Written Assignment #1 – Apple’s Strategy
Refer to Assurance of Learning Exercise #1 (Apple) in Chapter One of your Thompson (2022) text. Read “Apple Inc: Exemplifying a Successful Strategy” in Illustration Capsule 1.1.
Incorporate our course (Thompson text) work for the week and Develop your analysis by responding to the following questions:
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CRAFTING AND
EXECUTING
STRATEGY
The Quest for
Competitive
Advantage
Concepts and Cases
page iii
CRAFTING AND EXECUTING
STRATEGY
The Quest for Competitive
Advantage
Concepts and Cases | 23RD EDITION
Arthur A.
Thompson
Margaret
A. Peteraf
The University of
Alabama
Dartmouth
College
John E.
Gamble
Texas A&M
University–Corpus
Christi
A.J.
Strickland
III
The University
of Alabama
page iv
CRAFTING & EXECUTING STRATEGY: CONCEPTS AND CASES
Published by McGraw Hill LLC, 1325 Avenue of the Americas, New York, NY 10121. Copyright
©2022 by McGraw Hill LLC. All rights reserved. Printed in the United States of America. No part of
this publication may be reproduced or distributed in any form or by any means, or stored in a
database or retrieval system, without the prior written consent of McGraw Hill LLC, including, but
not limited to, in any network or other electronic storage or transmission, or broadcast for distance
learning.
Some ancillaries, including electronic and print components, may not be available to customers
outside the United States.
This book is printed on acid-free paper.
1 2 3 4 5 6 7 8 9 LWI 24 23 22 21
ISBN 978-1-265-02824-4
MHID 1-265-02824-9
Cover Image: Image Source/Getty Images
All credits appearing on page or at the end of the book are considered to be an extension of the
copyright page.
The Internet addresses listed in the text were accurate at the time of publication. The inclusion of a
website does not indicate an endorsement by the authors or McGraw Hill LLC, and McGraw Hill
LLC does not guarantee the accuracy of the information presented at these sites.
mheducation.com/highered
http://mheducation.com/highered
page v
To our families and especially our spouses:
Hasseline, Paul, Heather, and Kitty.
page vi
About the Authors
Courtesy of Arthur A. Thompson, Jr.
Arthur A. Thompson, Jr., earned his BS and PhD degrees in economics
from The University of Tennessee, spent three years on the economics
faculty at Virginia Tech, and served on the faculty of The University of
Alabama’s College of Commerce and Business Administration for 24 years.
In 1974 and again in 1982, Dr. Thompson spent semester-long sabbaticals
as a visiting scholar at the Harvard Business School.
His areas of specialization are business strategy, competition and market
analysis, and the economics of business enterprises. In addition to
publishing over 30 articles in some 25 different professional and trade
publications, he has authored or co-authored five textbooks and six
computer-based simulation exercises. His textbooks and strategy
simulations have been used at well over 1,000 college and university
campuses worldwide.
Dr. Thompson and his wife of 58 years have two daughters, two
grandchildren, and a Yorkshire Terrier.
Courtesy of Margaret A. Peteraf
Margaret A. Peteraf is the Leon E. Williams Professor of Management
Emerita at the Tuck School of Business at Dartmouth College. She is an
internationally recognized scholar of strategic management, with a long list
of publications in top management journals. She has earned myriad honors
and prizes for her contributions, including the 1999 Strategic Management
Society Best Paper Award recognizing the deep influence of her work on
the field of Strategic Management. Professor Peteraf is a fellow of the
Strategic Management Society and the Academy of Management. She
served previously as a member of the Board of Governors of both the
Society and the Academy of Management and as Chair of the Business
Policy and Strategy Division of the Academy. She has also served in
various editorial roles and on numerous editorial boards, including the
Strategic Management Journal, the Academy of Management Review, and
Organization Science. She has taught in Executive Education programs in
various programs around the world and has won teaching awards at the
MBA and Executive level.
Professor Peteraf earned her PhD, MA, and MPhil at Yale University and
held previous faculty appointments at Northwestern University’s Kellogg
Graduate School of Management and at the University of Minnesota’s
Carlson School of Management.
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Courtesy of Richard’s Photography, LLC.
John E. Gamble is a Professor of Management and Dean of the College of
Business at Texas A&M University–Corpus Christi. His teaching and
research for 25 years has focused on strategic management at the
undergraduate and graduate levels. He has conducted courses in strategic
management in Germany since 2001, which have been sponsored by the
University of Applied Sciences in Worms.
Dr. Gamble’s research has been published in various scholarly journals
and he is the author or co-author of more than 75 case studies published in
an assortment of strategic management and strategic marketing texts. He
has done consulting on industry and market analysis for clients in a diverse
mix of industries.
Professor Gamble received his PhD, MA, and BS degrees from The
University of Alabama and was a faculty member in the Mitchell College of
Business at the University of South Alabama before his appointment to the
faculty at Texas A&M University–Corpus Christi.
Courtesy of Dr. A. J. (Lonnie) Strickland
Dr. A. J. (Lonnie) Strickland is the Thomas R. Miller Professor of
Strategic Management at the Culverhouse School of Business at The
University of Alabama. He is a native of north Georgia, and attended the
University of Georgia, where he received a BS degree in math and physics;
Georgia Institute of Technology, where he received an MS in industrial
management; and Georgia State University, where he received his PhD in
business administration.
Lonnie’s experience in consulting and executive development is in the
strategic management arena, with a concentration in industry and
competitive analysis. He has developed strategic planning systems for
numerous firms all over the world. He served as Director of Marketing and
Strategy at BellSouth, has taken two companies to the New York Stock
Exchange, is one of the founders and directors of American Equity
Investment Life Holding (AEL), and serves on numerous boards of
directors. He is a very popular speaker in the area of strategic management.
Lonnie and his wife, Kitty, have been married for over 49 years. They
have two children and two grandchildren. Each summer, Lonnie and his
wife live on their private game reserve in South Africa where they enjoy
taking their friends on safaris.
B
page viii
Preface
y offering the most engaging, clearly articulated, and conceptually
sound text on strategic management, Crafting and Executing Strategy
has been able to maintain its position as the leading textbook in strategic
management for over 35 years. With this latest edition, we build on this
strong foundation, maintaining the attributes of the book that have long
made it the most teachable text on the market, while updating the content,
sharpening its presentation, and providing enlightening new illustrations
and examples.
The distinguishing mark of the 23rd edition is its enriched and enlivened
presentation of the material in each of the 12 chapters, providing an as up-
to-date and engrossing discussion of the core concepts and analytical tools
as you will find anywhere. As with each of our new editions, there is an
accompanying lineup of exciting new cases that bring the content to life and
are sure to provoke interesting classroom discussions, deepening students’
understanding of the material in the process.
While this 23rd edition retains the 12-chapter structure of the prior
edition, every chapter—indeed every paragraph and every line—has been
reexamined, refined, and refreshed. New content has been added to keep the
material in line with the latest developments in the theory and practice of
strategic management. In other areas, coverage has been trimmed to keep
the book at a more manageable size. Scores of new examples have been
added, along with many new Illustration Capsules, to enrich understanding
of the content and to provide students with a ringside view of strategy in
action. The result is a text that cuts straight to the chase in terms of what
students really need to know and gives instructors a leg up on teaching that
material effectively. It remains, as always, solidly mainstream and balanced,
mirroring both the penetrating insight of academic thought and the
pragmatism of real-world strategic management.
A standout feature of this text has always been the tight linkage between
the content of the chapters and the cases. The lineup of cases that
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accompany the 23rd edition is outstanding in this respect—a truly appealing
mix of strategically relevant and thoughtfully crafted cases, certain to
engage students and sharpen their skills in applying the concepts and tools
of strategic analysis. Many involve high-profile companies that the students
will immediately recognize and relate to; all are framed around key
strategic issues and serve to add depth and context to the topical content of
the chapters. We are confident you will be impressed with how well these
cases work in the classroom and the amount of student interest they will
spark.
For some years now, growing numbers of strategy instructors at business
schools worldwide have been transitioning from a purely text-case course
structure to a more robust and energizing text-case-simulation course
structure. Incorporating a competition-based strategy simulation has the
strong appeal of providing class members with an immediate and engaging
opportunity to apply the concepts and analytical tools covered in the
chapters and to become personally involved in crafting and executing a
strategy for a virtual company that they have been assigned to manage and
that competes head-to-head with companies run by other class
members. Two widely used and pedagogically effective online
strategy simulations, The Business Strategy Game and GLO-BUS, are
optional companions for this text. Both simulations were created by Arthur
Thompson, one of the text authors, and, like the cases, are closely linked to
the content of each chapter in the text. The Exercises for Simulation
Participants, found at the end of each chapter and integrated into the
Connect package for the text, provide clear guidance to class members in
applying the concepts and analytical tools covered in the chapters to the
issues and decisions that they have to wrestle with in managing their
simulation company.
To assist instructors in assessing student achievement of program
learning objectives, in line with AACSB requirements, the 23rd edition
includes a set of Assurance of Learning Exercises at the end of each chapter
that link to the specific learning objectives appearing at the beginning of
each chapter and highlighted throughout the text. An important instructional
feature of the 23rd edition is its more closely integrated linkage of selected
chapter-end Assurance of Learning Exercises and cases to Connect™. Your
students will be able to use Connect™ to (1) complete chapter-specific
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activities, including selected Assurance of Learning Exercises appearing at
the end of each of the 12 chapters as well as video and comprehension
cases, (2) complete chapter-end quizzes, (3) complete suggested assignment
questions for 14 of the 27 cases in this edition and (4) complete assignment
questions for simulation users. All Connect exercises are automatically
graded (with the exception of select Exercises for Simulation Participants),
thereby enabling you to easily assess the learning that has occurred.
In addition, both of the companion strategy simulations have a built-in
Learning Assurance Report that quantifies how well each member of your
class performed on nine skills/learning measures versus tens of thousands of
other students worldwide who completed the simulation in the past 12
months. We believe the chapter-end Assurance of Learning Exercises, the
all-new online and automatically graded Connect™ exercises, and the
Learning Assurance Report generated at the conclusion of The Business
Strategy Game and GLO-BUS simulations provide you with easy-to-use,
empirical measures of student learning in your course. All can be used in
conjunction with other instructor-developed or school-developed scoring
rubrics and assessment tools to comprehensively evaluate course or
program learning outcomes and measure compliance with AACSB
accreditation standards.
Taken together, the various components of the 23rd edition package and
the supporting set of instructor resources provide you with enormous course
design flexibility and a powerful kit of teaching/learning tools. We’ve done
our very best to ensure that the elements constituting the 23rd edition will
work well for you in the classroom, help you economize on the time needed
to be well prepared for each class, and cause students to conclude that your
course is one of the very best they have ever taken—from the standpoint of
both enjoyment and learning.
DIFFERENTIATING FEATURES OF
THE 23RD EDITION
Nine standout features strongly differentiate this text and the accompanying
instructional package from others in the field:
1. We provide the clearest discussion of business models to be found
anywhere. By introducing this often-misunderstood concept right in the
first chapter and defining it precisely, we give students a leg up on
grasping this important concept. Follow-on discussions in the next eight
chapters drive the concept home. Illustration capsules and cases show
how a new business model can enable a company to compete
successfully even against well-established rivals. In some cases, a new
business model can even be the agent for disrupting an existing industry.
2. Our integrated coverage of the two most popular perspectives on
strategic management— positioning theory and resource-based theory—
is unsurpassed by any other leading strategy text. Principles and concepts
from both the positioning perspective and the resource-based perspective
are prominently and comprehensively integrated into our coverage of
crafting both single-business and multibusiness strategies. By
highlighting the relationship between a firm’s resources and capabilities
to the activities it conducts along its value chain, we show explicitly how
these two perspectives relate to one another. Moreover, in Chapters 3
through 8 it is emphasized repeatedly that a company’s strategy must be
matched not only to its external market circumstances but also to its
internal resources and competitive capabilities.
3. With this new edition, we provide the clearest, easiest to understand
presentation of the value-price-cost framework. In recent years, this
framework has become an essential aid to teaching students how
companies create economic value in the course of conducting business.
We show how this simple framework informs the concept of the business
model as well as the all-important concept of competitive advantage. In
Chapter 5, we add further clarity by showing in pictorial fashion how the
value-price-cost framework relates to the different sources of competitive
advantage that underlie the five generic strategies.
4. Our coverage of cooperative strategies and the role that
interorganizational activity can play in the pursuit of competitive
advantage is similarly distinguished. The topics of the value net,
ecosystems, strategic alliances, licensing, joint ventures, and other types
of collaborative relationships are featured prominently in a number of
chapters and are integrated into other material throughout the text. We
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show how strategies of this nature can contribute to the success of single-
business companies as well as multibusiness enterprises, whether with
respect to firms operating in domestic markets or those operating in the
international realm.
5. The attention we give to international strategies, in all their dimensions,
make this textbook an indispensable aid to understanding strategy
formulation and execution in an increasingly connected, global world.
Our treatment of this topic as one of the most critical elements of the
scope of a company’s activities brings home to students the connection
between the topic of international strategy with other topics concerning
firm scope, such as multibusiness (or corporate) strategy, outsourcing,
insourcing, and vertical integration.
6. With a standalone chapter devoted to these topics, our coverage of
business ethics, corporate social responsibility, and environmental
sustainability goes well beyond that offered by any other leading strategy
text. Chapter 9, “Ethics, Corporate Social Responsibility, Environmental
Sustainability, and Strategy,” fulfills the important functions of (1)
alerting students to the role and importance of ethical and socially
responsible decision making and (2) addressing the accreditation
requirement of the AACSB International that business ethics be
visibly and thoroughly embedded in the core curriculum. Moreover,
discussions of the roles of values and ethics are integrated into portions
of other chapters, beginning with the first chapter, to further reinforce
why and how considerations relating to ethics, values, social
responsibility, and sustainability should figure prominently into the
managerial task of crafting and executing company strategies.
7. Long known as an important differentiator of this text, the case collection
in the 23rd edition is truly unrivaled from the standpoints of student
appeal, teachability, and suitability for drilling students in the use of the
concepts and analytical treatments in Chapters 1 through 12. The 27
cases included in this edition are the very latest, the best, and the most on
target that we could find. The ample information about the cases in the
Instructor’s Manual makes it effortless to select a set of cases each term
that will capture the interest of students from start to finish.
8. The text is now optimized for hybrid and online delivery through robust
assignment and assessment content integrated into Connect™. This will
enable professors to gauge class members’ prowess in accurately
completing (a) additional exercises and selected chapter-end exercises,
(b) chapter-end quizzes, (c) exercises for simulation participants, and (d)
exercises for 14 of the cases in this edition.
9. Two cutting-edge and widely used strategy simulations—The Business
Strategy Game and GLO-BUS—are optional companions to the 23rd
edition. These give you an unmatched capability to employ a text-case-
simulation model of course delivery.
ORGANIZATION, CONTENT, AND
FEATURES OF THE 23RD-EDITION
TEXT CHAPTERS
Chapter 1 serves as a brief, general introduction to the topic of strategy,
focusing on the central questions of “What is strategy?” and “Why is it
important?” As such, it serves as the perfect accompaniment for your
opening-day lecture on what the course is all about and why it matters.
Using the example of Apple, Inc., to drive home the concepts in this
chapter, we introduce students to what we mean by “competitive
advantage” and the key features of business-level strategy. Describing
strategy making as a process, we explain why a company’s strategy is
partly planned and partly reactive and why a strategy tends to co-evolve
with its environment over time. As part of this strategy making process,
we discuss the importance of ethics in choosing among strategic
alternatives. We introduce the concept of a business model and offer a
clear definition along with an illustration capsule that provides examples
from the real world of business. We explain why a viable business model
must provide both an attractive value proposition for the company’s
customers and a formula for making profits for the company. A key
feature of this chapter is a depiction of how the value-price-cost
framework can be used to frame this discussion. We show how the mark
of a winning strategy is its ability to pass three tests: (1) the fit test (for
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internal and external fit), (2) the competitive advantage test, and (3) the
performance test. And we explain why good company performance
depends not only upon a sound strategy but upon solid strategy execution
as well.
Chapter 2 presents a more complete overview of the strategic
management process, covering topics ranging from the role of vision,
mission, and values to what constitutes good corporate governance. It
makes a great assignment for the second day of class and provides a
smooth transition into the heart of the course. It introduces
students to such core concepts as strategic versus financial
objectives, the balanced scorecard, strategic intent, and business-level
versus corporate-level strategies. It explains why all managers are on a
company’s strategy-making, strategy- executing team and why a
company’s strategic plan is a collection of strategies devised by different
managers at different levels in the organizational hierarchy. The chapter
concludes with a section on the role of the board of directors in the
strategy-making, strategy-executing process and examines the conditions
that have led to recent high-profile corporate governance failures. The
illustration capsule on Volkswagen’s emissions scandal brings this section
to life.
The next two chapters introduce students to the two most fundamental
perspectives on strategy making: the positioning view, exemplified by
Michael Porter’s classic “five forces model of competition,” and the
resource-based view. Chapter 3 provides what has long been the clearest,
most straightforward discussion of the five forces framework to be found
in any text on strategic management. It also offers a set of complementary
analytical tools for conducting competitor analysis, identifying strategic
groups along with the mobility barriers that limit movement among them,
and demonstrates the importance of tailoring strategy to fit the
circumstances of a company’s industry and competitive environment. The
chapter includes a discussion of the value net framework, which is useful
for conducting analysis of how cooperative as well as competitive moves
by various parties contribute to the creation and capture of value in an
industry.
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Chapter 4 presents the resource-based view of the firm, showing why
resource and capability analysis is such a powerful tool for sizing up a
company’s competitive assets. It offers a simple framework for
identifying a company’s resources and capabilities and explains how the
VRIN framework can be used to determine whether they can provide the
company with a sustainable competitive advantage over its competitors.
Other topics covered in this chapter include dynamic capabilities, SWOT
analysis, value chain analysis, benchmarking, and competitive strength
assessments, thus enabling a solid appraisal of a company’s cost position
and customer value proposition vis-á-vis its rivals. An important feature
of this chapter is a table showing how key financial and operating ratios
are calculated and how to interpret them. Students will find this table
handy in doing the number crunching needed to evaluate whether a
company’s strategy is delivering good financial performance.
Chapter 5 sets forth the basic approaches available for competing and
winning in the marketplace in terms of the five generic competitive
strategies— broad low-cost, broad differentiation, best-cost, focused
differentiation, and focused low cost. It demonstrates pictorially the link
between generic strategies, the value-price-cost framework, and
competitive advantage. The chapter also describes when each of the five
approaches works best and what pitfalls to avoid. Additionally, it explains
the role of cost drivers and uniqueness drivers in reducing a company’s
costs and enhancing its differentiation, respectively.
Chapter 6 focuses on other strategic actions a company can take to
complement its competitive approach and maximize the power of its
overall strategy. These include a variety of offensive or defensive
competitive moves, and their timing, such as blue-ocean strategies and
first-mover advantages and disadvantages. It also includes choices
concerning the breadth of a company’s activities (or its scope of
operations along an industry’s entire value chain), ranging from
horizontal mergers and acquisitions, to vertical integration, outsourcing,
and strategic alliances. This material serves to segue into the scope issues
covered in the next two chapters on international and diversification
strategies.
Chapter 7 takes up the topic of how to compete in international markets.
It begins with a discussion of why differing market conditions across
countries must necessarily influence a company’s strategic choices about
how to enter and compete in foreign markets. It presents five major
strategic options for expanding a company’s geographic scope and
competing in foreign markets: export strategies, licensing, franchising,
establishing a wholly owned subsidiary via acquisition or “greenfield”
venture, and alliance strategies. It includes coverage of topics such as
Porter’s Diamond of National Competitive Advantage, multi-market
competition, and the choice between multidomestic, global, and
transnational strategies. This chapter explains the impetus for sharing,
transferring, or accessing valuable resources and capabilities across
national borders in the quest for competitive advantage, connecting the
material to that on the resource-based view from Chapter 4. The chapter
concludes with a discussion of the unique characteristics of competing in
developing-country markets.
Chapter 8 concerns strategy making in the multibusiness company,
introducing the topic of corporate-level strategy with its special focus on
diversification. The first portion of this chapter describes when and why
diversification makes good strategic sense, the different means of
diversifying a company’s business lineup, and the pros and cons of
related versus unrelated diversification strategies. The second part of the
chapter looks at how to evaluate the attractiveness of a diversified
company’s business lineup, how to decide whether it has a good
diversification strategy, and what strategic options are available for
improving a diversified company’s future performance. The evaluative
technique integrates material concerning both industry analysis and the
resource-based view, in that it considers the relative attractiveness of the
various industries the company has diversified into, the company’s
competitive strength in each of its lines of business, and the extent to
which its different businesses exhibit both strategic fit and resource fit.
Although the topic of ethics and values comes up at various points in this
textbook, Chapter 9 brings more direct attention to such issues and may
be used as a stand-alone assignment in either the early, middle, or late
part of a course. It concerns the themes of ethical standards in business,
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approaches to ensuring consistent ethical standards for companies with
international operations, corporate social responsibility, and
environmental sustainability. The contents of this chapter are sure to give
students some things to ponder, rouse lively discussion, and help to make
students more ethically aware and conscious of why all companies should
conduct their business in a socially responsible and sustainable manner.
The next three chapters (Chapters 10, 11, and 12) comprise a module on
strategy execution that is presented in terms of a 10-step action
framework. Chapter 10 provides an overview of this framework and then
explores the first three of these tasks: (1) staffing the organization with
people capable of executing the strategy well, (2) building the
organizational capabilities needed for successful strategy execution, and
(3) creating an organizational structure supportive of the strategy
execution process.
Chapter 11 discusses five additional managerial actions that advance the
cause of good strategy execution: (1) allocating resources to enable the
strategy execution process, (2) ensuring that policies and procedures
facilitate rather than impede strategy execution, (3) using process
management tools and best practices to drive continuous improvement in
the performance of value chain activities, (4) installing information and
operating systems that help company personnel carry out their
strategic roles, and (5) using rewards and incentives to
encourage good strategy execution and the achievement of performance
targets.
Chapter 12 completes the 10-step framework with a consideration of the
importance of creating a healthy corporate culture and exercising
effective leadership in promoting good strategy execution. The recurring
theme throughout the final three chapters is that executing strategy
involves deciding on the specific actions, behaviors, and conditions
needed for a smooth strategy-supportive operation and then following
through to get things done and deliver results. The goal here is to ensure
that students understand that the strategy-executing phase is a make-
things-happen and make-them-happen-right kind of managerial exercise
—one that is critical for achieving operating excellence and reaching the
goal of strong company performance.
In this latest edition, we have put our utmost effort into ensuring that the
12 chapters are consistent with the latest and best thinking of academics and
practitioners in the field of strategic management and provide the topical
coverage required for both undergraduate and MBA-level strategy courses.
The ultimate test of the text, of course, is the positive pedagogical impact it
has in the classroom. If this edition sets a more effective stage for your
lectures and does a better job of helping you persuade students that the
discipline of strategy merits their rapt attention, then it will have fulfilled its
purpose.
THE CASE COLLECTION
The 27-case lineup in this edition is flush with interesting companies and
valuable lessons for students in the art and science of crafting and executing
strategy. There’s a good blend of cases from a length perspective—about
two-thirds of the cases are under 15 pages yet offer plenty for students to
chew on; and the remainder are detail-rich cases that call for more sweeping
analysis.
At least 25 of the 27 cases involve companies, products, people, or
activities that students will have heard of, know about from personal
experience, or can easily identify with. The lineup includes at least 20 cases
that will deepen student understanding of the special demands of competing
in industry environments where product life cycles are short and
competitive maneuvering among rivals is quite active. Twenty-three of the
cases involve situations in which company resources and competitive
capabilities play as large a role in the strategy-making, strategy executing
scheme of things as industry and competitive conditions do. Scattered
throughout the lineup are 20 cases concerning nonU.S. companies, globally
competitive industries, and/or cross-cultural situations. These cases, in
conjunction with the globalized content of the text chapters, provide
abundant material for linking the study of strategic management tightly to
the ongoing globalization of the world economy. You’ll also find 8 cases
dealing with the strategic problems of family-owned or relatively small
entrepreneurial businesses and 24 cases involving public companies and
situations where students can do further research on the Internet.
page xv
The “Guide to Case Analysis” follows the last case. It contains sections
on what a case is, why cases are a standard part of courses in strategy,
preparing a case for class discussion, doing a written case analysis, doing an
oral presentation, and using financial ratio analysis to assess a company’s
financial condition. We suggest having students read this guide before the
first class discussion of a case.
A number of cases have accompanying YouTube video segments which
are listed in Section 3 of the Instructor’s Manual, in a separate Video
Library within the Instructor’s Resources, and in the Teaching Note for each
case.
THE TWO STRATEGY SIMULATION
SUPPLEMENTS: THE BUSINESS
STRATEGY GAME AND GLO-BUS
The Business Strategy Game and GLO-BUS: Developing Winning
Competitive Strategies— two competition-based strategy simulations that
are delivered online and that feature automated processing and grading of
performance—are being marketed by the publisher as companion
supplements for use with the 23rd edition (and other texts in the field).
The Business Strategy Game is the world’s most popular strategy
simulation, having been used by nearly 3,600 different instructors for
courses involving close to one million students at 1,300 university
campuses in 76 countries. It features global competition in the athletic
footwear industry, a product/market setting familiar to students
everywhere and one whose managerial challenges are easily grasped. A
freshly updated and much-enhanced version of The Business Strategy
Game was introduced in August 2018.
GLO-BUS, a newer and somewhat simpler strategy simulation first
introduced in 2004 and freshly revamped in 2016 to center on
competition in two exciting product categories—wearable miniature
action cameras and unmanned camera-equipped drones suitable for
multiple commercial purposes, has been used by 2,100 different
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instructors for courses involving nearly 360,000 students at 800+
university campuses in 53 countries.
How the Strategy Simulations Work
In both The Business Strategy Game (BSG) and GLO-BUS, class members
are divided into teams of one to five persons and assigned to run a company
that competes head-to-head against companies run by other class members.
In both simulations, companies compete in a global market arena, selling
their products in four geographic regions— Europe-Africa, North America,
Asia-Pacific, and Latin America. Each management team is called upon to
craft a strategy for their company and make decisions relating to production
operations, workforce compensation, pricing and marketing, social
responsibility/citizenship, and finance.
Company co-managers are held accountable for their decision making.
Each company’s performance is scored on the basis of earnings per share,
return-on-equity investment, stock price, credit rating, and image rating.
Rankings of company performance, along with a wealth of industry and
company statistics, are available to company co-managers after each
decision round to use in making strategy adjustments and operating
decisions for the next competitive round. You can be certain that the market
environment, strategic issues, and operating challenges that company co-
managers must contend with are very tightly linked to what your class
members will be reading about in the text chapters. The circumstances that
co-managers face in running their simulation company embrace the very
concepts, analytical tools, and strategy options they encounter in the text
chapters (this is something you can quickly confirm by skimming through
some of the Exercises for Simulation Participants that appear at the end of
each chapter).
We suggest that you schedule one or two practice rounds and anywhere
from four to 10 regular (scored) decision rounds (more rounds are better
than fewer rounds). Each decision round represents a year of company
operations and will entail roughly two hours of time for
company co-managers to complete. In traditional 13-week,
semester-long courses, there is merit in scheduling one decision round per
week. In courses that run five to 10 weeks, it is wise to schedule two
decision rounds per week for the last several weeks of the term ( sample
course schedules are provided for courses of varying length and varying
numbers of class meetings).
When the instructor-specified deadline for a decision round arrives, the
simulation server automatically accesses the saved decision entries of each
company, determines the competitiveness and buyer appeal of each
company’s product offering relative to the other companies being run by
students in your class, and then awards sales and market shares to the
competing companies, geographic region by geographic region. The unit
sales volumes awarded to each company are totally governed by
How its prices compare against the prices of rival brands.
How its product quality compares against the quality of rival brands.
How its product line breadth and selection compare.
How its advertising effort compares.
And so on, for a total of 11 competitive factors that determine unit sales
and market shares.
The competitiveness and overall buyer appeal of each company’s product
offering in comparison to the product offerings of rival companies is all-
decisive—this algorithmic feature is what makes BSG and GLO-BUS
“competition-based” strategy simulations. Once each company’s sales and
market shares are awarded based on the competitiveness and buyer appeal
of its respective overall product offering vis-à-vis those of rival companies,
the various company and industry reports detailing the outcomes of the
decision round are then generated. Company co-managers can access the
results of the decision round 15 to 20 minutes after the decision deadline.
The Compelling Case for Incorporating Use of a Strategy
Simulation
There are three exceptionally important benefits associated with using a
competition-based simulation in strategy courses taken by seniors and MBA
students:
A three-pronged text-case-simulation course model delivers significantly
more teaching-learning power than the traditional text-case model. Using
page xvii
both cases and a strategy simulation to drill students in thinking
strategically and applying what they read in the text chapters is a stronger,
more effective means of helping them connect theory with practice and
develop better business judgment. What cases do that a simulation cannot
is give class members broad exposure to a variety of companies and
industry situations and insight into the kinds of strategy-related problems
managers face. But what a competition-based strategy simulation does far
better than case analysis is thrust class members squarely into an active,
hands-on managerial role where they are totally responsible for assessing
market conditions, determining how to respond to the actions of
competitors, forging a long-term direction and strategy for their company,
and making all kinds of operating decisions. Because they are held fully
accountable for their decisions and their company’s performance, co-
managers are strongly motivated to dig deeply into company operations,
probe for ways to be more cost-efficient and competitive, and ferret out
strategic moves and decisions calculated to boost company performance.
Consequently, incorporating both case assignments and a
strategy simulation to develop the skills of class members in
thinking strategically and applying the concepts and tools of strategic
analysis turns out to be more pedagogically powerful than relying solely
on case assignments—there’s stronger retention of the lessons learned
and better achievement of course learning objectives.
To provide you with quantitative evidence of the learning that occurs
with using The Business Strategy Game or GLO-BUS, there is a built-in
Learning Assurance Report showing how well each class member
performs on nine skills/learning measures versus tens of thousands of
students worldwide who have completed the simulation in the past 12
months.
The competitive nature of a strategy simulation arouses positive energy
and steps up the whole tempo of the course by a notch or two. Nothing
sparks class excitement quicker or better than the concerted efforts on the
part of class members at each decision round to achieve a high industry
ranking and avoid the perilous consequences of being outcompeted by
other class members. Students really enjoy taking on the role of a
manager, running their own company, crafting strategies, making all
kinds of operating decisions, trying to outcompete rival companies, and
getting immediate feedback on the resulting company performance. Lots
of back-and-forth chatter occurs when the results of the latest simulation
round become available and co-managers renew their quest for strategic
moves and actions that will strengthen company performance. Co-
managers become emotionally invested in running their company and
figuring out what strategic moves to make to boost their company’s
performance. Interest levels climb. All this stimulates learning and causes
students to see the practical relevance of the subject matter and the
benefits of taking your course.
As soon as your students start to say, “Wow! Not only is this fun but I
am learning a lot,” which they will, you have won the battle of engaging
students in the subject matter and moved the value of taking your course
to a much higher plateau in the business school curriculum. This
translates into a livelier, richer learning experience from a student
perspective and better instructor-course evaluations.
Use of a fully automated online simulation reduces the time instructors
spend on course preparation, course administration, and grading. Since
the simulation exercise involves a 20- to 30-hour workload for student
teams (roughly two hours per decision round times 10 to 12 rounds, plus
optional assignments), simulation adopters often compensate by trimming
the number of assigned cases from, say, 10 to 12 to perhaps 4 to 6. This
significantly reduces the time instructors spend reading cases, studying
teaching notes, and otherwise getting ready to lead class discussion of a
case or grade oral team presentations. Course preparation time is further
cut because you can use several class days to have students bring their
laptops to class or meet in a computer lab to work on upcoming decision
rounds or a three-year strategic plan (in lieu of lecturing on a chapter or
covering an additional assigned case). Not only does use of a simulation
permit assigning fewer cases, but it also permits you to eliminate at least
one assignment that entails considerable grading on your part. Grading
one less written case or essay exam or other written assignment saves
enormous time. With BSG and GLO-BUS, grading is effortless and takes
only minutes; once you enter percentage weights for each assignment in
your online grade book, a suggested overall grade is calculated for you.
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You’ll be pleasantly surprised—and quite pleased—at how little time it
takes to gear up for and administer The Business Strategy Game or GLO-
BUS.
In sum, incorporating use of a strategy simulation turns out to be a
win–win proposition for both students and instructors. Moreover, a very
convincing argument can be made that a competition-based strategy
simulation is the single most effective teaching/ learning tool that
instructors can employ to teach the discipline of business and competitive
strategy, to make learning more enjoyable, and to promote better
achievement of course learning objectives.
A Bird’s-Eye View of The Business Strategy Game
The setting for The Business Strategy Game (BSG) is the global athletic
footwear industry (there can be little doubt in today’s world that a globally
competitive strategy simulation is vastly superior to a simulation with a
domestic-only setting). Global market demand for footwear grows at the
rate of seven to nine percent annually for the first five years and five to
seven percent annually for the second five years. However, market growth
rates vary by geographic region—North America, Latin America, Europe-
Africa, and Asia-Pacific.
Companies begin the simulation producing branded and private-label
footwear in two plants, one in North America and one in Asia. They have
the option to establish production facilities in Latin America and Europe-
Africa. Company co-managers exercise control over production costs on the
basis of the styling and quality they opt to manufacture, plant location
(wages and incentive compensation vary from region to region), the use of
best practices and Six Sigma programs to reduce the production of defective
footwear and to boost worker productivity, and compensation practices.
All newly produced footwear is shipped in bulk containers to one of four
geographic distribution centers. All sales in a geographic region are made
from footwear inventories in that region’s distribution center. Costs at the
four regional distribution centers are a function of inventory storage costs,
packing and shipping fees, import tariffs paid on incoming pairs shipped
from foreign plants, and exchange rate impacts. At the start of the
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simulation, import tariffs average $4 per pair in North America, $6 in
Europe-Africa, $8 per pair in Latin America, and $10 in the Asia-Pacific
region. Instructors have the option to alter tariffs as the game progresses.
Companies market their brand of athletic footwear to footwear retailers
worldwide and to individuals buying online at the company’s website. Each
company’s sales and market share in the branded footwear segments hinge
on its competitiveness on 13 factors: attractive pricing, footwear styling and
quality, product line breadth, advertising, use of mail-in rebates, appeal of
celebrities endorsing a company’s brand, success in convincing footwear
retailers to carry its brand, number of weeks it takes to fill retailer orders,
effectiveness of a company’s online sales effort at its website, and brand
reputation. Sales of private-label footwear hinge solely on being the low-
price bidder.
All told, company co-managers make as many as 57 types of decisions
each period that cut across production operations (up to 11 decisions per
plant, with a maximum of four plants), the addition of facility space,
equipment, and production improvement options (up to eight decisions per
plant), worker compensation and training (up to six decisions per plant),
shipping and distribution center operations (five decisions per geographic
region), pricing and marketing (up to nine decisions in four geographic
regions), bids to sign celebrities (two decision entries per bid), financing of
company operations (up to eight decisions), and corporate social
responsibility and environmental sustainability (up to eight decisions). Plus,
there are 10 entries for each region pertaining to assumptions about the
upcoming-year actions and competitive efforts of rival companies that
factor directly into the forecasts of a company’s unit sales, revenues, and
market share in each of the four geographic regions.
Each time company co-managers make a decision entry, an
assortment of on-screen calculations instantly shows the projected effects
on unit sales, revenues, market shares, unit costs, profit, earnings per share,
ROE, and other operating statistics. The on-screen calculations help team
members evaluate the relative merits of one decision entry versus another
and put together a promising strategy.
Companies can employ any of the five generic competitive strategy
options in selling branded footwear—low-cost leadership, differentiation,
best-cost provider, focused low cost, and focused differentiation. They can
pursue essentially the same strategy worldwide or craft slightly or very
different strategies for the Europe-Africa, Asia-Pacific, Latin America, and
North America markets. They can strive for competitive advantage based
on more advertising, a wider selection of models, more appealing
styling/quality, bigger rebates, and so on.
Any well-conceived, well-executed competitive approach is capable of
succeeding, provided it is not overpowered by the strategies of competitors
or defeated by the presence of too many copycat strategies that dilute its
effectiveness. The challenge for each company’s management team is to
craft and execute a competitive strategy that produces good performance on
five measures: earnings per share, return on equity investment, stock price
appreciation, credit rating, and brand image.
All activity for The Business Strategy Game takes place at www.bsg-
online.com.
A Bird’s-Eye View of GLO-BUS
In GLO-BUS, class members run companies that are in a neck-and-neck
race for global market leadership in two product categories: (1) wearable
video cameras smaller than a teacup that deliver stunning video quality and
have powerful photo capture capabilities (comparable to those designed and
marketed by global industry leader GoPro and numerous others) and (2)
sophisticated camera-equipped copter drones that incorporate a company
designed and assembled action-capture camera and that are sold to
commercial enterprises for prices in the $850 to 2,000+ range. Global
market demand for action cameras grows at the rate of six to eight percent
annually for the first five years and four to six percent annually for the
second five years. Global market demand for commercial drones grows
briskly at rates averaging 18 percent for the first two years, then gradually
slows over eight years to a rate of four to six percent.
Companies assemble action cameras and drones of varying designs and
performance capabilities at a Taiwan facility and ship finished goods
directly to buyers in North America, Asia-Pacific, Europe-Africa, and Latin
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America. Both products are assembled usually within two weeks of being
received and are then shipped to buyers no later than two to three days after
assembly. Companies maintain no finished goods inventories and all parts
and components are delivered by suppliers on a just-in-time basis (which
eliminates the need to track inventories and simplifies the accounting for
plant operations and costs).
Company co-managers determine the quality and performance features of
the cameras and drones being assembled. They impact production costs by
raising/lowering specifications for parts/components and expenditures for
product R&D, adjusting work force compensation, spending more/less on
worker training and productivity improvement, lengthening/shortening
warranties offered (which affects warranty costs), and how cost-efficiently
they manage assembly operations. They have options to manage/ control
selling and certain other costs as well.
Each decision round, company co-managers make some 50 types of
decisions relating to the design and performance of the company’s two
products (21 decisions, 10 for cameras and 11 for drones), assembly
operations and workforce compensation (up to eight decision
entries for each product), pricing and marketing (seven decisions
for cameras and five for drones), corporate social responsibility and
citizenship (up to six decisions), and the financing of company operations
(up to eight decisions). In addition, there are 10 entries for cameras and
seven entries for drones involving assumptions about the competitive
actions of rivals; these entries help company co-managers to make more
accurate forecasts of their company’s unit sales (so they have a good idea of
how many cameras and drones will need to be assembled each year to fill
customer orders). Each time co-managers make a decision entry, an
assortment of on-screen calculations instantly shows the projected effects
on unit sales, revenues, market shares, total profit, earnings per share, ROE,
costs, and other operating outcomes. All of these on-screen calculations
help co-managers evaluate the relative merits of one decision entry versus
another. Company managers can try out as many different decision
combinations as they wish in stitching the separate decision entries into a
cohesive whole that is projected to produce good company performance.
Competition in action cameras revolves around 11 factors that determine
each company’s unit sales/market share:
1. How each company’s average wholesale price to retailers compares
against the all-company average wholesale prices being charged in each
geographic region.
2. How each company’s camera performance and quality compares against
industry-wide camera performance/quality.
3. How the number of week-long sales promotion campaigns a company
has in each region compares against the regional average number of
weekly promotions.
4. How the size of each company’s discounts off the regular wholesale
prices during sales promotion campaigns compares against the regional
average promotional discount.
5. How each company’s annual advertising expenditures compare against
regional average advertising expenditures.
6. How the number of models in each company’s camera line compares
against the industry-wide average number of models.
7. The number of retailers stocking and merchandising a company’s brand
in each region.
8. Annual expenditures to support the merchandising efforts of retailers
stocking a company’s brand in each region.
9. The amount by which a company’s expenditures for ongoing
improvement and updating of its company’s website in a region is
above/below the all-company regional average expenditure.
10. How the length of each company’s camera warranties compare against
the warranty periods of rival companies.
11. How well a company’s brand image/reputation compares against the
brand images/ reputations of rival companies.
Competition among rival makers of commercial copter drones is more
narrowly focused on just nine sales-determining factors:
1. How a company’s average retail price for drones at the company’s
website in each region compares against the all-company regional
average website price.
2. How each company’s drone performance and quality compares against
the all- company average drone performance/quality.
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3. How the number of models in each company’s drone line compares
against the industry-wide average number of models.
4. How each company’s annual expenditures to recruit/support third-party
online electronics retailers in merchandising its brand of drones in each
region compares against the regional average.
5. The amount by which a company’s price discount to third-party online
retailers is above/below the regional average discounted price.
6. How well a company’s expenditures for search engine advertising in a
region compares against the regional average.
7. How well a company’s expenditures for ongoing improvement and
updating of its website in a region compares against the regional average.
8. How the length of each company’s drone warranties in a region compares
against the regional average warranty period.
9. How well a company’s brand image/reputation compares against the
brand images/ reputations of rival companies.
Each company typically seeks to enhance its performance and build
competitive advantage via its own custom-tailored competitive strategy
based on more attractive pricing, greater advertising, a wider selection of
models, more appealing performance/ quality, longer warranties, a better
image/reputation, and so on. The greater the differences in the overall
competitiveness of the product offerings of rival companies, the bigger the
differences in their resulting sales volumes and market shares. Conversely,
the smaller the overall competitive differences in the product offerings of
rival companies, the smaller the differences in sales volumes and market
shares. This algorithmic approach is what makes GLO-BUS a “competition-
based” strategy simulation and accounts for why the sales and market share
outcomes for each decision round are always unique to the particular
strategies and decision combinations employed by the competing
companies.
As with BSG, all the various generic competitive strategy options—low-
cost leadership, differentiation, best-cost provider, focused low-cost, and
focused differentiation—are viable choices for pursuing competitive
advantage and good company performance. A company can have a strategy
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aimed at being the clear market leader in either action cameras or drones or
both. It can focus its competitive efforts on one or two or three geographic
regions or strive to build strong market positions in all four geographic
regions. It can pursue essentially the same strategy worldwide or craft
customized strategies for the Europe-Africa, Asia-Pacific, Latin America,
and North America markets. Just as with The Business Strategy Game, most
any well-conceived, well-executed competitive approach is capable of
succeeding, provided it is not overpowered by the strategies of competitors
or defeated by the presence of too many copycat strategies that dilute its
effectiveness.
The challenge for each company’s management team is to craft and
execute a competitive strategy that produces good performance on five
measures: earnings per share, return on equity investment, stock price
appreciation, credit rating, and brand image.
All activity for GLO-BUS occurs at www.glo-bus.com.
Special Note: The time required of company co-managers to complete each
decision round in GLO-BUS is typically about 15 to 30 minutes less than
for The Business Strategy Game because
(a
) there are only 8 market segments (versus 12 in BSG),
(b
) co-managers have only one assembly site to operate (versus
potentially as many as four plants in BSG, one in each
geographic region), and
(c
) newly assembled cameras and drones are shipped directly to
buyers, eliminating the need to manage finished goods
inventories and operate distribution centers.
Administration and Operating Features of the Two
Simulations
http://www.glo-bus.com/
The Internet delivery and user-friendly designs of both BSG and GLO-BUS
make them incredibly easy to administer, even for first-time users. And the
menus and controls are so similar that you can readily switch between the
two simulations or use one in your undergraduate class and the other in a
graduate class. If you have not yet used either of the two simulations, you
may find the following of particular interest:
Setting up the simulation for your course is done online and takes about
10 to 15 minutes. Once setup is completed, no other administrative
actions are required beyond those of moving participants to a different
team (should the need arise) and monitoring the progress of the
simulation (to whatever extent desired).
Participant’s Guides are delivered electronically to class members at the
website— students can read the guide on their monitors or print out a
copy, as they prefer.
There are two to four minute Video Tutorials scattered throughout the
software (including each decision screen and each page of each report)
that provide on-demand guidance to class members who may be uncertain
about how to proceed.
Complementing the Video Tutorials are detailed and clearly written Help
sections explaining “all there is to know” about (a) each decision entry
and the relevant cause-effect relationships, (b) the information on each
page of the Industry Reports, and (c) the numbers presented in the
Company Reports. The Video Tutorials and the Help screens allow
company co-managers to figure things out for themselves, thereby
curbing the need for students to ask the instructor “how things work.”
Team members running the same company who are logged in
simultaneously on different computers at different locations can click a
button to enter Collaboration Mode, enabling them to work
collaboratively from the same screen in viewing reports and making
decision entries, and click a second button to enter Audio Mode, letting
them talk to one another and hold an online meeting.
When in “Collaboration Mode,” each team member sees the same
screen at the same time as all other team members who are logged in
and have joined Collaboration Mode. If one team member chooses
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to view a particular decision screen, that same screen appears on the
monitors for all team members in Collaboration Mode.
Each team member controls their own color-coded mouse pointer
(with their first-name appearing in a color-coded box linked to their
mouse pointer) and can make a decision entry or move the mouse to
point to particular on-screen items.
A decision entry change made by one team member is seen by all, in
real time, and all team members can immediately view the on-screen
calculations that result from the new decision entry.
If one team member wishes to view a report page and clicks on the
menu link to the desired report, that same report page will
immediately appear for the other team members engaged in
collaboration.
Use of Audio Mode capability requires that each team member work
from a computer with a built-in microphone (if they want to be heard
by their team members) and speakers (so they may hear their
teammates) or else have a headset with a microphone that they can
plug into their desktop or laptop. A headset is recommended for best
results, but most laptops now are equipped with a built-in
microphone and speakers that will support use of our new voice chat
feature.
Real-time VoIP audio chat capability among team members who
have entered both the Audio Mode and the Collaboration Mode is a
tremendous boost in functionality that enables team members to go
online simultaneously on computers at different locations and
conveniently and effectively collaborate in running their simulation
company.
In addition, instructors have the capability to join the online session
of any company and speak with team members, thus circumventing
the need for team members to arrange for and attend a meeting in the
instructor’s office. Using the standard menu for administering a
particular industry, instructors can connect with the company
desirous of assistance. Instructors who wish not only to talk but also
to enter Collaboration (highly recommended because all attendees
are then viewing the same screen) have a red-colored mouse pointer
linked to a red box labeled Instructor.
Without a doubt, the Collaboration and Voice-Chat capabilities are
hugely valuable for students enrolled in online and distance-learning
courses where meeting face-to-face is impractical or time-consuming.
Likewise, the instructors of online and distance-learning courses will
appreciate having the capability to join the online meetings of particular
company teams when their advice or assistance is requested.
Both simulations work equally well for online courses and in-person
classes.
Participants and instructors are notified via e-mail when the results are
ready (usually about 15 to 20 minutes after the decision round deadline
specified by the instructor/game administrator).
Following each decision round, participants are provided with a complete
set of reports—a six-page Industry Report, a Competitive Intelligence
report for each geographic region that includes strategic group maps and a
set of Company Reports (income statement, balance sheet, cash flow
statement, and assorted production, marketing, and cost statistics).
Two “open-book” multiple-choice tests of 20 questions are built into each
simulation. The quizzes, which you can require or not as you see fit, are
taken online and automatically graded, with scores reported
instantaneously to participants and automatically recorded in the
instructor’s electronic grade book. Students are automatically provided
with three sample questions for each test.
Both simulations contain a three-year strategic plan option that you can
assign. Scores on the plan are automatically recorded in the instructor’s
online grade book.
At the end of the simulation, you can have students complete online peer
evaluations (again, the scores are automatically recorded in your online
grade book).
Both simulations have a Company Presentation feature that enables each
team of company co-managers to easily prepare PowerPoint slides for use
in describing their strategy and summarizing their company’s
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performance in a presentation to either the class, the instructor, or an
“outside” board of directors.
A Learning Assurance Report provides you with hard data concerning
how well your students performed vis-à-vis students playing the
simulation worldwide over the past 12 months. The report is based on
nine measures of student proficiency, business know-how, and decision-
making skill and can also be used in evaluating the extent to which your
school’s academic curriculum produces the desired degree of student
learning insofar as accreditation standards are concerned.
For more details on either simulation, please consult
Section 2 of the Instructor’s Manual accompanying this text or register as
an instructor at the simulation websites (www.bsg-online.com and
www.glo-bus.com) to access even more comprehensive information. You
should also consider signing up for one of the webinars that the simulation
authors conduct several times each month (sometimes several times
weekly) to demonstrate how the software works, walk you through the
various features and menu options, and answer any questions. You have an
open invitation to call the senior author of this text at (205) 722-9145 to
arrange a personal demonstration or talk about how one of the simulations
might work in one of your courses. We think you’ll be quite impressed with
the cutting-edge capabilities that have been programmed into The Business
Strategy Game and GLO-BUS, the simplicity with which both simulations
can be administered, and their exceptionally tight connection to the text
chapters, core concepts, and standard analytical tools.
RESOURCES AND SUPPORT
MATERIALS FOR THE 23RD EDITION
For Students
Key Points Summaries At the end of each chapter is a synopsis
of the core concepts, analytical tools, and other key points discussed in the
chapter. These chapter-end synopses, along with the core concept
http://www.bsg-online.com/
http://www.glo-bus.com/
page xxv
definitions and margin notes scattered throughout each chapter, help
students focus on basic strategy principles, digest the messages of each
chapter, and prepare for tests.
Two Sets of Chapter-End Exercises Each chapter
concludes with two sets of exercises. The Assurance of Learning Exercises
are useful for helping students prepare for class discussion and to gauge
their understanding of the material. The Exercises for Simulation
Participants are designed expressly for use in class which incorporate the
use of a simulation. These exercises explicitly connect the chapter content
to the simulation company the students are running. Even if they are not
assigned by the instructor, they can provide helpful practice for students as
a study aid.
Connect™ The 23rd edition takes full advantage of Connect™, a
personalized teaching and learning tool. The Connect™ package for this
edition includes several robust and valuable features that simplify the task
of assigning and grading three types of exercises for students:
Autograded chapter quizzes that students can take to measure their grasp
of the material presented in each of the 12 chapters.
A variety of interactive exercises for each of the 12 chapters that drill
students in the use and application of the concepts and tools of strategic
analysis, including selected Assurance of Learning Exercises and newly
integrated Exercises for Simulation Participants.
Case Exercises for 14 of the 27 cases in this edition that require students
to work through answers to a select number of the assignment questions
for the case. These exercises have multiple components and are tailored
to match the circumstances presented in each case, calling upon students
to do whatever strategic thinking and strategic analysis are
called for to arrive at pragmatic, analysis-based action
recommendations for improving company performance.
All Connect™ exercises are automatically graded (with the exception of
a few select Exercises for Simulation Participants that entail answers in the
form of short essays), thereby simplifying the task of evaluating each class
member’s performance and monitoring the learning outcomes. The
progress-tracking function built into Connect™ enables you to
View scored work immediately and track individual or group
performance with assignment and grade reports.
Access an instant view of student or class performance relative to
learning objectives.
Collect data and generate reports required by many accreditation
organizations, such as AACSB International.
SmartBook 2.0® SmartBook 2.0 is the first and only adaptive
reading experience designed to change the way students read and learn. It
creates a personalized reading experience by highlighting the most
impactful concepts a student needs to learn at that moment in time. As a
student engages with SmartBook, the reading experience continuously
adapts by highlighting content based on what the student knows and doesn’t
know. This ensures that the focus is on the content he or she needs to learn,
while simultaneously promoting long-term retention of material. Use
SmartBook’s real-time reports to quickly identify the concepts that require
more attention from individual students–or the entire class. The end result?
Students are more engaged with course content, can better prioritize their
time, and come to class ready to participate.
For Instructors
Assurance of Learning Aids Each chapter begins with a set of
Learning Objectives, which are tied directly to the material in the text
meant to address these objectives with helpful signposts. At the conclusion
of each chapter, there is a set of Assurance of Learning Exercises that can
be used as the basis for class discussion, oral presentation assignments,
short written reports, and substitutes for case assignments. Similarly, there
is a set of Exercises for Simulation Participants that are designed expressly
for use by adopters who have incorporated use of a simulation and want to
go a step further in tightly and explicitly connecting the chapter content to
the simulation company their students are running. New to this edition is
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the incorporation of these assignable Exercises for Simulation Participants
within Connect. The questions in both sets of exercises (along with those
Illustration Capsules that qualify as “mini-cases”) can be used to round out
the rest of a 75- minute class period should your lecture on a chapter last for
only 50 minutes.
Instructor Library The Connect Instructor Library is your
repository for additional resources to improve student engagement in and
out of class. You can select and use any asset that enhances your lecture.
Instructor’s Manual The accompanying IM contains:
A section on suggestions for organizing and structuring your course.
Sample syllabi and course outlines.
A set of lecture notes on each chapter.
Answers to the chapter-end Assurance of Learning Exercises.
A test bank for all 12 chapters.
A comprehensive case teaching note for each of the 27 cases. These
teaching notes are filled with suggestions for using the case effectively,
have very thorough, analysis-based answers to the suggested assignment
questions for the case, and contain an epilogue detailing any important
developments since the case was written.
Test Builder The accompanying Test Bank, which contains over 900
multiple choice and short answer/essay questions, is available in Connect™
via Test Builder.
Test Builder is a cloud-based tool that enables instructors to format tests
that can be printed or administered within an LMS. Test Builder offers a
modern, streamlined interface for easy content configuration that matches
course needs, without requiring a download. Test Builder provides a secure
interface for better protection of content and allows for just-in-time updates
to flow directly into assessments.
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PowerPoint Slides To facilitate delivery preparation of your
lectures and to serve as chapter outlines, you’ll have access to
approximately 500 colorful and professional-looking slides displaying core
concepts, analytical procedures, key points, and all the figures in the text
chapters.
CREATE™ is McGraw-Hill’s custom-publishing program where
you can access full-length readings and cases that accompany Crafting and
Executing Strategy: The Quest for a Competitive Advantage
(http://create.mheducation.com/thompson). Through Create™, you will
be able to select from 30 readings that go specifically with this textbook.
These include cases and readings from Harvard, MIT, and much more! You
can assemble your own course and select the chapters, cases, and readings
that work best for you. Also, you can choose from several ready-to-go,
author-recommended complete course solutions. Among the pre-loaded
solutions, you’ll find options for undergrad, MBA, accelerated, and other
strategy courses.
The Business Strategy Game and GLO-BUS Online
Simulations Using one of the two companion simulations is a
powerful and constructive way of emotionally connecting students to the
subject matter of the course. We know of no more effective way to arouse
the competitive energy of students and prepare them for the challenges of
real-world business decision making than to have them match strategic wits
with classmates in running a company in head-to-head competition for
global market leadership.
ACKNOWLEDGMENTS
We heartily acknowledge the contributions of the case researchers whose
case-writing efforts appear herein and the companies whose cooperation
made the cases possible. To each one goes a very special thank-you. We
cannot overstate the importance of timely, carefully researched
http://create.mheducation.com/thompson
cases in contributing to a substantive study of strategic management issues
and practices.
A great number of colleagues and students at various universities,
business acquaintances, and people at McGraw-Hill provided inspiration,
encouragement, and counsel during the course of this project. Like all text
authors in the strategy field, we are intellectually indebted to the many
academics whose research and writing have blazed new trails and advanced
the discipline of strategic management. In addition, we’d like to thank the
following reviewers who provided seasoned advice and splendid
suggestions over the years for improving the chapters:
Robert B. Baden, Edward Desmarais, Stephen F. Hallam, Joy Karriker,
Wendell Seaborne, Joan H. Bailar, David Blair, Jane Boyland, William J.
Donoher, Stephen A. Drew, Jo Anne Duffy, Alan Ellstrand, Susan Fox-
Wolfgramm, Rebecca M. Guidice, Mark Hoelscher, Sean D. Jasso, Xin
Liang, Paul Mallette, Dan Marlin, Raza Mir, Mansour Moussavi, James
D. Spina, Monica A. Zimmerman, Dennis R. Balch, Jeffrey R. Bruehl,
Edith C. Busija, Donald A. Drost, Randall Harris, Mark Lewis
Hoelscher, Phyllis Holland, James W. Kroeger, Sal Kukalis, Brian W.
Kulik, Paul Mallette, Anthony U. Martinez, Lee Pickler, Sabine Reddy,
Thomas D. Schramko, V. Seshan, Charles Strain, Sabine Turnley, S.
Stephen Vitucci, Andrew Ward, Sibin Wu, Lynne Patten, Nancy E.
Landrum, Jim Goes, Jon Kalinowski, Rodney M. Walter, Judith D.
Powell, Seyda Deligonul, David Flanagan, Esmerlda Garbi, Mohsin
Habib, Kim Hester, Jeffrey E. McGee, Diana J. Wong, F. William
Brown, Anthony F. Chelte, Gregory G. Dess, Alan B. Eisner, John
George, Carle M. Hunt, Theresa Marron-Grodsky, Sarah Marsh, Joshua
D. Martin, William L. Moore, Donald Neubaum, George M. Puia, Amit
Shah, Lois M. Shelton, Mark Weber, Steve Barndt, J. Michael Geringer,
Ming-Fang Li, Richard Stackman, Stephen Tallman, Gerardo R. Ungson,
James Boulgarides, Betty Diener, Daniel F. Jennings, David Kuhn,
Kathryn Martell, Wilbur Mouton, Bobby Vaught, Tuck Bounds, Lee
Burk, Ralph Catalanello, William Crittenden, Vince Luchsinger, Stan
Mendenhall, John Moore, Will Mulvaney, Sandra Richard, Ralph
Roberts, Thomas Turk, Gordon Von Stroh, Fred Zimmerman, S. A.
Billion, Charles Byles, Gerald L. Geisler, Rose Knotts, Joseph
page xxviii
Rosenstein, James B. Thurman, Ivan Able, W. Harvey Hegarty, Roger
Evered, Charles B. Saunders, Rhae M. Swisher, Claude I. Shell, R.
Thomas Lenz, Michael C. White, Dennis Callahan, R. Duane Ireland,
William E. Burr II, C. W. Millard, Richard Mann, Kurt Christensen, Neil
W. Jacobs, Louis W. Fry, D. Robley Wood, George J. Gore, and William
R. Soukup.
We owe a debt of gratitude to Professors Catherine A. Maritan, Jeffrey A.
Martin, Richard S. Shreve, and Anant K. Sundaram for their helpful
comments on various chapters. We’d also like to thank the following
students of the Tuck School of Business for their assistance with the
revisions: Alen A. Ameni, Dipti Badrinath, Stephanie K. Berger, Courtney
D. Bragg, Katie Coster, Jacob Crandall, Robin Daley, Kathleen T. Durante,
Shawnda Lee Duvigneaud, Isaac E. Freeman, Vedrana B. Greatorex,
Brittany J. Hattingh, Sadé M. Lawrence, Heather Levy, Margaret W.
Macauley, Ken Martin, Brian R. McKenzie, Mathew O’Sullivan, Sara
Paccamonti, Byron Peyster, Jeremy Reich, Carry S. Resor, Edward J.
Silberman, David Washer, and Lindsey Wilcox. And we’d like to
acknowledge the help of Dartmouth students Avantika Agarwal, Charles K.
Anumonwo, Maria Hart, Meaghan I. Haugh, Artie Santry, as well as Tuck
staff member Doreen Aher.
As always, we value your recommendations and thoughts
about the book. Your comments regarding coverage and contents will be
taken to heart, and we always are grateful for the time you take to call our
attention to printing errors, deficiencies, and other shortcomings. Please e-
mail us at athompso@cba.ua.edu,
margaret.a.peteraf@tuck.dartmouth.edu, john.gamble@tamucc.edu, or
astrickl@cba.ua.edu.
Arthur A. Thompson
Margaret A. Peteraf
John E. Gamble
A. J. Strickland
mailto://athompso@cba.ua.edu
mailto://margaret.a.peteraf@tuck.dartmouth.edu
mailto://john.gamble@tamucc.edu
mailto://astrickl@cba.ua.edu
page xxix
The Business Strategy Game or
GLO-BUS Simulation Exercises
The Business Strategy Game or GLO-BUS Simulation Exercises
Either one of these text supplements involves teams of students
managing companies in a head-to-head contest for global market
leadership. Company co-managers have to make decisions relating to
product quality, production, workforce compensation and training,
pricing and marketing, and financing of company operations. The
challenge is to craft and execute a strategy that is powerful enough to
deliver good financial performance despite the competitive efforts of
rival companies. Each company competes in North America, Latin
America, Europe-Africa, and Asia-Pacific.Fanatic Studio/Getty Images
page xxx
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page xxxiii
page xxxii
Brief Contents
PART
1 Concepts and Techniques for Crafting
and Executing Strategy
Section A: Introduction and Overview
1 What Is Strategy and Why Is It Important?
2
2 Charting a Company’s Direction 20
Section B: Core Concepts and Analytical Tools
3 Evaluating a Company’s External
Environment 50
4 Evaluating a Company’s Resources,
Capabilities, and Competitiveness 90
Section C: Crafting a Strategy
5 The Five Generic Competitive Strategies
126
6 Strengthening a Company’s
Competitive Position 156
7 Strategies for Competing in International
Markets 186
8 Corporate Strategy 222
9 Ethics, Corporate Social Responsibility,
Environmental Sustainability, and Strategy
266
Section D: Executing the Strategy
10 Building an Organization Capable of Good
Strategy Execution 296
11 Managing Internal Operations 328
12 Corporate Culture and Leadership 352
PART
2 Cases in Crafting and Executing
Strategy
Section A: Crafting Strategy in Single-Business
Companies
1 Airbnb in 2020 C2
2 Competition in the Craft Beer Industry in
2020 C7
3 Costco Wholesale in 2020: Mission,
Business Model, and Strategy C18
4 Ford Motor Company: Will the Company’s
Strategic Moves Restore its
Competitiveness and Financial
Performance? C43
5 Macy’s, Inc.: Will Its Strategy Allow It to
Survive in the Changing Retail Sector?
C51
6 TOMS Shoes: Expanding Its Successful
One For One Business Model C59
7 lululemon athletica’s Strategy in 2020: Is
the Recent Growth in Retail Stores,
Revenues, and Profitability Sustainable?
C68
8 Under Armour’s Strategy in 2020: Can It
Revive Sales and Profitability in Its Core
North American Market? C86
9 Spotify in 2020: Can the Company Remain
Competitive? C112
10 Beyond Meat, Inc. C124
11 Netflix’s 2020 Strategy for Battling Rivals in
the Global Market for Streamed Video
Subscribers C140
12 Twitter Inc. in 2020 C161
13 Yeti in 2020: Can Brand Name and
Innovation Keep it Ahead of the
Competition? C173
14 GoPro in 2020: Have its Turnaround
Strategies Failed? C184
15 Publix Super Markets: Its Strategy in the
U.S. Supermarket and Grocery Store
Industry C198
16 Tesla’s Strategy in 2020: Can It Deliver
Sustained Profitability? C212
17 Unilever’s Purpose-led Brand Strategy:
Can Alan Jope Balance Purpose and
Profits? C238
18 Domino’s Pizza: Business Continuity
Strategy during the Covid-19 Pandemic
C249
19 Burbank Housing: Building from the Inside
Out C260
20 Boeing 737 MAX: What Response Strategy
is Needed to Ensure Passenger Safety and
Restore the Company’s Reputation? C273
21 The Walt Disney Company: Its
Diversification Strategy in 2020 C279
22 Robin Hood C293
Section B: Crafting Strategy in Diversified Companies
23 Southwest Airlines in 2020: Culture, Values,
and Operating Practices C295
24 Uber Technologies in 2020: Is the Gig
Economy Labor Force Working for Uber?
C315
Section C: Implementing and Executing Strategy
25 Starbucks in 2020: Is the Company on
Track to Achieve Attractive Growth and
Operational Excellence? C325
page xxxiv
26 Nucor Corporation in 2020:
Pursuing Efforts to Grow Sales and Market
Share Despite Tough Market Conditions
C354
27 Eliminating Modern Slavery from Supply
Chains: Can Nestlé Lead the Way? C389
Guide to Case Analysis CA-1
INDEXES Company I-1
Name I-9
Subject I-15
page xxxv
Contents
PART
1 Concepts and Techniques for Crafting
and Executing Strategy 1
Section A: Introduction and Overview
1 What Is Strategy and Why Is It Important? 2
WHAT DO WE MEAN BY STRATEGY? 4
Strategy Is about Competing Differently 4
Strategy and the Quest for Competitive Advantage 5
Why a Company’s Strategy Evolves over Time 8
A Company’s Strategy Is Partly Proactive and Partly Reactive 9
Strategy and Ethics: Passing the Test of Moral Scrutiny 9
A COMPANY’S STRATEGY AND ITS BUSINESS MODEL
11
WHAT MAKES A STRATEGY A WINNER? 12
WHY CRAFTING AND EXECUTING STRATEGY ARE
IMPORTANT TASKS 14
Good Strategy + Good Strategy Execution = Good Management 15
THE ROAD AHEAD 15
ILLUSTRATION CAPSULES
1.1 Apple Inc.: Exemplifying a Successful Strategy 7
1.2 Pandora, SiriusXM, and Over-the-Air Broadcast Radio: Three Contrasting
Business Models 13
2 Charting a Company’s Direction 20
WHAT DOES THE STRATEGY-MAKING, STRATEGY-
EXECUTING PROCESS ENTAIL? 22
STAGE 1: DEVELOPING A STRATEGIC VISION,
MISSION STATEMENT, AND SET OF CORE VALUES
24
page xxxvi
Developing a Strategic Vision 24
Communicating the Strategic Vision 25
Expressing the Essence of the Vision in a Slogan 27
Why a Sound, Well-Communicated Strategic Vision Matters 27
Developing a Company Mission Statement 27
Linking the Vision and Mission with Company Values 28
STAGE 2: SETTING OBJECTIVES 31
Setting Stretch Objectives 31
What Kinds of Objectives to Set 31
The Need for a Balanced Approach to Objective Setting 32
Setting Objectives for Every Organizational Level 34
STAGE 3: CRAFTING A STRATEGY 35
Strategy Making Involves Managers at All Organizational Levels 35
A Company’s Strategy-Making Hierarchy 36
Uniting the Strategy-Making Hierarchy 39
A Strategic Vision + Mission + Objectives + Strategy = A Strategic Plan
39
STAGE 4: EXECUTING THE STRATEGY 40
STAGE 5: EVALUATING PERFORMANCE AND
INITIATING CORRECTIVE ADJUSTMENTS 41
CORPORATE GOVERNANCE: THE ROLE OF THE
BOARD OF DIRECTORS IN THE STRATEGY-
CRAFTING, STRATEGY-EXECUTING PROCESS 41
ILLUSTRATION CAPSULES
2.1 Examples of Strategic Visions—How Well Do They Measure Up? 26
2.2 TOMS Shoes: A Mission with a Company 30
2.3 Examples of Company Objectives 33
2.4 Corporate Governance Failures at Volkswagen 44
Section B: Core Concepts and Analytical Tools
3 Evaluating a Company’s External Environment 50
ASSESSING THE COMPANY’S INDUSTRY AND
COMPETITIVE ENVIRONMENT 52
ANALYZING THE COMPANY’S MACRO-ENVIRONMENT
53
ASSESSING THE COMPANY’S INDUSTRY AND
COMPETITIVE ENVIRONMENT 57
page xxxvii
The Five Forces Framework 57
Competitive Pressures Created by the Rivalry among Competing Sellers
57
The Choice of Competitive Weapons 61
Competitive Pressures Associated with the Threat of New Entrants 61
Whether Entry Barriers Are High or Low 62
The Expected Reaction of Industry Members in Defending against New Entry
63
Competitive Pressures from the Sellers of Substitute Products 64
Competitive Pressures Stemming from Supplier Bargaining Power 67
Competitive Pressures Stemming from Buyer Bargaining Power and Price
Sensitivity 69
Whether Buyers Are More or Less Price-Sensitive 71
Is the Collective Strength of the Five Competitive Forces Conducive to
Good Profitability? 72
Matching Company Strategy to Competitive Conditions 73
COMPLEMENTORS AND THE VALUE NET 73
INDUSTRY DYNAMICS AND THE FORCES DRIVING
CHANGE 74
Identifying the Forces Driving Industry Change 75
Assessing the Impact of the Forces Driving Industry Change 78
Adjusting the Strategy to Prepare for the Impacts of Driving Forces 78
STRATEGIC GROUP ANALYSIS 78
Using Strategic Group Maps to Assess the Market Positions of Key
Competitors 78
The Value of Strategic Group Maps 79
COMPETITOR ANALYSIS AND THE SOAR
FRAMEWORK 81
Current Strategy 82
Objectives 82
Resources and Capabilities 82
Assumptions 83
KEY SUCCESS FACTORS 83
THE INDUSTRY OUTLOOK FOR PROFITABILITY 84
ILLUSTRATION CAPSULES
3.1 The Differential Effects of the Coronavirus Pandemic of 2020 56
3.2 Comparative Market Positions of Selected Companies in the Pizza Chain
Industry: A Strategic Group Map Example 80
3.3 Business Ethics and Competitive Intelligence 84
page xxxviii
4 Evaluating a Company’s Resources, Capabilities,
and Competitiveness 90
QUESTION 1: HOW WELL IS THE COMPANY’S
PRESENT STRATEGY WORKING? 92
QUESTION 2: WHAT ARE THE COMPANY’S
STRENGTHS AND WEAKNESSES IN RELATION TO
THE MARKET OPPORTUNITIES AND EXTERNAL
THREATS? 95
Identifying a Company’s Internal Strengths 96
Identifying Company Internal Weaknesses 97
Identifying a Company’s Market Opportunities 97
Identifying External Threats 97
What Do the SWOT Listings Reveal? 99
QUESTION 3: WHAT ARE THE COMPANY’S MOST
IMPORTANT RESOURCES AND CAPABILITIES, AND
WILL THEY GIVE THE COMPANY A LASTING
COMPETITIVE ADVANTAGE? 100
Identifying the Company’s Resources and Capabilities 100
Types of Company Resources 101
Identifying Organizational Capabilities 102
Assessing the Competitive Power of a Company’s Resources and
Capabilities 103
The Four Tests of a Resource’s Competitive Power 103
A Company’s Resources and Capabilities Must Be Managed Dynamically
105
The Role of Dynamic Capabilities 105
QUESTION 4: HOW DO VALUE CHAIN ACTIVITIES
IMPACT A COMPANY’S COST STRUCTURE AND
CUSTOMER VALUE PROPOSITION? 106
The Concept of a Company Value Chain 106
Comparing the Value Chains of Rival Companies 108
A Company’s Primary and Secondary Activities Identify the Major
Components of Its Internal Cost Structure 108
The Value Chain System 109
Benchmarking: A Tool for Assessing the Costs and Effectiveness of Value
Chain Activities 111
Strategic Options for Remedying a Cost or Value Disadvantage 113
Improving Internally Performed Value Chain Activities 113
Improving Supplier-Related Value Chain Activities 114
Improving Value Chain Activities of Distribution Partners 114
Translating Proficient Performance of Value Chain Activities into
Competitive Advantage 115
How Value Chain Activities Relate to Resources and Capabilities 115
QUESTION 5: IS THE COMPANY COMPETITIVELY
STRONGER OR WEAKER THAN KEY RIVALS? 116
Strategic Implications of Competitive Strength Assessments 118
QUESTION 6: WHAT STRATEGIC ISSUES AND
PROBLEMS MERIT FRONT-BURNER MANAGERIAL
ATTENTION? 119
ILLUSTRATION CAPSULES
4.1 The Value Chain for Everlane, Inc. 109
4.2 Benchmarking in the Solar Industry 112
4.3 Benchmarking and Ethical Conduct 113
Section C: Crafting a Strategy
5 The Five Generic Competitive Strategies 126
TYPES OF GENERIC COMPETITIVE STRATEGIES
128
BROAD LOW-COST STRATEGIES 129
The Two Major Avenues for Achieving a Cost Advantage 129
Cost-Efficient Management of Value Chain Activities 129
Revamping of the Value Chain System to Lower Costs 132
Examples of Companies That Revamped Their Value Chains to Reduce Costs
132
The Keys to a Successful Broad Low-Cost Strategy 134
When a Low-Cost Strategy Works Best 134
Pitfalls to Avoid in Pursuing a Low-Cost Strategy 135
BROAD DIFFERENTIATION STRATEGIES 136
Managing the Value Chain in Ways that Enhance Differentiation 136
Revamping the Value Chain System to Increase Differentiation 138
Delivering Superior Value via a Broad Differentiation Strategy 139
When a Differentiation Strategy Works Best 140
Pitfalls to Avoid in Pursuing a Differentiation Strategy 141
FOCUSED (OR MARKET NICHE) STRATEGIES 142
A Focused Low-Cost Strategy 142
A Focused Differentiation Strategy 144
page xxxix
When a Focused Low-Cost or Focused Differentiation Strategy Is
Attractive 144
The Risks of a Focused Low-Cost or Focused Differentiation
Strategy 146
BEST-COST (HYBRID) STRATEGIES 146
When a Best-Cost Strategy Works Best 147
The Risk of a Best-Cost Strategy 149
THE CONTRASTING FEATURES OF THE GENERIC
COMPETITIVE STRATEGIES 149
Successful Generic Strategies Are Resource-Based 149
Generic Strategies and the Three Different Approaches to Competitive
Advantage 151
ILLUSTRATION CAPSULES
5.1 Vanguard’s Path to Becoming the Low-Cost Leader in Investment
Management 133
5.2 Clinícas del Azúcar’s Focused Low-Cost Strategy 143
5.3 Canada Goose’s Focused Differentiation Strategy 145
5.4 Trader Joe’s Focused Best-Cost Strategy 148
6 Strengthening a Company’s Competitive Position
156
LAUNCHING STRATEGIC OFFENSIVES TO IMPROVE A
COMPANY’S MARKET POSITION 158
Choosing the Basis for Competitive Attack 158
Choosing Which Rivals to Attack 160
Blue-Ocean Strategy—a Special Kind of Offensive 160
DEFENSIVE STRATEGIES—PROTECTING MARKET
POSITION AND COMPETITIVE ADVANTAGE 161
Blocking the Avenues Open to Challengers 162
Signaling Challengers That Retaliation Is Likely 163
TIMING A COMPANY’S STRATEGIC MOVES 163
The Potential for First-Mover Advantages 163
The Potential for Late-Mover Advantages or First-Mover Disadvantages
166
To Be a First Mover or Not 166
STRENGTHENING A COMPANY’S MARKET POSITION
VIA ITS SCOPE OF OPERATIONS 167
page xl
HORIZONTAL MERGER AND ACQUISITION
STRATEGIES 168
Why Mergers and Acquisitions Sometimes Fail to Produce Anticipated
Results 169
VERTICAL INTEGRATION STRATEGIES 171
The Advantages of a Vertical Integration Strategy 171
Integrating Backward to Achieve Greater Competitiveness 171
Integrating Forward to Enhance Competitiveness 172
The Disadvantages of a Vertical Integration Strategy 173
Weighing the Pros and Cons of Vertical Integration 174
OUTSOURCING STRATEGIES: NARROWING THE
SCOPE OF OPERATIONS 176
The Risk of Outsourcing Value Chain Activities 177
STRATEGIC ALLIANCES AND PARTNERSHIPS 177
Capturing the Benefits of Strategic Alliances 179
The Drawbacks of Strategic Alliances and Their Relative Advantages
180
How to Make Strategic Alliances Work 181
ILLUSTRATION CAPSULES
6.1 Etsy’s Blue Ocean Strategy in Online Retailing of Handmade Crafts 162
6.2 Tinder Swipes Right for First-Mover Success 165
6.3 Walmart’s Expansion into E-Commerce via Horizontal Acquisition 170
6.4 Tesla’s Vertical Integration Strategy 175
7 Strategies for Competing in International Markets
186
WHY COMPANIES DECIDE TO ENTER FOREIGN
MARKETS 188
WHY COMPETING ACROSS NATIONAL BORDERS
MAKES STRATEGY MAKING MORE COMPLEX 189
Home-Country Industry Advantages and the Diamond Model 189
Demand Conditions 189
Factor Conditions 190
Related and Supporting Industries 191
Firm Strategy, Structure, and Rivalry 191
Opportunities for Location-Based Advantages 191
page xli
The Impact of Government Policies and Economic Conditions in Host
Countries 192
The Risks of Adverse Exchange Rate Shifts 193
Cross-Country Differences in Demographic, Cultural, and Market
Conditions 195
STRATEGIC OPTIONS FOR ENTERING
INTERNATIONAL MARKETS 196
Export Strategies 196
Licensing Strategies 197
Franchising Strategies 197
Foreign Subsidiary Strategies 198
Alliance and Joint Venture Strategies 199
The Risks of Strategic Alliances with Foreign Partners 200
INTERNATIONAL STRATEGY: THE THREE MAIN
APPROACHES 201
Multidomestic Strategies—a “Think-Local, Act-Local” Approach 202
Global Strategies—a “Think-Global, Act-Global” Approach 203
Transnational Strategies—a “Think-Global, Act-Local” Approach 204
INTERNATIONAL OPERATIONS AND THE QUEST FOR
COMPETITIVE ADVANTAGE 206
Using Location to Build Competitive Advantage 207
When to Concentrate Activities in a Few Locations 207
When to Disperse Activities across Many Locations 208
Sharing and Transferring Resources and Capabilities across Borders to
Build Competitive Advantage 208
Benefiting from Cross-Border Coordination 210
CROSS-BORDER STRATEGIC MOVES 210
Waging a Strategic Offensive 210
Defending against International Rivals 211
STRATEGIES FOR COMPETING IN THE MARKETS OF
DEVELOPING COUNTRIES 212
Strategy Options for Competing in Developing-Country Markets 212
DEFENDING AGAINST GLOBAL GIANTS: STRATEGIES
FOR LOCAL COMPANIES IN DEVELOPING
COUNTRIES 214
ILLUSTRATION CAPSULES
7.1 Walgreens Boots Alliance, Inc.: Entering Foreign Markets via Alliance
Followed by Merger 200
7.2 Four Seasons Hotels: Local Character, Global Service 206
7.3 WeChat’s Strategy for Defending against International Social Media Giants
in China 216
8 Corporate Strategy 222
WHAT DOES CRAFTING A DIVERSIFICATION
STRATEGY ENTAIL? 224
WHEN TO CONSIDER DIVERSIFYING 224
BUILDING SHAREHOLDER VALUE: THE ULTIMATE
JUSTIFICATION FOR DIVERSIFYING 225
APPROACHES TO DIVERSIFYING THE BUSINESS
LINEUP 226
Diversifying by Acquisition of an Existing Business 226
Entering a New Line of Business through Internal Development 227
Using Joint Ventures to Achieve Diversification 227
Choosing a Mode of Entry 228
The Question of Critical Resources and Capabilities 228
The Question of Entry Barriers 228
The Question of Speed 228
The Question of Comparative Cost 229
CHOOSING THE DIVERSIFICATION PATH: RELATED
VERSUS UNRELATED BUSINESSES 229
DIVERSIFICATION INTO RELATED BUSINESSES 229
Identifying Cross-Business Strategic Fit along the Value Chain 232
Strategic Fit in Supply Chain Activities 234
Strategic Fit in R&D and Technology Activities 234
Manufacturing-Related Strategic Fit 234
Strategic Fit in Sales and Marketing Activities 234
Distribution-Related Strategic Fit 235
Strategic Fit in Customer Service Activities 235
Strategic Fit, Economies of Scope, and Competitive Advantage 235
From Strategic Fit to Competitive Advantage, Added Profitability, and Gains
in Shareholder Value 236
DIVERSIFICATION INTO UNRELATED BUSINESSES
238
Building Shareholder Value via Unrelated Diversification 238
The Benefits of Astute Corporate Parenting 240
Judicious Cross-Business Allocation of Financial Resources 241
Acquiring and Restructuring Undervalued Companies 241
page xlii
The Path to Greater Shareholder Value through Unrelated
Diversification 242
The Drawbacks of Unrelated Diversification 242
Demanding Managerial Requirements 242
Limited Competitive Advantage Potential 243
Misguided Reasons for Pursuing Unrelated Diversification 243
COMBINATION RELATED–UNRELATED
DIVERSIFICATION STRATEGIES 244
EVALUATING THE STRATEGY OF A DIVERSIFIED
COMPANY 244
Step 1: Evaluating Industry Attractiveness 245
Calculating Industry-Attractiveness Scores 246
Interpreting the Industry-Attractiveness Scores 247
Step 2: Evaluating Business Unit Competitive Strength 248
Calculating Competitive-Strength Scores for Each Business Unit 248
Interpreting the Competitive-Strength Scores 249
Using a Nine-Cell Matrix to Simultaneously Portray Industry Attractiveness
and Competitive Strength 249
Step 3: Determining the Competitive Value of Strategic Fit in Diversified
Companies 252
Step 4: Checking for Good Resource Fit 252
Financial Resource Fit 253
Nonfinancial Resource Fit 255
Step 5: Ranking Business Units and Assigning a Priority for Resource
Allocation 256
Allocating Financial Resources 256
Step 6: Crafting New Strategic Moves to Improve Overall Corporate
Performance 257
Sticking Closely with the Present Business Lineup 257
Broadening a Diversified Company’s Business Base 257
Retrenching to a Narrower Diversification Base 259
Restructuring a Diversified Company’s Business Lineup 260
ILLUSTRATION CAPSULES
8.1 Examples of Companies Pursuing a Related Diversification Strategy
233
8.2 The Kraft–Heinz Merger: Pursuing the Benefits of Cross-Business
Strategic Fit 237
8.3 Examples of Companies Pursuing an Unrelated Diversification Strategy
239
8.4 Restructuring Strategically at VF Corporation 261
page xliii
9 Ethics, Corporate Social Responsibility,
Environmental Sustainability, and Strategy 266
WHAT DO WE MEAN BY BUSINESS ETHICS? 268
WHERE DO ETHICAL STANDARDS COME FROM—ARE
THEY UNIVERSAL OR DEPENDENT ON LOCAL
NORMS? 268
The School of Ethical Universalism 268
The School of Ethical Relativism 269
The Use of Underage Labor 269
The Payment of Bribes and Kickbacks 270
Why Ethical Relativism Is Problematic for Multinational Companies 271
Ethics and Integrative Social Contracts Theory 271
HOW AND WHY ETHICAL STANDARDS IMPACT THE
TASKS OF CRAFTING AND EXECUTING STRATEGY
272
DRIVERS OF UNETHICAL BUSINESS STRATEGIES
AND BEHAVIOR 273
Faulty Oversight, Enabling the Unscrupulous Pursuit of Personal Gain and
Self-Interest 273
Heavy Pressures on Company Managers to Meet Short-Term Performance
Targets 275
A Company Culture That Puts Profitability and Business Performance Ahead
of Ethical Behavior 276
WHY SHOULD COMPANY STRATEGIES BE ETHICAL?
277
The Moral Case for an Ethical Strategy 277
The Business Case for Ethical Strategies 277
STRATEGY, CORPORATE SOCIAL RESPONSIBILITY,
AND ENVIRONMENTAL SUSTAINABILITY 279
The Concepts of Corporate Social Responsibility and Good Corporate
Citizenship 280
Corporate Social Responsibility and the Triple Bottom Line 282
What Do We Mean by Sustainability and Sustainable Business Practices?
285
Crafting Corporate Social Responsibility and Sustainability Strategies
287
The Moral Case for Corporate Social Responsibility and Environmentally
Sustainable Business Practices 289
page xliv
The Business Case for Corporate Social Responsibility and
Environmentally Sustainable Business Practices 289
ILLUSTRATION CAPSULES
9.1 Ethical Violations at Uber and their Consequences 274
9.2 How PepsiCo Put Its Ethical Principles into Practice 279
9.3 Warby Parker: Combining Corporate Social Responsibility with Affordable
Fashion 283
9.4 Unilever’s Focus on Sustainability 288
Section D: Executing the Strategy
10 Building an Organization Capable of Good Strategy
Execution 296
A FRAMEWORK FOR EXECUTING STRATEGY 298
The Principal Components of the Strategy Execution Process 298
What’s Covered in Chapters 10, 11, and 12 299
BUILDING AN ORGANIZATION CAPABLE OF GOOD
STRATEGY EXECUTION: THREE KEY ACTIONS
300
STAFFING THE ORGANIZATION 302
Putting Together a Strong Management Team 302
Recruiting, Training, and Retaining Capable Employees 303
DEVELOPING AND BUILDING CRITICAL RESOURCES
AND ORGANIZATIONAL CAPABILITIES 305
Three Approaches to Building and Strengthening Organizational
Capabilities 306
Developing Organizational Capabilities Internally 306
Acquiring Capabilities through Mergers and Acquisitions 307
Accessing Capabilities through Collaborative Partnerships 308
The Strategic Role of Employee Training 309
Strategy Execution Capabilities and Competitive Advantage 309
MATCHING ORGANIZATIONAL STRUCTURE TO THE
STRATEGY 310
Deciding Which Value Chain Activities to Perform Internally and Which to
Outsource 311
Aligning the Firm’s Organizational Structure with Its Strategy 313
Making Strategy-Critical Activities the Main Building Blocks of the
Organizational Structure 314
page xlv
Matching Type of Organizational Structure to Strategy Execution
Requirements 314
Determining How Much Authority to Delegate 317
Centralized Decision Making: Pros and Cons 318
Decentralized Decision Making: Pros and Cons 319
Capturing Cross-Business Strategic Fit in a Decentralized Structure 320
Providing for Internal Cross-Unit Coordination 320
Facilitating Collaboration with External Partners and Strategic Allies 322
Further Perspectives on Structuring the Work Effort 322
ILLUSTRATION CAPSULES
10.1 Management Development at Deloitte Touche Tohmatsu Limited 304
10.2 Zara’s Strategy Execution Capabilities 310
10.3 Which Value Chain Activities Does Apple Outsource and Why? 312
11 Managing Internal Operations 328
ALLOCATING RESOURCES TO THE STRATEGY
EXECUTION EFFORT 330
INSTITUTING POLICIES AND PROCEDURES THAT
FACILITATE STRATEGY EXECUTION 331
EMPLOYING BUSINESS PROCESS MANAGEMENT
TOOLS 333
Promoting Operating Excellence: Three Powerful Business Process
Management Tools 333
Business Process Reengineering 333
Total Quality Management Programs 334
Six Sigma Quality Control Programs 335
The Difference between Business Process Reengineering and Continuous-
Improvement Programs Like Six Sigma and TQM 337
Capturing the Benefits of Initiatives to Improve Operations 338
INSTALLING INFORMATION AND OPERATING
SYSTEMS 339
Instituting Adequate Information Systems, Performance Tracking, and
Controls 340
Monitoring Employee Performance 341
USING REWARDS AND INCENTIVES TO PROMOTE
BETTER STRATEGY EXECUTION 341
Incentives and Motivational Practices That Facilitate Good Strategy
Execution 342
Striking the Right Balance between Rewards and Punishment 343
Linking Rewards to Achieving the Right Outcomes 345
Additional Guidelines for Designing Incentive Compensation Systems 346
ILLUSTRATION CAPSULES
11.1 Charleston Area Medical Center’s Six Sigma Program 337
11.2 How Wegmans Rewards and Motivates its Employees 344
11.3 Nucor Corporation: Tying Incentives Directly to Strategy Execution 347
12 Corporate Culture and Leadership 352
INSTILLING A CORPORATE CULTURE CONDUCIVE TO
GOOD STRATEGY EXECUTION 354
Identifying the Key Features of a Company’s Corporate Culture 355
The Role of Core Values and Ethics 355
Embedding Behavioral Norms in the Organization and Perpetuating the
Culture 356
The Role of Stories 357
Forces That Cause a Company’s Culture to Evolve 357
The Presence of Company Subcultures 358
Strong versus Weak Cultures 358
Strong-Culture Companies 358
Weak-Culture Companies 359
Why Corporate Cultures Matter to the Strategy Execution Process 360
Healthy Cultures That Aid Good Strategy Execution 361
High-Performance Cultures 361
Adaptive Cultures 362
Unhealthy Cultures That Impede Good Strategy Execution 363
Change-Resistant Cultures 364
Politicized Cultures 364
Insular, Inwardly Focused Cultures 364
Unethical and Greed-Driven Cultures 365
Incompatible, Clashing Subcultures 365
Changing a Problem Culture 365
Making a Compelling Case for Culture Change 366
Substantive Culture-Changing Actions 367
Symbolic Culture-Changing Actions 368
How Long Does It Take to Change a Problem Culture? 368
LEADING THE STRATEGY EXECUTION PROCESS
369
Staying on Top of How Well Things Are Going 370
Mobilizing the Effort for Excellence in Strategy Execution 371
page xlvi
Leading the Process of Making Corrective Adjustments 372
A FINAL WORD ON LEADING THE PROCESS OF
CRAFTING AND EXECUTING STRATEGY 373
ILLUSTRATION CAPSULES
12.1 PUMA’s High-Performance Culture 362
12.2 Driving Cultural Change at Goldman Sachs 369
PART
2 Cases in Crafting and Executing
Strategy
Section A: Crafting Strategy in Single-
Business Companies
1 Airbnb in 2020 C2
John D. Varlaro, Johnson & Wales University
John E. Gamble, Texas A&M University-Corpus Christi
2 Competition in the Craft Beer Industry
in 2020 C7
John D. Varlaro, Johnson & Wales University
John E. Gamble, Texas A&M University–Corpus Christi
3 Costco Wholesale in 2020: Mission,
Business Model, and Strategy C18
Arthur A. Thompson Jr., The University of Alabama
4 Ford Motor Company: Will the
Company’s Strategic Moves Restore
its Competitiveness and Financial
Performance? C43
Marlene M. Reed, Baylor University
Rochelle R. Brunson, Baylor University
5 Macy’s, Inc.: Will Its Strategy Allow It
to Survive in the Changing Retail
Sector? C51
Alen Badal, University of Liverpool
John E. Gamble, Texas A&M University-Corpus Christi
6 TOMS Shoes: Expanding Its
Successful One For One Business
Model C59
Margaret A. Peteraf, Tuck School of Business at Dartmouth
Sean Zhang and Carry S. Resor, Research Assistants,
Dartmouth College
7 lululemon athletica’s Strategy in
2020: Is the Recent Growth in Retail
Stores, Revenues, and Profitability
Sustainable? C68
Arthur A. Thompson, The University of Alabama
Randall D. Harris, Texas A&M University-Corpus Christi
8 Under Armour’s Strategy in 2020:
Can It Revive Sales and Profitability in
page xlvii
Its Core North American Market?
C86
Arthur A. Thompson, The University of Alabama
9 Spotify in 2020: Can the Company
Remain Competitive? C112
Diana R. Garza, University of the Incarnate Word
10 Beyond Meat, Inc. C124
Arthur A. Thompson, The University of Alabama
11 Netflix’s 2020 Strategy for Battling
Rivals in the Global Market for
Streamed Video Subscribers C140
Arthur A. Thompson, The University of Alabama
12 Twitter Inc. in 2020
C161
David L. Turnipseed, University of South Alabama
13 Yeti in 2020: Can Brand Name and
Innovation Keep it Ahead of the
Competition? C173
Diana R. Garza, University of the Incarnate Word
David L. Turnipseed, University of South Alabama
14 GoPro in 2020: Have its Turnaround
Strategies Failed? C184
David L. Turnipseed, University of South Alabama
John E. Gamble, Texas A&M University–Corpus Christi
15 Publix Super Markets: Its Strategy in
the U.S. Supermarket and Grocery
Store Industry C198
Gregory L. Prescott, University of West Florida
David L. Turnipseed, University of South Alabama
16 Tesla’s Strategy in 2020: Can It
Deliver Sustained Profitability?
C212
Arthur A. Thompson, The University of Alabama
17 Unilever’s Purpose-led Brand
Strategy: Can Alan Jope Balance
Purpose and Profits? C238
Syeda Maseeha Qumer, ICFAI Business School Hyderabad
Debapratim Purkayastha, ICFAI Business School Hyderabad
18 Domino’s Pizza: Business Continuity
Strategy during the Covid-19
Pandemic C249
Debapratim Purkayastha, IBS Hyderabad
Hadiya Faheem, IBS Hyderabad
19 Burbank Housing: Building from the
Inside Out C260
Christy Anderson, MBA Student, Sonoma State University
Armand Gilinsky Jr., Sonoma State University
page xlviii
20 Boeing 737 MAX: What Response
Strategy is Needed to Ensure
Passenger Safety and Restore the
Company’s Reputation? C273
Rochelle R. Brunson, Baylor University
Marlene M. Reed, Baylor University
21 The Walt Disney Company: Its
Diversification Strategy in 2020
C279
John E. Gamble, Texas A&M University-Corpus Christi
22 Robin Hood C293
Joseph Lampel, Alliance Manchester Business School
Section B: Crafting Strategy in
Diversified Companies
23 Southwest Airlines in 2020: Culture,
Values, and Operating Practices
C295
Arthur A. Thompson, The University of Alabama
John E. Gamble, Texas A&M University—Corpus Christi
24 Uber Technologies in 2020: Is the Gig
Economy Labor Force Working for
Uber? C315
Emily Farrell, MBA Candidate, Sonoma State University
Armand Gilinsky, Jr., Sonoma State University
Section C: Implementing and
Executing Strategy
25 Starbucks in 2020: Is the
Company on Track to Achieve
Attractive Growth and Operational
Excellence? C325
Arthur A. Thompson, The University of Alabama
26 Nucor Corporation in 2020: Pursuing
Efforts to Grow Sales and Market
Share Despite Tough Market
Conditions C354
Arthur A. Thompson, The University of Alabama
27 Eliminating Modern Slavery from
Supply Chains: Can Nestlé Lead the
Way? C389
Syeda Maseeha Qumer, ICFAI Business School, Hyderabad
Debapratim Purkayastha, ICFAI Business School, Hyderabad
Guide to Case Analysis CA-1
INDEXES Company I-1
Name I-9
Subject I-15
page 1
PART 1
Concepts and
Techniques for
Crafting and
Executing
Strategy
page 2
chapter 1
What Is Strategy and Why Is It
Important?
Learning Objectives
After reading this chapter, you should be able to:
LO 1-1 Understand what is meant by a company’s strategy and
why it needs to differ from competitors’ strategies.
LO 1-2 Grasp the concept of a sustainable competitive
advantage.
LO 1-3 Identify the five most basic strategic approaches for
setting a company apart from its rivals.
LO 1-4 Understand why a company’s strategy tends to evolve.
LO 1-5 Identify what constitutes a viable business model.
LO 1-6 Identify the three tests of a winning strategy.
page 3
Gary Waters/Ikon Images/Superstock
Strategy is about setting yourself apart from the competition.
Michael Porter—Professor and consultant
Strategy means making clear-cut choices about how to compete.
page 4
Jack Welch—Former CEO of General Electric
I believe that people make their own luck by great preparation and good strategy.
Jack Canfield—Corporate trainer and entrepreneur
According to The Economist, a leading publication on business, economics, and
international affairs, “In business, strategy is king. Leadership and hard work are all very
well and luck is mighty useful, but it is strategy that makes or breaks a firm.”1 Luck and
circumstance can explain why some companies are blessed with initial, short-lived
success. But only a well-crafted, well-executed, constantly evolving strategy can explain
why an elite set of companies somehow manage to rise to the top and stay there, year
after year, pleasing their customers, shareholders, and other stakeholders alike in the
process. Companies such as Apple, Disney, Starbucks, Alphabet (parent company of
Google), Berkshire Hathaway, General Electric, and Amazon come to mind—but long-
lived success is not just the province of U.S. companies. Diverse kinds of companies,
both large and small, from many different countries have been able to sustain strong
performance records, including Denmark’s Lego Group, the United Kingdom’s HSBC (in
banking), Dubai’s Emirates Airlines, Switzerland’s Rolex China Mobile (in
telecommunications), and India’s Tata Steel.
In this opening chapter, we define the concept of strategy and describe its many
facets. We introduce you to the concept of competitive advantage and explore the tight
linkage between a company’s strategy and its quest for competitive advantage. We will
also explain why company strategies are partly proactive and partly reactive, why they
evolve over time, and the relationship between a company’s strategy and its business
model. We conclude the chapter with a discussion of what sets a winning strategy apart
from others and why that strategy should also pass the test of moral scrutiny. By the
end of this chapter, you will have a clear idea of why the tasks of crafting and executing
strategy are core management functions and why excellent execution of an excellent
strategy is the most reliable recipe for turning a company into a standout performer over
the long term.
WHAT DO WE MEAN BY STRATEGY?
• LO 1-1
Understand what is
meant by a
company’s strategy
and why it needs to
differ from
competitors’
strategies.
A company’s strategy is the set of coordinated actions that its managers take
in order to outperform the company’s competitors and achieve superior
profitability. The objective of a well-crafted strategy is not merely temporary
competitive success and profits in the short run, but rather the sort of lasting
success that can support growth and secure the company’s future over the
long term. Achieving this entails making a managerial commitment to a
coherent array of well-considered choices about how to compete.2 These
include
How to position the company in the marketplace.
How to attract customers.
How to compete against rivals.
How to achieve the company’s performance targets.
How to capitalize on opportunities to grow the business.
How to respond to changing economic and market conditions.
CORE
CONCEPT
A company’s
strategy is the set
of coordinated
actions that its
managers take in
order to outperform
the company’s
competitors and
achieve superior
profitability.
In most industries, companies have considerable freedom in choosing the
hows of strategy.3 Some companies strive to achieve lower costs than rivals,
while others aim for product superiority or more personalized customer
service dimensions that rivals cannot match. Some companies opt for wide
product lines, while others concentrate their energies on a narrow product
lineup. Some deliberately confine their operations to local or regional
markets; others opt to compete nationally, internationally (several countries),
or globally (all or most of the major country markets worldwide). Choices of
how best to compete against rivals have to be made in light of the firm’s
resources and capabilities and in light of the competitive approaches rival
companies are employing.
Strategy Is about Competing Differently
Mimicking the strategies of successful industry rivals—with either copycat
product offerings or maneuvers to stake out the same market position—rarely
works. Rather, every company’s strategy needs to have some distinctive
element that draws in customers and provides a competitive edge. Strategy, at
its essence, is about competing differently—doing what rival firms don’t do
or what rival firms can’t do.4 This does not mean that the key elements of a
company’s strategy have to be 100 percent different, but rather that they must
differ in at least some important respects. A strategy stands a better chance of
succeeding when it is predicated on actions, business approaches, and
competitive moves aimed at (1) appealing to buyers in ways that set a
company apart from its rivals and (2) staking out a market position that is not
crowded with strong competitors.
A company’s strategy provides direction and guidance, in terms of not only
what the company should do but also what it should not do. Knowing what
not to do can be as important as knowing what to do, strategically. At best,
making the wrong strategic moves will prove a distraction and a waste of
company resources. At worst, it can bring about unintended long-term
consequences that put the company’s very survival at risk.
Strategy is about
competing differently
from rivals—doing
what competitors
don’t do or, even
page 5
better, doing what
they can’t do!
Figure 1.1 illustrates the broad types of actions and approaches that often
characterize a company’s strategy in a particular business or industry. For a
more concrete example, see Illustration Capsule 1.1 describing the elements
of Apple, Inc.’s successful strategy.
FIGURE 1.1 Identifying a Company’s Strategy—What to
Look For
Strategy and the Quest for Competitive
Advantage
page 6
• LO 1-2
Grasp the concept of
a sustainable
competitive
advantage.
The heart and soul of any strategy are the actions in the marketplace that
managers take to gain a competitive advantage over rivals. A company has a
competitive advantage whenever it has some type of edge over rivals in
attracting buyers and coping with competitive forces. A competitive
advantage is essential for realizing greater marketplace success and higher
profitability over the long term.
There are many routes to competitive advantage, but they all
involve one of two basic mechanisms. Either they provide the customer with
a product or service that the customer values more highly than others (higher
perceived value), or they produce their product or service more efficiently
(lower costs). Delivering superior value or delivering value more efficiently
—whatever form it takes—nearly always requires performing value chain
activities differently than rivals and building capabilities that are not readily
matched. In Illustration Capsule 1.1, it is evident that Apple, Inc. has gained a
competitive advantage over its rivals in the technological device industry
through its efforts to create “must-have,” exciting new products, that are
beautifully designed, technologically advanced, easy to use, and sold in
appealing stores that offer a fun experience, knowledgeable staff, and
excellent service. By differentiating itself in this manner from its competitors
Apple has been able to charge prices for its products that are well above those
of its rivals and far exceed the low cost of its inputs. Its expansion policies
have allowed the company to make it easy for customers to find an Apple
store in almost any high-quality mall or urban shopping district, further
enhancing the brand and cementing customer loyalty. A creative distinctive
strategy such as that used by Apple is a company’s most reliable ticket for
developing a competitive advantage over its rivals. If a strategy is not
distinctive, then there can be no competitive advantage, since no firm would
be meeting customer needs better or operating more efficiently than any
other.
If a company’s competitive edge holds promise for being sustainable (as
opposed to just temporary), then so much the better for both the strategy and
the company’s future profitability. What makes a competitive advantage
sustainable (or durable), as opposed to temporary, are elements of the
strategy that give buyers lasting reasons to prefer a company’s products or
services over those of competitors—reasons that competitors are unable to
nullify, duplicate, or overcome despite their best efforts. In the case of Apple,
the company’s unparalleled name recognition, its reputation for technically
superior, beautifully designed, “must-have” products, and the accessibility of
the appealing, consumer-friendly stores with knowledgeable staff, make it
difficult for competitors to weaken or overcome Apple’s competitive
advantage. Not only has Apple’s strategy provided the company with a
sustainable competitive advantage, but it has made Apple, Inc. one of the
most admired companies on the planet.
CORE
CONCEPT
A company achieves
a competitive
advantage when it
provides buyers with
superior value
compared to rival
sellers or offers the
same value at a
lower cost to the
firm. The advantage
is sustainable if it
persists despite the
best efforts of
competitors to
match or surpass
this advantage.
Five of the most frequently used and dependable strategic approaches to
setting a company apart from rivals, building strong customer loyalty, and
gaining a competitive advantage are
page 7
• LO 1-3
Identify the five most
basic strategic
approaches for
setting a company
apart from rivals.
1. A low-cost provider strategy—achieving a cost-based advantage over
rivals. Walmart and Southwest Airlines have earned strong market
positions because of the low-cost advantages they have achieved over their
rivals. Low-cost provider strategies can produce a durable competitive
edge when rivals find it hard to match the low-cost leader’s approach to
driving costs out of the business.
2. A broad differentiation strategy—seeking to differentiate the company’s
product or service from that of rivals in ways that will appeal to a broad
spectrum of buyers. Successful adopters of differentiation strategies
include Apple (innovative products), Johnson & Johnson in baby products
(product reliability), Rolex (luxury and prestige), and BMW (engineering
design and performance). One way to sustain this type of competitive
advantage is to be sufficiently innovative to thwart the efforts of clever
rivals to copy or closely imitate the product offering.
