, coffee chains specifically (www.intracen.org/WorkArea/DownloadAsset.aspx?id=37584); Germany 2008 (http://cyberpress.de/2008/04/coffee-shops-booming-in-germany/); India 2012 (http://search.proquest.com.ezproxy.rollins.edu:2048/abicomplete/docview/920010101/fulltext/134EC9DFF036503B9E2/12?accountid=13584); Japan 2006 (www.doutor.co.jp/ir/en/financial/market.html); UK 2012; (http://search.proquest.com.ezproxy.rollins.edu:2048/abicomplete/docview/873820700/fulltextPDF/134E8B1AFF616A60506/1?accountid=13584); US 2007 (www.grin.com/en/e-book/111348/coffee-shop-industry-a-strategic-analysis). Accessed May 14, 2012. **Data from Business Monitor International, except for U.S. data; U.S. data from IBISWorld Industry Report 72221b Coffee & Snack Shops in the US, statistic given as growth of coffee and snack shops 2011–16. www.businessmonitor.com/ accessed May 14, 2012, http://clients.ibisworld.com.ezproxy.rollins.edu:2048/industryus/default.aspx?indid=1973 accessed May 14, 2012. ***Data for Italy based on 2010 value of imported coffee, adjusted from Euros to US$, www.cbi.eu/?pag=85&doc=6174&typ=mid_document, accessed May 14, 2012. Variable sources: CIA World Factbook: Total population, GDP per capita US$, Urbanization, Income per capita of the top 10% of the population; Doing Business: Ease of Doing Business rank; International Trade Center: Coffee consumption per capita, per annum, kilograms; Business Monitor International: Coffee sales in US$million (2011f), Projected percentage market growth; Illy Company Data: Illy coffee sales in US$million (2011).

Exhibit 5

HOFSTEDE’S DIMENSIONS

United United Italy Brazil China Germany India Japan Kingdom States Power distance 50 69 80 35 77 54 35 40 Individualism 76 38 20 67 48 46 89 91 Masculinity 70 49 66 66 56 95 66 62 Uncertainty avoidance 75 76 40 65 40 92 35 46 Long-term orientation 34 65 118 31 61 80 25 29

Source: http://geert-hofstede.com/countries.html, accessed May 14, 2012.

Exhibit 6

RISK AND CONTROL CONSIDERATIONS IN SELECTING AN ENTRY MODE

Use outside these parameters is a copyright violation.

Source: Ilan Alon, “Global Marketing: Contemporary Theory, Practice and Case,” McGraw Hill, New York, 2013, p. 206.

For use only in the course Strategic Management at Abilene Christian University taught by Sarah Easter from January 14, 2019 to May 06, 2019.

195 NOTICE REGARDING COPYRIGHT This custom course package contains intellectual property that is protected by copyright law. It is illegal to copy the material within this package without the written consent of the holder(s) of the copyright. This material has been copied under licence from Access Copyright or with permission from the copyright owner. Resale or further copying of anything in this package is strictly prohibited.