Exam cases: • Pacific Brands • Myer Ltd • Starbucks Pre-seen exam information Semester 2 2013 CPA Program professional level Global Strategy and Leadership © CPA Australia Ltd 2013 Case Scenario 1—Pacific Brands Pacific Brands: Rebuilding the brand Pacific Brands is an ASX listed Australian business with headquarters in Melbourne and operations throughout Australia as well as in New Zealand, the United Kingdom, Malaysia, China and Indonesia. The Company employs over 5000 employees worldwide. The company originally commenced manufacturing Dunlop bicycle tyres in 1893. Since that time, the company has grown into the business that it is today through a variety of different strategies. In 2009, the company took the decision to refocus the business on brands and move away from manufacturing, resulting in some controversy. The following is an extract from the article titled ‘Rebuilding the brand’ that appeared in the ‘AFR Boss Magazine’ (March 2011) and describes how Sue Morphet, the CEO of Pacific Brands from January 2008 to September 2012, used different strategies to change and transform the company in order to generate growth. Pacific Brands chief Sue Morphet has probably learnt more on the job in her three years running Pacific Brands than many CEOs glean in a decade. Just over two years ago, the clothing and textile manufacturer she heads became notorious for closing down 10 local factories and cutting about 1800 jobs (1200 were made redundant in manufacturing) as the company shifted production to China. The vitriol was prolonged and intense. Morphet, barely in her job a year then, was at the epicentre: personally criticised for everything from her salary to an uncaring attitude. Since then, Morphet has refused most interview requests. Never a fan of the limelight, her priority, she says, has been implementing a three-year restructuring strategy: cost-cutting; reorganising capital management and debt refinancing; simplifying logistics and operations; sourcing production offshore and developing capabilities required as a brand marketer. Those clipped phrases don’t do justice to the urgency the imperative had in 2009. In the midst of the financial crisis, Pacific Brands was a complex business with more than 900 labels, 350-odd brands and about 8000 staff; it was teetering on the edge of collapse. Beyond that, it also bore a weighty legacy from its corporate history and private equity ownership. Carrying more than $800 million in debt and a market capitalisation that had sunk to $100 million—with a big chunk of that debt due for refinancing the following year—Pacific Brands was receiving the stiff attentions of its bankers. Something had to give. Like many local manufacturers, it had been shifting work offshore for years, but it was the last big Australian producer still making clothing in any capacity—including singlets, T-shirts and underwear at factories in Unanderra, Cessnock, Nunawading and Coolaroo. In a charged political environment, Morphet agrees, the company’s predicament became emblematic of major structural upheaval in Australia’s economy and manufacturing sector, plus the impact of globalisation. ‘It was an industry that had become redundant, not necessarily just our factories.’ It would be a shame to define Morphet by what happened in that period, Pacific Brands chairman James MacKenzie says. ‘In reality, that is a decision that should have been taken years ago. What she had the guts to do was come in … and demonstrate that it had to be done. She knew what she was doing was right and it took her a while to convince the board it was right. She stuck to her guns.’ The managing director of Integrity Asset Management, Paul Fiani, who bought into the company in May 2009 and is now a major shareholder, says Morphet should be given credit for doing what no one else would do. ‘Sue received a very hard time for [moving manufacturing, which] was grossly unfair, as the company was on a path to inevitable failure if it kept trying to sell goods that cost it more to make than all its competitors,’ Fiani says. ‘In my view, this initiative alone saved the company.’ Global Strategy and Leadership Page 2 of 19 Morphet argues the changes were designed to provide flexibility to deal with changing markets. ‘We had to build that into Pacific Brands. We could no longer afford to subsidise local manufacturing but also we had to remove complexity within our operations and we had to have strong market focus.’ Looking back, she says, of course adverse reaction to the cuts was expected. ‘We knew that we had very strong brands and that the market would be devastated that these brands were almost leaving the shore. We knew that the market was very unsure of what was ahead of it in terms of commercial stability because we’d been watching offshore for months. And we were the first of the mainstream blue-collar companies to make a significant shift and it would have frightened people.’ While a local company with strong ‘Aussie’ branding was always going to cop some extra flak, some observers also believe the criticism was fanned by a disaffected few in the business community who had failed to face up to such unpalatable decisions. Without a doubt, Morphet says, there were many factors in play. ‘Good brands belong to the people who use them, not to the people who make them,’ she says. ‘So they felt as if we had let them down.’ Standing firm Despite the fierce and, at times, personal criticism, Morphet says there was no turning back. Her first year at the helm of the company may have tested her severely but she did not shy from the decision or her part in it. Nor did she blame her predecessors for the company’s debt levels and the risk of going into receivership; nor remind investors that it was private equity investors CVC that decided to list the company in 2004, reaping plenty of dollars. Many of the issues she and Pacific Brands have faced in recent years are shared among manufacturers. Integrity Asset Management’s Paul Fiani says Morphet’s introduction of product focus and some impressive new talent have been very important to the turnaround. He says the previous approach of growth via new brands was flawed and born out of the company’s private equity beginnings. ‘This strategy distracted management from its main focus and also cost a lot of money to support,’ he says. Morphet also staunchly supports the streamlining of the brands. ‘We are not an industrial company … we really are focused on consumer goods and textile,’ she says. ‘It was far too complex for the capabilities we had.’ Out went the Wrangler and Lee jeans but the company stuck with Bonds, Yakka, KingGee, Tontine, Folly, Berlei, Rio and Clarks shoes. It is in the process of selling off the beds and foam businesses (Dunlop Foams and Sleepmaker; the deal is under the Australian Competition and Consumer Commission (ACCC) review). It has also boosted its local design abilities and is expanding the Sheridan brand and retail strategy [via its own stores]. The business is now in four segments: underwear and hosiery makes up about a third of sales but contributes more than half of earnings; workwear and homewear account for just over 22 per cent each; plus there is the still-troubled footwear, outerwear and sport business. The company last month announced a $175 million write-down on the division. ‘The market’s tough, the market’s polarised and the brands that will succeed in the future will be the ones that are number one in their category,’ Morphet says. ‘We had to remove the complexity around them, to ensure they have absolute long-term opportunity. ‘So we’ve reduced it down to less than 100, and with that there are a dozen key brands that drive our business and give us our benefits and we are absolutely focusing on those.’ The retail environment continues to leave no margin for error. Kmart*, for example, made the decision to replace labels like Bonds last year with its own home-brand products. And in recent months, sales have been down in department stores and supermarket channels. Morphet insists Kmart hasn’t dropped Bonds but the market has changed and become extremely polarised since the GFC. Shoppers either buy the number one brand or the price point offer, and retailers are following suit. Consumers will justify a luxury brand for some purchases but hunt down a bargain for more mundane goods, Morphet explains. Pacific Brands is now about two-thirds of the way through its three-year restructuring program. The plan, while costing more than management anticipated, is on track to deliver net cost savings of $150 million in 2011. The company also has been reducing its debt, and patient investors had their dividends reinstated in the latest first half. Amid tough trading conditions, in the latest half-year, sales fell and write-downs pushed the company to a $166 million loss. But margins have improved strongly. First-half earnings before interest, tax, and amortisation (EBITA) before significant items increased 30.1 per cent to $104.5 million. But those results also exposed the impact of rising costs for cotton, Chinese labour and freight, on top of weak sales from the fickle retail environment. * Kmart is one of Australia’s large retailers. Global Strategy and Leadership Page 3 of 19 There remain market concerns about the strategy and its ability to generate medium-term growth. Merrill Lynch analyst David Errington has been bearish from the start. In a February 2009 note to clients, he questioned whether Pacific Brands was in control of its destiny and criticised the sell-off of so many brands.