ILLUSTRATION
CAPSULE 1.1 Apple Inc.:
Exemplifying a Successful Strategy
Apple Inc. is one of the most profitable companies in the world, with revenues of more
than $265 billion. For more than 10 consecutive years, it has ranked number one on
Fortune’s list of the “World’s Most Admired Companies.” Given the worldwide popularity
of its products and services, along with its reputation for superior technological innovation
and design capabilities, this is not surprising. The key elements of Apple’s successful
strategy include:
Designing and developing its own operating systems, hardware, application software,
and services. This allows Apple to bring the best user experience to its customers
through products and solutions with innovative design, superior ease-of-use, and
seamless integration across platforms. The ability to use services like iCloud across
devices incentivizes users to join Apple’s technological ecosystem and has been
critical to fostering brand loyalty.
Continuously investing in research and development (R&D) and frequently introducing
products. Apple has invested heavily in R&D, spending upwards of $11 billion a year,
to ensure a continual and timely injection of competitive products, services, and
technologies into the marketplace. Its successful products and services include the
Mac, iPod, iPhone, iPad, Apple Watch, Apple TV, and Apple Music. It is currently
investing in an Apple electric car and Apple solar energy.
Strategically locating its stores and staffing them with knowledgeable personnel. By
operating its own Apple stores and positioning them in high-traffic locations, Apple is
better equipped to provide its customers with the optimal buying experience. The
stores’ employees are well versed in the value of the hardware and software
integration and demonstrate the unique solutions available on its products. This high-
quality sale and after-sale supports allows Apple to continuously attract new and retain
existing customers.
Expanding Apple’s reach domestically and internationally. Apple operates more than
500 retail stores across 24 countries. During fiscal year 2019, 60 percent of Apple’s
revenue came from international sales.
PUGUN SJ/Shutterstock
Maintaining a quality brand image, supported by premium pricing. Although the
computer industry is incredibly price competitive, Apple has managed to sustain a
competitive edge by focusing on its inimitable value proposition and deliberately
keeping a price premium—thus creating an aura of prestige around its products.
page 8
Committing to corporate social responsibility and sustainability through supplier
relations. Apple’s strict Code of Conduct requires its suppliers to comply with several
standards regarding safe working conditions, fair treatment of workers, and
environmentally safe manufacturing.
Cultivating a diverse workforce rooted in transparency. Apple believes that diverse
teams make innovation possible and is dedicated to incorporating a broad range of
perspectives in its workforce. Every year, Apple publishes data showing the
representation of women and different race and ethnicity groups across functions.
Note: Developed with Shawnda Lee Duvigneaud
Sources: Apple 10-K, Company website.
3. A focused low-cost strategy—concentrating on a narrow buyer segment (or
market niche) and outcompeting rivals by having lower costs and thus
being able to serve niche members at a lower price. Private-label
manufacturers of food, health and beauty products, and nutritional
supplements use their low-cost advantage to offer supermarket buyers
lower prices than those demanded by producers of branded
products. IKEA’s emphasis on modular furniture, ready for
assembly, makes it a focused low-cost player in the furniture market.
4. A focused differentiation strategy—concentrating on a narrow buyer
segment (or market niche) and outcompeting rivals by offering buyers
customized attributes that meet their specialized needs and tastes better
than rivals’ products. Lululemon, for example, specializes in high-quality
yoga clothing and the like, attracting a devoted set of buyers in the process.
Tesla, Inc., with its electric cars, LinkedIn specializing in the business and
employment aspects of social networking, and Goya Foods in Hispanic
specialty food products provide some other examples of this strategy.
5. A best-cost provider strategy—giving customers more value for the money
by satisfying their expectations on key quality features, performance,
and/or service attributes while beating their price expectations. This
approach is a hybrid strategy that blends elements of low-cost provider and
differentiation strategies; the aim is to have lower costs than rivals while
simultaneously offering better differentiating attributes. Target is an
example of a company that is known for its hip product design (a
reputation it built by featuring limited edition lines by designers such as
Rodarte, Victoria Beckham, and Jason Wu), as well as a more appealing
shopping ambience for discount store shoppers. Its dual focus on low costs
as well as differentiation shows how a best-cost provider strategy can offer
customers great value for the money.
Winning a sustainable competitive edge over rivals with any of the
preceding five strategies generally hinges as much on building competitively
valuable expertise and capabilities that rivals cannot readily match as it does
on having a distinctive product offering. Clever rivals can nearly always copy
the attributes of a popular product or service, but for rivals to match the
experience, know-how, and specialized capabilities that a company has
developed and perfected over a long period of time is substantially harder to
do and takes much longer. The success of the Swatch in watches, for
example, was driven by impressive design, marketing, and engineering
capabilities, while Apple has demonstrated outstanding product innovation
capabilities in digital music players, smartphones, and e-readers. Hyundai has
become the world’s fastest-growing automaker as a result of its advanced
manufacturing processes and unparalleled quality control systems.
Capabilities such as these have been hard for competitors to imitate or best.
Why a Company’s Strategy Evolves over Time
• LO 1-4
Understand why a
company’s strategy
tends to evolve.
The appeal of a strategy that yields a sustainable competitive advantage is
that it offers the potential for a more enduring edge than a temporary
advantage over rivals. But sustainability is a relative term, with some
advantages lasting longer than others. And regardless of how sustainable a
competitive advantage may appear to be at a given point in time, conditions
change. Even a substantial competitive advantage over rivals may crumble in
the face of drastic shifts in market conditions or disruptive innovations.
Therefore, managers of every company must be willing and ready to modify
the strategy in response to changing market conditions, advancing
technology, unexpected moves by competitors, shifting buyer needs,
page 9
emerging market opportunities, and new ideas for improving the strategy.
Most of the time, a company’s strategy evolves incrementally as management
fine-tunes various pieces of the strategy and adjusts the strategy in response
to unfolding events.5 However, on occasion, major strategy shifts are called
for, such as when the strategy is clearly failing or when industry
conditions change in dramatic ways. Industry environments
characterized by high-velocity change require companies to repeatedly adapt
their strategies.6 For example, companies in industries with rapid-fire
advances in technology like 3-D printing, shale fracking, and genetic
engineering often find it essential to adjust key elements of their strategies
several times a year. When the technological change is drastic enough to
“disrupt” the entire industry, displacing market leaders and altering market
boundaries, companies may find it necessary to “reinvent” entirely their
approach to providing value to their customers.
Regardless of whether a company’s strategy changes gradually or swiftly,
the important point is that the task of crafting strategy is not a one-time event
but always a work in progress. Adapting to new conditions and constantly
evaluating what is working well enough to continue and what needs to be
improved are normal parts of the strategy-making process, resulting in an
evolving strategy.7
Changing
circumstances and
ongoing
management efforts
to improve the
strategy cause a
company’s strategy
to evolve over time
—a condition that
makes the task of
crafting strategy a
work in progress,
not a one-time
event.
A Company’s Strategy Is Partly Proactive and
Partly Reactive
The evolving nature of a company’s strategy means that the typical company
strategy is a blend of (1) proactive, planned initiatives to improve the
company’s financial performance and secure a competitive edge and (2)
reactive responses to unanticipated developments and fresh market
conditions. The biggest portion of a company’s current strategy flows from
previously initiated actions that have proven themselves in the marketplace
and newly launched initiatives aimed at edging out rivals and boosting
financial performance. This part of management’s action plan for running the
company is its deliberate strategy, consisting of proactive strategy elements
that are both planned and realized as planned (while other planned strategy
elements may not work out and are abandoned in consequence)—see Figure
1.2.8
A company’s
strategy is shaped
partly by
management
analysis and choice
and partly by the
necessity of
adapting and
learning by doing.
FIGURE 1.2 A Company’s Strategy Is a Blend of Proactive
Initiatives and Reactive Adjustments
But managers must always be willing to supplement or modify the
proactive strategy elements with as-needed reactions to unanticipated
conditions. Inevitably, there will be occasions when market and competitive
conditions take an unexpected turn that calls for some kind of strategic
reaction. Hence, a portion of a company’s strategy is always developed on the
fly, coming as a response to fresh strategic maneuvers on the part of rival
firms, unexpected shifts in customer requirements, fast-changing
technological developments, newly appearing market opportunities, a
changing political or economic climate, or other unanticipated happenings in
the surrounding environment. These adaptive strategy adjustments make up
the firm’s emergent strategy. A company’s strategy in toto (its realized
strategy) thus tends to be a combination of proactive and reactive elements,
with certain strategy elements being abandoned because they have become
obsolete or ineffective. A company’s realized strategy can be observed in the
pattern of its actions over time, which is a far better indicator than any of its
strategic plans on paper or any public pronouncements about its strategy.
CORE
CONCEPT
page 10
A company’s
deliberate strategy
consists of proactive
strategy elements
that are planned; its
emergent strategy
consists of reactive
strategy elements
that emerge as
changing conditions
warrant.
A strategy cannot be
considered ethical
just because it
involves actions that
are legal. To meet
the standard of
being ethical, a
strategy must entail
actions and behavior
that can pass moral
scrutiny in the sense
of not being
deceitful, unfair or
harmful to others,
disreputable, or
unreasonably
damaging to the
environment.
Strategy and Ethics: Passing the Test of Moral
Scrutiny
In choosing among strategic alternatives, company managers are well advised
to embrace actions that can pass the test of moral scrutiny. Just keeping a
company’s strategic actions within the bounds of what is legal does not mean
the strategy is ethical. Ethical and moral standards are not fully
governed by what is legal. Rather, they involve issues of “right”
versus “wrong” and duty—what one should do. A strategy is ethical only if it
does not entail actions that cross the moral line from “can do” to “should not
do.” For example, a company’s strategy definitely crosses into the “should
not do” zone and cannot pass moral scrutiny if it entails actions and
page 11
behaviors that are deceitful, unfair or harmful to others, disreputable, or
unreasonably damaging to the environment. A company’s strategic actions
cross over into the “should not do” zone and are likely to be deemed
unethical when (1) they reflect badly on the company or (2) they adversely
impact the legitimate interests and well-being of shareholders, customers,
employees, suppliers, the communities where it operates, and society at large
or (3) they provoke public outcries about inappropriate or “irresponsible”
actions, behavior, or outcomes.
Admittedly, it is not always easy to categorize a given strategic behavior as
ethical or unethical. Many strategic actions fall in a gray zone and can be
deemed ethical or unethical depending on how high one sets the bar for what
qualifies as ethical behavior. For example, is it ethical for advertisers of
alcoholic products to place ads in media having an audience of as much as 50
percent underage viewers? Is it ethical for companies to employ
undocumented workers who may have been brought to the United States as
children? Is it ethical for Nike, Under Armour, and other makers of athletic
wear to pay a university athletic department large sums of money as an
“inducement” for the university’s athletic teams to use their brand of
products? Is it ethical for pharmaceutical manufacturers to charge higher
prices for life-saving drugs in some countries than they charge in others? Is it
ethical for a company to ignore the damage done to the environment by its
operations in a particular country, even though they are in compliance with
current environmental regulations in that country?
Senior executives with strong ethical convictions are generally
proactive in linking strategic action and ethics; they forbid the pursuit of
ethically questionable business opportunities and insist that all aspects of
company strategy are in accord with high ethical standards. They make it
clear that all company personnel are expected to act with integrity, and they
put organizational checks and balances into place to monitor behavior,
enforce ethical codes of conduct, and provide guidance to employees
regarding any gray areas. Their commitment to ethical business conduct is
genuine, not hypocritical lip service.
The reputational and financial damage that unethical strategies and
behavior can do is substantial. When a company is put in the public spotlight
because certain personnel are alleged to have engaged in misdeeds, unethical
page 12
behavior, fraudulent accounting, or criminal behavior, its revenues and stock
price are usually hammered hard. Many customers and suppliers shy away
from doing business with a company that engages in sleazy practices or turns
a blind eye to its employees’ illegal or unethical behavior. Repulsed by
unethical strategies or behavior, wary customers take their business elsewhere
and wary suppliers tread carefully. Moreover, employees with character and
integrity do not want to work for a company whose strategies are shady or
whose executives lack character and integrity. Consequently, solid business
reasons exist for companies to shun the use of unethical strategy elements.
Besides, immoral or unethical actions are just plain wrong.
A COMPANY’S STRATEGY AND ITS
BUSINESS MODEL
• LO 1-5
Identify what
constitutes a viable
business model.
At the core of every sound strategy is the company’s business model. A
business model is management’s blueprint for delivering a valuable product
or service to customers in a manner that will generate revenues sufficient to
cover costs and yield an attractive profit.9 The two elements of a company’s
business model are (1) its customer value proposition and (2) its profit
formula. The customer value proposition lays out the company’s approach to
satisfying buyer wants and needs at a price customers will consider a good
value. The profit formula describes the company’s approach to determining a
cost structure that will allow for acceptable profits, given the pricing tied to
its customer value proposition. Figure 1.3 illustrates the elements of the
business model in terms of what is known as the value-price-cost
framework.10 As the framework indicates, the customer value
proposition can be expressed as V − P, which is essentially the
customers’ perception of how much value they are getting for the money. The
profit formula, on a per-unit basis, can be expressed as P − C. Plainly, from a
customer perspective, the greater the value delivered (V) and the lower the
price (P), the more attractive is the company’s value proposition. On the
other hand, the lower the costs (C), given the customer value proposition (V −
P), the greater the ability of the business model to be a moneymaker. Thus,
the profit formula reveals how efficiently a company can meet customer
wants and needs and deliver on the value proposition. The nitty-gritty issue
surrounding a company’s business model is whether it can execute its
customer value proposition profitably. Just because company managers have
crafted a strategy for competing and running the business does not
automatically mean that the strategy will lead to profitability—it may or it
may not.
CORE
CONCEPT
A company’s
business model
sets forth the logic
for how its strategy
will create value for
customers and at
the same time
generate revenues
sufficient to cover
costs and realize a
profit.
FIGURE 1.3 The Business Model and the Value-Price-Cost
Framework
Aircraft engine manufacturer Rolls-Royce employs an innovative “power-
by-the-hour” business model that charges airlines leasing fees for engine use,
maintenance, and repairs based on actual hours flown. The company retains
ownership of the engines and is able to minimize engine maintenance costs
through the use of sophisticated sensors that optimize maintenance and repair
schedules. Gillette’s business model in razor blades involves selling a
“master product”—the razor—at an attractively low price and then making
money on repeat purchases of razor blades that can be produced cheaply and
sold at high profit margins. Printer manufacturers like Hewlett-Packard,
Canon, and Epson pursue much the same business model as Gillette—selling
printers at a low (virtually break-even) price and making large profit margins
on the repeat purchases of ink cartridges and other printer supplies.
McDonald’s invented the business model for fast food—providing value to
customers in the form of economical quick-service meals at clean, convenient
locations. Its profit formula involves such elements as standardized cost-
efficient store design, stringent specifications for ingredients, detailed
operating procedures for each unit, sizable investment in human resources
and training, and heavy reliance on advertising and in-store promotions to
drive volume. Illustration Capsule 1.2 describes three contrasting business
models in radio broadcasting.
WHAT MAKES A STRATEGY A
WINNER?
• LO 1-6
Identify the three
tests of a winning
strategy.
Three tests can be applied to determine whether a strategy is a winning
strategy:
1. The Fit Test: How well does the strategy fit the company’s situation? To
qualify as a winner, a strategy has to be well matched to industry and
competitive conditions, a company’s best market opportunities, and other
pertinent aspects of the business environment in which the company
operates. No strategy can work well unless it exhibits good external fit
with respect to prevailing market conditions. At the same time, a winning
strategy must be tailored to the company’s resources and competitive
capabilities and be supported by a complementary set of functional
activities (i.e., activities in the realms of supply chain management,
operations, sales and marketing, and so on). That is, it must also exhibit
internal fit and be compatible with a company’s ability to execute the
strategy in a competent manner. Unless a strategy exhibits good fit with
both the external and internal aspects of a company’s overall situation, it is
likely to be an underperformer and fall short of producing winning results.
Winning strategies also exhibit dynamic fit in the sense that they evolve
over time in a manner that maintains close and effective alignment with the
company’s situation even as external and internal conditions change.11
To pass the fit test, a
strategy must exhibit
fit along three
dimensions: (1)
external, (2) internal,
and (3) dynamic.
page 13
ILLUSTRATION
CAPSULE 1.2 Pandora, SiriusXM,
and Over-the-Air Broadcast Radio: Three
Contrasting Business Models
Vivien Killilea/Stringer/Getty Images
Pandora SiriusXM Over-the-Air RadioBroadcasters
Pandora SiriusXM Over-the-Air RadioBroadcasters
Customer
value
proposition
Through free-
of-charge
Internet radio
service, allowed
PC, tablet
computer, and
smartphone
users to create
up to 100
personalized
music and
comedy
stations.
Utilized
algorithms to
generate
playlists based
on users’
predicted music
preferences.
Offered
programming
interrupted by
brief,
occasional ads;
eliminated
advertising for
Pandora One
subscribers.
For a monthly
subscription fee,
provided
satellite-based
music, news,
sports, national
and regional
weather, traffic
reports in limited
areas, and talk
radio
programming.
Also offered
subscribers
streaming
Internet
channels and
the ability to
create
personalized
commercial-free
stations for
online and
mobile listening.
Offered
programming
interrupted only
by brief,
occasional ads.
Provided free-
of-charge music,
national and
local news, local
traffic reports,
national and
local weather,
and talk radio
programming.
Included
frequent
programming
interruption for
ads.
page 14
Pandora SiriusXM Over-the-Air RadioBroadcasters
Profit
formula
Revenue
generation:
Display, audio, and
video ads targeted
to different
audiences and
sold to local and
national buyers;
subscription
revenues
generated from an
advertising-free
option called
Pandora One.
Cost structure:
Fixed costs
associated with
developing
software for
computers, tablets,
and smartphones.
Fixed and variable
costs related to
operating data
centers to support
streaming network,
content royalties,
marketing, and
support activities.
Profit margin:
Profitability
dependent on
generating
sufficient
advertising
revenues and
subscription
revenues to cover
costs and provide
attractive profits.
Revenue
generation:
Monthly
subscription fees,
sales of satellite
radio equipment,
and advertising
revenues.
Cost structure:
Fixed costs
associated with
operating a
satellite-based
music delivery
service and
streaming Internet
service.
Fixed and variable
costs related to
programming and
content royalties,
marketing, and
support activities.
Profit margin:
Profitability
dependent on
attracting a
sufficiently large
number of
subscribers to
cover costs and
provide attractive
profits.
Revenue
generation:
Advertising sales to
national and local
businesses.
Cost structure:
Fixed costs
associated with
terrestrial
broadcasting
operations. Fixed
and variable costs
related to local
news reporting,
advertising sales
operations, network
affiliate fees,
programming and
content royalties,
commercial
production
activities, and
support activities.
Profit margin:
Profitability
dependent on
generating
sufficient
advertising
revenues to cover
costs and provide
attractive profits.
A
winning strategy
must pass three
tests:
1. The fit test
2. The competitive
advantage test
3. The performance
test
2. The Competitive Advantage Test: Is the strategy helping the company
achieve a competitive advantage? Is the competitive advantage likely to be
sustainable? Strategies that fail to achieve a competitive advantage over
rivals are unlikely to produce superior performance. And unless the
competitive advantage is sustainable, superior performance is unlikely to
last for more than a brief period of time. Winning strategies enable a
company to achieve a competitive advantage over key rivals that is long-
lasting. The bigger and more durable the competitive advantage, the more
powerful it is.
3. The Performance Test: Is the strategy producing superior company
performance? The mark of a winning strategy is strong company
performance. Two kinds of performance indicators tell the most about the
caliber of a company’s strategy: (1) competitive strength and market
standing and (2) profitability and financial strength. Above-average
financial performance or gains in market share, competitive position, or
profitability are signs of a winning strategy.
Strategies—either existing or proposed—that come up short on one or
more of the preceding tests are plainly less desirable than strategies passing
all three tests with flying colors. New initiatives that don’t seem to match the
company’s internal and external situations should be scrapped before they
come to fruition, while existing strategies must be scrutinized on a regular
basis to ensure they have good fit, offer a competitive advantage, and are
contributing to above-average performance or performance improvements.
Failure to pass one or more of the three tests should prompt managers to
make immediate changes in an existing strategy.
page 15
WHY CRAFTING AND EXECUTING
STRATEGY ARE IMPORTANT TASKS
Crafting and executing strategy are top-priority managerial tasks for two big
reasons. First, a clear and reasoned strategy is management’s prescription for
doing business, its road map to competitive advantage, its game plan for
pleasing customers, and its formula for improving performance. High-
performing enterprises are nearly always the product of astute, creative, and
proactive strategy making. Companies don’t get to the top of the industry
rankings or stay there with flawed strategies, copycat strategies, or timid
attempts to try to do better. Only a handful of companies can boast of hitting
home runs in the marketplace due to lucky breaks or the good
fortune of having stumbled into the right market at the right time
with the right product. Even if this is the case, success will not be lasting
unless the companies subsequently craft a strategy that capitalizes on their
luck, builds on what is working, and discards the rest. So there can be little
argument that the process of crafting a company’s strategy matters—and
matters a lot.
Second, even the best-conceived strategies will result in performance
shortfalls if they are not executed proficiently. The processes of crafting and
executing strategies must go hand in hand if a company is to be successful in
the long term. The chief executive officer of one successful company put it
well when he said
In the main, our competitors are acquainted with the same fundamental concepts and techniques
and approaches that we follow, and they are as free to pursue them as we are. More often than not,
the difference between their level of success and ours lies in the relative thoroughness and self-
discipline with which we and they develop and execute our strategies for the future.
Good Strategy + Good Strategy Execution =
Good Management
Crafting and executing strategy are thus core management tasks. Among all
the things managers do, nothing affects a company’s ultimate success or
failure more fundamentally than how well its management team charts the
company’s direction, develops competitively effective strategic moves, and
pursues what needs to be done internally to produce good day-in, day-out
page 16
strategy execution and operating excellence. Indeed, good strategy and good
strategy execution are the most telling and trustworthy signs of good
management. The rationale for using the twin standards of good strategy
making and good strategy execution to determine whether a company is well
managed is therefore compelling: The better conceived a company’s strategy
and the more competently it is executed, the more likely the company will be
a standout performer in the marketplace. In stark contrast, a company that
lacks clear-cut direction, has a flawed strategy, or can’t execute its strategy
competently is a company whose financial performance is probably suffering,
whose business is at long-term risk, and whose management is sorely
lacking.
THE ROAD AHEAD
Throughout the chapters to come and in Part 2 of this text, the spotlight is on
the foremost question in running a business enterprise: What must managers
do, and do well, to make a company successful in the marketplace? The
answer that emerges is that doing a good job of managing inherently requires
good strategic thinking and good management of the strategy-making,
strategy-executing process.
How well a company
performs is directly
attributable to the
caliber of its strategy
and the proficiency
with which the
strategy is executed.
The mission of this book is to provide a solid overview of what every
business student and aspiring manager needs to know about crafting and
executing strategy. We will explore what good strategic thinking entails,
describe the core concepts and tools of strategic analysis, and examine the ins
and outs of crafting and executing strategy. The accompanying cases will
help build your skills in both diagnosing how well the strategy-making,
strategy-executing task is being performed and prescribing actions
for how the strategy in question or its execution can be improved.
The strategic management course that you are enrolled in may also include a
strategy simulation exercise in which you will run a company in head-to-head
competition with companies run by your classmates. Your mastery of the
strategic management concepts presented in the following chapters will put
you in a strong position to craft a winning strategy for your company and
figure out how to execute it in a cost-effective and profitable manner. As you
progress through the chapters of the text and the activities assigned during the
term, we hope to convince you that first-rate capabilities in crafting and
executing strategy are essential to good management.
As you tackle the content and accompanying activities of this book, ponder
the following observation by the essayist and poet Ralph Waldo Emerson:
“Commerce is a game of skill which many people play, but which few play
well.” If your efforts help you become a savvy player and better equip you to
succeed in business, the time and energy you spend here will indeed prove
worthwhile.
KEY POINTS
1. A company’s strategy is the set of coordinated actions that its managers
take in order to outperform its competitors and achieve superior
profitability.
2. The success of a company’s strategy depends upon competing differently
from rivals and gaining a competitive advantage over them.
3. A company achieves a competitive advantage when it provides buyers with
superior value compared to rival sellers or produces its products or services
more efficiently. The advantage is sustainable if it persists despite the best
efforts of competitors to match or surpass this advantage.
4. A company’s strategy typically evolves over time, emerging from a blend
of (1) proactive deliberate actions on the part of company managers to
improve the strategy and (2) reactive emergent responses to unanticipated
developments and fresh market conditions.
5. A company’s business model sets forth the logic for how its strategy will
create value for customers and at the same time generate revenues
sufficient to cover costs and realize a profit. Thus, it contains two crucial
elements: (1) the customer value proposition—a plan for satisfying
customer wants and needs at a price customers will consider good value,
and (2) the profit formula—a plan for a cost structure that will enable the
LO 1-1, LO 1-2, LO
1-3
LO 1-4, LO 1-6
page 17
company to deliver the customer value proposition profitably. These
elements are illustrated by the value-price-cost framework.
6. A winning strategy will pass three tests: (1) fit (external, internal, and
dynamic consistency), (2) competitive advantage (durable competitive
advantage), and (3) performance (outstanding financial and market
performance).
7. Ethical strategies must entail actions and behavior that can pass the test of
moral scrutiny in the sense of not being deceitful, unfair or harmful to
others, disreputable, or unreasonably damaging to the environment.
8. Crafting and executing strategy are core management functions. How well
a company performs and the degree of market success it enjoys are directly
attributable to the caliber of its strategy and the proficiency with which the
strategy is executed.
ASSURANCE OF LEARNING EXERCISES
1. Based on your experiences and/or knowledge of
Apple’s current products and services, does Apple’s
strategy (as described in Illustration Capsule 1.1)
seem to set it apart from rivals? Does the strategy
seem to be keyed to a cost-based advantage,
differentiating features, serving the unique needs of
a niche, or some combination of these? What is
there about Apple’s strategy that can lead to
sustainable competitive advantage?
2. Elements of Amazon’s strategy have evolved in
meaningful ways since the company’s founding in
1994. After reviewing the company’s history and all
of the links at the company’s investor relations site
ir.aboutamazon.com prepare a one- to two-page
report that discusses how its strategy has evolved.
Your report should also assess how well Amazon’s
strategy passes the three tests of a winning strategy.
http://ir.aboutamazon.com/
LO 1-5
LO 1-1
LO 1-6
LO 1-3
3. Go to investor.siriusxm.com and check whether
Sirius XM’s recent financial reports indicate that its
business model is working. Are its subscription fees
increasing or declining? Are its revenue stream
advertising and equipment sales growing or
declining? Does its cost structure allow for
acceptable profit margins?
EXERCISES FOR SIMULATION PARTICIPANTS
Three basic questions must be answered by managers of
organizations of all sizes as they begin the process of crafting strategy:
What is our present situation?
Where do we want to go from here?
How are we going to get there?
After you have read the Participant’s Guide or Player’s Manual for the
strategy simulation exercise that you will participate in during this academic
term, you and your co-managers should come up with brief one- or two-
paragraph answers to these three questions prior to entering your first set of
decisions. While your answer to the first of the six questions can be
developed from your reading of the manual, the remaining questions will
require a collaborative discussion among the members of your company’s
management team about how you intend to manage the company you have
been assigned to run.
1. Your company’s strategy in the business simulation
for this course should include choices about what
types of issues?
2. What is your company’s current situation? A
substantive answer to this question should cover the
following issues:
Does your company appear to be in sound financial condition?
What problems does your company have that need to be addressed?
3. Why will your company matter to customers? A
complete answer to this question should say
http://investor.siriusxm.com/
LO 1-5
LO 1-6
LO 1-1, 1-2, 1-6
page 18
something about each of the following: How will
you goals or aspirations do you have for your
company?
How will you create customer value?
What will be distinctive about the company’s products or services?
How will capabilities and resources be deployed to deliver customer
value?
4. What are the primary elements of your company’s
business model?
Describe your customer value proposition.
Discuss the profit formula tied to your business model.
What level of revenues is required for your company’s business model to
become a moneymaker?
5. How will you build and sustain competitive
advantage?
Which of the basic strategic and competitive approaches discussed in this
chapter do you think makes the most sense to pursue?
What kind of competitive advantage over rivals will you try to achieve?
How do you envision that your strategy might evolve as you react to the
competitive moves of rival firms?
Does your strategy have the ability to pass the three tests of a winning
strategy? Explain.
6. Why will strategy execution be important to your
company’s success?
ENDNOTES
1 B. R, “Strategy,” The Economist, October 19, 2012, www.economist.com/blogs/schumpeter/2012/10/z-business-
quotations-1 (accessed January 4, 2014).
2 Jan Rivkin, “An Alternative Approach to Making Strategic Choices,” Harvard Business School case 9-702-433, 2001.
3 Michael E. Porter, “What Is Strategy?” Harvard Business Review 74, no. 6 (November–December 1996), pp. 65–67.
4 Ibid.
5 Eric T. Anderson and Duncan Simester, “A Step-by-Step Guide to Smart Business Experiments,” Harvard Business
Review 89, no. 3 (March 2011).
6 Shona L. Brown and Kathleen M. Eisenhardt, Competing on the Edge: Strategy as Structured Chaos (Boston, MA:
Harvard Business School Press, 1998).
http://www.economist.com/blogs/schumpeter/2012/10/z-business-quotations-1
page 19
7 Cynthia A. Montgomery, “Putting Leadership Back into Strategy,” Harvard Business Review 86, no. 1 (January 2008).
8 Henry Mintzberg and J. A. Waters, “Of Strategies, Deliberate and Emergent,” Strategic Management Journal 6 (1985);
Costas Markides, “Strategy as Balance: From ‘Either-Or’ to ‘And,’ ” Business Strategy Review 12, no. 3 (September
2001).
9 Mark W. Johnson, Clayton M. Christensen, and Henning Kagermann, “Reinventing Your Business Model,” Harvard
Business Review 86, no. 12 (December 2008); Joan Magretta, “Why Business Models Matter,” Harvard Business Review
80, no. 5 (May 2002).
10 A. Brandenburger and H. Stuart, “Value-Based Strategy,” Journal of Economics and Management Strategy 5 (1996),
pp. 5–24; D. Hoopes, T. Madsen, and G. Walker, “Guest Editors’ Introduction to the Special Issue: Why Is There a
Resource-Based View? Toward a Theory of Competitive Heterogeneity,” Strategic Management Journal 24 (2003), pp.
889–992; M. Peteraf and J. Barney, “Unravelling the Resource-Based Tangle,” Managerial and Decision Economics 24
(2003), pp. 309–323.
11 Rivkin, “An Alternative Approach to Making Strategic Choices.”
page 20
chapter 2
Charting a Company’s Direction
Its Vision, Mission, Objectives, and
Strategy
Learning Objectives
After reading this chapter, you should be able to:
LO 2-1 Understand why it is critical for managers to have a
clear strategic vision of where the company needs
to head.
LO 2-2 Explain the importance of setting both strategic and
financial objectives.
LO 2-3 Explain why the strategic initiatives taken at various
organizational levels must be tightly coordinated.
LO 2-4 Recognize what a company must do to execute its
strategy proficiently.
LO 2-5 Comprehend the role and responsibility of a company’s
board of directors in overseeing the strategic
management process.
page 21
Pamela Hamilton/Getty Images
Sound strategy starts with having the right goal.
Michael Porter—Professor and consultant
Purpose must be deliberately conceived and chosen, and then pursued.
page 22
Clayton Christensen—Professor and consultant
A vision without a strategy remains an illusion.
Lee Bolman—Author and leadership consultant
Crafting and executing strategy are the heart and soul of managing a business
enterprise. But exactly what is involved in developing a strategy and executing it
proficiently? What goes into charting a company’s strategic course and long-term
direction? Is any analysis required? Does a company need a strategic plan? What are
the various components of the strategy-making, strategy-executing process and to what
extent are company personnel—aside from senior management—involved in the
process?
This chapter presents an overview of the ins and outs of crafting and executing
company strategies. The focus is on management’s direction-setting responsibilities—
charting a strategic course, setting performance targets, and choosing a strategy
capable of producing the desired outcomes. We explain why strategy-making is a task
for a company’s entire management team and which kinds of strategic decisions tend to
be made at which levels of management. The chapter concludes with a look at the roles
and responsibilities of a company’s board of directors and how good corporate
governance protects shareholder interests and promotes good management.
WHAT DOES THE STRATEGY-MAKING,
STRATEGY-EXECUTING PROCESS
ENTAIL?
Crafting and executing a company’s strategy is an ongoing process that
consists of five interrelated stages:
1. Developing a strategic vision that charts the company’s long-term
direction, a mission statement that describes the company’s purpose, and a
set of core values to guide the pursuit of the vision and mission.
2. Setting objectives for measuring the company’s performance and tracking
its progress in moving in the intended long-term direction.
3. Crafting a strategy for advancing the company along the path management
has charted and achieving its performance objectives.
4. Executing the chosen strategy efficiently and effectively.
5. Monitoring developments, evaluating performance, and initiating
corrective adjustments in the company’s vision and mission statement,
objectives, strategy, or approach to strategy execution in light of actual
experience, changing conditions, new ideas, and new opportunities.
Figure 2.1 displays this five-stage process, which we examine next in some
detail. The first three stages of the strategic management process involve
making a strategic plan. A strategic plan maps out where a company is
headed, establishes strategic and financial targets, and outlines the basic
business model, competitive moves, and approaches to be used in achieving
the desired business results.1 We explain this more fully at the conclusion of
our discussion of stage 3, later in this chapter.
CORE
CONCEPT
A strategic
inflection point is
the point at which
the extent of
industry change
requires
management to
consider changing
the company’s
strategic vision.
FIGURE 2.1 The Strategy-Making, Strategy-Executing
Process
The five-stage process model illustrates the need for management to
evaluate a number of external and internal factors in deciding upon a strategic
direction, appropriate objectives, and approaches to crafting and executing
strategy (see Table 2.1). Management’s decisions that are made in the
strategic management process must be shaped by the prevailing economic
conditions and competitive environment and the company’s own internal
resources and competitive capabilities. These strategy-shaping conditions
will be the focus of Chapters 3 and 4.
TABLE 2.1 Factors Shaping Decisions in the Strategy-
Making, Strategy-Execution Process
External Considerations
Does sticking with the company’s present strategic course present attractive
opportunities for growth and profitability?
What kind of competitive forces are industry members facing, and are they acting to
enhance or weaken the company’s prospects for growth and profitability?
What factors are driving industry change, and what impact on the company’s
prospects will they have?
How are industry rivals positioned, and what strategic moves are they likely to make
next?
page 23
page 24
What are the key factors of future competitive success, and does the industry offer
good prospects for attractive profits for companies possessing those capabilities?
Internal Considerations
Does the company have an appealing customer value proposition?
What are the company’s competitively important resources and capabilities, and are
they potent enough to produce a sustainable competitive advantage?
Does the company have sufficient business and competitive strength to seize market
opportunities and nullify external threats?
Are the company’s costs competitive with those of key rivals?
Is the company competitively stronger or weaker than key rivals?
The model shown in Figure 2.1 also illustrates the need for management to
evaluate the company’s performance on an ongoing basis. Any indication that
the company is failing to achieve its objectives calls for corrective
adjustments in one of the first four stages of the process. The company’s
implementation efforts might have fallen short, and new tactics must be
devised to fully exploit the potential of the company’s strategy. If
management determines that the company’s execution efforts are sufficient, it
should challenge the assumptions underlying the company’s business model
and strategy, and make alterations to better fit competitive conditions and the
company’s internal capabilities. If the company’s strategic approach to
competition is rated as sound, then perhaps management set overly ambitious
targets for the company’s performance.
The evaluation stage of the strategic management process shown in Figure
2.1 also allows for a change in the company’s vision, but this should be
necessary only when it becomes evident to management that the industry has
changed in a significant way that renders the vision obsolete. Such occasions
can be referred to as strategic inflection points. When a company reaches a
strategic inflection point, management has tough decisions to make about the
company’s direction because abandoning an established course
carries considerable risk. However, responding to unfolding
changes in the marketplace in a timely fashion lessens a company’s chances
of becoming trapped in a stagnant or declining business or letting attractive
new growth opportunities slip away.
STAGE 1: DEVELOPING A STRATEGIC
VISION, MISSION STATEMENT, AND
SET OF CORE VALUES
• LO 2-1
Understand why it is
critical for managers
to have a clear
strategic vision of
where the company
needs to head.
Very early in the strategy-making process, a company’s senior managers must
wrestle with the issue of what directional path the company should take. Can
the company’s prospects be improved by changing its product offerings, or
the markets in which it participates, or the customers it aims to serve?
Deciding to commit the company to one path versus another pushes
managers to draw some carefully reasoned conclusions about whether the
company’s present strategic course offers attractive opportunities for growth
and profitability or whether changes of one kind or another in the company’s
strategy and long-term direction are needed.
Developing a Strategic Vision
Top management’s views about the company’s long-term direction and what
product-market-customer business mix seems optimal for the road ahead
constitute a strategic vision for the company. A strategic vision delineates
management’s aspirations for the company’s future, providing a panoramic
view of “where we are going” and a convincing rationale for why this makes
good business sense. A strategic vision thus points an organization in a
particular direction, charts a strategic path for it to follow, builds commitment
to the future course of action, and molds organizational identity. A clearly
articulated strategic vision communicates management’s aspirations to
stakeholders (customers, employees, stockholders, suppliers, etc.) and helps
steer the energies of company personnel in a common direction. The vision of
Google’s cofounders Larry Page and Sergey Brin “to organize the world’s
information and make it universally accessible and useful” provides a good
example. In serving as the company’s guiding light, it has captured the
imagination of stakeholders and the public at large, served as the basis for
crafting the company’s strategic actions, and aided internal efforts to mobilize
and direct the company’s resources.
CORE
CONCEPT
A strategic vision
describes
management’s
aspirations for the
company’s future
and the course and
direction charted to
achieve them.
Well-conceived visions are distinctive and specific to a particular
organization; they avoid generic, feel-good statements like “We will become
a global leader and the first choice of customers in every market we serve.”2
Likewise, a strategic vision proclaiming management’s quest “to be the most
innovative” or “to be recognized as the best company in the industry” offers
scant guidance about a company’s long-term direction or the kind of
company that management is striving to build.
A surprising number of the vision statements found on company websites
and in annual reports are vague and unrevealing, saying very little about the
company’s future direction. Some could apply to almost any company in any
industry. Many read like a public relations statement—high-sounding words
that someone came up with because it is fashionable for companies to have
an official vision statement.3 An example is Hilton Hotel’s vision “to fill the
earth with light and the warmth of hospitality,” which simply borders on the
incredulous. The real purpose of a vision statement is to serve as a
management tool for giving the organization a sense of direction.
An effectively
communicated
page 25
vision is a valuable
management tool for
enlisting the
commitment of
company personnel
to actions that move
the company in the
intended long-term
direction.
For a strategic vision to function as a valuable management tool, it must
convey what top executives want the business to look like and provide
managers at all organizational levels with a reference point in making
strategic decisions and preparing the company for the future. It must say
something definitive about how the company’s leaders intend to position the
company beyond where it is today. Table 2.2 provides some dos
and don’ts in composing an effectively worded vision statement.
Illustration Capsule 2.1 provides a critique of the strategic visions of several
prominent companies.
TABLE 2.2 Wording a Vision Statement—the Dos and
Don’ts
The Dos The Don’ts
Be graphic. Paint a clear picture of where
the company is headed and the market
position(s) the company is striving to
stake out.
Don’t be vague or incomplete. Never
skimp on specifics about where the
company is headed or how the company
intends to prepare for the future.
Be forward-looking and directional.
Describe the strategic course that will help
the company prepare for the future.
Don’t dwell on the present. A vision is
not about what a company once did or
does now; it’s about “where we are
going.”
Keep it focused. Focus on providing
managers with guidance in making
decisions and allocating resources.
Don’t use overly broad language. Avoid
all-inclusive language that gives the
company license to pursue any
opportunity.
page 26
page 27
The Dos The Don’ts
Have some wiggle room. Language that
allows some flexibility allows the
directional course to be adjusted as
market, customer, and technology
circumstances change.
Don’t state the vision in bland or
uninspiring terms. The best vision
statements have the power to motivate
company personnel and inspire
shareholder confidence about the
company’s future.
Be sure the journey is feasible. The
path and direction should be within the
realm of what the company can
accomplish; over time, a company should
be able to demonstrate measurable
progress in achieving the vision.
Don’t be generic. A vision statement that
could apply to companies in any of
several industries (or to any of several
companies in the same industry) is not
specific enough to provide any guidance.
Indicate why the directional path
makes good business sense. The
directional path should be in the long-term
interests of stakeholders (especially
shareholders, employees, and suppliers).
Don’t rely on superlatives. Visions that
claim the company’s strategic course is
the “best” or “most successful” usually
lack specifics about the path the company
is taking to get there.
Make it memorable. A well-stated vision
is short, easily communicated, and
memorable. Ideally, it should be reducible
to a few choice lines or a one-phrase
slogan.
Don’t run on and on. A vision statement
that is not concise and to the point will
tend to lose its audience.
Sources: John P. Kotter, Leading Change (Boston: Harvard Business School Press, 1996);
Hugh Davidson, The Committed Enterprise (Oxford: Butterworth Heinemann, 2002); Michel
Robert, Strategy Pure and Simple II (New York: McGraw-Hill, 1992).
Communicating the Strategic Vision
A strategic vision offers little value to the organization unless it’s effectively
communicated down the line to lower-level managers and employees. A
vision cannot provide direction for middle managers or inspire and energize
employees unless everyone in the company is familiar with it and can
observe senior management’s commitment to the vision. It is particularly
important for executives to provide a compelling rationale for a dramatically
new strategic vision and company direction. When company
personnel don’t understand or accept the need for redirecting
organizational efforts, they are prone to resist change. Hence,
explaining the basis for the new direction, addressing employee concerns
head-on, calming fears, lifting spirits, and providing updates and progress
reports as events unfold all become part of the task in mobilizing support for
the vision and winning commitment to needed actions.
ILLUSTRATION
CAPSULE 2.1 Examples of Strategic Visions
—How Well Do They Measure Up?
Philip Arno Photography/Shutterstock
Vision Statement Effective Elements Shortcomings
Vision Statement Effective Elements Shortcomings
Whole Foods
Whole Foods Market is a dynamic
leader in the quality food business. We
are a mission-driven company that aims
to set the standards of excellence for
food retailers. We are building a
business in which high standards
permeate all aspects of our company.
Quality is a state of mind at Whole
Foods Market.
Our motto—Whole Foods, Whole
People, Whole Planet—emphasizes
that our vision reaches far beyond just
being a food retailer. Our success in
fulfilling our vision is measured by
customer satisfaction, team member
happiness and excellence, return on
capital investment, improvement in the
state of the environment and local and
larger community support.
Our ability to instill a clear sense of
interdependence among our various
stakeholders (the people who are
interested and benefit from the success
of our company) is contingent upon our
efforts to communicate more often,
more openly, and more
compassionately. Better communication
equals better understanding and more
trust.
Forward-
looking
Graphic
Focused
Makes good
business
sense
Long
Not
memorable
Keurig Dr. Pepper
A leading producer and distributor of hot
and cold beverages to satisfy every
consumer need, anytime and anywhere.
Easy to
communicate
Focused
Not distinctive
Not forward-
looking
Nike
NIKE, Inc. fosters a culture of invention.
We create products, services and
experiences for today’s athlete* while
solving problems for the next
generation.
*If you have a body, you are an athlete.
Forward-
looking
Flexible
Vague
Not focused
Note: Developed with Frances C. Thunder.
Source: Company websites (accessed online February 12, 2016).
Winning the support of organization members for the vision nearly always
requires putting “where we are going and why” in writing, distributing the
statement organizationwide, and having top executives personally explain the
vision and its rationale to as many people as feasible. Ideally, executives
should present their vision for the company in a manner that reaches out and
grabs people. An engaging and convincing strategic vision has enormous
motivational value—for the same reason that a stonemason is more inspired
by the opportunity to build a great cathedral for the ages than a house. Thus,
executive ability to paint a convincing and inspiring picture of a company’s
journey to a future destination is an important element of effective strategic
leadership.
Expressing the Essence of the Vision in a Slogan The task of effectively
conveying the vision to company personnel is assisted when management can
capture the vision of where to head in a catchy or easily remembered slogan.
A number of organizations have summed up their vision in a brief phrase.
Instagram’s vision is “Capture and share the world’s moments,” while
Charles Schwab’s is simply “Helping investors help themselves.” Habitat for
Humanity’s aspirational vision is “A world where everyone has a decent
place to live.” Even Scotland Yard has a catchy vision, which is to “make
London the safest major city in the world.” Creating a short slogan to
illuminate an organization’s direction and using it repeatedly as a reminder of
“where we are headed and why” helps rally organization members to
maintain their focus and hurdle whatever obstacles lie in the company’s path.
Why a Sound, Well-Communicated Strategic Vision Matters A well-
thought-out, forcefully communicated strategic vision pays off in several
respects: (1) It crystallizes senior executives’ own views about the firm’s
long-term direction; (2) it reduces the risk of rudderless decision making; (3)
it is a tool for winning the support of organization members to help make the
vision a reality; (4) it provides a beacon for lower-level managers in setting
departmental objectives and crafting departmental strategies that are in sync
with the company’s overall strategy; and (5) it helps an organization prepare
for the future. When top executives are able to demonstrate significant
page 28
progress in achieving these five benefits, the first step in organizational
direction setting has been successfully completed.
Developing a Company Mission Statement
The defining characteristic of a strategic vision is what it says about the
company’s future strategic course—“the direction we are headed and the
shape of our business in the future.” It is aspirational. In contrast, a mission
statement describes the enterprise’s present business and purpose—“who we
are, what we do, and why we are here.” It is purely descriptive. Ideally, a
company mission statement (1) identifies the company’s products and/or
services, (2) specifies the buyer needs that the company seeks to satisfy and
the customer groups or markets that it serves, and (3) gives the company its
own identity. The mission statements that one finds in company annual
reports or posted on company websites are typically quite brief; some do a
better job than others of conveying what the enterprise’s current business
operations and purpose are all about.
The distinction
between a strategic
vision and a mission
statement is fairly
clear-cut: A
strategic vision
portrays a
company’s
aspirations for its
future (“where we
are going”), whereas
a company’s
mission describes
the scope and
purpose of its
present business
(“who we are, what
we do, and why we
are here”).
Consider, for example, the mission statement of FedEx
Corporation, which has long been known for its overnight shipping service,
but also for pioneering the package tracking system now in general use:
The FedEx Corporation offers express and fast delivery transportation services, delivering an
estimated 3 million packages daily all around the globe. Its services include overnight courier,
ground, heavy freight, document copying, and logistics services.
Note that FedEx’s mission statement does a good job of conveying “who
we are, what we do, and why we are here,” but it provides no sense of “where
we are headed.” This is as it should be, since a company’s vision statement is
that which speaks to the future.
Another example of a well-stated mission statement with ample specifics
about what the organization does is that of St. Jude Children’s Research
Hospital: “to advance cures, and means of prevention, for pediatric
catastrophic diseases through research and treatment. Consistent with the
vision of our founder Danny Thomas, no child is denied treatment based on
race, religion or a family’s ability to pay.” Twitter’s mission statement, while
short, still captures the essence of what the company is about: “To give
everyone the power to create and share ideas and information instantly,
without barriers.” An example of a not-so-revealing mission statement is that
of JetBlue: “To inspire humanity—both in the air and on the ground.” It says
nothing about the company’s activities or business makeup and could apply
to many companies in many different industries. A person unfamiliar with
JetBlue could not even discern from its mission statement that it is an airline,
without reading between the lines. Coca-Cola, which markets more than 500
beverage brands in over 200 countries, also has an uninformative mission
statement: “to refresh the world; to inspire moments of optimism and
happiness; to create value and make a difference.” The usefulness of a
mission statement that cannot convey the essence of a company’s business
activities and purpose is unclear.
All too often, companies couch their mission in terms of making a profit,
like Dean Foods with its mission “To maximize long-term stockholder
value.” This, too, is flawed. Profit is more correctly an objective and a result
of what a company does. Moreover, earning a profit is the obvious intent of
every commercial enterprise. Companies such as Gap, Inc., Edward Jones,
Honda, The Boston Consulting Group, Citigroup, DreamWorks Animation,
and Intuit are all striving to earn a profit for shareholders; but plainly the
fundamentals of their businesses are substantially different when it comes to
“who we are and what we do.” It is management’s answer to “make a profit
doing what and for whom?” that reveals the substance of a company’s true
mission and business purpose.
To be well worded, a
company mission
statement must
employ language
specific enough to
distinguish its
business makeup
and purpose from
those of other
enterprises and give
the company its own
identity.
Linking the Vision and Mission with Company
Values
Companies commonly develop a set of values to guide the actions and
behavior of company personnel in conducting the company’s business and
pursuing its strategic vision and mission. By values (or core values, as they
are often called) we mean certain designated beliefs, traits, and behavioral
norms that management has determined should guide the pursuit of its vision
and mission. Values relate to such things as fair treatment, honor and
integrity, ethical behavior, innovativeness, teamwork, a passion for top-notch
quality or superior customer service, social responsibility, and community
citizenship.
CORE
CONCEPT
A company’s values
are the beliefs,
traits, and
behavioral norms
that company
personnel are
expected to display
in conducting the
company’s business
and pursuing its
page 29
strategic vision and
mission.
Most companies articulate four to eight core values that company
personnel are expected to display and that are supposed to be mirrored in how
the company conducts its business. Build-A-Bear Workshop, with
its cuddly Teddy bears and stuffed animals, credits six core values
with creating its highly acclaimed working environment: (1) Reach, (2)
Learn, (3) Di-bear-sity (4) Colla-bear-ate, (5) Give, and (6) Cele-bear-ate.
Zappos prides itself on its 10 core values, which employees are expected to
embody:
1. Deliver WOW Through Service
2. Embrace and Drive Change
3. Create Fun and a Little Weirdness
4. Be Adventurous, Creative, and Open-Minded
5. Pursue Growth and Learning
6. Build Open and Honest Relationships with Communication
7. Build a Positive Team and Family Spirit
8. Do More with Less
9. Be Passionate and Determined
10. Be Humble
Do companies practice what they preach when it comes to their professed
values? Sometimes no, sometimes yes—it runs the gamut. At one extreme
are companies with window-dressing values; the values are given lip service
by top executives but have little discernible impact on either how company
personnel behave or how the company operates. Such companies have value
statements because they are in vogue and make the company look good. The
limitation of these value statements becomes apparent whenever corporate
misdeeds come to light. Prime examples include Volkswagen, with its
emissions scandal, and Uber, facing multiple allegations of misbehavior and a
criminal probe of illegal operations. At the other extreme are companies
whose executives are committed to grounding company operations on sound
values and principled ways of doing business. Executives at these companies
deliberately seek to ingrain the designated core values into the corporate
culture—the core values thus become an integral part of the company’s DNA
page 30
and what makes the company tick. At such values-driven companies,
executives “walk the talk” and company personnel are held accountable for
embodying the stated values in their behavior.
At companies where the stated values are real rather than cosmetic,
managers connect values to the pursuit of the strategic vision and mission in
one of two ways. In companies with long-standing values that are deeply
entrenched in the corporate culture, senior managers are careful to craft a
vision, mission, strategy, and set of operating practices that match established
values; moreover, they repeatedly emphasize how the value-based behavioral
norms contribute to the company’s business success. If the company changes
to a different vision or strategy, executives make a point of explaining how
and why the core values continue to be relevant. Few companies with sincere
commitment to established core values ever undertake strategic moves that
conflict with ingrained values. In new companies, top management has to
consider what values and business conduct should characterize the company
and then draft a value statement that is circulated among managers and
employees for discussion and possible modification. A final value statement
that incorporates the desired behaviors and that connects to the vision and
mission is then officially adopted. Some companies combine their vision,
mission, and values into a single statement or document, circulate it to all
organization members, and in many instances post the vision, mission, and
value statement on the company’s website. Illustration Capsule 2.2 describes
how the success of TOMS Shoes has been largely driven by the nature of its
mission, linked to the vision and core values of its founder.
ILLUSTRATION
CAPSULE 2.2 TOMS Shoes: A Mission with
a Company
TOMS Shoes was founded in 2006 by Blake Mycoskie after a trip to Argentina where he
witnessed many children with no access to shoes in areas of extreme poverty. Mycoskie
returned to the United States and founded TOMS Shoes with the purpose of matching
every pair of shoes purchased by customers with a new pair of shoes to give to a child in
need, a model he called One for One®. In contrast to many companies that begin with a
product and then articulate a mission, Mycoskie started with the mission and then built a
company around it. Although the company has since expanded their product portfolio, its
mission remains essentially the same:
With every product you purchase, TOMS will help a person in need. One for One.®
TOMS’s mission is ingrained in their business model. While Mycoskie could have set
up a nonprofit organization to address the problem he witnessed, he was certain he didn’t
want to rely on donors to fund giving to the poor; he wanted to create a business that
would fund the giving itself. With the one-for-one model, TOMS built the cost of giving
away a pair of shoes into the price of each pair they sold, enabling the company to make
a profit while still giving away shoes to the needy.
Much of TOMS’s success (and ability to differentiate itself in a competitive
marketplace) is attributable to the appeal of its mission and origin story. Mycoskie first got
TOMS shoes into a trendy store in LA because he told them the story of why he founded
the company, which got picked up by the LA Times and quickly spread. As the company
has expanded communication channels, they continue to focus on leading with the story
of their mission to ensure that customers know they are doing more than just buying a
product.
As TOMS expanded to other products, they stayed true to the one-for-one business
model, adapting it to each new product category. In 2011, the company launched TOMS
Eyewear, where every purchase of glasses helps restore sight to an individual. They’ve
since launched TOMS Roasting Co. that helps support access to safe water with every
purchase of coffee, TOMS Bags where purchases fund resources for safe birth, and
TOMS High Road Backpack Collection where purchases provide training for bullying
prevention.
Shutterstock/Teresa Schaeffer
By ingraining the mission in the company’s business model, TOMS has been able to
truly live up to Mycoskie’s aspiration of a mission with a company, funding giving through
page 31
a for-profit business. TOMS even ensured that the business model will never change;
when Mycoskie sold 50 percent of the company to Bain Capital in 2014, part of the
transaction protected the one-for-one business model forever. TOMS is a successful
example of a company that proves a commitment to core values can spur both revenue
growth and giving back.
Note: Developed with Carry S. Resor
Sources: TOMS Shoes website, accessed February 2018, http://www.toms.com/about-
toms; Lebowitz, Shana, Business Insider, “TOMS Blake Mycoskie Talks Growing a
Business While Balancing Profit with Purpose,” June 15, 2016,
http://www.businessinsider.com/toms-blake-mycoskie-talks-growing-a-business-
while-balancing-profit-with-purpose-2016-6; Mycoskie, Blake, Harvard Business
Review, “The Founder of TOMS on Reimaging the Company’s Mission,” from January-
February 2016 issue, https://hbr.org/2016/01/the-founder-of-toms-on-reimagining-
the-companys-mission.
STAGE 2: SETTING OBJECTIVES
• LO 2-2
Explain the
importance of setting
both strategic and
financial objectives.
The managerial purpose of setting objectives is to convert the vision and
mission into specific performance targets. Objectives reflect management’s
aspirations for company performance in light of the industry’s prevailing
economic and competitive conditions and the company’s internal capabilities.
Well-stated objectives must be specific, as well as quantifiable or
measurable. As Bill Hewlett, cofounder of Hewlett-Packard, shrewdly
observed, “You cannot manage what you cannot measure. . . . And what gets
measured gets done.”4 Concrete, measurable objectives are managerially
valuable for three reasons: (1) They focus organizational attention and align
actions throughout the organization, (2) they serve as yardsticks for tracking a
company’s performance and progress, and (3) they motivate employees to
expend greater effort and perform at a high level. For company objectives to
http://www.toms.com/about-toms
http://www.businessinsider.com/toms-blake-mycoskie-talks-growing-a-business-while-balancing-profit-with-purpose-2016-6
https://hbr.org/2016/01/the-founder-of-toms-on-reimagining-the-companys-mission
serve their purpose well, they must also meet three other criteria: they must
contain a deadline for achievement and they must be challenging, yet
achievable.
CORE
CONCEPT
Objectives are an
organization’s
performance targets
—the specific results
management wants
to achieve.
Well-chosen
objectives are:
specific
measurable
time-limited
challenging
achievable
Setting Stretch Objectives
The experiences of countless companies teach that one of the best ways to
promote outstanding company performance is for managers to set
performance targets high enough to stretch an organization to perform at its
full potential and deliver the best possible results. Challenging company
personnel to go all out and deliver “stretch” gains in performance pushes an
enterprise to be more inventive, to exhibit more urgency in improving both its
financial performance and its business position, and to be more intentional
and focused in its actions. Employing stretch goals can help create an
exciting work environment and attract the best people. In many cases, stretch
objectives spur exceptional performance and help build a firewall against
contentment with modest gains in organizational performance.
CORE
CONCEPT
Stretch objectives
set performance
page 32
targets high enough
to stretch an
organization to
perform at its full
potential and deliver
the best possible
results. Extreme
stretch goals are
warranted only
under certain
conditions.
There is a difference, however, between stretch goals that are clearly
reachable with enough effort, and those that are well beyond the
organization’s current capabilities, regardless of the level of effort. Extreme
stretch goals, involving radical expectations, fail more often than not. And
failure to meet such goals can kill motivation, erode employee confidence,
and damage both worker and company performance. CEO Marissa Mayer’s
inability to return Yahoo to greatness is a case in point.
Extreme stretch goals can work as envisioned under certain circumstances.
High profile success stories at companies such as Southwest Airlines, 3M,
SpaceX, and General Electric provide evidence. But research suggests that
success of this sort depends upon two conditions being met: (1) the company
must have ample resources available, and (2) its recent performance must be
strong. Under any other circumstances, managers would be well advised not
to pursue overly ambitious stretch goals.5
What Kinds of Objectives to Set
Two distinct types of performance targets are required: those relating to
financial performance and those relating to strategic performance. Financial
objectives communicate management’s goals for financial performance.
Strategic objectives are goals concerning a company’s marketing standing
and competitive position. A company’s set of financial and strategic
objectives should include both near-term and longer-term performance
targets. Short-term (quarterly or annual) objectives focus attention
on delivering performance improvements in the current period and
satisfy shareholder expectations for near-term progress. Longer-term targets
(three to five years off) force managers to consider what to do now to put the
company in position to perform better later. Long-term objectives are critical
for achieving optimal long-term performance and stand as a barrier to a
nearsighted management philosophy and an undue focus on short-term
results. When trade-offs have to be made between achieving long-term
objectives and achieving short-term objectives, long-term objectives should
take precedence (unless the achievement of one or more short-term
performance targets has unique importance). Examples of commonly used
financial and strategic objectives are listed in Table 2.3. Illustration Capsule
2.3 provides selected financial and strategic objectives of three prominent
companies.
CORE
CONCEPT
Financial
objectives
communicate
management’s goals
for financial
performance.
Strategic
objectives lay out
target outcomes
concerning a
company’s market
standing,
competitive position,
and future business
prospects.
TABLE 2.3 Common Financial and Strategic Objectives
Financial Objectives Strategic Objectives
Financial Objectives Strategic Objectives
An x percent increase in annual
revenues
Annual increases in after-tax profits of
x percent
Annual increases in earnings per share
of x percent
Annual dividend increases of x percent
Profit margins of x percent
An x percent return on capital
employed (ROCE) or return on
shareholders’ equity (ROE) investment
Increased shareholder value in the
form of an upward-trending stock price
Bond and credit ratings of x
Internal cash flows of x dollars to fund
new capital investment
Winning an x percent market share
Achieving lower overall costs than
rivals
Overtaking key competitors on product
performance, quality, or customer
service
Deriving x percent of revenues from
the sale of new products introduced
within the past five years
Having broader or deeper
technological capabilities than rivals
Having a wider product line than rivals
Having a better-known or more
powerful brand name than rivals
Having stronger national or global
sales and distribution capabilities than
rivals
Consistently getting new or improved
products to market ahead of rivals
The Need for a Balanced Approach to Objective
Setting
The importance of setting and attaining financial objectives is obvious.
Without adequate profitability and financial strength, a company’s long-term
health and ultimate survival are jeopardized. Furthermore, subpar earnings
and a weak balance sheet alarm shareholders and creditors and put the jobs of
senior executives at risk. In consequence, companies often focus most of their
attention on financial outcomes. However, good financial performance, by
itself, is not enough. Of equal or greater importance is a company’s strategic
performance—outcomes that indicate whether a company’s market position
and competitiveness are deteriorating, holding steady, or improving. A
stronger market standing and greater competitive vitality—especially when
accompanied by competitive advantage—is what enables a company to
improve its financial performance.
Moreover, financial performance measures are really lagging indicators
that reflect the results of past decisions and organizational activities.6 But a
company’s past or current financial performance is not a reliable indicator of
page 33
page 34
its future prospects—poor financial performers often turn things around and
do better, while good financial performers can fall upon hard
times. The best and most reliable leading indicators of a
company’s future financial performance and business prospects are strategic
outcomes that indicate whether the company’s competitiveness and market
position are stronger or weaker. The accomplishment of strategic objectives
signals that the company is well positioned to sustain or improve its
performance. For instance, if a company is achieving ambitious strategic
objectives such that its competitive strength and market position are on the
rise, then there’s reason to expect that its future financial
performance will be better than its current or past performance. If
a company is losing ground to competitors and its market position is slipping
—outcomes that reflect weak strategic performance—then its ability to
maintain its present profitability is highly suspect.
ILLUSTRATION
CAPSULE 2.3 Examples of Company
Objectives
JETBLUE
Produce above average industry margins by offering a quality product at a competitive
price; generate revenues of over $6.6 billion, up 3.4 percent year over year; earn a net
income of $759 million, an annual increase of 12.0 percent; further develop fare options,
a co-branded credit card, and the Mint franchise; commit to achieving total cost savings
of $250 to $300 million by 2020; kickoff multi-year cabin restyling program; convert all
core A321 aircraft from 190 to 200 seats; target growth in key cities like Boston, plan to
grow 150 flights a day to 200 over the coming years; grow toward becoming the carrier of
choice in South Florida; organically grow west coast presence by expanding Mint offering
to more transcontinental routes; optimize fare mix to increase overall average fare.
LULULEMON ATHLETICA, INC.
Optimize and strategically grow square footage in North America; explore new concepts
such as stores that are tailored to each community; build a robust digital ecosystem with
key investments in customer relationship management, analytics, and capabilities to
elevate guest experience across all touch points; continue to expand the brand globally
through international expansion, open 11 new stores in Asia and Europe, which include
the first stores in China, South Korea, and Switzerland—operating a total of 50+ stores
across nine countries outside of North America; increase revenue $4 billion by 2020;
increase total comparable sales, which includes comparable store sales and direct to
consumer, by 6 percent increase gross profit as a percentage of net revenue, or gross
margin, by 51.2 percent; increase income from operations for fiscal 2016 by 14 percent.
Eric Broder Van Dyke/Shutterstock
GENERAL MILLS
Generate low single-digit organic net sales growth and high single-digit growth in
earnings per share. Deliver double-digit returns to shareholders over the long term. To
drive future growth, focus on Consumer First strategy to gain a deep understanding of
consumer needs and respond quickly to give them what they want; more specifically: (1)
grow cereal globally with a strong line-up of new products, including new flavors of iconic
Cheerios, (2) innovate in fast growing segments of the yogurt category to improve
performance and expand the yogurt platform into new cities in China; (3) expand
distribution and advertising for high performing brands, such as Häagen-Dazs and Old El
Paso; (4) build a more agile organization by streamlining support functions, allowing for
more fluid use of resources and idea sharing around the world; enhancing e-commerce
know-how to capture more growth in this emerging channel; and investing in strategic
revenue management tools to optimize promotions, prices and mix of products to drive
sales growth.
Note: Developed with Kathleen T. Durante
Sources: Information posted on company websites.
Consequently, it is important to use a performance measurement system
that strikes a balance between financial and strategic objectives.7 The most
widely used framework of this sort is known as the Balanced Scorecard.8
This is a method for linking financial performance objectives to specific
strategic objectives that derive from a company’s business model. It maps out
the key objectives of a company, with performance indicators, along four
dimensions:
Financial: listing financial objectives
Customer: objectives relating to customers and the market
Internal process: objectives relating to productivity and quality
Organizational: objectives concerning human capital, culture,
infrastructure, and innovation
CORE
CONCEPT
The Balanced
Scorecard is a
widely used method
for combining the
use of both strategic
and financial
objectives, tracking
their achievement,
and giving
management a more
complete and
balanced view of
how well an
organization is
performing.
CORE
CONCEPT
The four dimensions
of a Balanced
Scorecard:
1. Financial
2. Customer
3. Internal Process
4. Organizational
(formerly called
Growth and
Learning)
Done well, this can provide a company’s employees with clear guidelines
about how their jobs are linked to the overall objectives of the organization,
so they can contribute most productively and collaboratively to the
achievement of these goals. The balanced scorecard methodology continues
to be ranked as one of the most popular management tools.9 Over 50 percent
of companies in the United States, Europe, and Asia report using a balanced
scorecard approach to measuring strategic and financial performance.10
Organizations that have adopted the balanced scorecard approach include 7-
Eleven, Ann Taylor Stores, Allianz Italy, Wells Fargo Bank, Ford Motor
Company, Verizon, ExxonMobil, Pfizer, DuPont, Royal Canadian Mounted
Police, U.S. Army Medical Command, and over 30 colleges and
universities.11 Despite its popularity, the balanced scorecard is not without
limitations. Importantly, it may not capture some of the most important
priorities of a particular organization, such as resource acquisition or
partnering with other organizations. Further, as with most strategy tools, its
value depends on implementation and follow through as much as on
substance.
Setting Objectives for Every Organizational Level
Objective setting should not stop with top management’s establishing
companywide performance targets. Company objectives need to be broken
down into performance targets for each of the organization’s separate
businesses, product lines, functional departments, and individual work units.
Employees within various functional areas and operating levels will be
guided much better by specific objectives relating directly to their
departmental activities than broad organizational-level goals. Objective
setting is thus a top-down process that must extend to the lowest
organizational levels. This means that each organizational unit must take care
to set performance targets that support—rather than conflict with or negate—
the achievement of companywide strategic and financial objectives.
The ideal situation is a team effort in which each organizational unit strives
to produce results that contribute to the achievement of the company’s
performance targets and strategic vision. Such consistency signals that
organizational units know their strategic role and are on board in helping the
company move down the chosen strategic path and produce the desired
results.
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STAGE 3: CRAFTING A STRATEGY
• LO 2-3
Explain why the
strategic initiatives
taken at various
organizational levels
must be tightly
coordinated.
As indicated in Chapter 1, the task of stitching a strategy together entails
addressing a series of “hows”: how to attract and please customers, how to
compete against rivals, how to position the company in the marketplace, how
to respond to changing market conditions, how to capitalize on attractive
opportunities to grow the business, and how to achieve strategic and financial
objectives. Choosing among the alternatives available in a way that coheres
into a viable business model requires an understanding of the basic principles
of strategic management. Fast-changing business environments demand
astute entrepreneurship searching for opportunities to do new things or to do
existing things in new or better ways.
In choosing among opportunities and addressing the hows of strategy,
strategists must embrace the risks of uncertainty and the discomfort that
naturally accompanies such risks. Bold strategies involve making difficult
choices and placing bets on the future. Good strategic planning is not about
eliminating risks, but increasing the odds of success.
This places a premium on astute entrepreneurship searching for
opportunities to do new things or to do existing things in new or better
ways.12 The faster a company’s business environment is changing, the more
critical it becomes for its managers to be good entrepreneurs in diagnosing
the direction and force of the changes underway and in responding with
timely adjustments in strategy. Strategy makers have to pay attention to early
warnings of future change and be willing to experiment with dare-to-be-
different ways to establish a market position in that future. When obstacles
page 36
appear unexpectedly in a company’s path, it is up to management to adapt
rapidly and innovatively. Masterful strategies come from doing things
differently from competitors where it counts—out-innovating them, being
more efficient, being more imaginative, adapting faster—rather than running
with the herd. Good strategy making is therefore inseparable from good
business entrepreneurship. One cannot exist without the other.
Strategy Making Involves Managers at All
Organizational Levels
A company’s senior executives obviously have lead strategy-making roles
and responsibilities. The chief executive officer (CEO), as captain of the ship,
carries the mantles of chief direction setter, chief objective setter, chief
strategy maker, and chief strategy implementer for the total enterprise.
Ultimate responsibility for leading the strategy-making, strategy-executing
process rests with the CEO. And the CEO is always fully accountable for the
results the strategy produces, whether good or bad. In some enterprises, the
CEO or owner functions as chief architect of the strategy, personally deciding
what the key elements of the company’s strategy will be, although he or she
may seek the advice of key subordinates and board members. A CEO-
centered approach to strategy development is characteristic of small owner-
managed companies and some large corporations that were founded by the
present CEO or that have a CEO with strong strategic leadership skills. Elon
Musk at Tesla Motors and SpaceX, Mark Zuckerberg at Facebook, Jeff Bezos
at Amazon, Jack Ma of Alibaba, Warren Buffett at Berkshire Hathaway, and
Marillyn Hewson at Lockheed Martin are examples of high-profile corporate
CEOs who have wielded a heavy hand in shaping their company’s strategy.
In most corporations, however, strategy is the product of more
than just the CEO’s handiwork. Typically, other senior executives—business
unit heads, the chief financial officer, and vice presidents for production,
marketing, and other functional departments—have influential strategy-
making roles and help fashion the chief strategy components. Normally, a
company’s chief financial officer is in charge of devising and implementing
an appropriate financial strategy; the production vice president takes the lead
in developing the company’s production strategy; the marketing vice
president orchestrates sales and marketing strategy; a brand manager is in
charge of the strategy for a particular brand in the company’s product lineup;
and so on. Moreover, the strategy-making efforts of top managers are
complemented by advice and counsel from the company’s board of directors;
normally, all major strategic decisions are submitted to the board of directors
for review, discussion, perhaps modification, and official approval.
But strategy making is by no means solely a top management function, the
exclusive province of owner-entrepreneurs, CEOs, high-ranking executives,
and board members. The more a company’s operations cut across different
products, industries, and geographic areas, the more that headquarters
executives have little option but to delegate considerable strategy-making
authority to down-the-line managers in charge of particular subsidiaries,
divisions, product lines, geographic sales offices, distribution centers, and
plants. On-the-scene managers who oversee specific operating units can be
reliably counted on to have more detailed command of the strategic issues for
the particular operating unit under their supervision since they have more
intimate knowledge of the prevailing market and competitive conditions,
customer requirements and expectations, and all the other relevant aspects
affecting the several strategic options available. Managers with day-to-day
familiarity of, and authority over, a specific operating unit thus have a big
edge over headquarters executives in making wise strategic choices for their
unit. The result is that, in most of today’s companies, crafting and executing
strategy is a collaborative team effort in which every company manager plays
a strategy-making role—ranging from minor to major—for the area he or she
heads.
In most companies,
crafting and
executing strategy is
a collaborative team
effort in which every
manager has a role
for the area he or
she heads; it is
rarely something
that only high-level
managers do.
page 37
Take, for example, a company like General Electric, a $213 billion global
corporation with nearly 300,000 employees, operations in over 180 countries,
and businesses that include jet engines, lighting, power generation, medical
imaging and diagnostic equipment, locomotives, industrial automation,
aviation services, and financial services. While top-level headquarters
executives may well be personally involved in shaping GE’s overall strategy
and fashioning important strategic moves, they simply cannot know enough
about the situation in every GE organizational unit to direct every strategic
move made in GE’s worldwide organization. Rather, it takes involvement on
the part of GE’s whole management team—top executives, business group
heads, the heads of specific business units and product categories, and key
managers in plants, sales offices, and distribution centers—to craft the
thousands of strategic initiatives that end up composing the whole of GE’s
strategy.
The larger and more
diverse the
operations of an
enterprise, the more
points of strategic
initiative it has and
the more levels of
management that
have a significant
strategy-making
role.
A Company’s Strategy-Making Hierarchy
In diversified companies like GE, where multiple and sometimes strikingly
different businesses have to be managed, crafting a full-fledged strategy
involves four distinct types of strategic actions and initiatives. Each of these
involves different facets of the company’s overall strategy and calls for the
participation of different types of managers, as shown in Figure 2.2.
FIGURE 2.2 A Company’s Strategy-Making Hierarchy
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As shown in Figure 2.2, corporate strategy is orchestrated by the
CEO and other senior executives and establishes an overall strategy for
managing a set of businesses in a diversified, multibusiness company.
Corporate strategy concerns how to improve the combined performance of
the set of businesses the company has diversified into by capturing cross-
business synergies and turning them into competitive advantage. It addresses
the questions of what businesses to hold or divest, which new markets to
enter, and how to best enter new markets (by acquisition, creation of a
strategic alliance, or through internal development, for example). Corporate
strategy and business diversification are the subjects of Chapter 8, in which
they are discussed in detail.
CORE
CONCEPT
Corporate strategy
establishes an
overall game plan
for managing a set
of businesses in a
diversified,
multibusiness
company. Business
strategy is primarily
concerned with
strengthening the
company’s market
position and building
competitive
advantage in a
single-business
company or in a
single business unit
of a diversified
multibusiness
corporation.
Business strategy is concerned with strengthening the market position,
building competitive advantage, and improving the performance of a single
line of business. Business strategy is primarily the responsibility of business
unit heads, although corporate-level executives may well exert strong
influence; in diversified companies it is not unusual for corporate officers to
insist that business-level objectives and strategy conform to corporate-level
objectives and strategy themes. The business head has at least two other
strategy-related roles: (1) seeing that lower-level strategies are well
conceived, consistent, and adequately matched to the overall business
strategy; and (2) keeping corporate-level officers (and sometimes the board
of directors) informed of emerging strategic issues.
Functional-area strategies concern the approaches employed in managing
particular functions within a business—like research and development
(R&D), production, procurement of inputs, sales and marketing, distribution,
customer service, and finance. A company’s marketing strategy, for example,
represents the managerial game plan for running the sales and marketing part
of the business. A company’s product development strategy represents the
game plan for keeping the company’s product lineup in tune with what
buyers are looking for.
Functional strategies flesh out the details of a company’s business strategy.
Lead responsibility for functional strategies within a business is normally
delegated to the heads of the respective functions, with the general manager
of the business having final approval. Since the different functional-level
strategies must be compatible with the overall business strategy and with one
another to have beneficial impact, there are times when the general business
manager exerts strong influence on the content of the functional strategies.
Operating strategies concern the relatively narrow approaches for
managing key operating units (e.g., plants, distribution centers, purchasing
centers) and specific operating activities with strategic significance (e.g.,
quality control, materials purchasing, brand management, Internet sales). A
plant manager needs a strategy for accomplishing the plant’s objectives,
carrying out the plant’s part of the company’s overall manufacturing game
plan, and dealing with any strategy-related problems that exist at the plant. A
company’s advertising manager needs a strategy for getting maximum
audience exposure and sales impact from the ad budget. Operating strategies,
while of limited scope, add further detail and completeness to functional
strategies and to the overall business strategy. Lead responsibility for
operating strategies is usually delegated to frontline managers, subject to the
review and approval of higher-ranking managers.
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Even though operating strategy is at the bottom of the strategy-making
hierarchy, its importance should not be downplayed. A major plant that fails
in its strategy to achieve production volume, unit cost, and quality targets can
damage the company’s reputation for quality products and undercut the
achievement of company sales and profit objectives. Frontline managers are
thus an important part of an organization’s strategy-making team.
One cannot reliably judge the strategic importance of a given
action simply by the strategy level or location within the managerial
hierarchy where it is initiated.
A company’s
strategy is at full
power only when its
many pieces are
united.
In single-business companies, the uppermost level of the strategy-making
hierarchy is the business strategy, so a single-business company has three
levels of strategy: business strategy, functional-area strategies, and operating
strategies. Proprietorships, partnerships, and owner-managed enterprises may
have only one or two strategy-making levels since it takes only a few key
people to craft and oversee the firm’s strategy. The larger and more diverse
the operations of an enterprise, the more points of strategic initiative it has
and the more levels of management that have a significant strategy-making
role.
Uniting the Strategy-Making Hierarchy
The components of a company’s strategy up and down the strategy hierarchy
should be cohesive and mutually reinforcing, fitting together like a jigsaw
puzzle. Anything less than a unified collection of strategies weakens the
overall strategy and is likely to impair company performance.13 It is the
responsibility of top executives to achieve this unity by clearly
communicating the company’s vision, mission, objectives, and major strategy
components to down-the-line managers and key personnel. Midlevel and
frontline managers cannot craft unified strategic moves without first
understanding the company’s long-term direction and knowing the major
components of the corporate and/or business strategies that their strategy-
making efforts are supposed to support and enhance. Thus, as a general rule,
strategy making must start at the top of the organization, then proceed
downward from the corporate level to the business level, and then from the
business level to the associated functional and operating levels. Once
strategies up and down the hierarchy have been created, lower-level strategies
must be scrutinized for consistency with and support of higher-level
strategies. Any strategy conflicts must be addressed and resolved, either by
modifying the lower-level strategies with conflicting elements or by adapting
the higher-level strategy to accommodate what may be more appealing
strategy ideas and initiatives bubbling up from below.
A Strategic Vision + Mission + Objectives +
Strategy = A Strategic Plan
Developing a strategic vision and mission, setting objectives, and crafting a
strategy are basic direction-setting tasks. They map out where a company is
headed, delineate its strategic and financial targets, articulate the basic
business model, and outline the competitive moves and operating approaches
to be used in achieving the desired business results. Together, these elements
constitute a strategic plan for coping with industry conditions, competing
against rivals, meeting objectives, and making progress along the chosen
strategic course.14 Typically, a strategic plan includes a commitment to
allocate resources to carrying out the plan and specifies a time period for
achieving goals.
CORE
CONCEPT
A company’s
strategic plan lays
out its direction,
business model,
competitive strategy,
and performance
targets for some
specified period of
time.
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In companies that do regular strategy reviews and develop explicit
strategic plans, the strategic plan usually ends up as a written document that
is circulated to most managers. Near-term performance targets are the part of
the strategic plan most often communicated to employees more generally and
spelled out explicitly. A number of companies summarize key elements of
their strategic plans in the company’s annual report to
shareholders, in postings on their websites, or in statements
provided to the business media; others, perhaps for reasons of competitive
sensitivity, make only vague, general statements about their strategic plans.15
In small, privately owned companies it is rare for strategic plans to exist in
written form. Small-company strategic plans tend to reside in the thinking
and directives of owner-executives; aspects of the plan are revealed in
conversations with company personnel about where to head, what to
accomplish, and how to proceed.
STAGE 4: EXECUTING THE STRATEGY
• LO 2-4
Recognize what a
company must do to
achieve operating
excellence and to
execute its strategy
proficiently.
Managing the implementation of a strategy is easily the most demanding and
time-consuming part of the strategic management process. Converting
strategic plans into actions and results tests a manager’s ability to direct
organizational change, motivate company personnel, build and strengthen
competitive capabilities, create and nurture a strategy-supportive work
climate, and meet or beat performance targets. Initiatives to put the strategy
in place and execute it proficiently must be launched and managed on many
organizational fronts.
Management’s action agenda for executing the chosen strategy emerges
from assessing what the company will have to do to achieve the financial and
page 41
strategic performance targets. Each company manager has to think through
the answer to the question “What needs to be done in my area to execute my
piece of the strategic plan, and what actions should I take to get the process
under way?” How much internal change is needed depends on how much of
the strategy is new, how far internal practices and competencies deviate from
what the strategy requires, and how well the present work culture supports
good strategy execution. Depending on the amount of internal change
involved, full implementation and proficient execution of the company
strategy (or important new pieces thereof) can take several months to several
years.
In most situations, managing the strategy execution process includes the
following principal aspects:
Creating a strategy-supporting structure.
Staffing the organization to obtain needed skills and expertise.
Developing and strengthening strategy-supporting resources and
capabilities.
Allocating ample resources to the activities critical to strategic success.
Ensuring that policies and procedures facilitate effective strategy execution.
Organizing the work effort along the lines of best practice.
Installing information and operating systems that enable company
personnel to perform essential activities.
Motivating people and tying rewards directly to the achievement of
performance objectives.
Creating a company culture conducive to successful strategy execution.
Exerting the internal leadership needed to propel implementation forward.
Good strategy execution requires diligent pursuit of operating excellence.
It is a job for a company’s whole management team. Success hinges on the
skills and cooperation of operating managers who can push for needed
changes in their organizational units and consistently deliver good results.
Management’s handling of the strategy implementation process
can be considered successful if things go smoothly enough that
the company meets or beats its strategic and financial performance targets
and shows good progress in achieving management’s strategic vision. In
Chapters 10, 11, and 12, we discuss the various aspects of the strategy
implementation process more fully.
STAGE 5: EVALUATING
PERFORMANCE AND INITIATING
CORRECTIVE ADJUSTMENTS
The fifth component of the strategy management process—monitoring new
external developments, evaluating the company’s progress, and making
corrective adjustments—is the trigger point for deciding whether to continue
or change the company’s vision and mission, objectives, strategy, business
model and/or strategy execution methods.16 As long as the company’s
strategy continues to pass the three tests of a winning strategy discussed in
Chapter 1 (good fit, competitive advantage, strong performance), company
executives may decide to stay the course. Simply fine-tuning the strategic
plan and continuing with efforts to improve strategy execution are sufficient.
But whenever a company encounters disruptive changes in its
environment, questions need to be raised about the appropriateness of its
direction and strategy. If a company experiences a downturn in its market
position or persistent shortfalls in performance, then company managers are
obligated to ferret out the causes—do they relate to poor strategy, poor
strategy execution, or both?—and take timely corrective action. A company’s
direction, objectives, business model, and strategy have to be revisited
anytime external or internal conditions warrant.
Likewise, managers are obligated to assess which of the company’s
operating methods and approaches to strategy execution merit continuation
and which need improvement. Proficient strategy execution is always the
product of much organizational learning. It is achieved unevenly—coming
quickly in some areas and proving troublesome in others. Consequently, top-
notch strategy execution entails vigilantly searching for ways to improve and
then making corrective adjustments whenever and wherever it is useful to do
so.
A company’s vision,
mission, objectives,
strategy, and
page 42
approach to strategy
execution are never
final; reviewing
whether and when
to make revisions is
an ongoing process.
CORPORATE GOVERNANCE: THE
ROLE OF THE BOARD OF DIRECTORS
IN THE STRATEGY-CRAFTING,
STRATEGY-EXECUTING PROCESS
• LO 2-5
Comprehend the
role and
responsibility of a
company’s board of
directors in
overseeing the
strategic
management
process.
Although senior managers have the lead responsibility for crafting and
executing a company’s strategy, it is the duty of a company’s board of
directors to exercise strong oversight and see that management performs the
various tasks involved in each of the five stages of the strategy-making,
strategy-executing process in a manner that best serves the interests of
shareholders and other stakeholders, including the company’s customers,
employees, and the communities in which the company operates.17 A
company’s board of directors has four important obligations to fulfill:
1. Oversee the company’s financial accounting and financial reporting
practices. While top executives, particularly the company’s CEO and CFO
(chief financial officer), are primarily responsible for seeing that
the company’s financial statements fairly and accurately report the
results of the company’s operations, board members have a legal
obligation to warrant the accuracy of the company’s financial reports and
protect shareholders. It is their job to ensure that generally accepted
accounting principles (GAAP) are used properly in preparing the
company’s financial statements and that proper financial controls are in
place to prevent fraud and misuse of funds. Virtually all boards of directors
have an audit committee, always composed entirely of outside directors
(inside directors hold management positions in the company and either
directly or indirectly report to the CEO). The members of the audit
committee have the lead responsibility for overseeing the decisions of the
company’s financial officers and consulting with both internal and external
auditors to ensure accurate financial reporting and adequate financial
controls.
2. Critically appraise the company’s direction, strategy, and business
approaches. Board members are also expected to guide management in
choosing a strategic direction and to make independent judgments about
the validity and wisdom of management’s proposed strategic actions. This
aspect of their duties takes on heightened importance when the company’s
strategy is failing or is plagued with faulty execution, and certainly when
there is a precipitous collapse in profitability. But under more normal
circumstances, many boards have found that meeting agendas become
consumed by compliance matters with little time left to discuss matters of
strategic importance. The board of directors and management at Philips
Electronics hold annual two- to three-day retreats devoted exclusively to
evaluating the company’s long-term direction and various strategic
proposals. The company’s exit from the semiconductor business and its
increased focus on medical technology and home health care resulted from
management-board discussions during such retreats.18
3. Evaluate the caliber of senior executives’ strategic leadership skills. The
board is always responsible for determining whether the current CEO is
doing a good job of strategic leadership (as a basis for awarding salary
increases and bonuses and deciding on retention or removal).19 Boards
must also exercise due diligence in evaluating the strategic leadership
skills of other senior executives in line to succeed the CEO. When the
incumbent CEO steps down or leaves for a position elsewhere, the board
must elect a successor, either going with an insider or deciding that an
page 43
outsider is needed to perhaps radically change the company’s strategic
course. Often, the outside directors on a board visit company facilities and
talk with company personnel personally to evaluate whether the strategy is
on track, how well the strategy is being executed, and how well issues and
problems are being addressed by various managers. For example,
independent board members at GE visit operating executives at each major
business unit once a year to assess the company’s talent pool and stay
abreast of emerging strategic and operating issues affecting the company’s
divisions. Home Depot board members visit a store once per quarter to
determine the health of the company’s operations.20
4. Institute a compensation plan for top executives that rewards them for
actions and results that serve stakeholder interests, and most especially
those of shareholders. A basic principle of corporate governance is that the
owners of a corporation (the shareholders) delegate operating authority and
managerial control to top management in return for compensation. In their
role as agents of shareholders, top executives have a clear and unequivocal
duty to make decisions and operate the company in accord with
shareholder interests. (This does not mean disregarding the
interests of other stakeholders—employees, suppliers, the communities in
which the company operates, and society at large.) Most boards of
directors have a compensation committee, composed entirely of directors
from outside the company, to develop a salary and incentive compensation
plan that rewards senior executives for boosting the company’s long-term
performance on behalf of shareholders. The compensation committee’s
recommendations are presented to the full board for approval. But during
the past 10 years, many boards of directors have done a poor job of
ensuring that executive salary increases, bonuses, and stock option awards
are tied tightly to performance measures that are truly in the long-term
interests of shareholders. Rather, compensation packages at many
companies have increasingly rewarded executives for short-term
performance improvements—most notably, for achieving quarterly and
annual earnings targets and boosting the stock price by specified
percentages. This has had the perverse effect of causing company
managers to become preoccupied with actions to improve a company’s
near-term performance, often motivating them to take unwise business
risks to boost short-term earnings by amounts sufficient to qualify for
multimillion-dollar compensation packages (that many see as obscenely
large). The focus on short-term performance has proved damaging to long-
term company performance and shareholder interests—witness the huge
loss of shareholder wealth that occurred at many financial institutions
during the banking crisis of 2008–2009 because of executive risk-taking in
subprime loans, credit default swaps, and collateralized mortgage
securities. As a consequence, the need to overhaul and reform executive
compensation has become a hot topic in both public circles and corporate
boardrooms. Illustration Capsule 2.4 discusses how weak governance at
Volkswagen contributed to the 2015 emissions cheating scandal, which
cost the company billions of dollars and the trust of its stakeholders.
CORE
CONCEPT
A company’s
stakeholders
include its
stockholders,
employees,
suppliers, the
communities in
which the company
operates, and
society at large.
Every corporation should have a strong independent board of directors that
(1) is well informed about the company’s performance, (2) guides and judges
the CEO and other top executives, (3) has the courage to curb management
actions the board believes are inappropriate or unduly risky, (4) certifies to
shareholders that the CEO is doing what the board expects, (5) provides
insight and advice to management, and (6) is intensely involved in debating
the pros and cons of key decisions and actions.21 Boards of directors that lack
the backbone to challenge a strong-willed or “imperial” CEO or that rubber-
stamp almost anything the CEO recommends without probing inquiry and
debate abdicate their fiduciary duty to represent and protect shareholder
interests.
Effective corporate
governance requires
page 44
the board of
directors to oversee
the company’s
strategic direction,
evaluate its senior
executives, handle
executive
compensation, and
oversee financial
reporting practices.
ILLUSTRATION
CAPSULE 2.4 Corporate
Governance Failures at Volkswagen
In 2015, Volkswagen admitted to installing “defeat devices” on at least 11 million vehicles
with diesel engines. These devices enabled the cars to pass emission tests, even though
the engines actually emitted pollutants up to 40 times above what is allowed in the United
States. Current estimates are that it will cost the company at least €7 billion to cover the
cost of repairs and lawsuits. Although management must have been involved in
approving the use of cheating devices, the Volkswagen supervisory board has been
unwilling to accept any responsibility. Some board members even questioned whether it
was the board’s responsibility to be aware of such problems, stating “matters of technical
expertise were not for us” and “the scandal had nothing, not one iota, to do with the
advisory board.” Yet governing boards do have a responsibility to be well informed, to
provide oversight, and to become involved in key decisions and actions. So what caused
this corporate governance failure? Why is this the third time in the past 20 years that
Volkswagen has been embroiled in scandal?
The key feature of Volkswagen’s board that appears to have led to these issues is a
lack of independent directors. However, before explaining this in more detail it is
important to understand the German governance model. German corporations operate
two-tier governance structures, with a management board, and a separate supervisory
board that does not contain any current executives. In addition, German law requires
large companies to have at least 50 percent supervisory board representation from
workers. This structure is meant to provide more oversight by independent board
members and greater involvement by a wider set of stakeholders.
In Volkswagen’s case, these objectives have been effectively circumvented. Although
Volkswagen’s supervisory board does not include any current management, the
chairmanship appears to be a revolving door of former senior executives. Ferdinand
Piëch, the chair during the scandal, was CEO for 9 years prior to becoming chair in 2002.
Martin Winterkorn, the recently ousted CEO, was expected to become supervisory board
page 45
chair prior to the scandal. The company continues to elevate management to the
supervisory board even though they have presided over past scandals. Hans Dieter
Poetsch, the newly appointed chair, was part of the management team that did not inform
the supervisory board of the EPA investigation for two weeks.
Vytautas Kielaitis/Shutterstock
VW also has a unique ownership structure where a single family, Porsche, controls
more than 50 percent of voting shares. Piëch, a family member and chair until 2015,
forced out CEOs and installed unqualified family members on the board, such as his
former nanny and current wife. He also pushed out independent-minded board members,
such as Gerhard Cromme, author of Germany’s corporate governance code. The
company has lost numerous independent directors over the past 10 years, leaving it with
only one non-shareholder, non-labor representative. Although Piëch has now been
removed, it is unclear that Volkswagen’s board has solved the underlying problem.
Shareholders have seen billions of dollars wiped away and the Volkswagen brand
tarnished. As long as the board continues to lack independent directors, change will likely
be slow.
Note: Developed with Jacob M. Crandall.
Sources: “Piëch under Fire,” The Economist, December 8, 2005; Chris Bryant and
Richard Milne, “Boardroom Politics at Heart of VW Scandal,” Financial Times, October 4,
2015; Andreas Cremer and Jan Schwartz, “Volkswagen Mired in Crisis as Board
Members Criticize Piech,” Reuters, April 24, 2015; Richard Milne, “Volkswagen: System
Failure,” Financial Times, November 4, 2015.
KEY POINTS
The strategic management process consists of five interrelated and integrated
stages:
1. Developing a strategic vision of the company’s future, a mission statement
that defines the company’s current purpose, and a set of core values to
guide the pursuit of the vision and mission. This stage of strategy making
provides direction for the company, motivates and inspires company
personnel, aligns and guides actions throughout the organization, and
communicates to stakeholders management’s aspirations for the company’s
future.
2. Setting objectives to convert the vision and mission into performance
targets that can be used as yardsticks for measuring the company’s
performance. Objectives need to spell out how much of what kind of
performance by when. Two broad types of objectives are required:
financial objectives and strategic objectives. A balanced scorecard
approach for measuring company performance entails setting both
financial objectives and strategic objectives. Stretch objectives can spur
exceptional performance and help build a firewall against complacency
and mediocre performance. Extreme stretch objectives, however, are only
warranted in limited circumstances.
3. Crafting a strategy to achieve the objectives and move the company along
the strategic course that management has charted. A single business
enterprise has three levels of strategy—business strategy for the company
as a whole, functional-area strategies (e.g., marketing, R&D, logistics), and
operating strategies (for key operating units, such as manufacturing plants).
In diversified, multibusiness companies, the strategy-making task involves
four distinct types or levels of strategy: corporate strategy for the company
as a whole, business strategy (one for each business the company has
diversified into), functional-area strategies within each business, and
operating strategies. Thus, strategy making is an inclusive collaborative
activity involving not only senior company executives but also the heads
of major business divisions, functional-area managers, and operating
managers on the frontlines.
4. Executing the chosen strategy and converting the strategic plan into action.
Management’s agenda for executing the chosen strategy emerges from
LO 2-1
page 46
assessing what the company will have to do to achieve the targeted
financial and strategic performance. Management’s handling of the
strategy implementation process can be considered successful if things go
smoothly enough that the company meets or beats its strategic and
financial performance targets and shows good progress in achieving
management’s strategic vision.
5. Monitoring developments, evaluating performance, and initiating
corrective adjustments in light of actual experience, changing conditions,
new ideas, and new opportunities. This stage of the strategy management
process is the trigger point for deciding whether to continue or change the
company’s vision and mission, objectives, business model strategy, and/or
strategy execution methods.
The sum of a company’s strategic vision, mission, objectives, and strategy
constitutes a strategic plan for coping with industry conditions, outcompeting
rivals, meeting objectives, and making progress toward aspirational goals.
Boards of directors have a duty to shareholders as well as other
stakeholders to play a vigilant role in overseeing management’s handling of a
company’s strategy-making, strategy-executing process. This entails four
important obligations: (1) Ensure that the company issues accurate financial
reports and has adequate financial controls; (2) critically appraise the
company’s direction, strategy, and strategy execution; (3) evaluate the caliber
of senior executives’ strategic leadership skills; and (4) institute a
compensation plan for top executives that rewards them for actions and
results that serve stakeholder interests, most especially those of shareholders.
ASSURANCE OF LEARNING EXERCISES
1. Using the information in Table 2.2, critique the
adequacy and merit of the following vision
statements, listing effective elements and
shortcomings. Rank the vision statements from best
to worst once you complete your evaluation.
LO 2-2
page 47
Vision Statement EffectiveElements ShortcomingsVision Statement
Effective
Elements Shortcomings
American Express
We work hard every day to make American
Express the world’s most respected service
brand.
Hilton Hotels Corporation
Our vision is to be the first choice of the world’s
travelers. Hilton intends to build on the rich heritage
and strength of our brands by:
Consistently delighting our customers
Investing in our team members
Delivering innovative products and services
Continuously improving performance
Increasing shareholder value
Creating a culture of pride
Strengthening the loyalty of our constituents
MasterCard
A world beyond cash.
BASF
We are “The Chemical Company” successfully
operating in all major markets.
Our customers view BASF as their partner of
choice.
Our innovative products, intelligent solutions and
services make us the most competent worldwide
supplier in the chemical industry.
We generate a high return on assets.
We strive for sustainable development.
We welcome change as an opportunity.
We, the employees of BASF, together ensure
our success.
Sources: Company websites and annual reports.
2. Go to the company investor relations websites for
Starbucks (investor.starbucks.com), Pfizer
(www.pfizer.com/investors), and Salesforce
http://investor.starbucks.com/
http://www.pfizer.com/investors
LO 2-4
LO 2-5
LO 2-5
LO 2-1
(investor.salesforce.com) to find examples of
strategic and financial objectives. List four
objectives for each company, and indicate which of
these are strategic and which are financial.
3. Go to the investor relations website for Walmart
(investors.walmartstores.com) and review past
presentations Walmart has made during various
investor conferences by clicking on the Events
option in the navigation bar. Prepare a one- to two-
page report that outlines what Walmart has said to
investors about its approach to strategy execution.
Specifically, what has management discussed
concerning staffing, resource allocation, policies and
procedures, information and operating systems,
continuous improvement, rewards and incentives,
corporate culture, and internal leadership at the
company?
4. Based on the information provided in Illustration
Capsule 2.4, describe the ways in which Volkswagen
did not fulfill the requirements of effective corporate
governance. In what ways did the board of directors
sidestep its obligations to protect shareholder
interests? How could Volkswagen better select its
board of directors to avoid mistakes such as the
emissions scandal in 2015?
EXERCISES FOR SIMULATION PARTICIPANTS
1. Which of the five stages of the strategy formulation,
strategy execution process apply to your company in
the simulation?
2. Meet with your co-managers and prepare a strategic
vision statement for your company. It should be at
least one sentence long and no longer than a brief
paragraph. When you are finished, check to see if
your vision statement meets the conditions for an
http://investor.salesforce.com/
http://investors.walmartstores.com/
LO 2-2
LO 2-3
LO 2-4
page 48
effectively worded strategic vision set forth in Table
2.2. If not, then revise it accordingly. What would be
a good slogan that captures the essence of your
strategic vision and that could be used to help
communicate the vision to company personnel,
shareholders, and other stakeholders?
3. What are your company’s financial objectives?
What are your company’s strategic objectives?
4. What are the three to four key elements of your
company’s strategy?
5. The strategy execution process for your company in
the business simulation includes which principle
aspects?
ENDNOTES
1 Gordon Shaw, Robert Brown, and Philip Bromiley, “Strategic Stories: How 3M Is Rewriting Business Planning,” Harvard
Business Review 76, no. 3 (May–June 1998); David J. Collis and Michael G. Rukstad, “Can You Say What Your Strategy
Is?” Harvard Business Review 86, no. 4 (April 2008) pp. 82–90.
2 Hugh Davidson, The Committed Enterprise: How to Make Vision and Values Work (Oxford: Butterworth Heinemann,
2002); W. Chan Kim and Renée Mauborgne, “Charting Your Company’s Future,” Harvard Business Review 80, no. 6
(June 2002), pp. 77–83; James C. Collins and Jerry I. Porras, “Building Your Company’s Vision,” Harvard Business
Review 74, no. 5 (September–October 1996), pp. 65–77; Jim Collins and Jerry Porras, Built to Last: Successful Habits of
Visionary Companies (New York: HarperCollins, 1994); Michel Robert, Strategy Pure and Simple II: How Winning
Companies Dominate Their Competitors (New York: McGraw-Hill, 1998).
3 Davidson, The Committed Enterprise, pp. 20 and 54.
4 As quoted in Charles H. House and Raymond L. Price, “The Return Map: Tracking Product Teams,” Harvard Business
Review 60, no. 1 (January–February 1991), p. 93.
5 Sitkin, S., Miller, C. and See, K., “The Stretch Goal Paradox”, Harvard Business Review, 95, no. 1
(January–February, 2017, pp. 92–99.
6 Robert S. Kaplan and David P. Norton, The Strategy-Focused Organization (Boston: Harvard Business School Press,
2001); Robert S. Kaplan and David P. Norton, The Balanced Scorecard: Translating Strategy into Action (Boston:
Harvard Business School Press, 1996).
7 Kaplan and Norton, The Strategy-Focused Organization; Kaplan and Norton, The Balanced Scorecard; Kevin B.
Hendricks, Larry Menor, and Christine Wiedman, “The Balanced Scorecard: To Adopt or Not to Adopt,” Ivey Business
Journal 69, no. 2 (November–December 2004), pp. 1–7; Sandy Richardson, “The Key Elements of Balanced Scorecard
Success,” Ivey Business Journal 69, no. 2 (November–December 2004), pp. 7–9.
8 Kaplan and Norton, The Balanced Scorecard.
9 Ibid.
10 Ibid.
11 Information posted on the website of the Balanced Scorecard Institute, balancedscorecard.org (accessed October,
2015).
12 Henry Mintzberg, Bruce Ahlstrand, and Joseph Lampel, Strategy Safari: A Guided Tour through the Wilds of Strategic
Management (New York: Free Press, 1998); Bruce Barringer and Allen C. Bluedorn, “The Relationship between
Corporate Entrepreneurship and Strategic Management,” Strategic Management Journal 20 (1999), pp. 421–444; Jeffrey
G. Covin and Morgan P. Miles, “Corporate Entrepreneurship and the Pursuit of Competitive Advantage,”
Entrepreneurship: Theory and Practice 23, no. 3 (Spring 1999), pp. 47–63; David A. Garvin and Lynne C. Levesque,
http://balancedscorecard.org/
page 49
“Meeting the Challenge of Corporate Entrepreneurship,” Harvard Business Review 84, no. 10 (October 2006), pp. 102–
112.
13 Joseph L. Bower and Clark G. Gilbert, “How Managers’ Everyday Decisions Create or Destroy Your Company’s
Strategy,” Harvard Business Review 85, no. 2 (February 2007), pp. 72–79.
14 Gordon Shaw, Robert Brown, and Philip Bromiley, “Strategic Stories: How 3M Is Rewriting Business Planning,”
Harvard Business Review 76, no. 3 (May–June 1998), pp. 41–50.
15 David Collis and Michael Rukstad, “Can You Say What Your Stratgey Is?” Harvard Business Review, May 2008, pp.
82–90.
16 Cynthia A. Montgomery, “Putting Leadership Back into Strategy,” Harvard Business Review 86, no. 1 (January 2008),
pp. 54–60.
17 Jay W. Lorsch and Robert C. Clark, “Leading from the Boardroom,” Harvard Business Review 86, no. 4 (April 2008),
pp. 105–111.
18 Ibid.
19 Stephen P. Kaufman, “Evaluating the CEO,” Harvard Business Review 86, no. 10 (October 2008), pp. 53–57.
20 Ibid.
21 David A. Nadler, “Building Better Boards,” Harvard Business Review 82, no. 5 (May 2004), pp. 102–105; Cynthia A.
Montgomery and Rhonda Kaufman, “The Board’s Missing Link,” Harvard Business Review 81, no. 3 (March 2003), pp.
86–93; John Carver, “What Continues to Be Wrong with Corporate Governance and How to Fix It,” Ivey Business Journal
68, no. 1 (September–October 2003), pp. 1–5. See also Gordon Donaldson, “A New Tool for Boards: The Strategic
Audit,” Harvard Business Review 73, no. 4 (July–August 1995), pp. 99–107.
page 50
chapter 3
Evaluating a Company’s External
Environment
Learning Objectives
After reading this chapter, you should be able to:
LO 3-1 Recognize the factors in a company’s broad macro-
environment that may have strategic significance.
LO 3-2 Use analytic tools to diagnose the competitive conditions
in a company’s industry.
LO 3-3 Map the market positions of key groups of industry rivals.
LO 3-4 Determine whether an industry’s outlook presents a
company with sufficiently attractive opportunities for
growth and profitability.
page 51
Fanatic Studio/Getty Images
No matter what it takes, the goal of strategy is to beat the competition.
Kenichi Ohmae—Consultant and author
Companies that solely focus on competition will die. Those that focus on value creation will thrive.
Edward de Bono—Author and consultant
Continued innovation is the best way to beat the competition.
Thomas A Edison—Inventor and Businessman
In Chapter 2, we learned that the strategy formulation, strategy execution process begins
with an appraisal of the company’s present situation. Two facets of a company’s situation
are especially pertinent: (1) its external environment—most notably, the competitive
page 52
conditions of the industry in which the company operates; and (2) its internal environment
—particularly the company’s resources and organizational capabilities.
Insightful diagnosis of a company’s external and internal environments is a prerequisite
for managers to succeed in crafting a strategy that is an excellent fit with the company’s
situation—the first test of a winning strategy. As depicted in Figure 3.1, strategic thinking
begins with an appraisal of the company’s external and internal environments (as a basis
for deciding on a long-term direction and developing a strategic vision). It then moves
toward an evaluation of the most promising alternative business models, and strategies
and finally culminates in choosing a specific strategy.
FIGURE 3.1 From Analyzing the Company’s Situation to
Choosing a Strategy
This chapter presents the concepts and analytic tools for zeroing in on those aspects of
a company’s external environment that should be considered in making strategic choices.
Attention centers on the broad environmental context, the specific market arena in which
a company operates, the drivers of change, the positions and likely actions of rival
companies, and key success factors. In Chapter 4, we explore the methods of evaluating
a company’s internal circumstances and competitive capabilities.
ASSESSING THE COMPANY’S
INDUSTRY AND COMPETITIVE
page 53
ENVIRONMENT
Thinking strategically about a company’s industry and competitive
environment entails using some well-validated concepts and analytical tools to
get clear answers to seven questions:
1. Do macro-environmental factors and industry characteristics offer sellers
opportunities for growth and attractive profits?
2. What kinds of competitive forces are industry members facing, and how
strong is each force?
3. What forces are driving industry change, and what impact will these changes
have on competitive intensity and industry profitability?
4. What market positions do industry rivals occupy—who is strongly
positioned and who is not?
5. What strategic moves are rivals likely to make next?
6. What are the key factors of competitive success?
7. Does the industry outlook offer good prospects for profitability?
Analysis-based answers to these questions are prerequisites for a strategy
offering good fit with the external situation. The remainder of this chapter is
devoted to describing the methods of obtaining solid answers to these seven
questions.
ANALYZING THE COMPANY’S MACRO-
ENVIRONMENT
• LO 3-1
Recognize the
factors in a
company’s broad
macro-environment
that may have
strategic
significance.
page 54
A company’s external environment includes the immediate industry and
competitive environment and a broader “macro-environment” (see Figure 3.2).
This macro-environment comprises six principal components: political factors;
economic conditions in the firm’s general environment (local, country,
regional, worldwide); sociocultural forces; technological factors;
environmental factors (concerning the natural environment); and
legal/regulatory conditions. Each of these components has the potential to
affect the firm’s more immediate industry and competitive environment,
although some are likely to have a more important effect than others. An
analysis of the impact of these factors is often referred to as PESTEL analysis,
an acronym that serves as a reminder of the six components involved
(Political, Economic, Sociocultural, Technological, Environmental,
Legal/regulatory).
FIGURE 3.2 The Components of a Company’s Macro-
Environment
CORE
CONCEPT
PESTEL analysis
can be used to
assess the strategic
relevance of the
six principal
components of the
macro-environment:
Political, Economic,
Social,
Technological,
Environmental, and
Legal/Regulatory
forces.
Since macro-economic factors affect different industries in different ways
and to different degrees, it is important for managers to determine which of
these represent the most strategically relevant factors outside the firm’s
industry boundaries. By strategically relevant, we mean important enough to
have a bearing on the decisions the company ultimately makes about its long-
term direction, objectives, strategy, and business model. The impact of the
outer-ring factors depicted in Figure 3.2 on a company’s choice of strategy can
range from big to small. Those factors that are likely to a bigger impact deserve
the closest attention. But even factors that have a low impact on the company’s
business situation merit a watchful eye since their level of impact may change.
CORE
CONCEPT
The macro-
environment
encompasses the
broad environmental
context in which a
company’s industry
is situated.
For example, when stringent new federal banking regulations are announced,
banks must rapidly adapt their strategies and lending practices to be in
compliance. Cigarette producers must adapt to new antismoking ordinances,
the decisions of governments to impose higher cigarette taxes, the growing
cultural stigma attached to smoking and newly emerging e-cigarette
technology. The homebuilding industry is affected by such macro-influences as
trends in household incomes and buying power, rules and regulations that make
it easier or harder for homebuyers to obtain mortgages, changes in mortgage
interest rates, shifting preferences of families for renting versus owning a
home, and shifts in buyer preferences for homes of various sizes, styles, and
price ranges. Companies in the food processing, restaurant, sports, and fitness
industries have to pay special attention to changes in lifestyles, eating habits,
leisure-time preferences, and attitudes toward nutrition and fitness in
fashioning their strategies. Table 3.1 provides a brief description of the
components of the macro-environment and some examples of the industries or
business situations that they might affect.
page 55
TABLE 3.1 The Six Components of the Macro-Environment
Component Description
Political
factors
Pertinent political factors include matters such as tax policy, fiscal
policy, tariffs, the political climate, and the strength of institutions such
as the federal banking system. Some political policies affect certain
types of industries more than others. An example is energy policy,
which clearly affects energy producers and heavy users of energy
more than other types of businesses.
Economic
conditions
Economic conditions include the general economic climate and specific
factors such as interest rates, exchange rates, the inflation rate, the
unemployment rate, the rate of economic growth, trade deficits or
surpluses, savings rates, and per-capita domestic product. Some
industries, such as construction, are particularly vulnerable to
economic downturns but are positively affected by factors such as low
interest rates. Others, such as discount retailing, benefit when general
economic conditions weaken, as consumers become more price-
conscious.
Sociocultural
forces
Sociocultural forces include the societal values, attitudes, cultural
influences, and lifestyles that impact demand for particular goods and
services, as well as demographic factors such as the population size,
growth rate, and age distribution. Sociocultural forces vary by locale
and change over time. An example is the trend toward healthier
lifestyles, which can shift spending toward exercise equipment and
health clubs and away from alcohol and snack foods. The
demographic effect of people living longer is having a huge impact on
the health care, nursing homes, travel, hospitality, and entertainment
industries.
Tec
hnological
factors
Technological factors include the pace of technological change and
technical developments that have the potential for wide-ranging effects
on society, such as genetic engineering, nanotechnology, and solar
energy technology. They include institutions involved in creating new
knowledge and controlling the use of technology, such as R&D
consortia, university-sponsored technology incubators, patent and
copyright laws, and government control over the Internet.
Technological change can encourage the birth of new industries, such
as drones, virtual reality technology, and connected wearable devices.
They can disrupt others, as cloud computing, 3-D printing, and big data
solution have done, and they can render other industries obsolete (film
cameras, music CDs).
Component Description
Environmental
forces
These include ecological and environmental forces such as weather,
climate, climate change, and associated factors like flooding, fire, and
water shortages. These factors can directly impact industries such as
insurance, farming, energy production, and tourism. They may have an
indirect but substantial effect on other industries such as transportation
and utilities. The relevance of environmental considerations stems
from the fact that some industries contribute more significantly than
others to air and water pollution or to the depletion of irreplaceable
natural resources, or to inefficient energy/resource usage, or are
closely associated with other types of environmentally damaging
activities (unsustainable agricultural practices, the creation of waste
products that are not recyclable or biodegradable). Growing numbers
of companies worldwide, in response to stricter environmental
regulations and also to mounting public concerns about the
environment, are implementing actions to operate in a more
environmentally and ecologically responsible manner.
Legal and
regulatory
factors
These factors include the regulations and laws with which companies
must comply, such as consumer laws, labor laws, antitrust laws, and
occupational health and safety regulation. Some factors, such as
financial services regulation, are industry-specific. Others affect certain
types of industries more than others. For example, minimum wage
legislation largely impacts low-wage industries (such as nursing homes
and fast food restaurants) that employ substantial numbers of relatively
unskilled workers. Companies in coal-mining, meat-packing, and steel-
making, where many jobs are hazardous or carry high risk of injury, are
much more impacted by occupational safety regulations than are
companies in industries such as retailing or software programming.
As the events surrounding the coronavirus pandemic of 2020 made
abundantly clear, there is a class of macro-level external factors that is not
included as part of PESTEL analysis. This is the set of factors that occurs more
irregularly and unpredictably, unlike the categories within PESTEL that can be
expected to affect firms in an ongoing and more foreseeable manner. This
additional set of factors can be thought of as societal shocks to the macro-
environment; they include terrorism (whether by domestic or foreign agents),
civil war, foreign invasion or occupation, and epidemics and pandemics.
Societal shocks such as these also affect different industries and companies to
varying degrees, but they are much harder for companies to anticipate and
prepare for since they often begin with little warning. The coordinated terrorist
attacks by al-Qaeda against the United States now referred to as 9/11 (since
they occurred on September 11, 2001) offer an example. These attacks had a
significant economic impact, not only within the United States, but on world
page 56
markets as well. New York City’s businesses suffered enormously, particularly
those located within and nearby the World Trade Center complex.
Industries suffering an outsized effect include the airline industry,
which had to cut back travel capacity by nearly 20%, and the export industry.
Illustration Capsule 3.1 illustrates how another such societal shock—the
coronavirus pandemic of 2020—affected industries, businesses, geographies,
and countries differentially.
ILLUSTRATION
CAPSULE 3.1 The Differential Effects of the
Coronavirus Pandemic of 2020
While the world had suffered through a number of other pandemics, including the Spanish
Flu (which caused somewhere between 20 to 50 million deaths in 1918–1919), the
Coronavirus pandemic of 2020 was predicted to be even more devastating. Not only was
the world now more interconnected due to globalization, but the disease causing the
pandemic, known as Covid-19, was easily transmissible. By April 1, 2020, there were
already more than 31,000 deaths worldwide, despite the fact that the disease had not yet
peaked in some of the world’s most populous countries.
The virus was new to the world and identified as such in early January, 2020. First
appearing in Wuhan, a Chinese city of 11 million, it spread around the globe rapidly,
reaching at least 170 countries by the end of March. Different countries were affected by
the pandemic at different rates and handled the crisis in different ways. Nations that were
particularly hard hit by Covid-19 include China, Italy (with 1/3 of the deaths as of April 1,
2020), Spain, France, Iran, and the United States. Italy’s high death rate may be explained
in part due to demographics, since its much older population was more susceptible to the
disease. But in contrast to South Korea, which utilized extensive testing to identify and
control the spread of the disease, Italy failed to test widely. The United States also found
itself with insufficient test kits to implement South Korea’s strategy, a situation exacerbated
by the Trump administration’s downplaying the seriousness of the threat until March.
Shutterstock / theskaman306
The economic impact of the pandemic was catastrophic, despite a $2 trillion U.S. fiscal
stimulus package and similar measures elsewhere designed to combat its economic
consequences. Emerging markets seemed destined to absorb much of the hit, as
international investment dried up, tourism collapsed, and demand for commodities fell. But
even wealthy nations were not immune from dire consequences, although different sectors
and industries were affected to varying degrees. In the United States, the hospitality and
transportation industries were hard hit, along with retail, oil and gas, live sports and other
forms of entertainment. Small businesses and low-margin industries, with little ability to
weather a significant downturn, were particularly vulnerable. Some industries, such as
health care, online retail, and delivery services found themselves facing demand in excess
of their capabilities, especially in light of supply chain breakdowns. A number of large
companies responded to the crisis by switching to the production of supplies needed for
managing the crisis. GM, Ford, and other automakers aided the efforts to produce critically
needed ventilators, while distilleries such as Tito’s Handmade Vodka and Dillon’s Distillery
began making hand sanitizers. Fashion companies, such as Inditex (with its Zara brand)
and Los Angeles Apparel, turned their production capabilities toward making hospital
gowns and face masks. Virtually no company was unaffected by the pandemic, but those
which quickly adopted practices to remain nimble, control costs, minimize job losses,
support their workers and suppliers, and join in the effort to combat the crisis were best
positioned to weather it.
Sources: “Timeline: How the new coronavirus spread, Aljazeera news, March 29, 2020;
“These companies are switching gears to help address coronavirus shortages”, by Chloe
Hadavas, Slate, March 23, 2020; SlateStatista.com (accessed April 1, 2020).
http://slatestatista.com/
page 57
As company managers scan the external environment, they must
be alert for potentially important outer-ring developments (whether in the form
of societal shocks or among the components of PESTEL analysis), assess their
impact and influence, and adapt the company’s direction and strategy as
needed. However, the factors in a company’s environment having the greatest
strategy-shaping impact typically pertain to the company’s immediate industry
and competitive environment. Consequently, it is on a company’s industry and
competitive environment (depicted in the center of Figure 3.2) that we
concentrate the bulk of our attention in this chapter.
ASSESSING THE COMPANY’S
INDUSTRY AND COMPETITIVE
ENVIRONMENT
• LO 3-2
Use analytic tools to
diagnose the
competitive
conditions in a
company’s industry.
After gaining an understanding of the industry’s general economic
characteristics, attention should be focused on the competitive dynamics of the
industry. This entails using some well-validated concepts and analytic tools.
These include the five forces framework, the value net, driving forces, strategic
groups, competitor analysis, and key success factors. Proper use of these
analytic tools can provide managers with the understanding needed to craft a
strategy that fits the company’s situation within their industry environment.
The remainder of this chapter is devoted to describing how managers can use
these tools to inform and improve their strategic choices.
The Five Forces Framework
The character and strength of the competitive forces operating in an industry
are never the same from one industry to another. The most powerful and widely
used tool for diagnosing the principal competitive pressures in a market is the
five forces framework.1 This framework, depicted in Figure 3.3, holds that
competitive pressures on companies within an industry come from five
sources. These include (1) competition from rival sellers, (2) competition from
potential new entrants to the industry, (3) competition from producers of
substitute products, (4) supplier bargaining power, and (5) customer bargaining
power.
FIGURE 3.3 The Five Forces Model of Competition: A Key
Analytic Tool
Sources: Adapted from M. E. Porter, “How Competitive Forces Shape Strategy,” Harvard
Business Review 57, no. 2 (1979), pp. 137–145; M. E. Porter, “The Five Competitive Forces
That Shape Strategy,” Harvard Business Review 86, no. 1 (2008), pp. 80–86.
Using the five forces model to determine the nature and strength of
competitive pressures in a given industry involves three steps:
Step 1: For each of the five forces, identify the different parties involved,
along with the specific factors that bring about competitive pressures.
Step 2: Evaluate how strong the pressures stemming from each of the five
forces are (strong, moderate, or weak).
Step 3: Determine whether the five forces, overall, are supportive of high
industry profitability.
Competitive Pressures Created by the Rivalry
among Competing Sellers
The strongest of the five competitive forces is often the rivalry for buyer
patronage among competing sellers of a product or service. The intensity of
rivalry among competing sellers within an industry depends on a number of
identifiable factors. Figure 3.4 summarizes these factors, identifying those that
intensify or weaken rivalry among direct competitors in an industry. A brief
explanation of why these factors affect the degree of rivalry is in order:
FIGURE 3.4 Factors Affecting the Strength of Rivalry
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Rivalry increases when buyer demand is growing slowly or
declining. Rapidly expanding buyer demand produces enough new
business for all industry members to grow without having to draw customers
away from rival enterprises. But in markets where buyer demand is slow-
growing or shrinking, companies eager to gain more business are likely to
engage in aggressive price discounting, sales promotions, and other tactics to
increase their sales volumes at the expense of rivals, sometimes to the point
of igniting a fierce battle for market share.
Rivalry increases as it becomes less costly for buyers to switch brands. The
less costly (or easier) it is for buyers to switch their purchases from one seller
to another, the easier it is for sellers to steal customers away from rivals.
When the cost of switching brands is higher, buyers are less prone to
brand switching and sellers have protection from rivalrous moves.
Switching costs include not only monetary costs but also the time,
inconvenience, and psychological costs involved in switching brands. For
example, retailers may not switch to the brands of rival manufacturers
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because they are hesitant to sever long-standing supplier relationships or
incur the additional expense of retraining employees, accessing technical
support, or testing the quality and reliability of the new brand. Consumers
may not switch brands because they become emotionally attached to a
particular brand (e.g. if you identify with the Harley motorcycle brand and
lifestyle).
Rivalry increases as the products of rival sellers become less strongly
differentiated. When the offerings of rivals are identical or weakly
differentiated, buyers have less reason to be brand-loyal—a condition that
makes it easier for rivals to convince buyers to switch to their offerings.
Moreover, when the products of different sellers are virtually identical,
shoppers will choose on the basis of price, which can result in fierce price
competition among sellers. On the other hand, strongly differentiated product
offerings among rivals breed high brand loyalty on the part of buyers who
view the attributes of certain brands as more appealing or better suited to
their needs.
Rivalry is more intense when industry members have too much
inventory or significant amounts of idle production capacity,
especially if the industry’s product entails high fixed costs or high storage
costs. Whenever a market has excess supply (overproduction relative to
demand), rivalry intensifies as sellers cut prices in a desperate effort to cope
with the unsold inventory. A similar effect occurs when a product is
perishable or seasonal, since firms often engage in aggressive price cutting to
ensure that everything is sold. Likewise, whenever fixed costs account for a
large fraction of total cost so that unit costs are significantly lower at full
capacity, firms come under significant pressure to cut prices whenever they
are operating below full capacity. Unused capacity imposes a significant
cost-increasing penalty because there are fewer units over which to spread
fixed costs. The pressure of high fixed or high storage costs can push rival
firms into offering price concessions, special discounts, and rebates and
employing other volume-boosting competitive tactics.
Rivalry intensifies as the number of competitors increases and they become
more equal in size and capability. When there are many competitors in a
market, companies eager to increase their meager market share often engage
in price-cutting activities to drive sales, leading to intense rivalry. When
there are only a few competitors, companies are more wary of how their
rivals may react to their attempts to take market share away from them. Fear
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of retaliation and a descent into a damaging price war leads to restrained
competitive moves. Moreover, when rivals are of comparable size and
competitive strength, they can usually compete on a fairly equal footing—an
evenly matched contest tends to be fiercer than a contest in which one or
more industry members have commanding market shares and substantially
greater resources than their much smaller rivals.
Rivalry becomes more intense as the diversity of competitors increases in
terms of long-term directions, objectives, strategies, and countries of origin.
A diverse group of sellers often contains one or more mavericks willing to
try novel or rule-breaking market approaches, thus generating a more volatile
and less predictable competitive environment. Globally competitive markets
are often more rivalrous, especially when aggressors have lower costs and
are intent on gaining a strong foothold in new country markets.
Rivalry is stronger when high exit barriers keep unprofitable firms from
leaving the industry. In industries where the assets cannot easily be sold or
transferred to other uses, where workers are entitled to job protection, or
where owners are committed to remaining in business for personal reasons,
failing firms tend to hold on longer than they might otherwise—even when
they are bleeding red ink. Deep price discounting typically ensues, in a
desperate effort to cover costs and remain in business. This sort of rivalry can
destabilize an otherwise attractive industry.
The previous factors, taken as whole, determine whether the rivalry in an
industry is relatively strong, moderate, or weak. When rivalry is strong, the
battle for market share is generally so vigorous that the profit margins of most
industry members are squeezed to bare-bones levels. When rivalry is moderate,
a more normal state, the maneuvering among industry members, while lively
and healthy, still allows most industry members to earn acceptable profits.
When rivalry is weak, most companies in the industry are relatively well
satisfied with their sales growth and market shares and rarely undertake
offensives to steal customers away from one another. Weak rivalry means that
there is no downward pressure on industry profitability due to this particular
competitive force.
The Choice of Competitive Weapons
Competitive battles among rival sellers can assume many forms that extend
well beyond lively price competition. For example, competitors may resort to
such marketing tactics as special sales promotions, heavy advertising, rebates,
or low-interest-rate financing to drum up additional sales. Rivals may race one
another to differentiate their products by offering better performance features
or higher quality or improved customer service or a wider product selection.
They may also compete through the rapid introduction of next-generation
products, the frequent introduction of new or improved products, and efforts to
build stronger dealer networks, establish positions in foreign markets, or
otherwise expand distribution capabilities and market presence. Table 3.2
displays the competitive weapons that firms often employ in battling rivals,
along with their primary effects with respect to price (P), cost (C), and value
(V)—the elements of an effective business model and the value-price-cost
framework, discussed in Chapter 1.
TABLE 3.2 Common “Weapons” for Competing with Rivals
Types of Competitive
Weapons Primary Effects
Discounting prices,
holding clearance sales
Lowers price (P), increases total sales volume and market
share, lowers profits if price cuts are not offset by large
increases in sales volume
Offering coupons,
advertising items on
sale
Increases sales volume and total revenues, lowers price (P),
increases unit costs (C), may lower profit margins per unit sold
(P – C)
Advertising product or
service characteristics,
using ads to enhance a
company’s image
Boosts buyer demand, increases product differentiation and
perceived value (V), increases total sales volume and market
share, but may increase unit costs (C) and lower profit
margins per unit sold
Innovating to improve
product performance
and quality
Increases product differentiation and value (V), boosts buyer
demand, boosts total sales volume, likely to increase unit
costs (C)
Introducing new or
improved features,
increasing the number
of styles to provide
greater product
selection
Increases product differentiation and value (V), strengthens
buyer demand, boosts total sales volume and market share,
likely to increase unit costs (C)
Increasing
customization of
product or service
Increases product differentiation and value (V), increases
buyer switching costs, boosts total sales volume, often
increases unit costs (C)
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Types of Competitive
Weapons Primary Effects
Building a bigger, better
dealer network
Broadens access to buyers, boosts total sales volume and
market share, may increase unit costs (C)
Improving warranties,
offering low-interest
financing
Increases product differentiation and value (V), increases unit
costs (C), increases buyer switching costs, boosts total sales
volume and market share
Competitive Pressures Associated with the Threat
of New Entrants
New entrants into an industry threaten the position of rival firms since they will
compete fiercely for market share, add to the number of industry rivals, and
add to the industry’s production capacity in the process. But even the threat of
new entry puts added competitive pressure on current industry members and
thus functions as an important competitive force. This is because credible
threat of entry often prompts industry members to lower their prices and
initiate defensive actions in an attempt to deter new entrants. Just how
serious the threat of entry is in a particular market depends on (1)
whether entry barriers are high or low, and (2) the expected reaction of existing
industry members to the entry of newcomers.
Whether Entry Barriers Are High or Low The strength of the threat of
entry is governed to a large degree by the height of the industry’s entry
barriers. High barriers reduce the threat of potential entry, whereas low barriers
enable easier entry. Entry barriers are high under the following conditions:2
There are sizable economies of scale in production, distribution, advertising,
or other activities. When incumbent companies enjoy cost advantages
associated with large-scale operations, outsiders must either enter on a large
scale (a costly and perhaps risky move) or accept a cost disadvantage and
consequently lower profitability.
Incumbents have other hard to replicate cost advantages over new entrants.
Aside from enjoying economies of scale, industry incumbents can have cost
advantages that stem from the possession of patents or proprietary
technology, exclusive partnerships with the best and cheapest suppliers,
favorable locations, and low fixed costs (because they have older facilities
that have been mostly depreciated). Learning-based cost savings can also
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accrue from experience in performing certain activities such as
manufacturing or new product development or inventory management. The
extent of such savings can be measured with learning/experience curves. The
steeper the learning/experience curve, the bigger the cost advantage of the
company with the largest cumulative production volume. The microprocessor
industry provides an excellent example of this:
Manufacturing unit costs for microprocessors tend to decline about 20 percent each time cumulative
production volume doubles. With a 20 percent experience curve effect, if the first 1 million chips cost
$100 each, once production volume reaches 2 million, the unit cost would fall to $80 (80 percent of
$100), and by a production volume of 4 million, the unit cost would be $64 (80 percent of $80).3
Customers have strong brand preferences and high degrees of loyalty to
seller. The stronger the attachment of buyers to established brands, the harder
it is for a newcomer to break into the marketplace. In such cases, a new
entrant must have the financial resources to spend enough on advertising and
sales promotion to overcome customer loyalties and build its own clientele.
Establishing brand recognition and building customer loyalty can be a slow
and costly process. In addition, if it is difficult or costly for a customer to
switch to a new brand, a new entrant may have to offer a discounted price or
otherwise persuade buyers that its brand is worth the switching costs. Such
barriers discourage new entry because they act to boost financial
requirements and lower expected profit margins for new entrants.
Patents and other forms of intellectual property protection are in place. In a
number of industries, entry is prevented due to the existence of intellectual
property protection laws that remain in place for a given number of years.
Often, companies have a “wall of patents” in place to prevent other
companies from entering with a “me too” strategy that replicates a key piece
of technology.
There are strong “network effects” in customer demand. In industries where
buyers are more attracted to a product when there are many other users of the
product, there are said to be “network effects,” since demand is higher the
larger the network of users. Video game systems are an example because
users prefer to have the same systems as their friends so that they can play
together on systems they all know and can share games. When
incumbents have a large existing base of users, new entrants with
otherwise comparable products face a serious disadvantage in attracting
buyers.
Capital requirements are high. The larger the total dollar investment needed
to enter the market successfully, the more limited the pool of potential
entrants. The most obvious capital requirements for new entrants relate to
manufacturing facilities and equipment, introductory advertising and sales
promotion campaigns, working capital to finance inventories and customer
credit, and sufficient cash to cover startup costs.
There are difficulties in building a network of distributors/dealers or in
securing adequate space on retailers’ shelves. A potential entrant can face
numerous distribution-channel challenges. Wholesale distributors may be
reluctant to take on a product that lacks buyer recognition. Retailers must be
recruited and convinced to give a new brand ample display space and an
adequate trial period. When existing sellers have strong, well-functioning
distributor–dealer networks, a newcomer has an uphill struggle in squeezing
its way into existing distribution channels. Potential entrants sometimes have
to “buy” their way into wholesale or retail channels by cutting their prices to
provide dealers and distributors with higher markups and profit margins or
by giving them big advertising and promotional allowances. As a
consequence, a potential entrant’s own profits may be squeezed unless and
until its product gains enough consumer acceptance that distributors and
retailers are willing to carry it.
There are restrictive regulatory policies. Regulated industries like cable TV,
telecommunications, electric and gas utilities, radio and television
broadcasting, liquor retailing, nuclear power, and railroads entail
government-controlled entry. Government agencies can also limit or even bar
entry by requiring licenses and permits, such as the medallion required to
drive a taxicab in New York City. Government-mandated safety regulations
and environmental pollution standards also create entry barriers because they
raise entry costs. Recently enacted banking regulations in many countries
have made entry particularly difficult for small new bank startups—
complying with all the new regulations along with the rigors of competing
against existing banks requires very deep pockets.
There are restrictive trade policies. In international markets, host
governments commonly limit foreign entry and must approve all foreign
investment applications. National governments commonly use tariffs and
trade restrictions (antidumping rules, local content requirements, quotas, etc.)
to raise entry barriers for foreign firms and protect domestic producers from
outside competition.
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The Expected Reaction of Industry Members in Defending against New
Entry A second factor affecting the threat of entry relates to the ability and
willingness of industry incumbents to launch strong defensive maneuvers to
maintain their positions and make it harder for a newcomer to compete
successfully and profitably. Entry candidates may have second thoughts about
attempting entry if they conclude that existing firms will mount well-funded
campaigns to hamper (or even defeat) a newcomer’s attempt to gain a market
foothold big enough to compete successfully. Such campaigns can include any
of the “competitive weapons” listed in Table 3.2, such as ramping up
advertising expenditures, offering special price discounts to the very customers
a newcomer is seeking to attract, or adding attractive new product features (to
match or beat the newcomer’s product offering). Such actions can raise a
newcomer’s cost of entry along with the risk of failing, making the prospect of
entry less appealing. The result is that even the expectation on the part of new
entrants that industry incumbents will contest a newcomer’s entry may
be enough to dissuade entry candidates from going forward. Microsoft
can be counted on to fiercely defend the position that Windows enjoys in
computer operating systems and that Microsoft Office has in office
productivity software. This may well have contributed to Microsoft’s ability to
continuously dominate this market space.
However, there are occasions when industry incumbents have nothing in
their competitive arsenal that is formidable enough to either discourage entry
or put obstacles in a newcomer’s path that will defeat its strategic efforts to
become a viable competitor. In the restaurant industry, for example, existing
restaurants in a given geographic market have few actions they can take to
discourage a new restaurant from opening or to block it from attracting enough
patrons to be profitable. A fierce competitor like Nike was unable to prevent
newcomer Under Armour from rapidly growing its sales and market share in
sports apparel. Furthermore, there are occasions when industry incumbents can
be expected to refrain from taking or initiating any actions specifically aimed at
contesting a newcomer’s entry. In large industries, entry by small startup
enterprises normally poses no immediate or direct competitive threat to
industry incumbents and their entry is not likely to provoke defensive actions.
For instance, a new online retailer with sales prospects of maybe $5 to $10
million annually can reasonably expect to escape competitive retaliation from
much larger online retailers selling similar goods. The less that a newcomer’s
entry will adversely impact the sales and profitability of industry incumbents,
the more reasonable it is for potential entrants to expect industry incumbents to
refrain from reacting defensively.
Even high entry
barriers may not
suffice to keep out
certain kinds of
entrants: those with
resources and
capabilities that
enable them to leap
over or bypass the
barriers.
Figure 3.5 summarizes the factors that cause the overall competitive pressure
from potential entrants to be strong or weak. An analysis of these factors can
help managers determine whether the threat of entry into their industry is high
or low, in general. But certain kinds of companies—those with sizable
financial resources, proven competitive capabilities, and a respected brand
name—may be able to hurdle an industry’s entry barriers even when they are
high.4 For example, when Honda opted to enter the U.S. lawn-mower market in
competition against Toro, Snapper, Craftsman, John Deere, and others, it was
easily able to hurdle entry barriers that would have been formidable to other
newcomers because it had long-standing expertise in gasoline engines and a
reputation for quality and durability in automobiles that gave it instant
credibility with homeowners. As a result, Honda had to spend relatively little
on inducing dealers to handle the Honda lawn-mower line or attracting
customers. Similarly, Samsung’s brand reputation in televisions, DVD players,
and other electronics products gave it strong credibility in entering the market
for smartphones—Samsung’s Galaxy smartphones are now a formidable rival
of Apple’s iPhone.
FIGURE 3.5 Factors Affecting the Threat of Entry
It is also important to recognize that the barriers to entering an industry can
become stronger or weaker over time. For example, once key patents
preventing new entry in the market for functional 3-D printers expired, the way
was open for new competition to enter this industry. On the other hand, new
strategic actions by incumbent firms to increase advertising, strengthen
distributor–dealer relations, step up R&D, or improve product quality can erect
higher roadblocks to entry.
High entry barriers
and weak entry
threats today do not
always translate into
high entry barriers
and weak entry
threats tomorrow.
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Competitive Pressures from the Sellers of
Substitute Products
Companies in one industry are vulnerable to competitive pressure from the
actions of companies in a closely adjoining industry whenever buyers view the
products of the two industries as good substitutes. Substitutes do not include
other brands within your industry; this type of pressure comes from
outside the industry. Substitute products from outside the industry are
those that can perform the same or similar functions for the consumer as
products within your industry. For instance, the producers of eyeglasses and
contact lenses face competitive pressures from the doctors who do corrective
laser surgery. Similarly, the producers of sugar experience competitive
pressures from the producers of sugar substitutes (high-fructose corn syrup,
agave syrup, and artificial sweeteners). Internet providers of news-related
information have put brutal competitive pressure on the publishers of
newspapers. The makers of smartphones, by building ever better cameras into
their cell phones, have cut deeply into the sales of producers of handheld
digital cameras—most smartphone owners now use their phone to take pictures
rather than carrying a digital camera for picture-taking purposes.
As depicted in Figure 3.6, three factors determine whether the
competitive pressures from substitute products are strong or weak. Competitive
pressures are stronger when
FIGURE 3.6 Factors Affecting Competition from Substitute
Products
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1. Good substitutes are readily available and attractively priced. The presence
of readily available and attractively priced substitutes creates competitive
pressure by placing a ceiling on the prices industry members can charge
without risking sales erosion. This price ceiling, at the same time, puts a lid
on the profits that industry members can earn unless they find ways to cut
costs.
2. Buyers view the substitutes as comparable or better in terms of quality,
performance, and other relevant attributes. The availability of substitutes
inevitably invites customers to compare performance, features, ease of use,
and other attributes besides price. The users of paper cartons constantly
weigh the price-performance trade-offs with plastic containers and
metal cans, for example. Movie enthusiasts are increasingly
weighing whether to go to movie theaters to watch newly released movies or
wait until they can watch the same movies streamed to their home TV by
Netflix, Amazon Prime, cable providers, and other on-demand sources.
3. The costs that buyers incur in switching to the substitutes are low. Low
switching costs make it easier for the sellers of attractive substitutes to lure
buyers to their offerings; high switching costs deter buyers from purchasing
substitute products.
Some signs that the competitive strength of substitute products is increasing
include (1) whether the sales of substitutes are growing faster than the sales of
the industry being analyzed, (2) whether the producers of substitutes are
investing in added capacity, and (3) whether the producers of substitutes are
earning progressively higher profits.
But before assessing the competitive pressures coming from substitutes,
company managers must identify the substitutes, which is less easy than it
sounds since it involves (1) determining where the industry boundaries lie and
(2) figuring out which other products or services can address the same basic
customer needs as those produced by industry members. Deciding on the
industry boundaries is necessary for determining which firms are direct rivals
and which produce substitutes. This is a matter of perspective—there are no
hard-and-fast rules, other than to say that other brands of the same basic
product constitute rival products and not substitutes. Ultimately, it’s simply the
buyer who decides what can serve as a good substitute.
Competitive Pressures Stemming from Supplier
Bargaining Power
Whether the suppliers of industry members represent a weak or strong
competitive force depends on the degree to which suppliers have sufficient
bargaining power to influence the terms and conditions of supply in their favor.
Suppliers with strong bargaining power are a source of competitive pressure
because of their ability to charge industry members higher prices, pass costs on
to them, and limit their opportunities to find better deals. For instance,
Microsoft and Intel, both of which supply PC makers with essential
components, have been known to use their dominant market status not only to
charge PC makers premium prices but also to leverage their power over PC
makers in other ways. The bargaining power of these two companies over their
customers is so great that both companies have faced antitrust charges on
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numerous occasions. Prior to a legal agreement ending the practice, Microsoft
pressured PC makers to load only Microsoft products on the PCs they shipped.
Intel has defended itself against similar antitrust charges, but in filling orders
for newly introduced Intel chips, it continues to give top priority to PC makers
that use the biggest percentages of Intel chips in their PC models. Being on
Intel’s list of preferred customers helps a PC maker get an early allocation of
Intel’s latest chips and thus allows the PC maker to get new models to market
ahead of rivals.
Small-scale retailers often must contend with the power of manufacturers
whose products enjoy well-known brand names, since consumers expect to
find these products on the shelves of the retail stores where they shop. This
provides the manufacturer with a degree of pricing power and often the ability
to push hard for favorable shelf displays. Supplier bargaining power is also a
competitive factor in industries where unions have been able to organize the
workforce (which supplies labor). Air pilot unions, for example, have
employed their bargaining power to increase pilots’ wages and benefits in the
air transport industry. The growing clout of the largest healthcare union in the
United States has led to better wages and working conditions in nursing homes.
As shown in Figure 3.7, a variety of factors determine the
strength of suppliers’ bargaining power. Supplier power is stronger when
FIGURE 3.7 Factors Affecting the Bargaining Power of
Suppliers
Demand for suppliers’ products is high and the products are in short supply.
A surge in the demand for particular items shifts the bargaining power to the
suppliers of those products; suppliers of items in short supply have pricing
power.
Suppliers provide differentiated inputs that enhance the performance of the
industry’s product. The more valuable a particular input is in terms of
enhancing the performance or quality of the products of industry members,
the more bargaining leverage suppliers have. In contrast, the suppliers of
commodities are in a weak bargaining position, since industry members have
no reason other than price to prefer one supplier over another.
It is difficult or costly for industry members to switch their purchases from
one supplier to another. Low switching costs limit supplier bargaining power
by enabling industry members to change suppliers if any one supplier
attempts to raise prices by more than the costs of switching. Thus, the higher
the switching costs of industry members, the stronger the bargaining power
of their suppliers.
The supplier industry is dominated by a few large companies and it is more
concentrated than the industry it sells to. Suppliers with sizable market
shares and strong demand for the items they supply generally have sufficient
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bargaining power to charge high prices and deny requests from industry
members for lower prices or other concessions.
Industry members are incapable of integrating backward to self-
manufacture items they have been buying from suppliers. As a rule,
suppliers are safe from the threat of self-manufacture by their customers until
the volume of parts a customer needs becomes large enough for the customer
to justify backward integration into self-manufacture of the component.
When industry members can threaten credibly to self-manufacture suppliers’
goods, their bargaining power over suppliers increases proportionately.
Suppliers provide an item that accounts for no more than a small fraction of
the costs of the industry’s product. The more that the cost of a particular part
or component affects the final product’s cost, the more that industry members
will be sensitive to the actions of suppliers to raise or lower their prices.
When an input accounts for only a small proportion of total input costs,
buyers will be less sensitive to price increases. Thus, suppliers’ power
increases when the inputs they provide do not make up a large proportion of
the cost of the final product.
Good substitutes are not available for the suppliers’ products. The lack of
readily available substitute inputs increases the bargaining power of suppliers
by increasing the dependence of industry members on the suppliers.
Industry members are not major customers of suppliers. As a rule, suppliers
have less bargaining leverage when their sales to members of the industry
constitute a big percentage of their total sales. In such cases, the well-being
of suppliers is closely tied to the well-being of their major customers, and
their dependence upon them increases. The bargaining power of suppliers is
stronger, then, when they are not bargaining with major customers.
In identifying the degree of supplier power in an industry, it is important to
recognize that different types of suppliers are likely to have different amounts
of bargaining power. Thus, the first step is for managers to identify the
different types of suppliers, paying particular attention to those that provide the
industry with important inputs. The next step is to assess the bargaining power
of each type of supplier separately.
Competitive Pressures Stemming from Buyer
Bargaining Power and Price Sensitivity
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Whether buyers are able to exert strong competitive pressures on industry
members depends on (1) the degree to which buyers have bargaining power
and (2) the extent to which buyers are price-sensitive. Buyers with strong
bargaining power can limit industry profitability by demanding price
concessions, better payment terms, or additional features and services that
increase industry members’ costs. Buyer price sensitivity limits the profit
potential of industry members by restricting the ability of sellers to raise prices
without losing revenue due to lost sales.
As with suppliers, the leverage that buyers have in negotiating favorable
terms of sale can range from weak to strong. Individual consumers seldom
have much bargaining power in negotiating price concessions or other
favorable terms with sellers. However, their price sensitivity varies by
individual and by the type of product they are buying (whether it’s a necessity
or a discretionary purchase, for example). Similarly, small businesses usually
have weak bargaining power because of the small-size orders they place with
sellers. Many relatively small wholesalers and retailers join buying groups to
pool their purchasing power and approach manufacturers for better terms than
could be gotten individually. Large business buyers, in contrast, can have
considerable bargaining power. For example, large retail chains like
Walmart, Best Buy, Staples, and Home Depot typically have
considerable bargaining power in purchasing products from manufacturers, not
only because they buy in large quantities, but also because of manufacturers’
need for access to their broad base of customers. Major supermarket chains like
Kroger, Albertsons, Hannaford, and Aldi have sufficient bargaining power to
demand promotional allowances and lump-sum payments (called slotting fees)
from food products manufacturers in return for stocking certain brands or
putting them in the best shelf locations. Motor vehicle manufacturers have
strong bargaining power in negotiating to buy original-equipment tires from
tire makers such as Bridgestone, Goodyear, Michelin, Continental, and Pirelli,
partly because they buy in large quantities and partly because consumers are
more likely to buy replacement tires that match the tire brand on their vehicle
at the time of its purchase. The starting point for the analysis of buyers as a
competitive force is to identify the different types of buyers along the value
chain—then proceed to analyzing the bargaining power and price sensitivity of
each type separately. It is important to recognize that not all buyers of an
industry’s product have equal degrees of bargaining power with sellers, and
some may be less sensitive than others to price, quality, or service differences.
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Figure 3.8 summarizes the factors determining the strength of buyer power
in an industry. The top of this chart lists the factors that increase buyers’
bargaining power, which we discuss next. Note that the first five
factors are the mirror image of those determining the bargaining
power of suppliers.
FIGURE 3.8 Factors Affecting the Power of Buyers
Buyer bargaining power is stronger when
Buyer demand is weak in relation to the available supply. Weak or declining
demand and the resulting excess supply create a “buyers’ market,” in which
bargain-hunting buyers have leverage in pressing industry members for
better deals and special treatment. Conversely, strong or rapidly growing
market demand creates a “sellers’ market” characterized by tight supplies or
shortages—conditions that put buyers in a weak position to wring
concessions from industry members.
Industry goods are standardized or differentiation is weak. In such
circumstances, buyers make their selections on the basis of price, which
increases price competition among vendors.
Buyers’ costs of switching to competing brands or substitutes are relatively
low. Switching costs put a cap on how much industry producers can raise
prices or reduce quality before they will lose the buyer’s business.
Buyers are large and few in number relative to the number of sellers. The
larger the buyers, the more important their business is to the seller and the
more sellers will be willing to grant concessions.
Buyers pose a credible threat of integrating backward into the business of
sellers. Beer producers like Anheuser Busch InBev SA/NV (whose brands
include Budweiser, Molson Coors, and Heineken) have partially integrated
backward into metal-can manufacturing to gain bargaining power in
obtaining the balance of their can requirements from otherwise powerful
metal-can manufacturers.
Buyers are well informed about the product offerings of sellers (product
features and quality, prices, buyer reviews) and the cost of production (an
indicator of markup). The more information buyers have, the better
bargaining position they are in. The mushrooming availability of product
information on the Internet (and its ready access on smartphones) is giving
added bargaining power to consumers, since they can use this to find or
negotiate better deals. Apps such as ShopSavvy and BuyVia are now making
comparison shopping even easier.
Buyers have discretion to delay their purchases or perhaps even not make a
purchase at all. Consumers often have the option to delay purchases of
durable goods (cars, major appliances), or decline to buy discretionary goods
(massages, concert tickets) if they are not happy with the prices offered.
Business customers may also be able to defer their purchases of certain
items, such as plant equipment or maintenance services. This puts pressure
on sellers to provide concessions to buyers so that the sellers can keep their
sales numbers from dropping off.
Whether Buyers Are More or Less Price-Sensitive Low-income and
budget-constrained consumers are almost always price-sensitive; bargain-
hunting consumers are highly price-sensitive by nature. Most consumers grow
more price-sensitive as the price tag of an item becomes a bigger fraction of
their spending budget. Similarly, business buyers besieged by weak sales,
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intense competition, and other factors squeezing their profit margins are price-
sensitive. Price sensitivity also grows among businesses as the cost of an item
becomes a bigger fraction of their cost structure. Rising prices of frequently
purchased items heighten the price sensitivity of all types of buyers. On the
other hand, the price sensitivity of all types of buyers decreases the more that
the quality of the product matters.
The following factors increase buyer price sensitivity and result
in greater competitive pressures on the industry as a result:
Buyer price sensitivity increases when buyers are earning low profits or have
low income. Price is a critical factor in the purchase decisions of low-income
consumers and companies that are barely scraping by. In such cases, their
high price sensitivity limits the ability of sellers to charge high prices.
Buyers are more price-sensitive if the product represents a large fraction of
their total purchases. When a purchase eats up a large portion of a buyer’s
budget or represents a significant part of his or her cost structure, the buyer
cares more about price than might otherwise be the case.
Buyers are more price-sensitive when the quality of the product is not
uppermost in their considerations. Quality matters little when products are
relatively undifferentiated, leading buyers to focus more on price. But when
quality affects performance, or can reduce a business buyer’s other costs (by
saving on labor, materials, etc.), price will matter less.
Is the Collective Strength of the Five Competitive
Forces Conducive to Good Profitability?
Assessing whether each of the five competitive forces gives rise to strong,
moderate, or weak competitive pressures sets the stage for evaluating whether,
overall, the strength of the five forces is conducive to good profitability. Is any
of the competitive forces sufficiently powerful to undermine industry
profitability? Can companies in this industry reasonably expect to earn decent
profits in light of the prevailing competitive forces?
The most extreme case of a “competitively unattractive” industry occurs
when all five forces are producing strong competitive pressures: Rivalry among
sellers is vigorous, low entry barriers allow new rivals to gain a market
foothold, competition from substitutes is intense, and both suppliers and buyers
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are able to exercise considerable leverage. Strong competitive pressures
coming from all five directions drive industry profitability to unacceptably low
levels, frequently producing losses for many industry members and forcing
some out of business. But an industry can be competitively unattractive without
all five competitive forces being strong. In fact, intense competitive pressures
from just one of the five forces may suffice to destroy the conditions for good
profitability and prompt some companies to exit the business.
As a rule, the strongest competitive forces determine the extent of the
competitive pressure on industry profitability. Thus, in evaluating the strength
of the five forces overall and their effect on industry profitability, managers
should look to the strongest forces. Having more than one strong force will not
worsen the effect on industry profitability, but it does mean that the industry
has multiple competitive challenges with which to cope. In that sense, an
industry with three to five strong forces is even more “unattractive” as a place
to compete. Especially intense competitive conditions due to multiple strong
forces seem to be the norm in tire manufacturing, apparel, and commercial
airlines, three industries where profit margins have historically been thin.
CORE
CONCEPT
The strongest of the
five forces
determines the
extent of the
downward pressure
on an industry’s
profitability.
In contrast, when the overall impact of the five competitive forces is
moderate to weak, an industry is “attractive” in the sense that the average
industry member can reasonably expect to earn good profits and a nice return
on investment. The ideal competitive environment for earning superior profits
is one in which both suppliers and customers have limited power, there are no
good substitutes, high barriers block further entry, and rivalry among present
sellers is muted. Weak competition is the best of all possible worlds
for also-ran companies because even they can usually eke out a
decent profit—if a company can’t make a decent profit when competition is
weak, then its business outlook is indeed grim.
Matching Company Strategy to Competitive
Conditions
Working through the five forces model step by step not only aids strategy
makers in assessing whether the intensity of competition allows good
profitability but also promotes sound strategic thinking about how to better
match company strategy to the specific competitive character of the
marketplace. Effectively matching a company’s business strategy to prevailing
competitive conditions has two aspects:
1. Pursuing avenues that shield the firm from as many of the different
competitive pressures as possible.
2. Initiating actions calculated to shift the competitive forces in the company’s
favor by altering the underlying factors driving the five forces.
A company’s
strategy is
strengthened the
more it provides
insulation from
competitive
pressures, shifts the
competitive battle in
the company’s favor,
and positions the
firm to take
advantage of
attractive growth
opportunities.
But making headway on these two fronts first requires identifying
competitive pressures, gauging the relative strength of each of the five
competitive forces, and gaining a deep enough understanding of the state of
competition in the industry to know which strategy buttons to push.
COMPLEMENTORS AND THE VALUE
NET
Not all interactions among industry participants are necessarily competitive in
nature. Some have the potential to be cooperative, as the value net framework
demonstrates. Like the five forces framework, the value net includes an
analysis of buyers, suppliers, and substitutors (see Figure 3.9). But it differs
from the five forces framework in several important ways.
First, the analysis focuses on the interactions of industry participants with a
particular company. Thus, it places that firm in the center of the framework, as
Figure 3.9 shows. Second, the category of “competitors” is defined to include
not only the focal firm’s direct competitors or industry rivals but also the
sellers of substitute products and potential entrants. Third, the value net
framework introduces a new category of industry participant that is not found
in the five forces framework—that of “complementors.” Complementors are
the producers of complementary products, which are products that enhance the
value of the focal firm’s products when they are used together. Some examples
include snorkels and swim fins or shoes and shoelaces.
CORE
CONCEPT
Complementors
are the producers of
complementary
products, which are
products that
enhance the value
of the focal firm’s
products when they
are used together.
FIGURE 3.9 The Value Net
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The inclusion of complementors draws particular attention to the fact that
success in the marketplace need not come at the expense of other industry
participants. Interactions among industry participants may be cooperative in
nature rather than competitive. In the case of complementors, an increase in
sales for them is likely to increase the sales of the focal firm as well. But the
value net framework also encourages managers to consider other forms of
cooperative interactions and realize that value is created jointly by all industry
participants. For example, a company’s success in the marketplace depends on
establishing a reliable supply chain for its inputs, which implies the need for
cooperative relations with its suppliers. Often a firm works hand in
hand with its suppliers to ensure a smoother, more efficient
operation for both parties. Newell-Rubbermaid, and Procter & Gamble for
example, work cooperatively as suppliers to companies such as Walmart,
Target, and Kohl’s. Even direct rivals may work cooperatively if they
participate in industry trade associations or engage in joint lobbying efforts.
Value net analysis can help managers discover the potential to improve their
position through cooperative as well as competitive interactions.
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INDUSTRY DYNAMICS AND THE
FORCES DRIVING CHANGE
While it is critical to understand the nature and intensity of competitive and
cooperative forces in an industry, it is equally critical to understand that the
intensity of these forces is fluid and subject to change. All industries are
affected by new developments and ongoing trends that alter industry
conditions, some more speedily than others. The popular hypothesis that
industries go through a life cycle of takeoff, rapid growth, maturity, market
saturation and slowing growth, followed by stagnation or decline is but one
aspect of industry change—many other new developments and emerging trends
cause industry change.5 Any strategies devised by management will therefore
play out in a dynamic industry environment, so it’s imperative that managers
consider the factors driving industry change and how they might affect the
industry environment. Moreover, with early notice, managers may be able to
influence the direction or scope of environmental change and improve the
outlook.
Industry and competitive conditions change because forces are
enticing or pressuring certain industry participants (competitors, customers,
suppliers, complementors) to alter their actions in important ways. The most
powerful of the change agents are called driving forces because they have the
biggest influences in reshaping the industry landscape and altering competitive
conditions. Some driving forces originate in the outer ring of the company’s
macro-environment (see Figure 3.2), but most originate in the company’s more
immediate industry and competitive environment.
CORE
CONCEPT
Driving forces are
the major underlying
causes of change in
industry and
competitive
conditions.
Driving-forces analysis has three steps: (1) identifying what the driving
forces are; (2) assessing whether the drivers of change are, on the whole, acting
to make the industry more or less attractive; and (3) determining what strategy
changes are needed to prepare for the impact of the driving forces. All three
steps merit further discussion.
Identifying the Forces Driving Industry Change
Many developments can affect an industry powerfully enough to qualify as
driving forces. Some drivers of change are unique and specific to a particular
industry situation, but most drivers of industry and competitive change fall into
one of the following categories:
Changes in an industry’s long-term growth rate. Shifts in industry growth up
or down have the potential to affect the balance between industry supply and
buyer demand, entry and exit, and the character and strength of competition.
Whether demand is growing or declining is one of the key factors
influencing the intensity of rivalry in an industry, as explained earlier. But
the strength of this effect will depend on how changes in the industry growth
rate affect entry and exit in the industry. If entry barriers are low, then growth
in demand will attract new entrants, increasing the number of industry rivals
and changing the competitive landscape.
Increasing globalization. Globalization can be precipitated by such factors as
the blossoming of consumer demand in developing countries, the availability
of lower-cost foreign inputs, and the reduction of trade barriers, as has
occurred recently in many parts of Latin America and Asia. Significant
differences in labor costs among countries give manufacturers a strong
incentive to locate plants for labor-intensive products in low-wage countries
and use these plants to supply market demand across the world. Wages in
China, India, Vietnam, Mexico, and Brazil, for example, are much lower than
those in the United States, Germany, and Japan. The forces of globalization
are sometimes such a strong driver that companies find it highly
advantageous, if not necessary, to spread their operating reach into more and
more country markets. Globalization is very much a driver of industry
change in such industries as energy, mobile phones, steel, social media,
public accounting, commercial aircraft, electric power generation equipment,
and pharmaceuticals.
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Emerging new Internet capabilities and applications. Mushrooming use of
high-speed Internet service and Voice-over-Internet-Protocol (VoIP)
technology, growing acceptance of online shopping, and the exploding
popularity of Internet applications (“apps”) have been major drivers of
change in industry after industry. The Internet has allowed online discount
stock brokers, such as E*TRADE, and TD Ameritrade to mount a strong
challenge against full-service firms such as Edward Jones and Merrill Lynch.
The newspaper industry has yet to figure out a strategy for surviving the
advent of online news.
Massive open online courses (MOOCs) facilitated by
organizations such as Coursera, edX, and Udacity are profoundly affecting
higher education. The “Internet of things” will feature faster speeds, dazzling
applications, and billions of connected gadgets performing an array of
functions, thus driving further industry and competitive changes. But Internet-
related impacts vary from industry to industry. The challenges are to assess
precisely how emerging Internet developments are altering a particular
industry’s landscape and to factor these impacts into the strategy-making
equation.
Shifts in who buys the products and how the products are used. Shifts in
buyer demographics and the ways products are used can greatly alter
competitive conditions. Longer life expectancies and growing percentages of
relatively well-to-do retirees, for example, are driving demand growth in
such industries as cosmetic surgery, assisted living residences, and vacation
travel. The burgeoning popularity of streaming video has affected broadband
providers, wireless phone carriers, and television broadcasters, and created
opportunities for such new entertainment businesses as Hulu and Netflix.
Technological change and manufacturing process innovation. Advances in
technology can cause disruptive change in an industry by introducing
substitutes or can alter the industry landscape by opening up whole new
industry frontiers. For instance, revolutionary change in autonomous system
technology has put Google, Tesla, Apple, and every major automobile
manufacturer into a race to develop viable self-driving vehicles.
Product innovation. An ongoing stream of product innovations tends to alter
the pattern of competition in an industry by attracting more first-time buyers,
rejuvenating industry growth, and/or increasing product differentiation, with
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concomitant effects on rivalry, entry threat, and buyer power. Product
innovation has been a key driving force in the smartphone industry, which in
an ever more connected world is driving change in other industries. Philips
Lighting Hue bulbs now allow homeowners to use a smartphone app to
remotely turn lights on and off, blink if an intruder is detected, and create a
wide range of white and color ambiances. Wearable action-capture cameras
and unmanned aerial view drones are rapidly becoming a disruptive force in
the digital camera industry by enabling photography shots and videos not
feasible with handheld digital cameras.
Marketing innovation. When firms are successful in introducing new ways to
market their products, they can spark a burst of buyer interest, widen
industry demand, increase product differentiation, and lower unit costs—any
or all of which can alter the competitive positions of rival firms and force
strategy revisions. Consider, for example, the growing propensity of
advertisers to place a bigger percentage of their ads on social media sites like
Facebook and Twitter.
Entry or exit of major firms. Entry by a major firm thus often produces a new
ball game, not only with new key players but also with new rules for
competing. Similarly, exit of a major firm changes the competitive structure
by reducing the number of market leaders and increasing the dominance of
the leaders who remain.
Diffusion of technical know-how across companies and countries. As
knowledge about how to perform a particular activity or execute a particular
manufacturing technology spreads, products tend to become more
commodity-like. Knowledge diffusion can occur through scientific journals,
trade publications, onsite plant tours, word of mouth among suppliers and
customers, employee migration, and Internet sources.
Changes in cost and efficiency. Widening or shrinking differences in the
costs among key competitors tend to dramatically alter the state of
competition. Declining costs of producing tablets have enabled price cuts and
spurred tablet sales (especially lower-priced models) by making
them more affordable to lower-income households worldwide.
Lower cost e-books are cutting into sales of costlier hardcover books as
increasing numbers of consumers have laptops, iPads, Kindles, and other
brands of tablets.
Reductions in uncertainty and business risk. Many companies are hesitant to
enter industries with uncertain futures or high levels of business risk because
it is unclear how much time and money it will take to overcome various
technological hurdles and achieve acceptable production costs (as is the case
in the solar power industry). Over time, however, diminishing risk levels and
uncertainty tend to stimulate new entry and capital investments on the part of
growth-minded companies seeking new opportunities, thus dramatically
altering industry and competitive conditions.
Regulatory influences and government policy changes. Government
regulatory actions can often mandate significant changes in industry
practices and strategic approaches—as has recently occurred in the world’s
banking industry. New rules and regulations pertaining to government-
sponsored health insurance programs are driving changes in the health care
industry. In international markets, host governments can drive competitive
changes by opening their domestic markets to foreign participation or closing
them to protect domestic companies.
Changing societal concerns, attitudes, and lifestyles. Emerging social issues
as well as changing attitudes and lifestyles can be powerful instigators of
industry change. Growing concern about the effects of climate change has
emerged as a major driver of change in the energy industry. Concerns about
the use of chemical additives and the nutritional content of food products
have been driving changes in the restaurant and food industries. Shifting
societal concerns, attitudes, and lifestyles alter the pattern of competition,
favoring those players that respond with products targeted to the new trends
and conditions.
The most important
part of driving-forces
analysis is to
determine whether
the collective impact
of the driving forces
will increase or
decrease market
demand, make
competition more or
less intense, and
lead to higher or
lower industry
profitability.
page 78
While many forces of change may be at work in a given industry, no more
than three or four are likely to be true driving forces powerful enough to
qualify as the major determinants of why and how the industry is changing.
Thus, company strategists must resist the temptation to label every change they
see as a driving force. Table 3.3 lists the most common driving forces.
TABLE 3.3 The Most Common Drivers of Industry Change
Changes in the long-term industry growth rate
Increasing globalization
Emerging new Internet capabilities and applications
Shifts in buyer demographics
Technological change and manufacturing process innovation
Product and marketing innovation
Entry or exit of major firms
Diffusion of technical know-how across companies and countries
Changes in cost and efficiency
Reductions in uncertainty and business risk
Regulatory influences and government policy changes
Changing societal concerns, attitudes, and lifestyles
Assessing the Impact of the Forces Driving
Industry Change
The second step in driving-forces analysis is to determine whether the
prevailing change drivers, on the whole, are acting to make the industry
environment more or less attractive. Three questions need to be answered:
1. Are the driving forces, on balance, acting to cause demand for the industry’s
product to increase or decrease?
2. Is the collective impact of the driving forces making competition more or
less intense?
3. Will the combined impacts of the driving forces lead to higher or lower
industry profitability?
The real payoff of
driving-forces
analysis is to help
managers
understand what
strategy changes
are needed to
prepare for the
impacts of the
driving forces.
Getting a handle on the collective impact of the driving forces requires
looking at the likely effects of each factor separately, since the driving forces
may not all be pushing change in the same direction. For example, one driving
force may be acting to spur demand for the industry’s product while another is
working to curtail demand. Whether the net effect on industry demand is up or
down hinges on which change driver is the most powerful.
Adjusting the Strategy to Prepare for the Impacts
of Driving Forces
The third step in the strategic analysis of industry dynamics—where the real
payoff for strategy making comes—is for managers to draw some conclusions
about what strategy adjustments will be needed to deal with the impacts of the
driving forces. But taking the “right” kinds of actions to prepare for the
industry and competitive changes being wrought by the driving forces first
requires accurate diagnosis of the forces driving industry change and the
impacts these forces will have on both the industry environment and the
company’s business. To the extent that managers are unclear about the drivers
of industry change and their impacts, or if their views are off-base, the chances
of making astute and timely strategy adjustments are slim. So driving-forces
analysis is not something to take lightly; it has practical value and is basic to
the task of thinking strategically about where the industry is headed and how to
prepare for the changes ahead.
STRATEGIC GROUP ANALYSIS
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• LO 3-3
Map the market
positions of key
groups of industry
rivals.
Within an industry, companies commonly sell in different price/quality ranges,
appeal to different types of buyers, have different geographic coverage, and so
on. Some are more attractively positioned than others. Understanding which
companies are strongly positioned and which are weakly positioned is an
integral part of analyzing an industry’s competitive structure. The best
technique for revealing the market positions of industry competitors is
strategic group mapping.
CORE
CONCEPT
Strategic group
mapping is a
technique for
displaying the
different market or
competitive
positions that rival
firms occupy in the
industry.
Using Strategic Group Maps to Assess the Market
Positions of Key Competitors
A strategic group consists of those industry members with similar competitive
approaches and positions in the market. Companies in the same strategic group
can resemble one another in a variety of ways. They may have
comparable product-line breadth, sell in the same price/quality range,
employ the same distribution channels, depend on identical technological
approaches, compete in much the same geographic areas, or offer buyers
essentially the same product attributes or similar services and technical
assistance.6 Evaluating strategy options entails examining what strategic
groups exist, identifying the companies within each group, and determining if a
competitive “white space” exists where industry competitors are able to create
and capture altogether new demand. As part of this process, the number of
strategic groups in an industry and their respective market positions can be
displayed on a strategic group map.
CORE
CONCEPT
A strategic group is
a cluster of industry
rivals that have
similar competitive
approaches and
market positions.
The procedure for constructing a strategic group map is straightforward:
Identify the competitive characteristics that delineate strategic approaches
used in the industry. Typical variables used in creating strategic group maps
are price/quality range (high, medium, low), geographic coverage (local,
regional, national, global), product-line breadth (wide, narrow), degree of
service offered (no frills, limited, full), use of distribution channels (retail,
wholesale, Internet, multiple), degree of vertical integration (none, partial,
full), and degree of diversification into other industries (none, some,
considerable).
Plot the firms on a two-variable map using pairs of these variables.
Assign firms occupying about the same map location to the same strategic
group.
Draw circles around each strategic group, making the circles proportional to
the size of the group’s share of total industry sales revenues.
This produces a two-dimensional diagram like the one for the U.S. pizza
chain industry in Illustration Capsule 3.2.
Several guidelines need to be observed in creating strategic group maps.
First, the two variables selected as axes for the map should not be highly
correlated; if they are, the circles on the map will fall along a diagonal and
reveal nothing more about the relative positions of competitors than would be
revealed by comparing the rivals on just one of the variables. For instance, if
companies with broad product lines use multiple distribution channels while
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companies with narrow lines use a single distribution channel, then looking at
the differences in distribution-channel approaches adds no new information
about positioning.
Second, the variables chosen as axes for the map should reflect important
differences among rival approaches—when rivals differ on both variables, the
locations of the rivals will be scattered, thus showing how they are positioned
differently. Third, the variables used as axes don’t have to be either quantitative
or continuous; rather, they can be discrete variables, defined in terms of distinct
classes and combinations. Fourth, drawing the sizes of the circles on the map
proportional to the combined sales of the firms in each strategic group allows
the map to reflect the relative sizes of each strategic group. Fifth, if more than
two good variables can be used as axes for the map, then it is wise to draw
several maps to give different exposures to the competitive positioning
relationships present in the industry’s structure—there is not necessarily one
best map for portraying how competing firms are positioned.
The Value of Strategic Group Maps
Strategic group maps are revealing in several respects. The most important has
to do with identifying which industry members are close rivals and which are
distant rivals. Firms in the same strategic group are the closest rivals; the next
closest rivals are in the immediately adjacent groups. Often, firms in
strategic groups that are far apart on the map hardly compete at all.
For instance, Walmart’s clientele, merchandise selection, and pricing points are
much too different to justify calling Walmart a close competitor of Neiman
Marcus or Saks Fifth Avenue. For the same reason, the beers produced by
Yuengling are really not in competition with the beers produced by Pabst.
Strategic group
maps reveal which
companies are close
competitors and
which are distant
competitors.
ILLUSTRATION
CAPSULE 3.2 Comparative Market Positions
of Selected Companies in the Pizza Chain
Industry: A Strategic Group Map Example
Note: Circles are drawn roughly proportional to the sizes of the chains, based on revenues.
The second thing to be gleaned from strategic group mapping is that not all
positions on the map are equally attractive.7 Two reasons account for why
some positions can be more attractive than others:
1. Prevailing competitive pressures from the industry’s five forces may cause
the profit potential of different strategic groups to vary. The profit prospects
of firms in different strategic groups can vary from good to poor because of
differing degrees of competitive rivalry within strategic groups, differing
pressures from potential entrants to each group, differing degrees of
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exposure to competition from substitute products outside the industry, and
differing degrees of supplier or customer bargaining power from group to
group. For instance, in the ready-to-eat cereal industry, there are
significantly higher entry barriers (capital requirements, brand loyalty, etc.)
for the strategic group comprising the large branded-cereal makers
than for the group of generic-cereal makers or the group of small
natural-cereal producers. Differences among the branded rivals versus the
generic cereal makers make rivalry stronger within the generic-cereal
strategic group. Among apparel retailers, the competitive battle between
Marshall’s and TJ MAXX is more intense (with consequently smaller profit
margins) than the rivalry among Prada, Burberry, Gucci, Armani, and other
high-end fashion retailers.
2. Industry driving forces may favor some strategic groups and hurt others.
Likewise, industry driving forces can boost the business outlook for some
strategic groups and adversely impact the business prospects of others. In the
energy industry, producers of renewable energy, such as solar and wind
power, are gaining ground over fossil fuel-based producers due to
improvements in technology and increased concern over climate change.
Firms in strategic groups that are being adversely impacted by driving forces
may try to shift to a more favorably situated position. If certain firms are
known to be trying to change their competitive positions on the map, then
attaching arrows to the circles showing the targeted direction helps clarify
the picture of competitive maneuvering among rivals.
Some strategic
groups are more
favorably positioned
than others because
they confront
weaker competitive
forces and/or
because they are
more favorably
impacted by industry
driving forces.
Thus, part of strategic group map analysis always entails drawing
conclusions about where on the map is the “best” place to be and why. Which
companies/strategic groups are destined to prosper because of their positions?
Which companies/strategic groups seem destined to struggle? What accounts
for why some parts of the map are better than others? Since some strategic
groups are more attractive than others, one might ask why less well-positioned
firms do not simply migrate to the more attractive position. The answer is that
mobility barriers restrict movement between groups in the same way that
entry barriers prevent easy entry into attractive industries. The most profitable
strategic groups may be protected from entry by high mobility barriers.
CORE
CONCEPT
Mobility barriers
restrict firms in one
strategic group from
entering another
more attractive
strategic group in
the same industry.
COMPETITOR ANALYSIS AND THE
SOAR FRAMEWORK
Unless a company pays attention to the strategies and situations of competitors
and has some inkling of what moves they will be making, it ends up flying
blind into competitive battle. As in sports, scouting the opposition is an
essential part of game plan development. Gathering competitive intelligence
about the strategic direction and likely moves of key competitors allows a
company to prepare defensive countermoves, to craft its own strategic moves
with some confidence about what market maneuvers to expect from rivals in
response, and to exploit any openings that arise from competitors’ missteps.
The question is where to look for such information, since rivals rarely reveal
their strategic intentions openly. If information is not directly available, what
are the best indicators?
Studying
competitors’ past
behavior and
preferences
provides a valuable
assist in anticipating
what moves rivals
page 82
are likely to make
next and
outmaneuvering
them in the
marketplace.
Michael Porter’s SOAR Framework for Competitor Analysis points to
four indicators of a rival’s likely strategic moves and countermoves. These
include a rival’s Strategy, Objectives, Assumptions about itself and the industry,
and Resources and capabilities, as shown in Figure 3.10. A strategic profile of
a competitor that provides good clues to its behavioral proclivities can be
constructed by characterizing the rival along these four dimensions. By
“behavioral proclivities,” we mean what competitive moves a rival is likely to
make and how they are likely to react to the competitive moves of your
company—its probable actions and reactions. By listing all that you
know about a competitor (or a set of competitors) with respect to
each of the four elements of the SOAR framework, you are likely to gain some
insight about how the rival will behave in the near term. And knowledge of this
sort can help you to predict how this will affect you, and how you should
position yourself to respond. That is, what should you do to protect yourself or
gain advantage now (in advance); and what should you do in response to your
rivals next moves?
FIGURE 3.10 The SOAR Framework for Competitor Analysis
page 83
Current Strategy To succeed in predicting a competitor’s next moves,
company strategists need to have a good understanding of each rival’s current
strategy, as an indicator of its pattern of behavior and best strategic options.
Questions to consider include: How is the competitor positioned in the market?
What is the basis for its competitive advantage (if any)? What kinds of
investments is it making (as an indicator of its growth trajectory)?
Objectives An appraisal of a rival’s objectives should include not only its
financial performance objectives but strategic ones as well (such as those
concerning market share). What is even more important is to consider the
extent to which the rival is meeting these objectives and whether it is under
pressure to improve. Rivals with good financial performance are likely to
continue their present strategy with only minor fine-tuning. Poorly performing
rivals are virtually certain to make fresh strategic moves.
Resources and Capabilities A rival’s strategic moves and countermoves are
both enabled and constrained by the set of resources and capabilities the rival
has at hand. Thus, a rival’s resources and capabilities (and efforts to acquire
new resources and capabilities) serve as a strong signal of future strategic
actions (and reactions to your company’s moves). Assessing a rival’s
resources and capabilities involves sizing up not only its strengths in this
respect but its weaknesses as well.
Assumptions How a rival’s top managers think about their strategic
situation can have a big impact on how the rival behaves. Banks that believe
they are “too big to fail,” for example, may take on more risk than is
financially prudent. Assessing a rival’s assumptions entails considering its
assumptions about itself as well as about the industry it participates in.
Information regarding these four analytic components can often be gleaned
from company press releases, information posted on the company’s website
(especially the presentations management has recently made to securities
analysts), and such public documents as annual reports and 10-K filings. Many
companies also have a competitive intelligence unit that sifts through the
available information to construct up-to-date strategic profiles of rivals.8
Doing the necessary detective work can be time-consuming, but scouting
competitors well enough to anticipate their next moves allows managers to
prepare effective countermoves (perhaps even beat a rival to the punch) and to
take rivals’ probable actions into account in crafting their own best course of
action. Despite the importance of gathering such information, these activities
should never cross the bounds of ethical impropriety (see Illustration Capsule
3.3).
KEY SUCCESS FACTORS
An industry’s key success factors (KSFs) are those competitive factors that
most affect industry members’ ability to survive and prosper in the
marketplace: the particular strategy elements, product attributes, operational
approaches, resources, and competitive capabilities that spell the difference
between being a strong competitor and a weak competitor—and between profit
and loss. KSFs by their very nature are so important to competitive success that
all firms in the industry must pay close attention to them or risk becoming an
industry laggard or failure. To indicate the significance of KSFs another way,
how well the elements of a company’s strategy measure up against an
industry’s KSFs determines whether the company can meet the basic criteria
for surviving and thriving in the industry. Identifying KSFs, in light of the
prevailing and anticipated industry and competitive conditions, is therefore
always a top priority in analytic and strategy-making considerations. Company
page 84
strategists need to understand the industry landscape well enough to separate
the factors most important to competitive success from those that are less
important.
CORE
CONCEPT
Key success
factors are the
strategy elements,
product and service
attributes,
operational
approaches,
resources, and
competitive
capabilities that are
essential to
surviving and
thriving in the
industry.
Key success factors vary from industry to industry, and even from time to
time within the same industry, as change drivers and competitive conditions
change. But regardless of the circumstances, an industry’s key success factors
can always be deduced by asking the same three questions:
1. On what basis do buyers of the industry’s product choose between the
competing brands of sellers? That is, what product attributes and service
characteristics are crucial?
2. Given the nature of competitive rivalry prevailing in the marketplace, what
resources and competitive capabilities must a company have to be
competitively successful?
3. What shortcomings are almost certain to put a company at a significant
competitive disadvantage?
ILLUSTRATION
CAPSULE 3.3 Business Ethics and
Competitive Intelligence
Those who gather competitive intelligence on rivals can sometimes cross the fine line
between honest inquiry and unethical or even illegal behavior. For example, calling rivals to
get information about prices, the dates of new product introductions, or wage and salary
levels is legal, but misrepresenting one’s company affiliation during such calls is unethical.
Pumping rivals’ representatives at trade shows is ethical only if one wears a name tag with
accurate company affiliation indicated.
Avon Products at one point secured information about its biggest rival, Mary Kay
Cosmetics (MKC), by having its personnel search through the garbage bins outside MKC’s
headquarters. When MKC officials learned of the action and sued, Avon claimed it did
nothing illegal since a 1988 Supreme Court case had ruled that trash left on public property
(in this case, a sidewalk) was anyone’s for the taking. Avon even produced a videotape of
its removal of the trash at the MKC site. Avon won the lawsuit—but Avon’s action, while
legal, scarcely qualifies as ethical.
Only rarely are there more than five key factors for competitive success.
And even among these, two or three usually outrank the others in importance.
Managers should therefore bear in mind the purpose of identifying key success
factors—to determine which factors are most important to competitive success
—and resist the temptation to label a factor that has only minor importance as a
KSF.
In the beer industry, for example, although there are many types of buyers
(wholesale, retail, end consumer), it is most important to understand the
preferences and buying behavior of the beer drinkers. Their purchase decisions
are driven by price, taste, convenient access, and marketing. Thus, the KSFs
include a strong network of wholesale distributors (to get the company’s brand
stocked and favorably displayed in retail outlets, bars, restaurants, and
stadiums, where beer is sold) and clever advertising (to induce beer drinkers to
buy the company’s brand and thereby pull beer sales through the established
wholesale and retail channels). Because there is a potential for strong buyer
power on the part of large distributors and retail chains, competitive success
depends on some mechanism to offset that power, of which advertising (to
create demand pull) is one. Thus, the KSFs also include superior product
differentiation (as in microbrews) or superior firm size and branding
capabilities (as in national brands). The KSFs also include full utilization of
page 85
brewing capacity (to keep manufacturing costs low and offset the high costs of
advertising, branding, and product differentiation).
Correctly diagnosing an industry’s KSFs also raises a company’s chances of
crafting a sound strategy. The key success factors of an industry point to those
things that every firm in the industry needs to attend to in order to retain
customers and weather the competition. If the company’s strategy cannot
deliver on the key success factors of its industry, it is unlikely to earn enough
profits to remain a viable business.
THE INDUSTRY OUTLOOK FOR
PROFITABILITY
• LO 3-4
Determine whether
an industry’s outlook
presents a company
with sufficiently
attractive
opportunities for
growth and
profitability.
Each of the frameworks presented in this chapter—PESTEL, five forces
analysis, driving forces, strategy groups, competitor analysis, and key success
factors—provides a useful perspective on an industry’s outlook for future
profitability. Putting them all together provides an even richer and more
nuanced picture. Thus, the final step in evaluating the industry and
competitive environment is to use the results of each of the analyses
performed to determine whether the industry presents the company with strong
prospects for competitive success and attractive profits. The important factors
on which to base a conclusion include
How the company is being impacted by the state of the macro-environment.
Whether strong competitive forces are squeezing industry profitability to
subpar levels.
Whether the presence of complementors and the possibility of cooperative
actions improve the company’s prospects.
Whether industry profitability will be favorably or unfavorably affected by
the prevailing driving forces.
Whether the company occupies a stronger market position than rivals.
Whether this is likely to change in the course of competitive interactions.
How well the company’s strategy delivers on the industry key success
factors.
As a general proposition, the anticipated industry environment is
fundamentally attractive if it presents a company with good opportunity for
above-average profitability; the industry outlook is fundamentally unattractive
if a company’s profit prospects are unappealingly low.
However, it is a mistake to think of a particular industry as being equally
attractive or unattractive to all industry participants and all potential entrants.9
Attractiveness is relative, not absolute, and conclusions one way or the other
have to be drawn from the perspective of a particular company. For instance, a
favorably positioned competitor may see ample opportunity to capitalize on the
vulnerabilities of weaker rivals even though industry conditions are otherwise
somewhat dismal. At the same time, industries attractive to insiders may be
unattractive to outsiders because of the difficulty of challenging current market
leaders or because they have more attractive opportunities elsewhere.
The degree to which
an industry is
attractive or
unattractive is not
the same for all
industry participants
and all potential
entrants.
When a company decides an industry is fundamentally attractive and
presents good opportunities, a strong case can be made that it should invest
aggressively to capture the opportunities it sees and to improve its long-term
competitive position in the business. When a strong competitor concludes an
industry is becoming less attractive, it may elect to simply protect its present
position, investing cautiously—if at all—and looking for opportunities in other
page 86
industries. A competitively weak company in an unattractive industry may see
its best option as finding a buyer, perhaps a rival, to acquire its business.
KEY POINTS
Thinking strategically about a company’s external situation involves probing
for answers to the following questions:
1. What are the strategically relevant factors in the macro-environment, and
how do they impact an industry and its members? Industries differ
significantly as to how they are affected by conditions and developments in
the broad macro-environment. Using PESTEL analysis to identify which of
these factors is strategically relevant is the first step to understanding how a
company is situated in its external environment.
2. What kinds of competitive forces are industry members facing, and how
strong is each force? The strength of competition is a composite of five
forces: (1) rivalry within the industry, (2) the threat of new entry
into the market, (3) inroads being made by the sellers of substitutes,
(4) supplier bargaining power, and (5) buyer power. All five must be
examined force by force, and their collective strength evaluated. One strong
force, however, can be sufficient to keep average industry profitability low.
Working through the five forces model aids strategy makers in assessing
how to insulate the company from the strongest forces, identify attractive
arenas for expansion, or alter the competitive conditions so that they offer
more favorable prospects for profitability.
3. What cooperative forces are present in the industry, and how can a company
harness them to its advantage? Interactions among industry participants are
not only competitive in nature but cooperative as well. This is particularly
the case when complements to the products or services of an industry are
important. The Value Net framework assists managers in sizing up the
impact of cooperative as well as competitive interactions on their firm.
4. What factors are driving changes in the industry, and what impact will they
have on competitive intensity and industry profitability? Industry and
competitive conditions change because certain forces are acting to create
incentives or pressures for change. The first step is to identify the three or
four most important drivers of change affecting the industry being analyzed
(out of a much longer list of potential drivers). Once an industry’s change
page 87
drivers have been identified, the analytic task becomes one of determining
whether they are acting, individually and collectively, to make the industry
environment more or less attractive.
5. What market positions do industry rivals occupy—who is strongly positioned
and who is not? Strategic group mapping is a valuable tool for understanding
the similarities, differences, strengths, and weaknesses inherent in the market
positions of rival companies. Rivals in the same or nearby strategic groups
are close competitors, whereas companies in distant strategic groups usually
pose little or no immediate threat. The lesson of strategic group mapping is
that some positions on the map are more favorable than others. The profit
potential of different strategic groups may not be the same because industry
driving forces and competitive forces likely have varying effects on the
industry’s distinct strategic groups. Moreover, mobility barriers restrict
movement between groups in the same way that entry barriers prevent easy
entry into attractive industries.
6. What strategic moves are rivals likely to make next? Anticipating the actions
of rivals can help a company prepare effective countermoves. Using the
SOAR Framework for Competitor Analysis is helpful in this regard.
7. What are the key factors for competitive success? An industry’s key success
factors (KSFs) are the particular strategy elements, product attributes,
operational approaches, resources, and competitive capabilities that all
industry members must have in order to survive and prosper in the industry.
For any industry, they can be deduced by answering three basic questions:
(1) On what basis do buyers of the industry’s product choose between the
competing brands of sellers, (2) what resources and competitive capabilities
must a company have to be competitively successful, and (3) what
shortcomings are almost certain to put a company at a significant
competitive disadvantage?
8. Is the industry outlook conducive to good profitability? The last step in
industry analysis is summing up the results from applying each of the
frameworks employed in answering questions 1 to 7: PESTEL, five forces
analysis, Value Net, driving forces, strategic group mapping, competitor
analysis, and key success factors. Applying multiple lenses to the
question of what the industry outlook looks like offers a more
robust and nuanced answer. If the answers from each framework, seen as a
whole, reveal that a company’s profit prospects in that industry are above-
average, then the industry environment is basically attractive for that
LO 3-2
LO 3-3
LO 3-1, LO 3-4
company. What may look like an attractive environment for one company
may appear to be unattractive from the perspective of a different company.
Clear, insightful diagnosis of a company’s external situation is an essential
first step in crafting strategies that are well matched to industry and
competitive conditions. To do cutting-edge strategic thinking about the external
environment, managers must know what questions to pose and what analytic
tools to use in answering these questions. This is why this chapter has
concentrated on suggesting the right questions to ask, explaining concepts and
analytic approaches, and indicating the kinds of things to look for.
ASSURANCE OF LEARNING EXERCISES
1. Prepare a brief analysis of the organic food industry
using the information provided by the Organic Trade
Association at www.ota.com and the Organic Report
magazine at theorganicreport.com. That is, based on
the information provided on these websites, draw a
five forces diagram for the organic food industry and
briefly discuss the nature and strength of each of the
five competitive forces.
2. Based on the strategic group map in Illustration
Capsule 3.2, which pizza chains are Hungry Howie’s
closest competitors? With which strategic group does
California Pizza Kitchen compete the least, according
to this map? Why do you think no Pizza chains are
positioned in the area above the Pizza Hut’s strategic
group?
3. The National Restaurant Association publishes an
annual industry fact book that can be found at
www.restaurant.org. Based on information in the
latest report, does it appear that macro-environmental
factors and the economic characteristics of the
industry will present industry participants with
attractive opportunities for growth and profitability?
Explain.
http://www.ota.com/
http://theorganicreport.com/
http://www.restaurant.org/
LO 3-1
LO 3-2
LO 3-3
LO 3-4
page 88
LO 3-2
LO 3-3
LO 3-4
EXERCISES FOR SIMULATION PARTICIPANTS
1. Which of the factors listed in Table 3.1 might have the
most strategic relevance for your industry?
2. Which of the five competitive forces is creating the
strongest competitive pressures for your company?
3. What are the “weapons of competition” that rival
companies in your industry can use to gain sales and
market share? See Table 3.2 to help you identify the
various competitive factors.
4. What are the factors affecting the intensity of rivalry
in the industry in which your company is competing?
Use Figure 3.4 and the accompanying discussion to
help you in pinpointing the specific factors most
affecting competitive intensity. Would you
characterize the rivalry and jockeying for better
market position, increased sales, and market share
among the companies in your industry as fierce, very
strong, strong, moderate, or relatively weak? Why?
5. Are there any driving forces in the industry in which
your company is competing? If so, what
impact will these driving forces have? Will
they cause competition to be more or less intense?
Will they act to boost or squeeze profit margins? List
at least two actions your company should consider
taking in order to combat any negative impacts of the
driving forces.
6. Draw a strategic group map showing the market
positions of the companies in your industry. Which
companies do you believe are in the most attractive
position on the map? Which companies are the most
weakly positioned? Which companies do you believe
are likely to try to move to a different position on the
strategic group map?
7. What do you see as the key factors for being a
successful competitor in your industry? List at least
three.
LO 3-4
page 89
8. Does your overall assessment of the industry suggest
that industry rivals have sufficiently attractive
opportunities for growth and profitability? Explain.
ENDNOTES
1 Michael E. Porter, Competitive Strategy (New York: Free Press, 1980); Michael E. Porter, “The Five Competitive Forces
That Shape Strategy,” Harvard Business Review 86, no. 1 (January 2008), pp. 78–93.
2 J. S. Bain, Barriers to New Competition (Cambridge, MA: Harvard University Press, 1956); F. M. Scherer, Industrial
Market Structure and Economic Performance (Chicago: Rand McNally, 1971).
3 Ibid.
4 C. A. Montgomery and S. Hariharan, “Diversified Expansion by Large Established Firms,” Journal of Economic Behavior &
Organization 15, no. 1 (January 1991).
5 For a more extended discussion of the problems with the life-cycle hypothesis, see Porter, Competitive Strategy, pp. 157–
162.
6 Mary Ellen Gordon and George R. Milne, “Selecting the Dimensions That Define Strategic Groups: A Novel Market-Driven
Approach,” Journal of Managerial Issues 11, no. 2 (Summer 1999), pp. 213–233.
7 Avi Fiegenbaum and Howard Thomas, “Strategic Groups as Reference Groups: Theory, Modeling and Empirical
Examination of Industry and Competitive Strategy,” Strategic Management Journal 16 (1995), pp. 461–476; S. Ade
Olusoga, Michael P. Mokwa, and Charles H. Noble, “Strategic Groups, Mobility Barriers, and Competitive Advantage,”
Journal of Business Research 33 (1995), pp. 153–164.
8 Larry Kahaner, Competitive Intelligence (New York: Simon & Schuster, 1996).
9 B. Wernerfelt and C. Montgomery, “What Is an Attractive Industry?” Management Science 32, no. 10 (October 1986), pp.
1223–1230.
page 90
chapter 4
Evaluating a Company’s Resources,
Capabilities, and Competitiveness
Learning Objectives
After reading this chapter, you should be able to:
LO 4-1 Evaluate how well a company’s strategy is working.
LO 4-2 Assess the company’s strengths and weaknesses in light of
market opportunities and external threats.
LO 4-3 Explain why a company’s resources and capabilities are
critical for gaining a competitive edge over rivals.
LO 4-4 Understand how value chain activities affect a company’s
cost structure and customer value proposition.
LO 4-5 Explain how a comprehensive evaluation of a company’s
competitive situation can assist managers in making critical
decisions about their next strategic moves.
page 91
PhotoDisc Imaging/Getty Images
Crucial, of course, is having a difference that matters in the industry.
Cynthia Montgomery—Professor and author
If you don’t have a competitive advantage, don’t compete.
Jack Welch—Former CEO of General Electric
Organizations succeed in a competitive marketplace over the long run because they can do certain things
their customers value better than can their competitors.
Robert Hayes, Gary Pisano, and David Upton—Professors and consultants
page 92
Chapter 3 described how to use the tools of industry and competitor analysis to assess a
company’s external environment and lay the groundwork for matching a company’s strategy to
its external situation. This chapter discusses techniques for evaluating a company’s internal
situation, including its collection of resources and capabilities and the activities it performs
along its value chain. Internal analysis enables managers to determine whether their strategy
is likely to give the company a significant competitive edge over rival firms (given external
conditions). Combined with external analysis, it facilitates an understanding of how to
reposition a firm to take advantage of new opportunities and to cope with emerging
competitive threats. The analytic spotlight will be trained on six questions:
1. How well is the company’s present strategy working?
2. What are the company’s strengths and weaknesses in relation to the market opportunities
and external threats?
3. What are the company’s most important resources and capabilities, and will they give the
company a lasting competitive advantage over rival companies?
4. How do a company’s value chain activities impact its cost structure and customer value
proposition?
5. Is the company competitively stronger or weaker than key rivals?
6. What strategic issues and problems merit front-burner managerial attention?
In probing for answers to these questions, five analytic tools—resource and capability
analysis, SWOT analysis, value chain analysis, benchmarking, and competitive strength
assessment—will be used. All five are valuable techniques for revealing a company’s
competitiveness and for helping company managers match their strategy to the company’s
particular circumstances. Accordingly, this will enable the company to pass the first of the
three tests of a winning strategy (the Fit Test), as discussed in Chapter 1.
QUESTION 1: HOW WELL IS THE
COMPANY’S PRESENT STRATEGY
WORKING?
• LO 4-1
Evaluate how well a
company’s strategy
is working.
Before evaluating how well a company’s present strategy is working, it is best to
start with a clear view of what the strategy entails. The first thing to examine is the
company’s competitive approach. What moves has the company made recently to
attract customers and improve its market position—for instance, has it cut prices,
improved the design of its product, added new features, stepped up advertising,
entered a new geographic market, or merged with a competitor? Is it striving for a
competitive advantage based on low costs or a better product offering? Is it
concentrating on serving a broad spectrum of customers or a narrow market niche?
The company’s functional strategies in R&D, production, marketing, finance,
human resources, information technology, and so on further characterize company
strategy, as do any efforts to establish alliances with other enterprises. Figure 4.1
shows the key components of a single-business company’s strategy.
FIGURE 4.1 Identifying the Components of a Single-Business
Company’s Strategy
A determination of the effectiveness of this strategy requires a more in-depth
type of analysis. The two best indicators of how well a company’s strategy is
working are (1) whether the company is recording gains in financial strength and
profitability, and (2) whether the company’s competitive strength and market
standing are improving. Persistent shortfalls in meeting company performance
page 93
targets and weak marketplace performance relative to rivals are reliable warning
signs that the company has a weak strategy, suffers from poor strategy
execution, or both. Specific indicators of how well a company’s
strategy is working include
Trends in the company’s sales and earnings growth.
Trends in the company’s stock price.
The company’s overall financial strength.
The company’s customer retention rate.
The rate at which new customers are acquired.
Evidence of improvement in internal processes such as defect rate, order
fulfillment, delivery times, days of inventory, and employee productivity.
The stronger a company’s current overall performance, the more likely it has a
well-conceived, well-executed strategy. The weaker a company’s financial
performance and market standing, the more its current strategy must be questioned
and the more likely the need for radical changes. Table 4.1 provides a compilation
of the financial ratios most commonly used to evaluate a company’s financial
performance and balance sheet strength.
Sluggish financial
performance and
second-rate market
accomplishments
almost always signal
weak strategy, weak
execution, or both.
TABLE 4.1 Key Financial Ratios: How to Calculate Them and
What They Mean
Ratio How Calculated What It Shows
Profitability ratios
1. Gross profit
margin
Shows the
percentage of
revenues available to
cover operating
expenses and yield a
profit.
Ratio How Calculated What It Shows
2. Operating
profit margin
(or return on
sales) or
Shows the
profitability of current
operations without
regard to interest
charges and income
taxes. Earnings
before interest and
taxes is known as
EBIT in financial and
business accounting.
3. Net profit
margin (or
net return on
sales)
Shows after-tax
profits per dollar of
sales.
4. Total return
on assets
A measure of the
return on total
investment in the
enterprise. Interest is
added to after-tax
profits to form the
numerator, since
total assets are
financed by creditors
as well as by
stockholders.
5. Net return on
total assets
(ROA)
A measure of the
return earned by
stockholders on the
firm’s total assets.
6. Return on
stockholders’
equity (ROE)
The return
stockholders are
earning on their
capital investment in
the enterprise. A
return in the 12% to
15% range is
average.
page 94
Ratio How Calculated What It Shows
7. Return on
invested
capital
(ROIC)—
sometimes
referred to
as return on
capital
employed
(ROCE)
A measure of the
return that
shareholders are
earning on the
monetary capital
invested in the
enterprise. A higher
return reflects
greater bottom-line
effectiveness in the
use of long-term
capital.
Liquidity ratios
1. Current ratio Shows a firm’s ability
to pay current
liabilities using
assets that can be
converted to cash in
the near term. Ratio
should be higher
than 1.0.
2. Working
capital
Current assets − Current liabilities The cash available
for a firm’s day-to-
day operations.
Larger amounts
mean the company
has more internal
funds to (1) pay its
current liabilities on a
timely basis and (2)
finance inventory
expansion, additional
accounts receivable,
and a larger base of
operations without
resorting to
borrowing or raising
more equity capital.
Leverage ratios
Ratio How Calculated What It Shows
1. Total debt-to-
assets ratio
Measures the extent
to which borrowed
funds (both short-
term loans and long-
term debt) have
been used to finance
the firm’s operations.
A low ratio is better
—a high fraction
indicates overuse of
debt and greater risk
of bankruptcy.
2. Long-term
debt-to-
capital ratio
A measure of
creditworthiness and
balance sheet
strength. It indicates
the percentage of
capital investment
that has been
financed by both
long-term lenders
and stockholders. A
ratio below 0.25 is
preferable since the
lower the ratio, the
greater the capacity
to borrow additional
funds. Debt-to-
capital ratios above
0.50 indicate an
excessive reliance
on long-term
borrowing, lower
creditworthiness, and
weak balance sheet
strength.
Ratio How Calculated What It Shows
3. Debt-to-
equity ratio
Shows the balance
between debt (funds
borrowed both short
term and long term)
and the amount that
stockholders have
invested in the
enterprise. The
further the ratio is
below 1.0, the
greater the firm’s
ability to borrow
additional funds.
Ratios above 1.0 put
creditors at greater
risk, signal weaker
balance sheet
strength, and often
result in lower credit
ratings.
4. Long-term
debt-to-
equity ratio
Shows the balance
between long-term
debt and
stockholders’ equity
in the firm’s long-
term capital
structure. Low ratios
indicate a greater
capacity to borrow
additional funds if
needed.
5. Times-
interest-
earned (or
coverage)
ratio
Measures the ability
to pay annual
interest charges.
Lenders usually
insist on a minimum
ratio of 2.0, but ratios
above 3.0 signal
progressively better
creditworthiness.
Activity ratios
1. Days of
inventory
Measures inventory
management
efficiency. Fewer
days of inventory are
better.
page 95
Ratio How Calculated What It Shows
2. I
n
ventory
turnover
Measures the
number of inventory
turns per year.
Higher is better.
3. Average
collection
period
or
Indicates the
average length of
time the firm must
wait after making a
sale to receive cash
payment. A shorter
collection time is
better.
Other important measures of financial performance
1. Dividend
yield on
common
stock
A measure of the
return that
shareholders receive
in the form of
dividends. A “typical”
dividend yield is 2%
to 3%. The dividend
yield for fast-growth
companies is often
below 1%; the
dividend yield for
slow-growth
companies can run
4% to 5%.
2. Price-to-
earnings
(P/E) ratio
P/E ratios above 20
indicate strong
investor confidence
in a firm’s outlook
and earnings growth;
firms whose future
earnings are at risk
or likely to grow
slowly typically have
ratios below 12.
3. Dividend
payout ratio
Indicates the
percentage of after-
tax profits paid out
as dividends.
Ratio How Calculated What It Shows
4. Internal cash
flow
After-tax profits + Depreciation A rough estimate of
the cash a
company’s business
is generating after
payment of operating
expenses, interest,
and taxes. Such
amounts can be
used for dividend
payments or funding
capital expenditures.
5. Free cash
flow
After-tax profits + Depreciation − Capital
expenditures − Dividends
A rough estimate of
the cash a
company’s business
is generating after
payment of operating
expenses, interest,
taxes, dividends, and
desirable
reinvestments in the
business. The larger
a company’s free
cash flow, the
greater its ability to
internally fund new
strategic initiatives,
repay debt, make
new acquisitions,
repurchase shares of
stock, or increase
dividend payments.
QUESTION 2: WHAT ARE THE
COMPANY’S STRENGTHS AND
WEAKNESSES IN RELATION TO THE
MARKET OPPORTUNITIES AND
EXTERNAL THREATS?
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• LO 4-2
Assess the
company’s strengths
and weaknesses in
light of market
opportunities and
external threats.
An examination of the financial and other indicators discussed previously can tell
you how well a strategy is working, but they tell you little about the underlying
reasons—why it’s working or not. The simplest and most easily applied tool for
gaining some insight into the reasons for the success of a strategy or lack thereof is
known as SWOT analysis. SWOT is an acronym that stands for a
company’s internal Strengths and Weaknesses, market Opportunities, and
external Threats. Another name for SWOT analysis is Situational Analysis. A
first-rate SWOT analysis can help explain why a strategy is working well (or not)
by taking a good hard look a company’s strengths in relation to its weaknesses and
in relation to the strengths and weaknesses of competitors. Are the company’s
strengths great enough to make up for its weaknesses? Has the company’s strategy
built on these strengths and shielded the company from its weaknesses? Do the
company’s strengths exceed those of its rivals or have they been overpowered?
Similarly, a SWOT analysis can help determine whether a strategy has been
effective in fending off external threats and positioning the firm to take advantage
of market opportunities.
CORE
CONCEPT
SWOT analysis, or
Situational Analysis,
is a popular, easy-
to-use tool for sizing
up a company’s
strengths and
weaknesses, its
market
opportunities, and
external threats.
SWOT analysis has long been one of the most popular and widely used
diagnostic tools for strategists. It is used fruitfully by organizations that range in
type from large corporations to small businesses, to government agencies to non-
profits such as churches and schools. Its popularity stems in part from its ease of
use, but also because it can be used not only to evaluate the efficacy of a strategy,
but also as the basis for crafting a strategy from the outset that capitalizes on the
company’s strengths, overcomes its weaknesses, aims squarely at capturing the
company’s best opportunities, and defends against competitive and macro-
environmental threats. Moreover, a SWOT analysis can help a company with a
strategy that is working well in the present determine whether the company is in a
position to pursue new market opportunities and defend against emerging threats to
its future well-being.
Basing a company’s
strategy on its most
competitively
valuable strengths
gives the company
its best chance for
market success.
Identifying a Company’s Internal Strengths
An internal strength is something a company is good at doing or an attribute that
enhances its competitiveness in the marketplace.
One way to appraise a company’s strengths is to ask: What activities does the
company perform well? This question directs attention to the company’s skill level
in performing key pieces of its business—such as supply chain management,
R&D, production, distribution, sales and marketing, and customer service. A
company’s skill or proficiency in performing different facets of its operations can
range from the extreme of having minimal ability to perform an activity (perhaps
having just struggled to do it the first time) to the other extreme of being able to
perform the activity better than any other company in the industry.
When a company’s proficiency rises from that of mere ability to perform an
activity to the point of being able to perform it consistently well and at acceptable
cost, it is said to have a competence—a true capability, in other words. If a
company’s competence level in some activity domain is superior to that of its
rivals it is known as a distinctive competence. A core competence is a
proficiently performed internal activity that is central to a company’s strategy and
is typically distinctive as well. A core competence is a more competitively
valuable strength than a competence because of the activity’s key role in the
company’s strategy and the contribution it makes to the company’s market success
and profitability. Often, core competencies can be leveraged to create new markets
page 97
or new product demand, as the engine behind a company’s growth. Procter and
Gamble has a core competence in brand management, which has led to an ever-
increasing portfolio of market-leading consumer products, including Charmin,
Tide, Crest, Tampax, Olay, Febreze, Luvs, Pampers, and Swiffer. Nike
has a core competence in designing and marketing innovative athletic
footwear and sports apparel. Kellogg has a core competence in developing,
producing, and marketing breakfast cereals.
CORE
CONCEPT
A competence is an
activity that a
company has
learned to perform
with proficiency.
A distinctive
competence is a
capability that
enables a company
to perform a
particular set of
activities better than
its rivals.
CORE
CONCEPT
A core competence
is an activity that a
company performs
proficiently and that
is also central to its
strategy and
competitive success.
Identifying Company Internal Weaknesses
An internal weakness is something a company lacks or does poorly (in comparison
to others) or a condition that puts it at a disadvantage in the marketplace. It can be
thought of as a competitive deficiency. A company’s internal weaknesses can
relate to (1) inferior or unproven skills, expertise, or intellectual capital in
competitively important areas of the business, or (2) deficiencies in competitively
important physical, organizational, or intangible assets. Nearly all companies have
competitive deficiencies of one kind or another. Whether a company’s internal
weaknesses make it competitively vulnerable depends on how much they matter in
the marketplace and whether they are offset by the company’s strengths.
CORE
CONCEPT
A company’s
strengths represent
its competitive
assets; its
weaknesses are
shortcomings that
constitute
competitive
liabilities.
Table 4.2 lists many of the things to consider in compiling a company’s
strengths and weaknesses. Sizing up a company’s complement of strengths and
deficiencies is akin to constructing a strategic balance sheet, where strengths
represent competitive assets and weaknesses represent competitive liabilities.
Obviously, the ideal condition is for the company’s competitive assets to outweigh
its competitive liabilities by an ample margin!
TABLE 4.2 What to Look for in Identifying a Company’s
Strengths, Weaknesses, Opportunities, and Threats
Strengths and Competitive Assets Weaknesses and Competitive Deficiencies
Strengths and Competitive Assets Weaknesses and Competitive Deficiencies
Ample financial resources to grow the
business
Strong brand-name image or reputation
Distinctive core competencies
Cost advantages over rivals
Attractive customer base
Proprietary technology, superior
technological skills, important patents
Strong bargaining power over suppliers or
buyers
Superior product quality
Wide geographic coverage and/or strong
global distribution capability
Alliances and/or joint ventures that provide
access to valuable technology,
competencies, and/or attractive
geographic markets
No distinctive core competencies
Lack of attention to customer needs
Inferior product quality
Weak balance sheet, too much debt
Higher costs than competitors
Too narrow a product line relative to rivals
Weak brand image or reputation
Lack of adequate distribution capability
Lack of management depth
A plague of internal operating problems or
obsolete facilities
Too much underutilized plant capacity
Market Opportunities External Threats
Meet sharply rising buyer demand for the
industry’s product
Serve additional customer groups or
market segments
Expand into new geographic markets
Expand the company’s product line to
meet a broader range of customer needs
Enter new product lines or new
businesses
Take advantage of falling trade barriers in
attractive foreign markets
Take advantage of an adverse change in
the fortunes of rival firms
Acquire rival firms or companies with
attractive technological expertise or
competencies
Take advantage of emerging technological
developments to innovate
Enter into alliances or other cooperative
ventures
Increased intensity of competition
Slowdowns in market growth
Likely entry of potent new competitors
Growing bargaining power of customers or
suppliers
A shift in buyer needs and tastes away
from the industry’s product
Adverse demographic changes that
threaten to curtail demand for the
industry’s product
Adverse economic conditions that
threaten critical suppliers or distributors
Changes in technology—particularly
disruptive technology that can undermine
the company’s distinctive competencies
Restrictive foreign trade policies
Costly new regulatory requirements
Tight credit conditions
Rising prices on energy or other key
inputs
Identifying a Company’s Market Opportunities
Market opportunity is a big factor in shaping a company’s strategy. Indeed,
managers can’t properly tailor strategy to the company’s situation without first
identifying its market opportunities and appraising the growth and profit potential
each one holds. Depending on the prevailing circumstances, a company’s
opportunities can be plentiful or scarce, fleeting or lasting, and can range from
wildly attractive to marginally interesting or unsuitable.
Newly emerging and fast-changing markets sometimes present stunningly big or
“golden” opportunities, but it is typically hard for managers at one company to
peer into “the fog of the future” and spot them far ahead of managers at other
companies.1 But as the fog begins to clear, golden opportunities are nearly always
seized rapidly—and the companies that seize them are usually those that have been
staying alert with diligent market reconnaissance and preparing themselves to
capitalize on shifting market conditions swiftly. Table 4.2 displays a sampling of
potential market opportunities.
Identifying External Threats
Often, certain factors in a company’s external environment pose threats to its
profitability and competitive well-being. Threats can stem from such factors as the
emergence of cheaper or better technologies, the entry of lower-cost competitors
into a company’s market stronghold, new regulations that are more burdensome to
a company than to its competitors, unfavorable demographic shifts, and political
upheaval in a foreign country where the company has facilities.
Simply making lists
of a company’s
strengths,
weaknesses,
opportunities, and
threats is not
enough; the payoff
from SWOT analysis
comes from the
conclusions about a
company’s situation
and the implications
for strategy
improvement that
flow from the four
lists.
External threats may pose no more than a moderate degree of adversity (all
companies confront some threatening elements in the course of doing business), or
page 98
page 99
they may be imposing enough to make a company’s situation look tenuous. On
rare occasions, market shocks can give birth to a sudden-death threat that throws a
company into an immediate crisis and a battle to survive. Many of the
world’s major financial institutions were plunged into unprecedented
crisis in 2008–2009 by the aftereffects of high-risk mortgage lending, inflated
credit ratings on subprime mortgage securities, the collapse of housing prices, and
a market flooded with mortgage-related investments (collateralized debt
obligations) whose values suddenly evaporated. It is management’s job to identify
the threats to the company’s future prospects and to evaluate what strategic actions
can be taken to neutralize or lessen their impact.
What Do the SWOT Listings Reveal?
SWOT analysis involves more than making four lists. In crafting a new strategy, it
offers a strong foundation for understanding how to position the company to build
on its strengths in seizing new business opportunities and how to mitigate external
threats by shoring up its competitive deficiencies. In assessing the effectiveness of
an existing strategy, it can be used to glean insights regarding the company’s
overall business situation (thus the name Situational Analysis); and it can help
translate these insights into recommended strategic actions. Figure 4.2 shows the
steps involved in gleaning insights from SWOT analysis.
FIGURE 4.2 The Steps Involved in SWOT Analysis: Identify the
Four Components of SWOT, Draw Conclusions,
Translate Implications into Strategic Actions
page 100
The beauty of SWOT analysis is its simplicity; but this is also its primary
limitation. For a deeper and more accurate understanding of a company’s situation,
more sophisticated tools are required. Chapter 3 introduced you to a set of tools for
analyzing a company’s external situation. In the rest of this chapter, we look more
deeply at a company’s internal situation, beginning with the company’s resources
and capabilities.
QUESTION 3: WHAT ARE THE
COMPANY’S MOST IMPORTANT
RESOURCES AND CAPABILITIES, AND
WILL THEY GIVE THE COMPANY A
LASTING COMPETITIVE ADVANTAGE?
• LO 4-3
Explain why a
company’s
resources and
capabilities are
critical for gaining a
competitive edge
over rivals.
An essential element of a company’s internal environment is the nature of
resources and capabilities. A company’s resources and capabilities are its
competitive assets and determine whether its competitive power in the
marketplace will be impressively strong or disappointingly weak. Companies with
second-rate competitive assets nearly always are relegated to a trailing position in
the industry.
CORE
CONCEPT
A company’s
resources and
capabilities
represent its
competitive assets
and are
determinants of its
competitiveness and
ability to succeed in
the marketplace.
Resource and capability analysis provides managers with a powerful tool for
sizing up the company’s competitive assets and determining whether they can
provide the foundation necessary for competitive success in the marketplace. This
is a two-step process. The first step is to identify the company’s resources and
capabilities. The second step is to examine them more closely to ascertain which
are the most competitively important and whether they can support a sustainable
competitive advantage over rival firms.2 This second step involves applying the
four tests of a resource’s competitive power.
Resource and
capability analysis
is a powerful tool for
sizing up a
company’s
competitive assets
and determining
whether the assets
can support a
sustainable
competitive
advantage over
market rivals.
Identifying the Company’s Resources and
Capabilities
A firm’s resources and capabilities are the fundamental building blocks of its
competitive strategy. In crafting strategy, it is essential for managers to know how
to take stock of the company’s full complement of resources and capabilities. But
before they can do so, managers and strategists need a more precise definition of
these terms.
In brief, a resource is a productive input or competitive asset that is owned or
controlled by the firm. Firms have many different types of resources at their
disposal that vary not only in kind but in quality as well. Some are of a higher
quality than others, and some are more competitively valuable, having greater
potential to give a firm a competitive advantage over its rivals. For example, a
company’s brand is a resource, as is an R&D team—yet some brands such as
Coca-Cola and Xerox are well known, with enduring value, while others have little
more name recognition than generic products. In similar fashion, some R&D teams
are far more innovative and productive than others due to the outstanding talents of
the individual team members, the team’s composition, its experience, and its
chemistry.
A capability (or competence) is the capacity of a firm to perform some internal
activity competently. Capabilities or competences also vary in form, quality, and
competitive importance, with some being more competitively valuable than others.
American Express displays superior capabilities in brand management and
marketing; Starbucks’s employee management, training, and real estate capabilities
are the drivers behind its rapid growth; Microsoft’s competences are in developing
operating systems for computers and user software like Microsoft Office®.
Organizational capabilities are developed and enabled through the deployment of
a company’s resources.3 For example, Nestlé’s brand management capabilities for
its 2,000 + food, beverage, and pet care brands draw on the knowledge of the
company’s brand managers, the expertise of its marketing department, and the
page 101company’s relationships with retailers in nearly 200 countries. W. L.
Gore’s product innovation capabilities in its fabrics and medical and
industrial product businesses result from the personal initiative, creative talents,
and technological expertise of its associates and the company’s culture that
encourages accountability and creative thinking.
CORE
CONCEPT
A resource is a
competitive asset
that is owned or
controlled by a
company; a
capability (or
competence) is the
capacity of a firm to
perform some
internal activity
competently.
Capabilities are
developed and
enabled through the
deployment of a
company’s
resources.
Types of Company Resources A useful way to identify a company’s resources
is to look for them within categories, as shown in Table 4.3. Broadly speaking,
resources can be divided into two main categories: tangible and intangible
resources. Although human resources make up one of the most important parts of a
company’s resource base, we include them in the intangible category to emphasize
the role played by the skills, talents, and knowledge of a company’s human
resources.
TABLE 4.3 Types of Company Resources
Tangible resources
page 102
Tangible resources
Physical resources: land and real estate; manufacturing plants, equipment, and/or
distribution facilities; the locations of stores, plants, or distribution centers, including the
overall pattern of their physical locations; ownership of or access rights to natural resources
(such as mineral deposits)
Financial resources: cash and cash equivalents; marketable securities; other financial assets
such as a company’s credit rating and borrowing capacity
Technological assets: patents, copyrights, production technology, innovation technologies,
technological processes
Organizational resources: IT and communication systems (satellites, servers, workstations,
etc.); other planning, coordination, and control systems; the company’s organizational design
and reporting structure
Intangible resources
Human assets and intellectual capital: the education, experience, knowledge, and talent of
the workforce, cumulative learning, and tacit knowledge of employees; collective learning
embedded in the organization, the intellectual capital and know-how of specialized teams
and work groups; the knowledge of key personnel concerning important business functions;
managerial talent and leadership skill; the creativity and innovativeness of certain personnel
Brands, company image, and reputational assets: brand names, trademarks, product or
company image, buyer loyalty and goodwill; company reputation for quality, service, and
reliability; reputation with suppliers and partners for fair dealing
Relationships: alliances, joint ventures, or partnerships that provide access to technologies,
specialized know-how, or geographic markets; networks of dealers or distributors; the trust
established with various partners
Company culture and incentive system: the norms of behavior, business principles, and
ingrained beliefs within the company; the attachment of personnel to the company’s ideals;
the compensation system and the motivation level of company personnel
Tangible resources are the most easily identified, since tangible resources are
those that can be touched or quantified readily. Obviously, they include various
types of physical resources such as manufacturing facilities and mineral resources,
but they also include a company’s financial resources, technological resources,
and organizational resources such as the company’s communication and control
systems. Note that technological resources are included among tangible resources,
by convention, even though some types, such as copyrights and trade secrets,
might be more logically categorized as intangible.
Intangible resources are harder to discern, but they are often among the most
important of a firm’s competitive assets. They include various sorts of human
assets and intellectual capital, as well as a company’s brands, image, and
reputational assets. While intangible resources have no material
existence on their own, they are often embodied in something material.
Thus, the skills and knowledge resources of a firm are embodied in its managers
and employees; a company’s brand name is embodied in the company logo or
product labels. Other important kinds of intangible resources include a company’s
relationships with suppliers, buyers, or partners of various sorts, and the company’s
culture and incentive system.
Listing a company’s resources category by category can prevent managers from
inadvertently overlooking some company resources that might be competitively
important. At times, it can be difficult to decide exactly how to categorize certain
types of resources. For example, resources such as a work group’s specialized
expertise in developing innovative products can be considered to be technological
assets or human assets or intellectual capital and knowledge assets; the work ethic
and drive of a company’s workforce could be included under the company’s
human assets or its culture and incentive system. In this regard, it is important to
remember that it is not exactly how a resource is categorized that matters but,
rather, that all of the company’s different types of resources are included in the
inventory. The real purpose of using categories in identifying a company’s
resources is to ensure that none of a company’s resources go unnoticed when sizing
up the company’s competitive assets.
Identifying Organizational Capabilities Organizational capabilities are more
complex entities than resources; indeed, they are built up through the use of
resources and draw on some combination of the firm’s resources as they are
exercised. Virtually all organizational capabilities are knowledge-based, residing in
people and in a company’s intellectual capital, or in organizational processes and
systems, which embody tacit knowledge. For example, Amazon’s speedy delivery
capabilities rely on the knowledge of its fulfillment center managers, its
relationship with the United Parcel Service, and the experience of its
merchandisers to correctly predict inventory flow. Bose’s capabilities in auditory
system design arise from the talented engineers that form the R&D team as well as
the company’s strong culture, which celebrates innovation and beautiful design.
Because of their complexity, organizational capabilities are harder to categorize
than resources and more challenging to search for as a result. There are, however,
two approaches that can make the process of uncovering and identifying a firm’s
capabilities more systematic. The first method takes the completed listing of a
firm’s resources as its starting point. Since organizational capabilities are built
from resources and utilize resources as they are exercised, a firm’s resources can
provide a strong set of clues about the types of capabilities the firm is likely to
have accumulated. This approach simply involves looking over the firm’s
resources and considering whether (and to what extent) the firm has built up any
related capabilities. So, for example, a fleet of trucks, the latest RFID tracking
technology, and a set of large automated distribution centers may be indicative of
page 103
sophisticated capabilities in logistics and distribution. R&D teams composed of
top scientists with expertise in genomics may suggest organizational capabilities in
developing new gene therapies or in biotechnology more generally.
The second method of identifying a firm’s capabilities takes a functional
approach. Many organizational capabilities relate to fairly specific functions; these
draw on a limited set of resources and typically involve a single department or
organizational unit. Capabilities in injection molding or continuous casting or
metal stamping are manufacturing-related; capabilities in direct selling,
promotional pricing, or database marketing all connect to the sales and marketing
functions; capabilities in basic research, strategic innovation, or new product
development link to a company’s R&D function. This approach
requires managers to survey the various functions a firm performs to
find the different capabilities associated with each function.
A problem with this second method is that many of the most important
capabilities of firms are inherently cross-functional. Cross-functional capabilities
draw on a number of different kinds of resources and are multidimensional in
nature—they spring from the effective collaboration among people with different
types of expertise working in different organizational units. Warby Parker draws
from its cross-functional design process to create its popular eyewear. Its design
capabilities are not just due to its creative designers, but are the product of their
capabilities in market research and engineering as well as their relations with
suppliers and manufacturing companies. Cross-functional capabilities and other
complex capabilities involving numerous linked and closely integrated competitive
assets are sometimes referred to as resource bundles.
CORE
CONCEPT
A resource bundle
is a linked and
closely integrated
set of competitive
assets centered
around one or more
cross-functional
capabilities.
It is important not to miss identifying a company’s resource bundles, since they
can be the most competitively important of a firm’s competitive assets. Resource
bundles can sometimes pass the four tests of a resource’s competitive power
(described below) even when the individual components of the resource bundle
cannot. Although PetSmart’s supply chain and marketing capabilities are matched
well by rival Petco, the company continues to outperform competitors through its
customer service capabilities (including animal grooming and veterinary and day
care services). Nike’s bundle of styling expertise, marketing research skills,
professional endorsements, brand name, and managerial know-how has allowed it
to remain number one in the athletic footwear and apparel industry for more than
20 years.
Assessing the Competitive Power of a Company’s
Resources and Capabilities
To assess a company’s competitive power, one must go beyond merely identifying
its resources and capabilities to probe its caliber.4 Thus, the second step in
resource and capability analysis is designed to ascertain which of a company’s
resources and capabilities are competitively superior and to what extent they can
support a company’s quest for a sustainable competitive advantage over market
rivals. When a company has competitive assets that are central to its strategy and
superior to those of rival firms, they can support a competitive advantage, as
defined in Chapter 1. If this advantage proves durable despite the best efforts of
competitors to overcome it, then the company is said to have a sustainable
competitive advantage. While it may be difficult for a company to achieve a
sustainable competitive advantage, it is an important strategic objective because it
imparts a potential for attractive and long-lived profitability.
CORE
CONCEPT
Recall that a
competitive
advantage means
that you can
produce more value
(V) for the customer
than rivals can, or
the same value at
lower cost (C). In
other words, your V-
C is greater than the
V-C of competitors.
V-C is what we call
the Total Economic
Value produced by a
company.
page 104
The Four Tests of a Resource’s Competitive Power The competitive power of
a resource or capability is measured by how many of four specific tests it can
pass.5 These tests are referred to as the VRIN tests for sustainable competitive
advantage—VRIN is a shorthand reminder standing for Valuable, Rare,
Inimitable, and Nonsubstitutable. The first two tests determine whether a resource
or capability can support a competitive advantage. The last two determine whether
the competitive advantage can be sustained.
CORE
CONCEPT
The VRIN tests for
sustainable
competitive
advantage ask
whether a resource
is valuable, rare,
inimitable, and
nonsubstitutable.
1. Is the resource or organizational capability competitively Valuable? To be
competitively valuable, a resource or capability must be directly relevant to the
company’s strategy, making the company a more effective competitor. Unless
the resource or capability contributes to the effectiveness of the company’s
strategy, it cannot pass this first test. An indicator of its effectiveness is
whether the resource enables the company to strengthen its business
model by improving its customer value proposition and/or profit formula (see
Chapter 1). Google failed in converting its technological resources and software
innovation capabilities into success for Google Wallet, which incurred losses of
more than $300 million before being abandoned in 2016. While these resources
and capabilities have made Google the world’s number-one search engine, they
proved to be less valuable in the mobile payments industry.
CORE
CONCEPT
The Total
Economic Value
produced by a
company is equal to
V-C. It is the
difference between
the buyer’s
perceived value
regarding a product
or service and what
it costs the company
to produce it.
2. Is the resource or capability Rare—is it something rivals lack? Resources and
capabilities that are common among firms and widely available cannot be a
source of competitive advantage. All makers of branded cereals have valuable
marketing capabilities and brands, since the key success factors in the ready-to-
eat cereal industry demand this. They are not rare. However, the brand strength
of Oreo cookies is uncommon and has provided Kraft Foods with greater market
share as well as the opportunity to benefit from brand extensions such as Golden
Oreos, Oreo Thins, and Mega Stuf Oreos. A resource or capability is considered
rare if it is held by only a small percentage of firms in an industry or specific
competitive domain. Thus, while general management capabilities are not rare
in an absolute sense, they are relatively rare in some of the less developed
regions of the world and in some business domains.
3. Is the resource or capability Inimitable—is it hard to copy? The more difficult
and more costly it is for competitors to imitate a company’s resource or
capability, the more likely that it can also provide a sustainable competitive
advantage. Resources and capabilities tend to be difficult to copy when they are
unique (a fantastic real estate location, patent-protected technology, an
unusually talented and motivated labor force), when they must be built over
time in ways that are difficult to imitate (a well-known brand name, mastery of a
complex process technology, years of cumulative experience and learning), and
when they entail financial outlays or large-scale operations that few industry
members can undertake (a global network of dealers and distributors). Imitation
is also difficult for resources and capabilities that reflect a high level of social
complexity (company culture, interpersonal relationships among the managers or
R&D teams, trust-based relations with customers or suppliers) and causal
ambiguity, a term that signifies the hard-to-disentangle nature of the complex
resources, such as a web of intricate processes enabling new drug discovery.
Hard-to-copy resources and capabilities are important competitive assets,
contributing to the longevity of a company’s market position and offering the
potential for sustained profitability.
CORE
CONCEPT
Social complexity
and causal
page 105
ambiguity are two
factors that inhibit
the ability of rivals to
imitate a firm’s most
valuable resources
and capabilities.
Causal ambiguity
makes it very hard
to figure out how a
complex resource
contributes to
competitive
advantage and
therefore exactly
what to imitate.
4. Is the resource or capability Nonsubstitutable—is it invulnerable to the threat of
substitution from different types of resources and capabilities? Even resources
that are competitively valuable, rare, and costly to imitate may lose much of
their ability to offer competitive advantage if rivals possess equivalent substitute
resources. For example, manufacturers relying on automation to gain a cost-
based advantage in production activities may find their technology-based
advantage nullified by rivals’ use of low-wage offshore manufacturing.
Resources can contribute to a sustainable competitive advantage only when
resource substitutes aren’t on the horizon.
The vast majority of companies are not well endowed with standout resources or
capabilities, capable of passing all four tests with high marks. Most firms have a
mixed bag of resources—one or two quite valuable, some good, many satisfactory
to mediocre. Resources and capabilities that are valuable pass the first of the four
tests. As key contributors to the effectiveness of the strategy, they are relevant to
the firm’s competitiveness but are no guarantee of competitive advantage. They
may offer no more than competitive parity with competing firms.
Passing both of the first two tests requires more—it requires
resources and capabilities that are not only valuable but also rare. This is a much
higher hurdle that can be cleared only by resources and capabilities that are
competitively superior. Resources and capabilities that are competitively superior
are the company’s true strategic assets. They provide the company with a
competitive advantage over its competitors, if only in the short run.
To pass the last two tests, a resource must be able to maintain its competitive
superiority in the face of competition. It must be resistant to imitative attempts and
efforts by competitors to find equally valuable substitute resources. Assessing the
availability of substitutes is the most difficult of all the tests since substitutes are
harder to recognize, but the key is to look for resources or capabilities held by
other firms or being developed that can serve the same function as the company’s
core resources and capabilities.6
Very few firms have resources and capabilities that can pass all four tests, but
those that do enjoy a sustainable competitive advantage with far greater profit
potential. Costco is a notable example, with strong employee incentive programs
and capabilities in supply chain management that have surpassed those of its
warehouse club rivals for over 35 years. Lincoln Electric Company, less well
known but no less notable in its achievements, has been the world leader in
welding products for over 100 years as a result of its unique piecework incentive
system for compensating production workers and the unsurpassed worker
productivity and product quality that this system has fostered.
A Company’s Resources and Capabilities Must Be Managed Dynamically
Even companies like Costco and Lincoln Electric cannot afford to rest on their
laurels. Rivals that are initially unable to replicate a key resource may develop
better and better substitutes over time. Resources and capabilities can depreciate
like other assets if they are managed with benign neglect. Disruptive changes in
technology, customer preferences, distribution channels, or other competitive
factors can also destroy the value of key strategic assets, turning resources and
capabilities “from diamonds to rust.”7
Resources and capabilities must be continually strengthened and nurtured to
sustain their competitive power and, at times, may need to be broadened and
deepened to allow the company to position itself to pursue emerging market
opportunities.8 Organizational resources and capabilities that grow stale can impair
competitiveness unless they are refreshed, modified, or even phased out and
replaced in response to ongoing market changes and shifts in company strategy.
Management’s challenge in managing the firm’s resources and capabilities
dynamically has two elements: (1) attending to the ongoing modification of
existing competitive assets, and (2) casting a watchful eye for opportunities to
develop totally new kinds of capabilities.
A company requires
a dynamically
evolving portfolio of
resources and
capabilities to
sustain its
competitiveness and
help drive
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improvements in its
performance.
The Role of Dynamic Capabilities Companies that know the importance of
recalibrating and upgrading their most valuable resources and capabilities ensure
that these activities are done on a continual basis. By incorporating these activities
into their routine managerial functions, they gain the experience necessary to be
able to do them consistently well. At that point, their ability to freshen and renew
their competitive assets becomes a capability in itself—a dynamic capability. A
dynamic capability is the ability to modify, deepen, or augment the company’s
existing resources and capabilities.9 This includes the capacity to improve existing
resources and capabilities incrementally, in the way that Toyota aggressively
upgrades the company’s capabilities in fuel-efficient hybrid engine technology and
constantly fine-tunes its famed Toyota production system. Likewise, management
at BMW developed new organizational capabilities in hybrid engine design that
allowed the company to launch its highly touted i3 and i8 plug-in hybrids. A
dynamic capability also includes the capacity to add new resources and
capabilities to the company’s competitive asset portfolio. One way to do
this is through alliances and acquisitions. An example is General Motor’s
partnership with Korean electronics firm LG Corporation, which enabled GM to
develop a manufacturing and engineering platform for producing electric vehicles.
This enabled GM to beat the likes of Tesla and Nissan to market with the first
affordable all-electric car with good driving range—the Chevy Bolt EV.
CORE
CONCEPT
A dynamic
capability is an
ongoing capacity of
a company to modify
its existing
resources and
capabilities or create
new ones.
QUESTION 4: HOW DO VALUE CHAIN
ACTIVITIES IMPACT A COMPANY’S COST
STRUCTURE AND CUSTOMER VALUE
PROPOSITION?
• LO 4-4
Understand how
value chain activities
can affect a
company’s cost
structure and
customer value
proposition.
Company managers are often stunned when a competitor cuts its prices to
“unbelievably low” levels or when a new market entrant introduces a great new
product at a surprisingly low price. While less common, new entrants can also
storm the market with a product that ratchets the quality level up so high that
customers will abandon competing sellers even if they have to pay more for the
new product. This is what seems to have happened with Apple’s iPhone 7 and
iMac computers.
Regardless of where on the quality spectrum a company competes, it must
remain competitive in terms of its customer value proposition in order to stay in
the game. Patagonia’s value proposition, for example, remains attractive to
customers who value quality, wide selection, and corporate environmental
responsibility over cheaper outerwear alternatives. Since its inception in 1925, the
New Yorker’s customer value proposition has withstood the test of time by
providing readers with an amalgam of well-crafted and topical writing.
Recall from our discussion of the Customer Value Proposition in Chapter 1: The
value (V) provided to the customer depends on how well a customer’s needs are
met for the price paid (V-P). How well customer needs are met depends on the
perceived quality of a product or service as well as on other, more tangible
attributes. The greater the amount of customer value that the company can offer
profitably compared to its rivals, the less vulnerable it will be to competitive
attack. For managers, the key is to keep close track of how cost-effectively the
company can deliver value to customers relative to its competitors. If it can deliver
the same amount of value with lower expenditures (or more value at the same
cost), it will maintain a competitive edge.
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The greater the
amount of customer
value that a
company can offer
profitably relative to
close rivals, the less
competitively
vulnerable the
company becomes.
Two analytic tools are particularly useful in determining whether a company’s
costs and customer value proposition are competitive: value chain analysis and
benchmarking.
The higher a
company’s costs are
above those of close
rivals, the more
competitively
vulnerable the
company becomes.
The Concept of a Company Value Chain
Every company’s business consists of a collection of activities undertaken in the
course of producing, marketing, delivering, and supporting its product or service.
All the various activities that a company performs internally combine to form a
value chain—so called because the underlying intent of a company’s activities is
ultimately to create value for buyers.
CORE
CONCEPT
A company’s value
chain identifies the
primary activities
and related support
activities that create
customer value.
As shown in Figure 4.3, a company’s value chain consists of two broad
categories of activities: the primary activities foremost in creating value for
customers and the requisite support activities that facilitate and enhance the
performance of the primary activities.10 The kinds of primary and
secondary activities that constitute a company’s value chain vary
according to the specifics of a company’s business; hence, the listing
of the primary and support activities in Figure 4.3 is illustrative rather than
definitive. For example, the primary activities at a hotel operator like Starwood
Hotels and Resorts mainly consist of site selection and construction, reservations,
and hotel operations (check-in and check-out, maintenance and housekeeping,
dining and room service, and conventions and meetings); principal support
activities that drive costs and impact customer value include hiring and training
hotel staff and handling general administration. Supply chain management is a
crucial activity for Boeing and Amazon but is not a value chain component at
Facebook, WhatsApp, or Goldman Sachs. Sales and marketing are dominant
activities at GAP and Match.com but have only minor roles at oil-drilling
companies and natural gas pipeline companies. Customer delivery is a crucial
activity at Domino’s Pizza and Blue Apron but insignificant at Starbucks and
Dunkin Donuts.
FIGURE 4.3 A Representative Company Value Chain
http://match.com/
Source: Based on the discussion in Michael E. Porter, Competitive Advantage (New York: Free
Press, 1985), pp. 37–43.
With its focus on value-creating activities, the value chain is an ideal tool for
examining the workings of a company’s customer value proposition and business
model. It permits a deep look at the company’s cost structure and ability to offer
low prices. It reveals the emphasis that a company places on activities that enhance
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differentiation and support higher prices, such as service and marketing. It also
includes a profit margin component (P-C), since profits are necessary to
compensate the company’s owners and investors, who bear risks and provide
capital. Tracking the profit margin along with the value-creating activities is
critical because unless an enterprise succeeds in delivering customer value
profitably (with a sufficient return on invested capital), it can’t survive for long.
Attention to a company’s profit formula in addition to its customer value
proposition is the essence of a sound business model, as described in Chapter 1.
Illustration Capsule 4.1 shows representative costs for various value chain
activities performed by Everlane, Inc., an American clothing retailer that sells
primarily online.
Comparing the Value Chains of Rival Companies Value chain analysis
facilitates a comparison of how rivals, activity by activity, deliver value to
customers. Even rivals in the same industry may differ significantly in terms of the
activities they perform. For instance, the “operations” component of the value
chain for a manufacturer that makes all of its own parts and components and
assembles them into a finished product differs from the “operations” of a rival
producer that buys the needed parts and components from outside suppliers and
performs only assembly operations. How each activity is performed may affect a
company’s relative cost position as well as its capacity for differentiation. Thus,
even a simple comparison of how the activities of rivals’ value chains differ can
reveal competitive differences.
A Company’s Primary and Secondary Activities Identify the Major
Components of Its Internal Cost Structure The combined costs of all the
various primary and support activities constituting a company’s value chain define
its internal cost structure. Further, the cost of each activity contributes to whether
the company’s overall cost position relative to rivals is favorable or unfavorable.
The roles of value chain analysis and benchmarking are to develop the data for
comparing a company’s costs activity by activity against the costs of key rivals and
to learn which internal activities are a source of cost advantage or disadvantage.
Evaluating a company’s cost-competitiveness involves using what accountants
call activity-based costing to determine the costs of performing each value chain
activity.11 The degree to which a company’s total costs should be broken down into
costs for specific activities depends on how valuable it is to know the
costs of specific activities versus broadly defined activities. At the
very least, cost estimates are needed for each broad category of primary and
support activities, but cost estimates for more specific activities within each broad
category may be needed if a company discovers that it has a cost disadvantage vis-
à-vis rivals and wants to pin down the exact source or activity causing the cost
disadvantage. However, a company’s own internal costs may be insufficient to
assess whether its product offering and customer value proposition are competitive
with those of rivals. Cost and price differences among competing companies can
have their origins in activities performed by suppliers or by distribution allies
involved in getting the product to the final customers or end users of the product,
in which case the company’s entire value chain system becomes relevant.
A company’s cost-
competitiveness
depends not only on
the costs of
internally performed
activities (its own
value chain) but also
on costs in the value
chains of its
suppliers and
distribution-channel
allies.
ILLUSTRATION
CAPSULE 4.1 The Value Chain for Everlane,
Inc.
Everlane, Inc. prides itself on producing casual clothing, designed to last, in ethically managed
factories, under a policy of what they call “radical transparency”. From the start, they have made
their cost and margin breakdowns readily available on their website. Below is such a breakdown
for a pair of their slim-fit denim jeans:
M4OS Photos/Alamy Stock Photo
Materials (11 oz. denim – 98% cotton; 2% elastane $12.78
Hardware (metal fasteners, trim) 2.15
Labor 7.50
Cost of Goods 22.43
Shipping 1.90
Import Duties 3.70
Total Cost 28.03
Everlane Retail Price 68.00
Everlane Profit Margin (Retail Price – Total Cost) 39.97
Average Traditional Retailer’s Price 140.00
Source: Everlane.com/about (accessed 2/08/20).
The Value Chain System
A company’s value chain is embedded in a larger system of activities that includes
the value chains of its suppliers and the value chains of whatever wholesale
distributors and retailers it utilizes in getting its product or service to end users.
This value chain system (sometimes called a vertical chain) has implications that
extend far beyond the company’s costs. It can affect attributes like product quality
that enhance differentiation and have importance for the company’s customer
http://everlane.com/about
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value proposition, as well as its profitability.12 Suppliers’ value chains are relevant
because suppliers perform activities and incur costs in creating and delivering the
purchased inputs utilized in a company’s own value-creating activities. The costs,
performance features, and quality of these inputs influence a company’s own costs
and product differentiation capabilities. Anything a company can do to
help its suppliers drive down the costs of their value chain activities or
improve the quality and performance of the items being supplied can enhance its
own competitiveness—a powerful reason for working collaboratively with
suppliers in managing supply chain activities.13 For example, automakers have
encouraged their automotive parts suppliers to build plants near the auto assembly
plants to facilitate just-in-time deliveries, reduce warehousing and shipping costs,
and promote close collaboration on parts design and production scheduling.
Similarly, the value chains of a company’s distribution-channel partners are
relevant because (1) the costs and margins of a company’s distributors and retail
dealers are part of the price the ultimate consumer pays and (2) the quality of the
activities that such distribution allies perform affect sales volumes and customer
satisfaction. For these reasons, companies that don’t sell directly to the end
consumer work closely with their distribution allies (including their direct
customers) to perform value chain activities in mutually beneficial ways. For
instance, motor vehicle manufacturers have a competitive interest in working
closely with their automobile dealers to promote higher sales volumes and better
customer satisfaction with dealers’ repair and maintenance services. Producers of
kitchen cabinets are heavily dependent on the sales and promotional activities of
their distributors and building supply retailers and on whether distributors and
retailers operate cost-effectively enough to be able to sell at prices that lead to
attractive sales volumes.
As a consequence, accurately assessing a company’s competitiveness entails
scrutinizing the nature and costs of value chain activities throughout the entire
value chain system for delivering its products or services to end-use customers. A
typical value chain system that incorporates the value chains of suppliers, business
buyers, and other forward-channel allies (if any) is shown in Figure 4.4. As was
the case with company value chains, the specific activities constituting value chain
systems vary significantly from industry to industry. The primary value chain
system activities in the pulp and paper industry (timber farming, logging, pulp
mills, and papermaking) differ from the primary value chain system activities in
the home appliance industry (parts and components manufacture, assembly,
wholesale distribution, retail sales) and yet again from the computer software
industry (programming, disk loading, marketing, distribution). Some value chains
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may also include strategic partners whose activities may likewise affect both the
value and cost of the end product.
FIGURE 4.4 A Representative Value Chain System
Source: Based in part on the single-industry value chain displayed in Michael E. Porter, Competitive
Advantage (New York: Free Press, 1985), p. 35.
Benchmarking: A Tool for Assessing the Costs and
Effectiveness of Value Chain Activities
Benchmarking entails comparing how different companies perform various value
chain activities—how materials are purchased, how inventories are managed, how
products are assembled, how fast the company can get new products to market,
how customer orders are filled and shipped—and then making cross-company
comparisons of the costs and effectiveness of these activities.14 The comparison is
often made between companies in the same industry, but benchmarking can also
involve comparing how activities are done by companies in other industries. The
objectives of benchmarking are simply to identify the best means of performing an
activity and to emulate those best practices. It can be used to benchmark the
activities of a company’s internal value chain or the activities within an entire
value chain system.
CORE
CONCEPT
Benchmarking is a
potent tool for
improving a value
chain activities that
is based on learning
how other
companies perform
them and borrowing
their “best
practices.”
A best practice is a method of performing an activity or business process that
consistently delivers superior results compared to other approaches.15 To qualify as
a legitimate best practice, the method must have been employed by at least one
enterprise and shown to be consistently more effective in lowering costs, improving
quality or performance, shortening time requirements, enhancing safety, or
achieving some other highly positive operating outcome. Best practices thus
identify a path to operating excellence with respect to value chain activities.
CORE
CONCEPT
A best practice is a
method of
performing an
activity that
consistently delivers
superior results
compared to other
approaches.
Xerox pioneered the use of benchmarking to become more cost-competitive,
quickly deciding not to restrict its benchmarking efforts to its office equipment
rivals but to extend them to any company regarded as “world class” in performing
any activity relevant to Xerox’s business. Other companies quickly picked up on
Xerox’s approach. Toyota managers got their idea for just-in-time inventory
deliveries by studying how U.S. supermarkets replenished their shelves. Southwest
Airlines reduced the turnaround time of its aircraft at each scheduled stop by
studying pit crews on the auto racing circuit. More than 80 percent of Fortune 500
companies reportedly use benchmarking for comparing themselves against rivals
on cost and other competitively important measures. Illustration Capsule 4.2
describes benchmarking practices in the solar industry.
The tough part of benchmarking is not whether to do it but, rather, how to gain
access to information about other companies’ practices and costs. Sometimes
benchmarking can be accomplished by collecting information from published
reports, trade groups, and industry research firms or by talking to knowledgeable
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industry analysts, customers, and suppliers. Sometimes field trips to the facilities
of competing or noncompeting companies can be arranged to observe how things
are done, compare practices and processes, and perhaps exchange data on
productivity and other cost components. However, such companies, even if they
agree to host facilities tours and answer questions, are unlikely to share
competitively sensitive cost information. Furthermore, comparing two companies’
costs may not involve comparing apples to apples if the two companies employ
different cost accounting principles to calculate the costs of particular activities.
However, a third and fairly reliable source of benchmarking information has
emerged. The explosive interest of companies in benchmarking costs and
identifying best practices has prompted consulting organizations (e.g., Accenture,
A. T. Kearney, Benchnet—The Benchmarking Exchange, and Best Practices, LLC)
and several associations (e.g., the QualServe Benchmarking Clearinghouse, and
the Strategic Planning Institute’s Council on Benchmarking) to gather
benchmarking data, distribute information about best practices, and provide
comparative cost data without identifying the names of particular companies.
Having an independent group gather the information and report it in a manner that
disguises the names of individual companies protects competitively
sensitive data and lessens the potential for unethical behavior on the
part of company personnel in gathering their own data about competitors. The
ethical dimension of benchmarking is discussed in Illustration Capsule 4.3.
Benchmarking the
costs of company
activities against
those of rivals
provides hard
evidence of whether
a company is cost-
competitive.
ILLUSTRATION
CAPSULE 4.2 Benchmarking in the Solar
Industry
The cost of solar power production is dropping rapidly, leading to lower solar power prices for
consumers and an expanding market for solar companies. According to the Solar Energy
Industries Association, over 11 gigawatts (GW) of solar serving electric utilities were installed in
2016—enough to supply power for approximately 1.8 million households. Simultaneously, the
solar landscape is becoming more competitive. As of 2017, 46 firms had installed a cumulative
total of over 45 GW of solar serving electric utilities in the United States.
As competition grows, benchmarking plays an increasingly critical role in assessing a solar
company’s relative costs and price positioning compared to other firms. This is often measured
using the all-in installation and production costs per kilowatt hour generated by a solar asset,
called the “Levelized Cost of Energy” (LCOE). Kilowatt hours are the units of electricity that are
sold to consumers.
In 2008, SunPower—one of the largest solar firms in the United States—used benchmarking
to target a 50 percent decrease in its solar LCOE by 2012. This early benchmarking strategy
helped the company to defend against new market entrants offering lower prices. But in the
ensuing years, between 2009 and 2014, the overall industry solar LCOE fell by 78 percent,
leading the company to conclude that an even more aggressive approach was needed to
manage downward pricing pressure. Over the course of 2017, SunPower’s quarterly earnings
calls highlighted efforts to compete on benchmark prices by simplifying its company structure;
divesting from non-core assets; and diversifying beyond the low-cost, large-scale utility solar
market and into residential and commercial solar where it could compete more easily on price.
Geniusksy/Shutterstock
Continuing to anticipate and adapt to falling solar prices requires reliable industry data on
benchmark costs. The National Renewable Energy Laboratory (NREL) Quarterly U.S. Solar
Photovoltaic System Cost Benchmark breaks down industry solar costs by inputs, including
solar modules, structural hardware, and electrical components, as well as soft costs like labor
and land expenses. This enables firms like SunPower to assess how their component costs
compare to benchmarks and informs SunPower’s outlook for how solar prices will continue to
fall over time.
For solar to play a major role in U.S. power generation, costs must keep decreasing. As solar
companies race toward lower costs, benchmarking will continue to be a core strategic tool in
determining pricing and market positioning.
Note: Developed with Mathew O’Sullivan.
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Sources: Solar Power World, “Top 500 Solar Contractors” (2017); SunPower, “The Drivers of
the Levelized Cost of Electricity for Utility-Scale Photovoltaics” (2008); Lazard, “Levelized Cost
of Energy Analysis, Version 8.0” (2014).
Industry associations are another source of data that may be used for
benchmarking purposes. In the cement industry, for example, the Portland Cement
Association publishes key plant level data for the industry that enables companies
to understand whether their own plants are cost leaders or laggards. Benchmarking
data is also provided by some government agencies; data of this sort plays an
important role in electricity pricing, for example.
ILLUSTRATION
CAPSULE 4.3 Benchmarking and Ethical
Conduct
Because discussions between benchmarking partners can involve competitively sensitive data,
conceivably raising questions about possible restraint of trade or improper business conduct,
the Strategic Planning Institute’s Council on Benchmarking and the Global Benchmarking
Network urge all individuals and organizations involved in benchmarking to abide by a code of
conduct grounded in ethical business behavior. The code is based on the following principles:
Principle of Legality. Avoid discussions or actions that might lead to or imply an interest in
restraint of trade: market or customer allocation schemes, price fixing, dealing arrangements,
bid rigging, bribery, or misappropriation. Do not discuss costs with competitors if costs are an
element of pricing.
Principle of Exchange. Be willing to provide the same level of information that you request, in
any benchmarking exchange.
Principle of Confidentiality. Treat benchmarking interchange as something confidential to the
individuals and organizations involved. Information obtained must not be communicated
outside the partnering organizations without prior consent of participating benchmarking
partners. An organization’s participation in a study should not be communicated externally
without their permission.
Principle of Use. Use information obtained through benchmarking partnering only for the
purpose of improvement of operations within the partnering companies themselves. External
use or communication of a benchmarking partner’s name with their data or observed
practices requires permission of that partner. Do not, as a consultant or client, extend one
company’s benchmarking study findings to another without the first company’s permission.
Principle of First Party Contact. Initiate contacts, whenever possible, through a benchmarking
contact designated by the partner company. Obtain mutual agreement with the contact on
any hand off of communication or responsibility to other parties.
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Principle of Third Party Contact. Obtain an individual’s permission before providing their
name in response to a contact request.
Principle of Preparation. Demonstrate commitment to the efficiency and effectiveness of the
benchmarking process with adequate preparation at each process step; particularly, at initial
partnering contact.
Source: BPIR.com (Business Performance Improvement Resource),
https://www.bpir.com/benchmarking-code-of-conduct-bpir.com/menu-id-56.html
(accessed 2/08/20).
Strategic Options for Remedying a Cost or Value
Disadvantage
The results of value chain analysis and benchmarking may disclose cost or value
disadvantages relative to key rivals. Such information is vital in crafting strategic
actions to eliminate any such disadvantages and improve profitability. Information
of this nature can also help a company find new avenues for enhancing its
competitiveness through lower costs or a more attractive customer value
proposition. There are three main areas in a company’s total value chain system
where company managers can try to improve its efficiency and effectiveness in
delivering customer value: (1) a company’s own internal activities, (2) suppliers’
part of the value chain system, and (3) the forward-channel portion of the value
chain system.
Improving Internally Performed Value Chain Activities Managers can
pursue any of several strategic approaches to reduce the costs of internally
performed value chain activities and improve a company’s cost-competitiveness.
They can implement best practices throughout the company, particularly for high-
cost activities. They can redesign the product and/or some of its components to
eliminate high-cost components or facilitate speedier and more economical
manufacture or assembly. They can relocate high-cost activities (such as
manufacturing) to geographic areas where they can be performed more
cheaply or outsource activities to lower-cost vendors or contractors.
To improve the effectiveness of the company’s customer value proposition and
enhance differentiation, managers can take several approaches. They can adopt
best practices for quality, marketing, and customer service. They can reallocate
resources to activities that address buyers’ most important purchase criteria,
which will have the biggest impact on the value delivered to the customer. They
can adopt new technologies that spur innovation, improve design, and enhance
http://bpir.com/
https://www.bpir.com/benchmarking-code-of-conduct-bpir.com/menu-id-56.html
creativity. Additional approaches to managing value chain activities to lower costs
and/or enhance customer value are discussed in Chapter 5.
Improving Supplier-Related Value Chain Activities Supplier-related cost
disadvantages can be attacked by pressuring suppliers for lower prices, switching
to lower-priced substitute inputs, and collaborating closely with suppliers to
identify mutual cost-saving opportunities.16 For example, just-in-time deliveries
from suppliers can lower a company’s inventory and internal logistics costs and
may also allow suppliers to economize on their warehousing, shipping, and
production scheduling costs—a win–win outcome for both. In a few instances,
companies may find that it is cheaper to integrate backward into the business of
high-cost suppliers and make the item in-house instead of buying it from outsiders.
Similarly, a company can enhance its customer value proposition through its
supplier relationships. Some approaches include selecting and retaining suppliers
that meet higher-quality standards, providing quality-based incentives to suppliers,
and integrating suppliers into the design process. Fewer defects in parts from
suppliers not only improve quality throughout the value chain system but can
lower costs as well since less waste and disruption occur in the production
processes.
Improving Value Chain Activities of Distribution Partners Any of three
means can be used to achieve better cost-competitiveness in the forward portion of
the industry value chain:
1. Pressure distributors, dealers, and other forward-channel allies to reduce their
costs and markups.
2. Collaborate with them to identify win–win opportunities to reduce costs—for
example, a chocolate manufacturer learned that by shipping its bulk chocolate in
liquid form in tank cars instead of as 10-pound molded bars, it could not only
save its candy bar manufacturing customers the costs associated with unpacking
and melting but also eliminate its own costs of molding bars and packing them.
3. Change to a more economical distribution strategy, including switching to
cheaper distribution channels (selling direct via the Internet) or integrating
forward into company-owned retail outlets.
The means to enhancing differentiation through activities at the forward end of the
value chain system include (1) engaging in cooperative advertising and promotions
with forward allies (dealers, distributors, retailers, etc.), (2) creating exclusive
arrangements with downstream sellers or utilizing other mechanisms that increase
their incentives to enhance delivered customer value, and (3) creating and
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enforcing standards for downstream activities and assisting in training channel
partners in business practices. Harley-Davidson, for example, enhances the
shopping experience and perceptions of buyers by selling through retailers that sell
Harley-Davidson motorcycles exclusively and meet Harley-Davidson standards.
The bottlers of Pepsi and Coca Cola engage in cooperative promotional activities
with large grocery chains such as Kroger, Publix, and Safeway.
Translating Proficient Performance of Value Chain
Activities into Competitive Advantage
A company that does a first-rate job of managing the activities of its value chain or
value chain system relative to competitors stands a good chance of profiting from
its competitive advantage. A company’s value-creating activities can offer a
competitive advantage in one of two ways (or both):
1. They can contribute to greater efficiency and lower costs relative to competitors.
2. They can provide a basis for differentiation, so customers are willing to pay
relatively more for the company’s goods and services.
Achieving a cost-based competitive advantage requires determined management
efforts to be cost-efficient in performing value chain activities. Such efforts have to
be ongoing and persistent, and they have to involve each and every value chain
activity. The goal must be continuous cost reduction, not a one-time or on-again–
off-again effort. Companies like Dollar General, Nucor Steel, Irish airline Ryanair,
T.J.Maxx, and French discount retailer Carrefour have been highly successful in
managing their value chains in a low-cost manner.
Ongoing and persistent efforts are also required for a competitive advantage
based on differentiation. Superior reputations and brands are built up slowly over
time, through continuous investment and activities that deliver consistent,
reinforcing messages. Differentiation based on quality requires vigilant
management of activities for quality assurance throughout the value chain. While
the basis for differentiation (e.g., status, design, innovation, customer service,
reliability, image) may vary widely among companies pursuing a differentiation
advantage, companies that succeed do so on the basis of a commitment to
coordinated value chain activities aimed purposefully at this objective. Examples
include Rolex (status), Braun (design), Room and Board (craftsmanship), Zappos
and L.L. Bean (customer service), Salesforce.com and Tesla (innovation), and
FedEx (reliability).
http://salesforce.com/
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How Value Chain Activities Relate to Resources and Capabilities There is a
close relationship between the value-creating activities that a company performs
and its resources and capabilities. An organizational capability or competence
implies a capacity for action; in contrast, a value-creating activity initiates the
action. With respect to resources and capabilities, activities are “where the rubber
hits the road.” When companies engage in a value-creating activity, they do so by
drawing on specific company resources and capabilities that underlie and enable
the activity. For example, brand-building activities depend on human resources,
such as experienced brand managers (including their knowledge and expertise in
this arena), as well as organizational capabilities in advertising and marketing.
Cost-cutting activities may derive from organizational capabilities in inventory
management, for example, and resources such as inventory tracking systems.
Because of this correspondence between activities and supporting resources and
capabilities, value chain analysis can complement resource and capability analysis
as another tool for assessing a company’s competitive advantage. Resources and
capabilities that are both valuable and rare provide a company with what it takes
for competitive advantage. For a company with competitive assets of this sort, the
potential is there. When these assets are deployed in the form of a value-creating
activity, that potential is realized due to their competitive superiority. Resource
analysis is one tool for identifying competitively superior resources and
capabilities. But their value and the competitive superiority of that value can be
assessed objectively only after they are deployed. Value chain analysis
and benchmarking provide the type of data needed to make that
objective assessment.
Value chain analysis
and benchmarking
provide the type of
data needed to
assess objectively
whether a
company’s
resources and
capabilities are
competitively
superior.
Performing value
chain activities with
capabilities that
permit the company
to either outmatch
rivals on
differentiation or
beat them on costs
will give the
company a
competitive
advantage.
There is also a dynamic relationship between a company’s activities and its
resources and capabilities. Value-creating activities are more than just the
embodiment of a resource’s or capability’s potential. They also contribute to the
formation and development of organizational capabilities. The road to competitive
advantage begins with management efforts to build organizational expertise in
performing certain competitively important value chain activities. With consistent
practice and continuous investment of company resources, these activities rise to
the level of a reliable organizational capability or a competence. To the extent that
top management makes the growing capability a cornerstone of the company’s
strategy, this capability becomes a core competence for the company. Later, with
further organizational learning and gains in proficiency, the core competence may
evolve into a distinctive competence, giving the company superiority over rivals in
performing an important value chain activity. Such superiority, if it gives the
company significant competitive clout in the marketplace, can produce an
attractive competitive edge over rivals. Whether the resulting competitive
advantage is on the cost side or on the differentiation side (or both) will depend on
the company’s choice of which types of competence-building activities to engage
in over this time period.
QUESTION 5: IS THE COMPANY
COMPETITIVELY STRONGER OR
WEAKER THAN KEY RIVALS?
• LO 4-5
Explain how a
comprehensive
evaluation of a
company’s
competitive situation
can assist managers
in making critical
decisions about their
next strategic
moves.
Using resource analysis, value chain analysis, and benchmarking to determine a
company’s competitiveness on value and cost is necessary but not sufficient. A
more comprehensive assessment needs to be made of the company’s overall
competitive strength. The answers to two questions are of particular interest: First,
how does the company rank relative to competitors on each of the important
factors that determine market success? Second, all things considered, does the
company have a net competitive advantage or disadvantage versus major
competitors?
An easy-to-use method for answering these two questions involves developing
quantitative strength ratings for the company and its key competitors on each
industry key success factor and each competitively pivotal resource, capability, and
value chain activity. Much of the information needed for doing a competitive
strength assessment comes from previous analyses. Industry and competitive
analyses reveal the key success factors and competitive forces that separate
industry winners from losers. Benchmarking data and scouting key competitors
provide a basis for judging the competitive strength of rivals on such factors as
cost, key product attributes, customer service, image and reputation, financial
strength, technological skills, distribution capability, and other factors. Resource
and capability analysis reveals which of these are competitively important, given
the external situation, and whether the company’s competitive advantages are
sustainable. SWOT analysis provides a more general forward-looking picture of
the company’s overall situation.
Step 1 in doing a competitive strength assessment is to make a list of the
industry’s key success factors and other telling measures of competitive strength or
weakness (6 to 10 measures usually suffice). Step 2 is to assign weights to each of
the measures of competitive strength based on their perceived importance. (The
sum of the weights for each measure must add up to 1.) Step 3 is to calculate
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page 118
weighted strength ratings by scoring each competitor on each strength
measure (using a 1-to-10 rating scale, where 1 is very weak and 10 is
very strong) and multiplying the assigned rating by the assigned weight. Step 4 is
to sum the weighted strength ratings on each factor to get an overall measure of
competitive strength for each company being rated. Step 5 is to use the overall
strength ratings to draw conclusions about the size and extent of the company’s net
competitive advantage or disadvantage and to take specific note of areas of
strength and weakness.
Table 4.4 provides an example of competitive strength assessment in which a
hypothetical company (ABC Company) competes against two rivals. In the
example, relative cost is the most telling measure of competitive
strength, and the other strength measures are of lesser importance. The
company with the highest rating on a given measure has an implied competitive
edge on that measure, with the size of its edge reflected in the difference between
its weighted rating and rivals’ weighted ratings. For instance, Rival 1’s 3.00
weighted strength rating on relative cost signals a considerable cost advantage over
ABC Company (with a 1.50 weighted score on relative cost) and an even bigger
cost advantage over Rival 2 (with a weighted score of 0.30). The measure-by-
measure ratings reveal the competitive areas in which a company is strongest and
weakest, and against whom.
TABLE 4.4 A Representative Weighted Competitive Strength
Assessment
Competitive Strength Assessment(rating scale: 1 = very weak, 10 = very strong)
ABC Co. Rival 1 Rival 2
Key Success
Factor/Strength
Measure
Importance
Weight
Strength
Rating
Weighted
Score
Strength
Rating
Weighted
Score
Strength
Rating
Weighted
Score
Quality/product
performance 0.10 8 0.80 5 0.50 1 0.10
Reputation/image 0.10 8 0.80 7 0.70 1 0.10
Manufacturing
capability 0.10 2 0.20 10 1.00 5 0.50
Technological skills 0.05 10 0.50 1 0.05 3 0.15
Dealer
network/distribution
capability
0.05 9 0.45 4 0.20 5 0.25
Competitive Strength Assessment(rating scale: 1 = very weak, 10 = very strong)
ABC Co. Rival 1 Rival 2
Key Success
Factor/Strength
Measure
Importance
Weight
Strength
Rating
Weighted
Score
Strength
Rating
Weighted
Score
Strength
Rating
Weighted
Score
New product
innovation
capability
0.05 9 0.45 4 0.20 5 0.25
Financial
resources 0.10 5 0.50 10 1.00 3 0.30
Relative cost
position 0.30 5 1.50 10 3.00 1 0.30
Customer service
capabilities 0.15 5 0.75 7 1.05 1 0.15
Sum of importance
weights 1.00
Overall weighted
competitive
strength rating
5.95 7.70 2.10
The overall competitive strength scores indicate how all the different strength
measures add up—whether the company is at a net overall competitive advantage
or disadvantage against each rival. The higher a company’s overall weighted
strength rating, the stronger its overall competitiveness versus rivals. The bigger
the difference between a company’s overall weighted rating and the scores of
lower-rated rivals, the greater is its implied net competitive advantage. Thus, Rival
1’s overall weighted score of 7.70 indicates a greater net competitive advantage
over Rival 2 (with a score of 2.10) than over ABC Company (with a score of 5.95).
Conversely, the bigger the difference between a company’s overall rating and the
scores of higher-rated rivals, the greater its implied net competitive disadvantage.
Rival 2’s score of 2.10 gives it a smaller net competitive disadvantage against
ABC Company (with an overall score of 5.95) than against Rival 1 (with an
overall score of 7.70).
High-weighted
competitive strength
ratings signal a
strong competitive
position and
possession of
competitive
advantage; low
ratings signal a
weak position and
competitive
disadvantage.
Strategic Implications of Competitive Strength
Assessments
In addition to showing how competitively strong or weak a company is relative to
rivals, the strength ratings provide guidelines for designing wise offensive and
defensive strategies. For example, if ABC Company wants to go on the offensive
to win additional sales and market share, such an offensive probably needs to be
aimed directly at winning customers away from Rival 2 (which has a lower overall
strength score) rather than Rival 1 (which has a higher overall strength score).
Moreover, while ABC has high ratings for technological skills (a 10 rating), dealer
network/distribution capability (a 9 rating), new product innovation capability (a 9
rating), quality/product performance (an 8 rating), and reputation/image (an 8
rating), these strength measures have low importance weights—meaning that ABC
has strengths in areas that don’t translate into much competitive clout in the
marketplace. Even so, it outclasses Rival 2 in all five areas, plus it enjoys
substantially lower costs than Rival 2 (ABC has a 5 rating on relative cost position
versus a 1 rating for Rival 2)—and relative cost position carries the highest
importance weight of all the strength measures. ABC also has greater competitive
strength than Rival 3 regarding customer service capabilities (which carries the
second-highest importance weight). Hence, because ABC’s strengths are in the
very areas where Rival 2 is weak, ABC is in a good position to attack Rival 2.
Indeed, ABC may well be able to persuade a number of Rival 2’s customers to
switch their purchases over to its product.
A company’s
competitive strength
scores pinpoint its
strengths and
weaknesses against
rivals and point
directly to the kinds
of offensive and
defensive actions it
can use to exploit its
competitive
strengths and
reduce its
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competitive
vulnerabilities.
But ABC should be cautious about cutting price aggressively to win customers
away from Rival 2, because Rival 1 could interpret that as an attack by ABC to
win away Rival 1’s customers as well. And Rival 1 is in far and away the best
position to compete on the basis of low price, given its high rating on relative cost
in an industry where low costs are competitively important (relative cost carries an
importance weight of 0.30). Rival 1’s strong relative cost position vis-
à-vis both ABC and Rival 2 arms it with the ability to use its lower-
cost advantage to thwart any price cutting on ABC’s part. Clearly ABC is
vulnerable to any retaliatory price cuts by Rival 1—Rival 1 can easily defeat both
ABC and Rival 2 in a price-based battle for sales and market share. If ABC wants
to defend against its vulnerability to potential price cutting by Rival 1, then it
needs to aim a portion of its strategy at lowering its costs.
The point here is that a competitively astute company should utilize the strength
scores in deciding what strategic moves to make. When a company has important
competitive strengths in areas where one or more rivals are weak, it makes sense to
consider offensive moves to exploit rivals’ competitive weaknesses. When a
company has important competitive weaknesses in areas where one or more rivals
are strong, it makes sense to consider defensive moves to curtail its vulnerability.
QUESTION 6: WHAT STRATEGIC ISSUES
AND PROBLEMS MERIT FRONT-BURNER
MANAGERIAL ATTENTION?
The final and most important analytic step is to zero in on exactly what strategic
issues company managers need to address—and resolve—for the company to be
more financially and competitively successful in the years ahead. This step
involves drawing on the results of both industry analysis and the evaluations of the
company’s internal situation. The task here is to get a clear fix on exactly what
strategic and competitive challenges confront the company, which of the
company’s competitive shortcomings need fixing, and what specific problems
merit company managers’ front-burner attention. Pinpointing the specific issues
that management needs to address sets the agenda for deciding what actions to
take next to improve the company’s performance and business outlook.
The “priority list” of issues and problems that have to be wrestled with can
include such things as how to stave off market challenges from new foreign
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competitors, how to combat the price discounting of rivals, how to reduce the
company’s high costs, how to sustain the company’s present rate of growth in light
of slowing buyer demand, whether to correct the company’s competitive
deficiencies by acquiring a rival company with the missing strengths, whether to
expand into foreign markets, whether to reposition the company and move to a
different strategic group, what to do about growing buyer interest in substitute
products, and what to do to combat the aging demographics of the company’s
customer base. The priority list thus always centers on such concerns as “how to
. . . ,” “what to do about . . . ,” and “whether to . . .” The purpose of the priority list
is to identify the specific issues and problems that management needs to address,
not to figure out what specific actions to take. Deciding what to do—which
strategic actions to take and which strategic moves to make—comes later (when it
is time to craft the strategy and choose among the various strategic alternatives).
Compiling a “priority
list” of problems
creates an agenda
of strategic issues
that merit prompt
managerial
attention.
A good strategy
must contain ways
to deal with all the
strategic issues and
obstacles that stand
in the way of the
company’s financial
and competitive
success in the years
ahead.
If the items on the priority list are relatively minor—which suggests that the
company’s strategy is mostly on track and reasonably well matched to the
company’s overall situation—company managers seldom need to go much beyond
fine-tuning the present strategy. If, however, the problems confronting the
company are serious and indicate the present strategy is not well suited for the road
ahead, the task of crafting a better strategy needs to be at the top of management’s
action agenda.
KEY POINTS
There are six key questions to consider in evaluating a company’s ability to
compete successfully against market rivals:
1. How well is the present strategy working? This involves evaluating the strategy
in terms of the company’s financial performance and market standing. The
stronger a company’s current overall performance, the less likely the need for
radical strategy changes. The weaker a company’s performance, the more its
current strategy must be questioned.
2. What is the company’s overall situation, in terms of its internal strengths and
weaknesses in relation to its market opportunities and external threats? The
answer to this question comes from performing a SWOT analysis. A company’s
strengths and competitive assets are strategically relevant because they are the
most logical and appealing building blocks for strategy; internal weaknesses are
important because they may represent vulnerabilities that need correction.
External opportunities and threats come into play because a good strategy
necessarily aims at capturing a company’s most attractive opportunities and at
defending against threats to its well-being.
3. What are the company’s most important resources and capabilities and can they
give the company a sustainable advantage? A company’s resources can be
identified using the tangible/intangible typology presented in this chapter. Its
capabilities can be identified either by starting with its resources to look for
related capabilities or looking for them within the company’s different
functional domains.
The answer to the second part of the question comes from conducting the four
tests of a resource’s competitive power—the VRIN tests. If a company has
resources and capabilities that are competitively valuable and rare, the firm will
have a competitive advantage over market rivals. If its resources and capabilities
are also hard to copy (inimitable), with no good substitutes (nonsubstitutable),
then the firm may be able to sustain this advantage even in the face of active
efforts by rivals to overcome it.
4. Are the company’s cost structure and value proposition competitive? One telling
sign of whether a company’s situation is strong or precarious is whether its costs
are competitive with those of industry rivals. Another sign is how the company
compares with rivals in terms of differentiation—how effectively it delivers on
its customer value proposition. Value chain analysis and benchmarking are
essential tools in determining whether the company is performing particular
functions and activities well, whether its costs are in line with those of
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LO 4-1
competitors, whether it is differentiating in ways that really enhance customer
value, and whether particular internal activities and business processes need
improvement. They complement resource and capability analysis by providing
data at the level of individual activities that provide more objective evidence of
whether individual resources and capabilities, or bundles of resources and linked
activity sets, are competitively superior.
5. On an overall basis, is the company competitively stronger or weaker than key
rivals? The key appraisals here involve how the company matches up against
key rivals on industry key success factors and other chief determinants of
competitive success and whether and why the company has a net competitive
advantage or disadvantage. Quantitative competitive strength assessments, using
the method presented in Table 4.4, indicate where a company is competitively
strong and weak and provide insight into the company’s ability to defend or
enhance its market position. As a rule, a company’s competitive strategy should
be built around its competitive strengths and should aim at shoring up areas
where it is competitively vulnerable. When a company has important
competitive strengths in areas where one or more rivals are weak, it
makes sense to consider offensive moves to exploit rivals’ competitive
weaknesses. When a company has important competitive weaknesses in areas
where one or more rivals are strong, it makes sense to consider defensive moves
to curtail its vulnerability.
6. What strategic issues and problems merit front-burner managerial attention?
This analytic step zeros in on the strategic issues and problems that stand in the
way of the company’s success. It involves using the results of industry analysis
as well as resource and value chain analysis of the company’s competitive
situation to identify a “priority list” of issues to be resolved for the company to
be financially and competitively successful in the years ahead. Actually
deciding on a strategy and what specific actions to take is what comes after
developing the list of strategic issues and problems that merit front-burner
management attention.
Like good industry analysis, solid analysis of the company’s competitive situation
vis-à-vis its key rivals is a valuable precondition for good strategy making.
ASSURANCE OF LEARNING EXERCISES
1. Using the financial ratios provided in Table 4.1 and
following the financial statement information presented
page 122
for Urban Outfitters, Inc., calculate the following ratios
for Urban Outfitters for both 2018 and 2019:
a. Gross profit margin
b. Operating profit margin
c. Net profit margin
d. Times-interest-earned (or coverage) ratio
e. Return on stockholders’ equity
f. Return on assets
g. Debt-to-equity ratio
h. Days of inventory
i. Inventory turnover ratio
j. Average collection period
Based on these ratios, did Urban Outfitter’s financial
performance improve, weaken, or remain about the same
from 2018 to 2019?
Consolidated Income Statements for Urban Outfitters, Inc.,
2018–2019 (in thousands, except per share data)
2018 2019
Net sales (total revenue) $3,616,014 $3,950,623
Cost of sales 2,440,507 2,603,911
Selling, general, and administrative 915,615
965,399
Operating income $259,892 $381,313
Other income (expense)
Other expenses (4,840) (6,325)
Interest income and other, net 6,314 10,565
Income before income taxes 261,366 385,553
Provision for income taxes 153,103 87,550
Net income $108,263 $298,003
Basic earnings per share $ 0.97 $ 2.75
Diluted earnings per share $ 0.96 $ 2.72
Source: Urban Outfitters, Inc., 2019.
page 123
Consolidated Balance Sheets for Urban Outfitters, Inc., 2018–
2019 (in thousands, except per share data)
January 31, 2018 January 31, 2019
Assets
Current Assets
Cash and cash equivalents $ 282,220 $ 358,260
Short-term investments 165,125 279,232
Receivables, net 76,962 80,461
Merchandise inventories 351,395 370,507
Prepaid expenses and other current assets 103,055 114,296
Total current assets 978,757 1,202,756
Net property and equipment 813,768 796,029
Deferred income taxes and Other assets 160,255 161,730
Total assets $1,952,780 $2,160,515
Liabilities and Shareholders’ Equity
Current Liabilities
Accounts payable $ 128,246 $ 144,414
Accrued salaries and benefits 36,058 54,799
Accrued expenses and Other current liabilities 195,910 187,431
Total current liabilities 360,214
$ 386,644
Long-term debt 0 0
Deferred rent and other liabilities 284,773 291,663
Total liabilities 671,417 651,877
Commitments and Contingencies
Equity
Preferred stock $.0001 par value; 10,000,000 shares
authorized; no shares issued and outstanding 0 0
Common stock $.0001 par value; 200,000,000 shares
authorized; 105,642,283 and 108,248,568 shares
issued and outstanding
11 11
Additional paid-in capital $ 0 $ 684
Retained earnings 1,489,087 1,300,208
Total stockholders’ equity 1,489,098 1,300,90
LO 4-2, LO 4-3
LO 4-4
LO 4-5
January 31, 2018 January 31, 2019
Total Liabilities and Equity $2,160,515 $1,952,780
Source: Urban Outfitters, Inc., 2019 10-K.
2. Cinnabon, famous for its cinnamon rolls, is an American
chain commonly located in high traffic areas, such as
airports and malls. They operate more than 1,200 bakeries
in more than 48 countries. How many of the four tests of
the competitive power of a resource does the store
network pass? Using your general knowledge of this
industry, perform a SWOT analysis. Explain your
answers.
3. Review the information in Illustration Capsule 4.1
concerning Everlane’s average costs of producing and
selling a pair of denim jeans, and compare this with the
representative value chain depicted in Figure 4.3. Then
answer the following questions:
a. Which of the company’s costs correspond to the
primary value chain activities depicted in Figure 4.3?
b. Which of the company’s costs correspond to the support
activities described in Figure 4.3?
c. What value chain activities might be important in
securing or maintaining Everlane’s advantage? Explain
your answer.
4. Using the methodology illustrated in Table 4.3 and your
knowledge as an automobile owner, prepare a competitive
strength assessment for General Motors and its rivals
Ford, Chrysler, Toyota, and Honda. Each of the five
automobile manufacturers should be evaluated on the key
success factors and strength measures of cost-
competitiveness, product-line breadth, product quality
and reliability, financial resources and profitability, and
customer service. What does your competitive strength
assessment disclose about the overall competitiveness of
each automobile manufacturer? What factors account
most for Toyota’s competitive success? Does Toyota have
competitive weaknesses that were disclosed by your
analysis? Explain.
LO 4-1
LO 4-1
LO 4-1
LO 4-2, LO 4-3
LO 4-2, LO 4-3
LO 4-4
page 124
EXERCISES FOR SIMULATION PARTICIPANTS
1. Using the formulas in Table 4.1 and the data in your
company’s latest financial statements, calculate the
following measures of financial performance for your
company:
a. Operating profit margin
b. Total return on total assets
c. Current ratio
d. Working capital
e. Long-term debt-to-capital ratio
f. Price-to-earnings ratio
2. On the basis of your company’s latest financial statements
and all the other available data regarding your company’s
performance that appear in the industry report, list the
three measures of financial performance on which your
company did best and the three measures on which your
company’s financial performance was worst.
3. What hard evidence can you cite that indicates your
company’s strategy is working fairly well (or perhaps not
working so well, if your company’s performance is
lagging that of rival companies)?
4. What internal strengths and weaknesses does your
company have? What external market opportunities for
growth and increased profitability exist for your
company? What external threats to your company’s future
well-being and profitability do you and your co-managers
see? What does the preceding SWOT analysis indicate
about your company’s present situation and future
prospects—where on the scale from “exceptionally
strong” to “alarmingly weak” does the attractiveness of
your company’s situation rank?
5. Does your company have any core competencies? If so,
what are they?
6. What are the key elements of your company’s value
chain? Refer to Figure 4.3 in developing your answer.
LO 4-5
page 125
7. Using the methodology presented in Table 4.4, do a
weighted competitive strength assessment for your
company and two other companies that you and your co-
managers consider to be very close competitors.
ENDNOTES
1 Donald Sull, “Strategy as Active Waiting,” Harvard Business Review 83, no. 9 (September 2005), pp. 121–126.
2 Birger Wernerfelt, “A Resource-Based View of the Firm,” Strategic Management Journal 5, no. 5 (September–October 1984),
pp. 171–180; Jay Barney, “Firm Resources and Sustained Competitive Advantage,” Journal of Management 17, no. 1 (1991),
pp. 99–120.
3 R. Amit and P. Schoemaker, “Strategic Assets and Organizational Rent,” Strategic Management Journal 14 (1993).
4 Jay B. Barney, “Looking Inside for Competitive Advantage,” Academy of Management Executive 9, no. 4 (November 1995), pp.
49–61; Christopher A. Bartlett and Sumantra Ghoshal, “Building Competitive Advantage through People,” MIT Sloan
Management Review 43, no. 2 (Winter 2002), pp. 34–41; Danny Miller, Russell Eisenstat, and Nathaniel Foote, “Strategy from
the Inside Out: Building Capability-Creating Organizations,” California Management Review 44, no. 3 (Spring 2002), pp. 37–54.
5 M. Peteraf and J. Barney, “Unraveling the Resource-Based Tangle,” Managerial and Decision Economics 24, no. 4 (June–July
2003), pp. 309–323.
6 Margaret A. Peteraf and Mark E. Bergen, “Scanning Dynamic Competitive Landscapes: A Market-Based and Resource-Based
Framework,” Strategic Management Journal 24 (2003), pp. 1027–1042.
7 C. Montgomery, “Of Diamonds and Rust: A New Look at Resources,” in C. Montgomery (ed.), Resource-Based and
Evolutionary Theories of the Firm (Boston: Kluwer Academic, 1995), pp. 251–268.
8 Constance E. Helfat and Margaret A. Peteraf, “The Dynamic Resource-Based View: Capability Lifecycles,” Strategic
Management Journal 24, no. 10 (2003).
9 D. Teece, G. Pisano, and A. Shuen, “Dynamic Capabilities and Strategic Management,” Strategic Management Journal 18, no.
7 (1997), pp. 509–533; K. Eisenhardt and J. Martin, “Dynamic Capabilities: What Are They?” Strategic Management
Journal 21, no. 10–11 (2000), pp. 1105–1121; M. Zollo and S. Winter, “Deliberate Learning and the Evolution of
Dynamic Capabilities,” Organization Science 13 (2002), pp. 339–351; C. Helfat et al., Dynamic Capabilities: Understanding
Strategic Change in Organizations (Malden, MA: Blackwell, 2007).
10 Michael Porter in his 1985 best seller Competitive Advantage (New York: Free Press).
11 John K. Shank and Vijay Govindarajan, Strategic Cost Management (New York: Free Press, 1993), especially chaps. 2–6, 10,
and 11; Robin Cooper and Robert S. Kaplan, “Measure Costs Right: Make the Right Decisions,” Harvard Business Review 66,
no. 5 (September–October, 1988), pp. 96–103; Joseph A. Ness and Thomas G. Cucuzza, “Tapping the Full Potential of ABC,”
Harvard Business Review 73, no. 4 (July–August 1995), pp. 130–138.
12 Porter, Competitive Advantage, p. 34.
13 Hau L. Lee, “The Triple-A Supply Chain,” Harvard Business Review 82, no. 10 (October 2004), pp. 102–112.
14 Gregory H. Watson, Strategic Benchmarking: How to Rate Your Company’s Performance against the World’s Best (New York:
Wiley, 1993); Robert C. Camp, Benchmarking: The Search for Industry Best Practices That Lead to Superior Performance
(Milwaukee: ASQC Quality Press, 1989); Dawn Iacobucci and Christie Nordhielm, “Creative Benchmarking,” Harvard Business
Review 78 no. 6 (November–December 2000), pp. 24–25.
15 www.businessdictionary.com/definition/best-practice.html (accessed December 2, 2009).
16 Reuben E. Stone, “Leading a Supply Chain Turnaround,” Harvard Business Review 82, no. 10 (October 2004), pp. 114–121.
http://www.businessdictionary.com/definition/best-practice.html
page 126
chapter 5
The Five Generic Competitive Strategies
Learning Objectives
After reading this chapter, you should be able to:
LO 5-1 Understand what distinguishes each of the five generic strategies and explain
why some of these strategies work better in certain kinds of competitive
conditions than in others.
LO 5-2 Recognize the major avenues for achieving a competitive advantage based on
lower costs.
LO 5-3 Identify the major avenues to a competitive advantage based on differentiating a
company’s product or service offering from the offerings of rivals.
LO 5-4 Explain the attributes of a best-cost strategy—a hybrid of low-cost and
differentiation strategies.
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page 128
Roy Scott/Media Bakery
It’s all about strategic positioning and competition.
Michele Hutchins—Consultant
Strategic positioning means performing different activities from rivals or performing similar activities in different ways.
Michael E. Porter—Professor, author, and cofounder of Monitor Consulting
I learnt the hard way about positioning in business, about catering to the right segments.
Shaffi Mather—Social entrepreneur
A company can employ any of several basic approaches to gaining a competitive advantage over rivals, but they all
involve delivering more value to customers than rivals or delivering value more efficiently than rivals (or both). More value
for customers can mean a good product at a lower price, a superior product worth paying more for, or a best-value offering
that represents an attractive combination of price, features, service, and other appealing attributes. Greater efficiency
means delivering a given level of value to customers at a lower cost to the company. But whatever approach to delivering
value the company takes, it nearly always requires performing value chain activities differently than rivals and building
competitively valuable resources and capabilities that rivals cannot readily match or outdo.
This chapter describes the five generic competitive strategy options. Each of the five generic strategies represents a
distinctly different approach to competing in the marketplace. Which of the five to employ is a company’s first and foremost
choice in crafting an overall strategy and beginning its quest for competitive advantage.
TYPES OF GENERIC COMPETITIVE STRATEGIES
• LO 5-1
Understand what
distinguishes each
of the five generic
strategies and
explain why some of
these strategies
work better in certain
kinds of competitive
conditions than in
others.
A company’s competitive strategy lays out the specific efforts of the company to position itself in the
marketplace, please customers, ward off competitive threats, and achieve a particular kind of competitive
advantage. The chances are remote that any two companies—even companies in the same industry—will
employ competitive strategies that are exactly alike in every detail. However, when one strips away the
details to get at the real substance, the two biggest factors that distinguish one competitive strategy from
another boil down to (1) whether a company’s market target is broad or narrow and (2) whether the
company is pursuing a competitive advantage linked to lower costs or differentiation. These two factors
give rise to four distinct competitive strategy options, plus one hybrid option, as shown in Figure 5.1 and
listed next.1
FIGURE 5.1 The Five Generic Competitive Strategies
Source: This is an expanded version of a three-strategy classification discussed in Michael E. Porter, Competitive Strategy (New
York: Free Press, 1980).
1. A broad, low-cost strategy—striving to achieve broad lower overall costs than rivals on comparable
products that attract a broad spectrum of buyers, usually by underpricing rivals.
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2. A broad differentiation strategy—seeking to differentiate the company’s product offering from rivals’
with attributes that will appeal to a broad spectrum of buyers.
3. A focused low-cost strategy—concentrating on the needs and requirements of a narrow buyer segment
(or market niche) and striving to meet these needs at lower costs than rivals (thereby being able to
serve niche members at a lower price).
4. A focused differentiation strategy—concentrating on a narrow buyer segment (or market niche) and
offering niche members customized attributes that meet their tastes and requirements better than rivals’
products.
5. A best-cost strategy—striving to incorporate upscale product attributes at a lower cost than rivals.
Being the “best-cost” producer of an upscale, multifeatured product allows a company to give
customers more value for their money by underpricing rivals whose products have similar upscale,
multifeatured attributes. This competitive approach is a hybrid strategy that blends elements of the
previous four options in a unique and often effective way. It may be focused or broad in its appeal.
The remainder of this chapter explores the ins and outs of these five generic competitive strategies and
how they differ.
BROAD LOW-COST STRATEGIES
• LO 5-2
Recognize the major
avenues for
achieving a
competitive
advantage based on
lower costs.
Striving to achieve lower costs than rivals targeting a broad spectrum of buyers is an especially effective
competitive approach in markets with many price-sensitive buyers. A company achieves low-cost
leadership when it becomes the industry’s lowest-cost producer rather than just being one of perhaps
several competitors with comparatively low costs. But a low-cost producer’s foremost strategic objective
is meaningfully lower costs than rivals—not necessarily the absolutely lowest possible cost. In striving for
a cost advantage over rivals, company managers must incorporate features and services that buyers
consider essential. A product offering that is too frills-free can be viewed by consumers as offering little
value regardless of its pricing.
CORE
CONCEPT
The essence of a
broad, low-cost
strategy is to
produce goods or
services for a broad
base of buyers at a
lower cost than
rivals.
A company has two options for translating a low-cost advantage over rivals into superior profit
performance. Option 1 is to use the lower-cost edge to underprice competitors and attract price-sensitive
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buyers in great enough numbers to increase total profits. Option 2 is to maintain the present price, be
content with the present market share, and use the lower-cost edge to raise total profits by earning a
higher profit margin on each unit sold.
While many companies are inclined to exploit a low-cost advantage by using option 1 (attacking rivals
with lower prices), this strategy can backfire if rivals respond with retaliatory price cuts (in order to
protect their customer base and defend against a loss of sales). A rush to cut prices can often trigger a
price war that lowers the profits of all price discounters. The bigger the risk that rivals will respond with
matching price cuts, the more appealing it becomes to employ the second option for using a low-cost
advantage to achieve higher profitability.
The Two Major Avenues for Achieving a Cost Advantage
To achieve a low-cost edge over rivals, a firm’s cumulative costs across its overall value chain must be
lower than competitors’ cumulative costs. There are two major avenues for accomplishing this:2
1. Perform internal value chain activities and/or value chain system activities more cost-effectively than
rivals.
2. Revamp the firm’s overall value chain to eliminate or bypass some cost-producing activities.
A low-cost
advantage over
rivals can translate
into superior
profitability through
lower price and
higher market share
or higher profit
margins.
Cost-Efficient Management of Value Chain Activities For a company to do a more cost-effective job
of managing its value chain than rivals, managers must diligently search out cost-saving opportunities in
every part of the value chain. No activity can escape cost-saving scrutiny, and all company
personnel must be expected to use their talents and ingenuity to come up with innovative and
effective ways to keep down costs. Particular attention must be paid to a set of factors known as cost
drivers that have a strong effect on a company’s costs and can be used as levers to lower costs. Figure 5.2
shows the most important cost drivers. Cost-cutting approaches that demonstrate an effective use of the
cost drivers include
CORE
CONCEPT
A cost driver is a
factor that has a
strong influence on
a company’s costs.
FIGURE 5.2 Cost Drivers: The Keys to Driving Down Company Costs
page 131
Source: Adapted from Michael E. Porter, Competitive Advantage: Creating and Sustaining Superior Performance (New York:
Free Press, 1985).
1. Capturing all available economies of scale. Economies of scale stem from an ability to lower unit costs
by increasing the scale of operation. Economies of scale may be available at different points along a
company’s value chain (both internally and elsewhere along its value chain system). Often, a large
plant is more economical to operate than a small one, particularly if it can be operated round the clock
robotically. Economies of scale may be available due to a large warehouse operation on the input side
or a large distribution center on the output side. In global industries, selling a mostly standard product
worldwide tends to lower unit costs as opposed to making separate products (each at lower scale) for
each country market. There are economies of scale in advertising as well. For example, Anheuser-
Busch InBev SA/NV could afford to pay the $5.6 million cost of a 30-second Super Bowl ad in 2020
because the cost could be spread out over the hundreds of millions of units of Budweiser that the
company sells.
2. Taking full advantage of experience and learning-curve effects. The cost of performing an activity can
decline over time as the learning and experience of company personnel build. Learning and experience
economies can stem from debugging and mastering newly introduced technologies, using the
experiences and suggestions of workers to install more efficient plant layouts and assembly procedures,
and the added speed and effectiveness that accrues from repeatedly picking sites for and building new
plants, distribution centers, or retail outlets.
3. Operating facilities at full capacity. Whether a company is able to operate at or near full capacity has a
big impact on unit costs when its value chain contains activities associated with substantial fixed costs.
Higher rates of capacity utilization allow depreciation and other fixed costs to be spread over a larger
unit volume, thereby lowering fixed costs per unit. The more capital-intensive the business and the
higher the fixed costs as a percentage of total costs, the greater the unit-cost penalty for operating at
less than full capacity.
4. Improving supply chain efficiency. Partnering with suppliers to streamline the ordering and purchasing
process, to reduce inventory carrying costs via just-in-time inventory practices, to economize on
shipping and materials handling, and to ferret out other cost-saving opportunities is a much-used
approach to cost reduction. A company with a distinctive competence in cost-efficient supply chain
management, such as Colgate-Palmolive or Unilever (leading consumer products companies), can
sometimes achieve a sizable cost advantage over less adept rivals.
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5. Substituting lower-cost inputs wherever there is little or no sacrifice in product quality or performance.
If the costs of certain raw materials and parts are “too high,” a company can switch to using lower-cost
items or maybe even design the high-cost components out of the product altogether.
6. Using the company’s bargaining power vis-à-vis suppliers or others in the value chain system to gain
concessions. Home Depot, for example, has sufficient bargaining clout with suppliers to win price
discounts on large-volume purchases.
7. Using online systems and sophisticated software to achieve operating efficiencies. For example,
sharing data and production schedules with suppliers, coupled with the use of enterprise resource
planning (ERP) and manufacturing execution system (MES) software, can reduce parts inventories,
trim production times, and lower labor requirements.
8. Improving process design and employing advanced production technology. Often, production costs can
be cut by (1) using design for manufacture (DFM) procedures and computer-assisted design (CAD)
techniques that enable more integrated and efficient production methods, (2) investing in highly
automated robotic production technology, and (3) shifting to a mass-customization production process.
Dell’s highly automated PC assembly plant in Austin, Texas, is a prime example of the use of advanced
product and process technologies. Many companies are ardent users of total quality management
(TQM) systems, business process reengineering, Six Sigma methodology, and other business process
management techniques that aim at boosting efficiency and reducing costs.
9. Being alert to the cost advantages of outsourcing or vertical integration. Outsourcing the performance
of certain value chain activities can be more economical than performing them in-house if outside
specialists, by virtue of their expertise and volume, can perform the activities at lower cost. On the
other hand, there can be times when integrating into the activities of either suppliers or distribution-
channel allies can lower costs through greater production efficiencies, reduced transaction
costs, or a better bargaining position.
10. Motivating employees through incentives and company culture. A company’s incentive system can
encourage not only greater worker productivity but also cost-saving innovations that come from worker
suggestions. The culture of a company can also spur worker pride in productivity and continuous
improvement. Companies that are well known for their cost-reducing incentive systems and culture
include Nucor Steel, which characterizes itself as a company of “20,000 teammates,” Southwest
Airlines, and DHL Express (rival of FedEx).
Revamping of the Value Chain System to Lower Costs Dramatic cost advantages can often emerge
from redesigning the company’s value chain system in ways that eliminate costly work steps and entirely
bypass certain cost-producing value chain activities. Such value chain revamping can include
Selling direct to consumers and bypassing the activities and costs of distributors and dealers. To
circumvent the need for distributors and dealers, a company can create its own direct sales force, which
adds the costs of maintaining and supporting a sales force but may be cheaper than using independent
distributors and dealers to access buyers. Alternatively, they can conduct sales operations at the
company’s website, since the costs for website operations and shipping may be substantially cheaper
than going through distributor-dealer channels). Costs in the wholesale and retail portions of the value
chain frequently represent 35 to 50 percent of the final price consumers pay, so establishing a direct
sales force or selling online may offer big cost savings.
Streamlining operations by eliminating low-value-added or unnecessary work steps and activities. At
Walmart, some items supplied by manufacturers are delivered directly to retail stores rather than being
routed through Walmart’s distribution centers and delivered by Walmart trucks. In other instances,
Walmart unloads incoming shipments from manufacturers’ trucks arriving at its distribution centers and
loads them directly onto outgoing Walmart trucks headed to particular stores without ever moving the
goods into the distribution center. Many supermarket chains have greatly reduced in-store meat
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butchering and cutting activities by shifting to meats that are cut and packaged at the meatpacking plant
and then delivered to their stores in ready-to-sell form.
Reducing materials-handling and shipping costs by having suppliers locate their plants or warehouses
close to the company’s own facilities. Having suppliers locate their plants or warehouses close to a
company’s own plant facilitates just-in-time deliveries of parts and components to the exact workstation
where they will be used in assembling the company’s product. This not only lowers incoming shipping
costs but also curbs or eliminates the company’s need to build and operate storerooms for incoming
parts and to have plant personnel move the inventories to the workstations as needed for assembly.
Illustration Capsule 5.1 describes the path that Vanguard has followed in achieving its position as the
low-cost leader of the investment management industry.
ILLUSTRATION
CAPSULE 5.1 Vanguard’s Path to Becoming the Low-Cost
Leader in Investment Management
Vanguard is now one of the world’s largest investment management companies. It became an industry giant by leading the
way in low-cost passive index investing. In active trading, an investment manager is compensated for making an educated
decision on which stocks to sell and which to buy. This incurs both transactional and management fees. In contrast, passive
index portfolios aim to mirror the movements of a major market index like the S&P 500, Dow Jones Industrial Average, or
NASDAQ. Passive portfolios incur fewer fees and can be managed with lower operating costs. A measure used to compare
operating costs in this industry is known as the expense ratio, which is the percentage of an investment that goes toward
expenses. In 2019, Vanguard’s expense ratio was less than 14 percent of the industry’s average expense ratio. Vanguard
was the first to capitalize on what was at the time an underappreciated fact: over long horizons, well-managed index funds,
with their lower costs and fees, typically outperform their actively trading competitors.
Vanguard provides low-cost investment options for its clients in several ways. By creating funds that track index(es) over
a long horizon, the client does not incur transaction and management fees normally charged in actively managed funds.
Possibly more important, Vanguard was created with a unique client-owner structure. When you invest with Vanguard you
become an owner of Vanguard. This structure effectively cut out traditional shareholders who seek to share in profits. Under
client ownership, any returns in excess of operating costs are returned to the clients/investors.
Vanguard keeps its costs low in several other ways. One notable one is its focus on its employees and organizational
structure. The company prides itself on low turnover rates (8 percent) and very flat organizational structure. In several
instances Vanguard has been able to capitalize on being a fast follower. They launched several product lines after their
competitors introduced those products. Being a fast follower allowed them to develop superior products and reach scale
more quickly—both further lowering their cost structure.
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Keith Srakocic/AP Images
The low-cost structure has not come at the expense of performance. Vanguard now has 410 funds, over 30 million
investors, has surpassed $5.5 trillion in AUM (assets under management), and is growing faster than all its competitors
combined. When Money published its January 2020 list of recommended investment funds, 44 percent of the funds listed
were Vanguard funds.
Vanguard’s low-cost strategy has been so successful that industry experts now refer to The Vanguard Effect. This refers
to the pressure that this investment management giant has put on competitors to lower their fees in order to compete with
Vanguard’s low-cost value proposition.
Note: Developed with Vedrana B. Greatorex.
Sources: https://www.nytimes.com/2017/04/14/business/mutfund/vanguard-mutual-index-funds-growth.html;
https://investor.vanguard.com; Sunderam, A., Viceira, L., & Ciechanover, A. (2016) The Vanguard Group, Inc. in 2015:
Celebrating 40. HBS No. 9-216-026. Boston, MA: Harvard Business School Publishing; Money.com; About
Vanguard.com/Fast Facts About Vanguard.
Examples of Companies That Revamped Their Value Chains to Reduce Costs Nucor Corporation,
the most profitable steel producer in the United States and one of the largest steel producers worldwide,
drastically revamped the value chain process for manufacturing steel products by using relatively
inexpensive electric arc furnaces and continuous casting processes. Using electric arc furnaces to melt
recycled scrap steel eliminated many of the steps used by traditional steel mills that made their steel
products from iron ore, coke, limestone, and other ingredients using costly coke ovens, basic oxygen blast
furnaces, ingot casters, and multiple types of finishing facilities—plus Nucor’s value chain system
required far fewer employees. As a consequence, Nucor produces steel with a far lower capital
investment, a far smaller workforce, and far lower operating costs than traditional steel mills. Nucor’s
strategy to replace the traditional steelmaking value chain with its simpler, quicker value chain
approach has made it one of the world’s lowest-cost producers of steel, allowing it to take a
huge amount of market share away from traditional steel companies and earn attractive profits. This
approach has allowed the company to remain steadily profitable even as a flood of illegally subsidized
imports wreaked havoc on the rest of the North American steel market.
Success in
achieving a low-cost
edge over rivals
comes from out-
managing rivals in
finding ways to
perform value chain
activities faster,
more accurately, and
more cost-
effectively.
Southwest Airlines has achieved considerable cost savings by reconfiguring the traditional value chain
of commercial airlines, thereby permitting it to offer travelers lower fares. Its mastery of fast turnarounds
at the gates (about 25 minutes versus 45 minutes for rivals) allows its planes to fly more hours per day.
This translates into being able to schedule more flights per day with fewer aircraft, allowing Southwest to
generate more revenue per plane on average than rivals. Southwest does not offer assigned seating,
baggage transfer to connecting airlines, or first-class seating and service, thereby eliminating all the cost-
producing activities associated with these features. The company’s fast and user-friendly online
reservation system facilitates e-ticketing and reduces staffing requirements at telephone reservation
centers and airport counters. Its use of automated check-in equipment reduces staffing requirements for
terminal check-in. The company’s carefully designed point-to-point route system minimizes connections,
delays, and total trip time for passengers, allowing about 75 percent of Southwest passengers to fly
nonstop to their destinations and at the same time reducing Southwest’s costs for flight operations.
https://investor.vanguard.com/
http://money.com/
http://vanguard.com/Fast
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The Keys to a Successful Broad Low-Cost Strategy
While broad, low-cost companies are champions of frugality, they seldom hesitate to spend aggressively
on resources and capabilities that promise to drive costs out of the business. Indeed, having competitive
assets of this type and ensuring that they remain competitively superior is essential for achieving
competitive advantage as a broad, low-cost leader. Walmart, for example, has been an early adopter of
state-of-the-art technology throughout its operations; however, the company carefully estimates the cost
savings of new technologies before it rushes to invest in them. By continuously investing in complex,
cost-saving technologies that are hard for rivals to match, Walmart has sustained its low-cost advantage
for over 45 years.
A low-cost producer
is in the best
position to win the
business of price-
sensitive buyers, set
the floor on market
price, and still earn a
profit.
Uber and Lyft, employing a formidable low-cost provider strategy and an innovative business model,
have stormed their way into hundreds of locations across the world, totally disrupting and seemingly
forever changing competition in the taxi markets where they have a presence. And, most significantly, the
ultra-low fares charged by Uber and Lyft have resulted in dramatic increases in the demand for taxi
services, particularly those provided by these two low-cost providers. Other companies noted for their
successful use of broad low-cost strategies include Spirit Airlines, EasyJet, and Ryanair in airlines; Briggs
& Stratton in small gasoline engines; Huawei in networking and telecommunications equipment; Bic in
ballpoint pens; Stride Rite in footwear; and Poulan in chain saws.
When a Low-Cost Strategy Works Best
A low-cost strategy becomes increasingly appealing and competitively powerful when
1. Price competition among rival sellers is vigorous. Low-cost leaders are in the best position to compete
offensively on the basis of price, to gain market share at the expense of rivals, to win the business of
price-sensitive buyers, to remain profitable despite strong price competition, and to survive price wars.
2. The products of rival sellers are essentially identical and readily available from many eager sellers.
Look-alike products and/or overabundant product supply set the stage for lively price competition; in
such markets, it is the less efficient, higher-cost companies whose profits get squeezed the most.
3. There are few ways to achieve product differentiation that have value to buyers. When the differences
between product attributes or brands do not matter much to buyers, buyers are nearly always sensitive
to price differences, and industry-leading companies tend to be those with the lowest-priced brands.
4. Buyers incur low costs in switching their purchases from one seller to another. Low switching costs
give buyers the flexibility to shift purchases to lower-priced sellers having equally good products or to
attractively priced substitute products. A low-cost leader is well positioned to use low price to induce
potential customers to switch to its brand.
5. Buyers are price-sensitive or have the power to bargain down prices. When buyers are focused
primarily on price or have substantial bargaining power, then a low-cost strategy becomes something of
a necessity!
Pitfalls to Avoid in Pursuing a Low-Cost Strategy
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Perhaps the biggest mistake a low-cost producer can make is getting carried away with overly aggressive
price cutting. Higher unit sales and market shares do not automatically translate into higher profits.
Reducing price results in earning a lower profit margin on each unit sold. Thus, reducing price improves
profitability only if the lower price increases unit sales enough to offset the loss in revenues due to the
lower per unit profit margin. A simple numerical example tells the story: Suppose a firm selling
1,000 units at a price of $10, a cost of $9, and a profit margin of $1 opts to cut price 5 percent to $9.50—
which reduces the firm’s profit margin to $0.50 per unit sold. If unit costs remain at $9, then it takes a 100
percent sales increase to 2,000 units just to offset the narrower profit margin and get back to total profits
of $1,000. Hence, whether a price cut will result in higher or lower profitability depends on how big the
resulting sales gains will be and how much, if any, unit costs will fall as sales volumes increase.
A second pitfall is relying on cost reduction approaches that can be easily copied by rivals. If rivals
find it relatively easy or inexpensive to imitate the leader’s low-cost methods, then the leader’s advantage
will be too short-lived to yield a valuable edge in the marketplace.
Reducing price does
not lead to higher
total profits unless
the added gains in
unit sales are large
enough to offset the
loss in revenues due
to lower margins per
unit sold.
A third pitfall is becoming too fixated on cost reduction. Low costs cannot be pursued so zealously that
a firm’s offering ends up being too feature-poor to generate buyer appeal. Furthermore, a company
driving hard to push down its costs has to guard against ignoring declining buyer sensitivity to price,
increased buyer interest in added features or service, or new developments that alter how buyers use the
product. Otherwise, it risks losing market ground if buyers start opting for more upscale or feature-rich
products.
Even if these mistakes are avoided, a low-cost strategy still entails risk. An innovative rival may
discover an even lower-cost value chain approach. Important cost-saving technological breakthroughs
may suddenly emerge. And if a low-cost producer has heavy investments in its present means of
operating, then it can prove costly to quickly shift to the new value chain approach or a new technology.
A low-cost
producer’s product
offering must always
contain enough
attributes to be
attractive to
prospective buyers
—low price, by itself,
is not always
appealing to buyers.
BROAD DIFFERENTIATION STRATEGIES
• LO 5-3
Identify the major
avenues to a
competitive
advantage based on
differentiating a
company’s product
or service offering
from the offerings of
rivals.
Differentiation strategies are attractive whenever buyers’ needs and preferences are too diverse to be fully
satisfied by a standardized product offering. Successful product differentiation requires careful study to
determine what attributes buyers will find appealing, valuable, and worth paying for.3 Then the company
must incorporate a combination of these desirable features into its product or service that will be different
enough to stand apart from the product or service offerings of rivals. A broad differentiation strategy
achieves its aim when a wide range of buyers find the company’s offering more appealing than that of
rivals and worth a somewhat higher price.
CORE
CONCEPT
The essence of a
broad
differentiation
strategy is to offer
unique product
attributes that a wide
range of buyers find
appealing and worth
paying more for.
Successful differentiation allows a firm to do one or more of the following:
Command a premium price for its product.
Increase unit sales (because additional buyers are won over by the differentiating features).
Gain buyer loyalty to its brand (because buyers are strongly attracted to the differentiating features
and bond with the company and its products).
Differentiation enhances profitability whenever a company’s product can command a sufficiently
higher price or generate sufficiently bigger unit sales to more than cover the added costs of achieving the
differentiation. Company differentiation strategies fail when buyers don’t place much value on the brand’s
uniqueness and/or when a company’s differentiating features are easily matched by its rivals.
Companies can pursue differentiation from many angles: a unique taste (Red Bull, Listerine); multiple
features (Microsoft Office, Apple Watch); wide selection and one-stop shopping (Home Depot,
Alibaba.com); superior service (Ritz-Carlton, Nordstrom); spare parts availability (John Deere; Morgan
Motors); engineering design and performance (Mercedes, BMW); high fashion design (Prada, Gucci);
product reliability (Whirlpool, LG, and Bosch in large home appliances); quality manufacture (Michelin);
technological leadership (3M Corporation in bonding and coating products); a full range of services
(Charles Schwab in stock brokerage); and wide product selection (Campbell’s soups; Frito-Lay snack
foods.).
http://alibaba.com/
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Managing the Value Chain in Ways that Enhance Differentiation
Differentiation is not something in marketing and advertising departments, nor is it limited to the catchalls
of quality and service. Differentiation opportunities can exist in activities all along a company’s value
chain and value chain system. The most systematic approach that managers can take, however, involves
focusing on the value drivers, a set of factors—analogous to cost drivers—that are particularly effective
in creating differentiation. Figure 5.3 contains a list of important value drivers. Ways that managers can
enhance differentiation based on value drivers include the following:
CORE
CONCEPT
A value driver is a
factor that is
particularly effective
in creating
differentiation.
FIGURE 5.3 Value Drivers: The Keys to Creating a Differentiation Advantage
Source: Adapted from Michael E. Porter, Competitive Advantage: Creating and Sustaining Superior Performance (New York:
Free Press, 1985).
1. Create product features and performance attributes that appeal to a wide range of buyers. The physical
and functional features of a product have a big influence on differentiation, including features such as
added user safety or enhanced environmental protection. Styling and appearance are big differentiating
factors in the apparel and motor vehicle industries. Size and weight matter in binoculars and mobile
devices. Most companies employing broad differentiation strategies make a point of
incorporating innovative and novel features in their product or service offering, especially
those that improve performance and functionality.
2. Improve customer service or add extra services. Better customer services, in areas such as delivery,
returns, and repair, can be as important in creating differentiation as superior product features.
Examples include superior technical assistance to buyers, higher-quality maintenance services, more
and better product information provided to customers, more and better training materials for end users,
better credit terms, quicker order processing, and greater customer convenience.
3. Invest in production-related R&D activities. Engaging in production R&D may permit custom-order
manufacture at an efficient cost, provide wider product variety and selection through product
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“versioning,” or improve product quality. Many manufacturers have developed flexible manufacturing
systems that allow different models and product versions to be made on the same assembly line. Being
able to provide buyers with made-to-order products can be a potent differentiating capability.
4. Strive for innovation and technological advances. Successful innovation is the route to more frequent
first-on-the-market victories and is a powerful differentiator. If the innovation proves hard to replicate,
through patent protection or other means, it can provide a company with a first-mover advantage that is
sustainable.
5. Pursue continuous quality improvement. Quality control processes reduce product defects, prevent
premature product failure, extend product life, make it economical to offer longer warranty coverage,
improve economy of use, result in more end-user convenience, or enhance product
appearance. Companies whose quality management systems meet certification standards,
such as the ISO 9001 standards, can enhance their reputation for quality with customers.
6. Increase marketing and brand-building activities. Marketing and advertising can have a tremendous
effect on the value perceived by buyers and therefore their willingness to pay more for the company’s
offerings. They can create differentiation even when little tangible differentiation exists otherwise. For
example, blind taste tests show that even the most loyal Pepsi or Coke drinkers have trouble telling one
cola drink from another.4 Brands create customer loyalty, which increases the perceived “cost” of
switching to another product.
7. Seek out high-quality inputs. Input quality can ultimately spill over to affect the performance or quality
of the company’s end product. Starbucks, for example, gets high ratings on its coffees partly because it
has very strict specifications on the coffee beans purchased from suppliers.
8. Emphasize human resource management activities that improve the skills, expertise, and knowledge of
company personnel. A company with high-caliber intellectual capital often has the capacity to generate
the kinds of ideas that drive product innovation, technological advances, better product design and
product performance, improved production techniques, and higher product quality. Well-designed
incentive compensation systems can often unleash the efforts of talented personnel to develop and
implement new and effective differentiating attributes.
Revamping the Value Chain System to Increase Differentiation Just as pursuing a cost advantage
can involve the entire value chain system, the same is true for a differentiation advantage. Activities
performed upstream by suppliers or downstream by distributors and retailers can have a meaningful effect
on customers’ perceptions of a company’s offerings and its value proposition. Approaches to enhancing
differentiation through changes in the value chain system include
Coordinating with downstream channel allies to enhance customer value. Coordinating with
downstream partners such as distributors, dealers, brokers, and retailers can contribute to differentiation
in a variety of ways. Methods that companies use to influence the value chain activities of their channel
allies include setting standards for downstream partners to follow, providing them with templates to
standardize the selling environment or practices, training channel personnel, or cosponsoring
promotions and advertising campaigns. Coordinating with retailers is important for enhancing the
buying experience and building a company’s image. Coordinating with distributors or shippers can
mean quicker delivery to customers, more accurate order filling, and/or lower shipping costs. The Coca-
Cola Company considers coordination with its bottler-distributors so important that it has at times taken
over a troubled bottler to improve its management and upgrade its plant and equipment before releasing
it again.5
Coordinating with suppliers to better address customer needs. Collaborating with suppliers can also be
a powerful route to a more effective differentiation strategy. Coordinating and collaborating with
suppliers can improve many dimensions affecting product features and quality. This is particularly true
for companies that engage only in assembly operations, such as Dell in PCs and Ducati in motorcycles.
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Close coordination with suppliers can also enhance differentiation by speeding up new product
development cycles or speeding delivery to end customers. Strong relationships with suppliers can also
mean that the company’s supply requirements are prioritized when industry supply is insufficient to
meet overall demand.
Delivering Superior Value via a Broad Differentiation Strategy
Differentiation strategies depend on meeting customer needs in unique ways or creating new needs
through activities such as innovation or persuasive advertising. The objective is to offer customers
something that rivals can’t—at least in terms of the level of satisfaction. There are four basic routes to
achieving this aim:
The first route is to incorporate product attributes and user features that lower the buyer’s overall costs
of using the company’s product. This is the least obvious and most overlooked route to a differentiation
advantage. It is a differentiating factor since it can help business buyers be more competitive in their
markets and more profitable. Producers of materials and components often win orders for their products
by reducing a buyer’s raw-material waste (providing cut-to-size components), reducing a buyer’s
inventory requirements (providing just-in-time deliveries), using online systems to reduce a buyer’s
procurement and order processing costs, and providing free technical support. This route to differentiation
can also appeal to individual consumers who are looking to economize on their overall costs of
consumption. Making a company’s product more economical for a consumer to use can be done by
incorporating energy-efficient features (energy-saving appliances and lightbulbs help cut buyers’ utility
bills; fuel-efficient vehicles cut buyer costs for gasoline) and/or by increasing maintenance intervals and
product reliability to lower buyer costs for maintenance and repairs.
A second route is to incorporate tangible features that increase customer satisfaction with the product,
such as product specifications, functions, and styling. This can be accomplished by including attributes
that add functionality; enhance the design; save time for the user; are more reliable; or make the product
cleaner, safer, quieter, simpler to use, more portable, more convenient, or longer-lasting than rival brands.
Smartphone manufacturers are in a race to introduce next-generation devices capable of being used for
more purposes and having simpler menu functionality.
A third route to a differentiation-based competitive advantage is to incorporate intangible features that
enhance buyer satisfaction in noneconomic ways. Toyota’s Prius and GM’s Chevy Bolt appeal to
environmentally conscious motorists not only because these drivers want to help reduce global carbon
dioxide emissions but also because they identify with the image conveyed. Bentley, Ralph Lauren, Louis
Vuitton, Burberry, Cartier, and Coach have differentiation-based competitive advantages linked to buyer
desires for status, image, prestige, upscale fashion, superior craftsmanship, and the finer things in life.
Intangibles that contribute to differentiation can extend beyond product attributes to the reputation of the
company and to customer relations or trust.
Differentiation can
be based on
tangible or intangible
attributes.
The fourth route is to signal the value of the company’s product offering to buyers. The value of certain
differentiating features is rather easy for buyers to detect, but in some instances buyers may have trouble
assessing what their experience with the product will be. Successful differentiators go to great lengths to
make buyers knowledgeable about a product’s value and employ various signals of value. Typical signals
of value include a high price (in instances where high price implies high quality and performance), more
appealing or fancier packaging than competing products, ad content that emphasizes a product’s standout
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attributes, the quality of brochures and sales presentations, and the luxuriousness and ambience of a
seller’s facilities. The nature of a company’s facilities are important for high-end retailers and other types
of companies whose facilities are frequented by customers; they make potential buyers aware of the
professionalism, appearance, and personalities of the seller’s employees and/or make
potential buyers realize that a company has prestigious customers. Signaling value is
particularly important (1) when the nature of differentiation is based on intangible features and is
therefore subjective or hard to quantify, (2) when buyers are making a first-time purchase and are unsure
what their experience with the product will be, (3) when repurchase is infrequent, and (4) when buyers are
unsophisticated.
Regardless of the approach taken, achieving a successful differentiation strategy requires, first, that the
company have capabilities in areas such as customer service, marketing, brand management, and
technology that can create and support differentiation. That is, the resources, competencies, and value
chain activities of the company must be well matched to the requirements of the strategy. For the strategy
to result in competitive advantage, the company’s competencies must also be sufficiently unique in
delivering value to buyers that they help set its product offering apart from those of rivals. They must be
competitively superior. There are numerous examples of companies that have differentiated themselves
on the basis of distinctive capabilities. Health care facilities like M.D. Anderson, Mayo Clinic, and
Cleveland Clinic have specialized expertise and equipment for treating certain diseases that most
hospitals and health care providers cannot afford to emulate. When a major news event occurs, many
people turn to Fox News and CNN because they have the capabilities to get reporters on the scene
quickly, break away from their regular programming (without suffering a loss of advertising revenues
associated with regular programming), and devote extensive air time to newsworthy stories.
The most successful approaches to differentiation are those that are difficult for rivals to duplicate.
Indeed, this is the route to a sustainable competitive advantage based on differentiation. While resourceful
competitors can, in time, clone almost any tangible product attribute, socially complex intangible
attributes such as company reputation, long-standing relationships with buyers, and image are much
harder to imitate. Differentiation that creates switching costs that lock in buyers also provides a route to
sustainable advantage. For example, if a buyer makes a substantial investment in learning to use one type
of system, that buyer is less likely to switch to a competitor’s system. (This has kept many users from
switching away from Microsoft Office products, despite the fact that there are other applications with
superior features.) As a rule, differentiation yields a longer-lasting and more profitable competitive edge
when it is based on a well-established brand image, patent-protected product innovation, complex
technical superiority, a reputation for superior product quality and reliability, relationship-based customer
service, and unique competitive capabilities.
Easy-to-copy
differentiating
features cannot
produce sustainable
competitive
advantage.
When a Differentiation Strategy Works Best
Differentiation strategies tend to work best in market circumstances where
Buyer needs and uses of the product are diverse. Diverse buyer preferences allow industry rivals to set
themselves apart with product attributes that appeal to particular buyers. For instance, the diversity of
consumer preferences for menu selection, ambience, pricing, and customer service gives restaurants
exceptionally wide latitude in creating a differentiated product offering. Other industries with diverse
buyer needs include magazine publishing, automobile manufacturing, footwear, and kitchen appliances.
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There are many ways to differentiate the product or service that have value to buyers. Industries in
which competitors have opportunities to add features to products and services are well suited
to differentiation strategies. For example, hotel chains can differentiate on such features as
location, size of room, range of guest services, in-hotel dining, and the quality and luxuriousness of
bedding and furnishings. Similarly, cosmetics producers are able to differentiate based on prestige and
image, formulations that fight the signs of aging, UV light protection, exclusivity of retail locations, the
inclusion of antioxidants and natural ingredients, or prohibitions against animal testing. Basic
commodities, such as chemicals, mineral deposits, and agricultural products, provide few opportunities
for differentiation.
Few rival firms are following a similar differentiation approach. The best differentiation approaches
involve trying to appeal to buyers on the basis of attributes that rivals are not emphasizing. A
differentiator encounters less head-to-head rivalry when it goes its own separate way in creating value
and does not try to out-differentiate rivals on the very same attributes. When many rivals base their
differentiation efforts on the same attributes, the most likely result is weak brand differentiation and
“strategy overcrowding”—competitors end up chasing much the same buyers with much the same
product offerings.
Technological change is fast-paced and competition revolves around rapidly evolving product features.
Rapid product innovation and frequent introductions of next-version products heighten buyer interest
and provide space for companies to pursue distinct differentiating paths. In smartphones and wearable
Internet devices, drones for hobbyists and commercial use, automobile lane detection sensors, and
battery-powered cars, rivals are locked into an ongoing battle to set themselves apart by introducing the
best next-generation products. Companies that fail to come up with new and improved products and
distinctive performance features quickly lose out in the marketplace.
Pitfalls to Avoid in Pursuing a Differentiation Strategy
Differentiation strategies can fail for any of several reasons. A differentiation strategy keyed to product or
service attributes that are easily and quickly copied is always suspect. Rapid imitation means that no rival
achieves differentiation, since whenever one firm introduces some value-creating aspect that strikes the
fancy of buyers, fast-following copycats quickly reestablish parity. This is why a firm must seek out
sources of value creation that are time-consuming or burdensome for rivals to match if it hopes to use
differentiation to win a sustainable competitive edge.
Any differentiating
feature that works
well is a magnet for
imitators.
Differentiation strategies can also falter when buyers see little value in the unique attributes of a
company’s product. Thus, even if a company succeeds in setting its product apart from those of rivals, its
strategy can result in disappointing sales and profits if the product does not deliver adequate perceived
value to buyers. Anytime many potential buyers look at a company’s differentiated product offering with
indifference, the company’s differentiation strategy is in deep trouble.
The third big pitfall is overspending on efforts to differentiate the company’s product offering, thus
eroding profitability. Company efforts to achieve differentiation nearly always raise costs—often
substantially, since marketing and R&D are expensive undertakings. The key to profitable differentiation
is either to keep the unit cost of achieving differentiation below the price premium that the differentiating
attributes can command (thus increasing the profit margin per unit sold) or to offset thinner profit margins
per unit by selling enough additional units to increase total profits. If a company goes overboard in
pursuing costly differentiation, it could be saddled with unacceptably low profits or even losses.
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Other common mistakes in crafting a differentiation strategy include
Offering only trivial improvements in quality, service, or performance features vis-à-vis rivals’
products. Trivial differences between rivals’ product offerings may not be visible or important to
buyers. If a company wants to generate the fiercely loyal customer following needed to earn superior
profits and open up a differentiation-based competitive advantage over rivals, then its strategy must
result in strong rather than weak product differentiation. In markets where differentiators do no better
than achieve weak product differentiation, customer loyalty is weak, the costs of brand switching are
low, and no one company has enough of a differentiation edge to command a price premium over rival
brands.
Over-differentiating so that product quality, features, or service levels exceed the needs of most buyers.
A dazzling array of features and options not only drives up product price but also runs the risk that
many buyers will conclude that a less deluxe and lower-priced brand is a better value since they have
little occasion to use the deluxe attributes.
Charging too high a price premium. While buyers may be intrigued by a product’s deluxe features, they
may nonetheless see it as being overpriced relative to the value delivered by the differentiating
attributes. A company must guard against turning off would-be buyers with what is perceived as “price
gouging.” Normally, the bigger the price premium for the differentiating extras, the harder it is to keep
buyers from switching to the lower-priced offerings of competitors.
Over-differentiating
and overcharging
are fatal
differentiation
strategy mistakes. A
low-cost strategy
can defeat a
differentiation
strategy when
buyers are satisfied
with a basic product
and don’t think
“extra” attributes are
worth a higher price.
FOCUSED (OR MARKET NICHE) STRATEGIES
What sets focused strategies apart from broad low-cost and broad differentiation strategies is concentrated
attention on a narrow piece of the total market. The target segment, or niche, can be in the form of a
geographic segment (such as New England), or a customer segment (such as young urban creatives or
“yuccies”), or a product segment (such as a class of models or some version of the overall product type).
Community Coffee, the largest family-owned specialty coffee retailer in the United States, has a
geographic focus on the state of Louisiana and communities across the Gulf of Mexico. Community holds
only a small share of the national coffee market but has recorded sales in excess of $100 million and has
won a strong following in the Southeastern United States. Examples of firms that concentrate on a well-
defined market niche keyed to a particular product or buyer segment include Zipcar (hourly and daily car
rental in urban areas), Airbnb and HomeAway (owner of VRBO) (by-owner lodging rental), Fox News
Channel and HGTV (cable TV), Blue Nile (online jewelry), Tesla Motors (electric cars), and CGA, Inc. (a
specialist in providing insurance to cover the cost of lucrative hole-in-one prizes at golf tournaments).
Microbreweries, local bakeries, bed-and-breakfast inns, and retail boutiques have also scaled their
operations to serve narrow or local customer segments.
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A Focused Low-Cost Strategy
A focused low-cost strategy aims at securing a competitive advantage by serving buyers in the target
market niche at a lower cost (and usually lower price) than those of rival competitors. This strategy has
considerable attraction when a firm can lower costs significantly by limiting its customer base to a well-
defined buyer segment. The avenues to achieving a cost advantage over rivals also serving the target
market niche are the same as those for broad low-cost leadership—use the cost drivers to perform value
chain activities more efficiently than rivals and search for innovative ways to bypass
nonessential value chain activities. The only real difference between a broad low-cost strategy
and a focused low-cost strategy is the size of the buyer group to which a company is appealing—the
former involves a product offering that appeals to almost all buyer groups and market segments, whereas
the latter aims at just meeting the needs of buyers in a narrow market segment.
ILLUSTRATION
CAPSULE 5.2 Clinícas del Azúcar’s Focused Low-Cost
Strategy
Though diabetes is a manageable condition, it is the leading cause of death in Mexico. Over 14 million adults (14 percent of
all adults) suffer from diabetes, 3.5 million cases remain undiagnosed, and more than 80,000 die due to related
complications each year. The key driver behind this public health crisis is limited access to affordable, high-quality care.
Approximately 90 percent of the population cannot access diabetes care due to financial and time constraints; private care
can cost upwards of $1,000 USD per year (approximately 45 percent of Mexico’s population has an annual income less
than $2,000 USD) while average wait times alone at public clinics surpass five hours. Clinícas del Azúcar (CDA), however,
is quickly scaling a solution that uses a focused low-cost strategy to provide affordable and convenient care to low-income
patients.
By relentlessly focusing only on the needs of its target population, CDA has reduced the cost of diabetes care by more
than 70 percent and clinic visit times by over 80 percent. The key has been the use of proprietary technology and a
streamlined care system. First, CDA leverages evidence-based algorithms to diagnose patients for a fraction of the costs of
traditional diagnostic tests. Similarly, its mobile outreach significantly reduces the costs of supporting patients in managing
their diabetes after leaving CDA facilities. Second, CDA has redesigned the care process to implement a streamlined
“patient process flow” that eliminates the need for multiple referrals to other care providers and brings together the
necessary professionals and equipment into one facility. Consequently, CDA has become a one-stop shop for diabetes
care, providing every aspect of diabetes treatment under one roof.
Rob Marmion/Shutterstock
The bottom line: CDA’s cost structure allows it to keep its prices for diabetes treatment very low, saving patients both time
and money. Patients choose from three different care packages, ranging from preventive to comprehensive care, paying an
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annual fee that runs between approximately $70 and $200 USD. Given this increase in affordability and convenience, CDA
estimates that it has saved its patients over $2 million USD in medical costs and will soon increase access to affordable,
high-quality care for 10 to 80 percent of the population. These results have attracted investment from major funders
including Endeavor, Echoing Green, and the Clinton Global Initiative. As a result, CDA and others expect CDA to grow from
five clinics serving approximately 5,000 patients to more than 50 clinics serving over 100,000 patients throughout Mexico by
2020.
Note: Developed with David B. Washer.
Sources: www.clinicasdelazucar.com; “Funding Social Enterprises Report,” Echoing Green, June 2014; Jude Webber,
“Mexico Sees Poverty Climb Despite Rise in Incomes,” Financial Times online, July 2015,
www.ft.com/intl/cms/s/3/98460bbc-31e1-11e5-8873-775ba7c2ea3d.html#axzz3zz8grtec; “Javier Lozano,” Schwab
Foundation for Social Entrepreneurship online, 2016, www.schwabfound.org/content/javier-lozano.
Budget motel chains, like Motel 6, Sleep Inn, and Super 8, cater to price-conscious travelers who just
want to pay for a clean, no-frills place to spend the night. Illustration Capsule 5.2 describes how Clinícas
del Azúcar’s focus on lowering the costs of diabetes care is allowing it to address a major health issue in
Mexico.
Focused low-cost strategies are fairly common. Costco, BJ’s, and Sam’s Club sell large
lots of goods at wholesale prices to small businesses and bargain-hunters. Producers of private-label
goods are able to achieve low costs in product development, marketing, distribution, and advertising by
concentrating on making generic items imitative of name-brand merchandise and selling directly to retail
chains wanting a low-priced store brand. The Perrigo Company Plc has become a leading manufacturer of
over-the-counter health care products and self-care, with 2018 sales of nearly $5 billion, by focusing on
producing private-label brands for retailers such as Walmart, CVS, Walgreens, Rite Aid, and Safeway.
A Focused Differentiation Strategy
Focused differentiation strategies involve offering superior products or services tailored to the unique
preferences and needs of a narrow, well-defined group of buyers. Successful use of a focused
differentiation strategy depends on (1) the existence of a buyer segment that is looking for special product
or service attributes and (2) a firm’s ability to create a product or service offering that stands apart from
that of rivals competing in the same target market niche.
Companies like Molton Brown in bath, body, and beauty products, Bugatti in high-performance
automobiles, and Four Seasons Hotels in lodging employ successful differentiation-based focused
strategies targeted at upscale buyers wanting products and services with world-class attributes. Indeed,
most markets contain a buyer segment willing to pay a big price premium for the very finest items
available, thus opening the strategic window for some competitors to pursue differentiation-based focused
strategies aimed at the very top of the market pyramid. Whole Foods Market, which was acquired by
Amazon in 2017, became the largest organic and natural foods supermarket chain in the United States by
catering to health-conscious consumers who prefer organic, natural, minimally processed, and locally
grown foods. Whole Foods prides itself on stocking the highest-quality organic and natural foods it can
find; the company defines quality by evaluating the ingredients, freshness, taste, nutritive value,
appearance, and safety of the products it carries. Illustration Capsule 5.3 describes how Canada Goose has
become a popular winter apparel brand with a focused differentiation strategy.
When a Focused Low-Cost or Focused Differentiation Strategy Is
Attractive
A focused strategy aimed at securing a competitive edge based on either low costs or differentiation
becomes increasingly attractive as more of the following conditions are met:
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http://www.ft.com/intl/cms/s/3/98460bbc-31e1-11e5-8873-775ba7c2ea3d.html#axzz3zz8grtec
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The target market niche is big enough to be profitable and offers good growth potential.
Industry leaders have chosen not to compete in the niche—in which case focusers can avoid battling
head to head against the industry’s biggest and strongest competitors.
It is costly or difficult for multisegment competitors to meet the specialized needs of niche buyers and
at the same time satisfy the expectations of their mainstream customers.
The industry has many different niches and segments, thereby allowing a focuser to pick the niche best
suited to its resources and capabilities. Also, with more niches there is room for focusers to concentrate
on different market segments and avoid competing in the same niche for the same customers.
Few if any rivals are attempting to specialize in the same target segment—a condition that reduces the
risk of segment overcrowding.
ILLUSTRATION
CAPSULE 5.3 Canada Goose’s Focused Differentiation
Strategy
Open up a winter edition of People and you will probably see photos of a celebrity sporting a Canada Goose parka.
Recognizable by a distinctive red, white, and blue arm patch, the brand’s parkas have been spotted on movie stars like
Emma Stone and Bradley Cooper, on New York City streets, and on the cover of Sports Illustrated. Lately, Canada Goose
has become extremely successful thanks to a focused differentiation strategy that enables it to thrive within its niche in the
$1.2 trillion fashion industry. By targeting upscale buyers and providing a uniquely functional and stylish jacket, Canada
Goose can charge nearly $1,000 per jacket and never need to put its products on sale.
While Canada Goose was founded in 1957, its recent transition to a focused differentiation strategy allowed it to rise to
the top of the luxury parka market. In 2001, CEO Dani Reiss took control of the company and made two key decisions.
First, he cut private-label and non-outerwear production in order to focus on the branded outerwear portion of Canada
Goose’s business. Second, Reiss decided to remain in Canada despite many North American competitors moving
production to Asia to increase profit margins. Fortunately for him, these two strategy decisions have led directly to the
company’s current success. While other luxury brands, like Moncler, are priced similarly, no competitor’s products fulfill the
promise of handling harsh winter weather quite like a Canada Goose “Made in Canada” parka. The Canadian heritage, use
of down sourced from rural Canada, real coyote fur (humanely trapped), and promise to provide warmth in sub-25°F
temperatures have let Canada Goose break away from the pack when it comes to selling parkas. The company’s distinctly
Canadian product has made it a hit among buyers, which is reflected in the willingness to pay a steep premium for
extremely high-quality and warm winter outerwear.
Galit Rodan/Bloomberg/Getty Images
Since Canada Goose’s shift to a focused differentiation strategy, the company has seen a boom in revenue and appeal
across the globe. Prior to Reiss’s strategic decisions in 2001, Canada Goose had annual revenue of about $3 million.
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Within a decade, the company had experienced over 4,000 percent growth in annual revenue; by the end of 2019,
revenues from purchases in more than 50 countries had exceeded $830 million. At this pace, it looks like Canada Goose
will remain a hot commodity as long as winter temperatures remain cold.
Note: Developed with Arthur J. Santry.
Sources: Drake Bennett, “How Canada Goose Parkas Migrated South,” Bloomberg Businessweek, March 13, 2015,
www.bloomberg.com; Hollie Shaw, “Canada Goose’s Made-in-Canada Marketing Strategy Translates into Success,”
Financial Post, May 18, 2012, www.financialpost.com; “The Economic Impact of the Fashion Industry,” The Economist,
June 13, 2015, www.maloney.house.gov; and company website (accessed January 26, 2020).
The advantages of focusing a company’s entire competitive effort on a single market niche are
considerable, especially for smaller and medium-sized companies that may lack the breadth and depth of
resources to tackle going after a broader customer base with a more complex set of needs. YouTube
became a household name by concentrating on short video clips posted online. Papa John’s, Little
Caesars, and Domino’s Pizza have created impressive businesses by focusing on the home delivery
segment.
The Risks of a Focused Low-Cost or Focused Differentiation
Strategy
Focusing carries several risks. One is the chance that competitors outside the niche will find effective
ways to match the focused firm’s capabilities in serving the target niche—perhaps by coming up with
products or brands specifically designed to appeal to buyers in the target niche or by developing expertise
and capabilities that offset the focuser’s strengths. In the lodging business, large chains like Marriott and
Hilton have launched multibrand strategies that allow them to compete effectively in several lodging
segments simultaneously. Hilton has flagship hotels with a full complement of services and amenities that
allow it to attract travelers and vacationers going to major resorts; it has Waldorf Astoria, Conrad Hotels
& Resorts, Hilton Hotels & Resorts, and DoubleTree hotels that provide deluxe comfort and service to
business and leisure travelers; it has Homewood Suites, Embassy Suites, and Home2 Suites designed as a
“home away from home” for travelers staying five or more nights; and it has nearly 700 Hilton Garden
Inn and 2,100 Hampton by Hilton locations that cater to travelers looking for quality lodging at an
“affordable” price. Tru by Hilton is the company’s newly introduced brand focused on value-conscious
travelers seeking basic accommodations. Hilton has also added Curio Collection, Tapestry Collection, and
Canopy by Hilton hotels that offer stylish, distinctive decors and personalized services that appeal to
young professionals seeking distinctive lodging alternatives. Multibrand strategies are attractive to large
companies such as Hilton precisely because they enable a company to enter a market niche and siphon
business away from companies that employ a focus strategy.
A second risk of employing a focused strategy is the potential for the preferences and needs of niche
members to shift over time toward the product attributes desired by buyers in the mainstream portion of
the market. An erosion of the differences across buyer segments lowers entry barriers into a focuser’s
market niche and provides an open invitation for rivals in adjacent segments to begin competing for the
focuser’s customers. A third risk is that the segment may become so attractive that it is soon inundated
with competitors, intensifying rivalry and splintering segment profits. And there is always the risk for
segment growth to slow to such a small rate that a focuser’s prospects for future sales and profit gains
become unacceptably dim.
BEST-COST (HYBRID) STRATEGIES
To profitably employ a best-cost strategy, a company must have the capability to incorporate upscale
attributes into its product offering at a lower cost than rivals. When a company can incorporate more
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appealing features, good to excellent product performance or quality, or more satisfying customer service
into its product offering at a lower cost than rivals, then it enjoys “best-cost” status—it is the low-cost
provider of a product or service with upscale attributes. A best-cost producer can use its low-cost
advantage to underprice rivals whose products or services have similarly upscale attributes and still earn
attractive profits. As Figure 5.1 indicates, best-cost strategies are a hybrid of low-cost and differentiation
strategies, incorporating features of both simultaneously. They may address either a broad or narrow
(focused) customer base. This permits companies to aim squarely at the sometimes great mass of value-
conscious buyers looking for a better product or service at a somewhat lower price. Value-conscious
buyers frequently shy away from both cheap low-end products and expensive high-end
products, but they are quite willing to pay a “fair” price for extra features and functionality they
find appealing and useful. The essence of a best-cost strategy is giving customers more value for the
money by satisfying buyer desires for appealing features and charging a lower price for these attributes
compared to rivals with similar-caliber product offerings.6
CORE
CONCEPT
Best-cost
strategies are a
hybrid of low-cost
and differentiation
strategies,
incorporating
features of both
simultaneously.
A best-cost strategy is different from a low-cost strategy because the additional attractive attributes
entail additional costs (which a low-cost producer can avoid by offering buyers a basic product with few
frills). Moreover, the two strategies aim at a distinguishably different market target. The target market for
a best-cost producer is value-conscious buyers—buyers who are looking for appealing extras and
functionality at a comparatively low price, regardless of whether they represent a broad or more focused
segment of the market. Value-hunting buyers (as distinct from price-conscious buyers looking for a basic
product at a bargain-basement price) often constitute a very sizable part of the overall market for a
product or service. A best-cost strategy differs from a differentiation strategy because it entails the ability
to produce upscale features at a lower cost than other high-end producers. This implies the ability to
profitably offer the buyer more value for the money.
Best-cost producers need not offer the highest end products and services (although they may); often the
quality levels are simply better than average. Positioning of this sort permits companies to aim squarely at
the sometimes great mass of value-conscious buyers looking for a better product or service at an
economical price. Value-conscious buyers frequently shy away from both cheap low-end products and
expensive high-end products, but they are quite willing to pay a “fair” price for extra features and
functionality they find appealing and useful. The essence of a best-cost strategy is the ability to provide
more value for the money by satisfying buyer desires for better quality while charging a lower price
compared to rivals with similar-caliber product offerings.
Toyota has employed a classic best-cost strategy for its Lexus line of motor vehicles. It has designed an
array of high-performance characteristics and upscale features into its Lexus models to make them
comparable in performance and luxury to Mercedes, BMW, Audi, Jaguar, Cadillac, and Lincoln models.
To signal its positioning in the luxury market segment, Toyota established a network of Lexus dealers,
separate from Toyota dealers, dedicated to providing exceptional customer service. Most important,
though, Toyota has drawn on its considerable know-how in making high-quality vehicles at low cost to
produce its high-tech upscale-quality Lexus models at substantially lower costs than other luxury vehicle
makers have been able to achieve in producing their models. To capitalize on its lower manufacturing
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costs, Toyota prices its Lexus models below those of comparable Mercedes, BMW, Audi, and Jaguar
models to induce value-conscious luxury car buyers to purchase a Lexus instead. The price differential
has typically been quite significant. For example, in 2017, a well-equipped Lexus RX 350 (a midsized
SUV) had a sticker price of $54,370, whereas the sticker price of a comparably equipped Mercedes GLE-
class SUV was $62,770 and the sticker price of a comparably equipped BMW X5 SUV was $66,670.
When a Best-Cost Strategy Works Best
• LO 5-4
Explain the
attributes of a best-
cost strategy—a
hybrid of low-cost
and differentiation
strategies.
A best-cost strategy works best in markets where product differentiation is the norm and an attractively
large number of value-conscious buyers can be induced to purchase midrange products rather than cheap,
basic products or expensive, top-of-the-line products. In markets such as these, a best-cost producer needs
to position itself near the middle of the market with either a medium-quality product at a below-
average price or a high-quality product at an average or slightly higher price. But as the Lexus
example shows, a firm with the capabilities to produce top-of-the-line products more efficiently than its
rivals, would also do well to pursue a best-cost strategy. Best-cost strategies also work well in
recessionary times, when masses of buyers become more value-conscious and are attracted to
economically priced products and services with more appealing attributes. However, unless a company
has the resources, know-how, and capabilities to incorporate upscale product or service attributes at a
lower cost than rivals, adopting a best-cost strategy is ill-advised. Illustration Capsule 5.4 describes how
Trader Joe’s has applied the principles of a focused best-cost strategy to thrive in the competitive grocery
store industry.
ILLUSTRATION
CAPSULE 5.4 Trader Joe’s Focused Best-Cost Strategy
Over the last 50 years, Trader Joe’s has built a cult-like following by offering a limited selection of highly popular private-
label products at great prices, under the Trader Joe’s brand. By pursuing a focused best-cost strategy, Trader Joe’s has
been able to thrive in the notoriously low-margin grocery business. Today, Trader Joe’s earns over $2,000 of annual sales
per square foot— nearly double that of Whole Foods.
One key to Trader Joe’s success, and a major part of its strategy, is its unique approach to product selection. By selling
mainly private label goods under its own brand, Trader Joe’s keeps its costs low, enabling it to offer lower prices. By being
very selective about the particular products that it carries, it has also managed to ensure that its brand is associated with
very high quality. The company’s policy is to swiftly replace any product that does not prove popular with another more
appealing product. This has paid off: when you ask U.S. consumers which grocery store represents quality, Trader Joe’s
tops the list. On a recent YouGov Brand Index poll, nearly 40 percent of consumers ranked Trader Joe’s best for quality—
the highest among its competitors. While Trader Joe’s offers far fewer stock-keeping units (SKUs) than a typical grocery
store—only 4,000 SKUs as compared to 50,000 + in a Kroger or Safeway—the upside for customers is that this also helps
to keep costs and prices low. It results in higher inventory turns (a key measure of efficiency in retail), lower inventory costs,
and lower rents since stores in any given location can be smaller.
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Ken Wolter/Shutterstock
Trader Joe’s also intentionally locates its stores in areas with value-focused customers who appreciate quality. Trader
Joe’s identifies potential sites for expansion by evaluating demographic information. This enables Trader Joe’s to focus on
serving young educated singles and couples who may not be able to afford more expensive groceries but prefer organics
and ready-to-eat products. Given that it occupies smaller sized retail spaces, Trader Joe’s can locate in walkable areas and
urban centers, the very same neighborhoods in which its chosen customer base lives. Because of its focused best-cost
strategy, it is unlikely that the company’s loyal customers will quit lining up to buy its tasty corn salsa or organic cold brew
coffee any time soon.
Note: Developed with Stephanie K. Berger.
Sources: Company website; Beth Kowitt, “Inside the Secret World of Trader Joe’s,” Fortune (August 2010); Elain Watson,
“Quirky, Cult-life, Aspirational, but Affordable: The Rise and Rise of Trader Joes,” Food Navigator USA (April 2014; Janie
Ryan, “The Surprising Secrets Behind Trader Joe’s Supply Chain”, Elementum.com, (December 13, 2018).
The Risk of a Best-Cost Strategy
A company’s biggest vulnerability in employing a best-cost strategy is getting squeezed between the
strategies of firms using low-cost and high-end differentiation strategies. Low-cost producers may be able
to siphon customers away with the appeal of a lower price (despite less appealing product attributes).
High-end differentiators may be able to steal customers away with the appeal of better product attributes
(even though their products carry a higher price tag). Thus, to be successful, a firm employing a best-cost
strategy must achieve significantly lower costs in providing upscale features so that it can outcompete
high-end differentiators on the basis of a significantly lower price. Likewise, it must offer buyers
significantly better product attributes to justify a price above what low-cost leaders are charging. In other
words, it must offer buyers a more attractive customer value proposition.
THE CONTRASTING FEATURES OF THE GENERIC
COMPETITIVE STRATEGIES
Deciding which generic competitive strategy should serve as the framework on which to hang the rest of
the company’s strategy is not a trivial matter. Each of the five generic competitive strategies positions the
company differently in its market and competitive environment. Each establishes a central theme for how
the company will endeavor to outcompete rivals. Each creates some boundaries or guidelines for
http://elementum.com/
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maneuvering as market circumstances unfold and as ideas for improving the strategy are debated. Each
entails differences in terms of product line, production emphasis, marketing emphasis, and means of
maintaining the strategy, as shown in Table 5.1.
A company’s
competitive strategy
should be well
matched to its
internal situation and
predicated on
leveraging its
collection of
competitively
valuable resources
and capabilities.
Thus, a choice of which generic strategy to employ spills over to affect many aspects of how the
business will be operated and the manner in which value chain activities must be managed. Deciding
which generic strategy to employ is perhaps the most important strategic commitment a company makes
—it tends to drive the rest of the strategic actions a company decides to undertake.
Successful Generic Strategies Are Resource-Based
For a company’s competitive strategy to succeed in delivering good performance and gain a competitive
edge over rivals, it has to be well matched to a company’s internal situation and underpinned by an
appropriate set of resources, know-how, and competitive capabilities. To succeed in employing a low-cost
strategy, a company must have the resources and capabilities to keep its costs below those of its
competitors. This means having the expertise to cost-effectively manage value chain activities better than
rivals by leveraging the cost drivers more effectively, and/or having the innovative capability to bypass
certain value chain activities being performed by rivals. To succeed in a differentiation strategy, a
company must have the resources and capabilities to leverage value drivers more effectively than rivals
and incorporate attributes into its product offering that a broad range of buyers will find appealing.
Successful focus strategies (both low cost and differentiation) require the capability to do an outstanding
job of satisfying the needs and expectations of niche buyers. Success in employing a best-cost strategy
requires the resources and capabilities to incorporate upscale product or service attributes at a lower cost
than rivals. For all types of generic strategies, success in sustaining the competitive edge depends on
having resources and capabilities that rivals have trouble duplicating and for which there are no good
substitutes.
TABLE 5.1 Distinguishing Features of the Five Generic Competitive Strategies
Broad Low-Cost BroadDifferentiation Focused Low-Cost
Focused
Differentiation Best-Cost
Strategic
target
A broad
cross-
section of
the market.
A broad
cross-section
of the
market.
A narrow
market niche
where buyer
needs and
preferences
are
distinctively
different.
A narrow
market niche
where buyer
needs and
preferences
are
distinctively
different.
A broad or narrow
range of value-
conscious buyers.
Broad Low-Cost BroadDifferentiation Focused Low-Cost
Focused
Differentiation Best-Cost
Basis of
competitive
strategy
Lower
overall
costs than
competitors.
Ability to
offer buyers
something
attractively
different from
competitors’
offerings.
Lower overall
cost than
rivals in
serving niche
members.
Attributes that
appeal
specifically to
niche
members.
Ability to
incorporate upscale
features and
attributes at lower
costs than rivals.
Product
line
A good
basic
product with
few frills
(acceptable
quality and
limited
selection).
Many
product
variations,
wide
selection;
emphasis on
differentiating
features.
Features and
attributes
tailored to the
tastes and
requirements
of niche
members.
Features and
attributes
tailored to the
tastes and
requirements
of niche
members.
Items with
appealing attributes
and assorted
features; better
quality, not
necessarily best.
Production
emphasis
A
continuous
search for
cost
reduction
without
sacrificing
acceptable
quality and
essential
features.
Build in
whatever
differentiating
features
buyers are
willing to pay
for; strive for
product
superiority.
A continuous
search for
cost
reduction for
products that
meet basic
needs of
niche
members.
Small-scale
production or
custom-made
products that
match the
tastes and
requirements
of niche
members.
Build in appealing
features and better
quality at lower cost
than rivals.
Marketing
emphasis
Low prices,
good value.
Try to make
a virtue out
of product
features
that lead to
low cost.
Tout
differentiating
features.
Charge a
premium
price to
cover the
extra costs of
differentiating
features.
Communicate
attractive
features of a
budget-priced
product
offering that
fits niche
buyers’
expectations.
Communicate
how product
offering does
the best job
of meeting
niche buyers’
expectations.
Emphasize delivery
of best value for the
money.
Keys to
maintaining
the
strategy
Strive to
manage
costs down,
year after
year, in
every area
of the
business.
Stress
continuous
improvement
in products
or services
and constant
innovation to
stay ahead
of imitative
competitors.
Stay
committed to
serving the
niche at the
lowest overall
cost; don’t
blur the firm’s
image by
entering other
market
segments or
adding other
products to
widen market
appeal.
Stay
committed to
serving the
niche better
than rivals;
don’t blur the
firm’s image
by entering
other market
segments or
adding other
products to
widen market
appeal.
Stress continuous
improvement in
products or
services and
constant innovation,
along with
continuous efforts
to improve
efficiency.
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Broad Low-Cost BroadDifferentiation Focused Low-Cost
Focused
Differentiation Best-Cost
Resources
and
capabilities
required
Capabilities
for driving
costs out of
the value
chain
system.
Examples:
large-scale
automated
plants, an
efficiency-
oriented
culture,
bargaining
power.
Capabilities
concerning
quality,
design,
intangibles,
and
innovation.
Examples:
marketing
capabilities,
R&D teams,
technology.
Capabilities
to lower costs
on niche
goods.
Examples:
lower input
costs for the
specific
product
desired by
the niche,
batch
production
capabilities.
Capabilities
to meet the
highly
specific
needs of
niche
members.
Examples:
custom
production,
close
customer
relations.
Capabilities to
simultaneously
deliver lower cost
and higher-
quality/differentiated
features.
Examples: TQM
practices, mass
customization.
Generic Strategies and the Three Different Approaches to
Competitive Advantage
Just as a company’s resources and capabilities underlie its choice of generic strategy, its generic strategy
determines its approach to gaining a competitive advantage. There are three such approaches. Clearly,
low-cost strategies aim for a cost advantage over rivals, differentiation strategies strive to create relatively
more perceived value for consumers, while best-cost strategies aim to do better than the average rival on
both dimensions. Whether the strategy is broad based or focused makes no difference as to the basic
approach employed (see Figure 5.1).
Exactly how this works is best understood with the use of the value-price-cost framework, first
introduced in Chapter 1 in the context of different kinds of business models. Figure 5.4 illustrates the
three basic approaches to competitive advantage in terms of the value-price-cost framework. The left
figure in the diagram represents an average competitor’s cost (C) of producing a good, how highly the
customer values it (V), and its price (P). The difference between the good’s value to the customer (V) and
its cost (C) is the total economic value (V-C) produced by the average competitor. And as explained in
Chapter 4, a company has a competitive advantage over another if its strategy generates more total
economic value. It is this excess in total economic value over rivals that allows the company to offer
customers a better value proposition or earn larger profits (or both). The dashed yellow lines facilitate a
comparison of the average competitor’s costs (C) and perceived value (V) with the costs and value
produced by each of the three basic types of generic strategies (low cost, differentiation, best cost). In this
way, it also facilitates a comparison of the total economic value generated by each of the three
representative generic strategies in relation to the average competitor, thereby shedding light on the nature
of each strategy’s competitive advantage.
FIGURE 5.4 Three Approaches to Competitive Advantage and the Value-Price-Cost
Framework
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As Figure 5.4 shows, a low-cost generic strategy aims to achieve lower costs than an
average competitor, at the sacrifice of some of the perceived value to the consumer. If the decrease in
costs is less than the decrease in perceived value, then the total economic value (V-C) for the low-cost
leader will be greater than the total economic value produced by its average rival and the low-cost leader
will have a competitive advantage. This is clearly the case for the example of a low-cost strategy depicted
in Figure 5.4. As is common with low-cost strategies, the example company has chosen to charge a lower
price than its average rival. The result is that even with a lower V, the low-cost leader offers the consumer
a more attractive (larger) consumer value proposition (depicted in mauve) and finds itself with a better
profit formula (depicted in blue).
In contrast, the example of a differentiation strategy shows that costs might well exceed those of the
average competitor. But with a successful differentiation strategy, that disadvantage is more than made up
for by the rise in the perceived value (V) of the differentiated good, giving the differentiator a clear
competitive advantage over the average rival (greater V-C). And while the price charged in this example
is a good deal higher in comparison with the average rival’s price, this differentiation strategy enables
both a larger consumer value proposition (in mauve) as well as greater profits (in blue).
The depiction of a best-cost strategy shows a company pursuing the middle ground of offering neither
the most highly valued goods in the market nor the lowest costs. But in comparison with the average
rival, it does better on both scores, resulting in more total economic value (V-C) and a substantial
competitive advantage. Once again, the example shows both a larger customer value proposition as well
as a more attractive profit formula.
The last thing to note is that the generic strategies depicted in Figure 5.4 are examples of successful
generic strategies. Being successful with a generic strategy depends on much more than positioning. It
depends on the competitive context (the company’s external situation) and on the company’s internal
situation, including its complement of resources and capabilities. Importantly, it also depends on how well
the strategy is executed—the topic of this text’s three concluding chapters.
KEY POINTS
1. Deciding which of the five generic competitive strategies to employ—broad low-cost, broad
differentiation, focused low-cost, focused differentiation, or best-cost—is perhaps the most important
strategic commitment a company makes. It tends to drive the remaining strategic actions a company
undertakes and sets the whole tone for pursuing a competitive advantage over rivals.
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LO 5-1, LO 5-2, LO
5-3, LO 5-4
2. In employing a broad low-cost strategy and trying to achieve a low-cost advantage over rivals, a
company must do a better job than rivals of cost-effectively managing value chain activities and/or it
must find innovative ways to eliminate cost-producing activities. An effective use of cost drivers is key.
Low-cost strategies work particularly well when price competition is strong and the products of rival
sellers are virtually identical, when there are not many ways to differentiate, when buyer switching
costs are low, and when buyers are price-sensitive or have the power to bargain down prices.
3. Broad differentiation strategies seek to produce a competitive edge by incorporating attributes that set a
company’s product or service offering apart from rivals in ways that buyers consider valuable and
worth paying for. This depends on the appropriate use of value drivers. Successful differentiation
allows a firm to (1) command a premium price for its product, (2) increase unit sales (if additional
buyers are won over by the differentiating features), and/or (3) gain buyer loyalty to its brand
(because some buyers are strongly attracted to the differentiating features and bond with the
company and its products). Differentiation strategies work best when buyers have diverse product
preferences, when few other rivals are pursuing a similar differentiation approach, and when
technological change is fast-paced and competition centers on rapidly evolving product features. A
differentiation strategy is doomed when competitors are able to quickly copy the appealing product
attributes, when a company’s differentiation efforts fail to interest many buyers, and when a company
overspends on efforts to differentiate its product offering or tries to overcharge for its differentiating
extras.
4. A focused strategy delivers competitive advantage either by achieving lower costs than rivals in
serving buyers constituting the target market niche or by developing a specialized ability to offer niche
buyers an appealingly differentiated offering that meets their needs better than rival brands do. A
focused strategy based on either low cost or differentiation becomes increasingly attractive when the
target market niche is big enough to be profitable and offers good growth potential, when it is costly or
difficult for multisegment competitors to meet the specialized needs of the target market niche and at
the same time satisfy the expectations of their mainstream customers, when there are one or more
niches that present a good match for a focuser’s resources and capabilities, and when few other rivals
are attempting to specialize in the same target segment.
5. Best-cost strategies create competitive advantage on the basis of their capability to incorporate
attractive or upscale attributes at a lower cost than rivals. Best-cost strategies can be either broad or
focused. A best-cost strategy works best in broad or narrow market segments with value-conscious
buyers desirous of purchasing better products and services for less money.
6. In all cases, competitive advantage depends on having competitively superior resources and capabilities
that are a good fit for the chosen generic strategy. A sustainable advantage depends on maintaining that
competitive superiority with resources, capabilities, and value chain activities that rivals have trouble
matching and for which there are no good substitutes.
ASSURANCE OF LEARNING EXERCISES
1. Best Buy is the largest consumer electronics retailer in the United States, with
fiscal 2019 sales of nearly $43 billion. The company competes aggressively on
price with such rivals as Costco, Sam’s Club, Walmart, and Target, but it is also
known by consumers for its first-rate customer service. Best Buy customers have
commented that the retailer’s sales staff is exceptionally knowledgeable about
the company’s products and can direct them to the exact location of difficult-to-
find items. Best Buy customers also appreciate that demonstration models of PC
monitors, digital media players, and other electronics are fully powered and
ready for in-store use. Best Buy’s Geek Squad tech support and installation
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LO 5-2
LO 5-1, LO 5-2, LO
5-3, LO 5-4
LO 5-3
LO 5-1, LO 5-2, LO
5-3, LO 5-4
services are additional customer service features that are valued by many
customers.
How would you characterize Best Buy’s competitive strategy? Should it be
classified as a low-cost strategy? A differentiation strategy? A best-cost strategy?
Also, has the company chosen to focus on a narrow piece of the market, or does
it appear to pursue a broad market approach? Explain your answer.
2. Illustration Capsule 5.1 discusses Vanguard’s position as the low-cost leader in
the investment management industry. Based on information provided in the
capsule, explain how Vanguard built its low-cost advantage in the industry and
why a low-cost strategy can succeed in the industry.
3. USAA is a Fortune 500 insurance and financial services company with 2018
annual sales exceeding $30 billion. The company was founded in 1922 by 25
Army officers who decided to insure each other’s vehicles and continues to limit
its membership to active-duty and retired military members, officer candidates,
and adult children and spouses of military-affiliated USAA members. The
company has received countless awards, including being listed among Fortune’s
World’s Most Admired Companies in 2014 through 2019 and 100 Best
Companies to Work For in 2010 through 2019. You can read more about the
company’s history and strategy at www.usaa.com.
How would you characterize USAA’s competitive strategy? Should it be
classified as a low-cost strategy? A differentiation strategy? A best-cost strategy?
Also, has the company chosen to focus on a narrow piece of the market, or does
it appear to pursue a broad market approach? Explain your answer.
4. Explore Kendra Scott’s website at www.kendrascott.com and see if you can
identify at least three ways in which the company seeks to differentiate itself
from rival jewelry firms. Is there reason to believe that Kendra Scott’s
differentiation strategy has been successful in producing a competitive
advantage? Why or why not?
EXERCISEs FOR SIMULATION PARTICIPANTS
1. Which one of the five generic competitive strategies can best be utilized to
compete successfully in the business simulation by your company?
2. Which rival companies appear to be employing a low-cost strategy?
3. Which rival companies appear to be employing a differentiation strategy?
4. Which rival companies appear to be employing a best-cost strategy?
5. Which cost drivers and/or value drivers are important for creating superior total
economic value in the business simulation?
6. What is your company’s action plan to achieve a sustainable competitive
advantage over rival companies? List at least three (preferably more than three)
specific kinds of decision entries on specific decision screens that your company
has made or intends to make to win this kind of competitive edge over rivals.
ENDNOTES
1 Michael E. Porter, Competitive Strategy: Techniques for Analyzing Industries and Competitors (New York: Free Press, 1980), chap. 2; Michael E. Porter, “What Is
Strategy?” Harvard Business Review 74, no. 6 (November–December 1996).
2 Michael E. Porter, Competitive Advantage: Creating and Sustaining Superior Performance (New York: Free Press, 1985).
http://www.usaa.com./
http://www.kendrascott.com/
page 155
3 Richard L. Priem, “A Consumer Perspective on Value Creation,” Academy of Management Review 32, no. 1 (2007), pp. 219–235.
4 jrscience.wcp.muohio.edu/nsfall01/FinalArticles/Final-IsitWorthitBrandsan.html.
5 D. Yoffie, “Cola Wars Continue: Coke and Pepsi in 2006,” Harvard Business School case 9-706-447.
6 Peter J. Williamson and Ming Zeng, “Value-for-Money Strategies for Recessionary Times,” Harvard Business Review 87, no. 3 (March 2009), pp. 66–74.
http://jrscience.wcp.muohio.edu/nsfall01/FinalArticles/Final-IsitWorthitBrandsan.html.
page 156
chapter 6
Strengthening a Company’s
Competitive Position
Strategic Moves, Timing, and
Scope of Operations
Learning Objectives
After reading this chapter, you should be able to:
LO 6-1 Understand whether, how, and when to deploy offensive
or defensive strategic moves.
LO 6-2 Identify when being a first mover, a fast follower, or a
late mover is most advantageous.
LO 6-3 Explain the strategic benefits and risks of expanding a
company’s horizontal scope through mergers and
acquisitions.
LO 6-4 Explain the advantages and disadvantages of extending
the company’s scope of operations via vertical
integration.
LO 6-5 Recognize the conditions that favor farming out certain
value chain activities to outside parties.
LO 6-6 Understand how to capture the benefits and minimize
the drawbacks of strategic alliances and partnerships.
Fanatic Studio/Getty Images
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Whenever you look at any potential merger or acquisition, you look at the potential to create value
for your shareholders.
Dilip Shanghvi—Founder and managing director of Sun Pharmaceuticals
Alliances have become an integral part of contemporary strategic thinking.
Fortune Magazine
The important thing about outsourcing . . . is that it becomes a very powerful tool to leverage
talent, improve productivity, and reduce work cycles.
Azim Premji—Chairman of Wipro Limited (India’s third-largest outsourcer)
Once a company has settled on which of the five generic competitive strategies to
employ, attention turns to what other strategic actions it can take to complement its
competitive approach and maximize the power of its overall strategy. The first set of
decisions concerns whether to undertake offensive or defensive competitive moves,
and the timing of such moves. The second set concerns expanding or contracting the
breadth of a company’s activities (or its scope of operations along an industry’s entire
value chain). All in all, the following measures to strengthen a company’s competitive
position must be considered:
Whether to go on the offensive and initiate aggressive strategic moves to improve
the company’s market position.
Whether to employ defensive strategies to protect the company’s market position.
When to undertake new strategic initiatives—whether advantage or disadvantage lies
in being a first mover, a fast follower, or a late mover.
Whether to bolster the company’s market position by merging with or acquiring
another company in the same industry.
Whether to integrate backward or forward into more stages of the industry value
chain system.
Which value chain activities, if any, should be outsourced.
Whether to enter into strategic alliances or partnership arrangements with other
enterprises.
This chapter presents the pros and cons of each of these strategy-enhancing
measures.
LAUNCHING STRATEGIC OFFENSIVES
TO IMPROVE A COMPANY’S MARKET
POSITION
• LO 6-1
Understand whether,
how, and when to
deploy offensive or
defensive strategic
moves.
No matter which of the five generic competitive strategies a firm employs,
there are times when a company should go on the offensive to improve its
market position and performance. Strategic offensives are called for when a
company spots opportunities to gain profitable market share at its rivals’
expense or when a company has no choice but to try to whittle away at a
strong rival’s competitive advantage. Companies like Facebook, Amazon,
Apple, and Google play hardball, aggressively pursuing competitive
advantage and trying to reap the benefits a competitive edge offers—a
leading market share, excellent profit margins, and rapid growth.1 The best
offensives tend to incorporate several principles: (1) focusing relentlessly on
building competitive advantage and then striving to convert it into a
sustainable advantage, (2) applying resources where rivals are least able to
defend themselves, (3) employing the element of surprise as opposed to
doing what rivals expect and are prepared for, and (4) displaying a capacity
for swift and decisive actions to overwhelm rivals.2
Choosing the Basis for Competitive Attack
As a rule, challenging rivals on competitive grounds where they are strong is
an uphill struggle.3 Offensive initiatives that exploit competitor weaknesses
stand a better chance of succeeding than do those that challenge competitor
strengths, especially if the weaknesses represent important vulnerabilities and
weak rivals can be caught by surprise with no ready defense.
Sometimes a
company’s best
strategic option is to
seize the initiative,
go on the attack,
and launch a
strategic offensive to
improve its market
position.
Strategic offensives should exploit the power of a company’s strongest
competitive assets—its most valuable resources and capabilities such as a
better-known brand name, a more efficient production or distribution system,
greater technological capability, or a superior reputation for quality. But a
consideration of the company’s strengths should not be made without also
considering the rival’s strengths and weaknesses. A strategic offensive should
be based on those areas of strength where the company has its greatest
competitive advantage over the targeted rivals. If a company has especially
good customer service capabilities, it can make special sales pitches to the
customers of those rivals that provide subpar customer service. Likewise, it
may be beneficial to pay special attention to buyer segments that a rival is
neglecting or is weakly equipped to serve. The best offensives use a
company’s most powerful resources and capabilities to attack rivals in the
areas where they are weakest.
The best offensives
use a company’s
most powerful
resources and
capabilities to attack
rivals in the areas
where they are
competitively
weakest.
Ignoring the need to tie a strategic offensive to a company’s competitive
strengths and what it does best is like going to war with a popgun—the
prospects for success are dim. For instance, it is foolish for a company with
relatively high costs to employ a price-cutting offensive. Likewise, it is ill-
advised to pursue a product innovation offensive without having proven
expertise in R&D and new product development.
The principal offensive strategy options include the following:
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1. Offering an equally good or better product at a lower price. Lower prices
can produce market share gains if competitors don’t respond with price
cuts of their own and if the challenger convinces buyers that its product is
just as good or better. However, such a strategy increases total profits only
if the gains in additional unit sales are enough to offset the impact of
thinner margins per unit sold. Price-cutting offensives should be initiated
only by companies that have first achieved a cost advantage.4 British
airline EasyJet used this strategy successfully against rivals such as British
Air, Alitalia, and Air France by first cutting costs to the bone and
then targeting leisure passengers who care more about low price
than in-flight amenities and service.5 Spirit Airlines is using this strategy in
the U.S. airline market.
2. Leapfrogging competitors by being first to market with next-generation
products. In technology-based industries, the opportune time to overtake
an entrenched competitor is when there is a shift to the next generation of
the technology. Eero got its whole-home Wi-Fi system to market nearly
one year before Linksys and Netgear developed competing systems,
helping it build a sizable market share and develop a reputation for cutting-
edge innovation in Wi-Fi systems.
3. Pursuing continuous product innovation to draw sales and market share
away from less innovative rivals. Ongoing introductions of new and
improved products can put rivals under tremendous competitive pressure,
especially when rivals’ new product development capabilities are weak.
But such offensives can be sustained only if a company can keep its
pipeline full with new product offerings that spark buyer enthusiasm.
4. Pursuing disruptive product innovations to create new markets. While this
strategy can be riskier and more costly than a strategy of continuous
innovation, it can be a game changer if successful. Disruptive innovation
involves perfecting a new product with a few trial users and then quickly
rolling it out to the whole market in an attempt to get many buyers to
embrace an altogether new and better value proposition quickly. Examples
include online universities, Twitter, Venmo, CampusBookRentals, and
Waymo (Alphabet’s self-driving tech company).
5. Adopting and improving on the good ideas of other companies (rivals or
otherwise). The idea of warehouse-type home improvement centers did not
originate with Home Depot cofounders Arthur Blank and Bernie Marcus;
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they got the “big-box” concept from their former employer, Handy Dan
Home Improvement. But they were quick to improve on Handy Dan’s
business model and take Home Depot to the next plateau in terms of
product-line breadth and customer service. Offensive-minded companies
are often quick to adopt any good idea (not nailed down by a patent or
other legal protection) and build on it to create competitive advantage for
themselves.
6. Using hit-and-run or guerrilla warfare tactics to grab market share from
complacent or distracted rivals. Options for “guerrilla offensives” include
occasionally lowballing on price (to win a big order or steal a key account
from a rival), surprising rivals with sporadic but intense bursts of
promotional activity (offering a discounted trial offer to draw customers
away from rival brands), or undertaking special campaigns to attract the
customers of rivals plagued with a strike or problems in meeting buyer
demand.6 Guerrilla offensives are particularly well suited to small
challengers that have neither the resources nor the market visibility to
mount a full-fledged attack on industry leaders.
7. Launching a preemptive strike to secure an industry’s limited resources or
capture a rare opportunity.7 What makes a move preemptive is its one-of-
a-kind nature—whoever strikes first stands to acquire competitive assets
that rivals can’t readily match. Examples of preemptive moves include (1)
securing the best distributors in a particular geographic region or country;
(2) obtaining the most favorable site at a new interchange or intersection,
in a new shopping mall, and so on; (3) tying up the most reliable, high-
quality suppliers via exclusive partnerships, long-term contracts, or
acquisition; and (4) moving swiftly to acquire the assets of distressed rivals
at bargain prices. To be successful, a preemptive move doesn’t have to
totally block rivals from following; it merely needs to give a firm a prime
position that is not easily circumvented.
How long it takes for an offensive action to yield good results
varies with the competitive circumstances.8 It can be short if buyers respond
immediately (as can occur with a dramatic cost-based price cut, an
imaginative ad campaign, or a disruptive innovation). Securing a competitive
edge can take much longer if winning consumer acceptance of the company’s
product will take some time or if the firm may need several years to debug a
new technology or put a new production capacity in place. But how long it
takes for an offensive move to improve a company’s market standing—and
whether the move will prove successful—depends in part on whether market
rivals recognize the threat and begin a counterresponse. Whether rivals will
respond depends on whether they are capable of making an effective response
and if they believe that a counterattack is worth the expense and the
distraction.9
Choosing Which Rivals to Attack
Offensive-minded firms need to analyze which of their rivals to challenge as
well as how to mount the challenge. The following are the best targets for
offensive attacks:10
Market leaders that are vulnerable. Offensive attacks make good sense
when a company that leads in terms of market share is not a true leader in
terms of serving the market well. Signs of leader vulnerability include
unhappy buyers, an inferior product line, aging technology or outdated
plants and equipment, a preoccupation with diversification into other
industries, and financial problems. Caution is well advised in challenging
strong market leaders—there’s a significant risk of squandering valuable
resources in a futile effort or precipitating a fierce and profitless
industrywide battle for market share.
Runner-up firms with weaknesses in areas where the challenger is strong.
Runner-up firms are an especially attractive target when a challenger’s
resources and capabilities are well suited to exploiting their weaknesses.
Struggling enterprises that are on the verge of going under. Challenging a
hard-pressed rival in ways that further sap its financial strength and
competitive position can weaken its resolve and hasten its exit from the
market. In this type of situation, it makes sense to attack the rival in the
market segments where it makes the most profits, since this will threaten its
survival the most.
Small local and regional firms with limited capabilities. Because small
firms typically have limited expertise and resources, a challenger with
broader and/or deeper capabilities is well positioned to raid their biggest
and best customers—particularly those that are growing rapidly, have
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increasingly sophisticated requirements, and may already be thinking about
switching to a supplier with a more full-service capability.
Blue-Ocean Strategy—a Special Kind of
Offensive
A blue-ocean strategy seeks to gain a dramatic competitive advantage by
abandoning efforts to beat out competitors in existing markets and, instead,
inventing a new market segment that allows a company to create and capture
altogether new demand.11 This strategy views the business universe as
consisting of two distinct types of market space. One is where industry
boundaries are well defined, the competitive rules of the game are
understood, and companies try to outperform rivals by capturing a bigger
share of existing demand. In such markets, intense competition constrains a
company’s prospects for rapid growth and superior profitability
since rivals move quickly to either imitate or counter the successes
of competitors. The second type of market space is a “blue ocean,” where the
industry does not really exist yet, is untainted by competition, and offers
wide-open opportunity for profitable and rapid growth if a company can
create new demand with a new type of product offering. The “blue ocean”
represents wide-open opportunity, offering smooth sailing in uncontested
waters for the company first to venture out upon it.
CORE
CONCEPT
A blue-ocean
strategy offers
growth in revenues
and profits by
discovering or
inventing new
industry segments
that create
altogether new
demand.
A terrific example of such blue-ocean market space is the online auction
industry that eBay created and now dominates. Other companies that have
created blue-ocean market spaces include NetJets in fractional jet ownership,
Drybar in hair blowouts, Tune Hotels in limited service “backpacker” hotels,
Uber and Lyft in ride-sharing services, and Cirque du Soleil in live
entertainment. Cirque du Soleil “reinvented the circus” by pulling in a whole
new group of customers—adults and corporate clients—who not only were
noncustomers of traditional circuses (like Ringling Brothers) but also were
willing to pay several times more than the price of a conventional circus
ticket to have a “sophisticated entertainment experience” featuring stunning
visuals and star-quality acrobatic acts. Australian winemaker Casella Wines
used a blue ocean strategy to find some uncontested market space for its
Yellow Tail brand. By creating a product designed to appeal to wider market
—one that also includes beer and spirit drinkers—Yellow Tail was able to
unlock substantial new demand, becoming the fastest growing wine brand in
U.S. history. Illustration Capsule 6.1 discusses the way that Etsy used a blue
ocean strategy to open up new competitive space in online retailing.
Blue-ocean strategies provide a company with a great opportunity in the
short run but they don’t guarantee a company’s long-term success, which
depends more on whether a company can protect the market position it
opened up and sustain its early advantage. Gilt Groupe serves as an example
of a company that opened up new competitive space in online luxury retailing
only to see its blue-ocean waters ultimately turn red. Its competitive success
early on prompted an influx of fast followers into the luxury flash-sale
industry, including HauteLook, RueLaLa, Lot18, and MyHabit.com. The new
rivals not only competed for online customers, who could switch costlessly
from site to site (since memberships were free), but also competed for unsold
designer inventory. Once valued at over $1 billion, Gilt Groupe was finally
sold to Hudson’s Bay, the owner of Sak’s Fifth Avenue, for just $250 million
in 2016.
DEFENSIVE STRATEGIES—
PROTECTING MARKET POSITION AND
COMPETITIVE ADVANTAGE
In a competitive market, all firms are subject to offensive challenges from
rivals. The purposes of defensive strategies are to lower the risk of being
http://myhabit.com/
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attacked, weaken the impact of any attack that occurs, and induce challengers
to aim their efforts at other rivals. While defensive strategies usually don’t
enhance a firm’s competitive advantage, they can definitely help fortify the
firm’s competitive position, protect its most valuable resources and
capabilities from imitation, and defend whatever competitive advantage it
might have. Defensive strategies can take either of two forms: actions to
block challengers or actions to signal the likelihood of strong retaliation.
ILLUSTRATION
CAPSULE 6.1 Etsy’s Blue Ocean Strategy in
Online Retailing of Handmade Crafts
Etsy, the online artisanal marketplace, was the inspirational idea of three New York
entrepreneurs who saw that eBay had become too large and ineffective for craftsman
and artisans who wished to sell their one-of-a-kind products online. While eBay’s timed
auction format made for an exciting experience for bargain-hunting consumers, Etsy in
contrast promoted its ability to connect thoughtful consumers with artisans selling unique
hand-crafted items. Typical Etsy buyers valued craftsmanship and wanted to know how
items were made and who made them. The ability to develop a direct relationship with
the seller was important to many Etsy buyers who enjoyed a personalized shopping
experience. Purchases made by Etsy buyers ranged from $5 ornaments to $50 hand-
made clothing items to $2,000 custom-made coffee tables.
Etsy thrived in what was initially uncontested competitive space. In 2015, to the
surprise of many, theirs was the largest venture capital backed IPO (Initial Public
Offering) to have come out of New York City. By 2018, they had 39 million active buyers
and 2.1 million crafters and artisans offering their products. The company’s gross
merchandise sales totaled more than $3.9 billion that same year. Etsy charged sellers a
3.5 percent transaction fee and a 20-cent listing fee and generated additional revenue
from payment processing fees and the sales of shipping labels. The company’s revenues
had grown from $74.6 million in 2012 to $603.7 million in 2018.
Piotr Swat/Shutterstock
The tremendous success of the company’s Blue Ocean Strategy had not gone
unnoticed. Amazon announced in May 2016 that it would launch a site featuring artisan
goods named Handmade. Amazon believed that its free 2-day shipping to Prime
members would give it an advantage over Etsy. Etsy’s share price took a steep dive in
2016, but by late 2019, the company’s stock was back up to nearly three times its IPO
first-day closing price of $22.24. The strength of its strategy and the quality of its
execution would determine if Etsy would be able to continue to thrive despite well-funded
new entrants into its specialty online retailing sector.
Note: Developed with Rochelle R. Brunson and Marlene M. Reed.
Blocking the Avenues Open to Challengers
The most frequently employed approach to defending a company’s present
position involves actions that restrict a challenger’s options for initiating a
competitive attack. There are any number of obstacles that can be put in the
path of would-be challengers. A defender can introduce new features, add
new models, or broaden its product line to close off gaps and vacant niches to
opportunity-seeking challengers. It can thwart rivals’ efforts to attack with a
lower price by maintaining its own lineup of economy-priced options. It can
discourage buyers from trying competitors’ brands by lengthening
warranties, making early announcements about impending new products or
price changes, offering free training and support services, or providing
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coupons and sample giveaways to buyers most prone to experiment. It can
induce potential buyers to reconsider switching. It can challenge the
quality or safety of rivals’ products. Finally, a defender can grant
volume discounts or better financing terms to dealers and distributors to
discourage them from experimenting with other suppliers, or it can convince
them to handle its product line exclusively and force competitors to use other
distribution outlets.
Good defensive
strategies can help
protect a competitive
advantage but rarely
are the basis for
creating one.
Signaling Challengers That Retaliation Is Likely
The goal of signaling challengers that strong retaliation is likely in the event
of an attack is either to dissuade challengers from attacking at all or to divert
them to less threatening options. Either goal can be achieved by letting
challengers know the battle will cost more than it is worth. Signals to would-
be challengers can be given by
Publicly announcing management’s commitment to maintaining the firm’s
present market share.
Publicly committing the company to a policy of matching competitors’
terms or prices.
Maintaining a war chest of cash and marketable securities.
Making an occasional strong counterresponse to the moves of weak
competitors to enhance the firm’s image as a tough defender.
To be an effective
defensive strategy
signaling needs to
be accompanied by
a credible
commitment to
follow through.
To be an effective defensive strategy, however, signaling needs to be
accompanied by a credible commitment to follow through.
TIMING A COMPANY’S STRATEGIC
MOVES
• LO 6-2
Identify when being
a first mover, a fast
follower, or a late
mover is most
advantageous.
When to make a strategic move is often as crucial as what move to make.
Timing is especially important when first-mover advantages and
disadvantages exist. Under certain conditions, being first to initiate a
strategic move can have a high payoff in the form of a competitive advantage
that later movers can’t dislodge. Moving first is no guarantee of success,
however, since first movers also face some significant disadvantages. Indeed,
there are circumstances in which it is more advantageous to be a fast follower
or even a late mover. Because the timing of strategic moves can be
consequential, it is important for company strategists to be aware of the
nature of first-mover advantages and disadvantages and the conditions
favoring each type of move.12
CORE
CONCEPT
Because of first-
mover advantages
and
disadvantages,
competitive
advantage can
spring from when a
move is made as
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well as from what
move is made.
The Potential for First-Mover Advantages
Market pioneers and other types of first movers typically bear greater risks
and greater development costs than firms that move later. If the market
responds well to its initial move, the pioneer will benefit from a monopoly
position (by virtue of being first to market) that enables it to recover its
investment costs and make an attractive profit. If the firm’s pioneering move
gives it a competitive advantage that can be sustained even after other firms
enter the market space, its first-mover advantage will be greater still. The
extent of this type of advantage, however, will depend on whether and how
fast follower firms can piggyback on the pioneer’s success and either imitate
or improve on its move.
There are six such conditions in which first-mover advantages
are most likely to arise:
1. When pioneering helps build a firm’s reputation and creates strong brand
loyalty. Customer loyalty to an early mover’s brand can create a tie that
binds, limiting the success of later entrants’ attempts to poach from the
early mover’s customer base and steal market share. For example, Open
Table’s early move as an online restaurant-reservation service built a
strong brand that has since fueled its expansion worldwide.
2. When a first mover’s customers will thereafter face significant switching
costs. Switching costs can protect first movers when consumers make large
investments in learning how to use a specific company’s product or in
purchasing complementary products that are also brand-specific. Switching
costs can also arise from loyalty programs or long-term contracts that give
customers incentives to remain with an initial provider. FreshDirect, for
example, offers its grocery-delivery customers bigger savings, the longer
they keep their service subscription.
3. When property rights protections thwart rapid imitation of the initial move.
In certain types of industries, property rights protections in the form of
patents, copyrights, and trademarks prevent the ready imitation of an early
mover’s initial moves. First-mover advantages in pharmaceuticals, for
example, are heavily dependent on patent protections, and patent races in
this industry are common. In other industries, however, patents provide
limited protection and can frequently be circumvented. Property rights
protections also vary among nations, since they are dependent on a
country’s legal institutions and enforcement mechanisms.
4. When an early lead enables the first mover to reap scale economies or
move down the learning curve ahead of rivals. If significant scale-based
advantages are available to an early mover, later entrants (with a smaller
market share) will face relatively higher production costs. This
disadvantage will make it even harder for later entrants to gain share and
overcome the first-mover scale advantage. When there is a steep learning
curve and when learning can be kept proprietary, a first mover can benefit
from volume-based cost advantages that grow ever larger as its experience
accumulates and its scale of operations increases. This type of first-mover
advantage is self-reinforcing and, as such, can preserve a first mover’s
competitive advantage over long periods of time. Honda’s advantage in
small multiuse motorcycles has been attributed to such an effect.
5. When a first mover can set the technical standard for the industry. In many
technology-based industries, the market will converge around a single
technical standard. By establishing the industry standard, a first mover can
gain a powerful advantage that, like experience-based advantages, builds
over time. The lure of such an advantage, however, can result in standard
wars among early movers, as each strives to set the industry standard. The
key to winning such wars is to enter early on the basis of strong fast-cycle
product development capabilities, gain the support of key customers and
suppliers, employ penetration pricing, and make allies of the producers of
complementary products.
6. When strong network effects compel increasingly more consumers to
choose the first mover’s product or service. As we described in Chapter 3,
network effects are at work whenever consumers benefit from having other
consumers use the same product or service that they use—a benefit that
increases with the number of consumers using the product. An example is
FaceTime. The more that people you know have FaceTime on their phones
or devices, the more that you are able to have a video conversation with
them if you also have FaceTime—a benefit that grows with the number of
users in your circle. Network effects can also occur with respect to
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suppliers. eBay has enjoyed a considerable first-mover advantage for
years, not just because of early brand name recognition but also because of
powerful network effects on the supply and demand side. The
more suppliers choose to auction their items on eBay, the more
attractive it is for others to do so as well, since the greater number of items
being auctioned attracts more and more potential buyers, which in turn
attracts more and more items being auctioned. Strong network effects are
self-reinforcing and may lead to a winner-take-all situation for the first
mover.
ILLUSTRATION
CAPSULE 6.2 Tinder Swipes Right for First-
Mover Success
Tinder, a simple, swipe-based dating app, entered the market in 2012 with a bang,
gaining over a million monthly active users in less than a year. While other dating apps
were already in existence, Tinder started the swiping phenomenon, thereby easing the
process of finding love online and making the use of dating apps commonplace. By 2014,
Tinder was processing over a billion swipes daily and users were spending an average of
an hour and a half on the app each day. (Today, the average user spends about an hour
on Facebook, Instagram, Snapchat, and Twitter—combined.)
Tinder’s fast start had much to do with the fact that it was easy-to-use, without the
time-consuming questionnaires of other dating services, and fun, with a game-like aspect
that many called addictive. In addition, Tinder was rolled out on college campuses using
viral marketing techniques that helped it to quickly gain acceptance among social circles
such as fraternities and sororities, in which “key influencers” boosted its popularity to the
point where it reached a critical mass. But its sustained success has had more to do with
the fact that it has been able to reap the benefits of a first mover advantage, as the first
major entrant into the field of mobile dating.
In the dating service industry, efficacy is wholly dependent on network effects (where
users of an app benefit increasingly as the number of users of that same app increases).
By focusing first on ensuring high usage among local social domains, Tinder benefited
from strong local network effects. As its popularity spread, users increasingly found
Tinder to be the most attractive app to use, since so many others were using it—thereby
strengthening the network effect advantage, and drawing ever more people to download
the Tinder app. With increased volume, Tinder gained other classic first mover
advantages, such as enhanced reputational benefits, learning curve efficiencies, and
increased interest from investors. By 2019, Tinder had nearly 8 million users, making the
app the most popular online dating app in the United States.
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BigTunaOnline/Shutterstock
Tinder’s first mover advantage has not kept others from entering the mobile dating
market. In fact, Tinder’s phenomenal success has led to a surge in new entrants, with
many imitating the Tinder’s most popular features. Despite this, Tinder’s first mover
advantage has proven protective in many ways. Tinder’s user base far outstrips the user
base of rivals. And while other apps have been trying to play catch up, Tinder has been
introducing new subscription products and other paid features to turn its market share
advantage into a profitability advantage. As it stands, most analysts see Tinder as the
mobile dating application with the highest commercial potential. And with a valuation of
$3B and the distinction of Apple’s top-grossing app in August 2017, it seems that Tinder
is here to stay.
Note: Developed with Lindsey Wilcox and Charles K. Anumonwo.
Sources: https://www.inc.com/issie-lapowsky/how-tinder-is-winning-the-mobile-
dating-wars.html; http://www.adweek.com/digital/mediakix-time-spent-social-
media-infographic/; www.pewresearch.org/fact-tank/2016/02/29/5-facts-about-
online-dating/; https://www.forbes.com/sites/stevenbertoni/2017/08/31/tinder-hits-3-
billion-valuation-after-match-group-converts-options/#653a516f34f9; company
website; J. Clement. Statista, November 22, 2019.
Illustration Capsule 6.2 describes how Tinder achieved a first-mover
advantage in the field of mobile dating.
https://www.inc.com/issie-lapowsky/how-tinder-is-winning-the-mobile-dating-wars.html
http://www.adweek.com/digital/mediakix-time-spent-social-media-infographic/
http://www.pewresearch.org/fact-tank/2016/02/29/5-facts-about-online-dating/
https://www.forbes.com/sites/stevenbertoni/2017/08/31/tinder-hits-3-billion-valuation-after-match-group-converts-options/#653a516f34f9
The Potential for Late-Mover Advantages or First-
Mover Disadvantages
In some instances there are advantages to being an adept follower rather than
a first mover. Late-mover advantages (or first-mover disadvantages) arise in
four instances:
When the costs of pioneering are high relative to the benefits accrued and
imitative followers can achieve similar benefits with far lower costs. This
is often the case when second movers can learn from a pioneer’s
experience and avoid making the same costly mistakes as the pioneer.
When an innovator’s products are somewhat primitive and do not live up
to buyer expectations, thus allowing a follower with better-performing
products to win disenchanted buyers away from the leader.
When rapid market evolution (due to fast-paced changes in either
technology or buyer needs) gives second movers the opening to leapfrog
a first mover’s products with more attractive next-version products.
When market uncertainties make it difficult to ascertain what will
eventually succeed, allowing late movers to wait until these needs are
clarified.
When customer loyalty to the pioneer is low and a first mover’s skills,
know-how, and actions are easily copied or even surpassed.
When the first mover must make a risky investment in complementary
assets or infrastructure (and these may be enjoyed at low cost or risk by
followers).
To Be a First Mover or Not
In weighing the pros and cons of being a first mover versus a fast follower
versus a late mover, it matters whether the race to market leadership in a
particular industry is a 10-year marathon or a 2-year sprint. In marathons, a
slow mover is not unduly penalized—first-mover advantages can be fleeting,
and there’s ample time for fast followers and sometimes even late movers to
catch up.13 Thus, the speed at which the pioneering innovation is likely to
catch on matters considerably as companies struggle with whether to pursue
an emerging market opportunity aggressively (as a first mover) or cautiously
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(as a late mover). For instance, it took 5.5 years for worldwide mobile phone
use to grow from 10 million to 100 million, and it took close to 10 years for
the number of at-home broadband subscribers to grow to 100 million
worldwide. The lesson here is that there is a market penetration curve for
every emerging opportunity. Typically, the curve has an inflection point at
which all the pieces of the business model fall into place, buyer demand
explodes, and the market takes off. The inflection point can come early on a
fast-rising curve (like the use of e-mail and watching movies streamed over
the Internet) or farther up on a slow-rising curve (as with battery-powered
motor vehicles, solar and wind power, and textbook rental for college
students). Any company that seeks competitive advantage by being a first
mover thus needs to ask some hard questions:
Does market takeoff depend on the development of complementary
products or services that currently are not available?
Is new infrastructure required before buyer demand can surge?
Will buyers need to learn new skills or adopt new behaviors?
Will buyers encounter high switching costs in moving to the newly
introduced product or service?
Are there influential competitors in a position to delay or derail the
efforts of a first mover?
When the answers to any of these questions are yes, then a
company must be careful not to pour too many resources into getting ahead
of the market opportunity—the race is likely going to be closer to a 10-year
marathon than a 2-year sprint.14 On the other hand, if the market is a winner-
take-all type of market, where powerful first-mover advantages insulate early
entrants from competition and prevent later movers from making any
headway, then it may be best to move quickly despite the risks.
STRENGTHENING A COMPANY’S
MARKET POSITION VIA ITS SCOPE OF
OPERATIONS
Apart from considerations of competitive moves and their timing, there is
another set of managerial decisions that can affect the strength of a
company’s market position. These decisions concern the scope of a
company’s operations—the breadth of its activities and the extent of its
market reach. Decisions regarding the scope of the firm focus on which
activities a firm will perform internally and which it will not.
CORE
CONCEPT
The scope of the
firm refers to the
range of activities
that the firm
performs internally,
the breadth of its
product and service
offerings, the extent
of its geographic
market presence,
and its mix of
businesses.
Consider, for example, Ralph Lauren Corporation. In contrast to Rambler’s
Way, a sustainable clothing company with a small chain of retail stores,
Ralph Lauren designs, markets, and distributes fashionable apparel and other
merchandise to approximately 13,000 major department stores and specialty
retailers throughout the world. In addition, it operates nearly 500 retail stores,
more than 650 concession-based shops within shops, and 10 e-commerce
sites. Scope decisions also concern which segments of the market to serve—
decisions that can include geographic market segments as well as product and
service segments. Almost 50 percent of Ralph Lauren’s sales are made
outside North America, and its product line includes apparel, fragrances,
home furnishings, eyewear, watches and jewelry, and handbags and other
leather goods. Its lineup of brands includes Polo Ralph Lauren, Club
Monaco, Chaps, and Double RL, as well as its Ralph Lauren Collection
brands.
Decisions such as these, in essence, determine where the boundaries of a
firm lie and the degree to which the operations within those boundaries
cohere. They also have much to do with the direction and extent of a
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business’s growth. In this chapter, we discuss different types of decisions
regarding the scope of the company in relation to a company’s business-level
strategy. In the next two chapters, we develop two additional dimensions of a
firm’s scope; Chapter 7 focuses on international expansion—a matter of
extending the company’s geographic scope into foreign markets; Chapter 8
takes up the topic of corporate strategy, which concerns diversifying into a
mix of different businesses. Scope issues are at the very heart of corporate-
level strategy.
Several dimensions of firm scope have relevance for business-level
strategy in terms of their capacity to strengthen a company’s position in a
given market. These include the firm’s horizontal scope, which is the range
of product and service segments that the firm serves within its product or
service market. Mergers and acquisitions involving other market participants
provide a means for a company to expand its horizontal scope. Expanding the
firm’s vertical scope by means of vertical integration can also affect the
success of its market strategy. Vertical scope is the extent to which the firm
engages in the various activities that make up the industry’s entire value
chain system, from initial activities such as raw-material production all the
way to retailing and after-sale service activities. Outsourcing decisions
concern another dimension of scope since they involve narrowing the firm’s
boundaries with respect to its participation in value chain activities. We
discuss the pros and cons of each of these options in the sections
that follow. Because strategic alliances and partnerships
provide an alternative to vertical integration and acquisition strategies and are
sometimes used to facilitate outsourcing, we conclude this chapter with a
discussion of the benefits and challenges associated with cooperative
arrangements of this nature.
CORE
CONCEPT
Horizontal scope is
the range of product
and service
segments that a firm
serves within its
focal market.
CORE
CONCEPT
Vertical scope is
the extent to which a
firm’s internal
activities encompass
the range of
activities that make
up an industry’s
entire value chain
system, from raw-
material production
to final sales and
service activities.
HORIZONTAL MERGER AND
ACQUISITION STRATEGIES
• LO 6-3
Explain the strategic
benefits and risks of
expanding a
company’s
horizontal scope
through mergers and
acquisitions.
Mergers and acquisitions are much-used strategic options to strengthen a
company’s market position. A merger is the combining of two or more
companies into a single corporate entity, with the newly created company
often taking on a new name. An acquisition is a combination in which one
company, the acquirer, purchases and absorbs the operations of another, the
acquired. The difference between a merger and an acquisition relates more to
the details of ownership, management control, and financial arrangements
than to strategy and competitive advantage. The resources and competitive
capabilities of the newly created enterprise end up much the same whether
the combination is the result of an acquisition or a merger.
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Horizontal mergers and acquisitions, which involve combining the
operations of firms within the same product or service market, provide an
effective means for firms to rapidly increase the scale and horizontal scope of
their core business. For example, the merger of AMR Corporation (parent of
American Airlines) with US Airways has increased the airlines’ scale of
operations and extended their reach geographically to create the world’s
largest airline.
Merger and acquisition strategies typically set sights on achieving any of
five objectives:15
1. Creating a more cost-efficient operation out of the combined companies.
When a company acquires another company in the same industry, there’s
usually enough overlap in operations that less efficient plants can be closed
or distribution and sales activities partly combined and downsized.
Likewise, it is usually feasible to squeeze out cost savings in
administrative activities, again by combining and downsizing such
administrative activities as finance and accounting, information
technology, human resources, and so on. The combined companies may
also be able to reduce supply chain costs because of greater bargaining
power over common suppliers and closer collaboration with supply chain
partners. By helping consolidate the industry and remove excess capacity,
such combinations can also reduce industry rivalry and improve industry
profitability.
2. Expanding a company’s geographic coverage. One of the best and quickest
ways to expand a company’s geographic coverage is to acquire rivals with
operations in the desired locations. Since a company’s size increases with
its geographic scope, another benefit is increased bargaining power with
the company’s suppliers or buyers. Greater geographic coverage can also
contribute to product differentiation by enhancing a company’s name
recognition and brand awareness. The vacation rental marketplace,
HomeAway, Inc., relied on an aggressive horizontal acquisition strategy to
expand internationally, as well as to extend its reach across the United
States. It now offers vacation rentals in 190 countries through its 50
websites in 23 languages. Travel company Expedia has since acquired
HomeAway, thus extending its reach horizontally into the vacation rental
product category—an objective described in the next point.
3. Extending the company’s business into new product categories.
Many times a company has gaps in its product line that need to be filled in
order to offer customers a more effective product bundle or the benefits of
one-stop shopping. For example, customers might prefer to acquire a suite
of software applications from a single vendor that can offer more
integrated solutions to the company’s problems. Acquisition can be a
quicker and more potent way to broaden a company’s product line than
going through the exercise of introducing a company’s own new product to
fill the gap. In 2018, Keurig Green Mountain vastly expanded its range of
beverage offerings by acquiring the Dr Pepper Snapple Group in an $18.7
billion deal.
4. Gaining quick access to new technologies or other resources and
capabilities. Making acquisitions to bolster a company’s technological
know-how or to expand its skills and capabilities allows a company to
bypass a time-consuming and expensive internal effort to build desirable
new resources and capabilities. Over the course of its history, Cisco
Systems has purchased over 200 companies to give it more technological
reach and product breadth, thereby enhancing its standing as the world’s
largest provider of hardware, software, and services for creating and
operating Internet networks.
5. Leading the convergence of industries whose boundaries are being blurred
by changing technologies and new market opportunities. In fast-cycle
industries or industries whose boundaries are changing, companies can use
acquisition strategies to hedge their bets about the direction that an
industry will take, to increase their capacity to meet changing demands,
and to respond flexibly to changing buyer needs and technological
demands. The convergence of the pharmacy industry with health insurers
and the benefits management industry led to the merger between Cigna and
Express Scripts as well as that between CVS and Aetna in 2018.
Illustration Capsule 6.3 describes how Walmart employed a horizontal
acquisition strategy to expand into the e-commerce domain.
Why Mergers and Acquisitions Sometimes Fail to
Produce Anticipated Results
page 170
Despite many successes, mergers and acquisitions do not always produce the
hoped-for outcomes.16 Cost savings may prove smaller than expected. Gains
in competitive capabilities may take substantially longer to realize or, worse,
may never materialize at all. Efforts to mesh the corporate cultures can stall
due to formidable resistance from organization members. Key employees at
the acquired company can quickly become disenchanted and leave; the
morale of company personnel who remain can drop to disturbingly low levels
because they disagree with newly instituted changes. Differences in
management styles and operating procedures can prove hard to resolve. In
addition, the managers appointed to oversee the integration of a newly
acquired company can make mistakes in deciding which activities to leave
alone and which activities to meld into their own operations and systems.
ILLUSTRATION
CAPSULE 6.3 Walmart’s Expansion into E-
Commerce via Horizontal Acquisition
As the boundaries between traditional retailing and online retailing have begun to blur,
Walmart has responded by expanding its presence in e-commerce via horizontal
acquisition. In 2016, Walmart acquired Jet.com, an innovative U.S. e-commerce start-up
that was designed to compete with Amazon. Jet sells everything from household goods
and electronics to beauty products, apparel, and toys from more than 2,400 retailer and
brand partners. Jet.com rewards customers for ordering multiple items, using a debit card
instead of a credit card, or choosing a no-returns option; it passes its cost savings on to
customers in the form of lower prices. The low-price approach of Jet.com fit well with
Walmart’s low-price strategy. In addition, Walmart hoped that the acquisition would help it
to accelerate its growth in e-commerce, provide quick access to some valuable e-
commerce knowledge and capabilities, increase its breadth of online product offerings,
and attract new customer segments.
Walmart, like other brick and mortar retailers, was facing a myriad of issues caused by
changing customer expectations. Consumers increasingly valued large assortments of
products, a convenient shopping experience, and low prices. Price sensitivity was
increasing due to the ease of comparing prices online. As a traditional retailer, Walmart
was facing stiff competition from Amazon, the world’s largest and fastest growing e-
commerce company. Amazon’s seemingly endless inventory of goods, excellent
customer service, expertise in search engine marketing, and appeal to a wide consumer
demographic added pressure on the overall global retail industry.
http://jet.com/
http://jet.com/
http://jet.com/
The acquisition of Jet built on the foundation already in place for Walmart to respond to
the external pressure and continue growing as an omni-channel retailer (i.e., bricks and
mortar, online, or mobile). After investing heavily in their own online channel,
Walmart.com, the company was looking for other ways to attract customers by lowering
prices, broadening their product assortment, and offering the simplest, most convenient
shopping experience. Jet’s breadth of products, access to millennial and higher-income
customer segments, and best in-class pricing algorithm would accelerate Walmart’s
progress across all of these priorities.
Sundry Photography/Shutterstock
Since the acquisition, Jet has continued to expand its own offerings with private-label
groceries, further increasing competition with Amazon’s AmazonFresh grocery business.
More recently, Walmart made several other acquisitions of online apparel companies,
thereby strengthening Jet’s apparel offerings and further expanding Walmart’s presence
in e-commerce. These include ShoeBuy (a competitor of Amazon-owned Zappos),
Bonobos in menswear, Moosejaw in outdoor gear and apparel, and Modcloth in vintage
and indie womenswear. While Walmart’s e-commerce sales still pale in comparison to
Amazon, this represents a promising start for Walmart, as the retail industry continues to
transform.
Note: Developed with Dipti Badrinath.
Sources: http://www.businessinsider.com/jet-walmart-weapon-vs-amazon-2017-9;
https://news.walmart.com/2016/08/08/walmart-agrees-to-acquire-jetcom-one-of-the-
fastest-growing-e-commerce-companies-in-the-us;
https://www.fool.com/investing/2017/10/03/1-year-later-wal-marts-jetcom-
acquisition-is-an-un.aspx; https://blog.walmart.com/business/20160919/five-big-
reasons-walmart-bought-jetcom.
http://walmart.com/
http://www.businessinsider.com/jet-walmart-weapon-vs-amazon-2017-9
https://news.walmart.com/2016/08/08/walmart-agrees-to-acquire-jetcom-one-of-the-fastest-growing-e-commerce-companies-in-the-us
https://www.fool.com/investing/2017/10/03/1-year-later-wal-marts-jetcom-acquisition-is-an-un.aspx
https://blog.walmart.com/business/20160919/five-big-reasons-walmart-bought-jetcom
page 171
A number of mergers and acquisitions have been notably unsuccessful.
Google’s $12.5 billion acquisition of struggling smartphone manufacturer
Motorola Mobility in 2012 turned out to be minimally beneficial in helping to
“supercharge Google’s Android ecosystem” (Google’s stated reason for
making the acquisition). When Google’s attempts to rejuvenate Motorola’s
smartphone business by spending over $1.3 billion on new
product R&D and revamping Motorola’s product line resulted in
disappointing sales and huge operating losses, Google sold Motorola
Mobility to China-based PC maker Lenovo for $2.9 billion in 2014 (however,
Google retained ownership of Motorola’s extensive patent portfolio). The
jury is still out on whether Lenovo’s acquisition of Motorola will prove to be
a moneymaker.
VERTICAL INTEGRATION STRATEGIES
• LO 6-4
Explain the
advantages and
disadvantages of
extending the
company’s scope of
operations via
vertical integration.
Expanding the firm’s vertical scope by means of a vertical integration
strategy provides another possible way to strengthen the company’s position
in its core market. A vertically integrated firm is one that participates in
multiple stages of an industry’s value chain system. Thus, if a manufacturer
invests in facilities to produce component parts that it had formerly purchased
from suppliers, or if it opens its own chain of retail stores to bypass its former
distributors, it is engaging in vertical integration. A good example of a
vertically integrated firm is Maple Leaf Foods, a major Canadian producer of
fresh and processed meats whose best-selling brands include Maple Leaf and
Schneiders. Maple Leaf Foods participates in hog and poultry production,
with company-owned hog and poultry farms; it has its own meat-processing
and rendering facilities; it packages its products and distributes them from
company-owned distribution centers; and it conducts marketing, sales, and
customer service activities for its wholesale and retail buyers but does not
otherwise participate in the final stage of the meat-processing vertical chain
—the retailing stage.
CORE
CONCEPT
A vertically
integrated firm is
one that performs
value chain activities
along more than one
stage of an
industry’s value
chain system.
A vertical integration strategy can expand the firm’s range of activities
backward into sources of supply and/or forward toward end users. When
Tiffany & Co., a manufacturer and retailer of fine jewelry, began sourcing,
cutting, and polishing its own diamonds, it integrated backward along the
diamond supply chain. Mining giant De Beers Group and Canadian miner
Aber Diamond integrated forward when they entered the diamond retailing
business.
A firm can pursue vertical integration by starting its own operations in
other stages of the vertical activity chain or by acquiring a company already
performing the activities it wants to bring in-house. Vertical integration
strategies can aim at full integration (participating in all stages of the vertical
chain) or partial integration (building positions in selected stages of the
vertical chain). Firms can also engage in tapered integration strategies, which
involve a mix of in-house and outsourced activity in any given stage of the
vertical chain. Oil companies, for instance, supply their refineries with oil
from their own wells as well as with oil that they purchase from other
producers—they engage in tapered backward integration. Coach, Inc., the
maker of Coach handbags and accessories, engages in tapered forward
integration since it operates full-price and factory outlet stores but also sells
its products through third-party department store outlets.
page 172
The Advantages of a Vertical Integration Strategy
Under the right conditions, a vertical integration strategy can add materially
to a company’s technological capabilities, strengthen the firm’s competitive
position, and boost its profitability.17 But it is important to keep in mind that
vertical integration has no real payoff strategy-wise or profit-wise unless the
extra investment can be justified by compensating improvements in company
costs, differentiation, or competitive strength.
Integrating Backward to Achieve Greater Competitiveness It is harder
than one might think to generate cost savings or improve profitability by
integrating backward into activities such as the manufacture of parts
and components (which could otherwise be purchased from
suppliers with specialized expertise in making the parts and components). For
backward integration to be a cost-saving and profitable strategy, a company
must be able to (1) achieve the same scale economies as outside suppliers and
(2) match or beat suppliers’ production efficiency with no drop-off in quality.
Neither outcome is easily achieved. To begin with, a company’s in-house
requirements are often too small to reach the optimum size for low-cost
operation. For instance, if it takes a minimum production volume of 1 million
units to achieve scale economies and a company’s in-house requirements are
just 250,000 units, then it falls far short of being able to match the costs of
outside suppliers (which may readily find buyers for 1 million or more units).
Furthermore, matching the production efficiency of suppliers is fraught with
problems when suppliers have considerable production experience, when the
technology they employ has elements that are hard to master, and/or when
substantial R&D expertise is required to develop next-version components or
keep pace with advancing technology in components production.
CORE
CONCEPT
Backward
integration involves
entry into activities
previously
performed by
suppliers or other
enterprises
positioned along
earlier stages of the
industry value chain
system; forward
integration involves
entry into value
chain system
activities closer to
the end user.
That said, occasions still arise when a company can gain or extend a
competitive advantage by performing a broader range of industry value chain
activities internally rather than having such activities performed by outside
suppliers. There are several ways that backward vertical integration can
contribute to a cost-based competitive advantage. When there are few
suppliers and when the item being supplied is a major component, vertical
integration can lower costs by limiting supplier power. Vertical integration
can also lower costs by facilitating the coordination of production flows and
avoiding bottlenecks and delays that disrupt production schedules.
Furthermore, when a company has proprietary know-how that it wants to
keep from rivals, then in-house performance of value-adding activities related
to this know-how is beneficial even if such activities could otherwise be
performed by outsiders.
Apple decided to integrate backward into producing its own chips for
iPhones, chiefly because chips are a major cost component, suppliers have
bargaining power, and in-house production would help coordinate design
tasks and protect Apple’s proprietary iPhone technology. International Paper
Company backward integrates into pulp mills that it sets up near its paper
mills and reaps the benefits of coordinated production flows, energy savings,
and transportation economies. It does this, in part, because outside suppliers
are generally unwilling to make a site-specific investment for a buyer.
Backward vertical integration can support a differentiation-based
competitive advantage when performing activities internally contributes to a
better-quality product or service offering, improves the caliber of customer
service, or in other ways enhances the performance of the final product. On
occasion, integrating into more stages along the industry value chain system
can add to a company’s differentiation capabilities by allowing it to
strengthen its core competencies, better master key skills or strategy-critical
page 173
technologies, or add features that deliver greater customer value. Spanish
clothing maker Inditex has backward integrated into fabric making, as well as
garment design and manufacture, for its successful Zara brand. By tightly
controlling the process and postponing dyeing until later stages, Zara can
respond quickly to changes in fashion trends and supply its customers with
the hottest items. Amazon and Netflix backward integrated by establishing
Amazon Studios and Netflix Originals to produce high-quality original
content for their streaming services.
Integrating Forward to Enhance Competitiveness Like backward
integration, forward integration can enhance competitiveness and contribute
to competitive advantage on the cost side as well as the differentiation (or
value) side. On the cost side, forward integration can lower costs by
increasing efficiency and reducing or eliminating the bargaining
power of companies that had wielded such power further along the value
system chain. It can allow manufacturers to gain better access to end users,
improve market visibility, and enhance brand name awareness. For example,
Harley-Davidson’s and Ducati’s company-owned retail stores are essentially
little museums, filled with iconography, that provide an environment
conducive to selling not only motorcycles and gear but also memorabilia,
clothing, and other items featuring the brand. Insurance companies and
brokerages like Allstate and Edward Jones have the ability to make
consumers’ interactions with local agents and office personnel a
differentiating feature by focusing on building relationships.
In many industries, independent sales agents, wholesalers, and retailers
handle competing brands of the same product and have no allegiance to any
one company’s brand—they tend to push whatever offers the biggest profits.
To avoid dependence on distributors and dealers with divided loyalties,
Goodyear has integrated forward into company-owned and franchised retail
tire stores. Consumer-goods companies like Coach, Under Armour,
Pepperidge Farm, Bath & Body Works, Nike, Tommy Hilfiger, and Ann
Taylor have integrated forward into retailing and operate their own branded
stores in factory outlet malls, enabling them to move overstocked items,
slow-selling items, and seconds.
Some producers have opted to integrate forward by selling directly to
customers at the company’s website. Indochino in custom men’s suits, Warby
page 174
Parker in eyewear, and Everlane in sustainable apparel are examples.
Bypassing regular wholesale and retail channels in favor of direct sales and
Internet retailing can have appeal if it reinforces the brand and enhances
consumer satisfaction or if it lowers distribution costs, produces a relative
cost advantage over certain rivals, and results in lower selling prices to end
users. In addition, sellers are compelled to include the Internet as a retail
channel when a sufficiently large number of buyers in an industry prefer to
make purchases online. However, a company that is vigorously pursuing
online sales to consumers at the same time that it is also heavily promoting
sales to consumers through its network of wholesalers and retailers is
competing directly against its distribution allies. Such actions constitute
channel conflict and create a tricky route to negotiate. A company that is
actively trying to expand online sales to consumers is signaling a weak
strategic commitment to its dealers and a willingness to cannibalize dealers’
sales and growth potential. The likely result is angry dealers and loss of
dealer goodwill. Quite possibly, a company may stand to lose more sales by
offending its dealers than it gains from its own online sales effort.
Consequently, in industries where the strong support and goodwill of dealer
networks is essential, companies may conclude that it is important to avoid
channel conflict and that their websites should be designed to partner with
dealers rather than compete against them.
The Disadvantages of a Vertical Integration
Strategy
Vertical integration has some substantial drawbacks beyond the potential for
channel conflict.18 The most serious drawbacks to vertical integration include
the following concerns:
Vertical integration raises a firm’s capital investment in the industry,
thereby increasing business risk (what if industry growth and profitability
unexpectedly go sour?).
Vertically integrated companies are often slow to adopt technological
advances or more efficient production methods when they are saddled with
older technology or facilities. A company that obtains parts and
components from outside suppliers can always shop the market
for the newest, best, and cheapest parts, whereas a vertically
integrated firm with older plants and technology may choose to continue
making suboptimal parts rather than face the high costs of writing off
undepreciated assets.
Vertical integration can result in less flexibility in accommodating shifting
buyer preferences. It is one thing to eliminate use of a component made by
a supplier and another to stop using a component being made in-house
(which can mean laying off employees and writing off the associated
investment in equipment and facilities). Integrating forward or backward
locks a firm into relying on its own in-house activities and sources of
supply. Most of the world’s automakers, despite their manufacturing
expertise, have concluded that purchasing a majority of their parts and
components from best-in-class suppliers results in greater design flexibility,
higher quality, and lower costs than producing parts or components in-
house.
Vertical integration may not enable a company to realize economies of
scale if its production levels are below the minimum efficient scale. Small
companies in particular are likely to suffer a cost disadvantage by
producing in-house.
Vertical integration poses all kinds of capacity-matching problems. In
motor vehicle manufacturing, for example, the most efficient scale of
operation for making axles is different from the most economic volume for
radiators, and different yet again for both engines and transmissions.
Building the capacity to produce just the right number of axles, radiators,
engines, and transmissions in-house—and doing so at the lowest unit costs
for each—poses significant challenges and operating complications.
Integration forward or backward typically calls for developing new types of
resources and capabilities. Parts and components manufacturing, assembly
operations, wholesale distribution and retailing, and direct sales via the
Internet represent different kinds of businesses, operating in different types
of industries, with different key success factors. Many manufacturers learn
the hard way that company-owned wholesale and retail networks require
skills that they lack, fit poorly with what they do best, and detract from
their overall profit performance. Similarly, a company that tries to produce
many components in-house is likely to find itself very hard-pressed to keep
up with technological advances and cutting-edge production practices for
each component used in making its product.
page 175
In today’s world of close working relationships with suppliers and efficient
supply chain management systems, relatively few companies can make a
strong economic case for integrating backward into the business of suppliers.
The best materials and components suppliers stay abreast of advancing
technology and best practices and are adept in making good quality items,
delivering them on time, and keeping their costs and prices as low as
possible.
Weighing the Pros and Cons of Vertical
Integration
All in all, therefore, a strategy of vertical integration can have both strengths
and weaknesses. The tip of the scales depends on (1) whether vertical
integration can enhance the performance of strategy-critical activities in ways
that lower cost, build expertise, protect proprietary know-how, or increase
differentiation; (2) what impact vertical integration will have on investment
costs, flexibility, and response times; (3) what administrative costs will be
incurred by coordinating operations across more vertical chain activities; and
(4) how difficult it will be for the company to acquire the set of skills and
capabilities needed to operate in another stage of the vertical chain. Vertical
integration strategies have merit according to which capabilities and value-
adding activities truly need to be performed in-house and which
can be performed better or cheaper by outsiders. Absent solid
benefits, integrating forward or backward is not likely to be an attractive
strategy option.
ILLUSTRATION
CAPSULE 6.4 Tesla’s Vertical Integration
Strategy
Unlike many vehicle manufacturers, Tesla embraces vertical integration from component
manufacturing all the way through vehicle sales and servicing. The majority of the
company’s $11.8 billion in 2017 revenue came from electric vehicle sales and leasing,
with the remainder coming from servicing those vehicles and selling residential battery
packs and solar energy systems.
At its core an electric vehicle manufacturer, Tesla uses both backward and forward
vertical integration to achieve multiple strategic goals. In order to drive innovation in a
critical part of its supply chain, Tesla has invested in a “gigafactory” that manufacturers
the batteries that are essential for a long-lasting electric vehicle. According to Tesla’s
former VP of Production, in-house manufacturing of key components and new parts that
require frequent updates has enabled the company to learn quickly and launch new
versions faster. Moreover, having closer relationships between engineering and
manufacturing gives Tesla greater control over product design. Tesla uses forward
vertical integration to improve the customer experience by owning the distribution and
servicing of the vehicles it builds. Their network of dealerships allows Tesla to sell directly
to consumers and handle maintenance needs without relying on third parties that
sometimes have competing priorities.
Beyond vertically integrating the manufacture and distribution of their electric vehicles,
Tesla uses the strategy to build the ecosystem that is necessary to support further
adoption of their vehicles. As many consumers perceive electric cars to have limited
range and long charging times that prevent long-distance travel, Tesla is building a
network of Supercharger stations to overcome this pain point. By investing in this
development themselves, Tesla does not need to wait for another company to deliver the
critical infrastructure that drivers demand before they switch from traditional gasoline-
powered cars. Similarly, Tesla sells solar power generation and storage products that
make it easier for customers to make the switch to transportation powered by sustainable
energy.
Hadrian/Shutterstock
While Tesla’s mission to accelerate the world’s transition to sustainable energy has
required large investments throughout the value chain, this strategy has not been without
challenges. Unlike batteries, seats are of limited strategic importance, yet Tesla decided
to manufacture their Model 3 seats in house. While there is no indication that the seats
were the source of major production delays in 2017, diverting resources to develop new
page 176
manufacturing capabilities could have added to the problem. Although Tesla’s vertical
integration strategy is not without downsides, it has enabled the firm to quickly roll out
innovative new products and launch the network that is required for widespread vehicle
adoption. Investors have rewarded Tesla for this bold strategy by lifting its valuation to
$80 billion by the start of 2020, higher than the other major American automakers.
Note: Developed with Edward J. Silberman.
Sources: Tesla 2017 Annual Report; G. Reichow, “Tesla’s Secret Second Floor,” Wired,
October 18,2017, https://www.wired.com/story/teslas-secret-second-floor/; A. Sage,
“Tesla’s Seat Strategy Goes Against the Grain. . . For Now,” Reuters, October 26, 2017,
https://www.reuters.com/article/us-tesla-seats/teslas-seat-strategy-goes-against-
the-grain-for-now-idUSKBN1CV0DS; Yahoo Finance.
Electric automobile maker Tesla, Inc. has made vertical integration a
central part of its strategy, as described in Illustration Capsule 6.4.
OUTSOURCING STRATEGIES:
NARROWING THE SCOPE OF
OPERATIONS
• LO 6-5
Recognize the
conditions that favor
farming out certain
value chain activities
to outside parties.
In contrast to vertical integration strategies, outsourcing strategies narrow the
scope of a business’s operations, in terms of what activities are performed
internally. Outsourcing involves contracting out certain value chain activities
that are normally performed in-house to outside vendors.19 Many PC makers,
for example, have shifted from assembling units in-house to outsourcing the
entire assembly process to manufacturing specialists, which can operate more
efficiently due to their greater scale, experience, and bargaining power over
components makers. Nearly all name-brand apparel firms have in-house
https://www.wired.com/story/teslas-secret-second-floor/
https://www.reuters.com/article/us-tesla-seats/teslas-seat-strategy-goes-against-the-grain-for-now-idUSKBN1CV0DS
capability to design, market, and distribute their products but they outsource
all fabric manufacture and garment-making activities. Starbucks finds
purchasing coffee beans from independent growers far more advantageous
than having its own coffee-growing operation, with locations scattered across
most of the world’s coffee-growing regions.
CORE
CONCEPT
Outsourcing
involves contracting
out certain value
chain activities that
are normally
performed in-house
to outside vendors.
Outsourcing certain value chain activities makes strategic sense whenever
An activity can be performed better or more cheaply by outside specialists.
A company should generally not perform any value chain activity
internally that can be performed more efficiently or effectively by outsiders
—the chief exception occurs when a particular activity is strategically
crucial and internal control over that activity is deemed essential. Dolce &
Gabbana, for example, outsources the manufacture of its brand of
sunglasses to Luxottica—a company considered to be the world’s best
sunglass manufacturing company, known for its Oakley, Oliver Peoples,
and Ray-Ban brands. Colgate-Palmolive, for instance, has reduced its
information technology operational costs by more than 10 percent annually
through an outsourcing agreement with IBM.
The activity is not crucial to the firm’s ability to achieve sustainable
competitive advantage. Outsourcing of support activities such as
maintenance services, data processing, data storage, fringe-benefit
management, and website operations has become commonplace. Many
smaller companies, for example, find it advantages to outsource HR
activities such as benefit administration, training, recruiting, hiring and
payroll to specialists, such as XcelHR, Insperity, Paychex, and Aon Hewitt.
The outsourcing improves organizational flexibility and speeds time to
market. Outsourcing gives a company the flexibility to switch suppliers in
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the event that its present supplier falls behind competing suppliers.
Moreover, seeking out new suppliers with the needed capabilities already
in place is frequently quicker, easier, less risky, and cheaper than hurriedly
retooling internal operations to replace obsolete capabilities or trying to
install and master new technologies.
It reduces the company’s risk exposure to changing technology and buyer
preferences. When a company outsources certain parts, components, and
services, its suppliers must bear the burden of incorporating state-of-the-art
technologies and/or undertaking redesigns and upgrades to accommodate a
company’s plans to introduce next-generation products. If what a supplier
provides falls out of favor with buyers, or is rendered unnecessary by
technological change, it is the supplier’s business that suffers rather than
the company’s.
It allows a company to concentrate on its core business, leverage its key
resources, and do even better what it already does best. A company is
better able to enhance its own capabilities when it concentrates its full
resources and energies on performing only those activities.
United Colors of Benetton and Sisley, for example, outsource the
production of handbags and other leather goods while devoting their
energies to the clothing lines for which they are known. Apple outsources
production of its iPod, iPhone, and iPad models to Chinese contract
manufacturer Foxconn and concentrates in-house on design, marketing, and
innovation. Hewlett-Packard and IBM have sold some of their
manufacturing plants to outsiders and contracted to repurchase the output
instead from the new owners.
The Risk of Outsourcing Value Chain Activities
The biggest danger of outsourcing is that a company will farm out the wrong
types of activities and thereby hollow out its own capabilities.20 For example,
in recent years companies eager to reduce operating costs have opted to
outsource such strategically important activities as product development,
engineering design, and sophisticated manufacturing tasks—the very
capabilities that underpin a company’s ability to lead sustained product
innovation. While these companies have apparently been able to lower their
operating costs by outsourcing these functions to outsiders, their ability to
lead the development of innovative new products is weakened because so
many of the cutting-edge ideas and technologies for next-generation products
come from outsiders.
A company must
guard against
outsourcing
activities that hollow
out the resources
and capabilities that
it needs to be a
master of its own
destiny.
Another risk of outsourcing comes from the lack of direct control. It may
be difficult to monitor, control, and coordinate the activities of outside parties
via contracts and arm’s-length transactions alone. Unanticipated problems
may arise that cause delays or cost overruns and become hard to resolve
amicably. Moreover, contract-based outsourcing can be problematic because
outside parties lack incentives to make investments specific to the needs of
the outsourcing company’s internal value chain.
Companies like Cisco Systems are alert to these dangers. Cisco guards
against loss of control and protects its manufacturing expertise by designing
the production methods that its contract manufacturers must use. Cisco keeps
the source code for its designs proprietary, thereby controlling the initiation
of all improvements and safeguarding its innovations from imitation. Further,
Cisco has developed online systems to monitor the factory operations of
contract manufacturers around the clock so that it knows immediately when
problems arise and can decide whether to get involved.
STRATEGIC ALLIANCES AND
PARTNERSHIPS
page 178
• LO 6-6
Understand how to
capture the benefits
and minimize the
drawbacks of
strategic alliances
and partnerships.
Strategic alliances and cooperative partnerships provide one way to gain
some of the benefits offered by vertical integration, outsourcing, and
horizontal mergers and acquisitions while minimizing the associated
problems. Companies frequently engage in cooperative strategies as an
alternative to vertical integration or horizontal mergers and acquisitions.
Increasingly, companies ayre also employing strategic alliances and
partnerships to extend their scope of operations via international expansion
and diversification strategies, as we describe in Chapters 7 and 8. Strategic
alliances and cooperative arrangements are now a common means of
narrowing a company’s scope of operations as well, serving as a useful way
to manage outsourcing (in lieu of traditional, purely price-oriented contracts).
For example, oil and gas companies engage in considerable vertical
integration—but Shell Oil Company and Pemex (Mexico’s state-owned
petroleum company) have found that joint ownership of their Deer Park
Refinery in Texas lowers their investment costs and risks in comparison to
going it alone. The colossal failure of the Daimler–Chrysler
merger formed an expensive lesson for Daimler AG about what
can go wrong with horizontal mergers and acquisitions; the Renault–Nissan–
Mitsubishi Alliance has proved more successful in developing the
capabilities for the manufacture of plug-in electric vehicles and introducing
the Nissan Leaf.
Many companies employ strategic alliances to manage the problems that
might otherwise occur with outsourcing—Cisco’s system of alliances guards
against loss of control, protects its proprietary manufacturing expertise, and
enables the company to monitor closely the assembly operations of its
partners while devoting its energy to designing new generations of the
switches, routers, and other Internet-related equipment for which it is known.
A strategic alliance is a formal agreement between two or more separate
companies in which they agree to work collaboratively toward some
strategically relevant objective. Typically, they involve shared financial
responsibility, joint contribution of resources and capabilities, shared risk,
shared control, and mutual dependence. They may be characterized by
cooperative marketing, sales, or distribution; joint production; design
collaboration; or projects to jointly develop new technologies or products.
They can vary in terms of their duration and the extent of the collaboration;
some are intended as long-term arrangements, involving an extensive set of
cooperative activities, while others are designed to accomplish more limited,
short-term objectives.
CORE
CONCEPT
A strategic alliance
is a formal
agreement between
two or more
separate companies
in which they agree
to work
cooperatively toward
some common
objective.
Collaborative arrangements may entail a contractual agreement, but they
commonly stop short of formal ownership ties between the partners (although
sometimes an alliance member will secure minority ownership of another
member).
A special type of strategic alliance involving ownership ties is the joint
venture. A joint venture entails forming a new corporate entity that is jointly
owned by two or more companies that agree to share in the revenues,
expenses, and control of the newly formed entity. Since joint ventures involve
setting up a mutually owned business, they tend to be more durable but also
riskier than other arrangements. In other types of strategic alliances, the
collaboration between the partners involves a much less rigid structure in
which the partners retain their independence from one another. If a strategic
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alliance is not working out, a partner can choose to simply walk away or
reduce its commitment to collaborating at any time.
CORE
CONCEPT
A joint venture is a
partnership involving
the establishment of
an independent
corporate entity that
the partners own
and control jointly,
sharing in its
revenues and
expenses.
An alliance becomes “strategic,” as opposed to just a convenient business
arrangement, when it serves any of the following purposes:21
1. It facilitates achievement of an important business objective (like lowering
costs or delivering more value to customers in the form of better quality,
added features, and greater durability).
2. It helps build, strengthen, or sustain a core competence or competitive
advantage.
3. It helps remedy an important resource deficiency or competitive weakness.
4. It helps defend against a competitive threat, or mitigates a significant risk
to a company’s business.
5. It increases bargaining power over suppliers or buyers.
6. It helps open up important new market opportunities.
7. It speeds the development of new technologies and/or product innovations.
Strategic cooperation is a much-favored approach in industries where new
technological developments are occurring at a furious pace along many
different paths and where advances in one technology spill over to affect
others (often blurring industry boundaries). Whenever industries are
experiencing high-velocity technological advances in many areas
simultaneously, firms find it virtually essential to have
cooperative relationships with other enterprises to stay on the leading edge of
technology, even in their own area of specialization. In industries like these,
alliances are all about fast cycles of learning, gaining quick access to the
latest round of technological know-how, and developing dynamic
capabilities. In bringing together firms with different skills and knowledge
bases, alliances open up learning opportunities that help partner firms better
leverage their own resources and capabilities.22
In 2017, Daimler entered into an agreement with automotive supplier
Robert Bosch GmbH to develop self-driving taxis that customers can hail
with a smartphone app; the objective is to make this a reality in urban areas
by the beginning of the next decade.
Microsoft has been partnering with a variety of companies to advance
technology in the healthcare industry. Its 2017 alliance with PAREXEL, a
clinical research organization, aims to use their combined capabilities to
accelerate drug development and bring new therapies to patients sooner. In
2018, it joined forces with immuno-sequencing company Adaptive
Biotechnologies to find ways to detect cancers and other diseases earlier
using Microsoft’s artificial intelligence capabilities.
Companies that
have formed a host
of alliances need to
manage their
alliances like a
portfolio.
Because of the varied benefits of strategic alliances, many large
corporations have become involved in 30 to 50 alliances, and a number have
formed hundreds of alliances. Hoffmann-La Roche, a multinational
healthcare company, has set up Roche Partnering to manage their more than
190 alliances. Companies that have formed a host of alliances need to
manage their alliances like a portfolio—terminating those that no longer
serve a useful purpose or that have produced meager results, forming
promising new alliances, and restructuring existing alliances to correct
performance problems and/or redirect the collaborative effort.
The best alliances
are highly selective,
focusing on
particular value
chain activities and
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on obtaining a
specific competitive
benefit. They enable
a firm to build on its
strengths and to
learn.
Capturing the Benefits of Strategic Alliances
The extent to which companies benefit from entering into alliances and
partnerships seems to be a function of six factors:23
1. Picking a good partner. A good partner must bring complementary
strengths to the relationship. To the extent that alliance members have
nonoverlapping strengths, there is greater potential for synergy and less
potential for coordination problems and conflict. In addition, a good
partner needs to share the company’s vision about the overall purpose of
the alliance and to have specific goals that either match or complement
those of the company. Strong partnerships also depend on good chemistry
among key personnel and compatible views about how the alliance should
be structured and managed.
2. Being sensitive to cultural differences. Cultural differences among
companies can make it difficult for their personnel to work together
effectively. Cultural differences can be problematic among companies
from the same country, but when the partners have different national
origins, the problems are often magnified. Unless there is respect among
all the parties for cultural differences, including those stemming from
different local cultures and local business practices, productive working
relationships are unlikely to emerge.
3. Recognizing that the alliance must benefit both sides. Information must be
shared as well as gained, and the relationship must remain forthright and
trustful. If either partner plays games with information or tries to take
advantage of the other, the resulting friction can quickly erode the value of
further collaboration. Open, trustworthy behavior on both sides is essential
for fruitful collaboration.
4. Ensuring that both parties live up to their commitments. Both parties have
to deliver on their commitments for the alliance to produce the intended
benefits. The division of work has to be perceived as fairly apportioned,
and the caliber of the benefits received on both sides has to be perceived as
adequate.
5. Structuring the decision-making process so that actions can be taken
swiftly when needed. In many instances, the fast pace of technological and
competitive changes dictates an equally fast decision-making process. If
the parties get bogged down in discussions or in gaining internal approval
from higher-ups, the alliance can turn into an anchor of delay and inaction.
6. Managing the learning process and then adjusting the alliance agreement
over time to fit new circumstances. One of the keys to long-lasting success
is adapting the nature and structure of the alliance to be responsive to
shifting market conditions, emerging technologies, and changing customer
requirements. Wise allies are quick to recognize the merit of an evolving
collaborative arrangement, where adjustments are made to accommodate
changing conditions and to overcome whatever problems arise in
establishing an effective working relationship.
Most alliances that aim at sharing technology or providing market access
turn out to be temporary, lasting only a few years. This is not necessarily an
indicator of failure, however. Strategic alliances can be terminated after a few
years simply because they have fulfilled their purpose; indeed, many
alliances are intended to be of limited duration, set up to accomplish specific
short-term objectives. Longer-lasting collaborative arrangements, however,
may provide even greater strategic benefits. Alliances are more likely to be
long-lasting when (1) they involve collaboration with partners that do not
compete directly, such as suppliers or distribution allies; (2) a trusting
relationship has been established; and (3) both parties conclude that
continued collaboration is in their mutual interest, perhaps because new
opportunities for learning are emerging.
The Drawbacks of Strategic Alliances and Their
Relative Advantages
While strategic alliances provide a way of obtaining the benefits of vertical
integration, mergers and acquisitions, and outsourcing, they also suffer from
some of the same drawbacks. Anticipated gains may fail to materialize due to
an overly optimistic view of the potential or a poor fit in terms of the
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combination of resources and capabilities. When outsourcing is conducted
via alliances, there is no less risk of becoming dependent on other companies
for essential expertise and capabilities—indeed, this may be the Achilles’
heel of such alliances. Moreover, there are additional pitfalls to collaborative
arrangements. The greatest danger is that a partner will gain access to a
company’s proprietary knowledge base, technologies, or trade secrets,
enabling the partner to match the company’s core strengths and costing the
company its hard-won competitive advantage. This risk is greatest when the
alliance is among industry rivals or when the alliance is for the purpose of
collaborative R&D, since this type of partnership requires an extensive
exchange of closely held information.
The question for managers is when to engage in a strategic alliance and
when to choose an alternative means of meeting their objectives. The answer
to this question depends on the relative advantages of each method and the
circumstances under which each type of organizational arrangement is
favored.
The principal advantages of strategic alliances over vertical integration or
horizontal mergers and acquisitions are threefold:
1. They lower investment costs and risks for each partner by facilitating
resource pooling and risk sharing. This can be particularly important when
investment needs and uncertainty are high, such as when a dominant
technology standard has not yet emerged.
2. They are more flexible organizational forms and allow for a more adaptive
response to changing conditions. Flexibility is essential when
environmental conditions or technologies are changing rapidly. Moreover,
strategic alliances under such circumstances may enable the development
of each partner’s dynamic capabilities.
3. They are more rapidly deployed—a critical factor when speed is of the
essence. Speed is of the essence when there is a winner-take-all type of
competitive situation, such as the race for a dominant technological design
or a race down a steep experience curve, where there is a large first-mover
advantage.
The key advantages of using strategic alliances rather than arm’s-length
transactions to manage outsourcing are (1) the increased ability to exercise
control over the partners’ activities and (2) a greater willingness for the
partners to make relationship-specific investments. Arm’s-length transactions
discourage such investments since they imply less commitment and do not
build trust.
On the other hand, there are circumstances when other organizational
mechanisms are preferable to alliances and partnering. Mergers and
acquisitions are especially suited for situations in which strategic alliances or
partnerships do not go far enough in providing a company with access to
needed resources and capabilities. Ownership ties are more permanent than
partnership ties, allowing the operations of the merger or acquisition
participants to be tightly integrated and creating more in-house control and
autonomy. Other organizational mechanisms are also preferable to alliances
when there is limited property rights protection for valuable know-how and
when companies fear being taken advantage of by opportunistic partners.
While it is important for managers to understand when strategic alliances
and partnerships are most likely (and least likely) to prove useful, it is also
important to know how to manage them.
How to Make Strategic Alliances Work
A surprisingly large number of alliances never live up to expectations. Even
though the number of strategic alliances increases by about 25 percent
annually, about 60 to 70 percent of alliances continue to fail each year.24 The
success of an alliance depends on how well the partners work together, their
capacity to respond and adapt to changing internal and external conditions,
and their willingness to renegotiate the bargain if circumstances so warrant.
A successful alliance requires real in-the-trenches collaboration, not merely
an arm’s-length exchange of ideas. Unless partners place a high value on the
contribution each brings to the alliance and the cooperative arrangement
results in valuable win–win outcomes, it is doomed to fail.
While the track record for strategic alliances is poor on average, many
companies have learned how to manage strategic alliances successfully and
routinely defy this average. Samsung Group, which includes Samsung
Electronics, successfully manages an ecosystem of over 1,300 partnerships
that enable productive activities from global procurement to local marketing
to collaborative R&D. Companies that have greater success in managing their
strategic alliances and partnerships often credit the following factors:
page 182
They create a system for managing their alliances. Companies need to
manage their alliances in a systematic fashion, just as they manage other
functions. This means setting up a process for managing the
different aspects of alliance management from partner selection to
alliance termination procedures. To ensure that the system is followed on a
routine basis by all company managers, many companies create a set of
explicit procedures, process templates, manuals, or the like.
They build relationships with their partners and establish trust.
Establishing strong interpersonal relationships is a critical factor in making
strategic alliances work since such relationships facilitate opening up
channels of communication, coordinating activity, aligning interests, and
building trust.
They protect themselves from the threat of opportunism by setting up
safeguards. There are a number of means for preventing a company from
being taken advantage of by an untrustworthy partner or unwittingly losing
control over key assets. Contractual safeguards, including noncompete
clauses, can provide other forms of protection.
They make commitments to their partners and see that their partners do the
same. When partners make credible commitments to a joint enterprise, they
have stronger incentives for making it work and are less likely to “free-
ride” on the efforts of other partners. Because of this, equity-based
alliances tend to be more successful than nonequity alliances.25
They make learning a routine part of the management process. There are
always opportunities for learning from a partner, but organizational
learning does not take place automatically. Whatever learning occurs
cannot add to a company’s knowledge base unless the learning is
incorporated systematically into the company’s routines and practices.
Finally, managers should realize that alliance management is an
organizational capability, much like any other. It develops over time, out of
effort, experience, and learning. For this reason, it is wise to begin slowly,
with simple alliances designed to meet limited, short-term objectives. Short-
term partnerships that are successful often become the basis for much more
extensive collaborative arrangements. Even when strategic alliances are set
up with the hope that they will become long-term engagements, they have a
page 183
better chance of succeeding if they are phased in so that the partners can learn
how they can work together most fruitfully.
KEY POINTS
1. Once a company has settled on which of the five generic competitive
strategies to employ, attention turns to how strategic choices regarding (1)
competitive actions, (2) timing of those actions, and (3) scope of
operations can complement its competitive approach and maximize the
power of its overall strategy.
2. Strategic offensives should, as a general rule, be grounded in a company’s
strategic assets and employ a company’s strengths to attack rivals in the
competitive areas where they are weakest.
3. Companies have a number of offensive strategy options for improving
their market positions: using a cost-based advantage to attack competitors
on the basis of price or value, leapfrogging competitors with next-
generation technologies, pursuing continuous product innovation, adopting
and improving the best ideas of others, using hit-and-run tactics to steal
sales away from unsuspecting rivals, and launching preemptive strikes. A
blue-ocean type of offensive strategy seeks to gain a dramatic new
competitive advantage by inventing a new industry or distinctive market
segment that renders existing competitors largely irrelevant and
allows a company to create and capture altogether new demand
in the absence of direct competitors.
4. The purposes of defensive strategies are to lower the risk of being attacked,
weaken the impact of any attack that occurs, and influence challengers to
aim their efforts at other rivals. Defensive strategies to protect a company’s
position usually take one of two forms: (1) actions to block challengers or
(2) actions to signal the likelihood of strong retaliation.
5. The timing of strategic moves also has relevance in the quest for
competitive advantage. Company managers are obligated to carefully
consider the advantages or disadvantages that attach to being a first mover
versus a fast follower versus a late mover.
6. Decisions concerning the scope of a company’s operations—which
activities a firm will perform internally and which it will not—can also
affect the strength of a company’s market position. The scope of the firm
refers to the range of its activities, the breadth of its product and service
offerings, the extent of its geographic market presence, and its mix of
businesses. Companies can expand their scope horizontally (more broadly
within their focal market) or vertically (up or down the industry value
chain system that starts with raw-material production and ends with sales
and service to the end consumer). Horizontal mergers and acquisitions
(combinations of market rivals) provide a means for a company to expand
its horizontal scope. Vertical integration expands a firm’s vertical scope.
7. Horizontal mergers and acquisitions typically have any of five objectives:
lowering costs, expanding geographic coverage, adding product categories,
gaining new technologies or other resources and capabilities, and preparing
for the convergence of industries.
8. Vertical integration, forward or backward, makes most strategic sense if it
strengthens a company’s position via either cost reduction or creation of a
differentiation-based advantage. Otherwise, the drawbacks of vertical
integration (increased investment, greater business risk, increased
vulnerability to technological changes, less flexibility in making product
changes, and the potential for channel conflict) are likely to outweigh any
advantages.
9. Outsourcing involves contracting out pieces of the value chain formerly
performed in-house to outside vendors, thereby narrowing the scope of the
firm. Outsourcing can enhance a company’s competitiveness whenever (1)
an activity can be performed better or more cheaply by outside specialists;
(2) the activity is not crucial to the firm’s ability to achieve sustainable
competitive advantage; (3) the outsourcing improves organizational
flexibility, speeds decision making, and cuts cycle time; (4) it reduces the
company’s risk exposure; and (5) it permits a company to concentrate on
its core business and focus on what it does best.
10. Strategic alliances and cooperative partnerships provide one way to gain
some of the benefits offered by vertical integration, outsourcing, and
horizontal mergers and acquisitions while minimizing the associated
problems. They serve as an alternative to vertical integration and mergers
and acquisitions, and as a supplement to outsourcing, allowing more
control relative to outsourcing via arm’s-length transactions.
LO 6-1, LO 6-2, LO
6-3
LO 6-4
LO 6-5
page 184
11. Companies that manage their alliances well generally (1) create a system
for managing their alliances, (2) build relationships with their partners and
establish trust, (3) protect themselves from the threat of opportunism by
setting up safeguards, (4) make commitments to their partners and see that
their partners do the same, and (5) make learning a routine part of the
management process.
ASSURANCE OF LEARNING EXERCISES
1. Live Nation Entertainment operates music venues,
provides management services to music artists, and
promotes more than 35,000 shows and 100 festivals
in 40 countries annually. The company acquired
House of Blues, merged with Ticketmaster, and
acquired concert and festival promoters in the
United States, Australia, and Great Britain. How has
the company used horizontal mergers and
acquisitions to strengthen its competitive position?
Are these moves primarily offensive or defensive?
Has either Live Nation or Ticketmaster achieved any
type of advantage based on the timing of its strategic
moves?
2. Tesla, Inc. has rapidly become a stand-out among
American car companies. Illustration Capsule 6.4
describes how Tesla has made vertical integration a
central part of its strategy. What value chain
segments has Tesla chosen to enter and perform
internally? How has vertical integration and
integration of its ecosystem aided the organization in
building competitive advantage? Has vertical
integration strengthened its market position?
Explain why or why not.
3. Perform an Internet search to identify at least two
companies in different industries that have entered
into outsourcing agreements with firms with
LO 6-6
LO 6-1, LO 6-2
LO 6-3
LO 6-4
LO 6-5
page 185
specialized services. In addition, describe what
value chain activities the companies have chosen to
outsource. Do any of these outsourcing agreements
seem likely to threaten any of the companies’
competitive capabilities?
4. Using your university library’s business research
resources, find two examples of how companies
have relied on strategic alliances or joint ventures to
substitute for horizontal or vertical integration.
EXERCISES FOR SIMULATION PARTICIPANTS
1. Has your company relied more on offensive or
defensive strategies to achieve your rank in the
industry? What options for being a first mover does
your company have? Do any of these first-mover
options hold competitive advantage potential?
2. What would be an advantage of a horizontal merger
within the industry?
3. What are the pros and cons of vertical integration in
the industry?
4. What do you see as pros and cons of outsourcing in
the business simulation?
ENDNOTES
1 George Stalk, Jr., and Rob Lachenauer, “Hardball: Five Killer Strategies for Trouncing the Competition,” Harvard
Business Review 82, no. 4 (April 2004); Richard D’Aveni, “The Empire Strikes Back: Counterrevolutionary Strategies for
Industry Leaders,” Harvard Business Review 80, no. 11 (November 2002); David J. Bryce and Jeffrey H. Dyer,
“Strategies to Crack Well-Guarded Markets,” Harvard Business Review 85, no. 5 (May 2007).
2 George Stalk, “Playing Hardball: Why Strategy Still Matters,” Ivey Business Journal 69, no.2 (November–December
2004), pp. 1–2; W. J. Ferrier, K. G. Smith, and C. M. Grimm, “The Role of Competitive Action in Market Share Erosion
and Industry Dethronement: A Study of Industry Leaders and Challengers,” Academy of Management Journal 42, no. 4
(August 1999), pp. 372–388.
3 David B. Yoffie and Mary Kwak, “Mastering Balance: How to Meet and Beat a Stronger Opponent,” California
Management Review 44, no. 2 (Winter 2002), pp. 8–24.
4 Ian C. MacMillan, Alexander B. van Putten, and Rita Gunther McGrath, “Global Gamesmanship,” Harvard Business
Review 81, no. 5 (May 2003); Ashkay R. Rao, Mark E. Bergen, and Scott Davis, “How to Fight a Price War,” Harvard
Business Review 78, no. 2 (March–April 2000).
5 D. B. Yoffie and M. A. Cusumano, “Judo Strategy–the Competitive Dynamics of Internet Time,”
Harvard Business Review 77, no. 1 (January–February 1999), pp. 70–81.
6 Ming-Jer Chen and Donald C. Hambrick, “Speed, Stealth, and Selective Attack: How Small Firms Differ from Large
Firms in Competitive Behavior,” Academy of Management Journal 38, no. 2 (April 1995), pp. 453–482; William E.
Rothschild, “Surprise and the Competitive Advantage,” Journal of Business Strategy 4, no. 3 (Winter 1984), pp. 10–18.
7 Ian MacMillan, “Preemptive Strategies,” Journal of Business Strategy 14, no. 2 (Fall 1983), pp. 16–26.
8 Ian C. MacMillan, “How Long Can You Sustain a Competitive Advantage?” in Liam Fahey (ed.), The Strategic Planning
Management Reader (Englewood Cliffs, NJ: Prentice Hall, 1989), pp. 23–24.
9 Kevin P. Coyne and John Horn, “Predicting Your Competitor’s Reactions,” Harvard Business Review 87, no. 4 (April
2009), pp. 90–97.
10 Philip Kotler, Marketing Management, 5th ed. (Englewood Cliffs, NJ: Prentice Hall, 1984).
11 W. Chan Kim and Renée Mauborgne, “Blue Ocean Strategy,” Harvard Business Review 82, no. 10 (October 2004), pp.
76–84.
12 Jeffrey G. Covin, Dennis P. Slevin, and Michael B. Heeley, “Pioneers and Followers: Competitive Tactics, Environment,
and Growth,” Journal of Business Venturing 15, no. 2 (March 1999), pp. 175–210; Christopher A. Bartlett and Sumantra
Ghoshal, “Going Global: Lessons from Late-Movers,” Harvard Business Review 78, no. 2 (March-April 2000), pp. 132–
145.
13 Costas Markides and Paul A. Geroski, “Racing to Be 2nd: Conquering the Industries of the Future,” Business Strategy
Review 15, no. 4 (Winter 2004), pp. 25–31.
14 Fernando Suarez and Gianvito Lanzolla, “The Half-Truth of First-Mover Advantage,” Harvard Business Review 83, no.
4 (April 2005), pp. 121–127.
15 Joseph L. Bower, “Not All M&As Are Alike–and That Matters,” Harvard Business Review 79, no. 3 (March 2001); O.
Chatain and P. Zemsky, “The Horizontal Scope of the Firm: Organizational Tradeoffs vs. Buyer-Supplier Relationships,”
Management Science 53, no. 4(April 2007), pp. 550–565.
16 Jeffrey H. Dyer, Prashant Kale, and Harbir Singh, “When to Ally and When to Acquire,” Harvard Business Review 82,
no. 4 (July–August 2004), pp. 109–110.
17 John Stuckey and David White, “When and When Not to Vertically Integrate,” Sloan Management Review (Spring
1993), pp. 71–83.
18 Thomas Osegowitsch and Anoop Madhok, “Vertical Integration Is Dead, or Is It?” Business Horizons 46, no. 2 (March–
April 2003), pp. 25–35.
19 Ronan McIvor, “What Is the Right Outsourcing Strategy for Your Process?” European Management Journal 26, no. 1
(February 2008), pp. 24–34.
20 Gary P. Pisano and Willy C. Shih, “Restoring American Competitiveness,” Harvard Business Review 87, no. 7-8 (July–
August 2009), pp. 114–125; Jérôme Barthélemy, “The Seven Deadly Sins of Outsourcing,” Academy of Management
Executive 17, no. 2 (May 2003), pp. 87–100.
21 Jason Wakeam, “The Five Factors of a Strategic Alliance,” Ivey Business Journal 68, no. 3 (May–June 2003), pp. 1–4.
22 A. Inkpen, “Learning, Knowledge Acquisition, and Strategic Alliances,” European Management Journal 16, no. 2 (April
1998), pp. 223–229.
23 Advertising Age, May 24, 2010, p. 14.
24 Patricia Anslinger and Justin Jenk, “Creating Successful Alliances,” Journal of Business Strategy 25, no. 2 (2004), pp.
18–23; Rosabeth Moss Kanter, “Collaborative Advantage: The Art of the Alliance,” Harvard Business Review 72, no. 4
(July–August 1994), pp. 96-108; Gary Hamel, Yves L. Doz, and C. K. Prahalad, “Collaborate with Your Competitors–and
Win,” Harvard Business Review 67, no. 1 (January–February 1989), pp. 133–139.
25 Y. G. Pan and D. K. Tse, “The Hierarchical Model of Market Entry Modes,” Journal of International Business Studies
31, no. 4 (2000), pp. 535–554.
page 186
chapter 7
Strategies for Competing in
International Markets
Learning Objectives
After reading this chapter, you should be able to:
LO 7-1 Identify the primary reasons companies choose to
compete in international markets.
LO 7-2 Understand how and why differing market conditions
across countries influence a company’s strategy
choices in international markets.
LO 7-3 Identify the differences among the five primary modes
of entry into foreign markets
LO 7-4 Identify the three main strategic approaches for
competing internationally.
LO 7-5 Explain how companies are able to use international
operations to improve overall competitiveness.
LO 7-6 Identify the unique characteristics of competing in
developing-country markets.
page 187
Fanatic Studio/Getty Images
Our key words now are globalization, new products and businesses, and speed.
Tsutomu Kanai—Former chair and president of Hitachi
You have no choice but to operate in a world shaped by globalization and the information
revolution. There are two options: Adapt or die.
Andy Grove—Former chair and CEO of Intel
What counts in global competition is the right strategy.
Heinrich von Pierer—Former CEO of Siemens AG
Any company that aspires to industry leadership in the 21st century must think in terms
of global, not domestic, market leadership. The world economy is globalizing at an
page 188
accelerating pace as ambitious, growth-minded companies race to build stronger
competitive positions in the markets of more and more countries, as countries
previously closed to foreign companies open up their markets, and as information
technology shrinks the importance of geographic distance. The forces of globalization
are changing the competitive landscape in many industries, offering companies
attractive new opportunities and at the same time introducing new competitive threats.
Companies in industries where these forces are greatest are therefore under
considerable pressure to come up with a strategy for competing successfully in
international markets.
This chapter focuses on strategy options for expanding beyond domestic boundaries
and competing in the markets of either a few or a great many countries. In the process
of exploring these options, we introduce such concepts as the Porter diamond of
national competitive advantage; and discuss the specific market circumstances that
support the adoption of multidomestic, transnational, and global strategies. The chapter
also includes sections on cross-country differences in cultural, demographic, and
market conditions; strategy options for entering foreign markets; the importance of
locating value chain operations in the most advantageous countries; and the special
circumstances of competing in developing markets such as those in China, India, Brazil,
Russia, and eastern Europe.
WHY COMPANIES DECIDE TO ENTER
FOREIGN MARKETS
A company may opt to expand outside its domestic market for any of five
major reasons:
1. To gain access to new customers. Expanding into foreign markets offers
potential for increased revenues, profits, and long-term growth; it becomes
an especially attractive option when a company encounters dwindling
growth opportunities in its home market. Companies often expand
internationally to extend the life cycle of their products, as Honda has done
with its classic 50-cc motorcycle, the Honda Cub (which is still selling
well in developing markets, more than 60 years after it was first introduced
in Japan). A larger target market also offers companies the opportunity to
earn a return on large investments more rapidly. This can be particularly
important in R&D-intensive industries, where development is fast-paced or
competitors imitate innovations rapidly.
• LO 7-1
Identify the primary
reasons companies
choose to compete
in international
markets.
2. To achieve lower costs through economies of scale, experience, and
increased purchasing power. Many companies are driven to sell in more
than one country because domestic sales volume alone is not large enough
to capture fully economies of scale in product development,
manufacturing, or marketing. Similarly, firms expand internationally to
increase the rate at which they accumulate experience and move down the
learning curve. International expansion can also lower a company’s input
costs through greater pooled purchasing power. The relatively small size of
country markets in Europe and limited domestic volume explains why
companies like Michelin, BMW, and Nestlé long ago began selling their
products all across Europe and then moved into markets in North America
and Latin America.
3. To gain access to low-cost inputs of production. Companies in industries
based on natural resources (e.g., oil and gas, minerals, rubber, and lumber)
often find it necessary to operate in the international arena since raw-
material supplies are located in different parts of the world and can be
accessed more cost-effectively at the source. Other companies enter
foreign markets to access low-cost human resources; this is particularly
true of industries in which labor costs make up a high proportion of total
production costs.
4. To further exploit its core competencies. A company may be able to extend
a market-leading position in its domestic market into a position of regional
or global market leadership by leveraging its core competencies further.
H&M Group is capitalizing on its considerable expertise in fashion
retailing to expand its reach internationally. By 2020, it had more than
5000 retail stores operating in 74 countries, and was continuing to expand
its global reach. Companies can often leverage their resources
internationally by replicating a successful business model, using it as a
page 189
basic blueprint for international operations, as Starbucks and McDonald’s
have done.1
5. To gain access to resources and capabilities located in foreign markets. An
increasingly important motive for entering foreign markets is to acquire
resources and capabilities that may be unavailable in a company’s home
market. Companies often make acquisitions abroad or enter into cross-
border alliances to gain access to capabilities that complement their own or
to learn from their partners.2 In other cases, companies choose to establish
operations in other countries to utilize local distribution networks, gain
local managerial or marketing expertise, or acquire specialized technical
knowledge.
In addition, companies that are the suppliers of other companies
often expand internationally when their major customers do so, to meet their
customers’ needs abroad and retain their position as a key supply chain
partner. For example, when motor vehicle companies have opened new plants
in foreign locations, big automotive parts suppliers have frequently opened
new facilities nearby to permit timely delivery of their parts and components
to the plant. Similarly, Newell-Rubbermaid, one of Walmart’s biggest
suppliers of household products, has followed Walmart into foreign markets.
WHY COMPETING ACROSS NATIONAL
BORDERS MAKES STRATEGY MAKING
MORE COMPLEX
Crafting a strategy to compete in one or more countries of the world is
inherently more complex for five reasons. First, different countries have
different home-country advantages in different industries; competing
effectively requires an understanding of these differences. Second, there are
location-based advantages to conducting particular value chain activities in
different parts of the world. Third, different political and economic conditions
make the general business climate more favorable in some countries than in
others. Fourth, companies face risk due to adverse shifts in currency
exchange rates when operating in foreign markets. And fifth, differences in
buyer tastes and preferences present a challenge for companies concerning
customizing versus standardizing their products and services.
• LO 7-2
Understand how and
why differing market
conditions across
countries influence a
company’s strategy
choices in
international
markets.
Home-Country Industry Advantages and the
Diamond Model
Certain countries are known for their strengths in particular industries. For
example, Chile has competitive strengths in industries such as copper, fruit,
fish products, paper and pulp, chemicals, and wine. Japan is known for
competitive strength in consumer electronics, automobiles, semiconductors,
steel products, and specialty steel. Where industries are more likely to
develop competitive strength depends on a set of factors that describe the
nature of each country’s business environment and vary from country to
country. Because strong industries are made up of strong firms, the strategies
of firms that expand internationally are usually grounded in one or more of
these factors. The four major factors are summarized in a framework
developed by Michael Porter and known as the Diamond of National
Competitive Advantage (see Figure 7.1).3
FIGURE 7.1 The Diamond of National Competitive
Advantage
Source: Adapted from Michael E. Porter, “The Competitive Advantage of Nations,” Harvard
Business Review, March–April 1990, pp. 73–93.
page 190
page 191
Demand Conditions The demand conditions in an industry’s home market
include the relative size of the market, its growth potential, and the nature of
domestic buyers’ needs and wants. Differing population sizes, income levels,
and other demographic factors give rise to considerable differences in market
size and growth rates from country to country. Industry sectors that are larger
and more important in their home market tend to attract more resources and
grow faster than others. For example, owing to widely differing population
demographics and income levels, there is a far bigger market for luxury
automobiles in the United States and Germany than in Argentina, India,
Mexico, and China. At the same time, in developing markets like India,
China, Brazil, and Malaysia, market growth potential is far higher than it is in
the more mature economies of Britain, Denmark, Canada, and Japan. The
potential for market growth in automobiles is explosive in China,
where 2017 sales of new vehicles amounted to 28.9 million,
surpassing U.S. sales of 17.2 million and making China the world’s largest
market for the eighth year in a row.4 Demanding domestic buyers for an
industry’s products spur greater innovativeness and improvements in quality.
Such conditions foster the development of stronger industries, with firms that
are capable of translating a home-market advantage into a competitive
advantage in the international arena.
Factor Conditions Factor conditions describe the availability, quality, and
cost of raw materials and other inputs (called factors of production) that firms
in an industry require for producing their products and services. The relevant
factors of production vary from industry to industry but can include
different types of labor, technical or managerial knowledge, land,
financial capital, and natural resources. Elements of a country’s infrastructure
may be included as well, such as its transportation, communication, and
banking systems. For instance, in India there are efficient, well-developed
national channels for distributing groceries, personal care items, and other
packaged products to the country’s 13 million retailers, (as of 2020) whereas
in China distribution is primarily local and there is a limited national network
for distributing most products. Competitively strong industries and firms
develop where relevant factor conditions are favorable.
Related and Supporting Industries Robust industries often develop in
locales where there is a cluster of related industries, including others within
the same value chain system (e.g., suppliers of components and equipment,
distributors) and the makers of complementary products or those that are
technologically related. The sports car makers Ferrari and Maserati, for
example, are located in an area of Italy known as the “engine technological
district,” which includes other firms involved in racing, such as Ducati
Motorcycles, along with hundreds of small suppliers. The advantage to firms
that develop as part of a related-industry cluster comes from the close
collaboration with key suppliers and the greater knowledge sharing
throughout the cluster, resulting in greater efficiency and innovativeness.
Firm Strategy, Structure, and Rivalry Different country environments
foster the development of different styles of management, organization, and
strategy. For example, strategic alliances are a more common strategy for
firms from Asian or Latin American countries, which emphasize trust and
cooperation in their organizations, than for firms from North America, where
individualism is more influential. In addition, countries vary in terms of the
competitive rivalry of their industries. Fierce rivalry in home markets tends to
hone domestic firms’ competitive capabilities and ready them for competing
internationally.
The Diamond
Framework can be
used to
1. predict from which
countries foreign
entrants are most
likely to come
2. decide which
foreign markets to
enter first
3. choose the best
country location
for different value
chain activities
For an industry in a particular country to become competitively strong, all
four factors must be favorable for that industry. When they are, the industry is
likely to contain firms that are capable of competing successfully in the
international arena. Thus the diamond framework can be used to reveal the
answers to several questions that are important for competing on an
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international basis. First, it can help predict where foreign entrants into an
industry are most likely to come from. This can help managers prepare to
cope with new foreign competitors, since the framework also reveals
something about the basis of the new rivals’ strengths. Second, it can reveal
the countries in which foreign rivals are likely to be weakest and thus can
help managers decide which foreign markets to enter first. And third, because
it focuses on the attributes of a country’s business environment that allow
firms to flourish, it reveals something about the advantages of conducting
particular business activities in that country. Thus the diamond framework is
an aid to deciding where to locate different value chain activities most
beneficially—a topic that we address next.
Opportunities for Location-Based Advantages
Increasingly, companies are locating different value chain activities in
different parts of the world to exploit location-based advantages that vary
from country to country. This is particularly evident with respect to the
location of manufacturing activities. Differences in wage rates, worker
productivity, energy costs, and the like create sizable variations in
manufacturing costs from country to country. By locating its plants
in certain countries, firms in some industries can reap major
manufacturing cost advantages because of lower input costs (especially
labor), relaxed government regulations, the proximity of suppliers and
technologically related industries, or unique natural resources. In such cases,
the low-cost countries become principal production sites, with most of the
output being exported to markets in other parts of the world. Companies that
build production facilities in low-cost countries (or that source their products
from contract manufacturers in these countries) gain a competitive advantage
over rivals with plants in countries where costs are higher. The competitive
role of low manufacturing costs is most evident in low-wage countries like
China, India, Pakistan, Cambodia, Vietnam, Mexico, Brazil, Guatemala, the
Philippines, and several countries in Africa and eastern Europe that have
become production havens for manufactured goods with high labor content
(especially textiles and apparel). Hourly compensation for manufacturing
workers in 2016 averaged about $3.27 in India, $2.06 in the Philippines,
$3.60 in China, $3.91 in Mexico, $9.82 in Taiwan, $8.60 in Hungary, $7.98
in Brazil, $10.96 in Portugal, $22.98 in South Korea, $23.67 in New Zealand,
$26.46 in Japan, $30.08 in Canada, $39.03 in the United States, $43.18 in
Germany, and $60.36 in Switzerland.5 China emerged as the manufacturing
capital of the world in large part because of its low wages—virtually all of
the world’s major manufacturing companies now have facilities in China.
For other types of value chain activities, input quality or availability are
more important considerations. Tiffany & Co. entered the mining industry in
Canada to access diamonds that could be certified as “conflict free” and not
associated with either the funding of African wars or unethical mining
conditions. Many U.S. companies locate call centers in countries such as
India and Ireland, where English is spoken and the workforce is well
educated. Other companies locate R&D activities in countries where there are
prestigious research institutions and well-trained scientists and engineers.
Likewise, concerns about short delivery times and low shipping costs make
some countries better locations than others for establishing distribution
centers.
The Impact of Government Policies and
Economic Conditions in Host Countries
Cross-country variations in government policies and economic conditions
affect both the opportunities available to a foreign entrant and the risks of
operating within the host country. The governments of some countries are
eager to attract foreign investments, and thus they go all out to create a
business climate that outsiders will view as favorable. Governments eager to
spur economic growth, create more jobs, and raise living standards for their
citizens usually enact policies aimed at stimulating business innovation and
capital investment; Ireland is a good example. They may provide such
incentives as reduced taxes, low-cost loans, site location and site
development assistance, and government-sponsored training for workers to
encourage companies to construct production and distribution facilities.
When new business-related issues or developments arise, “pro-business”
governments make a practice of seeking advice and counsel from business
leaders. When tougher business-related regulations are deemed appropriate,
they endeavor to make the transition to more costly and stringent regulations
somewhat business-friendly rather than adversarial.
page 193
On the other hand, governments sometimes enact policies that, from a
business perspective, make locating facilities within a country’s borders less
attractive. For example, the nature of a company’s operations may make it
particularly costly to achieve compliance with a country’s environmental
regulations. Some governments provide subsidies and low-
interest loans to domestic companies to enable them to better
compete against foreign companies. To discourage foreign imports,
governments may enact deliberately burdensome procedures and
requirements regarding customs inspection for foreign goods and may
impose tariffs or quotas on imports. Additionally, they may specify that a
certain percentage of the parts and components used in manufacturing a
product be obtained from local suppliers, require prior approval of capital
spending projects, limit withdrawal of funds from the country, and require
partial ownership of foreign company operations by local companies or
investors. There are times when a government may place restrictions on
exports to ensure adequate local supplies and regulate the prices of imported
and locally produced goods. Such government actions make a country’s
business climate less attractive and in some cases may be sufficiently onerous
as to discourage a company from locating facilities in that country or even
selling its products there.
A country’s business climate is also a function of the political and
economic risks associated with operating within its borders. Political risks
have to do with the instability of weak governments, growing possibilities
that a country’s citizenry will revolt against dictatorial government leaders,
the likelihood of new onerous legislation or regulations on foreign-owned
businesses, and the potential for future elections to produce corrupt or
tyrannical government leaders. In industries that a government deems critical
to the national welfare, there is sometimes a risk that the government will
nationalize the industry and expropriate the assets of foreign companies. In
2012, for example, Argentina nationalized the country’s top oil producer,
YPF, which was owned by Spanish oil major Repsol. In 2015, they
nationalized all of the Argentine railway network, some of which had been in
private hands. Other political risks include the loss of investments due to war
or political unrest, regulatory changes that create operating uncertainties,
security risks due to terrorism, and corruption. Economic risks have to do
with instability of a country’s economy and monetary system—whether
inflation rates might skyrocket or whether uncontrolled deficit spending on
the part of government or risky bank lending practices could lead to a
breakdown of the country’s monetary system and prolonged economic
distress. In some countries, the threat of piracy and lack of protection for
intellectual property are also sources of economic risk. Another is
fluctuations in the value of different currencies—a factor that we discuss in
more detail next.
CORE
CONCEPT
Political risks stem
from instability or
weakness in
national
governments and
hostility to foreign
business.
Economic risks
stem from instability
in a country’s
monetary system,
economic and
regulatory policies,
and the lack of
property rights
protections.
The Risks of Adverse Exchange Rate Shifts
When companies produce and market their products and services in many
different countries, they are subject to the impacts of sometimes favorable
and sometimes unfavorable changes in currency exchange rates. The rates of
exchange between different currencies can vary by as much as 20 to 40
percent annually, with the changes occurring sometimes gradually and
sometimes swiftly. Sizable shifts in exchange rates pose significant risks for
two reasons:
1. They are hard to predict because of the variety of factors involved and the
uncertainties surrounding when and by how much these factors will
change.
page 194
2. They create uncertainty regarding which countries represent the low-cost
manufacturing locations and which rivals have the upper hand in the
marketplace.
To illustrate the economic and competitive risks associated with fluctuating
exchange rates, consider the case of a U.S. company that has located
manufacturing facilities in Brazil (where the currency is reals—pronounced
“ray-alls”) and that exports most of the Brazilian-made goods to
markets in the European Union (where the currency is euros). To
keep the numbers simple, assume that the exchange rate is 4 Brazilian reals
for 1 euro and that the product being made in Brazil has a manufacturing cost
of 4 Brazilian reals (or 1 euro). Now suppose that the exchange rate shifts
from 4 reals per euro to 5 reals per euro (meaning that the real has declined in
value and that the euro is stronger). Making the product in Brazil is now
more cost-competitive because a Brazilian good costing 4 reals to produce
has fallen to only 0.8 euro at the new exchange rate (4 reals divided by 5 reals
per euro = 0.8 euro). This clearly puts the producer of the Brazilian-made
good in a better position to compete against the European makers of the same
good. On the other hand, should the value of the Brazilian real grow stronger
in relation to the euro—resulting in an exchange rate of 3 reals to 1 euro—the
same Brazilian-made good formerly costing 4 reals (or 1 euro) to produce
now has a cost of 1.33 euros (4 reals divided by 3 reals per
euro = 1.33 euros), putting the producer of the Brazilian-made good in a
weaker competitive position vis-à-vis the European producers. Plainly, the
attraction of manufacturing a good in Brazil and selling it in Europe is far
greater when the euro is strong (an exchange rate of 1 euro for 5 Brazilian
reals) than when the euro is weak and exchanges for only 3 Brazilian reals.
But there is one more piece to the story. When the exchange rate changes
from 4 reals per euro to 5 reals per euro, not only is the cost-competitiveness
of the Brazilian manufacturer stronger relative to European manufacturers of
the same item but the Brazilian-made good that formerly cost 1 euro and now
costs only 0.8 euro can also be sold to consumers in the European Union for a
lower euro price than before. In other words, the combination of a stronger
euro and a weaker real acts to lower the price of Brazilian-made goods in all
the countries that are members of the European Union, which is likely to spur
sales of the Brazilian-made good in Europe and boost Brazilian exports to
Europe. Conversely, should the exchange rate shift from 4 reals per euro to 3
page 195
reals per euro—which makes the Brazilian manufacturer less cost-
competitive with European manufacturers of the same item—the Brazilian-
made good that formerly cost 1 euro and now costs 1.33 euros will sell for a
higher price in euros than before, thus weakening the demand of European
consumers for Brazilian-made goods and acting to reduce Brazilian exports
to Europe. Brazilian exporters are likely to experience (1) rising demand for
their goods in Europe whenever the Brazilian real grows weaker relative to
the euro and (2) falling demand for their goods in Europe whenever the real
grows stronger relative to the euro. Consequently, from the standpoint of a
company with Brazilian manufacturing plants, a weaker Brazilian real is a
favorable exchange rate shift and a stronger Brazilian real is an unfavorable
exchange rate shift.
It follows from the previous discussion that shifting exchange rates have a
big impact on the ability of domestic manufacturers to compete with foreign
rivals. For example, U.S.-based manufacturers locked in a fierce competitive
battle with low-cost foreign imports benefit from a weaker U.S. dollar. There
are several reasons why this is so:
Declines in the value of the U.S. dollar against foreign currencies raise the
U.S. dollar costs of goods manufactured by foreign rivals at plants located
in the countries whose currencies have grown stronger relative to the U.S.
dollar. A weaker dollar acts to reduce or eliminate whatever cost advantage
foreign manufacturers may have had over U.S. manufacturers (and helps
protect the manufacturing jobs of U.S. workers).
A weaker dollar makes foreign-made goods more expensive in dollar terms
to U.S. consumers—this curtails U.S. buyer demand for foreign-made
goods, stimulates greater demand on the part of U.S. consumers
for U.S.-made goods, and reduces U.S. imports of foreign-made
goods.
Fluctuating
exchange rates
pose significant
economic risks to a
company’s
competitiveness in
foreign markets.
Exporters are
disadvantaged when
the currency of the
country where
goods are being
manufactured grows
stronger relative to
the currency of the
importing country.
A weaker U.S. dollar enables the U.S.-made goods to be sold at lower
prices to consumers in countries whose currencies have grown stronger
relative to the U.S. dollar—such lower prices boost foreign buyer demand
for the now relatively cheaper U.S.-made goods, thereby stimulating
exports of U.S.-made goods to foreign countries and creating more jobs in
U.S.-based manufacturing plants.
A weaker dollar has the effect of increasing the dollar value of profits a
company earns in foreign-country markets where the local currency is
stronger relative to the dollar. For example, if a U.S.-based manufacturer
earns a profit of €10 million on its sales in Europe, those €10 million
convert to a larger number of dollars when the dollar grows weaker against
the euro.
A weaker U.S. dollar is therefore an economically favorable exchange rate
shift for manufacturing plants based in the United States. A decline in the
value of the U.S. dollar strengthens the cost-competitiveness of U.S.-based
manufacturing plants and boosts buyer demand for U.S.-made goods. When
the value of the U.S. dollar is expected to remain weak for some time to
come, foreign companies have an incentive to build manufacturing facilities
in the United States to make goods for U.S. consumers rather than export the
same goods to the United States from foreign plants where production costs
in dollar terms have been driven up by the decline in the value of the dollar.
Conversely, a stronger U.S. dollar is an unfavorable exchange rate shift for
U.S.-based manufacturing plants because it makes such plants less cost-
competitive with foreign plants and weakens foreign demand for U.S.-made
goods. A strong dollar also weakens the incentive of foreign companies to
locate manufacturing facilities in the United States to make goods for U.S.
consumers. The same reasoning applies to companies that have plants in
countries in the European Union where euros are the local currency. A weak
euro versus other currencies enhances the cost-competitiveness of companies
page 196
manufacturing goods in Europe vis-à-vis foreign rivals with plants in
countries whose currencies have grown stronger relative to the euro; a strong
euro versus other currencies weakens the cost-competitiveness of companies
with plants in the European Union.
Domestic
companies facing
competitive pressure
from lower-cost
imports benefit when
their government’s
currency grows
weaker in relation to
the currencies of the
countries where the
lower-cost imports
are being made.
Cross-Country Differences in Demographic,
Cultural, and Market Conditions
Buyer tastes for a particular product or service sometimes differ substantially
from country to country. In France, consumers prefer top-loading washing
machines, whereas in most other European countries consumers prefer front-
loading machines. People in Hong Kong prefer compact appliances, but in
Taiwan large appliances are more popular. Ice cream flavors like matcha,
black sesame, and red beans have more appeal to East Asian customers than
they have for customers in the United States and in Europe. Sometimes,
product designs suitable in one country are inappropriate in another because
of differing local standards—for example, in the United States electrical
devices run on 110-volt electric systems, but in some European countries the
standard is a 240-volt electric system, necessitating the use of different
electrical designs and components. Cultural influences can also affect
consumer demand for a product. For instance, in South Korea many parents
are reluctant to purchase PCs even when they can afford them because of
concerns that their children will be distracted from their schoolwork by
surfing the Web, playing PC-based video games, and becoming Internet
“addicts.”6
Consequently, companies operating in an international marketplace have to
wrestle with whether and how much to customize their offerings in each
country market to match local buyers’ tastes and preferences or whether to
pursue a strategy of offering a mostly standardized product worldwide. While
making products that are closely matched to local tastes makes them more
appealing to local buyers, customizing a company’s products country by
country may raise production and distribution costs due to the greater variety
of designs and components, shorter production runs, and the complications of
added inventory handling and distribution logistics. Greater standardization
of a global company’s product offering, on the other hand, can lead to scale
economies and learning-curve effects, thus reducing per-unit production costs
and contributing to the achievement of a low-cost advantage. The tension
between the market pressures to localize a company’s product offerings
country by country and the competitive pressures to lower costs is one of the
big strategic issues that participants in foreign markets have to resolve.
STRATEGIC OPTIONS FOR ENTERING
INTERNATIONAL MARKETS
• LO 7-3
Identify the
differences among
the five primary
modes of entry into
foreign markets.
Once a company decides to expand beyond its domestic borders, it must
consider the question of how to enter foreign markets. There are five primary
modes of entry to choose among:
1. Maintain a home-country production base and export goods to foreign
markets.
2. License foreign firms to produce and distribute the company’s products
abroad.
3. Employ a franchising strategy in foreign markets.
page 197
4. Establish a subsidiary in a foreign market via acquisition or internal
development.
5. Rely on strategic alliances or joint ventures with foreign companies.
Which mode of entry to employ depends on a variety of factors, including
the nature of the firm’s strategic objectives, the firm’s position in terms of
whether it has the full range of resources and capabilities needed to operate
abroad, country-specific factors such as trade barriers, and the transaction
costs involved (the costs of contracting with a partner and monitoring its
compliance with the terms of the contract, for example). The options vary
considerably regarding the level of investment required and the associated
risks—but higher levels of investment and risk generally provide the firm
with the benefits of greater ownership and control.
Export Strategies
Using domestic plants as a production base for exporting goods to foreign
markets is an excellent initial strategy for pursuing international sales. It is a
conservative way to test the international waters. The amount of capital
needed to begin exporting is often minimal; existing production capacity may
well be sufficient to make goods for export. With an export-based entry
strategy, a manufacturer can limit its involvement in foreign markets by
contracting with foreign wholesalers experienced in importing to handle the
entire distribution and marketing function in their countries or regions of the
world. If it is more advantageous to maintain control over these functions,
however, a manufacturer can establish its own distribution and sales
organizations in some or all of the target foreign markets. Either way, a
home-based production and export strategy helps the firm minimize
its direct investments in foreign countries. Such strategies are
commonly favored by Chinese, Korean, and Italian companies—products are
designed and manufactured at home and then distributed through local
channels in the importing countries. The primary functions performed abroad
relate chiefly to establishing a network of distributors and perhaps conducting
sales promotion and brand-awareness activities.
Whether an export strategy can be pursued successfully over the long run
depends on the relative cost-competitiveness of the home-country production
base. In some industries, firms gain additional scale economies and learning-
curve benefits from centralizing production in plants whose output capability
exceeds demand in any one country market; exporting enables a firm to
capture such economies. However, an export strategy is vulnerable when (1)
manufacturing costs in the home country are substantially higher than in
foreign countries where rivals have plants, (2) the costs of shipping the
product to distant foreign markets are relatively high, (3) adverse shifts occur
in currency exchange rates, and (4) importing countries impose tariffs or
erect other trade barriers. Unless an exporter can keep its production and
shipping costs competitive with rivals’ costs, secure adequate local
distribution and marketing support of its products, and effectively hedge
against unfavorable changes in currency exchange rates, its success will be
limited.
Licensing Strategies
Licensing as an entry strategy makes sense when a firm with valuable
technical know-how, an appealing brand, or a unique patented product has
neither the internal organizational capability nor the resources to enter
foreign markets. Licensing also has the advantage of avoiding the risks of
committing resources to country markets that are unfamiliar, politically
volatile, economically unstable, or otherwise risky. By licensing the
technology, trademark, or production rights to foreign-based firms, a
company can generate income from royalties while shifting the costs and
risks of entering foreign markets to the licensee. One downside of the
licensing alternative is that the partner who bears the risk is also likely to be
the biggest beneficiary from any upside gain. Disney learned this lesson
when it relied on licensing agreements to open its first foreign theme park,
Tokyo Disneyland. When the venture proved wildly successful, it was its
licensing partner, the Oriental Land Company, and not Disney who reaped
the windfall. Another disadvantage of licensing is the risk of providing
valuable technological know-how to foreign companies and thereby losing
some degree of control over its use; monitoring licensees and safeguarding
the company’s proprietary know-how can prove quite difficult in some
circumstances. But if the royalty potential is considerable and the companies
to which the licenses are being granted are trustworthy and reputable, then
licensing can be a very attractive option. Many software and pharmaceutical
companies use licensing strategies to participate in foreign markets.
page 198
Franchising Strategies
While licensing works well for manufacturers and owners of proprietary
technology, franchising is often better suited to the international expansion
efforts of service and retailing enterprises. McDonald’s, Yum! Brands (the
parent of Pizza Hut, KFC, Taco Bell, and WingStreet), the UPS Store, Roto-
Rooter, 7-Eleven, and Hilton Hotels have all used franchising to build a
presence in foreign markets. Franchising has many of the same advantages as
licensing. The franchisee bears most of the costs and risks of
establishing foreign locations; a franchisor has to expend only the
resources to recruit, train, support, and monitor franchisees. The big problem
a franchisor faces is maintaining quality control; foreign franchisees do not
always exhibit strong commitment to consistency and standardization,
especially when the local culture does not stress the same kinds of quality
concerns. A question that can arise is whether to allow foreign franchisees to
make modifications in the franchisor’s product offering so as to better satisfy
the tastes and expectations of local buyers. Should McDonald’s give
franchisees in each nation some leeway in what products they put on their
menus? Should franchised KFC units in China be permitted to substitute
spices that appeal to Chinese consumers? Or should the same menu offerings
be rigorously and unvaryingly required of all franchisees worldwide?
Foreign Subsidiary Strategies
Very often companies electing to compete internationally prefer to have
direct control over all aspects of operating in a foreign market. Companies
that want to participate in direct performance of all essential value chain
activities typically establish a wholly owned subsidiary, either by acquiring a
local company or by establishing its own new operating organization from
the ground up. A subsidiary business that is established internally from
scratch is called an internal startup or a greenfield venture.
CORE
CONCEPT
A greenfield
venture (or internal
startup) is a
subsidiary business
that is established
by setting up the
entire operation from
the ground up.
Acquiring a local business is the quicker of the two options; it may be the
least risky and most cost-efficient means of hurdling such entry barriers as
gaining access to local distribution channels, building supplier relationships,
and establishing working relationships with government officials and other
key constituencies. Buying an ongoing operation allows the acquirer to move
directly to the task of transferring resources and personnel to the newly
acquired business, redirecting and integrating the activities of the acquired
business into its own operation, putting its own strategy into place, and
accelerating efforts to build a strong market position.
One thing an acquisition-minded firm must consider is whether to pay a
premium price for a successful local company or to buy a struggling
competitor at a bargain price. If the buying firm has little knowledge of the
local market but ample capital, it is often better off purchasing a capable,
strongly positioned firm. However, when the acquirer sees promising ways to
transform a weak firm into a strong one and has the resources and managerial
know-how to do so, a struggling company can be the better long-term
investment.
Entering a new foreign country via a greenfield venture makes sense when
a company already operates in a number of countries, has experience in
establishing new subsidiaries and overseeing their operations, and has a
sufficiently large pool of resources and capabilities to rapidly equip a new
subsidiary with the personnel and what it needs otherwise to compete
successfully and profitably. Four more conditions combine to make a
greenfield venture strategy appealing:
When creating an internal startup is cheaper than making an acquisition.
When adding new production capacity will not adversely impact the
supply–demand balance in the local market.
When a startup subsidiary has the ability to gain good distribution access
(perhaps because of the company’s recognized brand name).
When a startup subsidiary will have the size, cost structure, and capabilities
to compete head-to-head against local rivals.
page 199
Greenfield ventures in foreign markets can also pose
problems, just as other entry strategies do. They represent a costly capital
investment, subject to a high level of risk. They require numerous other
company resources as well, diverting them from other uses. They do not
work well in countries without strong, well-functioning markets and
institutions that protect the rights of foreign investors and provide other legal
protections. Moreover, an important disadvantage of greenfield ventures
relative to other means of international expansion is that they are the slowest
entry route—particularly if the objective is to achieve a sizable market share.
On the other hand, successful greenfield ventures may offer higher returns to
compensate for their high risk and slower path.
Collaborative
strategies involving
alliances or joint
ventures with foreign
partners are a
popular way for
companies to edge
their way into the
markets of foreign
countries.
Alliance and Joint Venture Strategies
Strategic alliances, joint ventures, and other cooperative agreements with
foreign companies are a widely used means of entering foreign markets.7 A
company can benefit immensely from a foreign partner’s familiarity with
local government regulations, its knowledge of the buying habits and product
preferences of consumers, its distribution-channel relationships, and so on.8
Both Japanese and American companies are actively forming alliances with
European companies to better compete in the 28-nation European Union (and
the five countries that are candidates to become EU members). Many U.S.
and European companies are allying with Asian companies in their efforts to
enter markets in China, India, Thailand, Indonesia, and other Asian countries.
Another reason for cross-border alliances is to capture economies of scale
in production and/or marketing. By joining forces in producing components,
assembling models, and marketing their products, companies can realize cost
savings not achievable with their own small volumes. A third reason to
employ a collaborative strategy is to share distribution facilities and dealer
networks, thus mutually strengthening each partner’s access to buyers. A
fourth benefit of a collaborative strategy is the learning and added expertise
that comes from performing joint research, sharing technological know-how,
studying one another’s manufacturing methods, and understanding how to
tailor sales and marketing approaches to fit local cultures and traditions. A
fifth benefit is that cross-border allies can direct their competitive energies
more toward mutual rivals and less toward one another; teaming up may help
them close the gap on leading companies. And, finally, alliances can be a
particularly useful way for companies across the world to gain agreement on
important technical standards—they have been used to arrive at standards for
assorted PC devices, Internet-related technologies, high-definition
televisions, and mobile phones.
Cross-border
alliances enable a
growth-minded
company to widen
its geographic
coverage and
strengthen its
competitiveness in
foreign markets; at
the same time, they
offer flexibility and
allow a company to
retain some degree
of autonomy and
operating control.
Cross-border alliances are an attractive means of gaining the
aforementioned types of benefits (as compared to merging with or acquiring
foreign-based companies) because they allow a company to preserve its
independence (which is not the case with a merger) and avoid using scarce
financial resources to fund acquisitions. Furthermore, an alliance offers the
flexibility to readily disengage once its purpose has been served or if the
benefits prove elusive, whereas mergers and acquisitions are more permanent
arrangements.9
page 200
Alliances may also be used to pave the way for an intended merger; they
offer a way to test the value and viability of a cooperative arrangement with a
foreign partner before making a more permanent commitment. Illustration
Capsule 7.1 shows how Walgreens pursued this strategy with Alliance Boots
in order to facilitate its expansion abroad.
ILLUSTRATION
CAPSULE 7.1 Walgreens Boots Alliance,
Inc.: Entering Foreign Markets via Alliance
Followed by Merger
Walgreens pharmacy began in 1901 as a single store on the South Side of Chicago and
grew to become the largest chain of pharmacy retailers in America. Walgreens was an
early pioneer of the “self-service” pharmacy and found success by moving quickly to build
a vast domestic network of stores after the Second World War. This growth-focused
strategy served Walgreens well up until the beginning of the 21st century, by which time it
had nearly saturated the U.S. market. By 2014, 75 percent of Americans lived within five
miles of a Walgreens. The company was also facing threats to its core business model.
Walgreens relies heavily on pharmacy sales, which generally are paid for by someone
other than the patient, usually the government or an insurance company. As the
government and insurers started to make a more sustained effort to cut costs,
Walgreens’s core profit center was at risk. To mitigate these threats, Walgreens looked to
enter foreign markets.
Walgreens found an ideal international partner in Alliance Boots. Based in the UK,
Alliance Boots had a global footprint with 3,300 stores across 10 countries. A partnership
with Alliance Boots had several strategic advantages, allowing Walgreens to gain swift
entry into foreign markets as well as complementary assets and expertise. First, it gave
Walgreens access to new markets beyond the saturated United States for its retail
pharmacies. Second, it provided Walgreens with a new revenue stream in wholesale
drugs. Alliance Boots held a vast European distribution network for wholesale drug sales;
Walgreens could leverage that network and expertise to build a similar model in the
United States. Finally, a merger with Alliance Boots would strengthen Walgreens’s
existing business by increasing the company’s market position and therefore bargaining
power with drug companies. In light of these advantages, Walgreens moved quickly to
partner with and later acquire Alliance Boots and merged both companies in 2014 to
become Walgreens Boots Alliance. Walgreens Boots Alliance, Inc. is now one of the
world’s largest drug purchasers, able to negotiate from a strong position with drug
companies and other suppliers to realize economies of scale in its current businesses.
page 201
Jonathan Weiss/Shutterstock
The market has thus far responded favorably to the merger. Walgreens Boots
Alliance’s stock has more than doubled in value since the first news of the partnership in
2012. However, the company is still struggling to integrate and faces new risks such as
currency fluctuation in its new combined position. Yet as the pharmaceutical industry
continues to consolidate, Walgreens is in an undoubtedly stronger position to continue to
grow in the future thanks to its strategic international acquisition.
Note: Developed with Katherine Coster.
Sources: Company 10-K Form, 2015,
investor.walgreensbootsalliance.com/secfiling.cfm?filingID=1140361-15-
38791&CIK=1618921; L. Capron and W. Mitchell, “When to Change a Winning Strategy,”
Harvard Business Review, July 25, 2012, hbr.org/2012/07/when-to-change-a-winning-
strat; T. Martin and R. Dezember, “Walgreen Spends $6.7 Billion on Alliance Boots
Stake,” The Wall Street Journal, June 20, 2012.
The Risks of Strategic Alliances with Foreign Partners Alliances and
joint ventures with foreign partners have their pitfalls, however. Sometimes a
local partner’s knowledge and expertise turns out to be less valuable than
expected (because its knowledge is rendered obsolete by fast-changing
market conditions or because its operating practices are archaic). Cross-
border allies typically must overcome language and cultural barriers and
figure out how to deal with diverse (or conflicting) operating practices. The
transaction costs of working out a mutually agreeable arrangement and
monitoring partner compliance with the terms of the arrangement
http://investor.walgreensbootsalliance.com/secfiling.cfm?filingID=1140361-15-38791&CIK=1618921;
http://hbr.org/2012/07/when-to-change-a-winning-strat
can be high. The communication, trust building, and coordination costs are
not trivial in terms of management time.10 Often, partners soon discover they
have conflicting objectives and strategies, deep differences of opinion about
how to proceed, or important differences in corporate values and ethical
standards. Tensions build, working relationships cool, and the hoped-for
benefits never materialize.11 It is not unusual for there to be little personal
chemistry among some of the key people on whom the success or failure of
the alliance depends—the rapport such personnel need to work well together
may never emerge. And even if allies are able to develop productive personal
relationships, they can still have trouble reaching mutually agreeable ways to
deal with key issues or launching new initiatives fast enough to stay abreast
of rapid advances in technology or shifting market conditions.
One worrisome problem with alliances or joint ventures is that a firm may
risk losing some of its competitive advantage if an alliance partner is given
full access to its proprietary technological expertise or other competitively
valuable capabilities. There is a natural tendency for allies to struggle to
collaborate effectively in competitively sensitive areas, thus spawning
suspicions on both sides about forthright exchanges of information and
expertise. It requires many meetings of many people working in good faith
over a period of time to iron out what is to be shared, what is to remain
proprietary, and how the cooperative arrangements will work.
Even if the alliance proves to be a win–win proposition for both parties,
there is the danger of becoming overly dependent on foreign partners for
essential expertise and competitive capabilities. Companies aiming for global
market leadership need to develop their own resources and capabilities in
order to be masters of their destiny. Frequently, experienced international
companies operating in 50 or more countries across the world find less need
for entering into cross-border alliances than do companies in the early stages
of globalizing their operations.12 Companies with global operations make it a
point to develop senior managers who understand how “the system” works in
different countries, plus they can avail themselves of local managerial talent
and know-how by simply hiring experienced local managers and thereby
detouring the hazards of collaborative alliances with local companies. One of
the lessons about cross-border partnerships is that they are more effective in
helping a company establish a beachhead of new opportunity in world
markets than they are in enabling a company to achieve and sustain global
market leadership.
INTERNATIONAL STRATEGY: THE
THREE MAIN APPROACHES
Broadly speaking, a firm’s international strategy is simply its strategy for
competing in two or more countries simultaneously. Typically, a company
will start to compete internationally by entering one or perhaps a select few
foreign markets—selling its products or services in countries where there is a
ready market for them. But as it expands further internationally, it will have
to confront head-on two conflicting pressures: the demand for responsiveness
to local needs versus the prospect of efficiency gains from offering a
standardized product globally. Deciding on the competitive approach to best
address these competing pressures is perhaps the foremost strategic issue that
must be addressed when a company is operating in two or more foreign
markets.13 Figure 7.2 shows a company’s three options for resolving this
issue: choosing a multidomestic, global, or transnational strategy.
• LO 7-4
Identify the three
main strategic
approaches for
competing
internationally.
CORE
CONCEPT
An international
strategy is a
strategy for
competing in two or
more countries
simultaneously.
page 202
FIGURE 7.2 Three Approaches for Competing Internationally
Multidomestic Strategies—a “Think-Local, Act-
Local” Approach
A multidomestic strategy is one in which a company varies its product
offering and competitive approach from country to country in an effort to
meet differing buyer needs and to address divergent local-market conditions.
It involves having plants produce different product versions for different local
markets and adapting marketing and distribution to fit local customs,
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cultures, regulations, and market requirements. In the food products industry,
it is common for companies to vary the ingredients in their products and sell
the localized versions under local brand names to cater to country-specific
tastes and eating preferences. Government requirements for gasoline
additives that help reduce carbon monoxide, smog, and other emissions are
almost never the same from country to country. BP utilizes localized
strategies in its gasoline and service station business segment because of
these cross-country formulation differences and because of customer
familiarity with local brand names. For example, the company markets
gasoline in the United States under its BP and Arco brands, but markets
gasoline in Germany, Belgium, Poland, Hungary, and the Czech Republic
under the Aral brand. Castrol, a BP-owned specialist in oil lubricants,
produces over 3,000 different formulas of lubricants to meet the
requirements of different climates, vehicle types and uses, and
equipment applications that characterize different country markets.
In essence, a multidomestic strategy represents a think-local, act-local
approach to international strategy. A think-local, act-local approach to
strategy making is most appropriate when the need for local responsiveness is
high due to significant cross-country differences in demographic, cultural,
and market conditions and when the potential for efficiency gains from
standardization is limited, as depicted in Figure 7.2. A think-local, act-local
approach is possible only when decision making is decentralized, giving local
managers considerable latitude for crafting and executing strategies for the
country markets they are responsible for. Giving local managers decision-
making authority allows them to address specific market needs and respond
swiftly to local changes in demand. It also enables them to focus their
competitive efforts, stake out attractive market positions vis-à-vis local
competitors, react to rivals’ moves in a timely fashion, and target new
opportunities as they emerge.14
CORE
CONCEPT
A multidomestic
strategy is one in
which a company
varies its product
offering and
competitive
approach from
country to country in
an effort to be
responsive to
differing buyer
preferences and
market conditions. It
is a think-local, act-
local type of
international
strategy, facilitated
by decision making
decentralized to the
local level.
Despite their obvious benefits, think-local, act-local strategies have three
big drawbacks:
1. They hinder transfer of a company’s capabilities, knowledge, and other
resources across country boundaries, since the company’s efforts are not
integrated or coordinated across country boundaries. This can make the
company less innovative overall.
2. They raise production and distribution costs due to the greater variety of
designs and components, shorter production runs for each product version,
and complications of added inventory handling and distribution logistics.
3. They are not conducive to building a single, worldwide competitive
advantage. When a company’s competitive approach and product offering
vary from country to country, the nature and size of any resulting
competitive edge also tends to vary. At the most, multidomestic strategies
are capable of producing a group of local competitive advantages of
varying types and degrees of strength.
Global Strategies—a “Think-Global, Act-Global”
Approach
A global strategy contrasts sharply with a multidomestic strategy in that it
takes a standardized, globally integrated approach to producing, packaging,
selling, and delivering the company’s products and services worldwide.
Companies employing a global strategy sell the same products under the
page 204
same brand names everywhere, utilize much the same distribution channels in
all countries, and compete on the basis of the same capabilities and marketing
approaches worldwide. Although the company’s strategy or product offering
may be adapted in minor ways to accommodate specific situations in a few
host countries, the company’s fundamental competitive approach (low cost,
differentiation, best cost, or focused) remains very much intact worldwide
and local managers stick close to the global strategy.
A think-global, act-global approach prompts company managers to
integrate and coordinate the company’s strategic moves worldwide and to
expand into most, if not all, nations where there is significant buyer demand.
It puts considerable strategic emphasis on building a global brand name and
aggressively pursuing opportunities to transfer ideas, new products, and
capabilities from one country to another. Global strategies are characterized
by relatively centralized value chain activities, such as production and
distribution. While there may be more than one manufacturing plant and
distribution center to minimize transportation costs, for example, they tend to
be few in number. Achieving the efficiency potential of a global
strategy requires that resources and best practices be shared,
value chain activities be integrated, and capabilities be transferred from one
location to another as they are developed. These objectives are best facilitated
through centralized decision making and strong headquarters control.
CORE
CONCEPT
A global strategy is
one in which a
company employs
the same basic
competitive
approach in all
countries where it
operates, sells
standardized
products globally,
strives to build
global brands, and
coordinates its
actions worldwide
with strong
headquarters
control. It represents
a think-global, act-
global approach.
Because a global strategy cannot accommodate varying local needs, it is an
appropriate strategic choice when there are pronounced efficiency benefits
from standardization and when buyer needs are relatively homogeneous
across countries and regions. A globally standardized and integrated
approach is especially beneficial when high volumes significantly lower costs
due to economies of scale or added experience (moving the company further
down a learning curve). It can also be advantageous if it allows the firm to
replicate a successful business model on a global basis efficiently or engage
in higher levels of R&D by spreading the fixed costs and risks over a higher-
volume output. It is a fitting response to industry conditions marked by
global competition.
Consumer electronics companies such as Apple, Nokia, and Motorola
Mobility tend to employ global strategies. The development of universal
standards in technology is one factor supporting the use of global strategies.
So is the rise of global accounting and financial reporting standards.
Whenever country-to-country differences are small enough to be
accommodated within the framework of a global strategy, a global strategy is
preferable because a company can more readily unify its operations and focus
on establishing a brand image and reputation that are uniform from country to
country. Moreover, with a global strategy a company is better able to focus its
full resources on securing a sustainable low-cost or differentiation-based
competitive advantage over both domestic rivals and global rivals.
There are, however, several drawbacks to global strategies: (1) They do not
enable firms to address local needs as precisely as locally based rivals can;
(2) they are less responsive to changes in local market conditions, in the form
of either new opportunities or competitive threats; (3) they raise
transportation costs and may involve higher tariffs; and (4) they involve
higher coordination costs due to the more complex task of managing a
globally integrated enterprise.
Transnational Strategies—a “Think-Global, Act-
Local” Approach
page 205
A transnational strategy (sometimes called glocalization) incorporates
elements of both a globalized and a localized approach to strategy making.
This type of middle-ground strategy is called for when there are relatively
high needs for local responsiveness as well as appreciable benefits to be
realized from standardization, as Figure 7.2 suggests. A transnational strategy
encourages a company to use a think-global, act-local approach to balance
these competing objectives.
CORE
CONCEPT
transnational
strategy is a think-
global, act-local
approach that
incorporates
elements of both
multidomestic and
global strategies.
Often, companies implement a transnational strategy with mass-
customization techniques that enable them to address local preferences in an
efficient, semi-standardized manner. McDonald’s, KFC, and Starbucks have
discovered ways to customize their menu offerings in various countries
without compromising costs, product quality, and operating effectiveness.
Unilever is responsive to local market needs regarding its consumer products,
while realizing global economies of scale in certain functions. Otis Elevator
found that a transnational strategy delivers better results than a global
strategy when it is competing in countries like China, where local needs are
highly differentiated. By switching from its customary single-brand approach
to a multibrand strategy aimed at serving different segments of the market,
Otis was able to double its market share in China and increased its revenues
sixfold over a nine-year period.15
As a rule, most companies that operate internationally
endeavor to employ as global a strategy as customer needs and market
conditions permit. Electronic Arts (EA) has two major design studios—one
in Vancouver, British Columbia, and one in Los Angeles—and smaller design
studios in locations including San Francisco, Orlando, London, and Tokyo.
page 206
This dispersion of design studios helps EA design games that are specific to
different cultures—for example, the London studio took the lead in designing
the popular FIFA Soccer game to suit European tastes and to replicate the
stadiums, signage, and team rosters; the U.S. studio took the lead in
designing games involving NFL football, NBA basketball, and NASCAR
racing.
A transnational strategy is far more conducive than other strategies to
transferring and leveraging subsidiary skills and capabilities. But, like other
approaches to competing internationally, transnational strategies also have
significant drawbacks:
1. They are the most difficult of all international strategies to implement due
to the added complexity of varying the elements of the strategy to
situational conditions.
2. They place large demands on the organization due to the need to pursue
conflicting objectives simultaneously.
3. Implementing the strategy is likely to be a costly and time-consuming
enterprise, with an uncertain outcome.
Illustration Capsule 7.2 explains how Four Seasons Hotels has been able to
compete successfully on the basis of a transnational strategy.
Table 7.1 provides a summary of the pluses and minuses of the three
approaches to competing internationally.
TABLE 7.1 Advantages and Disadvantages of
Multidomestic, Global, and Transnational Strategies
Advantages Disadvantages
Multidomestic
(think local, act
local)
Can meet the specific needs
of each market more
precisely
Can respond more swiftly to
localized changes in demand
Can target reactions to the
moves of local rivals
Can respond more quickly to
local opportunities and
threats
Hinders resource and
capability sharing or cross-
market transfers
Has higher production and
distribution costs
Is not conducive to a
worldwide competitive
advantage
Advantages Disadvantages
Global (think
global, act
global)
Has lower costs due to scale
and scope economies
Can lead to greater
efficiencies due to the ability
to transfer best practices
across markets
Increases innovation from
knowledge sharing and
capability transfer
Offers the benefit of a global
brand and reputation
Cannot address local needs
precisely
Is less responsive to
changes in local market
conditions
Involves higher
transportation costs and
tariffs
Has higher coordination and
integration costs
Transnational
(think global,
act local)
Offers the benefits of both
local responsiveness and
global integration
Enables the transfer and
sharing of resources and
capabilities across borders
Provides the benefits of
flexible coordination
Is more complex and harder
to implement
Entails conflicting goals,
which may be difficult to
reconcile and require trade-
offs
Involves more costly and
time-consuming
implementation
ILLUSTRATION
CAPSULE 7.2 Four Seasons Hotels: Local
Character, Global Service
Four Seasons Hotels is a Toronto, Canada–based manager of luxury hotel properties.
With more than 100 properties located in many of the world’s most popular tourist
destinations and business centers, Four Seasons commands a following of many of the
world’s most discerning travelers. In contrast to its key competitor, Ritz-Carlton, which
strives to create one uniform experience globally, Four Seasons Hotels has gained
market share by deftly combining local architectural and cultural experiences with globally
consistent luxury service.
When moving into a new market, Four Seasons always seeks out a local capital
partner. The understanding of local custom and business relationships this financier
brings is critical to the process of developing a new Four Seasons hotel. Four Seasons
also insists on hiring a local architect and design consultant for each property, as
opposed to using architects or designers it’s worked with in other locations. While this
can be a challenge, particularly in emerging markets, Four Seasons has found it is worth
it in the long run to have a truly local team.
The specific layout and programming of each hotel is also unique. For instance, when
Four Seasons opened its hotel in Mumbai, India, it prioritized space for large banquet
halls to target the Indian wedding market. In India, weddings often draw guests
numbering in the thousands. When moving into the Middle East, Four Seasons designed
its hotels with separate prayer rooms for men and women. In Bali, where destination
weddings are common, the hotel employs a “weather shaman” who, for some guests,
provides reassurance that the weather will cooperate for their special day. In all cases,
the objective is to provide a truly local experience.
When staffing its hotels, Four Seasons seeks to strike a fine balance between
employing locals who have an innate understanding of the local culture alongside
expatriate staff or “culture carriers” who understand the DNA of Four Seasons. It also
uses global systems to track customer preferences and employs globally consistent
service standards. Four Seasons claims that its guests experience the same high level of
service globally but that no two experiences are the same.
Chris Lawrence/Alamy Stock Photo
While it is much more expensive and time-consuming to design unique architectural
and programming experiences, doing so is a strategic trade-off Four Seasons has made
to achieve the local experience demanded by its high-level clientele. Likewise, it has
recognized that maintaining globally consistent operation processes and service
standards is important too. Four Seasons has struck the right balance between thinking
globally and acting locally—the marker of a truly transnational strategy. As a result, the
company has been rewarded with an international reputation for superior service and a
leading market share in the luxury hospitality segment.
Note: Developed with Brian R. McKenzie.
page 207
Sources: Four Seasons annual report and corporate website; interview with Scott
Woroch, executive vice president of development, Four Seasons Hotels, February 22,
2014.
INTERNATIONAL OPERATIONS AND
THE QUEST FOR COMPETITIVE
ADVANTAGE
There are three important ways in which a firm can gain competitive
advantage (or offset domestic disadvantages) by expanding outside its
domestic market. First, it can use location to lower costs or achieve greater
product differentiation. Second, it can transfer competitively valuable
resources and capabilities from one country to another or share
them across international borders to extend its competitive
advantages. And third, it can benefit from cross-border coordination
opportunities that are not open to domestic-only competitors.
• LO 7-5
Explain how
companies are able
to use international
operations to
improve overall
competitiveness.
Using Location to Build Competitive Advantage
To use location to build competitive advantage, a company must consider two
issues: (1) whether or not to concentrate some of the activities it performs in
only a few select countries of those in which they operate and if so (2) in
which countries to locate particular activities.
Companies that
compete
internationally can
pursue competitive
advantage in world
markets by locating
their value chain
activities in whatever
nations prove most
advantageous.
When to Concentrate Activities in a Few Locations It is advantageous
for a company to concentrate its activities in a limited number of locations
when
The costs of manufacturing or other activities are significantly lower in
some geographic locations than in others. For example, much of the
world’s athletic footwear is manufactured in Asia (China, Vietnam, and
Indonesia) because of low labor costs; much of the production of circuit
boards for PCs is located in Taiwan because of both low costs and the high-
caliber technical skills of the Taiwanese labor force.
Significant scale economies exist in production or distribution. The
presence of significant economies of scale in components production or
final assembly means that a company can gain major cost savings from
operating a few super-efficient plants as opposed to a host of small plants
scattered across the world. Makers of digital cameras and LED TVs located
in Japan, South Korea, and Taiwan have used their scale economies to
establish a low-cost advantage in this way. Achieving low-cost leadership
status often requires a company to have the largest worldwide
manufacturing share (as distinct from brand share or market share), with
production centralized in one or a few giant plants. Some companies even
use such plants to manufacture units sold under the brand names of rivals
to further boost production-related scale economies. Likewise, a company
may be able to reduce its distribution costs by establishing large-scale
distribution centers to serve major geographic regions of the world market
(e.g., North America, Latin America, Europe and the Middle East, and the
Asia-Pacific region).
Sizable learning and experience benefits are associated with performing an
activity. In some industries, learning-curve effects can allow a manufacturer
to lower unit costs, boost quality, or master a new technology more quickly
by concentrating production in a few locations. The key to riding down the
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learning curve is to concentrate production in a few locations to increase
the cumulative volume at a plant (and thus the experience of the plant’s
workforce) as rapidly as possible.
Certain locations have superior resources, allow better coordination of
related activities, or offer other valuable advantages. Companies often
locate a research unit or a sophisticated production facility in a particular
country to take advantage of its pool of technically trained personnel.
Adidas located its first robotic “speedfactory” in Germany to benefit from
its superior technological resources and to allow greater oversight from the
company’s headquarters (which are in Germany). Where just-in-time
inventory practices yield big cost savings and/or where an assembly firm
has long-term partnering arrangements with its key suppliers, parts
manufacturing plants may be clustered around final-assembly plants. A
customer service center or sales office may be opened in a particular
country to help cultivate strong relationships with pivotal customers
located nearby. Airbus established a major assembly site for their
commercial aircraft in Alabama since the United States is a major market.
When to Disperse Activities across Many Locations In some instances,
dispersing activities across locations is more advantageous than concentrating
them. Buyer-related activities—such as distribution, marketing, and after-sale
service—usually must take place close to buyers. This makes it necessary to
physically locate the capability to perform such activities in every country or
region where a firm has major customers. For example, firms that make
mining and oil-drilling equipment maintain operations in many locations
around the world to support customers’ needs for speedy equipment repair
and technical assistance. Large public accounting firms have offices in
numerous countries to serve the foreign operations of their international
corporate clients. Dispersing activities to many locations is also
competitively important when high transportation costs, diseconomies of
large size, and trade barriers make it too expensive to operate from a central
location. Many companies distribute their products from multiple locations to
shorten delivery times to customers. In addition, dispersing activities helps
hedge against the risks of fluctuating exchange rates, supply interruptions
(due to strikes, natural disasters, or transportation delays), and adverse
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political developments. Such risks are usually greater when activities are
concentrated in a single location.
Even though global firms have strong reason to disperse buyer-related
activities to many international locations, such activities as materials
procurement, parts manufacture, finished-goods assembly, technology
research, and new product development can frequently be decoupled from
buyer locations and performed wherever advantage lies. Components can be
made in Mexico; technology research done in Frankfurt; new products
developed and tested in Phoenix; and assembly plants located in Spain,
Brazil, Taiwan, or South Carolina, for example. Capital can be raised
wherever it is available on the best terms.
Sharing and Transferring Resources and
Capabilities across Borders to Build Competitive
Advantage
When a company has competitively valuable resources and capabilities, it
may be able to leverage them further by expanding internationally. If its
resources retain their value in foreign contexts, then entering new foreign
markets can extend the company’s resource-based competitive advantage
over a broader domain. For example, companies like Tiffany, Cartier, and
Rolex have utilized their powerful brand names to extend their
differentiation-based competitive advantages into markets far beyond their
home-country origins. In each of these cases, the luxury brand name
represents a valuable competitive asset that can readily be shared by all of the
company’s international stores, enabling them to attract buyers and gain a
higher degree of market penetration over a wider geographic area than would
otherwise be possible.
Another way for a company to extend its competitive advantage
internationally is to transfer technological know-how or other important
resources and capabilities from its operations in one country to its operations
in other countries. For instance, if a company discovers ways to assemble a
product faster and more cost-effectively at one plant, then that know-how can
be transferred to its assembly plants in other countries. Whirlpool’s efforts to
link its product R&D and manufacturing operations in North America, Latin
America, Europe, and Asia allowed it to accelerate the discovery
of innovative appliance features, coordinate the introduction of these features
in the appliance products marketed in different countries, and create a cost-
efficient worldwide supply chain. Whirlpool’s conscious efforts to integrate
and coordinate its various operations around the world have helped it achieve
operational excellence and speed product innovations to market. Walmart is
expanding its international operations with a strategy that involves
transferring its considerable resource capabilities in distribution and discount
retailing to its retail units in 28 foreign countries.
Cross-border sharing or transferring resources and capabilities provides a
cost-effective way for a company to leverage its core competencies more
fully and extend its competitive advantages into a wider array of geographic
markets. The cost of sharing or transferring already developed resources and
capabilities across country borders is low in comparison to the time and
considerable expense it takes to create them. Moreover, deploying them
abroad spreads the fixed development costs over a greater volume of unit
sales, thus contributing to low unit costs and a potential cost-based
competitive advantage in recently entered geographic markets. Even if the
shared or transferred resources or capabilities have to be adapted to local-
market conditions, this can usually be done at low additional cost.
Consider the case of Walt Disney’s theme parks as an example. The
success of the theme parks in the United States derives in part from core
resources such as the Disney brand name and characters like Mickey Mouse
that have universal appeal and worldwide recognition. These resources can be
freely shared with new theme parks as Disney expands internationally.
Disney can also replicate its theme parks in new countries cost-effectively
since it has already borne the costs of developing its core resources, park
attractions, basic park design, and operating capabilities. The cost of
replicating its theme parks abroad is relatively low, even if the parks need to
be adapted to a variety of local country conditions. Thus, in establishing
Disney parks in Tokyo, Paris, Hong Kong, and Shanghai, Disney has been
able to leverage the differentiation advantage conferred by resources such as
the Disney name and the park attractions. And by moving into new foreign
markets, it has augmented its competitive advantage further through the
efficiency gains that come from cross-border resource sharing and low-cost
capability transfer and business model replication.
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Sharing and transferring resources and capabilities across country borders
may also contribute to the development of broader or deeper competencies
and capabilities—helping a company achieve dominating depth in some
competitively valuable area. For example, the reputation for quality that
Honda established worldwide began in motorcycles but enabled the company
to command a position in both automobiles and outdoor power equipment in
multiple-country markets. A one-country customer base is often too small to
support the resource buildup needed to achieve such depth; this is particularly
true in a developing or protected market, where competitively powerful
resources are not required. By deploying capabilities across a larger
international domain, a company can gain the experience needed to upgrade
them to a higher performance standard. And by facing a more challenging set
of international competitors, a company may be spurred to develop a stronger
set of competitive capabilities. Moreover, by entering international markets,
firms may be able to augment their capability set by learning from
international rivals, cooperative partners, or acquisition targets.
However, cross-border resource sharing and transfers of capabilities are
not guaranteed recipes for competitive success. For example, whether a
resource or capability can confer a competitive advantage abroad
depends on the conditions of rivalry in each particular market. If
the rivals in a foreign-country market have superior resources and
capabilities, then an entering firm may find itself at a competitive
disadvantage even if it has a resource-based advantage domestically and can
transfer the resources at low cost. In addition, since lifestyles and buying
habits differ internationally, resources and capabilities that are valuable in
one country may not have value in another. Sometimes a popular or well-
regarded brand in one country turns out to have little competitive clout
against local brands in other countries.
Benefiting from Cross-Border Coordination
Companies that compete on an international basis have another source of
competitive advantage relative to their purely domestic rivals: They are able
to benefit from coordinating activities across different countries’ domains.16
For example, an international manufacturer can shift production from a plant
in one country to a plant in another to take advantage of exchange rate
fluctuations, to cope with components shortages, or to profit from changing
wage rates or energy costs. Production schedules can be coordinated
worldwide; shipments can be diverted from one distribution center to another
if sales rise unexpectedly in one place and fall in another. By coordinating
their activities, international companies may also be able to enhance their
leverage with host-country governments or respond adaptively to changes in
tariffs and quotas. Efficiencies can also be achieved by shifting workloads
from where they are unusually heavy to locations where personnel are
underutilized.
CROSS-BORDER STRATEGIC MOVES
While international competitors can employ any of the offensive and
defensive moves discussed in Chapter 6, there are two types of strategic
moves that are particularly suited for companies competing internationally.
The first is an offensive move that an international competitor is uniquely
positioned to make, due to the fact that it may have a strong or protected
market position in more than one country. The second type of move is a type
of defensive action involving multiple markets.
Waging a Strategic Offensive
One advantage to being an international competitor is the possibility of
having more than one significant and possibly protected source of profits.
This may provide the company with the financial strength to engage in
strategic offensives in selected country markets. The added financial
capability afforded by multiple profit sources gives an international
competitor the financial strength to wage an offensive campaign against a
domestic competitor whose only source of profit is its home market. The
international company has the flexibility of lowballing its prices or launching
high-cost marketing campaigns in the domestic company’s home market and
grabbing market share at the domestic company’s expense. Razor-thin
margins or even losses in these markets can be subsidized with the healthy
profits earned in its markets abroad—a practice called cross-market
subsidization.
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CORE
CONCEPT
Cross-market
subsidization—
supporting
competitive
offensives in one
market with
resources and
profits diverted from
operations in
another market—
can be a powerful
competitive weapon.
The international company can adjust the depth of its price
cutting to move in and capture market share quickly, or it can shave prices
slightly to make gradual market inroads (perhaps over a decade or more) so
as not to threaten domestic firms precipitously and trigger protectionist
government actions. If the domestic company retaliates with matching price
cuts or increased marketing expenses, it thereby exposes its entire revenue
stream and profit base to erosion; its profits can be squeezed substantially and
its competitive strength sapped, even if it is the domestic market leader.
A company is said to
be dumping when it
sells its goods in
foreign markets at
prices that are
1. well below the
prices at which it
normally sells
them in its home
market or
2. well below its full
costs per unit.
When taken to the extreme, cut-rate pricing attacks by international
competitors may draw charges of unfair “dumping.” A company is said to be
dumping when it sells its goods in foreign markets at prices that are (1) well
below the prices at which it normally sells them in its home market or (2)
well below its full costs per unit. Almost all governments can be expected to
retaliate against perceived dumping practices by imposing special tariffs on
goods being imported from the countries of the guilty companies. Indeed, as
the trade among nations has mushroomed over the past 10 years, most
governments have joined the World Trade Organization (WTO), which
promotes fair trade practices among nations and actively polices dumping.
Companies deemed guilty of dumping frequently come under pressure from
their own government to cease and desist, especially if the tariffs adversely
affect innocent companies based in the same country or if the advent of
special tariffs raises the specter of an international trade war.
Defending against International Rivals
Cross-border tactics involving multiple country markets can also be used as a
means of defending against the strategic moves of rivals with multiple
profitable markets of their own. If a company finds itself under competitive
attack by an international rival in one country market, one way to respond is
to conduct a counterattack against the rival in one of its key markets in a
different country—preferably where the rival is least protected and has the
most to lose. This is a possible option when rivals compete against one
another in much the same markets around the world and engage in
multimarket competition.
For companies with at least one major market, having a presence in a
rival’s key markets can be enough to deter the rival from making aggressive
attacks. The reason for this is that the combination of market presence in the
rival’s key markets and a highly profitable market elsewhere can send a
signal to the rival that the company could quickly ramp up production
(funded by the profit center) to mount a competitive counterattack if the rival
attacks one of the company’s key markets.
Multimarket
competition refers to
a situation where
rivals compete
against one another
in many of the same
markets.
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When international rivals compete against one another in multiple-country
markets, this type of deterrence effect can restrain them from taking
aggressive action against one another, due to the fear of a retaliatory response
that might escalate the battle into a cross-border competitive war. Mutual
restraint of this sort tends to stabilize the competitive position of
multimarket rivals against one another. And while it may prevent each firm
from making any major market share gains at the expense of its rival, it also
protects against costly competitive battles that would be likely to erode the
profitability of both companies without any compensating gain.
CORE
CONCEPT
When the same
companies compete
against one another
in multiple
geographic markets,
the threat of cross-
border
counterattacks may
be enough to
encourage mutual
restraint among
international rivals.
STRATEGIES FOR COMPETING IN THE
MARKETS OF DEVELOPING
COUNTRIES
• LO 7-6
Identify the unique
characteristics of
competing in
developing-country
markets.
Companies racing for global leadership have to consider competing in
developing-economy markets like China, India, Brazil, Indonesia, Thailand,
Poland, Mexico, and Russia—countries where the business risks are
considerable but where the opportunities for growth are huge, especially as
their economies develop and living standards climb toward levels in the
industrialized world.17 In today’s world, a company that aspires to
international market leadership (or to sustained rapid growth) cannot ignore
the market opportunities or the base of technical and managerial talent such
countries offer. For example, in 2018, China was the world’s second-largest
economy (behind the United States), based on the purchasing power of its
population of over 1.4 billion people. China’s growth in demand for
consumer goods has made it the fifth largest market for luxury goods, with
sales greater than those in developed markets such as Germany, Spain, and
the United Kingdom. Thus, no company that aspires to global market
leadership can afford to ignore the strategic importance of establishing
competitive market positions in the so-called BRIC countries (Brazil, Russia,
India, and China), as well as in other parts of the Asia-Pacific region, Latin
America, and eastern Europe.
Tailoring products to fit market conditions in developing countries,
however, often involves more than making minor product changes and
becoming more familiar with local cultures. McDonald’s has had to offer
vegetable burgers in parts of Asia and to rethink its prices, which are often
high by local standards and affordable only by the well-to-do. Kellogg has
struggled to introduce its cereals successfully because consumers in many
less developed countries do not eat cereal for breakfast. Single-serving
packages of detergents, shampoos, pickles, cough syrup, and cooking oils are
very popular in India because they allow buyers to conserve cash by
purchasing only what they need immediately. Thus, many companies find
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that trying to employ a strategy akin to that used in the markets of developed
countries is hazardous.18 Experimenting with some, perhaps many, local
twists is usually necessary to find a strategy combination that works.
Strategy Options for Competing in Developing-
Country Markets
There are several options for tailoring a company’s strategy to fit the
sometimes unusual or challenging circumstances presented in developing-
country markets:
Prepare to compete on the basis of low price. Consumers in developing
markets are often highly focused on price, which can give low-cost local
competitors the edge unless a company can find ways to attract buyers with
bargain prices as well as better products. For example, in order to enter the
market for laundry detergents in India, Unilever had to develop a low-cost
detergent (named Wheel), construct new low-cost production facilities,
package the detergent in single-use amounts so that it could be sold at a
very low unit price, distribute the product to local merchants by handcarts,
and craft an economical marketing campaign that included painted signs on
buildings and demonstrations near stores. The new brand quickly captured
$100 million in sales and by 2014 was the top detergent brand in India-
based dollar sales. Unilever replicated the strategy in India with
low-priced packets of shampoos and deodorants and in South
America with a detergent brand-named Ala.
Modify aspects of the company’s business model to accommodate the
unique local circumstances of developing countries. For instance,
Honeywell had sold industrial products and services for more than 100
years outside the United States and Europe using a foreign subsidiary
model that focused international activities on sales only. When Honeywell
entered China, it discovered that industrial customers in that country
considered how many key jobs foreign companies created in China, in
addition to the quality and price of the product or service when making
purchasing decisions. Honeywell added about 150 engineers, strategists,
and marketers in China to demonstrate its commitment to bolstering the
Chinese economy. Honeywell replicated its “East for East” strategy when it
entered the market for industrial products and services in India. Within 10
years of Honeywell establishing operations in China and three years of
expanding into India, the two emerging markets accounted for 30 percent
of the firm’s worldwide growth.
Try to change the local market to better match the way the company does
business elsewhere. An international company often has enough market
clout to drive major changes in the way a local country market operates.
When Japan’s Suzuki entered India, it triggered a quality revolution among
Indian auto parts manufacturers. Local component suppliers teamed up
with Suzuki’s vendors in Japan and worked with Japanese experts to
produce higher-quality products. Over the next two decades, Indian
companies became proficient in making top-notch components for
vehicles, won more prizes for quality than companies in any country other
than Japan, and broke into the global market as suppliers to many
automakers in Asia and other parts of the world. Mahindra and Mahindra,
one of India’s premier automobile manufacturers, has been recognized by a
number of organizations for its product quality. Among its most noteworthy
awards was its number-one ranking by J.D. Power Asia Pacific for new-
vehicle overall quality.
Stay away from developing markets where it is impractical or
uneconomical to modify the company’s business model to accommodate
local circumstances. Home Depot expanded successfully into Mexico, but
it has avoided entry into other developing countries because its value
proposition of good quality, low prices, and attentive customer service
relies on (1) good highways and logistical systems to minimize store
inventory costs, (2) employee stock ownership to help motivate store
personnel to provide good customer service, and (3) high labor costs for
housing construction and home repairs that encourage homeowners to
engage in do-it-yourself projects. Relying on these factors in North
American markets has worked spectacularly for Home Depot, but the
company found that it could not count on these factors in China, from
which it withdrew in 2012.
Company experiences in entering developing markets like Brazil, Russia,
India, and China indicate that profitability seldom comes quickly or easily.
Building a market for the company’s products can often turn into a long-term
process that involves reeducation of consumers, sizable investments in
advertising to alter tastes and buying habits, and upgrades of the local
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infrastructure (transportation systems, distribution channels, etc.). In such
cases, a company must be patient, work within the system to improve the
infrastructure, and lay the foundation for generating sizable revenues and
profits once conditions are ripe for market takeoff.
Profitability in
developing markets
rarely comes quickly
or easily—new
entrants have to
adapt their business
models to local
conditions, which
may not always be
possible.
DEFENDING AGAINST GLOBAL
GIANTS: STRATEGIES FOR LOCAL
COMPANIES IN DEVELOPING
COUNTRIES
If opportunity-seeking, resource-rich international companies are looking to
enter developing-country markets, what strategy options can local companies
use to survive? As it turns out, the prospects for local companies facing
global giants are by no means grim. Studies of local companies in developing
markets have disclosed five strategies that have proved themselves in
defending against globally competitive companies19:
1. Develop business models that exploit shortcomings in local distribution
networks or infrastructure. In many instances, the extensive collection of
resources possessed by the global giants is of little help in building a
presence in developing markets. The lack of well-established local
wholesaler and distributor networks, telecommunication systems,
consumer banking, or media necessary for advertising makes it difficult for
large internationals to migrate business models proved in developed
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markets to emerging markets. Emerging markets sometimes favor local
companies whose managers are familiar with the local language and
culture and are skilled in selecting large numbers of conscientious
employees to carry out labor-intensive tasks. Shanda, a Chinese producer
of massively multiplayer online role-playing games (MMORPGs),
overcame China’s lack of an established credit card network by selling
prepaid access cards through local merchants. The company’s focus on
online games also protects it from shortcomings in China’s software piracy
laws. An India-based electronics company carved out a market niche for
itself by developing an all-in-one business machine, designed especially
for India’s millions of small shopkeepers, that tolerates the country’s
frequent power outages.
2. Utilize keen understanding of local customer needs and preferences to
create customized products or services. When developing-country markets
are largely made up of customers with strong local needs, a good strategy
option is to concentrate on customers who prefer a local touch and to
accept the loss of the customers attracted to global brands.20 A local
company may be able to astutely exploit its local orientation—its
familiarity with local preferences, its expertise in traditional products, its
long-standing customer relationships. A small Middle Eastern cell phone
manufacturer competes successfully against industry giants Samsung,
Apple, Nokia, and Motorola by selling a model designed especially for
Muslims—it is loaded with the Koran, alerts people at prayer times, and is
equipped with a compass that points them toward Mecca. Shenzhen-based
Tencent has become the leader in instant messaging in China through its
unique understanding of Chinese behavior and culture.
3. Take advantage of aspects of the local workforce with which large
international companies may be unfamiliar. Local companies that lack the
technological capabilities of foreign entrants may be able to rely on their
better understanding of the local labor force to offset any disadvantage.
Focus Media is China’s largest outdoor advertising firm and has relied on
low-cost labor to update its more than 170,000 LCD displays and
billboards in over 90 cities in a low-tech manner, while international
companies operating in China use electronically networked screens that
allow messages to be changed remotely. Focus uses an army of
employees who ride to each display by bicycle to change
advertisements with programming contained on a USB flash drive or
DVD. Indian information technology firms such as Infosys Technologies
and Satyam Computer Services have been able to keep their personnel
costs lower than those of international competitors EDS and Accenture
because of their familiarity with local labor markets. While the large
internationals have focused recruiting efforts in urban centers like
Bangalore and Delhi, driving up engineering and computer science salaries
in such cities, local companies have shifted recruiting efforts to second-tier
cities that are unfamiliar to foreign firms.
4. Use acquisition and rapid-growth strategies to better defend against
expansion-minded internationals. With the growth potential of developing
markets such as China, Indonesia, and Brazil obvious to the world, local
companies must attempt to develop scale and upgrade their competitive
capabilities as quickly as possible to defend against the stronger
international’s arsenal of resources. Most successful companies in
developing markets have pursued mergers and acquisitions at a rapid-fire
pace to build first a nationwide and then an international presence.
Hindalco, India’s largest aluminum producer, has followed just such a path
to achieve its ambitions for global dominance. By acquiring companies in
India first, it gained enough experience and confidence to eventually
acquire much larger foreign companies with world-class capabilities.21
When China began to liberalize its foreign trade policies, Lenovo (the
Chinese PC maker) realized that its long-held position of market
dominance in China could not withstand the onslaught of new international
entrants such as Dell and HP. Its acquisition of IBM’s PC business allowed
Lenovo to gain rapid access to IBM’s globally recognized PC brand, its
R&D capability, and its existing distribution in developed countries. This
has allowed Lenovo not only to hold its own against the incursion of
global giants into its home market but also to expand into new markets
around the world.22
5. Transfer company expertise to cross-border markets and initiate actions to
contend on an international level. When a company from a developing
country has resources and capabilities suitable for competing in other
country markets, launching initiatives to transfer its expertise to foreign
markets becomes a viable strategic option. Televisa, Mexico’s largest
media company, used its expertise in Spanish culture and linguistics to
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become the world’s most prolific producer of Spanish-language soap
operas. By continuing to upgrade its capabilities and learn from its
experience in foreign markets, a company can sometimes transform itself
into one capable of competing on a worldwide basis, as an emerging global
giant. Sundaram Fasteners of India began its foray into foreign markets as
a supplier of radiator caps to General Motors—an opportunity it pursued
when GM first decided to outsource the production of this part. As a
participant in GM’s supplier network, the company learned about emerging
technical standards, built its capabilities, and became one of the first Indian
companies to achieve QS 9000 quality certification. With the expertise it
gained and its recognition for meeting quality standards, Sundaram was
then able to pursue opportunities to supply automotive parts in Japan and
Europe.
Illustration Capsule 7.3 discusses the strategy behind the success of
WeChat (China’s most popular messenger app), in keeping out international
social media rivals.
ILLUSTRATION
CAPSULE 7.3 WeChat’s Strategy for
Defending against International Social Media
Giants in China
WeChat, a Chinese social media and messenger app similar to Whatsapp, allows users
to chat, post photos, shop online, and share information as well as music. It has
continued to add new features, such as WeChat Games and WePay, which allow users
to send money electronically, much like Venmo. The company now serves more than a
billion active users, a testament to the success of its strategy.
WeChat has also had incredible success keeping out international rivals. Due to
censorship and regulations in China, Chinese social media companies have an inherent
advantage over foreign competitors. However, this is not why WeChat has become an
indispensable part of Chinese life.
WeChat has been able to surpass international rivals because, by better understanding
Chinese customer needs, it can anticipate their desires. WeChat added features that
allow users to check traffic cameras during rush hour, purchase tickets to movies, and
book doctor appointments all on the app. Booking appointments with doctors is a feature
that is wildly popular with the Chinese customer base due to common scheduling
difficulties. Essentially, WeChat created its own distribution network for sought after
information and goods in busy Chinese cities.
WeChat also has an understanding of local customs that international rivals can’t
match. In order to promote WePay, WeChat created a Chinese New Year lottery-like
promotion in which users could win virtual “red envelopes” on the app. Red envelopes of
money are traditionally given on Chinese New Year as presents. WePay was able to
grow users from 30 to 100 million in the month following the promotion due to the
popularity of the New Year’s feature. By 2020, many of WeChat’s over one billion active
users were also using WePay. WeChat continues to allow users to send red envelopes
and has continued New Year’s promotions in subsequent years with success. Even
Chinese companies have been bested by WeChat. Rival founder of Alibaba, Jack Ma,
admitted the promotion put WeChat ahead of his company, saying it was a “pearl harbor
attack” on his company. Chinese tech experts noted that the promotion was Ma’s
nightmare because it pushed WeChat to the forefront of Chinese person-to-person
payments.
BigTunaOnline/Shutterstock
WeChat’s strategy of continually developing new features also keeps the competition
at bay. As China’s “App for Everything,” it now permeates all walks of life in China in a
way that will likely continue to keep foreign competitors out.
Note: Developed with Meaghan I. Haugh.
Sources: Guilford, Gwynn. “WeChat’s Little Red Envelopes Are Brilliant Marketing for
Mobile Payments.” Quartz, January 29, 2014; Pasternack, Alex. “How Social Cash Made
WeChat the App for Everything,” Fast Company, January 3, 2017; “WeChat’s World,” The
Economist, August 6, 2016; Stanciu, Tudor. “Why WeChat City Services Is a Game-
Changing Move for Smartphone Adoption,” TechCrunch, April 24, 2015.
page 217
KEY POINTS
1. Competing in international markets allows a company to (1) gain access to
new customers; (2) achieve lower costs through greater economies of
scale, learning, and increased purchasing power; (3) gain access to low-
cost inputs of production; (4) further exploit its core competencies; and (5)
gain access to resources and capabilities located outside the company’s
domestic market.
2. Strategy making is more complex for five reasons: (1) Different countries
have home-country advantages in different industries; (2) there are
location-based advantages to performing different value chain activities in
different parts of the world; (3) varying political and economic risks make
the business climate of some countries more favorable than others; (4)
companies face the risk of adverse shifts in exchange rates when operating
in foreign countries; and (5) differences in buyer tastes and preferences
present a conundrum concerning the trade-off between customizing and
standardizing products and services.
3. The strategies of firms that expand internationally are usually grounded in
home-country advantages concerning demand conditions; factor
conditions; related and supporting industries; and firm strategy, structure,
and rivalry, as described by the Diamond of National Competitive
Advantage framework.
4. There are five strategic options for entering foreign markets. These include
maintaining a home-country production base and exporting goods to
foreign markets, licensing foreign firms to produce and distribute the
company’s products abroad, employing a franchising strategy, establishing
a foreign subsidiary via an acquisition or greenfield venture, and using
strategic alliances or other collaborative partnerships.
5. A company must choose among three alternative approaches for competing
internationally: (1) a multidomestic strategy—a think-local, act-local
approach to crafting international strategy; (2) a global strategy—a think-
global, act-global approach; and (3) a combination think-global, act-local
approach, known as a transnational strategy. A multidomestic strategy
page 218
(think local, act local) is appropriate for companies that must vary their
product offerings and competitive approaches from country to country in
order to accommodate different buyer preferences and market conditions.
The global strategy (think global, act global) works best when there are
substantial cost benefits to be gained from taking a standardized, globally
integrated approach and there is little need for local responsiveness. A
transnational strategy (think global, act local) is called for when there is a
high need for local responsiveness as well as substantial benefits from
taking a globally integrated approach. In this approach, a company strives
to employ the same basic competitive strategy in all markets but still
customizes its product offering and some aspect of its operations to fit
local market circumstances.
6. There are three general ways in which a firm can gain competitive
advantage (or offset domestic disadvantages) in international markets. One
way involves locating various value chain activities among nations in a
manner that lowers costs or achieves greater product differentiation. A
second way draws on an international competitor’s ability to extend its
competitive advantage by cost-effectively sharing, replicating, or
transferring its most valuable resources and capabilities across borders. A
third looks for benefits from cross-border coordination that are unavailable
to domestic-only competitors.
7. Two types of strategic moves are particularly suited for companies
competing internationally. The first involves waging strategic offenses in
international markets through cross-subsidization—a practice of
supporting competitive offensives in one market with resources
and profits diverted from operations in another market. The
second is a defensive move used to encourage mutual restraint among
competitors when there is international multimarket competition by
signaling that each company has the financial capability for mounting a
strong counterattack if threatened. For companies with at least one highly
profitable or well defended market, having a presence in a rival’s key
markets can be enough to deter the rival from making aggressive attacks.
8. Companies racing for global leadership have to consider competing in
developing markets like the BRIC countries—Brazil, Russia, India, and
China—where the business risks are considerable but the opportunities for
growth are huge. To succeed in these markets, companies often have to (1)
LO 7-1, LO 7-3
compete on the basis of low price, (2) modify aspects of the company’s
business model to accommodate local circumstances, and/or (3) try to
change the local market to better match the way the company does
business elsewhere. Profitability is unlikely to come quickly or easily in
developing markets, typically because of the investments needed to alter
buying habits and tastes, the increased political and economic risk, and/or
the need for infrastructure upgrades. And there may be times when a
company should simply stay away from certain developing markets until
conditions for entry are better suited to its business model and strategy.
9. Local companies in developing-country markets can seek to compete
against large international companies by (1) developing business models
that exploit shortcomings in local distribution networks or infrastructure,
(2) utilizing a superior understanding of local customer needs and
preferences or local relationships, (3) taking advantage of competitively
important qualities of the local workforce with which large international
companies may be unfamiliar, (4) using acquisition strategies and rapid-
growth strategies to better defend against expansion-minded international
companies, or (5) transferring company expertise to cross-border markets
and initiating actions to compete on an international level.
ASSURANCE OF LEARNING EXERCISES
1. L’Oréal markets over 500 brands of products in all
sectors of the beauty business in 140 countries. The
company’s international strategy involves
manufacturing these products in 43 plants located
around the world. L’Oréal’s international strategy is
discussed in its operations section of the company’s
website (www.loreal.com/careers/who-you-can-
be/operations) and in its press releases, annual
reports, and presentations. Why has the company
chosen to pursue a foreign subsidiary strategy? Are
there strategic advantages to global sourcing and
production in the cosmetics, fragrances, and hair
care products industry relative to an export strategy?
http://www.loreal.com/careers/who-you-can-be/operations
LO 7-1, LO 7-3
page 219
LO 7-2, LO 7-4
LO 7-5, LO 7-6
2. Alliances, joint ventures, and mergers with foreign
companies are widely used as a means of entering
foreign markets. Such arrangements have many
purposes, including learning about unfamiliar
environments, and the opportunity to access the
complementary resources and capabilities of a
foreign partner. Illustration Capsule 7.1 provides an
example of how Walgreens used a strategy of
entering foreign markets via alliance, followed by a
merger with the same entity. What was this entry
strategy designed to achieve, and why would this
make sense for a company like Walgreens?
3. Assume you are in charge of developing the strategy
for an international company selling products in
some 50 different countries around the
world. One of the issues you face is
whether to employ a multidomestic strategy, a
global strategy, or a transnational strategy.
a. If your company’s product is mobile phones,
which of these strategies do you think it would
make better strategic sense to employ? Why?
b. If your company’s product is dry soup mixes and
canned soups, would a multidomestic strategy
seem to be more advisable than a global strategy
or a transnational strategy? Why or why not?
c. If your company’s product is large home
appliances such as washing machines, ranges,
ovens, and refrigerators, would it seem to make
more sense to pursue a multidomestic strategy, a
global strategy, or a transnational strategy? Why?
4. Using your university library’s business research
resources and Internet sources, identify and discuss
three key strategies that General Motors is using to
compete in China.
LO 7-2
LO 7-2
page 220
EXERCISES FOR SIMULATION PARTICIPANTS
The following questions are for simulation participants whose
companies operate in an international market arena. If your company
competes only in a single country, then skip the questions in this section.
1. To what extent, if any, have you and your co-
managers adapted your company’s strategy to take
shifting exchange rates into account? In other words,
have you undertaken any actions to try to minimize
the impact of adverse shifts in exchange rates?
2. To what extent, if any, have you and your co-
managers adapted your company’s strategy to take
geographic differences in import tariffs or import
duties into account?
3. What are the attributes of each of the following
approaches to competing in international markets?
Multidomestic or think-local, act-local approach.
Global or think-global, act-global approach.
Transnational or think-global, act-local approach.
Explain your answer and indicate two or three
chief elements of your company’s strategy for
competing in two or more different geographic
regions.
ENDNOTES
1 Sidney G. Winter and Gabriel Szulanski, “Getting It Right the Second Time,” Harvard Business Review 80, no. 1
(January 2002), pp. 62–69.
2 P. Dussauge, B. Garrette, and W. Mitchell, “Learning from Competing Partners: Outcomes and Durations of Scale and
Link Alliances in Europe, North America and Asia,” Strategic Management Journal 21, no. 2 (February 2000), pp. 99–
126; K. W. Glaister and P. J. Buckley, “Strategic Motives for International Alliance Formation,” Journal of Management
Studies 33, no. 3 (May 1996), pp. 301–332.
3 Michael E. Porter, “The Competitive Advantage of Nations,” Harvard Business Review, March–April 1990, pp. 73–93.
4 Tom Mitchell and Avantika Chilkoti, “China Car Sales Accelerate Away from US and Brazil in 2013,” Financial Times,
January 9, 2014, www.ft.com/cms/s/0/8c649078-78f8-11e3-b381-00144feabdc0.html#axzz2rpEqjkZO.
5 U.S. Department of Labor, Bureau of Labor Statistics, “International Comparisons of Hourly Compensation Costs in
Manufacturing 2012,” August 9, 2013. (The numbers for India and China are estimates.)
http://www.ft.com/cms/s/0/8c649078-78f8-11e3-b381-00144feabdc0.html#axzz2rpEqjkZO.
page 221
6 Sangwon Yoon, “South Korea Targets Internet Addicts; 2 Million Hooked,” Valley News, April 25, 2010, p. C2.
7 Joel Bleeke and David Ernst, “The Way to Win in Cross-Border Alliances,” Harvard Business Review 69, no. 6
(November–December 1991), pp. 127–133; Gary Hamel, Yves L. Doz, and C. K. Prahalad, “Collaborate with Your
Competitors– and Win,” Harvard Business Review 67, no. 1 (January–February 1989), pp. 134–135.
8 K. W. Glaister and P. J. Buckley, “Strategic Motives for International Alliance Formation,” Journal of Management
Studies 33, no. 3 (May 1996), pp. 301–332.
9 Jeffrey H. Dyer, Prashant Kale, and Harbir Singh, “When to Ally and When to Acquire,” Harvard Business Review 82,
no. 7–8 (July–August 2004).
10 Yves Doz and Gary Hamel, Alliance Advantage: The Art of Creating Value through Partnering (Harvard Business
School Press, 1998); Rosabeth Moss Kanter, “Collaborative Advantage: The Art of the Alliance,” Harvard Business
Review 72, no. 4 (July–August 1994), pp. 96–108.
11 Jeremy Main, “Making Global Alliances Work,” Fortune, December 19, 1990, p. 125.
12 C. K. Prahalad and Kenneth Lieberthal, “The End of Corporate Imperialism,” Harvard Business Review 81, no. 8
(August 2003), pp. 109–117.
13 Pankaj Ghemawat, “Managing Differences: The Central Challenge of Global Strategy,” Harvard Business Review 85,
no. 3 (March 2007).
14 C. A. Bartlett and S. Ghoshal, Managing across Borders: The Transnational Solution, 2nd ed. (Boston: Harvard
Business School Press, 1998).
15 Lynn S. Paine, “The China Rules,” Harvard Business Review 88, no. 6 (June 2010), pp. 103–108.
16 C. K. Prahalad and Yves L. Doz, The Multinational Mission: Balancing Local Demands and Global Vision (New York:
Free Press, 1987).
17 David J. Arnold and John A. Quelch, “New Strategies in Emerging Markets,” Sloan Management Review 40, no. 1
(Fall 1998), pp. 7–20.
18 Tarun Khanna, Krishna G. Palepu, and Jayant Sinha, “Strategies That Fit Emerging Markets,” Harvard Business
Review 83, no. 6 (June 2005), p. 63; Arindam K. Bhattacharya and David C. Michael, “How Local Companies Keep
Multinationals at Bay,” Harvard Business Review 86, no. 3 (March 2008), pp. 94–95.
19 Tarun Khanna and Krishna G. Palepu, “Emerging Giants: Building World-Class Companies in Developing Countries,”
Harvard Business Review 84, no. 10 (October 2006), pp. 60–69.
20 Niroj Dawar and Tony Frost, “Competing with Giants: Survival Strategies for Local Companies in Emerging Markets,”
Harvard Business Review 77, no. 1 (January–February 1999), p. 122; Guitz Ger, “Localizing in the Global Village: Local
Firms Competing in Global Markets,” California Management Review 41, no. 4 (Summer 1999), pp. 64–84.
21 N. Kumar, “How Emerging Giants Are Rewriting the Rules of M&A,” Harvard Business Review, May 2009, pp. 115–
121.
22 H. Rui and G. Yip, “Foreign Acquisitions by Chinese Firms: A Strategic Intent Perspective,” Journal of World Business
43 (2008), pp. 213–226.
page 222
chapter 8
Corporate Strategy
Diversification and the Multibusiness
Company
Learning Objectives
After reading this chapter, you should be able to:
LO 8-1 Explain when and how business diversification can enhance shareholder
value.
LO 8-2 Describe how related diversification strategies can produce cross-business
strategic fit capable of delivering competitive advantage.
LO 8-3 Identify the merits and risks of unrelated diversification strategies.
LO 8-4 Use the analytic tools for evaluating a company’s diversification strategy.
LO 8-5 Understand the four main corporate strategy options a diversified company
can employ to improve company performance.
page 223
Richard Schneider/Getty Images
I suppose my formula might be: dream, diversify, and never miss an angle.
Walt Disney—Founder of the Walt Disney Company
Make winners out of every business in your company. Don’t carry losers.
Jack Welch—Legendary CEO of General Electric
Fit between a parent and its businesses is a two-edged sword: A good fit can create value; a bad one can destroy it.
Andrew Campbell, Michael Goold, and Marcus Alexander—Academics, authors, and consultants
This chapter moves up one level in the strategy-making hierarchy, from strategy making in a single-business
enterprise to strategy making in a diversified, multibusiness enterprise. Because a diversified company is a
collection of individual businesses, the strategy-making task is more complicated. In a one-business company,
managers have to come up with a plan for competing successfully in only a single industry environment—the result
is what Chapter 2 labeled as business strategy (or business-level strategy). But in a diversified company, the
strategy-making challenge involves assessing multiple industry environments and developing a set of business
strategies, one for each industry arena in which the diversified company operates. And top executives at a
diversified company must still go one step further and devise a companywide (or corporate) strategy for improving
page 224
the performance of the company’s overall business lineup and for making a rational whole out of its diversified
collection of individual businesses.
In the first part of this chapter, we describe what crafting a diversification strategy entails, when and why
diversification makes good strategic sense, the various approaches to diversifying a company’s business lineup,
and the pros and cons of related versus unrelated diversification strategies. The second part of the chapter looks at
how to evaluate the attractiveness of a diversified company’s business lineup, how to decide whether it has a good
diversification strategy, and the strategic options for improving a diversified company’s future performance.
WHAT DOES CRAFTING A DIVERSIFICATION
STRATEGY ENTAIL?
The task of crafting a diversified company’s overall corporate strategy falls squarely in the lap of
top-level executives and involves three distinct facets:
1. Picking new industries to enter and deciding on the means of entry. Pursuing a diversification
strategy requires that management decide which new industries to enter and then, for each new
industry, whether to enter by starting a new business from the ground up, by acquiring a company
already in the target industry, or by forming a joint venture or strategic alliance with another
company. The choice of industries depends upon on the strategic rationale (or justification) for
diversifying and the type of diversification being pursued—important issues that we discuss more
fully in sections to follow.
2. Pursuing opportunities to leverage cross-business value chain relationships, where there is
strategic fit, into competitive advantage. The task here is to determine whether there are
opportunities to strengthen a diversified company’s businesses by such means as transferring
competitively valuable resources and capabilities from one business to another, combining the
related value chain activities of different businesses to achieve lower costs, sharing resources,
such as the use of a powerful and well-respected brand name or an R&D facility, across multiple
businesses, and encouraging knowledge sharing and collaborative activity among the businesses.
3. Initiating actions to boost the combined performance of the corporation’s collection of
businesses. Strategic options for improving the corporation’s overall performance include (1)
sticking closely with the existing business lineup and pursuing opportunities presented by these
businesses, (2) broadening the scope of diversification by entering additional industries, (3)
retrenching to a narrower scope of diversification by divesting either poorly performing
businesses or those that no longer fit into management’s long-range plans, and (4) broadly
restructuring the entire company by divesting some businesses, acquiring others, and
reorganizing, to put a whole new face on the company’s business lineup.
The demanding and time-consuming nature of these three tasks explains why corporate
executives generally refrain from becoming immersed in the details of crafting and executing
business-level strategies. Rather, the normal procedure is to delegate lead responsibility for business
strategy to the heads of each business, giving them the latitude to develop strategies suited to the
particular industry environment in which their business operates and holding them accountable for
producing good financial and strategic results.
WHEN TO CONSIDER DIVERSIFYING
page 225
As long as a company has plentiful opportunities for profitable growth in its present industry, there
is no urgency to pursue diversification. But growth opportunities are often limited in mature
industries and markets where buyer demand is flat or declining. In addition, changing industry
conditions—new technologies, inroads being made by substitute products, fast-shifting buyer
preferences, or intensifying competition—can undermine a company’s ability to deliver ongoing
gains in revenues and profits. Consider, for example, what mobile phone companies and
marketers of Voice over Internet Protocol (VoIP) have done to the revenues of long-
distance providers such as AT&T, British Telecommunications, and NTT in Japan. Thus,
diversifying into new industries always merits strong consideration whenever a single-business
company encounters diminishing market opportunities and stagnating sales in its principal business.
The decision to diversify presents wide-ranging possibilities. A company can diversify into
closely related businesses or into totally unrelated businesses. It can diversify its present revenue
and earnings base to a small or major extent. It can move into one or two large new businesses or a
greater number of small ones. It can achieve diversification by acquiring an existing company,
starting up a new business from scratch, or forming a joint venture with one or more companies to
enter new businesses. In every case, however, the decision to diversify must start with a strong
economic justification for doing so.
BUILDING SHAREHOLDER VALUE: THE ULTIMATE
JUSTIFICATION FOR DIVERSIFYING
• LO 8-1
Explain when and
how business
diversification can
enhance
shareholder value.
Diversification must do more for a company than simply spread its business risk across various
industries. In principle, diversification cannot be considered wise or justifiable unless it results in
added long-term economic value for shareholders—value that shareholders cannot capture on their
own by purchasing stock in companies in different industries or investing in mutual funds to spread
their investments across several industries. A move to diversify into a new business stands little
chance of building shareholder value without passing the following three Tests of Corporate
Advantage1:
CORE
CONCEPT
To add shareholder
value, a move to
diversify into a new
business must pass
the three Tests of
Corporate
Advantage:
page 226
1. The industry
attractiveness test
2. The cost of entry
test
3. The better-off test
1. The industry attractiveness test. The industry to be entered through diversification must be
structurally attractive (in terms of the five forces), have resource requirements that match those of
the parent company, and offer good prospects for growth, profitability, and return on investment.
2. The cost of entry test. The cost of entering the target industry must not be so high as to exceed the
potential for good profitability. A catch-22 can prevail here, however. The more attractive an
industry’s prospects are for growth and good long-term profitability, the more expensive it can be
to enter. Entry barriers for startup companies are likely to be high in attractive industries—if
barriers were low, a rush of new entrants would soon erode the potential for high profitability.
And buying a well-positioned company in an appealing industry often entails a high acquisition
cost that makes passing the cost of entry test less likely. Since the owners of a successful and
growing company usually demand a price that reflects their business’s profit prospects, it’s easy
for such an acquisition to fail the cost of entry test.
3. The better-off test. Diversifying into a new business must offer potential for the company’s
existing businesses and the new business to perform better together under a single corporate
umbrella than they would perform operating as independent, stand-alone businesses—an effect
known as synergy. For example, let’s say that company A diversifies by purchasing company B
in another industry. If A and B’s consolidated profits in the years to come prove no greater than
what each could have earned on its own, then A’s diversification won’t provide its
shareholders with any added value. Company A’s shareholders could have achieved the
same 1 + 1 = 2 result by merely purchasing stock in company B. Diversification does not result in
added long-term value for shareholders unless it produces a 1 + 1 = 3 effect, whereby the
businesses perform better together as part of the same firm than they could have performed as
independent companies.
CORE
CONCEPT
Creating added
value for
shareholders via
diversification
requires building a
multibusiness
company in which
the whole is greater
than the sum of its
parts; such 1 + 1 = 3
effects are called
synergy.
Diversification moves must satisfy all three tests to grow shareholder value over the long term.
Diversification moves that can pass only one or two tests are suspect.
page 227
APPROACHES TO DIVERSIFYING THE BUSINESS
LINEUP
The means of entering new businesses can take any of three forms: acquisition, internal startup, or
joint ventures with other companies.
Diversifying by Acquisition of an Existing Business
Acquisition is a popular means of diversifying into another industry. Not only is it quicker than
trying to launch a new operation, but it also offers an effective way to hurdle such entry barriers as
acquiring technological know-how, establishing supplier relationships, achieving scale economies,
building brand awareness, and securing adequate distribution. Acquisitions are also commonly
employed to access resources and capabilities that are complementary to those of the acquiring firm
and that cannot be developed readily internally. Buying an ongoing operation allows the acquirer to
move directly to the task of building a strong market position in the target industry rather than
getting bogged down in trying to develop the knowledge, experience, scale of operation, and market
reputation necessary for a startup entrant to become an effective competitor.
CORE
CONCEPT
An acquisition
premium, or control
premium, is the
amount by which the
price offered
exceeds the
preacquisition
market value or
stock price of the
target company.
However, acquiring an existing business can prove quite expensive. The costs of acquiring
another business include not only the acquisition price but also the costs of performing the due
diligence to ascertain the worth of the other company, the costs of negotiating the purchase
transaction, and the costs of integrating the business into the diversified company’s portfolio. If the
company to be acquired is a successful company, the acquisition price will include a hefty premium
over the preacquisition value of the company for the right to control the company. For example, the
$1.2 billion that luxury fashion company Michael Kors paid to acquire luxury accessories brand
Jimmy Choo included a 36.5 percent premium over Jimmy Choo’s share price before being put up
for sale. Premiums are paid in order to convince the shareholders and managers of the target
company that it is in their financial interests to approve the deal. The average premium paid by U.S.
companies over the last 15 years was more often in the 20 to 25 percent range.
While acquisitions offer an enticing means for entering a new business, many fail to deliver on
their promise.2 Realizing the potential gains from an acquisition requires a successful integration of
the acquired company into the culture, systems, and structure of the acquiring firm. This can be a
costly and time-consuming operation. Acquisitions can also fail to deliver long-term shareholder
value if the acquirer overestimates the potential gains and pays a premium in excess of the realized
gains. High integration costs and excessive price premiums are two reasons that an
acquisition might fail the cost of entry test. Firms with significant experience in making acquisitions
are better able to avoid these types of problems.3
Entering a New Line of Business through Internal Development
Achieving diversification through internal development involves starting a new business subsidiary
from scratch. Internal development has become an increasingly important way for companies to
diversify and is often referred to as corporate venturing or new venture development. Although
building a new business from the ground up is generally a time-consuming and uncertain process, it
avoids the pitfalls associated with entry via acquisition and may allow the firm to realize greater
profits in the end. It may offer a viable means of entering a new or emerging industry where there
are no good acquisition candidates.
CORE
CONCEPT
Corporate
venturing (or new
venture
development) is the
process of
developing new
businesses as an
outgrowth of a
company’s
established
business operations.
It is also referred to
as corporate
entrepreneurship or
intrapreneurship
since it requires
entrepreneurial-like
qualities within a
larger enterprise.
Entering a new business via internal development, however, poses some significant hurdles. An
internal new venture not only has to overcome industry entry barriers but also must invest in new
production capacity, develop sources of supply, hire and train employees, build channels of
distribution, grow a customer base, and so on, unless the new business is quite similar to the
company’s existing business. The risks associated with internal startups can be substantial, and the
likelihood of failure is often high. Moreover, the culture, structures, and organizational systems of
some companies may impede innovation and make it difficult for corporate entrepreneurship to
flourish.
Generally, internal development of a new business has appeal only when (1) the parent company
already has in-house most of the resources and capabilities it needs to piece together a new business
and compete effectively; (2) there is ample time to launch the business; (3) the internal cost of entry
is lower than the cost of entry via acquisition; (4) adding new production capacity will not adversely
impact the supply–demand balance in the industry; and (5) incumbent firms are likely to be slow or
ineffective in responding to a new entrant’s efforts to crack the market.
Using Joint Ventures to Achieve Diversification
page 228
Entering a new business via a joint venture can be useful in at least three types of situations.4 First,
a joint venture is a good vehicle for pursuing an opportunity that is too complex, uneconomical, or
risky for one company to pursue alone. Second, joint ventures make sense when the opportunities in
a new industry require a broader range of competencies and know-how than a company can marshal
on its own. Many of the opportunities in satellite-based telecommunications, biotechnology, and
network-based systems that blend hardware, software, and services call for the coordinated
development of complementary innovations and the tackling of an intricate web of financial,
technical, political, and regulatory factors simultaneously. In such cases, pooling the resources and
competencies of two or more companies is a wiser and less risky way to proceed. Third, companies
sometimes use joint ventures to diversify into a new industry when the diversification move entails
having operations in a foreign country. However, as discussed in Chapters 6 and 7, partnering with
another company can have significant drawbacks due to the potential for conflicting objectives,
disagreements over how to best operate the venture, culture clashes, and so on. Joint ventures are
generally the least durable of the entry options, usually lasting only until the partners decide to go
their own ways.
Choosing a Mode of Entry
The choice of how best to enter a new business—whether through internal development,
acquisition, or joint venture—depends on the answers to four important questions:
Does the company have all of the resources and capabilities it requires to enter the business
through internal development, or is it lacking some critical resources?
Are there entry barriers to overcome?
Is speed an important factor in the firm’s chances for successful entry?
Which is the least costly mode of entry, given the company’s objectives?
The Question of Critical Resources and Capabilities If a firm has all the resources it needs to
start up a new business or will be able to easily purchase or lease any missing resources, it may
choose to enter the business via internal development. However, if missing critical resources cannot
be easily purchased or leased, a firm wishing to enter a new business must obtain these missing
resources through either acquisition or joint venture. Bank of America acquired Merrill Lynch to
obtain critical investment banking resources and capabilities that it lacked. The acquisition of these
additional capabilities complemented Bank of America’s strengths in corporate banking and opened
up new business opportunities for the company. Firms often acquire other companies as a way to
enter foreign markets where they lack local marketing knowledge, distribution capabilities, and
relationships with local suppliers or customers. McDonald’s acquisition of Burghy, Italy’s only
national hamburger chain, offers an example.5 If there are no good acquisition opportunities or if
the firm wants to avoid the high cost of acquiring and integrating another firm, it may choose to
enter via joint venture. This type of entry mode has the added advantage of spreading the risk of
entering a new business, an advantage that is particularly attractive when uncertainty is high. De
Beers’s joint venture with the luxury goods company LVMH provided De Beers not only with the
complementary marketing capabilities it needed to enter the diamond retailing business but also
with a partner to share the risk.
page 229
The Question of Entry Barriers The second question to ask is whether entry barriers would
prevent a new entrant from gaining a foothold and succeeding in the industry. If entry barriers are
low and the industry is populated by small firms, internal development may be the preferred mode
of entry. If entry barriers are high, the company may still be able to enter with ease if it has the
requisite resources and capabilities for overcoming high barriers. For example, entry barriers due to
reputational advantages may be surmounted by a diversified company with a widely known and
trusted corporate name. But if the entry barriers cannot be overcome readily, then the only feasible
entry route may be through acquisition of a well-established company. While entry barriers may
also be overcome with a strong complementary joint venture, this mode is the more uncertain
choice due to the lack of industry experience.
The Question of Speed Speed is another determining factor in deciding how to go about entering
a new business. Acquisition is a favored mode of entry when speed is of the essence, as is the case
in rapidly changing industries where fast movers can secure long-term positioning advantages.
Speed is important in industries where early movers gain experience-based advantages that grow
ever larger over time as they move down the learning curve. It is also important in technology-based
industries where there is a race to establish an industry standard or leading technological platform.
But, in other cases, it can be better to enter a market after the uncertainties about
technology or consumer preferences have been resolved and learn from the missteps of
early entrants. In these cases, when it is more advantageous to be a second-mover, joint venture or
internal development may be preferred.
The Question of Comparative Cost The question of which mode of entry is most cost-effective
is a critical one, given the need for a diversification strategy to pass the cost of entry test.
Acquisition can be a high-cost mode of entry due to the need to pay a premium over the share price
of the target company. When the premium is high, the price of the deal will exceed the worth of the
acquired company as a stand-alone business by a substantial amount. Whether it is worth it to pay
that high a price will depend on how much extra value will be created by the new combination of
companies in the form of synergies. Moreover, the true cost of an acquisition must include the
transaction costs of identifying and evaluating potential targets, negotiating a price, and
completing other aspects of deal making. Often, companies pay hefty fees to investment banking
firms, lawyers, and others to advise them and assist with the deal-making process. Finally, the true
cost must take into account the costs of integrating the acquired company into the parent company’s
portfolio of businesses.
CORE
CONCEPT
Transaction costs
are the costs of
completing a
business agreement
or deal, over and
above the price of
the deal. They can
include the costs of
searching for an
attractive target, the
costs of evaluating
its worth, bargaining
costs, and the costs
of completing the
transaction.
Joint ventures may provide a way to conserve on such entry costs. But even here, there are
organizational coordination costs and transaction costs that must be considered, including settling
on the terms of the arrangement. If the partnership doesn’t proceed smoothly and is not founded on
trust, these costs may be significant.
CHOOSING THE DIVERSIFICATION PATH:
RELATED VERSUS UNRELATED BUSINESSES
Once a company decides to diversify, it faces the choice of whether to diversify into related
businesses, unrelated businesses, or some mix of both. Businesses are said to be related when
their value chains exhibit competitively important cross-business commonalities. By this we mean
that there is a close correspondence between the businesses in terms of how they perform key value
chain activities and the resources and capabilities each needs to perform those activities. The big
appeal of related diversification is the opportunity to build shareholder value by leveraging these
cross-business commonalities into competitive advantages for the individual businesses, thus
allowing the company as a whole to perform better than just the sum of its businesses. Businesses
are said to be unrelated when the resource requirements and key value chain activities are so
dissimilar that no competitively important cross-business commonalities exist.
CORE
CONCEPT
Related
businesses
possess
competitively
valuable cross-
business value
chain and resource
commonalities;
unrelated
businesses have
dissimilar value
chains and resource
requirements, with
no competitively
important cross-
business
commonalities at the
value chain level.
The next two sections explore the ins and outs of related and unrelated diversification.
DIVERSIFICATION INTO RELATED BUSINESSES
page 230
• LO 8-2
Describe how
related
diversification
strategies can
produce cross-
business strategic fit
capable of delivering
competitive
advantage.
A related diversification strategy involves building the company around businesses where there is
good strategic fit across corresponding value chain activities. Strategic fit exists whenever one or
more activities constituting the value chains of different businesses are sufficiently similar to
present opportunities for cross-business sharing or transferring of the resources and
capabilities that enable these activities.6 That is to say, it implies the existence of
competitively important cross-business commonalities. Prime examples of such opportunities
include:
CORE
CONCEPT
Strategic fit exists
whenever one or
more activities
constituting the
value chains of
different businesses
are sufficiently
similar to present
opportunities for
cross-business
sharing or
transferring of the
resources and
capabilities that
enable these
activities.
Transferring specialized expertise, technological know-how, or other competitively valuable
strategic assets from one business’s value chain to another’s. Google’s ability to transfer software
developers and other information technology specialists from other business applications to the
development of its Android mobile operating system and Chrome operating system for PCs aided
considerably in the success of these new internal ventures.
Sharing costs between businesses by combining their related value chain activities into a single
operation. For instance, it is often feasible to manufacture the products of different businesses
in a single plant, use the same warehouses for shipping and distribution, or have a single sales
force for the products of different businesses if they are marketed to the same types of
customers.
page 231
Exploiting the common use of a well-known brand name. For example, Yamaha’s name in
motorcycles gave the company instant credibility and recognition in entering the personal-
watercraft business, allowing it to achieve a significant market share without spending large
sums on advertising to establish a brand identity for the WaveRunner. Likewise, Apple’s
reputation for producing easy-to-operate computers was a competitive asset that facilitated the
company’s diversification into digital music players, smartphones, and connected watches.
Sharing other resources (besides brands) that support corresponding value chain activities across
businesses. When Disney acquired Marvel Comics, management saw to it that Marvel’s iconic
characters, such as Spiderman, Iron Man, and the Black Widow, were shared with many of the
other Disney businesses, including its theme parks, retail stores, motion picture division, and
video game business. (Disney’s characters, starting with Mickey Mouse, have always been among
the most valuable of its resources.) Automobile companies like Ford share resources such as their
relationships with suppliers and dealer networks across their lines of business.
Engaging in cross-business collaboration and knowledge sharing to create new competitively
valuable resources and capabilities. Businesses performing closely related value chain activities
may seize opportunities to join forces, share knowledge and talents, and collaborate to create
altogether new capabilities (such as virtually defect-free assembly methods or increased ability to
speed new products to market) that will be mutually beneficial in improving their competitiveness
and business performance.
Related diversification is based on value chain matchups with respect to key value chain activities
—those that play a central role in each business’s strategy and that link to its industry’s key success
factors. Such matchups facilitate the sharing or transfer of the resources and capabilities that enable
the performance of these activities and underlie each business’s quest for competitive advantage. By
facilitating the sharing or transferring of such important competitive assets, related diversification
can elevate each business’s prospects for competitive success.
The resources and capabilities that are leveraged in related diversification are specialized
resources and capabilities. By this we mean that they have very specific applications; their use is
restricted to a limited range of business contexts in which these applications are competitively
relevant. Because they are adapted for particular applications, specialized resources and capabilities
must be utilized by particular types of businesses operating in specific kinds of industries to have
value; they have limited utility outside this designated range of industry and business
applications. This is in contrast to general resources and capabilities (such as general
management capabilities, human resource management capabilities, and general accounting
services), which can be applied usefully across a wide range of industry and business types.
CORE
CONCEPT
Related
diversification
involves sharing or
transferring
specialized
resources and
capabilities.
Specialized
resources and
capabilities have
very specific
applications and
their use is limited to
a restricted range of
industry and
business types, in
contrast to general
resources and
capabilities, which
can be widely
applied and can be
deployed across a
broad range of
industry and
business types.
L’Oréal is the world’s largest beauty products company, with almost $30 billion in revenues and a
successful strategy of related diversification built on leveraging a highly specialized set of resources
and capabilities. These include 18 dermatologic and cosmetic research centers, R&D capabilities
and scientific knowledge concerning skin and hair care, patents and secret formulas for hair and
skin care products, and robotic applications developed specifically for testing the safety of hair and
skin care products. These resources and capabilities are highly valuable for businesses focused on
products for human skin and hair—they are specialized to such applications, and, in consequence,
they are of little or no value beyond this restricted range of applications. To leverage these resources
in a way that maximizes their potential value, L’Oréal has diversified into cosmetics, hair care
products, skin care products, and fragrances (but not food, transportation, industrial services, or any
application area far from the narrow domain in which its specialized resources are competitively
relevant). L’Oréal’s businesses are related to one another on the basis of its value-generating
specialized resources and capabilities and the cross-business linkages among the value chain
activities that they enable.
Corning’s most competitively valuable resources and capabilities are specialized to applications
concerning fiber optics and specialty glass and ceramics. Over the course of its 165-year history, it
has developed an unmatched understanding of fundamental glass science and related technologies
in the field of optics. Its capabilities now span a variety of sophisticated technologies and include
expertise in domains such as custom glass composition, specialty glass melting and forming,
precision optics, high-end transmissive coatings, and optomechanical materials. Corning has
leveraged these specialized capabilities into a position of global leadership in five related market
segments: display technologies based on glass substrates; environmental technologies using ceramic
substrates and filters; optical communications, providing optical fiber, cable and connectivity
solutions; life sciences supporting research and drug discovery; and specialty materials employing
advanced optics and specialty glass solutions. The market segments into which Corning has
diversified are all related by their reliance on Corning’s specialized capability set and by the many
value chain activities that they have in common as a result.
General Mills has diversified into a closely related set of food businesses on the basis of its
capabilities in the realm of “kitchen chemistry” and food production technologies. Its four U.S.
retail divisions—meals and baking, cereal, snacks, and yogurt—include brands such as Old El Paso,
Cascadian Farm Lucky Charms and General Mills brand cereals, Nature Valley, Annie’s Organic,
Pillsbury and Betty Crocker, and Yoplait yogurt. Earlier it had diversified into restaurant businesses
on the mistaken notion that all food businesses were related. By exiting these businesses in the mid-
1990s, the company was able to improve its overall profitability and strengthen its position in its
remaining businesses. The lesson from its experience—and a takeaway for the managers of any
page 232
diversified company—is that it is not product relatedness that defines a well-crafted related
diversification strategy. Rather, the businesses must be related in terms of their key value chain
activities and the specialized resources and capabilities that enable these activities.7 An example is
Citizen Watch Company, whose products appear to be different (watches, machine tools, and flat
panel displays) but are related in terms of their common reliance on miniaturization know-how and
advanced precision technologies.
While companies pursuing related diversification strategies may also have opportunities to share
or transfer their general resources and capabilities (e.g., information systems; human
resource management practices; accounting and tax services; budgeting, planning, and
financial reporting systems; expertise in legal and regulatory affairs; and fringe-benefit management
systems), the most competitively valuable opportunities for resource sharing or transfer always
come from leveraging their specialized resources and capabilities. The reason for this is that
specialized resources and capabilities drive the key value-creating activities that both connect the
businesses (at points along their value chains where there is strategic fit) and link to the key success
factors in the markets where they are competitively relevant. Figure 8.1 illustrates the range of
opportunities to share and/or transfer specialized resources and capabilities among the value chain
activities of related businesses. It is important to recognize that even though general resources and
capabilities may be also shared by multiple business units, such resource sharing alone cannot form
the backbone of a strategy keyed to related diversification. Illustration Capsule 8.1 provides
examples of a few successful firms with related diversification strategies.
FIGURE 8.1 Related Businesses Provide Opportunities to Benefit from
Competitively Valuable Strategic Fit
Identifying Cross-Business Strategic Fit along the Value Chain
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Cross-business strategic fit can exist anywhere along the value chain—in R&D and technology
activities, in supply chain activities and relationships with suppliers, in manufacturing, in sales and
marketing, in distribution activities, or in customer service activities.8
ILLUSTRATION
CAPSULE 8.1 Examples of Companies Pursuing a Related
Diversification Strategy
INDITEX
Inditex began as a small family business making women’s clothing, but it has since evolved into one of the world’s
largest and most successful fashion retailers. The company is not just a retailer, however—it is involved with all
aspects of producing fashion: design, manufacture, distribution, and retail. Its growth has been driven by acquisition
as well as by internal growth and development. By 2020, Inditex included eight distinct brands or lines of business:
Zara, Zara Home, Pull&Bear, Massimo Dutti, Berksha (which includes the BSK and Man brands), Stradivarius,
Oysho (women’s lingerie, beachwear, and sport), and Uterqüe (accessories, leatherwear).
NEWS CORP
News Corp was created in 2013 when News Corporation was split into two independent companies: 21st Century
Fox and News Corp. This move allowed News Corp to focus on the newspaper and publishing businesses, while
21st Century Fox retained the other parts of News Corporation (mainly television and film). News Corp characterizes
itself today as a mass media company. The companies in its network include The New York Post, Harper Collins
Publishers, News Corp Australia, News UK, News America Marketing, Storyful (a social media newswire), Dow
Jones and Move (a provider of real estate information). News Corp Australia actually includes a broad portfolio of
national, metropolitan, regional, and community newspapers; while News UK has similar breadth. Despite the
general disruption in the newspaper industry due to Internet-related developments, News Corp recently announced
record-setting subscriber performances at Dow Jones and the Wall Street Journal—two of their most important
holdings.
KIMBERLY-CLARK CORPORATION
Kimberly-Clark is a Texas based multinational in the personal care industry, producing mostly paper-based
consumer products. Its products include iconic brands such as Kleenex, Huggies, Pull-Ups, Cottonelle, Scott, Viva,
Kotex, and Depend. The company has organized its products into five related lines of business: Adult Care, Baby
and Child Care, Family Care, Feminine Care, and K-C Professional. Its products are recognized and trusted around
the world—distributed across more than 175 countries. With its sharp focus on the consumer and financial discipline,
Kimberly-Clark has managed to sustain its record of solid performance and growth even during recessionary
periods, since the types of products it offers are always in demand. Its outlook for 2020 and beyond continues to
look rosy.
page 234
(top): Shutterstock/lentamart; (middle): Edith38/Shutterstock; (bottom): Neilson Barnard/Staff/Getty Images
Sources: Company websites, Wikipedia; https://www.businesswire.com/news/home/20200207005506/en/News-
Corp-Announces-Record-Setting-Subscriber-Performances-Dow; https://finance.yahoo.com/news/kimberly-
clarks-impressive-momentum-continue-130001056.html, accessed February 10, 2020.
Strategic Fit in Supply Chain Activities Businesses with strategic fit with respect to their
supply chain activities can perform better together because of the potential for transferring skills in
https://www.businesswire.com/news/home/20200207005506/en/News-Corp-Announces-Record-Setting-Subscriber-Performances-Dow
https://finance.yahoo.com/news/kimberly-clarks-impressive-momentum-continue-130001056.html
page 235
procuring materials, sharing resources and capabilities in logistics, collaborating with common
supply chain partners, and/or increasing leverage with shippers in securing volume discounts on
incoming parts and components. Dell’s strategic partnerships with leading suppliers of
microprocessors, circuit boards, disk drives, memory chips, flat-panel displays, wireless
capabilities, long-life batteries, and other PC-related components have been an important element of
the company’s strategy to diversify into servers, data storage devices, networking components,
plasma TVs, and printers—products that include many components common to PCs and that can be
sourced from the same strategic partners that provide Dell with PC components.
Strategic Fit in R&D and Technology Activities Businesses with strategic fit in R&D or
technology development perform better together than apart because of potential cost savings in
R&D, shorter times in getting new products to market, and more innovative products or processes.
Moreover, technological advances in one business can lead to increased sales for both.
Technological innovations have been the driver behind the efforts of cable TV companies to
diversify into high-speed Internet access (via the use of cable modems) and, further, to explore
providing local and long-distance telephone service to residential and commercial customers either
through a single wire or by means of Voice over Internet Protocol (VoIP) technology. These
diversification efforts have resulted in companies such as DISH Network and Comcast (through its
XFINITY subsidiary) offering TV, Internet, and phone bundles.
Manufacturing-Related Strategic Fit Cross-business strategic fit in manufacturing-related
activities can be exploited when a diversifier’s expertise in quality control and cost-efficient
production methods can be transferred to another business. When Emerson Electric diversified into
the chain-saw business, it transferred its expertise in low-cost manufacture to its newly acquired
Beaird-Poulan business division. The transfer drove Beaird-Poulan’s new strategy—to be the low-
cost provider of chainsaw products—and fundamentally changed the way Beaird-Poulan chain saws
were designed and manufactured. Another benefit of production-related value chain commonalities
is the ability to consolidate production into a smaller number of plants and significantly reduce
overall production costs. When snowmobile maker Bombardier diversified into motorcycles, it was
able to set up motorcycle assembly lines in the manufacturing facility where it was assembling
snowmobiles. When Smucker’s acquired Procter & Gamble’s Jif peanut butter business, it was able
to combine the manufacture of the two brands of peanut butter products while gaining greater
leverage with vendors in purchasing its peanut supplies.
Strategic Fit in Sales and Marketing Activities Various cost-saving opportunities spring from
diversifying into businesses with closely related sales and marketing activities. When the products
are sold directly to the same customers, sales costs can often be reduced by using a single sales
force instead of having two different salespeople call on the same customer. The products of related
businesses can be promoted at the same website and included in the same media ads and sales
brochures. There may be opportunities to reduce costs by consolidating order processing and billing
and by using common promotional tie-ins. When global power toolmaker Black & Decker acquired
Vector Products, it was able to use its own global sales force to sell the newly acquired
Vector power inverters, vehicle battery chargers, and rechargeable spotlights because the
types of customers that carried its power tools (discounters like Kmart, home centers, and hardware
stores) also stocked the types of products produced by Vector.
A second category of benefits arises when different businesses use similar sales and marketing
approaches. In such cases, there may be competitively valuable opportunities to transfer selling,
page 236
merchandising, advertising, and product differentiation skills from one business to another. Procter
& Gamble’s product lineup includes Pampers diapers, Olay beauty products, Tide laundry
detergent, Crest toothpaste, Charmin toilet tissue, Gillette razors and blades, Vicks cough and cold
products Oral-B toothbrushes, and Head & Shoulders shampoo. All of these have different
competitors and different supply chain and production requirements, but they all move through the
same wholesale distribution systems, are sold in common retail settings to the same shoppers, and
require the same marketing and merchandising skills.
Distribution-Related Strategic Fit Businesses with closely related distribution activities can
perform better together than apart because of potential cost savings in sharing the same distribution
facilities or using many of the same wholesale distributors and retail dealers. When Conair
Corporation acquired Allegro Manufacturing’s travel bag and travel accessory business, it was able
to consolidate its own distribution centers for hair dryers and curling irons with those of Allegro,
thereby generating cost savings for both businesses. Likewise, since Conair products and Allegro’s
neck rests, ear plugs, luggage tags, and toiletry kits were sold by the same types of retailers
(discount stores, supermarket chains, and drugstore chains), Conair was able to convince many of
the retailers not carrying Allegro products to take on the line.
Strategic Fit in Customer Service Activities Strategic fit with respect to customer service
activities can enable cost savings or differentiation advantages, just as it does along other points of
the value chain. For example, cost savings may come from consolidating after-sale service and
repair organizations for the products of closely related businesses into a single operation. Likewise,
different businesses can often use the same customer service infrastructure. For instance, an electric
utility that diversifies into natural gas, water, appliance repair services, and home security services
can use the same customer data network, the same call centers and local offices, the same billing
and accounting systems, and the same customer service infrastructure to support all of its products
and services. Through the transfer of best practices in customer service across a set of related
businesses or through the sharing of resources such as proprietary information about customer
preferences, a multibusiness company can also create a differentiation advantage through higher-
quality customer service.
Strategic Fit, Economies of Scope, and Competitive Advantage
Strategic fit in the value chain activities of a diversified corporation’s different businesses opens up
opportunities for economies of scope—a concept distinct from economies of scale. Economies of
scale are cost savings that accrue directly from a larger-sized operation—for example, unit costs
may be lower in a large plant than in a small plant. In contrast, economies of scope are cost savings
that flow from operating in multiple businesses (a larger scope of operation). They stem
directly from strategic fit along the value chains of related businesses, which in turn
enables the businesses to share resources or to transfer them from business to business at low cost.
Significant scope economies are open only to firms engaged in related diversification, since they are
the result of related businesses performing R&D together, transferring managers from one business
to another, using common manufacturing or distribution facilities, sharing a common sales force or
dealer network, using the same established brand name, and the like. The greater the cross-business
economies associated with resource sharing and transfer, the greater the potential for a related
diversification strategy to give the individual businesses of a multibusiness enterprise a cost
advantage over rivals.
CORE
CONCEPT
Economies of
scope are cost
reductions that flow
from operating in
multiple businesses
(a larger scope of
operation). This is in
contrast to
economies of scale,
which accrue from a
larger-sized
operation.
From Strategic Fit to Competitive Advantage, Added Profitability, and Gains in Shareholder
Value The cost advantage from economies of scope is due to the fact that resource sharing allows
a multibusiness firm to spread resource costs across its businesses and to avoid the expense of
having to acquire and maintain duplicate sets of resources—one for each business. But related
diversified companies can benefit from strategic fit in other ways as well.
Sharing or transferring valuable specialized assets among the company’s businesses can help
each business perform its value chain activities more proficiently. This translates into competitive
advantage for the businesses in one or two basic ways: (1) The businesses can contribute to greater
efficiency and lower costs relative to their competitors, and/or (2) they can provide a basis for
differentiation so that customers are willing to pay relatively more for the businesses’ goods and
services. In either or both of these ways, a firm with a well-executed related diversification strategy
can boost the chances of its businesses attaining a competitive advantage.
The greater the relatedness among a diversified company’s businesses, the bigger a company’s
window for converting strategic fit into competitive advantage. The strategic and business logic is
compelling: Capturing the benefits of strategic fit along the value chains of its related businesses
gives a diversified company a clear path to achieving competitive advantage over undiversified
competitors and competitors whose own diversification efforts don’t offer equivalent strategic-fit
benefits.9 Such competitive advantage potential provides a company with a dependable basis for
earning profits and a return on investment that exceeds what the company’s businesses could earn as
stand-alone enterprises. Converting the competitive advantage potential into greater profitability is
what fuels 1 + 1 = 3 gains in shareholder value—the necessary outcome for satisfying the better-off
test and proving the business merit of a company’s diversification effort.
Diversifying into
related businesses
where competitively
valuable strategic-fit
benefits can be
captured puts a
company’s
businesses in
position to perform
better financially as
part of the company
than they could have
performed as
independent
page 237
enterprises, thus
providing a clear
avenue for
increasing
shareholder value
and satisfying the
better-off test.
There are five things to bear in mind here:
1. Capturing cross-business strategic-fit benefits via a strategy of related diversification builds
shareholder value in ways that shareholders cannot undertake by simply owning a portfolio of
stocks of companies in different industries.
2. The capture of cross-business strategic-fit benefits is possible only via a strategy of related
diversification.
3. The greater the relatedness among a diversified company’s businesses, the bigger the company’s
window for converting strategic fit into competitive advantage for its businesses.
4. The benefits of cross-business strategic fit come from the transferring or sharing of competitively
valuable resources and capabilities among the businesses—resources and capabilities
that are specialized to certain applications and have value only in specific types of
industries and businesses.
5. The benefits of cross-business strategic fit are not automatically realized when a company
diversifies into related businesses; the benefits materialize only after management has
successfully pursued internal actions to capture them.
ILLUSTRATION
CAPSULE 8.2 The Kraft–Heinz Merger: Pursuing the
Benefits of Cross-Business Strategic Fit
The $62.6 billion merger between Kraft and Heinz that was finalized in the summer of 2015 created the third largest
food and beverage company in North America and the fifth largest in the world. It was a merger predicated on the
idea that the strategic fit between these two companies was such that they could create more value as a combined
enterprise than they could as two separate companies. As a combined enterprise, Kraft Heinz would be able to
exploit its cross-business value chain activities and resource similarities to more efficiently produce, distribute, and
sell profitable processed food products.
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Hayden Stirling/Shutterstock
Kraft and Heinz products share many of the same raw materials (milk, sugar, salt, wheat, etc.), which allows the
new company to leverage its increased bargaining power as a larger business to get better deals with suppliers,
using strategic fit in supply chain activities to achieve lower input costs and greater inbound efficiencies. Moreover,
because both of these brands specialized in prepackaged foods, there is ample manufacturing-related strategic fit in
production processes and packaging technologies that allow the new company to trim and streamline manufacturing
operations.
Their distribution-related strategic fit will allow for the complete integration of distribution channels and
transportation networks, resulting in greater outbound efficiencies and a reduction in travel time for products moving
from factories to stores. The Kraft Heinz Company is currently looking to leverage Heinz’s global platform to expand
Kraft’s products internationally. By utilizing Heinz’s already highly developed global distribution network and brand
familiarity (key specialized resources), Kraft can more easily expand into the global market of prepackaged and
processed food. Because these two brands are sold at similar types of retail stores (supermarket chains, wholesale
retailers, and local grocery stores), they are now able to claim even more shelf space with the increased bargaining
power of the combined company.
Strategic fit in sales and marketing activities will allow the company to develop coordinated and more effective
advertising campaigns. Toward this aim, the Kraft Heinz Company is moving to consolidate its marketing capabilities
under one marketing firm. Also, by combining R&D teams, the Kraft Heinz Company could come out with innovative
products that may appeal more to the growing number of on-the-go and health-conscious buyers in the market.
Many of these potential and predicted synergies for the Kraft Heinz Company have yet to be realized, since merger
integration activities always take time.
Note: Developed with Maria Hart.
Sources: www.forbes.com/sites/paulmartyn/2015/03/31/heinz-and-kraft-merger-makes-supply-management-
sense/; fortune.com/2015/03/25/kraft-mess-how-heinz-deal-helps/;
www.nytimes.com/2015/03/26/business/dealbook/kraft-and-heinz-to-merge.html?_r=2; company websites
(accessed December 3, 2015).
Illustration Capsule 8.2 describes the merger of Kraft Foods Group, Inc. with the H. J. Heinz
Holding Corporation, in pursuit of the strategic-fit benefits of a related diversification strategy.
DIVERSIFICATION INTO UNRELATED
BUSINESSES
http://www.forbes.com/sites/paulmartyn/2015/03/31/heinz-and-kraft-merger-makes-supply-management-sense/
http://fortune.com/2015/03/25/kraft-mess-how-heinz-deal-helps/
• LO 8-3
Identify the merits
and risks of
unrelated
diversification
strategies.
Achieving cross-business strategic fit is not a motivation for unrelated diversification. Companies
that pursue a strategy of unrelated diversification often exhibit a willingness to diversify into any
business in any industry where senior managers see an opportunity to realize consistently good
financial results. Such companies are frequently labeled conglomerates because their business
interests range broadly across diverse industries. Companies engaged in unrelated diversification
nearly always enter new businesses by acquiring an established company rather than by forming a
startup subsidiary within their own corporate structures or participating in joint ventures.
With a strategy of unrelated diversification, an acquisition is deemed to have potential if it passes
the industry-attractiveness and cost of entry tests and if it has good prospects for attractive financial
performance. Thus, with an unrelated diversification strategy, company managers spend much time
and effort screening acquisition candidates and evaluating the pros and cons of keeping or divesting
existing businesses, using such criteria as
A willingness to
diversify into any
business in any
industry is unlikely to
result in successful
unrelated
diversification. The
key to success even
for unrelated
diversification is to
create economic
value for
shareholders.
Whether the business can meet corporate targets for profitability and return on investment.
Whether the business is in an industry with attractive growth potential.
Whether the business is big enough to contribute significantly to the parent firm’s bottom line.
But the key to successful unrelated diversification is to go beyond these considerations and
ensure that the strategy passes the better-off test as well. This test requires more than just growth in
revenues; it requires growth in profits—beyond what could be achieved by a mutual fund or a
holding company that owns shares of the businesses without adding any value. Unless the
combination of businesses is more profitable together under the corporate umbrella than they are
apart as independent businesses, the strategy cannot create economic value for shareholders. And
unless it does so, there is no real justification for unrelated diversification, since top executives
have a fiduciary responsibility to maximize long-term shareholder value for the company’s owners
(its shareholders). Illustration Capsule 8.3 provides some examples of successful companies with
unrelated diversification.
page 239
Building Shareholder Value via Unrelated Diversification
Given the absence of cross-business strategic fit with which to create competitive advantages,
building shareholder value via unrelated diversification ultimately hinges on the ability of the parent
company to improve its businesses (and make the combination better off ) via other means. Critical
to this endeavor is the role that the parent company plays as a corporate parent.10 To the extent that
a company has strong parenting capabilities—capabilities that involve nurturing, guiding,
grooming, and governing constituent businesses—a corporate parent can propel its businesses
forward and help them gain ground over their market rivals. Corporate parents also contribute to the
competitiveness of their unrelated businesses by sharing or transferring general resources and
capabilities across the businesses—competitive assets that have utility in any type of industry and
that can be leveraged across a wide range of business types as a result. Examples of the kinds of
general resources that a corporate parent leverages in unrelated diversification include the
corporation’s reputation, credit rating, and access to financial markets; governance
mechanisms; management training programs; a corporate ethics program; a central data
and communications center; shared administrative resources such as public relations and legal
services; and common systems for functions such as budgeting, financial reporting, and quality
control.
ILLUSTRATION
CAPSULE 8.3 Examples of Companies Pursuing an
Unrelated Diversification Strategy
Tata
The Tata group is a global enterprise with total revenues exceeding $115 billion in 2020. It is organized into 11
“verticals,” which are essentially industry domains. The verticals include Information Technology, Steel, Automotive,
Consumer and Retail, Infrastructure, Financial Services, Aerospace and Defense, Tourism and Travel, Telecom and
Media, and Trading and Investments. Within these 11 verticals are 30 or more independently managed companies.
The most well-known of these include: Tata Motors, Tata Steel, Tata Chemicals, Titan (jewelry and eyewear), Tata
Power, Tata Communications, Tata Consumer Products, Tata Capital, Tata Consultancy Services, and Indian Hotels.
Berkshire Hathaway
Berkshire Hathaway is an American conglomerate with a long and successful history, often attributed to the sage
investment and acquisition strategy of its Chairman and CEO, Warren Buffet. Its holdings include an insurance
group, an energy group, a financial products group, and a diverse group covering manufacturing, service, and
retailing. Companies that are wholly owned by Berkshire Hathaway include GEICO, Dairy Queen, Duracell, Fruit of
the Loom, Burlington Northern Sante Fe Railway, and Helzberg Diamonds. It owns a significant share of a number of
other companies, including Bank of America, Southwest Airlines, Kraft Heinz, American Express, and Coca Cola.
Yamaha Corporation
The Yamaha Corporation no longer includes Yamaha Motor Co. (the motorcycle, snowmobile, boat, and motorized
product maker), although it is still a major shareholder. But even without Yamaha Motor, the Yamaha Corporation still
produces a wide array of products. It is the world’s largest producer of all types of musical instruments, along with
arguably related audio equipment and communication devices. But, in addition, it is involved in the production of
industrial robots, home appliances, sporting goods, industrial machinery and components, specialty metals, golf
products, resorts, and semiconductors.
page 240
(top left): The India Today Group/Contributor/Getty Images; (top right): Ranta Images/Shutterstock; (bottom):
Gwenael_LE_VOT/Getty Images
Sources: Company websites, Wikipedia, accessed February 14, 2020.
The Benefits of Astute Corporate Parenting One of the most important ways that corporate
parents contribute to the success of their businesses is by offering high-level oversight and
guidance.11 The top executives of a large diversified corporation have among them many years of
accumulated experience in a variety of business settings and can often contribute expert problem-
solving skills, creative strategy suggestions, and first-rate advice and guidance on how to improve
competitiveness and financial performance to the heads of the company’s various business
subsidiaries. This is especially true in the case of newly acquired, smaller businesses. Particularly
astute high-level guidance from corporate executives can help the subsidiaries perform better than
they would otherwise be able to do through the efforts of the business unit heads alone. The
outstanding leadership of Royal Little, the founder of Textron, was a major reason that the company
became an exemplar of the unrelated diversification strategy while he was CEO. Little’s bold moves
transformed the company from its origins as a small textile manufacturer into a global powerhouse
known for its Bell helicopters, Cessna aircraft, and a host of other strong brands in a wide array of
industries. Norm Wesley, a former CEO of the conglomerate Fortune Brands, is similarly credited
with driving the sharp rise in the company’s stock price while he was at the helm. Under his
leadership, Fortune Brands became the $7 billion maker of products ranging from spirits (e.g., Jim
Beam bourbon and rye, Gilbey’s gin and vodka, Courvoisier cognac) to golf products (e.g., Titleist
golf balls and clubs, FootJoy golf shoes and apparel, Scotty Cameron putters) to hardware (e.g.,
Moen faucets, American Lock security devices). (Fortune Brands has since been converted into two
separate entities, Beam Inc. and Fortune Brands Home & Security.)
Corporate parents can also create added value for their businesses by providing them with other
types of general resources that lower the operating costs of the individual businesses or that enhance
their operating effectiveness. The administrative resources located at a company’s corporate
headquarters are a prime example. They typically include legal services, accounting expertise and
tax services, and other elements of the administrative infrastructure, such as risk management
capabilities, information technology resources, and public relations capabilities. Providing
individual businesses with general support resources such as these creates value by lowering
companywide overhead costs, since each business would otherwise have to duplicate the centralized
activities.
CORE
CONCEPT
Corporate
parenting refers to
the role that a
diversified
corporation plays in
nurturing its
component
businesses through
the provision of top
management
expertise,
disciplined control,
financial resources,
and other types of
general resources
and capabilities
such as long-term
planning systems,
business
development skills,
management
development
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processes, and
incentive systems.
Corporate brands that do not connote any specific type of product are another type of general
corporate resource that can be shared among unrelated businesses. General Electric, for example,
successfully applied its GE brand to such unrelated products and businesses as medical products
and health care (GE Healthcare), jet engines (GE Aviation), and power and water technologies (GE
Power and Water). Corporate brands that are applied in this fashion are sometimes called umbrella
brands. Utilizing a well-known corporate name (GE) in a diversified company’s individual
businesses has the potential not only to lower costs (by spreading the fixed cost of developing and
maintaining the brand over many businesses) but also to enhance each business’s customer value
proposition by linking its products to a name that consumers trust. In similar fashion, a
corporation’s reputation for well-crafted products, for product reliability, or for trustworthiness can
lead to greater customer willingness to purchase the products of a wider range of a
diversified company’s businesses. Incentive systems, financial control systems, and a
company’s culture are other types of general corporate resources that may prove useful in enhancing
the daily operations of a diverse set of businesses. The parenting activities of corporate executives
may also include recruiting and hiring talented managers to run individual businesses.
An umbrella brand
is a corporate brand
name that can be
applied to a wide
assortment of
business types. As
such, it is a type of
general resource
that can be
leveraged in
unrelated
diversification.
We discuss two other commonly employed ways for corporate parents to add value to their
unrelated businesses next.
Judicious Cross-Business Allocation of Financial Resources By reallocating surplus cash
flows from some businesses to fund the capital requirements of other businesses—in essence,
having the company serve as an internal capital market—corporate parents may also be able to
create value. Such actions can be particularly important in times when credit is unusually tight (such
as in the wake of the worldwide banking crisis that began in 2008) or in economies with less well
developed capital markets. Under these conditions, with strong financial resources a corporate
parent can add value by shifting funds from business units generating excess cash (more than they
need to fund their own operating requirements and new capital investment opportunities) to other,
cash-short businesses with appealing growth prospects. A parent company’s ability to function as its
own internal capital market enhances overall corporate performance and increases shareholder value
to the extent that (1) its top managers have better access to information about investment
opportunities internal to the firm than do external financiers or (2) it can provide funds that would
otherwise be unavailable due to poor financial market conditions.
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Acquiring and Restructuring Undervalued Companies Another way for parent companies to
add value to unrelated businesses is by acquiring weakly performing companies at a bargain price
and then restructuring their operations in ways that produce sometimes dramatic increases in
profitability. Restructuring refers to overhauling and streamlining the operations of a business—
combining plants with excess capacity, selling off underutilized assets, reducing unnecessary
expenses, revamping its product offerings, consolidating administrative functions to reduce
overhead costs, and otherwise improving the operating efficiency and profitability of a company.
Restructuring generally involves transferring seasoned managers to the newly acquired business,
either to replace the top layers of management or to step in temporarily until the business is returned
to profitability or is well on its way to becoming a major market contender.
CORE
CONCEPT
Restructuring
refers to overhauling
and streamlining the
activities of a
business—
combining plants
with excess
capacity, selling off
underutilized assets,
reducing
unnecessary
expenses, and
otherwise improving
the productivity and
profitability of a
company.
Restructuring is often undertaken when a diversified company acquires a new business that is
performing well below levels that the corporate parent believes are achievable. Diversified
companies that have proven turnaround capabilities in rejuvenating weakly performing companies
can often apply these capabilities in a relatively wide range of unrelated industries. Newell Brands
(whose diverse product line includes Rubbermaid food storage, Sharpie pens, Graco strollers and
car seats, Goody hair accessories, Calphalon cookware, and Yankee Candle—all businesses with
different value chain activities) developed such a strong set of turnaround capabilities that the
company was said to “Newellize” the businesses it acquired.
Successful unrelated diversification strategies based on restructuring require the parent company
to have considerable expertise in identifying underperforming target companies and in negotiating
attractive acquisition prices so that each acquisition passes the cost of entry test. The capabilities in
this regard of Lord James Hanson and Lord Gordon White, who headed up the storied British
conglomerate Hanson Trust, played a large part in Hanson Trust’s impressive record of profitability.
The Path to Greater Shareholder Value through Unrelated
Diversification
For a strategy of unrelated diversification to produce companywide financial results above and
beyond what the businesses could generate operating as standalone entities, corporate executives
must do three things to pass the three Tests of Corporate Advantage:
1. Diversify into industries where the businesses can produce consistently good earnings and returns
on investment (to satisfy the industry-attractiveness test).
2. Negotiate favorable acquisition prices (to satisfy the cost of entry test).
3. Do a superior job of corporate parenting via high-level managerial oversight and resource
sharing, financial resource allocation and portfolio management, and/or the restructuring of
underperforming businesses (to satisfy the better-off test).
The best corporate parents understand the nature and value of the kinds of resources at their
command and know how to leverage them effectively across their businesses. Those that are able to
create more value in their businesses than other diversified companies have what is called a
parenting advantage. When a corporation has a parenting advantage, its top executives have the
best chance of being able to craft and execute an unrelated diversification strategy that can satisfy
all three Tests of Corporate Advantage and truly enhance long-term economic shareholder value.
CORE
CONCEPT
A diversified
company has a
parenting
advantage when it
is more able than
other companies to
boost the combined
performance of its
individual
businesses through
high-level guidance,
general oversight,
and other corporate-
level contributions.
The Drawbacks of Unrelated Diversification
Unrelated diversification strategies have two important negatives that undercut the pluses: very
demanding managerial requirements and limited competitive advantage potential.
Demanding Managerial Requirements Successfully managing a set of fundamentally different
businesses operating in fundamentally different industry and competitive environments is a
challenging and exceptionally difficult proposition.12 Consider, for example, that corporations like
General Electric, ITT, Mitsubishi, and Bharti Enterprises have dozens of business subsidiaries
making hundreds and sometimes thousands of products. While headquarters executives can glean
information about an industry from third-party sources, ask lots of questions when making
occasional visits to the operations of the different businesses, and do their best to learn about the
company’s different businesses, they still remain heavily dependent on briefings from business unit
heads and on “managing by the numbers”—that is, keeping a close track on the financial and
operating results of each subsidiary. Managing by the numbers works well enough when business
conditions are normal and the heads of the various business units are capable of consistently
meeting their numbers. But problems arise if things start to go awry in a business and corporate
management has to get deeply involved in the problems of a business it does not know much about.
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Because every business tends to encounter rough sledding at some juncture, unrelated
diversification is thus a somewhat risky strategy from a managerial perspective.13 Just one or two
unforeseen problems or big strategic mistakes—which are much more likely without close
corporate oversight—can cause a precipitous drop in corporate earnings and crash the parent
company’s stock price.
Hence, competently overseeing a set of widely diverse businesses can turn out to be much harder
than it sounds. In practice, comparatively few companies have proved that they have
top-management capabilities that are up to the task. There are far more companies
whose corporate executives have failed at delivering consistently good financial results with an
unrelated diversification strategy than there are companies with corporate executives who have been
successful.14 Unless a company truly has a parenting advantage, the odds are that the result of
unrelated diversification will be 1 + 1 = 2 or even less.
Limited Competitive Advantage Potential The second big negative is that unrelated
diversification offers only a limited potential for competitive advantage beyond what each
individual business can generate on its own. Unlike a related diversification strategy, unrelated
diversification provides no cross-business strategic-fit benefits that allow each business to perform
its key value chain activities in a more efficient and effective manner. A cash-rich corporate parent
pursuing unrelated diversification can provide its subsidiaries with much-needed capital, may
achieve economies of scope in activities relying on general corporate resources, may extend an
umbrella brand and may even offer some managerial know-how to help resolve problems in
particular business units, but otherwise it has little to add in the way of enhancing the competitive
strength of its individual business units. In comparison to the highly specialized resources that
facilitate related diversification, the general resources that support unrelated diversification tend to
be relatively low value, for the simple reason that they are more common. Unless they are of
exceptionally high quality (such as GE’s world-renowned general management capabilities and
umbrella brand or Newell Rubbermaid’s turnaround capabilities), resources and capabilities that are
general in nature are less likely to provide a significant source of competitive advantage for the
businesses of diversified companies. Without the competitive advantage potential of strategic fit in
competitively important value chain activities, consolidated performance of an unrelated group of
businesses may not be very much more than the sum of what the individual business units could
achieve if they were independent, in most circumstances.
Relying solely on
leveraging general
resources and the
expertise of
corporate executives
to wisely manage a
set of unrelated
businesses is a
much weaker
foundation for
enhancing
shareholder value
than is a strategy of
related
diversification.
Misguided Reasons for Pursuing Unrelated Diversification
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Companies sometimes pursue unrelated diversification for reasons that are entirely misguided.
These include the following:
Risk reduction. Spreading the company’s investments over a set of diverse industries to spread
risk cannot create long-term shareholder value since the company’s shareholders can more
flexibly (and more efficiently) reduce their exposure to risk by investing in a diversified portfolio
of stocks and bonds.
Growth. While unrelated diversification may enable a company to achieve rapid or continuous
growth, firms that pursue growth for growth’s sake are unlikely to maximize shareholder value.
Only profitable growth—the kind that comes from creating added value for shareholders—can
justify a strategy of unrelated diversification.
Stabilization. Managers sometimes pursue broad diversification in the hope that market
downtrends in some of the company’s businesses will be partially offset by cyclical upswings in
its other businesses, thus producing somewhat less earnings volatility. In actual practice, however,
there’s no convincing evidence that the consolidated profits of firms with unrelated diversification
strategies are more stable or less subject to reversal in periods of recession and economic stress
than the profits of firms with related diversification strategies.
Managerial motives. Unrelated diversification can provide benefits to managers such as
higher compensation (which tends to increase with firm size and degree of
diversification) and reduced their unemployment risk. Pursuing diversification for these reasons
will likely reduce shareholder value and violate managers’ fiduciary responsibilities.
Because unrelated diversification strategies at their best have only a limited potential for creating
long-term economic value for shareholders, it is essential that managers not compound this problem
by taking a misguided approach toward unrelated diversification, in pursuit of objectives that are
more likely to destroy shareholder value than create it.
Only profitable
growth—the kind
that comes from
creating added
value for
shareholders—can
justify a strategy of
unrelated
diversification.
COMBINATION RELATED–UNRELATED
DIVERSIFICATION STRATEGIES
There’s nothing to preclude a company from diversifying into both related and unrelated businesses.
Indeed, in actual practice the business makeup of diversified companies varies considerably. Some
diversified companies are really dominant-business enterprises—one major “core” business
accounts for 50 to 80 percent of total revenues and a collection of small related or unrelated
businesses accounts for the remainder. Some diversified companies are narrowly diversified around
a few (two to five) related or unrelated businesses. Others are broadly diversified around a wide-
ranging collection of related businesses, unrelated businesses, or a mixture of both. A number of
multibusiness enterprises have diversified into unrelated areas but have a collection of related
businesses within each area—thus giving them a business portfolio consisting of several unrelated
groups of related businesses. There’s ample room for companies to customize their diversification
strategies to incorporate elements of both related and unrelated diversification, as may suit their
own competitive asset profile and strategic vision. Combination related–unrelated diversification
strategies have particular appeal for companies with a mix of valuable competitive assets, covering
the spectrum from general to specialized resources and capabilities.
Figure 8.2 shows the range of alternatives for companies pursuing diversification.
FIGURE 8.2 Three Strategy Options for Pursuing Diversification
EVALUATING THE STRATEGY OF A DIVERSIFIED
COMPANY
• LO 8-4
Use the analytic
tools for evaluating a
company’s
diversification
strategy.
Strategic analysis of diversified companies builds on the concepts and methods used for single-
business companies. But there are some additional aspects to consider and a couple of new analytic
tools to master. The procedure for evaluating the pluses and minuses of a diversified company’s
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strategy and deciding what actions to take to improve the company’s performance involves six
steps:
1. Assessing the attractiveness of the industries the company has diversified into, both individually
and as a group.
2. Assessing the competitive strength of the company’s business units and drawing a nine-cell
matrix to simultaneously portray industry attractiveness and business unit competitive strength.
3. Evaluating the extent of cross-business strategic fit along the value chains of the
company’s various business units.
4. Checking whether the firm’s resources fit the requirements of its present business lineup.
5. Ranking the performance prospects of the businesses from best to worst and determining what
the corporate parent’s priorities should be in allocating resources to its various businesses.
6. Crafting new strategic moves to improve overall corporate performance.
The core concepts and analytic techniques underlying each of these steps merit further
discussion.
Step 1: Evaluating Industry Attractiveness
A principal consideration in evaluating the caliber of a diversified company’s strategy is the
attractiveness of the industries in which it has business operations. Several questions arise:
1. Does each industry the company has diversified into represent a good market for the company to
be in—does it pass the industry-attractiveness test?
2. Which of the company’s industries are most attractive, and which are least attractive?
3. How appealing is the whole group of industries in which the company has invested?
The more attractive the industries (both individually and as a group) that a diversified company is
in, the better its prospects for good long-term performance.
Calculating Industry-Attractiveness Scores A simple and reliable analytic tool for gauging
industry attractiveness involves calculating quantitative industry-attractiveness scores based on the
following measures:
Market size and projected growth rate. Big industries are more attractive than small industries,
and fast-growing industries tend to be more attractive than slow-growing industries, other things
being equal.
The intensity of competition. Industries where competitive pressures are relatively weak are more
attractive than industries where competitive pressures are strong.
Emerging opportunities and threats. Industries with promising opportunities and minimal threats
on the near horizon are more attractive than industries with modest opportunities and imposing
threats.
The presence of cross-industry strategic fit. The more one industry’s value chain and resource
requirements match up well with the value chain activities of other industries in which the
company has operations, the more attractive the industry is to a firm pursuing related
diversification. However, cross-industry strategic fit is not something that a company committed
to a strategy of unrelated diversification considers when it is evaluating industry attractiveness.
Resource requirements. Industries in which resource requirements are within the company’s reach
are more attractive than industries in which capital and other resource requirements could strain
corporate financial resources and organizational capabilities.
Social, political, regulatory, and environmental factors. Industries that have significant problems
in such areas as consumer health, safety, or environmental pollution or those subject to intense
regulation are less attractive than industries that do not have such problems.
Industry profitability. Industries with healthy profit margins and high rates of return on investment
are generally more attractive than industries with historically low or unstable profits.
Each attractiveness measure is then assigned a weight reflecting its relative importance in
determining an industry’s attractiveness, since not all attractiveness measures are equally important.
The intensity of competition in an industry should nearly always carry a high weight (say, 0.20 to
0.30). Strategic-fit considerations should be assigned a high weight in the case of companies with
related diversification strategies; but for companies with an unrelated diversification strategy,
strategic fit with other industries may be dropped from the list of attractiveness measures altogether.
The importance weights must add up to 1.
Finally, each industry is rated on each of the chosen industry-attractiveness measures, using a
rating scale of 1 to 10 (where a high rating signifies high attractiveness, and a low rating signifies
low attractiveness). Keep in mind here that the more intensely competitive an industry is, the lower
the attractiveness rating for that industry. Likewise, the more the resource requirements associated
with being in a particular industry are beyond the parent company’s reach, the lower the
attractiveness rating. On the other hand, the presence of good cross-industry strategic fit should be
given a very high attractiveness rating, since there is good potential for competitive advantage and
added shareholder value. Weighted attractiveness scores are then calculated by multiplying the
industry’s rating on each measure by the corresponding weight. For example, a rating of 8 times a
weight of 0.25 gives a weighted attractiveness score of 2. The sum of the weighted scores for all the
attractiveness measures provides an overall industry-attractiveness score. This procedure is
illustrated in Table 8.1.
TABLE 8.1 Calculating Weighted Industry-Attractiveness Scores
Industry-Attractiveness Measure
Industry A Industry B Industry C
Industry-
Attractiveness
Assessments
Importance
Weight
Attractiveness
Rating*
Weighted
Score
Attractiveness
Rating*
Weighted
Score
Attractiveness
Rating*
Weighted
Score
Market size and
projected growth
rate
0.10 8 0.80 3 0.30 5 0.50
Intensity of
competition 0.25 8 2.00 2 0.50 5 1.25
Emerging
opportunities and
threats
0.10 6 0.60 5 0.50 4 0.40
Cross-industry
strategic fit 0.30 8 2.40 2 0.60 3 0.90
Resource
requirements 0.10 5 0.50 5 0.50 4 0.40
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Industry-Attractiveness Measure
Industry A Industry B Industry C
Industry-
Attractiveness
Assessments
Importance
Weight
Attractiveness
Rating*
Weighted
Score
Attractiveness
Rating*
Weighted
Score
Attractiveness
Rating*
Weighted
Score
Social, political,
regulatory, and
environmental
factors
0.05 8 0.40 3 0.15 7 1.05
Industry
profitability
0.10 5 0.50 4 0.40 6 0.60
Sum of
importance
weights
1.00
Weighted overall
industry-
attractiveness
scores
7.20 2.95 5.10
*Rating scale: 1 = very unattractive to company; 10 = very attractive to company.
Interpreting the Industry-Attractiveness Scores Industries with a score much below 5
probably do not pass the attractiveness test. If a company’s industry-attractiveness scores are all
above 5, it is probably fair to conclude that the group of industries the company operates in is
attractive as a whole. But the group of industries takes on a decidedly lower degree of attractiveness
as the number of industries with scores below 5 increases, especially if industries with low scores
account for a sizable fraction of the company’s revenues.
For a diversified company to be a strong performer, a substantial portion of its revenues and
profits must come from business units with relatively high attractiveness scores. It is particularly
important that a diversified company’s principal businesses be in industries with a good outlook for
growth and above-average profitability. Having a big fraction of the company’s
revenues and profits come from industries with slow growth, low profitability, intense
competition, or other troubling conditions tends to drag overall company performance down.
Business units in the least attractive industries are potential candidates for divestiture, unless they
are positioned strongly enough to overcome the unattractive aspects of their industry environments
or they are a strategically important component of the company’s business makeup.
Step 2: Evaluating Business Unit Competitive Strength
The second step in evaluating a diversified company is to appraise the competitive strength of each
business unit in its respective industry. Doing an appraisal of each business unit’s strength and
competitive position in its industry not only reveals its chances for success in its industry but also
provides a basis for ranking the units from competitively strongest to competitively weakest and
sizing up the competitive strength of all the business units as a group.
Calculating Competitive-Strength Scores for Each Business Unit Quantitative measures of
each business unit’s competitive strength can be calculated using a procedure similar to that for
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measuring industry attractiveness. The following factors are used in quantifying the competitive
strengths of a diversified company’s business subsidiaries:
Relative market share. A business unit’s relative market share is defined as the ratio of its market
share to the market share held by the largest rival firm in the industry, with market share
measured in unit volume, not dollars. For instance, if business A has a market-leading share of 40
percent and its largest rival has 30 percent, A’s relative market share is 1.33. (Note that only
business units that are market share leaders in their respective industries can have relative market
shares greater than 1.) If business B has a 15 percent market share and B’s largest rival has 30
percent, B’s relative market share is 0.5. The further below 1 a business unit’s relative market
share is, the weaker its competitive strength and market position vis-à-vis rivals.
Costs relative to competitors’ costs. Business units that have low costs relative to those of key
competitors tend to be more strongly positioned in their industries than business units struggling
to maintain cost parity with major rivals. The only time a business unit’s competitive strength
may not be undermined by having higher costs than rivals is when it has incurred the higher costs
to strongly differentiate its product offering and its customers are willing to pay premium prices
for the differentiating features.
Ability to match or beat rivals on key product attributes. A company’s competitiveness depends in
part on being able to satisfy buyer expectations with regard to features, product performance,
reliability, service, and other important attributes.
Brand image and reputation. A widely known and respected brand name is a valuable
competitive asset in most industries.
Other competitively valuable resources and capabilities. Valuable resources and capabilities,
including those accessed through collaborative partnerships, enhance a company’s ability to
compete successfully and perhaps contend for industry leadership.
Ability to benefit from strategic fit with other business units. Strategic fit with other
businesses within the company enhances a business unit’s competitive strength and may
provide a competitive edge.
Ability to exercise bargaining leverage with key suppliers or customers. Having bargaining
leverage signals competitive strength and can be a source of competitive advantage.
Profitability relative to competitors. Above-average profitability on a consistent basis is a signal
of competitive advantage, whereas consistently below-average profitability usually denotes
competitive disadvantage.
After settling on a set of competitive-strength measures that are well matched to the
circumstances of the various business units, the company needs to assign weights indicating each
measure’s importance. As in the assignment of weights to industry-attractiveness measures, the
importance weights must add up to 1. Each business unit is then rated on each of the chosen
strength measures, using a rating scale of 1 to 10 (where a high rating signifies competitive strength,
and a low rating signifies competitive weakness). In the event that the available information is too
limited to confidently assign a rating value to a business unit on a particular strength measure, it is
usually best to use a score of 5—this avoids biasing the overall score either up or down. Weighted
strength ratings are calculated by multiplying the business unit’s rating on each strength measure by
the assigned weight. For example, a strength score of 6 times a weight of 0.15 gives a weighted
strength rating of 0.90. The sum of the weighted ratings across all the strength measures provides a
quantitative measure of a business unit’s overall competitive strength. Table 8.2 provides sample
calculations of competitive-strength ratings for three businesses.
TABLE 8.2 Calculating Weighted Competitive-Strength Scores for a Diversified
Company’s Business Units
Competitive-Strength Measures
Business A in Industry A Business B in Industry B Business C inIndustry C
Competitive-Strength
Measures
Importance
Weight
Strength
Rating*
Weighted
Score
Strength
Rating*
Weighted
Score
Strength
Rating*
Weighted
Score
Relative market
share 0.15 10 1.50 2 0.30 6 0.90
Costs relative to
competitors’ costs 0.20 7 1.40 4 0.80 5 1.00
Ability to match or
beat rivals on key
product attributes
0.05 9 0.45 5 0.25 8 0.40
Ability to benefit from
strategic fit with sister
businesses
0.20 8 1.60 4 0.80 8 0.80
Bargaining leverage
with
suppliers/customers
0.05 9 0.45 2 0.10 6 0.30
Brand image and
reputation 0.10 9 0.90 4 0.40 7 0.70
Other valuable
resources/capabilities 0.15 7 1.05 2 0.30 5 0.75
Profitability relative to
competitors
0.10 5 0.50 2 0.20 4 0.40
Sum of importance
weights 1.00
Weighted overall
competitive
strength scores
7.85 3.15 5.25
*Rating scale: 1 = very weak; 10 = very strong.
Interpreting the Competitive-Strength Scores Business units with competitive-strength ratings
above 6.7 (on a scale of 1 to 10) are strong market contenders in their industries. Businesses with
ratings in the 3.3-to-6.7 range have moderate competitive strength vis-à-vis rivals. Businesses with
ratings below 3.3 have a competitively weak standing in the marketplace. If a diversified company’s
business units all have competitive-strength scores above 5, it is fair to conclude that its business
units are all fairly strong market contenders in their respective industries. But as the number of
business units with scores below 5 increases, there’s reason to question whether the company can
perform well with so many businesses in relatively weak competitive positions. This concern takes
on even more importance when business units with low scores account for a sizable fraction of the
company’s revenues.
Using a Nine-Cell Matrix to Simultaneously Portray Industry Attractiveness and Competitive
Strength The industry-attractiveness and business-strength scores can be used to portray the
strategic positions of each business in a diversified company. Industry attractiveness is plotted on
the vertical axis and competitive strength on the horizontal axis. A nine-cell grid emerges from
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dividing the vertical axis into three regions (high, medium, and low attractiveness) and the
horizontal axis into three regions (strong, average, and weak competitive strength). As shown in
Figure 8.3, scores of 6.7 or greater on a rating scale of 1 to 10 denote high industry attractiveness,
scores of 3.3 to 6.7 denote medium attractiveness, and scores below 3.3 signal low attractiveness.
Likewise, high competitive strength is defined as scores greater than 6.7, average strength as scores
of 3.3 to 6.7, and low strength as scores below 3.3. Each business unit is plotted on the
nine-cell matrix according to its overall attractiveness score and strength score, and then
it is shown as a “bubble.” The size of each bubble is scaled to the percentage of revenues the
business generates relative to total corporate revenues. The bubbles in Figure 8.3 were located on
the grid using the three industry-attractiveness scores from Table 8.1 and the strength scores for the
three business units in Table 8.2.
FIGURE 8.3 A Nine-Cell Industry-Attractiveness–Competitive-Strength Matrix
The locations of the business units on the attractiveness–strength matrix provide valuable
guidance in deploying corporate resources. Businesses positioned in the three cells in the upper left
portion of the attractiveness–strength matrix (like business A) have both favorable industry
attractiveness and competitive strength.
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Next in priority come businesses positioned in the three diagonal cells stretching from the lower
left to the upper right (like business C). Such businesses usually merit intermediate priority in the
parent’s resource allocation ranking. However, some businesses in the medium-priority
diagonal cells may have brighter or dimmer prospects than others. For example, a small
business in the upper right cell of the matrix, despite being in a highly attractive industry, may
occupy too weak a competitive position in its industry to justify the investment and resources
needed to turn it into a strong market contender.
Businesses in the three cells in the lower right corner of the matrix (like business B) have
comparatively low industry attractiveness and minimal competitive strength, making
them weak performers with little potential for improvement. At best, they have the
lowest claim on corporate resources and may be good candidates for being divested (sold to other
companies). However, there are occasions when a business located in the three lower-right cells
generates sizable positive cash flows. It may make sense to retain such businesses and divert their
cash flows to finance expansion of business units with greater potential for profit growth.
The nine-cell attractiveness–strength matrix provides clear, strong logic for why a diversified
company needs to consider both industry attractiveness and business strength in allocating resources
and investment capital to its different businesses. A good case can be made for concentrating
resources in those businesses that enjoy higher degrees of attractiveness and competitive strength,
being very selective in making investments in businesses with intermediate positions on the grid,
and withdrawing resources from businesses that are lower in attractiveness and strength unless they
offer exceptional profit or cash flow potential.
Step 3: Determining the Competitive Value of Strategic Fit in
Diversified Companies
While this step can be bypassed for diversified companies whose businesses are all unrelated (since,
by design, strategic fit is lacking), assessing the degree of strategic fit across a company’s
businesses is central to evaluating its related diversification strategy. But more than just checking
for the presence of strategic fit is required here. The real question is how much competitive value
can be generated from whatever strategic fit exists. Are the cost savings associated with economies
of scope likely to give one or more individual businesses a cost-based advantage over rivals? How
much competitive value will come from the cross-business transfer of skills, technology, or
intellectual capital or the sharing of competitive assets? Can leveraging a potent umbrella brand or
corporate image strengthen the businesses and increase sales significantly? Could cross-business
collaboration to create new competitive capabilities lead to significant gains in performance?
Without significant cross-business strategic fit and dedicated company efforts to capture the
benefits, one has to be skeptical about the potential for a diversified company’s businesses to
perform better together than apart.
The greater the
value of cross-
business strategic fit
in enhancing the
performance of a
diversified
company’s
businesses, the
more competitively
powerful is the
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company’s related
diversification
strategy.
Figure 8.4 illustrates the process of comparing the value chains of a company’s businesses and
identifying opportunities to exploit competitively valuable cross-business strategic fit.
FIGURE 8.4 Identifying the Competitive Advantage Potential of Cross-
Business Strategic Fit
Step 4: Checking for Good Resource Fit
The businesses in a diversified company’s lineup need to exhibit good resource fit. In firms with a
related diversification strategy, good resource fit exists when the firm’s businesses have well-
matched specialized resource requirements at points along their value chains that are critical for the
businesses’ market success. Matching resource requirements are important in related diversification
because they facilitate resource sharing and low-cost resource transfer. In companies pursuing
unrelated diversification, resource fit exists when the company has solid parenting capabilities or
resources of a general nature that it can share or transfer to its component businesses.
Firms pursuing related diversification and firms with combination related–unrelated
diversification strategies can also benefit from leveraging corporate parenting capabilities and other
general resources. Another dimension of resource fit that concerns all types of multibusiness firms
is whether they have resources sufficient to support their group of businesses without being spread
too thin.
CORE
CONCEPT
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A company pursuing
related
diversification
exhibits resource fit
when its businesses
have matching
specialized resource
requirements along
their value chains; a
company pursuing
unrelated
diversification has
resource fit when
the parent company
has adequate
corporate resources
(parenting and
general resources)
to support its
businesses’ needs
and add value.
Financial Resource Fit The most important dimension of financial resource fit concerns whether
a diversified company can generate the internal cash flows sufficient to fund the capital
requirements of its businesses, pay its dividends, meet its debt obligations, and otherwise remain
financially healthy. (Financial resources, including the firm’s ability to borrow or otherwise raise
funds, are a type of general resource.) While additional capital can usually be raised in financial
markets, it is important for a diversified firm to have a healthy internal capital market that can
support the financial requirements of its business lineup. The greater the extent to which a
diversified company is able to fund investment in its businesses through internally generated cash
flows rather than from equity issues or borrowing, the more powerful its financial resource fit and
the less dependent the firm is on external financial resources. This can provide a competitive
advantage over single business rivals when credit market conditions are tight, as they have been in
the United States and abroad in recent years.
CORE
CONCEPT
A strong internal
capital market
allows a diversified
company to add
value by shifting
capital from
business units
generating free cash
flow to those
needing additional
capital to expand
and realize their
growth potential.
A portfolio approach to ensuring financial fit among a firm’s businesses is based
on the fact that different businesses have different cash flow and investment characteristics. For
example, business units in rapidly growing industries are often cash hogs—so labeled because the
cash flows they are able to generate from internal operations aren’t big enough to fund their
operations and capital requirements for growth. To keep pace with rising buyer demand, rapid-
growth businesses frequently need sizable annual capital investments—for new facilities and
equipment, for new product development or technology improvements, and for additional working
capital to support inventory expansion and a larger base of operations. Because a cash hog’s
financial resources must be provided by the corporate parent, corporate managers have to decide
whether it makes good financial and strategic sense to keep pouring new money into a cash hog
business.
CORE
CONCEPT
A portfolio
approach to
ensuring financial fit
among a firm’s
businesses is based
on the fact that
different businesses
have different cash
flow and investment
characteristics.
CORE
CONCEPT
A cash hog
business generates
cash flows that are
too small to fully
fund its growth; it
thereby requires
cash infusions to
provide additional
working capital and
finance new capital
investment.
In contrast, business units with leading market positions in mature industries may be cash cows
in the sense that they generate substantial cash surpluses over what is needed to adequately fund
their operations. Market leaders in slow-growth industries often generate sizable positive cash flows
over and above what is needed for growth and reinvestment because their industry-leading positions
tend to generate attractive earnings and because the slow-growth nature of their industry often
entails relatively modest annual investment requirements. Cash cows, although not attractive from a
growth standpoint, are valuable businesses from a financial resource perspective. The surplus cash
flows they generate can be used to pay corporate dividends, finance acquisitions, and provide funds
for investing in the company’s promising cash hogs. It makes good financial and strategic sense for
diversified companies to keep cash cows in a healthy condition, fortifying and defending their
market position so as to preserve their cash-generating capability and have an ongoing source of
financial resources to deploy elsewhere. General Electric considers its advanced materials,
equipment services, and appliance and lighting businesses to be cash cow businesses.
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CORE
CONCEPT
A cash cow
business generates
cash flows over and
above its internal
requirements, thus
providing a
corporate parent
with funds for
investing in cash
hog businesses,
financing new
acquisitions, or
paying dividends.
Viewing a diversified group of businesses as a collection of cash flows and cash requirements
(present and future flows) can be helpful in understanding what the financial ramifications of
diversification are and why having businesses with good financial resource fit can be important. For
instance, a diversified company’s businesses exhibit good financial resource fit when the excess cash
generated by its cash cow businesses is sufficient to fund the investment requirements of promising
cash hog businesses. Ideally, investing in promising cash hog businesses over time results in
growing the hogs into self-supporting star businesses that have strong or market-leading
competitive positions in attractive, high-growth markets and high levels of profitability. Star
businesses are often the cash cows of the future. When the markets of star businesses begin to
mature and their growth slows, their competitive strength should produce self-generated cash flows
that are more than sufficient to cover their investment needs. The “success sequence” is thus cash
hog to young star (but perhaps still a cash hog) to self-supporting star to cash cow. While the
practice of viewing a diversified company in terms of cash cows and cash hogs has declined in
popularity, it illustrates one approach to analyzing financial resource fit and allocating financial
resources across a portfolio of different businesses.
Aside from cash flow considerations, there are two other factors to consider in assessing whether
a diversified company’s businesses exhibit good financial fit:
Do any of the company’s individual businesses present financial challenges with respect to
contributing adequately to achieving companywide performance targets? A business exhibits
poor financial fit if it soaks up a disproportionate share of the company’s financial resources,
while making subpar or insignificant contributions to the bottom line. Too many
underperforming businesses reduce the company’s overall performance and ultimately
limit growth in shareholder value.
Does the corporation have adequate financial strength to fund its different businesses and
maintain a healthy credit rating? A diversified company’s strategy fails the resource-fit test when
the resource needs of its portfolio unduly stretch the company’s financial health and threaten to
impair its credit rating. Many of the world’s largest banks, including Royal Bank of Scotland,
Citigroup, and HSBC, recently found themselves so undercapitalized and financially
overextended that they were forced to sell off some of their business assets to meet regulatory
requirements and restore public confidence in their solvency.
Nonfinancial Resource Fit Just as a diversified company must have adequate financial resources
to support its various individual businesses, it must also have a big enough and deep enough pool of
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managerial, administrative, and other parenting capabilities to support all of its different businesses.
The following two questions help reveal whether a diversified company has sufficient nonfinancial
resources:
Does the parent company have (or can it develop) the specific resources and capabilities needed
to be successful in each of its businesses? Sometimes the resources a company has accumulated
in its core business prove to be a poor match with the competitive capabilities needed to succeed
in the businesses into which it has diversified. For instance, BTR, a multibusiness company in
Great Britain, discovered that the company’s resources and managerial skills were quite well
suited for parenting its industrial manufacturing businesses but not for parenting its distribution
businesses (National Tyre Services and Texas-based Summers Group). As a result, BTR decided
to divest its distribution businesses and focus exclusively on diversifying around small industrial
manufacturing. For companies pursuing related diversification strategies, a mismatch between the
company’s competitive assets and the key success factors of an industry can be serious enough to
warrant divesting businesses in that industry or not acquiring a new business. In contrast, when a
company’s resources and capabilities are a good match with the key success factors of industries
it is not presently in, it makes sense to take a hard look at acquiring companies in these industries
and expanding the company’s business lineup.
Are the parent company’s resources being stretched too thinly by the resource requirements of one
or more of its businesses? A diversified company must guard against overtaxing its resources and
capabilities, a condition that can arise when (1) it goes on an acquisition spree and management is
called on to assimilate and oversee many new businesses very quickly or (2) it lacks sufficient
resource depth to do a creditable job of transferring skills and competencies from one of its
businesses to another. The broader the diversification, the greater the concern about whether
corporate executives are overburdened by the demands of competently parenting so many
different businesses. Plus, the more a company’s diversification strategy is tied to transferring
know-how or technologies from existing businesses to newly acquired businesses, the more time
and money that has to be put into developing a deep-enough resource pool to supply these
businesses with the resources and capabilities they need to be successful.15 Otherwise, its
resource pool ends up being spread too thinly across many businesses, and the opportunity for
achieving 1 + 1 = 3 outcomes slips through the cracks.
Step 5: Ranking Business Units and Assigning a Priority for
Resource Allocation
Once a diversified company’s strategy has been evaluated from the perspective of industry
attractiveness, competitive strength, strategic fit, and resource fit, the next step is to use this
information to rank the performance prospects of the businesses from best to worst. Such ranking
helps top-level executives assign each business a priority for resource support and capital
investment.
The locations of the different businesses in the nine-cell industry-attractiveness– competitive-
strength matrix provide a solid basis for identifying high-opportunity businesses and low-
opportunity businesses. Normally, competitively strong businesses in attractive industries have
significantly better performance prospects than competitively weak businesses in unattractive
industries. Also, the revenue and earnings outlook for businesses in fast-growing industries is
normally better than for businesses in slow-growing industries. As a rule, business subsidiaries with
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the brightest profit and growth prospects, attractive positions in the nine-cell matrix, and solid
strategic and resource fit should receive top priority for allocation of corporate resources.
However, in ranking the prospects of the different businesses from best to worst, it is usually wise to
also take into account each business’s past performance in regard to sales growth, profit growth,
contribution to company earnings, return on capital invested in the business, and cash flow from
operations. While past performance is not always a reliable predictor of future performance, it does
signal whether a business is already performing well or has problems to overcome.
Allocating Financial Resources Figure 8.5 shows the chief strategic and financial options for
allocating a diversified company’s financial resources. Divesting businesses with the
weakest future prospects and businesses that lack adequate strategic fit and/or resource fit
is one of the best ways of generating additional funds for redeployment to businesses with better
opportunities and better strategic and resource fit. Free cash flows from cash cow businesses also
add to the pool of funds that can be usefully redeployed. Ideally, a diversified company will have
sufficient financial resources to strengthen or grow its existing businesses, make any new
acquisitions that are desirable, fund other promising business opportunities, pay off existing debt,
and periodically increase dividend payments to shareholders and/or repurchase shares of stock. But,
as a practical matter, a company’s financial resources are limited. Thus, to make the best use of the
available funds, top executives must steer resources to those businesses with the best prospects and
either divest or allocate minimal resources to businesses with marginal prospects—this is why
ranking the performance prospects of the various businesses from best to worst is so crucial.
Strategic uses of corporate financial resources should usually take precedence over strictly financial
considerations (see Figure 8.5) unless there is a compelling reason to strengthen the firm’s balance
sheet or better reward shareholders.
FIGURE 8.5 The Chief Strategic and Financial Options for Allocating a
Diversified Company’s Financial Resources
Step 6: Crafting New Strategic Moves to Improve Overall
Corporate Performance
• LO 8-5
Understand the four
main corporate
strategy options a
diversified company
can employ to
improve company
performance.
The conclusions flowing from the five preceding analytic steps set the agenda for crafting strategic
moves to improve a diversified company’s overall performance. The strategic options boil down to
four broad categories of actions (see Figure 8.6):
FIGURE 8.6 A Company’s Four Main Strategic Alternatives after It Diversifies
1. Sticking closely with the existing business lineup and pursuing the opportunities these businesses
present.
2. Broadening the company’s business scope by making new acquisitions in new industries.
3. Divesting certain businesses and retrenching to a narrower base of business operations.
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4. Restructuring the company’s business lineup and putting a whole new face on the company’s
business makeup.
Sticking Closely with the Present Business Lineup The option of sticking with the current
business lineup makes sense when the company’s existing businesses offer attractive growth
opportunities and can be counted on to create economic value for shareholders. As long as the
company’s set of existing businesses have good prospects and are in alignment with the company’s
diversification strategy, then major changes in the company’s business mix are unnecessary.
Corporate executives can concentrate their attention on getting the best performance from each of
the businesses, steering corporate resources into the areas of greatest potential and profitability. The
specifics of “what to do” to wring better performance from the present business lineup have to be
dictated by each business’s circumstances and the preceding analysis of the corporate parent’s
diversification strategy.
Broadening a Diversified Company’s Business Base Diversified companies sometimes find it
desirable to build positions in new industries, whether related or unrelated. Several motivating
factors are in play. One is sluggish growth that makes the potential revenue and profit boost of a
newly acquired business look attractive. A second is the potential for transferring resources and
capabilities to other related or complementary businesses. A third is rapidly changing
conditions in one or more of a company’s core businesses, brought on by technological,
legislative, or demographic changes. For instance, the passage of legislation in the United States
allowing banks, insurance companies, and stock brokerages to enter each other’s businesses spurred
a raft of acquisitions and mergers to create full-service financial enterprises capable of meeting the
multiple financial needs of customers. A fourth, and very important, motivating factor for adding
new businesses is to complement and strengthen the market position and competitive capabilities of
one or more of the company’s present businesses. Procter & Gamble’s acquisition of Gillette
strengthened and extended P&G’s reach into personal care and household products—Gillette’s
businesses included Oral-B toothbrushes, Gillette razors and razor blades, Duracell batteries, Braun
shavers, small appliances (coffeemakers, mixers, hair dryers, and electric toothbrushes), and
toiletries. Johnson & Johnson has used acquisitions to diversify far beyond its well-known Band-
Aid and baby care businesses and become a major player in pharmaceuticals, medical devices, and
medical diagnostics.
Another important avenue for expanding the scope of a diversified company is to
grow by extending the operations of existing businesses into additional country markets, as
discussed in Chapter 7. Expanding a company’s geographic scope may offer an exceptional
competitive advantage potential by facilitating the full capture of economies of scale and learning-
and experience-curve effects. In some businesses, the volume of sales needed to realize full
economies of scale and/or benefit fully from experience-curve effects exceeds the volume that can
be achieved by operating within the boundaries of just one or several country markets, especially
small ones.
Retrenching to a Narrower Diversification Base A number of diversified firms have had
difficulty managing a diverse group of businesses and have elected to exit some of them. Selling a
business outright to another company is far and away the most frequently used option for divesting
a business. In 2017, Samsung Electronics sold its printing business to HP, Inc. in order better focus
on its core smartphone, television, and memory chip businesses. But sometimes a business selected
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for divestiture has ample resources and capabilities to compete successfully on its own. In such
cases, a corporate parent may elect to spin off the unwanted business as a financially and
managerially independent company, either by selling shares to the public via an initial public
offering or by distributing shares in the new company to shareholders of the corporate parent. eBay
spun off PayPal in 2015 at a valuation of $45 billion—a value 30 times more than what eBay paid
for the company in a 2002 acquisition. In 2018, pesticide maker FMC Corp. spun off its lithium
business to boost profitability by focusing on its core business.
Retrenching to a narrower diversification base is usually undertaken when top management
concludes that its diversification has ranged too far afield and that the company can improve long-
term performance by concentrating on a smaller number of businesses. But there are other important
reasons for divesting one or more of a company’s present businesses. Sometimes divesting a
business has to be considered because market conditions in a once-attractive industry have badly
deteriorated. A business can become a prime candidate for divestiture because it lacks adequate
strategic or resource fit, because it is a cash hog with questionable long-term potential, or because
remedying its competitive weaknesses is too expensive relative to the likely gains in profitability.
Sometimes a company acquires businesses that, down the road, just do not work out as expected
even though management has tried its best. Subpar performance by some business units is bound to
occur, thereby raising questions of whether to divest them or keep them and attempt a turnaround.
Other business units, despite adequate financial performance, may not mesh as well with the rest of
the firm as was originally thought. For instance, PepsiCo divested its group of fast-food restaurant
businesses (Kentucky Fried Chicken, Pizza Hut, and Taco Bell) to focus on its core soft-drink and
snack-food businesses, where their specialized resources and capabilities could add more value.
A spin-off is an
independent
company created
when a corporate
parent divests a
business either by
selling shares to the
public via an initial
public offering or by
distributing shares in
the new company to
shareholders of the
corporate parent.
On occasion, a diversification move that seems sensible from a strategic-fit standpoint turns out
to be a poor cultural fit.16 When several pharmaceutical companies diversified into cosmetics and
perfume, they discovered their personnel had little respect for the “frivolous” nature of such
products compared to the far nobler task of developing miracle drugs to cure the ill. The absence of
shared values and cultural compatibility between the medical research and chemical-compounding
expertise of the pharmaceutical companies and the fashion and marketing orientation of the
cosmetics business was the undoing of what otherwise was diversification into businesses with
technology-sharing potential, product development fit, and some overlap in distribution
channels.
Diversified
companies need to
divest low-
performing
businesses or
businesses that
don’t fit in order to
concentrate on
expanding existing
businesses and
entering new ones
where opportunities
are more promising.
A useful guide to determine whether or when to divest a business subsidiary is to ask, “If we
were not in this business today, would we want to get into it now?” When the answer is no or
probably not, divestiture should be considered. Another signal that a business should be divested
occurs when it is worth more to another company than to the present parent; in such cases,
shareholders would be well served if the company sells the business and collects a premium price
from the buyer for whom the business is a valuable fit.
Restructuring a Diversified Company’s Business Lineup Restructuring a diversified company
on a companywide basis (corporate restructuring) involves divesting some businesses and/or
acquiring others, so as to put a whole new face on the company’s business lineup.17 Performing
radical surgery on a company’s business lineup is appealing when its financial performance is being
squeezed or eroded by
CORE
CONCEPT
Companywide
restructuring
(corporate
restructuring)
involves making
major changes in a
diversified company
by divesting some
businesses and/or
acquiring others, so
as to put a whole
new face on the
company’s business
lineup.
A serious mismatch between the company’s resources and capabilities and the type of
diversification that it has pursued.
Too many businesses in slow-growth, declining, low-margin, or otherwise unattractive industries.
Too many competitively weak businesses.
The emergence of new technologies that threaten the survival of one or more important
businesses.
Ongoing declines in the market shares of one or more major business units that are falling prey to
more market-savvy competitors.
An excessive debt burden with interest costs that eat deeply into profitability.
Ill-chosen acquisitions that haven’t lived up to expectations.
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On occasion, corporate restructuring can be prompted by special circumstances—such as when a
firm has a unique opportunity to make an acquisition so big and important that it has to sell several
existing business units to finance the new acquisition or when a company needs to sell off some
businesses in order to raise the cash for entering a potentially big industry with wave-of-the-future
technologies or products. As businesses are divested, corporate restructuring generally involves
aligning the remaining business units into groups with the best strategic fit and then redeploying the
cash flows from the divested businesses to either pay down debt or make new acquisitions to
strengthen the parent company’s business position in the industries it has chosen to emphasize.
Over the past decade, corporate restructuring has become a popular strategy at many diversified
companies, especially those that had diversified broadly into many different industries and lines of
business. Google is a prime example, having acquired over 200 businesses of varying types within
the past 20 years. This rapid expansion led to a corporate restructuring in 2015 that created a new
holding company called Alphabet, Inc. into which businesses other than Internet services were
moved, each to be managed by its own CEO. Google remained the umbrella company for its core
Internet service businesses, such as YouTube, Waze, the Android mobile operating system, and
Google Search. Ultimately, Google was also folded into Alphabet and became its largest subsidiary.
This restructuring allowed Google to slim down a bit and focus more on its core
businesses, while allowing the more unrelated companies greater independence under
Alphabet. The restructuring has purportedly accomplished much of its aims, reaching $1 trillion
market value by January 2020. Other seemingly successful restructuring efforts include Disney’s
reorganization into four business units to help it capitalize on growth opportunities, Hulu’s steps to
streamline while accommodating further growth, and the Wall Street Journal’s efforts to shift
toward a more digital strategy.
ILLUSTRATION
CAPSULE 8.4 Restructuring Strategically at VF
Corporation
Over its 120 year history, VF Corporation has become one of the world’s largest apparel, footwear, and accessories
companies through an aggressive acquisition strategy. Brands that they have acquired include North Face,
Timberland, Wrangler, Lee, Jan Sport, Nautica, Eagle Creek, Smart Wool, and Altra Footwear. In recent years,
however, the company’s top managers began to notice that different segments of their business had diverging
management requirements, due to differing distribution channels, customer needs, and growth patterns. The solution
was to restructure the company, which was characterized as very much a strategic move, since there was an
absence of good strategic fit among these two different types of businesses.
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Soundaholic studio/Shutterstock
In 2019, the company split itself into two separate organizations, moving VF’s Jeanswear organization into an
independent, publicly traded company (a type of move known as a spin-off ). The new company was named Kontoor
Brands, Inc., and included the Wrangler, Lee, and Rock & Republic brands, along with the VF Outlet business. VF
Corporation, also known as VFC, would retain the more dynamic, faster-moving active-lifestyle brands. The split was
hoped to enable the faster growing segments retained within VFC to pursue opportunities that are less relevant to
the concerns of the more staid sister business of Kontoor. It would also enable the brands within VFC to respond in
a more nimble way to the rapid changes that tend to characterize the world of fashion. While there are always risks
and uncertainties that come along with spin-offs, such as the risk of disruption of the businesses, and the temporary
diversion of management resources, the full year 2019 revenue was up by 13 percent, and the prospects going
forward looked rosy.
Sources: Company website; https://www.thestreet.com/investing/stocks/v-f-corp-ceo-why-we-just-made-one-
of-the-biggest-decisions-in-our-company-history-14681383, accessed February 4, 2020.
Illustration Capsule 8.4 discusses how VF Corporation, maker of North Face and other popular
“lifestyle” apparel brands, has used a restructuring strategy to rationalize its management of
different types of companies.
KEY POINTS
1. The purpose of diversification is to build shareholder value. Diversification builds shareholder
value only when a diversified group of businesses can perform better under the auspices of a
single corporate parent than they would as independent, standalone businesses. The goal is to
achieve not just a 1 + 1 = 2 result but rather to realize important 1 + 1 = 3 performance benefits—
an effect known as synergy. For a move to diversify into a new business to have a reasonable
prospect of adding shareholder value, it must be capable of passing the three Tests of Corporate
Advantage: the industry attractiveness test, the cost-of-entry test, and the better-off test.
2. Entry into new businesses can take any of three forms: acquisition, internal startup, or joint
venture. The choice of which is best depends on the firm’s resources and capabilities, the
industry’s entry barriers, the importance of speed, and relative costs.
3. There are two fundamental approaches to diversification—into related businesses and into
unrelated businesses. The rationale for related diversification is to benefit from strategic fit:
https://www.thestreet.com/investing/stocks/v-f-corp-ceo-why-we-just-made-one-of-the-biggest-decisions-in-our-company-history-14681383
page 263
diversify into businesses with commonalities across their respective value chains, and then
capitalize on the strategic fit by sharing or transferring the resources and capabilities across
matching value chain activities to gain competitive advantages.
4. Unrelated diversification strategies surrender the competitive advantage potential of strategic fit
at the value chain level in return for the potential that can be realized from superior corporate
parenting or the sharing and transfer of general resources and capabilities. An outstanding
corporate parent can benefit its businesses through (1) providing high-level oversight and making
available other corporate resources, (2) allocating financial resources across the business
portfolio (under certain circumstances), and (3) restructuring underperforming acquisitions.
5. Related diversification provides a stronger foundation for creating shareholder value than does
unrelated diversification, since the specialized resources and capabilities that are leveraged in
related diversification tend to be more valuable competitive assets than the general resources and
capabilities underlying unrelated diversification, which in most cases are relatively common and
easier to imitate.
6. Analyzing how good a company’s diversification strategy is consists of a six-step process:
Step 1: Evaluate the long-term attractiveness of the industries into which the firm has diversified.
Determining industry attractiveness involves developing a list of industry-attractiveness
measures, each of which might have a different importance weight.
Step 2: Evaluate the relative competitive strength of each of the company’s business units. The
purpose of rating the competitive strength of each business is to gain a clear understanding of
which businesses are strong contenders in their industries, which are weak contenders, and what
the underlying reasons are for their strength or weakness. The conclusions about industry
attractiveness can be joined with the conclusions about competitive strength by drawing a nine-
cell industry-attractiveness–competitive-strength matrix that helps identify the prospects of each
business and the level of priority each business should be given in allocating corporate resources
and investment capital.
Step 3: Check for the competitive value of cross-business strategic fit. A business is more
attractive strategically when it has value chain relationships with the other business units that
offer the potential to (1) combine operations to realize economies of scope, (2) transfer
technology, skills, know-how, or other resource capabilities from one business to another, (3)
leverage the use of a trusted brand name or other resources that enhance differentiation,
(4) share other competitively valuable resources among the company’s businesses, and
(5) build new resources and competitive capabilities via cross-business collaboration. Cross-
business strategic fit represents a significant avenue for producing competitive advantage beyond
what any one business can achieve on its own.
Step 4: Check whether the firm’s resources fit the resource requirements of its present business
lineup. In firms with a related diversification strategy, resource fit exists when the firm’s
businesses have matching resource requirements at points along their value chains that are critical
for the businesses’ market success. In companies pursuing unrelated diversification, resource fit
exists when the company has solid parenting capabilities or resources of a general nature that it
can share or transfer to its component businesses. When there is financial resource fit among the
businesses of any type of diversified company, the company can generate internal cash flows
sufficient to fund the capital requirements of its businesses, pay its dividends, meet its debt
obligations, and otherwise remain financially healthy.
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Step 5: Rank the performance prospects of the businesses from best to worst, and determine what
the corporate parent’s priority should be in allocating resources to its various businesses. The
most important considerations in judging business unit performance are sales growth, profit
growth, contribution to company earnings, and the return on capital invested in the business.
Normally, strong business units in attractive industries should head the list for corporate resource
support.
Step 6: Craft new strategic moves to improve overall corporate performance. This step draws on
the results of the preceding steps as the basis for selecting one of four different strategic paths for
improving a diversified company’s performance: (1) Stick closely with the existing business
lineup and pursue opportunities presented by these businesses, (2) broaden the scope of
diversification by entering additional industries, (3) retrench to a narrower scope of
diversification by divesting poorly performing businesses, or (4) broadly restructure the business
lineup with multiple divestitures and/or acquisitions.
ASSURANCE OF LEARNING EXERCISES
1. See if you can identify the value chain relationships that make the businesses of the following
companies related in competitively relevant ways. In particular, you should consider whether
there are cross-business opportunities for (1) transferring skills and technology, (2) combining
related value chain activities to achieve economies of scope, and/or (3) leveraging the use of a
well-respected brand name or other resources that enhance differentiation.
Bloomin’ Brands
Outback Steakhouse
Carrabba’s Italian Grill
Bonefish Grill (market-fresh fine seafood)
Fleming’s Prime Steakhouse & Wine Bar
L’Oréal
Maybelline, Lancôme, Helena Rubinstein, essie, Kiehl’s and Shu Uemura cosmetics
L’Oréal and Soft Sheen/Carson hair care products
Redken, Matrix, L’Oréal Professional, and Kerastase Paris professional hair care and
skin care products
Ralph Lauren and Giorgio Armani fragrances
Biotherm skin care products
La Roche–Posay and Vichy Laboratories dermo-cosmetics
Johnson & Johnson
Baby products (powder, shampoo, oil, lotion)
Band-Aids and other first-aid products
Women’s health and personal care products (Stayfree, Carefree, Sure & Natural)
Neutrogena, and Aveeno skin care products
Nonprescription drugs (Tylenol, Motrin, Pepcid AC, Mylanta, Monistat)
Prescription drugs
Prosthetic and other medical devices
LO 8-1, LO 8-2, LO
8-3
LO 8-1, LO 8-2
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Surgical and hospital products
Acuvue contact lenses
2. Peruse the business group listings for 3M Company shown as follows and listed at its website.
How would you characterize the company’s corporate strategy—related diversification, unrelated
diversification, or a combination related–unrelated diversification strategy? Explain your answer.
Consumer products—for the home and office including Post-it® and Scotch®
Electronics and Energy—technology solutions for customers in electronics and energy markets
Health Care—products for health care professionals
Industrial—abrasives, adhesives, specialty materials and filtration systems
Safety and Graphics—safety and security products; graphic solutions
3. ITT is a technology-oriented engineering and manufacturing company with the following
business divisions and products:
Industrial Process Division—industrial pumps, valves, and monitoring and control systems;
aftermarket services for the chemical, oil and gas, mining, pulp and paper, power, and
biopharmaceutical markets
Motion Technologies Division—durable brake pads, shock absorbers, and damping
technologies for the automotive and rail markets
Interconnect Solutions—connectors and fittings for the production of automobiles, aircraft,
railcars and locomotives, oil field equipment, medical equipment, and industrial equipment
Control Technologies—energy absorption and vibration dampening equipment, transducers and
regulators, and motion controls used in the production of robotics, medical equipment,
automobiles, subsea equipment, industrial equipment, aircraft, and military vehicles
Based on the previous listing, would you say that ITT’s business lineup reflects a strategy of
related diversification, unrelated diversification, or a combination of related and unrelated
diversification? What benefits are generated from any strategic fit existing between ITT’s
businesses? Also, what types of companies should ITT consider acquiring that might improve
shareholder value? Justify your answer.
EXERCISES FOR SIMULATION PARTICIPANTS
1. In the event that your company has the opportunity to diversify into other
products or businesses of your choosing, what would be the advantages of
opting to pursue related diversification, unrelated diversification, or a
combination of both? Explain why.
2. What strategic-fit benefits might be captured by transferring resources and
competitive capabilities to newly acquired related businesses.
3. If your company opted to pursue a strategy of related diversification, what
industries or product categories could it diversify into that would allow it
to achieve economies of scope? Name at least two or three such industries
or product categories, and indicate the specific kinds of cost savings that
might accrue from entry into each.
LO 8-1, LO 8-34. If your company opted to pursue a strategy of unrelated diversification,
what industries or product categories could it diversify into that would
allow it to capitalize on using its present brand name and corporate image
to good advantage in the newly entered businesses or product categories?
Name at least two or three such industries or product categories, and
indicate the specific benefits that might be captured by transferring your
company’s umbrella brand name to each.
ENDNOTES
1 Michael E. Porter, “From Competitive Advantage to Corporate Strategy,” Harvard Business Review 45, no. 3 (May–June 1987), pp. 46–49.
2 A. Shleifer and R. Vishny, “Takeovers in the 60s and the 80s—Evidence and Implications,” Strategic Management Journal 12 (Winter 1991), pp. 51–59; T.
Brush, “Predicted Change in Operational Synergy and Post-Acquisition Performance of Acquired Businesses,” Strategic Management Journal 17, no. 1
(1996), pp. 1–24; J. P. Walsh, “Top Management Turnover Following Mergers and Acquisitions,” Strategic Management Journal 9, no. 2 (1988), pp. 173–
183; A. Cannella and D. Hambrick, “Effects of Executive Departures on the Performance of Acquired Firms,” Strategic Management Journal 14 (Summer
1993), pp. 137–152; R. Roll, “The Hubris Hypothesis of Corporate Takeovers,” Journal of Business 59, no. 2 (1986), pp. 197–216; P. Haspeslagh and D.
Jemison, Managing Acquisitions (New York: Free Press, 1991).
3 M.L.A. Hayward, “When Do Firms Learn from Their Acquisition Experience? Evidence from 1990–1995,” Strategic Management Journal 23, no. 1 (2002),
pp. 21–29; G. Ahuja and R. Katila, “Technological Acquisitions and the Innovation Performance of Acquiring Firms: A Longitudinal Study,” Strategic
Management Journal 22, no. 3 (2001), pp. 197–220; H. Barkema and F. Vermeulen, “International Expansion through Start-Up or Acquisition: A Learning
Perspective,” Academy of Management Journal 41, no. 1 (1998), pp. 7–26.
4 Yves L. Doz and Gary Hamel, Alliance Advantage: The Art of Creating Value through Partnering (Boston: Harvard Business School Press, 1998), chaps. 1
and 2.
5 J. Glover, “The Guardian,” March 23, 1996, www.mcspotlight.org/media/press/guardpizza_23mar96.html.
6 Michael E. Porter, Competitive Advantage (New York: Free Press, 1985), pp. 318–319, 337–353; Porter, “From Competitive Advantage to Corporate
Strategy,” pp. 53–57; Constantinos C. Markides and Peter J. Williamson, “Corporate Diversification and Organization Structure: A Resource-Based View,”
Academy of Management Journal 39, no. 2 (April 1996), pp. 340–367.
7 David J. Collis and Cynthia A. Montgomery, “Creating Corporate Advantage,” Harvard Business Review 76, no. 3 (May–June 1998), pp. 72–80; Markides
and Williamson, “Corporate Diversification and Organization Structure.”
8 Jeanne M. Liedtka, “Collaboration across Lines of Business for Competitive Advantage,” Academy of Management Executive 10, no. 2 (May 1996), pp.
20–34.
9 Kathleen M. Eisenhardt and D. Charles Galunic, “Coevolving: At Last, a Way to Make Synergies Work,” Harvard Business Review 78, no. 1 (January–
February 2000), pp. 91–101; Constantinos C. Markides and Peter J. Williamson, “Related Diversification, Core Competences and Corporate Performance,”
Strategic Management Journal 15 (Summer 1994), pp. 149–165.
10 A. Campbell, M. Goold, and M. Alexander, “Corporate Strategy: The Quest for Parenting Advantage,” Harvard Business Review 73, no. 2 (March–April
1995), pp. 120–132.
11 Cynthia A. Montgomery and B. Wernerfelt, “Diversification, Ricardian Rents, and Tobin-Q,” RAND Journal of Economics 19, no. 4 (1988), pp. 623–632.
12 Patricia L. Anslinger and Thomas E. Copeland, “Growth through Acquisitions: A Fresh Look,” Harvard Business Review 74, no. 1 (January–February
1996), pp. 126–135.
13 M. Lubatkin and S. Chatterjee, “Extending Modern Portfolio Theory,” Academy of Management Journal 37, no.1 (February 1994), pp. 109–136.
14 Lawrence G. Franko, “The Death of Diversification? The Focusing of the World’s Industrial Firms, 1980–2000,” Business Horizons 47, no. 4 (July–August
2004), pp. 41–50.
15 David J. Collis and Cynthia A. Montgomery, “Competing on Resources: Strategy in the 90s,” Harvard Business Review 73, no. 4 (July–August 1995), pp.
118–128.
16 Peter F. Drucker, Management: Tasks, Responsibilities, Practices (New York: Harper & Row, 1974), p. 709.
17 Lee Dranikoff, Tim Koller, and Anton Schneider, “Divestiture: Strategy’s Missing Link,” Harvard Business Review 80, no. 5 (May 2002), pp. 74–83.
http://www.mcspotlight.org/media/press/guardpizza_23mar96.html.
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chapter 9
Ethics, Corporate Social
Responsibility, Environmental
Sustainability, and Strategy
Learning Objectives
After reading this chapter, you should be able to:
LO 9-1 Understand why the standards of ethical behavior in
business are no different from ethical standards in
general.
LO 9-2 Recognize conditions that give rise to unethical
business strategies and behavior.
LO 9-3 Identify the costs of business ethics failures.
LO 9-4 Understand the concepts of corporate social
responsibility and environmental sustainability and how
companies balance these duties with economic
responsibilities to shareholders.
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Richard Schneider/Getty Images
A well-run business must have high and consistent standards of ethics.
Richard Branson—Founder of Virgin Atlantic Airlines and Virgin Group
When sustainability is viewed as being a matter of survival for your business, I believe you can
create massive change.
Cameron Sinclair—Head of social innovation at Airbnb
page 268
Clearly, in capitalistic or market economies, a company has a responsibility to make a
profit and grow the business. Managers of public companies have a fiduciary duty to
operate the enterprise in a manner that creates value for the company’s shareholders—
a legal obligation. Just as clearly, a company and its personnel are duty-bound to obey
the law otherwise and comply with governmental regulations. But does a company also
have a duty to go beyond legal requirements and hold all company personnel
responsible for conforming to high ethical standards? Does it have an obligation to
contribute to the betterment of society, independent of the needs and preferences of the
customers it serves? Should a company display a social conscience by devoting a
portion of its resources to bettering society? Should its strategic initiatives be screened
for possible negative effects on future generations of the world’s population?
This chapter focuses on whether a company, in the course of trying to craft and
execute a strategy that delivers value to both customers and shareholders, also has a
duty to (1) act in an ethical manner; (2) be a committed corporate citizen and allocate
some of its resources to improving the well-being of employees, the communities in
which it operates, and society as a whole; and (3) adopt business practices that
conserve natural resources, protect the interests of future generations, and preserve the
well-being of the planet.
WHAT DO WE MEAN BY BUSINESS
ETHICS?
Ethics concerns principles of right or wrong conduct. Business ethics is the
application of ethical principles and standards to the actions and decisions of
business organizations and the conduct of their personnel.1 Ethical principles
in business are not materially different from ethical principles in general.
Why? Because business actions have to be judged in the context of society’s
standards of right and wrong, not with respect to a special set of ethical
standards applicable only to business situations. If dishonesty is considered
unethical and immoral, then dishonest behavior in business—whether it
relates to customers, suppliers, employees, shareholders, competitors, or
government—qualifies as equally unethical and immoral. If being ethical
entails not deliberately harming others, then businesses are ethically obliged
to recall a defective or unsafe product swiftly, regardless of the cost. If
society deems bribery unethical, then it is unethical for company personnel to
make payoffs to government officials to win government contracts or bestow
favors to customers to win or retain their business. In short, ethical behavior
in business situations requires adhering to generally accepted norms about
right or wrong conduct. As a consequence, company managers have an
obligation—indeed, a duty—to observe ethical norms when crafting and
executing strategy.
CORE
CONCEPT
Business ethics
deals with the
application of
general ethical
principles to the
actions and
decisions of
businesses and the
conduct of their
personnel.
• LO 9-1
Understand why the
standards of ethical
behavior in business
are no different from
ethical standards in
general.
WHERE DO ETHICAL STANDARDS
COME FROM—ARE THEY UNIVERSAL
OR DEPENDENT ON LOCAL NORMS?
Notions of right and wrong, fair and unfair, moral and immoral are present in
all societies and cultures. But there are three distinct schools of thought about
the extent to which ethical standards travel across cultures and whether
multinational companies can apply the same set of ethical standards in any
and all locations where they operate.
page 269
The School of Ethical Universalism
According to the school of ethical universalism, the most fundamental
conceptions of right and wrong are universal and transcend culture, society,
and religion.2 For instance, being truthful (not lying and not being
deliberately deceitful) strikes a chord of what’s right in the peoples of all
nations. Likewise, demonstrating integrity of character, not cheating or
harming people, and treating others with decency are concepts that resonate
with people of virtually all cultures and religions.
CORE
CONCEPT
The school of
ethical
universalism holds
that the most
fundamental
conceptions of right
and wrong are
universal and apply
to members of all
societies, all
companies, and all
businesspeople.
Common moral agreement about right and wrong actions and behaviors
across multiple cultures and countries gives rise to universal ethical standards
that apply to members of all societies, all companies, and all businesspeople.
These universal ethical principles set forth the traits and behaviors that are
considered virtuous and that a good person is supposed to believe in and to
display. Thus, adherents of the school of ethical universalism maintain that it
is entirely appropriate to expect all members of society (including all
personnel of all companies worldwide) to conform to these universal ethical
standards.3 For example, people in most societies would concur that it is
unethical for companies to knowingly expose workers to toxic chemicals and
hazardous materials or to sell products known to be unsafe or harmful to the
users.
The strength of ethical universalism is that it draws on the collective views
of multiple societies and cultures to put some clear boundaries on what
constitutes ethical and unethical business behavior, regardless of the country
or culture in which a company’s personnel are conducting activities. This
means that with respect to basic moral standards that do not vary significantly
according to local cultural beliefs, traditions, or religious convictions, a
multinational company can develop a code of ethics that it applies more or
less evenly across its worldwide operations. It can avoid the slippery slope
that comes from having different ethical standards for different company
personnel depending on where in the world they are working.
The School of Ethical Relativism
While undoubtedly there are some universal moral prescriptions (like being
truthful and trustworthy), there are also observable variations from one
society to another as to what constitutes ethical or unethical behavior. Indeed,
differing religious beliefs, social customs, traditions, core values, and
behavioral norms frequently give rise to different standards about what is fair
or unfair, moral or immoral, and ethically right or wrong. For instance,
European and American managers often establish standards of business
conduct that protect human rights such as freedom of movement and
residence, freedom of speech and political opinion, and the right to privacy.
In China, where societal commitment to basic human rights is weak, human
rights considerations play a small role in determining what is ethically right
or wrong in conducting business activities. In Japan, managers believe that
showing respect for the collective good of society is a more important ethical
consideration. In Muslim countries, managers typically apply ethical
standards compatible with the teachings of Muhammad. Consequently, the
school of ethical relativism holds that a “one-size-fits-all” template for
judging the ethical appropriateness of business actions and the behaviors of
company personnel is totally inappropriate. Rather, the underlying thesis of
ethical relativism is that whether certain actions or behaviors are ethically
right or wrong depends on the ethical norms of the country or culture in
which they take place. For businesses, this implies that when there are cross-
country or cross-cultural differences in ethical standards, it is appropriate for
local ethical standards to take precedence over what the ethical standards
may be in a company’s home market.4 In a world of ethical relativism, there
are few absolutes when it comes to business ethics, and thus few ethical
absolutes for consistently judging the ethical correctness of a company’s
conduct in various countries and markets.
CORE
CONCEPT
The school of
ethical relativism
holds that differing
religious beliefs,
customs, and
behavioral norms
across countries and
cultures give rise to
differing of
standards
concerning what is
ethically right or
wrong. These
differing standards
mean that whether
business-related
actions are right or
wrong depends on
the prevailing local
ethical standards.
This need to contour local ethical standards to fit local customs, local
notions of fair and proper individual treatment, and local business practices
gives rise to multiple sets of ethical standards. It also poses some challenging
ethical dilemmas. Consider the following two examples.
The Use of Underage Labor In industrialized nations, the use of underage
workers is considered taboo. Social activists are adamant that child labor is
unethical and that companies should neither employ children under the age of
18 as full-time employees nor source any products from foreign suppliers that
employ underage workers. Many countries have passed legislation forbidding
the use of underage labor or, at a minimum, regulating the employment of
people under the age of 18. However, in Eretria, Uzbekistan, Myanmar,
Somalia, Zimbabwe, Afghanistan, Sudan, North Korea, Yemen, and more
than 50 other countries, it is customary to view children as potential, even
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necessary, workers. In other countries, like China, India, Russia, and Brazil,
child labor laws are often poorly enforced.5 As of 2016, the
International Labor Organization estimated that there were about
152 million child laborers age 5 to 17 and that some 73 million of them were
engaged in hazardous work.6
Under ethical
relativism, there can
be no one-size-fits-
all set of authentic
ethical norms
against which to
gauge the conduct
of company
personnel.
While exposing children to hazardous work and long work hours is
unquestionably deplorable, the fact remains that poverty-stricken families in
many poor countries cannot subsist without the work efforts of young family
members; sending their children to school instead of having them work is not
a realistic option. If such children are not permitted to work (especially those
in the 12-to-17 age group)—due to pressures imposed by activist groups in
industrialized nations—they may be forced to go out on the streets begging or
to seek work in parts of the “underground” economy such as drug trafficking
and prostitution.7 So, if all businesses in countries where employing underage
workers is common succumb to the pressures to stop employing underage
labor, then have they served the best interests of the underage workers, their
families, and society in general? In recognition of this issue, organizations
opposing child labor are targeting certain forms of child labor such as
enslaved child labor and hazardous work. IKEA is an example of a company
that has worked hard to prevent any form of child labor by its suppliers. Its
practices go well beyond standards and safeguards to include measures
designed to address the underlying social problems of the communities in
which their suppliers operate.
The Payment of Bribes and Kickbacks A particularly thorny area facing
multinational companies is the degree of cross–country variability in paying
bribes.8 In many countries in eastern Europe, Africa, Latin America, and
Asia, it is customary to pay bribes to government officials in order to win a
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government contract, obtain a license or permit, or facilitate an administrative
ruling.9 In some developing nations, it is difficult for any company, foreign or
domestic, to move goods through customs without paying off low-level
officials. Senior managers in China and Russia often use their power to
obtain kickbacks when they purchase materials or other products for their
companies.10 Likewise, in many countries it is normal to make payments to
prospective customers in order to win or retain their business. Some people
stretch to justify the payment of bribes and kickbacks on grounds that bribing
government officials to get goods through customs or giving kickbacks to
customers to retain their business or win new orders is simply a payment for
services rendered, in the same way that people tip for service at restaurants.11
But while this is a clever rationalization, it rests on moral quicksand.
Companies that forbid the payment of bribes and kickbacks in their codes
of ethical conduct and that are serious about enforcing this prohibition face a
particularly vexing problem in countries where bribery and kickback
payments are an entrenched local custom. Complying with the company’s
code of ethical conduct in these countries is very often tantamount to losing
business to competitors that have no such scruples—an outcome that
penalizes ethical companies and ethical company personnel (who may suffer
lost sales commissions or bonuses). On the other hand, the payment of bribes
or kickbacks not only undercuts the company’s code of ethics but also risks
breaking the law. The Foreign Corrupt Practices Act (FCPA) prohibits U.S.
companies from paying bribes to government officials, political parties,
political candidates, or others in all countries where they do business. The
Organization for Economic Cooperation and Development (OECD) has
antibribery standards that criminalize the bribery of foreign public officials in
international business transactions—all 35 OECD member countries and
seven nonmember countries have adopted these standards.
Despite laws forbidding bribery to secure sales and contracts, the practice
persists. As of January 2017, 443 individuals and 158 entities were
sanctioned under criminal proceedings for foreign bribery by the OECD. At
least 125 of the sanctioned individuals were sentenced to prison.
In 2017, in the midst of a national opioid drug crisis, the
executive chairman of Insys Therapeutics was arrested for bribing doctors to
overprescribe the company’s opioid products. In the same year, oil services
giant Halliburton agreed to pay $29.2 million to settle charges brought
against it by the Security and Exchange Commission’s Foreign Corrupt
Practices Act Enforcement Division; one of their executives had to pay a
$75,000 penalty. The global snack company Cadbury Limited/Mondelez
International had to pay a $13 million penalty for violations that included
illicit payments to get approvals for a new chocolate factory in India. Other
well-known companies caught up in recent bribery cases include JPMorgan;
pharmaceutical companies GlaxoSmithKline, Novartis, and AstraZeneca;
casino company Las Vegas Sands; and aircraft manufacturer Embraer.
Why Ethical Relativism Is Problematic for Multinational Companies
Relying on the principle of ethical relativism to determine what is right or
wrong poses major problems for multinational companies trying to decide
which ethical standards to enforce companywide. It is a slippery slope indeed
to resolve conflicting ethical standards for operating in different countries
without any kind of higher-order moral compass. Consider, for example, the
ethical inconsistency of a multinational company that, in the name of ethical
relativism, declares it impermissible to engage in kickbacks unless such
payments are customary and generally overlooked by legal authorities. It is
likewise problematic for a multinational company to declare it ethically
acceptable to use underage labor at its plants in those countries where child
labor is allowed but ethically inappropriate to employ underage labor at its
plants elsewhere. If a country’s culture is accepting of environmental
degradation or practices that expose workers to dangerous conditions (toxic
chemicals or bodily harm), should a multinational company lower its ethical
bar in that country but rule the very same actions to be ethically wrong in
other countries?
Codes of conduct
based on ethical
relativism can be
ethically problematic
for multinational
companies by
creating a maze of
conflicting ethical
standards.
Business leaders who rely on the principle of ethical relativism to justify
conflicting ethical standards for operating in different countries have little
page 272
moral basis for establishing or enforcing ethical standards companywide.
Rather, when a company’s ethical standards vary from country to country, the
clear message being sent to employees is that the company has no ethical
standards or convictions of its own and prefers to let its standards of ethical
right and wrong be governed by the customs and practices of the countries in
which it operates. Applying multiple sets of ethical standards without some
kind of higher-order moral compass is scarcely a basis for holding company
personnel to high standards of ethical behavior. And it can lead to
prosecutions of both companies and individuals alike when there are
conflicting sets of laws.
Ethics and Integrative Social Contracts Theory
Integrative social contracts theory provides a middle position between the
opposing views of ethical universalism and ethical relativism.12 According to
this theory, the ethical standards a company should try to uphold are
governed by both (1) a limited number of universal ethical principles that are
widely recognized as putting legitimate ethical boundaries on behaviors in all
situations and (2) the circumstances of local cultures, traditions, and values
that further prescribe what constitutes ethically permissible behavior. The
universal ethical principles are based on the collective views of multiple
cultures and societies and combine to form a “social contract” that all
individuals, groups, organizations, and businesses in all situations have a duty
to observe. Within the boundaries of this social contract, local cultures or
groups can specify what other actions may or may not be ethically
permissible. While this system leaves some “moral free space” for
the people in a particular country (or local culture, or profession, or
even a company) to make specific interpretations of what other actions may
or may not be permissible, universal ethical norms always take precedence.
Thus, local ethical standards can be more stringent than the universal ethical
standards but never less so. For example, both the legal and medical
professions have standards regarding what kinds of advertising are ethically
permissible that extend beyond the universal norm that advertising not be
false or misleading.
CORE
CONCEPT
According to
integrated social
contracts theory,
universal ethical
principles based on
the collective views
of multiple societies
form a “social
contract” that all
individuals and
organizations have a
duty to observe in all
situations. Within the
boundaries of this
social contract, local
cultures or groups
can specify what
additional actions
may or may not be
ethically permissible.
The strength of integrated social contracts theory is that it accommodates
the best parts of ethical universalism and ethical relativism. Moreover,
integrative social contracts theory offers managers in multinational
companies clear guidance in resolving cross-country ethical differences:
Those parts of the company’s code of ethics that involve universal ethical
norms must be enforced worldwide, but within these boundaries there is
room for ethical diversity and the opportunity for host-country cultures to
exert some influence over the moral and ethical standards of business units
operating in that country.
According to
integrated social
contracts theory,
adherence to
universal or “first-
order” ethical norms
should always take
precedence over
local or “second-
order” norms.
A good example of the application of integrative social contracts theory to
business involves the payment of bribes and kickbacks. Yes, bribes and
kickbacks are common in some countries. But the fact that bribery flourishes
in a country does not mean it is an authentic or legitimate ethical norm.
Virtually all of the world’s major religions (e.g., Buddhism, Christianity,
Confucianism, Hinduism, Islam, Judaism, Sikhism, and Taoism) and all
moral schools of thought condemn bribery and corruption. Therefore, a
multinational company might reasonably conclude that there is a universal
ethical principle to be observed here—one of refusing to condone bribery and
kickbacks on the part of company personnel no matter what the local custom
is and no matter what the sales consequences are.
In instances
involving universally
applicable ethical
norms (like paying
bribes), there can be
no compromise on
what is ethically
permissible and
what is not.
HOW AND WHY ETHICAL STANDARDS
IMPACT THE TASKS OF CRAFTING
AND EXECUTING STRATEGY
Many companies have acknowledged their ethical obligations in official
codes of ethical conduct. In the United States, for example, the Sarbanes-
Oxley Act, passed in 2002, requires that companies whose stock is publicly
traded have a code of ethics or else explain in writing to the SEC why they do
not. But the senior executives of ethically principled companies understand
that there’s a big difference between having a code of ethics because it is
mandated and having ethical standards that truly provide guidance for a
company’s strategy and business conduct.13 They know that the litmus test of
whether a company’s code of ethics is cosmetic is the extent to which it is
embraced in crafting strategy and in operating the business day to day.
Executives committed to high standards make a point of considering three
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sets of questions whenever a new strategic initiative or policy or operating
practice is under review:
Is what we are proposing to do fully compliant with our code of ethical
conduct? Are there any areas of ambiguity that may be of concern?
Is there any aspect of the strategy (or policy or operating practice) that
gives the appearance of being ethically questionable?
Is there anything in the proposed action that customers, employees,
suppliers, stockholders, competitors, community activists, regulators, or the
media might consider ethically objectionable?
Unless questions of this nature are posed—either in open
discussion or by force of habit in the minds of company managers—there’s a
risk that strategic initiatives and/or the way daily operations are conducted
will become disconnected from the company’s code of ethics. If a company’s
executives believe strongly in living up to the company’s ethical standards,
they will unhesitatingly reject strategic initiatives and operating approaches
that don’t measure up. However, in companies with a cosmetic approach to
ethics, any linkage of the professed standards to its strategy and operating
practices stems mainly from a desire to avoid the risk of embarrassment and
possible disciplinary action for approving actions that are later deemed
unethical and perhaps illegal.
While most company managers are careful to ensure that a company’s
strategy is within the bounds of what is legal, evidence indicates they are not
always so careful to ensure that all elements of their strategies and operating
activities are within the bounds of what is considered ethical. In recent years,
there have been revelations of ethical misconduct on the part of managers at
such companies as Samsung, Kobe Steel, credit rating firm Equifax, United
Airlines, several leading investment banking firms, and a host of mortgage
lenders. Sexual harassment allegations plagued many companies in 2017,
including film company Weinstein Company LLC and entertainment giant
21st Century Fox. The consequences of crafting strategies that cannot pass
the test of moral scrutiny are manifested in sizable fines, devastating public
relations hits, sharp drops in stock prices that cost shareholders billions of
dollars, criminal indictments, and convictions of company executives. The
fallout from all these scandals has resulted in heightened management
attention to legal and ethical considerations in crafting strategy.
• LO 9-2
Recognize
conditions that give
rise to unethical
business strategies
and behavior.
DRIVERS OF UNETHICAL BUSINESS
STRATEGIES AND BEHAVIOR
Apart from the “business of business is business, not ethics” kind of thinking
apparent in recent high-profile business scandals, three other main drivers of
unethical business behavior also stand out14:
Faulty oversight, enabling the unscrupulous pursuit of personal gain and
self-interest.
Heavy pressures on company managers to meet or beat short-term
performance targets.
A company culture that puts profitability and business performance ahead
of ethical behavior.
Faulty Oversight, Enabling the Unscrupulous Pursuit of Personal Gain
and Self-Interest People who are obsessed with wealth accumulation,
power, status, and their own self-interest often push aside ethical principles in
their quest for personal gain. Driven by greed and ambition, they exhibit few
qualms in skirting the rules or doing whatever is necessary to achieve their
goals. A general disregard for business ethics can prompt all kinds of
unethical strategic maneuvers and behaviors at companies. The numerous
scandals that have tarnished the reputation of ridesharing company Uber and
forced the resignation of its CEO is a case in point, as described in
Illustration Capsule 9.1.
page 274
Responsible corporate governance and oversight by the company’s
corporate board is necessary to guard against self-dealing and the
manipulation of information to disguise such actions by a company’s
managers. Self-dealing occurs when managers take advantage of their
position to further their own private interests rather than those of the firm. As
discussed in Chapter 2, the duty of the corporate board (and its compensation
and audit committees in particular) is to guard against such actions. A strong,
independent board is necessary to have proper oversight of the company’s
financial practices and to hold top managers accountable for their actions.
CORE
CONCEPT
Self-dealing occurs
when managers
take advantage of
their position to
further their own
private interests
rather than those of
the firm.
ILLUSTRATION
CAPSULE 9.1 Ethical Violations at Uber and
their Consequences
The peer-to-peer ridesharing company Uber has been credited with transforming the
transportation industry, upending the taxi market, and changing the way consumers travel
from place to place. But its lack of attention to ethics has resulted in numerous scandals,
a tarnished reputation, a loss of market share to rival companies, and the ouster of its co-
founder Travis Kalanick from his position as the company’s CEO. The ethical lapses for
which Uber has been criticized include the following:
TY Lim/Shutterstock
Sexual harassment and a toxic workplace culture. In June 2017, Uber fired over 20
employees as a result of an investigation that uncovered widespread sexual
harassment that had been going on for years at the company. Female employees who
had reported incidents of sexual harassment were subjected to retaliation by their
managers, and reports of the incidents to senior executives resulted in inaction.
Price gouging during crises. During emergency situations such as Hurricane Sandy
and the 2017 London Bridge attack, Uber added high surcharges to the cost of their
services. This drew much censure, particularly since its competitors offered free or
reduced cost rides during those same times.
Data breaches and violations of user privacy. Since 2014, the names, email
addresses, and license information of over 700,000 drivers and the personal
information of over 65 million users have been disclosed as a result of data breaches.
Moreover, in 2016 the company paid a hacker $100,000 in ransom to prevent the
dissemination of personal driver and user data that had been breached, but it failed to
publicly disclose the situation for over six months.
Inadequate attention to consumer safety. Substandard vetting practices at Uber
came to light after one of its drivers was arrested as the primary suspect in a mass
shooting in Kalamazoo, Michigan, and after a series of reports alleging sexual assault
and misconduct by its drivers. Uber’s concern for safety was further questioned when
a pedestrian was tragically struck and killed by one of its self-driving vehicles in 2018.
Unfair competitive practices. When nascent competitor Gett launched in New York
City, Uber employees ordered and cancelled hundreds of rides to waste driver’s time
and then offered the drivers cash to drop Gett and join Uber. Uber has been accused
of employing similar practices against Lyft.
The ethical violations at Uber have not been without economic consequence. They
contributed to a significant market share loss to Lyft, Uber’s closest competitor in the
page 275
United States. In January 2017, when Uber was thought to have gouged its prices during
protests against legislation banning immigrants from specific countries, its market share
dropped 5 percentage points in a week. While Uber’s ethical dilemmas are not the sole
contributor to Lyft’s increase in market share and expansion rate, the negative
perceptions of Uber’s brand from its unethical actions has afforded its competitors
significant opportunities for brand and market share growth. And without a real change in
Uber’s culture and corporate governance practices, there is a strong likelihood that
ethical scandals involving Uber will continue to surface.
Note: Developed with Alen A. Amini.
Sources: https://www.recode.net/2017/8/31/16227670/uber-lyft-market-share-
deleteuber-decline-users; https://www.inc.com/associated-press/lyft-thrives-while-
rival-uber-tries-to-stabilize-regain-control-2017.html;
https://www.entrepreneur.com/article/300789.
A particularly egregious example of the lack of proper
oversight is the scandal over mortgage lending and banking practices that
resulted in a crisis for the U.S. residential real estate market and heartrending
consequences for many home buyers. This scandal stemmed from
consciously unethical strategies at many banks and mortgage companies to
boost the fees they earned on home mortgages by deliberately lowering
lending standards to approve so-called subprime loans for home buyers
whose incomes were insufficient to make their monthly mortgage payments.
Once these lenders earned their fees on these loans, they repackaged the loans
to hide their true nature and auctioned them off to unsuspecting investors,
who later suffered huge losses when the high-risk borrowers began to default
on their loan payments. (Government authorities later forced some of the
firms that auctioned off these packaged loans to repurchase them at the
auction price and bear the losses themselves.) A lawsuit by the attorneys
general of 49 states charging widespread and systematic fraud ultimately
resulted in a $26 billion settlement by the five largest U.S. banks (Bank of
America, Citigroup, JPMorgan Chase, Wells Fargo, and Ally Financial).
Included in the settlement were new rules designed to increase oversight and
reform policies and practices among the mortgage companies. The settlement
includes what are believed to be a set of robust monitoring and enforcement
mechanisms that should help prevent such abuses in the future.15
https://www.recode.net/2017/8/31/16227670/uber-lyft-market-share-deleteuber-decline-users
https://www.inc.com/associated-press/lyft-thrives-while-rival-uber-tries-to-stabilize-regain-control-2017.html
https://www.entrepreneur.com/article/300789
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Heavy Pressures on Company Managers to Meet Short-Term
Performance Targets When key personnel find themselves scrambling to
meet the quarterly and annual sales and profit expectations of investors and
financial analysts, they often feel enormous pressure to do whatever it takes
to protect their reputation for delivering good results. Executives at high-
performing companies know that investors will see the slightest sign of a
slowdown in earnings growth as a red flag and drive down the company’s
stock price. In addition, slowing growth or declining profits could lead to a
downgrade of the company’s credit rating if it has used lots of debt to finance
its growth. The pressure to “never miss a quarter”—to not upset the
expectations of analysts, investors, and creditors—prompts nearsighted
managers to engage in short-term maneuvers to make the numbers, regardless
of whether these moves are really in the best long-term interests of the
company. Sometimes the pressure induces company personnel to continue to
stretch the rules until the limits of ethical conduct are overlooked.16 Once
ethical boundaries are crossed in efforts to “meet or beat their numbers,” the
threshold for making more extreme ethical compromises becomes lower.
To meet its demanding profit target, Wells Fargo put such pressure on its
employees to hit sales quotas that many employees responded by fraudulently
opening customer accounts. In 2017, after the practices came to light, the
bank was forced to return $2.6 million to customers and pay $186 million in
fines to the government. Wells Fargo’s reputation took a big hit, its stock
price plummeted, and its CEO lost his job.
Company executives often feel pressured to hit financial performance
targets because their compensation depends heavily on the company’s
performance. Over the last two decades, it has become fashionable for boards
of directors to grant lavish bonuses, stock option awards, and other
compensation benefits to executives for meeting specified performance
targets. So outlandishly large were these rewards that executives
had strong personal incentives to bend the rules and engage in
behaviors that allowed the targets to be met. Much of the accounting
manipulation at the root of recent corporate scandals has entailed situations in
which executives benefited enormously from misleading accounting or other
shady activities that allowed them to hit the numbers and receive incentive
awards ranging from $10 million to more than $1 billion for hedge fund
managers.
The fundamental problem with short-termism—the tendency for
managers to focus excessive attention on short-term performance objectives
—is that it doesn’t create value for customers or improve the firm’s
competitiveness in the marketplace; that is, it sacrifices the activities that are
the most reliable drivers of higher profits and added shareholder value in the
long run. Cutting ethical corners in the name of profits carries exceptionally
high risk for shareholders—the steep stock price decline and tarnished brand
image that accompany the discovery of scurrilous behavior leave
shareholders with a company worth much less than before—and the
rebuilding task can be arduous, taking both considerable time and resources.
CORE
CONCEPT
Short-termism is
the tendency for
managers to focus
excessively on
short-term
performance
objectives at the
expense of longer-
term strategic
objectives. It has
negative
implications for the
likelihood of ethical
lapses as well as
company
performance in the
longer run.
A Company Culture That Puts Profitability and Business Performance
Ahead of Ethical Behavior When a company’s culture spawns an
ethically corrupt or amoral work climate, people have a company-approved
license to ignore “what’s right” and engage in any behavior or strategy they
think they can get away with. Such cultural norms as “Everyone else does it”
and “It is okay to bend the rules to get the job done” permeate the work
environment. At such companies, ethically immoral people are certain to play
down observance of ethical strategic actions and business conduct. Moreover,
cultural pressures to utilize unethical means if circumstances become
page 277
challenging can prompt otherwise honorable people to behave unethically. A
perfect example of a company culture gone awry on ethics is Enron, a now-
defunct but infamous company found guilty of one of the most sprawling
business frauds in U.S. history.17
Enron’s leaders pressured company personnel to be innovative and
aggressive in figuring out how to grow current earnings—regardless of the
methods. Enron’s annual “rank and yank” performance evaluation process, in
which the lowest-ranking 15 to 20 percent of employees were let go, made it
abundantly clear that bottom-line results were what mattered most. The name
of the game at Enron became devising clever ways to boost revenues and
earnings, even if this sometimes meant operating outside established policies
(and legal limits). In fact, outside-the-lines behavior was celebrated if it
generated profitable new business.
A high-performance–high-rewards climate came to pervade the Enron
culture, as the best workers (determined by who produced the best bottom-
line results) received impressively large incentives and bonuses. On Car Day
at Enron, an array of luxury sports cars arrived for presentation to the most
successful employees. Understandably, employees wanted to be seen as part
of Enron’s star team and partake in the benefits granted to Enron’s best and
brightest employees. The high monetary rewards, the ambitious and hard-
driving people whom the company hired and promoted, and the competitive,
results-oriented culture combined to give Enron a reputation not only for
trampling competitors but also for internal ruthlessness. The company’s win-
at-all-costs mindset nurtured a culture that gradually and then more rapidly
fostered the erosion of ethical standards, eventually making a mockery of the
company’s stated values of integrity and respect. When it became evident that
Enron was a house of cards propped up by deceitful accounting and myriad
unsavory practices, the company imploded in a matter of weeks—one of the
biggest bankruptcies of all time, costing investors $64 billion in losses.
In contrast, when high ethical principles are deeply ingrained
in the corporate culture of a company, culture can function as a powerful
mechanism for communicating ethical behavioral norms and gaining
employee buy-in to the company’s moral standards, business principles, and
corporate values. In such cases, the ethical principles embraced in the
company’s code of ethics and/or in its statement of corporate values are seen
as integral to the company’s identity, self-image, and ways of operating. The
message that ethics matters—and matters a lot—resounds loudly and clearly
throughout the organization and in its strategy and decisions.
WHY SHOULD COMPANY STRATEGIES
BE ETHICAL?
There are two reasons why a company’s strategy should be ethical: (1)
because a strategy that is unethical is morally wrong and reflects badly on the
character of the company and its personnel, and (2) because an ethical
strategy can be good business and serve the self-interest of shareholders.
The Moral Case for an Ethical Strategy
Managers do not dispassionately assess what strategic course to steer—how
strongly committed they are to observing ethical principles and standards
definitely comes into play in making strategic choices. Ethical strategy
making is generally the product of managers who are of strong moral
character (i.e., who are trustworthy, have integrity, and truly care about
conducting the company’s business honorably). Managers with high ethical
principles are usually advocates of a corporate code of ethics and strong
ethics compliance, and they are genuinely committed to upholding corporate
values and ethical business principles. They demonstrate their commitment
by displaying the company’s stated values and living up to its business
principles and ethical standards. They understand the difference between
merely adopting value statements and codes of ethics and ensuring that they
are followed strictly in a company’s actual strategy and business conduct. As
a consequence, ethically strong managers consciously opt for strategic
actions that can pass the strictest moral scrutiny—they display no tolerance
for strategies with ethically controversial components.
• LO 9-3
Identify the costs of
business ethics
failures.
The Business Case for Ethical Strategies
In addition to the moral reasons for adopting ethical strategies, there may be
solid business reasons. Pursuing unethical strategies and tolerating unethical
conduct not only damages a company’s reputation but also may result in a
wide-ranging set of other costly consequences. Figure 9.1 shows the kinds of
costs a company can incur when unethical behavior on its part is discovered,
the wrongdoings of company personnel are headlined in the media, and it is
forced to make amends for its behavior. The more egregious are a company’s
ethical violations, the higher the costs and the bigger the damage to its
reputation (and to the reputations of the company personnel involved). In
high-profile instances, the costs of ethical misconduct can easily run into the
hundreds of millions and even billions of dollars, especially if they provoke
widespread public outrage and many people were harmed. The penalties
levied on executives caught in wrongdoing can skyrocket as well, as the 150-
year prison term sentence of infamous financier and Ponzi scheme
perpetrator Bernie Madoff illustrates.
FIGURE 9.1 The Costs Companies Incur When Ethical
Wrongdoing Is Discovered
page 278
Source: Adapted from Terry Thomas, John R. Schermerhorn, and John W. Dienhart,
“Strategic Leadership of Ethical Behavior,” Academy of Management Executive 18, no. 2
(May 2004), p. 58.
The fallout of a company’s ethical misconduct goes well beyond the costs
of making amends for the misdeeds. Customers shun companies caught up in
highly publicized ethical scandals. Rehabilitating a company’s
shattered reputation is time-consuming and costly. Companies
with tarnished reputations have difficulty in recruiting and retaining talented
employees. Most ethically upstanding people are repulsed by a work
environment where unethical behavior is condoned; they don’t want to get
entrapped in a compromising situation, nor do they want their personal
reputations tarnished by the actions of an unsavory employer. Creditors are
unnerved by the unethical actions of a borrower because of the potential
business fallout and subsequent higher risk of default on loans.
All told, a company’s unethical behavior can do considerable damage to
shareholders in the form of lost revenues, higher costs, lower profits, lower
stock prices, and a diminished business reputation. To a significant degree,
therefore, ethical strategies and ethical conduct are good business. Most
companies understand the value of operating in a manner that wins the
page 279
approval of suppliers, employees, investors, and society at large. Most
businesspeople recognize the risks and adverse fallout attached to the
discovery of unethical behavior. Hence, companies have an incentive to
employ strategies that can pass the test of being ethical. Even if a company’s
managers are not personally committed to high ethical standards, they have
good reason to operate within ethical bounds, if only to (1) avoid the risk of
embarrassment, scandal, disciplinary action, fines, and possible jail time for
unethical conduct on their part; and (2) escape being held accountable for lax
enforcement of ethical standards and unethical behavior by personnel under
their supervision. Illustration Capsule 9.2 discusses PepsiCo’s commitment to
high ethical standards and their approach to putting their ethical principles
into practice.
Shareholders suffer
major damage when
a company’s
unethical behavior is
discovered. Making
amends for
unethical business
conduct is costly,
and it takes years to
rehabilitate a
tarnished company
reputation.
ILLUSTRATION
CAPSULE 9.2 How PepsiCo Put Its Ethical
Principles into Practice
PepsiCo is one of the world’s leading food and beverage companies with over $65 billion
in net revenue, coming from iconic brands such as Lays and Ruffles potato chips, Quaker
Oatmeal, Tropicana juice, Mountain Dew, and Diet Pepsi. The company is also known for
its dedication to ethical business practices, having ranked consistently as among the
World’s Most Ethical Companies by business ethics think tank Ethicsphere ever since the
award program was initiated. PepsiCo’s Global Code of Conduct plays a pivotal role in
ensuring that PepsiCo’s employees, managers, and directors around the world are
complying with the company’s high ethical standards. It provides specific guidance
concerning how to make decisions, how to treat others, and how to conduct business
globally, organized around four key operating principles: (1) respect in the workplace, (2)
integrity in the marketplace, (3) ethics in business activities, and (4) responsibility to
shareholders. Essentially, the Code of Conduct lays out a set of behavioral norms that
has come to define the company’s culture.
Even with a strong ethical culture, implementing a code of conduct across a global
organization of over 263,000 employees is challenging. To assist, PepsiCo set up a
Global Compliance & Ethics Department with primary responsibility for promoting,
monitoring, and enforcing the code. Employees at all levels are required to participate in
annual Code of Conduct training, through online courses as well as in-person, manager-
led workshops. Compliance training also takes place in a more targeted fashion, based
on role and geography, concerning such issues as bribery. Other types of
communications throughout the year, such as internal newsletter articles and messaging
from the leadership, reinforce the annual training.
monticello/Shutterstock
Employees are encouraged to seek guidance when faced with an ethical dilemma.
They are also encouraged to raise concerns and are obligated to report any Code
violations. A variety of channels have been set up for them to do this, including a hotline
operated by an independent third party. All reports of suspected violations are reviewed
in accordance with company policies designed to foster consistency of the investigative
process and corrective actions (which may include termination of employment). PepsiCo
has also established an annual peer-nominated Ethical Leadership Award designed to
recognize instances of exceptional ethical conduct by employees.
The leadership at PepsiCo believes that their commitment to ethical principles has
helped the company in attracting and retaining the best people. Indeed, PepsiCo has
been listed as among the Top Attractors of talent globally. In addition, the company has
page 280
regularly been listed as among the World’s Most Respected Companies (Barron) and the
World’s Most Admired Companies (Fortune).
Sources: Company website; https://ethisphere.com/pepsico-performance-purpose/.
STRATEGY, CORPORATE SOCIAL
RESPONSIBILITY, AND
ENVIRONMENTAL SUSTAINABILITY
The idea that businesses have an obligation to foster social betterment, a
much-debated topic over the past 50 years, took root in the 19th century
when progressive companies in the aftermath of the industrial revolution
began to provide workers with housing and other amenities. The notion that
corporate executives should balance the interests of all stakeholders—
shareholders, employees, customers, suppliers, the communities in
which they operate, and society at large—began to blossom in the
1960s. Some years later, a group of chief executives of America’s 200 largest
corporations, calling themselves the Business Roundtable, came out in strong
support of the concept of corporate social responsibility (CSR):
CORE
CONCEPT
Corporate social
responsibility
(CSR) refers to a
company’s duty to
operate in an
honorable manner,
provide good
working conditions
for employees,
encourage
workforce diversity,
be a good steward
of the environment,
and actively work to
better the quality of
life in the local
communities where
https://ethisphere.com/pepsico-performance-purpose/
it operates and in
society at large.
Balancing the shareholder’s expectations of maximum return against other priorities is one of the
fundamental problems confronting corporate management. The shareholder must receive a good
return but the legitimate concerns of other constituencies (customers, employees, communities,
suppliers and society at large) also must have the appropriate attention. . . . [Leading managers]
believe that by giving enlightened consideration to balancing the legitimate claims of all its
constituents, a corporation will best serve the interest of its shareholders.
• LO 9-4
Understand the
concepts of
corporate social
responsibility and
environmental
sustainability and
how companies
balance these duties
with economic
responsibilities to
shareholders.
Today, corporate social responsibility is a concept that resonates in western
Europe, the United States, Canada, and such developing nations as Brazil and
India.
The Concepts of Corporate Social Responsibility
and Good Corporate Citizenship
The essence of socially responsible business behavior is that a company
should balance strategic actions to benefit shareholders against the duty to be
a good corporate citizen. The underlying thesis is that company managers
should display a social conscience in operating the business and specifically
take into account how management decisions and company actions affect the
well-being of employees, local communities, the environment, and society at
large.18 Acting in a socially responsible manner thus encompasses more than
just participating in community service projects and donating money to
charities and other worthy causes. Demonstrating social responsibility also
entails undertaking actions that earn trust and respect from all stakeholders—
operating in an honorable and ethical manner, striving to make the company a
great place to work, demonstrating genuine respect for the environment, and
trying to make a difference in bettering society. As depicted in Figure 9.2,
corporate responsibility programs commonly include the following elements:
FIGURE 9.2 The Five Components of a Corporate Social
Responsibility Strategy
Source: Adapted from material in Ronald Paul Hill, Debra Stephens, and Iain Smith,
“Corporate Social Responsibility: An Examination of Individual Firm Behavior,” Business and
Society Review 108, no. 3 (September 2003), p. 348.
Striving to employ an ethical strategy and observe ethical principles in
operating the business. A sincere commitment to observing ethical
page 281
principles is a necessary component of a CSR strategy simply because
unethical conduct is incompatible with the concept of good corporate
citizenship and socially responsible business behavior.
Making charitable contributions, supporting community service endeavors,
engaging in broader philanthropic initiatives, and reaching out to make a
difference in the lives of the disadvantaged. Some companies fulfill their
philanthropic obligations by spreading their efforts over a multitude of
charitable and community activities—for instance, Cisco, LinkedIn, IBM,
and Google support a broad variety of community, art, and social welfare
programs. Others prefer to focus their energies more narrowly. McDonald’s
concentrates on sponsoring the Ronald McDonald House program (which
provides a home away from home for the families of seriously ill children
receiving treatment at nearby hospitals). Genentech and many
pharmaceutical companies run prescription assistance programs to provide
expensive medications at little or no cost to needy patients. Companies
frequently reinforce their philanthropic efforts by encouraging employees
to support charitable causes and participate in community affairs, often
through programs that match employee contributions.
Taking actions to protect the environment and, in particular, to minimize or
eliminate any adverse impact on the environment stemming from the
company’s own business activities. Corporate social responsibility
as it applies to environmental protection entails actively striving
to be a good steward of the environment. This means using the best
available science and technology to reduce environmentally harmful
aspects of the company’s operations below the levels required by prevailing
environmental regulations. It also means putting time and money into
improving the environment in ways that extend beyond a company’s own
industry boundaries—such as participating in recycling projects, adopting
energy conservation practices, and supporting efforts to clean up local
water supplies. Häagen-Dazs, a maker of all-natural ice creams, started a
social media campaign to raise awareness about the dangers associated
with the decreasing honeybee population; it donates a portion of its profits
to research on this issue. The Walt Disney Company has created strict
environmental targets for themselves and created the “Green Standard” to
inspire employees to reduce their environmental impact.
page 282
Creating a work environment that enhances the quality of life for
employees. Numerous companies exert extra effort to enhance the quality
of life for their employees at work and at home. This can include onsite day
care, flexible work schedules, workplace exercise facilities, special leaves
for employees to care for sick family members, work-at-home
opportunities, career development programs and education opportunities,
showcase plants and offices, special safety programs, and the like.
Building a diverse workforce with respect to gender, race,
national origin, and other aspects that different people bring to
the workplace. Most large companies in the United States have established
workforce diversity programs, and some go the extra mile to ensure that
their workplaces are attractive to ethnic minorities and inclusive of all
groups and perspectives. At some companies, the diversity initiative
extends to suppliers—sourcing items from small businesses owned by
women or members of ethnic minorities, for example. The pursuit of
workforce diversity can also be good business. At Coca-Cola, where
strategic success depends on getting people all over the world to become
loyal consumers of the company’s beverages, efforts to build a public
persona of inclusiveness for people of all races, religions, nationalities,
interests, and talents have considerable strategic value.
The particular combination of socially responsible endeavors a company
elects to pursue defines its corporate social responsibility (CSR) strategy.
The specific components emphasized in a CSR strategy vary from company
to company and are typically linked to a company’s core values. Few
companies have managed to integrate CSR as fully and seamlessly
throughout their organization as Burt’s Bees; there a special committee is
dedicated to leading the organization to attain its CSR goals with respect to
three primary areas: natural well-being, humanitarian responsibility, and
environmental sustainability. General Mills also centers its CSR strategy
around three themes: nourishing lives (via healthier and easier-to-prepare
foods), nourishing communities (via charitable donations to community
causes and volunteerism for community service projects), and nourishing the
environment (via efforts to conserve natural resources, reduce energy and
water usage, promote recycling, and otherwise support environmental
sustainability).19 Starbucks’s CSR strategy includes four main elements
(ethical sourcing, community service, environmental stewardship, and farmer
support), all of which have touch points with the way that the company
procures its coffee—a key aspect of its product differentiation strategy. Some
companies use other terms, such as corporate citizenship, corporate
responsibility, or sustainable responsible business (SRB) to characterize their
CSR initiatives. Illustration Capsule 9.3 describes Warby Parker’s approach
to corporate social responsibility—an approach that ensures that social
responsibility is reflected in all of the company’s actions and endeavors.
CORE
CONCEPT
A company’s CSR
strategy is defined
by the specific
combination of
socially beneficial
activities the
company opts to
support with its
contributions of time,
money, and other
resources.
Although there is wide variation in how companies devise and implement
a CSR strategy, communities of companies concerned with corporate social
responsibility (such as CSR Europe) have emerged to help companies share
best CSR practices. Moreover, a number of reporting standards have been
developed, including ISO 26000—a new internationally recognized standard
for social responsibility set by the International Standards Organization
(ISO).20 Companies that exhibit a strong commitment to corporate social
responsibility are often recognized by being included on lists such as
Corporate Responsibility magazine’s “100 Best Corporate Citizens” or
Corporate Knights magazine’s “Global 100 Most Sustainable Corporations.”
Corporate Social Responsibility and the Triple Bottom Line CSR
initiatives undertaken by companies are frequently directed at improving the
company’s triple bottom line (TBL)—a reference to three types of
performance metrics: economic, social, and environmental. The goal is for a
company to succeed simultaneously in all three dimensions, as illustrated in
Figure 9.3.21 The three dimensions of performance are often referred to in
page 283
terms of the “three pillars” of “people, planet, and profit.” The term people
refers to the various social initiatives that make up CSR strategies, such as
corporate giving, community involvement, and company efforts to improve
the lives of its internal and external stakeholders. Planet refers to a
firm’s ecological impact and environmental practices. The term
profit has a broader meaning with respect to the triple bottom line than it does
otherwise. It encompasses not only the profit a firm earns for its shareholders
but also the economic impact that the company has on society more
generally, in terms of the overall value that it creates and the overall costs that
it imposes on society. For example, Procter & Gamble’s Swiffer cleaning
system, one of the company’s best-selling products, not only offers an earth-
friendly design but also outperforms less ecologically friendly alternatives in
terms of its broader economic impact: It reduces demands on municipal water
sources, saves electricity that would be needed to heat mop water, and
doesn’t add to the amount of detergent making its way into waterways and
waste treatment facilities. Nike sees itself as bringing people, planet, and
profits into balance by producing innovative new products in a more
sustainable way, recognizing that sustainability is key to its future
profitability. TOMS shoes, which donates a pair of shoes to a child in need in
over 50 different countries for every pair purchased, has also built its strategy
around maintaining a well-balanced triple bottom line.
FIGURE 9.3 The Triple Bottom Line: Excelling on Three
Measures of Company Performance
Source: Developed with help from Amy E. Florentino.
ILLUSTRATION
CAPSULE 9.3 Warby Parker: Combining
Corporate Social Responsibility with Affordable
Fashion
Since its founding in 2010, Warby Parker has succeeded in selling over one million pairs
of high-fashion glasses at a discounted price of $95—roughly 80 percent below the
average $500 price tag on a comparable pair of eyeglasses from another producer. With
more than 70 stores in the United States, the company has built a brand recognized
universally as one of the strongest in the world; it consistently posts a net promoter score
(a measure of how likely someone would be to recommend the product) of close to 90—
higher than companies like Zappos and Apple.
Under its Buy a Pair, Give a Pair program, nearly more than five million pairs of glasses
have been distributed to needy people in more than 50 countries. Warby Parker also
supports partners, like Vision Spring, enabling them to provide basic eye exams and
teach community members how to manufacture and sell glasses at very low prices,
thereby providing vocational training and improving the standard of living in these
communities. The average impact on a recipient of a pair of donated glasses was a 20
percent increase in personal income and a 35 percent increase in productivity.
Efforts to be a responsible company expand beyond Warby Parker’s international
partnerships. The company voluntarily evaluates itself against benchmarks in the fields of
“environment,” “workers,” “customers,” “community,” and “governance,” demonstrating a
nearly unparalleled dedication to outcomes outside of profit. The company is widely seen
as an employer of choice and regularly attracts top talent for all roles across the
organization. It holds to an extremely high environmental standard, running an entirely
carbon neutral operation.
While socially impactful actions matter at Warby Parker, the company is mindful of the
critical role of its suppliers as well. Both founders spent countless hours coordinating
partnerships with dedicated suppliers to ensure quality, invested deeply in building a lean
manufacturing operation to minimize cost, and sought to build an organization that would
keep buyers happy. The net effect is a very economically healthy company—they post
around $3,000 in sales per square foot, second only to Apple stores—with financial
stability to pursue responsibilities outside of customer satisfaction.
Interim Archives/Contributor/Getty Images
page 284
The strong fundamentals put in place by the firm’s founders blend responsibility into its
DNA and attach each piece of commercial success to positive outcomes in the world.
The company was recently recognized as number one on Fast Company’s “Most
Innovative Companies” list and continues to build loyal followers—both of its products
and its CSR efforts—as it expands.
Note: Developed with Jeremy P. Reich.
Sources: Warby Parker and “B Corp” websites; Max Chafkin, “Warby Parker Sees the
Future of Retail,” Fast Company, February 17, 2015 (accessed February 22, 2016); Jenni
Avins, “Warby Parker Proves Customers Don’t Have to Care about Your Social Mission,”
Quartz, December 29, 2014 (accessed February 14, 2016).
Many companies now make a point of citing the beneficial
outcomes of their CSR strategies in press releases and issue special reports
for consumers and investors to review. Southwest Airlines makes reporting
an important part of its commitment to corporate responsibility; the company
posts its annual Southwest Airlines One Report on its website that describes
its initiatives and accomplishments with respect to each of the three pillars of
triple bottom line performance—people, planet, profit. Triple-bottom-line
reporting is emerging as an increasingly important way for companies to
make the results of their CSR strategies apparent to stakeholders and for
stakeholders to hold companies accountable for their impact on society. The
use of standard reporting frameworks and metrics, such as those developed
by the Global Reporting Initiative, promotes greater transparency and
facilitates benchmarking CSR efforts across firms and industries.
Investment firms have created mutual funds consisting of companies that
are excelling on the basis of the triple bottom line in order to attract funds
from environmentally and socially aware investors. The Dow Jones
Sustainability World Index is made up of the top 10 percent of the 2,500
companies listed in the Dow Jones World Index in terms of economic
performance, environmental performance, and social performance.
Companies are evaluated in these three performance areas, using indicators
such as corporate governance, climate change mitigation, and labor practices.
Table 9.1 shows a sampling of the companies selected for the Dow Jones
Sustainability World Index in 2013.
TABLE 9.1 A Selection of Companies Recognized for Their
Triple-Bottom-Line Performance in 2013
Name Market Sector Country
Peugeot SA Automobiles &Components France
Westpac Banking Group Banks Australia
CNH Industrial NV Capital Goods Great Britain
SGS SA Commercial &Professional Services Switzerland
LG Electronics Inc. Consumer Durables &Apparel South Korea
InterContinental Hotels Group Consumer Services Great Britain
UBS Group AB Diversified Financials Switzerland
Thai Oil PCL Energy Thailand
METRO AG Food & StaplesRetailing Germany
Coca-Cola HBC AG Food, Beverage &Tobacco Switzerland
Abbott Laboratories Health Care Equipment& Services United States
Henkel AG & Co. KGaA Household & PersonalProducts Germany
Allianz SE Insurance Germany
Grupo Argos SA Materials Colombia
Pearson PLC Media Great Britain
Roche Holding AG
Pharmaceuticals,
Biotechnology & Life
Sciences
Switzerland
Mirvac Group Real Estate Australia
Industria de Diseno Textil SA Retailing Spain
Advanced Semiconductor
Engineering Inc.
Semiconductors &
Semiconductor
Equipment
Taiwan
Amadeus IT Group SA Software & Services Spain
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Name Market Sector Country
Konica Minolta Inc. Technology Hardware& Equipment Japan
Koninklijke KPN NV TelecommunicationServices Netherlands
Royal Mail PLC Transportation Great Britain
Red Electric Corp SA Utilities Spain
Source: Adapted from RobecoSAM AG, www.sustainability-indices.com/review/industry-
group-leaders-2017.jsp (accessed March 4, 2018).
What Do We Mean by Sustainability and
Sustainable Business Practices?
The term sustainability is used in a variety of ways. In many firms, it is
synonymous with corporate social responsibility; it is seen by some as a term
that is gradually replacing CSR in the business lexicon. Indeed, sustainability
reporting and TBL reporting are often one and the same, as
illustrated by the Dow Jones Sustainability World Index, which
tracks the same three types of performance measures that constitute the triple
bottom line.
More often, however, the term takes on a more focused meaning,
concerned with the relationship of a company to its environment and its use
of natural resources, including land, water, air, plants, animals, minerals,
fossil fuels, and biodiversity. It is widely recognized that the world’s natural
resources are finite and are being consumed and degraded at rates that
threaten their capacity for renewal. Since corporations are the biggest users of
natural resources, managing and maintaining these resources is critical for the
long-term economic interests of corporations.
For some companies, this issue has direct and obvious implications for the
continued viability of their business model and strategy. Pacific Gas and
Electric has begun measuring the full carbon footprint of its supply chain to
become not only a “greener” company but a more efficient energy
producer.22 Beverage companies such as Coca-Cola and PepsiCo are having
to rethink their business models because of the prospect of future worldwide
http://www.sustainability-indices.com/review/industry-group-leaders-2017.jsp
water shortages. For other companies, the connection is less direct, but all
companies are part of a business ecosystem whose economic health depends
on the availability of natural resources. In response, most major companies
have begun to change how they do business, emphasizing the use of
sustainable business practices, defined as those capable of meeting the
needs of the present without compromising the ability to meet the needs of
the future. Many have also begun to incorporate a consideration of
environmental sustainability into their strategy-making activities.
CORE
CONCEPT
Sustainable
business practices
are those that meet
the needs of the
present without
compromising the
ability to meet the
needs of the future.
Environmental sustainability strategies entail deliberate and concerted
actions to operate businesses in a manner that protects natural resources and
ecological support systems, guards against outcomes that will ultimately
endanger the planet, and is therefore sustainable for centuries.23 One aspect
of environmental sustainability is keeping use of the Earth’s natural resources
within levels that can be replenished via the use of sustainable business
practices. In the case of some resources (like crude oil, freshwater, and edible
fish from the oceans), scientists say that use levels either are already
unsustainable or will be soon, given the world’s growing population and
propensity to consume additional resources as incomes and living standards
rise. Another aspect of sustainability concerns containing the adverse effects
of greenhouse gases and other forms of air pollution to reduce their impact on
undesirable climate and atmospheric changes. Other aspects of sustainability
include greater reliance on sustainable energy sources; greater use of
recyclable materials; the use of sustainable methods of growing foods (to
reduce topsoil depletion and the use of pesticides, herbicides, fertilizers, and
other chemicals that may be harmful to human health or ecological systems);
habitat protection; environmentally sound waste management practices; and
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increased attempts to decouple environmental degradation and economic
growth (according to scientists, economic growth has historically been
accompanied by declines in the well-being of the environment).
CORE
CONCEPT
A company’s
environmental
sustainability
strategy consists of
its deliberate actions
to protect the
environment,
provide for the
longevity of natural
resources, maintain
ecological support
systems for future
generations, and
guard against
ultimate
endangerment of the
planet.
Unilever, a diversified producer of processed foods, personal care, and
home cleaning products, is among the many committed corporations pursuing
sustainable business practices. The company tracks 11 sustainable
agricultural indicators in its processed-foods business and has launched a
variety of programs to improve the environmental performance of its
suppliers. Examples of such programs include special low-rate financing for
tomato suppliers choosing to switch to water-conserving irrigation systems
and training programs in India that have allowed contract cucumber growers
to reduce pesticide use by 90 percent while improving yields by 78 percent.
Unilever has also reengineered many internal processes to
improve the company’s overall performance on sustainability
measures. For example, the company has reduced water usage in the
production of their products by 37 percent since 2008 through the
implementation of sustainability initiatives. Unilever has also redesigned
packaging for many of its products to conserve natural resources and reduce
the volume of consumer waste. The company’s Suave shampoo bottles were
reshaped to save almost 150 tons of plastic resin per year, which is the
equivalent of 15 million fewer empty bottles making it to landfills annually.
As the producer of Lipton Tea, Unilever is the world’s largest purchaser of
tea leaves; the company committed to sourcing all of its tea from Rainforest
Alliance Certified farms, due to its comprehensive triple-bottom-line
approach toward sustainable farm management. Illustration Capsule 9.4
sheds more light on Unilever’s focus on sustainability.
Crafting Corporate Social Responsibility and
Sustainability Strategies
While CSR and environmental sustainability strategies take many forms,
those that both provide valuable social benefits and fulfill customer needs in
a superior fashion may also contribute to a company’s competitive
advantage.24 For example, while carbon emissions may be a generic social
concern for financial institutions such as Wells Fargo, Ford’s sustainability
strategy for reducing carbon emissions has produced both competitive
advantage and environmental benefits. Its Ford Fusion hybrid is among the
least polluting automobiles The Ford Explorer plug-in hybrid SUV launched
in Europe in 2019 provides 7-passenger seating capacity and has a 40-
kilometer zero-emission city driving range. The development of hybrid
models like the Fusion and the Explorer have helped Ford gain the loyalty of
fuel-conscious buyers and given the company a new green image. Keurig
Green Mountain (now part of Keurig Dr. Pepper) is committed to caring for
the environment while also improving the livelihoods in coffee-growing
communities. Their focus is on three primary solutions: (1) helping farmer
improve their farming techniques; (2) addressing local water scarcity and
planning for climate change; and (3) strengthening farmers’ organizations. Its
consumers are aware of these efforts and purchase Green Mountain coffee, in
part, to encourage such practices.
CSR strategies and environmental sustainability strategies are more likely
to contribute to a company’s competitive advantage if they are linked to a
company’s competitively important resources and capabilities or value chain
activities. Thus, it is common for companies engaged in natural resource
extraction, electric power production, forestry and paper products
manufacture, motor vehicles production, and chemical production to place
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more emphasis on addressing environmental concerns than, say, software and
electronics firms or apparel manufacturers. Companies whose business
success is heavily dependent on maintaining high employee morale or
attracting and retaining the best and brightest employees are somewhat more
prone to stress the well-being of their employees and foster a positive, high-
energy workplace environment that elicits the dedication and enthusiastic
commitment of employees, thus putting real meaning behind the claim “Our
people are our greatest asset.” EY, the third largest global accounting firm,
has been on Fortune’s list of 100 Best Companies to Work for every year for
the last 20 years. It has long been known for respecting differences, fostering
individuality, and promoting inclusiveness so that its more than 245,000
employees in over 150 countries can feel valued, engaged, and empowered in
developing creative ways to serve the firm’s clients.
CSR strategies and
environmental
sustainability
strategies that both
provide valuable
social benefits and
fulfill customer
needs in a superior
fashion can lead to
competitive
advantage.
Corporate social
agendas that
address only social
issues may help
boost a company’s
reputation for
corporate citizenship
but are unlikely to
improve its
competitive strength
in the marketplace.
At Whole Foods Market, a $16 billion supermarket chain specializing in
organic and natural foods, its environmental sustainability strategy is evident
in almost every segment of its company value chain and is a big
part of its differentiation strategy. The company’s procurement
policies encourage stores to purchase fresh fruits and vegetables from local
farmers and screen processed-food items for more than 400 common
ingredients that the company considers unhealthy or environmentally
unsound. Spoiled food items are sent to regional composting centers rather
than landfills, and all cleaning products used in its stores are biodegradable.
The company also has created the Animal Compassion Foundation to
develop natural and humane ways of raising farm animals and has converted
all of its vehicles to run on biofuels.
ILLUSTRATION
CAPSULE 9.4 Unilever’s Focus on
Sustainability
With over 53.7 billion euros in revenue in 2017, Unilever is one of the world’s largest
companies. The global consumer goods giant has products that are used by over 2 billion
people on any given day. It manufactures iconic global brands like Dove, Axe, Hellman’s,
Heartbrand, and many others. What it is also known for, however, is its commitment to
sustainability, leading GlobeScan’s Global Sustainability Survey for sustainable
companies with a score 2.5 times higher than its closest competitor.
Unilever implemented its sustainability plan in as transparent and explicit way as
possible, evidenced by the Unilever Sustainable Living Plan (USLP). The USLP was
released in 2010 by CEO Paul Polman, stating that the company’s goal was to double the
size of the business while halving its environmental footprint by 2020. Importantly, the
USLP has remained a guiding force for the company, which dedicates significant
resources and time to pursuing its sustainability goals. The plan is updated each year
with targets and goals, as well as an annual progress report.
According to Polman, Unilever’s focus on sustainability isn’t just charity, but is really an
act of self-interest. The company’s most recent annual report states “growth and
sustainability are not in conflict. In fact, in our experience, sustainability drives growth.”
Polman insists that this is the modern-day way to maximize profits, and that doing so is
simply rational business thinking.
To help implement this plan, Unilever has instituted a corporate accountability plan.
Each year, Unilever benchmarks its progress against three leading indices: the UN
Global Compact, the Global Reporting Initiative’s Index, and the UN Millennium
Development Goals. In its annual sustainability report, the company details its progress
toward its many sustainability goals. By 2018, Unilever had helped more than 601 million
people to improve their health and hygiene habits and had enabled over 716,000 small
farmers to improve their agricultural practices and/or their incomes.
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GeoPic/Alamy Stock Photo
Unilever has also created new business practices to reach even more ambitious
targets. Unilever set up a central corporate team dedicated to spreading best
sustainability practices from one factory or business unit to the rest of the company, a
major change from the siloed manner in which the company previously operated.
Moreover, the company set up a “small actions, big differences” fund to invest in
innovative ideas that help the company achieve its sustainability goal. To reduce
emissions from the overall footprint of its products and extend its sustainability efforts to
its entire supply chain, it has worked with its suppliers to source sustainable agricultural
products, improving from 14 percent sustainable in 2010 to 56 percent in 2017.
Note: Developed with Byron G. Peyster.
Sources: www.globescan.com/component/edocman/?
view=document&id=179&Itemid=591; www.fastcocreate.com/3051498/behind-the-
brand/why-unilever-is-betting-big-on-sustainability;
www.economist.com/news/business/21611103-second-time-its-120-year-history—
unilever-trying-redefine-what-it-means-be; company website (accessed March 13,
2016).
Not all companies choose to link their corporate
environmental or social agendas to their value chain, their business model, or
their industry. For example, the Clorox Company Foundation supports
programs that serve youth, focusing its giving on nonprofit civic
organizations, schools, and colleges. However, unless a company’s social
responsibility initiatives become part of the way it operates its business every
day, the initiatives are unlikely to catch fire and be fully effective. As an
executive at Royal Dutch/Shell put it, corporate social responsibility “is not a
http://www.globescan.com/component/edocman/?view=document&id=179&Itemid=591
http://www.fastcocreate.com/3051498/behind-the-brand/why-unilever-is-betting-big-on-sustainability
http://www.economist.com/news/business/21611103-second-time-its-120-year-history%E2%80%94unilever-trying-redefine-what-it-means-be
cosmetic; it must be rooted in our values. It must make a difference to the
way we do business.”25 The same is true for environmental sustainability
initiatives.
The Moral Case for Corporate Social
Responsibility and Environmentally Sustainable
Business Practices
The moral case for why businesses should act in a manner that benefits all of
the company’s stakeholders—not just shareholders—boils down to “It’s the
right thing to do.” Ordinary decency, civic-mindedness, and contributions to
society’s well-being should be expected of any business.26 In today’s social
and political climate, most business leaders can be expected to acknowledge
that socially responsible actions are important and that businesses have a duty
to be good corporate citizens. But there is a complementary school of thought
that business operates on the basis of an implied social contract with the
members of society. According to this contract, society grants a business the
right to conduct its business affairs and agrees not to unreasonably restrain its
pursuit of a fair profit for the goods or services it sells. In return for this
“license to operate,” a business is obligated to act as a responsible citizen, do
its fair share to promote the general welfare, and avoid doing any harm. Such
a view clearly puts a moral burden on a company to operate honorably,
provide good working conditions to employees, be a good environmental
steward, and display good corporate citizenship.
Every action a
company takes can
be interpreted as a
statement of what it
stands for.
The Business Case for Corporate Social
Responsibility and Environmentally Sustainable
Business Practices
page 290
Whatever the moral arguments for socially responsible business behavior and
environmentally sustainable business practices, there are definitely good
business reasons why companies should be public-spirited and devote time
and resources to social responsibility initiatives, environmental sustainability,
and good corporate citizenship:
Such actions can lead to increased buyer patronage. A strong visible social
responsibility or environmental sustainability strategy gives a company an
edge in appealing to consumers who prefer to do business with companies
that are good corporate citizens. Ben & Jerry’s, Whole Foods Market,
Stonyfield Farm, TOMS, Keurig Green Mountain, and Patagonia have
definitely expanded their customer bases because of their visible and well-
publicized activities as socially conscious companies. More and more
companies are also recognizing the cash register payoff of social
responsibility strategies that reach out to people of all cultures and
demographics (women, retirees, and ethnic groups).
A strong commitment to socially responsible behavior reduces the risk of
reputation-damaging incidents. Companies that place little importance on
operating in a socially responsible manner are more prone to
scandal and embarrassment. Consumer, environmental, and
human rights activist groups are quick to criticize businesses whose
behavior they consider to be out of line, and they are adept at getting their
message into the media and onto the Internet. Pressure groups can generate
widespread adverse publicity, promote boycotts, and influence like-minded
or sympathetic buyers to avoid an offender’s products.
The higher the
public profile of a
company or its
brand, the greater
the scrutiny of its
activities and the
higher the potential
for it to become a
target for pressure
group action.
Research has shown that product boycott announcements are associated
with a decline in a company’s stock price.27 When a major oil company
suffered damage to its reputation on environmental and social grounds, the
CEO repeatedly said that the most negative impact the company suffered—
and the one that made him fear for the future of the company—was that
bright young graduates were no longer attracted to working for the
company. For many years, Nike received stinging criticism for not policing
sweatshop conditions in the Asian factories that produced Nike footwear, a
situation that caused Nike cofounder and chair Phil Knight to observe that
“Nike has become synonymous with slave wages, forced overtime, and
arbitrary abuse.”28 In response, Nike began an extensive effort to monitor
conditions in the 800 factories of the contract manufacturers that produced
Nike shoes. As Knight said, “Good shoes come from good factories and
good factories have good labor relations.” Nonetheless, Nike has
continually been plagued by complaints from human rights activists that its
monitoring procedures are flawed and that it is not doing enough to correct
the plight of factory workers. As this suggests, a damaged reputation is not
easily repaired.
Socially responsible actions and sustainable business practices can lower
costs and enhance employee recruiting and workforce retention.
Companies with deservedly good reputations for social responsibility and
sustainable business practices are better able to attract and retain
employees, compared to companies with tarnished reputations. Some
employees just feel better about working for a company committed to
improving society. This can contribute to lower turnover and better worker
productivity. Other direct and indirect economic benefits include lower
costs for staff recruitment and training. For example, Starbucks is said to
enjoy much lower rates of employee turnover because of its full-benefits
package for both full-time and part-time employees, management efforts to
make Starbucks a great place to work, and the company’s socially
responsible practices. Sustainable business practices are often concomitant
with greater operational efficiencies. For example, when a U.S.
manufacturer of recycled paper, taking eco-efficiency to heart, discovered
how to increase its fiber recovery rate, it saved the equivalent of 20,000
tons of waste paper—a factor that helped the company become the
industry’s lowest-cost producer. By helping two-thirds of its employees to
stop smoking and by investing in a number of wellness programs for
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employees, Johnson & Johnson saved $250 million on its health care costs
over a 10-year period.29
Opportunities for revenue enhancement may also come from CSR and
environmental sustainability strategies. The drive for sustainability and
social responsibility can spur innovative efforts that in turn lead to new
products and opportunities for revenue enhancement. Electric cars such as
the Chevy Bolt and the Nissan Leaf are one example. In many cases, the
revenue opportunities are tied to a company’s core products. PepsiCo and
Coca-Cola, for example, have expanded into the juice business to offer a
healthier alternative to their carbonated beverages. General Electric has
created a profitable new business in wind turbines. In other cases, revenue
enhancement opportunities come from innovative ways to reduce waste
and use the by-products of a company’s production. Tyson Foods
now produces jet fuel for B-52 bombers from the vast amount of
animal waste resulting from its meat product business. Staples has become
one of the largest nonutility corporate producers of renewable energy in the
United States due to its installation of solar power panels in all of its outlets
(and the sale of what it does not consume in renewable energy credit
markets).
Well-conceived CSR strategies and sustainable business practices are in
the best long-term interest of shareholders. When CSR and sustainability
strategies increase buyer patronage, offer revenue-enhancing opportunities,
lower costs, increase productivity, and reduce the risk of reputation-
damaging incidents, they contribute to the economic value created by a
company and improve its profitability. A two-year study of leading
companies found that improving environmental compliance and developing
environmentally friendly products can enhance earnings per share,
profitability, and the likelihood of winning contracts. The stock prices of
companies that rate high on social and environmental performance criteria
have been found to perform 35 to 45 percent better than the average of the
2,500 companies that constitute the Dow Jones Global Index.30 A review of
135 studies indicated there is a positive, but small, correlation between
good corporate behavior and good financial performance; only two percent
of the studies showed that dedicating corporate resources to social
responsibility harmed the interests of shareholders.31 Furthermore, socially
responsible business behavior helps avoid or preempt legal and regulatory
actions that could prove costly and otherwise burdensome. In some cases, it
is possible to craft corporate social responsibility strategies that contribute
to competitive advantage and, at the same time, deliver greater value to
society. For instance, Walmart, by working with its suppliers to reduce the
use of packaging materials and revamping the routes of its delivery trucks
to cut out 100 million miles of travel, saved $200 million in costs (which
enhanced its cost-competitiveness vis-à-vis rivals) and lowered carbon
emissions.32 Thus, a social responsibility strategy that packs some punch
and is more than rhetorical flourish can produce outcomes that are in the
best interest of shareholders.
In sum, companies that take social responsibility and environmental
sustainability seriously can improve their business reputations and
operational efficiency while also reducing their risk exposure and
encouraging loyalty and innovation. Overall, companies that take special
pains to protect the environment (beyond what is required by law), are active
in community affairs, and are generous supporters of charitable causes and
projects that benefit society are more likely to be seen as good investments
and as good companies to work for or do business with. Shareholders are
likely to view the business case for social responsibility as a strong one,
particularly when it results in the creation of more customer value, greater
productivity, lower operating costs, and lower business risk—all of which
should increase firm profitability and enhance shareholder value even as the
company’s actions address broader stakeholder interests.
Socially responsible
strategies that
create value for
customers and lower
costs can improve
company profits and
shareholder value at
the same time that
they address other
stakeholder
interests.
There’s little hard
evidence indicating
shareholders are
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disadvantaged in
any meaningful way
by a company’s
actions to be socially
responsible.
Companies are, of course, sometimes rewarded for bad behavior—a
company that is able to shift environmental and other social costs associated
with its activities onto society as a whole can reap large short-term profits.
The major cigarette producers for many years were able to earn greatly
inflated profits by shifting the health-related costs of smoking onto others and
escaping any responsibility for the harm their products caused to
consumers and the general public. Only recently have they been
facing the prospect of having to pay high punitive damages for their actions.
Unfortunately, the cigarette makers are not alone in trying to evade paying for
the social harms of their operations for as long as they can. Calling a halt to
such actions usually hinges on (1) the effectiveness of activist social groups
in publicizing the adverse consequences of a company’s social
irresponsibility and marshaling public opinion for something to be done, (2)
the enactment of legislation or regulations to correct the inequity, and (3)
decisions on the part of socially conscious buyers to take their business
elsewhere.
KEY POINTS
1. Ethics concerns standards of right and wrong. Business ethics concerns the
application of ethical principles to the actions and decisions of business
organizations and the conduct of their personnel. Ethical principles in
business are not materially different from ethical principles in general.
2. There are three schools of thought about ethical standards for companies
with international operations:
According to the school of ethical universalism, common understandings
across multiple cultures and countries about what constitutes right and
wrong behaviors give rise to universal ethical standards that apply to
members of all societies, all companies, and all businesspeople.
According to the school of ethical relativism, different societal cultures
and customs have divergent values and standards of right and wrong.
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Thus, what is ethical or unethical must be judged in the light of local
customs and social mores and can vary from one culture or nation to
another.
According to the integrated social contracts theory, universal ethical
principles based on the collective views of multiple cultures and
societies combine to form a “social contract” that all individuals in all
situations have a duty to observe. Within the boundaries of this social
contract, local cultures or groups can specify what additional actions are
not ethically permissible. However, universal norms always take
precedence over local ethical norms.
3. Apart from the “business of business is business, not ethics” kind of
thinking, three other factors contribute to unethical business behavior: (1)
faulty oversight that enables the unscrupulous pursuit of personal gain, (2)
heavy pressures on company managers to meet or beat short-term earnings
targets, and (3) a company culture that puts profitability and good business
performance ahead of ethical behavior. In contrast, culture can function as
a powerful mechanism for promoting ethical business conduct when high
ethical principles are deeply ingrained in the corporate culture of a
company.
4. Business ethics failures can result in three types of costs: (1) visible costs,
such as fines, penalties, and lower stock prices; (2) internal administrative
costs, such as legal costs and costs of taking corrective action; and (3)
intangible costs or less visible costs, such as customer defections and
damage to the company’s reputation.
5. The term corporate social responsibility concerns a company’s duty to
operate in an honorable manner, provide good working conditions for
employees, encourage workforce diversity, be a good steward of the
environment, and support philanthropic endeavors in local communities
where it operates and in society at large. The particular
combination of socially responsible endeavors a company elects
to pursue defines its corporate social responsibility (CSR) strategy.
6. The triple bottom line refers to company performance in three realms:
economic, social, and environmental, often referred to as profit, people,
and planet. Increasingly, companies are reporting their performance with
respect to all three performance dimensions.
LO 9-1, LO 9-4
LO 9-2, LO 9-3
7. Sustainability is a term that is used in various ways, but most often it
concerns a firm’s relationship to the environment and its use of natural
resources. Sustainable business practices are those capable of meeting the
needs of the present without compromising the world’s ability to meet
future needs. A company’s environmental sustainability strategy consists
of its deliberate actions to protect the environment, provide for the
longevity of natural resources, maintain ecological support systems for
future generations, and guard against ultimate endangerment of the planet.
8. CSR strategies and environmental sustainability strategies that both
provide valuable social benefits and fulfill customer needs in a superior
fashion can lead to competitive advantage.
9. The moral case for corporate social responsibility and environmental
sustainability boils down to a simple concept: It’s the right thing to do.
There are also solid reasons why CSR and environmental sustainability
strategies may be good business—they can be conducive to greater buyer
patronage, reduce the risk of reputation-damaging incidents, provide
opportunities for revenue enhancement, and lower costs. Well-crafted CSR
and environmental sustainability strategies are in the best long-term
interest of shareholders, for the reasons just mentioned and because they
can avoid or preempt costly legal or regulatory actions.
ASSURANCE OF LEARNING EXERCISES
1. Widely known as an ethical company, Dell recently
committed itself to becoming a more
environmentally sustainable business. After
reviewing the About Dell section of its website
(www.dell.com/learn/us/en/uscorp1/about-dell),
prepare a list of eight specific policies and programs
that help the company achieve its vision of driving
social and environmental change while still
remaining innovative and profitable.
2. Prepare a one- to two-page analysis of a recent
ethics scandal using your university library’s
resources. Your report should (1) discuss the
conditions that gave rise to unethical business
http://www.dell.com/learn/us/en/uscorp1/about-dell
LO 9-4
LO 9-4
LO 9-1
LO 9-4
LO 9-3, LO 9-4
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strategies and behavior and (2) provide an overview
of the costs to the company resulting from the
company’s business ethics failure.
3. Based on information provided in Illustration
Capsule 9.3, explain how Warby Parker’s CSR
strategy has contributed to its success in the
marketplace. How are the company’s various
stakeholder groups affected by its commitment to
social responsibility? How would you evaluate its
triple-bottom-line performance?
4. The British outdoor clothing company Páramo was a
Guardian Sustainable Business Award winner in
2016. (Guardian stopped giving the award
afterward.) The company’s fabric technology and
use of chemicals is discussed at
https://www.theguardian.com/sustainable-
business/2016/may/27/outdoor-clothing-paramo-
toxic-pfc-greenpeace-fabric-technology. Describe
how Páramo’s business practices allowed it to
become recognized for its bold moves. How do
these initiatives help build competitive advantage?
EXERCISES FOR SIMULATION PARTICIPANTS
1. What factors build the business case for operating
your company in an ethical manner?
2. In what ways, if any, is your company exercising
corporate social responsibility? What are the
elements of your company’s CSR strategy? Are
there any changes to this strategy that you would
suggest?
3. If some shareholders complained that you and your
co-managers have been spending too little or too
much on corporate social responsibility, what would
you tell them?
https://www.theguardian.com/sustainable-business/2016/may/27/outdoor-clothing-paramo-toxic-pfc-greenpeace-fabric-technology
LO 9-4
LO 9-4
4. Is your company striving to conduct its business in
an environmentally sustainable manner? What
specific additional actions could your company take
that would make an even greater contribution to
environmental sustainability?
5. In what ways do a company’s environmental
sustainability strategy in the best long-term interest
of shareholders? Does it contribute to your
company’s competitive advantage or profitability?
ENDNOTES
1 James E. Post, Anne T. Lawrence, and James Weber, Business and Society: Corporate Strategy, Public Policy, Ethics,
10th ed. (New York: McGraw-Hill, 2002).
2 Mark S. Schwartz, “Universal Moral Values for Corporate Codes of Ethics,” Journal of Business Ethics 59, no. 1 (June
2005), pp. 27–44.
3 Mark S. Schwartz, “A Code of Ethics for Corporate Codes of Ethics,” Journal of Business Ethics 41, no. 1–2
(November–December 2002), pp. 27–43.
4 T. L. Beauchamp and N. E. Bowie, Ethical Theory and Business (Upper Saddle River, NJ: Prentice-Hall, 2001).
5 www.cnn.com/2013/10/15/world/child-labor-index-2014/ (accessed February 6, 2014).
6 U.S. Department of Labor, “The Department of Labor’s 2013 Findings on the Worst Forms of Child Labor,”
www.dol.gov/ilab/programs/ocft/PDF/2012OCFTreport .
7 W. M. Greenfield, “In the Name of Corporate Social Responsibility,” Business Horizons 47, no. 1 (January–February
2004), p. 22.
8 Rajib Sanyal, “Determinants of Bribery in International Business: The Cultural and Economic Factors,” Journal of
Business Ethics 59, no. 1 (June 2005), pp. 139–145.
9 Transparency International, Global Corruption Report, www.globalcorruptionreport.org.
10 Roger Chen and Chia-Pei Chen, “Chinese Professional Managers and the Issue of Ethical Behavior,” Ivey Business
Journal 69, no. 5 (May–June 2005), p. 1.
11 Antonio Argandoa, “Corruption and Companies: The Use of Facilitating Payments,” Journal of Business Ethics 60, no.
3 (September 2005), pp. 251–264.
12 Thomas Donaldson and Thomas W. Dunfee, “Towards a Unified Conception of Business Ethics: Integrative Social
Contracts Theory,” Academy of Management Review 19, no. 2 (April 1994), pp. 252–284; Andrew Spicer, Thomas W.
Dunfee, and Wendy J. Bailey, “Does National Context Matter in Ethical Decision Making? An Empirical Test of Integrative
Social Contracts Theory,” Academy of Management Journal 47, no. 4 (August 2004), p. 610.
13 Lynn Paine, Rohit Deshpandé, Joshua D. Margolis, and Kim Eric Bettcher, “Up to Code: Does Your Company’s
Conduct Meet World-Class Standards?” Harvard Business Review 83, no. 12 (December 2005), pp. 122–133.
14 John F. Veiga, Timothy D. Golden, and Kathleen Dechant, “Why Managers Bend Company Rules,” Academy of
Management Executive 18, no. 2 (May 2004).
15 Lorin Berlin and Emily Peck, “National Mortgage Settlement: States, Big Banks Reach $25 Billion Deal,” Huff Post
Business, February 9, 2012, www.huffingtonpost.com/2012/02/09/-national-mortgage-settlement_n_1265292.html
(accessed February 15, 2012).
16 Ronald R. Sims and Johannes Brinkmann, “Enron Ethics (Or: Culture Matters More than Codes),” Journal of Business
Ethics 45, no. 3 (July 2003), pp. 244–246.
17 Kurt Eichenwald, Conspiracy of Fools: A True Story (New York: Broadway Books, 2005).
18 Timothy M. Devinney, “Is the Socially Responsible Corporation a Myth? The Good, the Bad, and the Ugly of Corporate
Social Responsibility,” Academy of Management Perspectives 23, no. 2 (May 2009), pp. 44–56.
19 Information posted at www.generalmills.com (accessed March 13, 2013).
http://www.cnn.com/2013/10/15/world/child-labor-index-2014/
http://www.dol.gov/ilab/programs/ocft/PDF/2012OCFTreport
http://www.globalcorruptionreport.org/
http://www.huffingtonpost.com/2012/02/09/-national-mortgage-settlement_n_1265292.html
http://www.generalmills.com/
page 295
20 Adrian Henriques, “ISO 26000: A New Standard for Human Rights?” Institute for Human Rights and Business, March
23, 2010, www.institutehrb.org/blogs/guest/iso_26000_a_new_standard_for_human_rights.html?
gclid=CJih7NjN2aICFVs65QodrVOdyQ (accessed July 7, 2010).
21 Gerald I. J. M. Zetsloot and Marcel N. A. van Marrewijk, “From Quality to Sustainability,” Journal of Business Ethics 55
(2004), pp. 79–82.
22 Tilde Herrera, “PG&E Claims Industry First with Supply Chain Footprint Project,” GreenBiz.com, June 30, 2010,
www.greenbiz.com/news/2010/06/30/-pge—claims-industry-first-supply-chain-carbon-footprint-project.
23 J. G. Speth, The Bridge at the End of the World: Capitalism, the Environment, and Crossing from Crisis to
Sustainability (New Haven, CT: Yale University Press, 2008).
24 Michael E. Porter and Mark R. Kramer, “Strategy & Society: The Link between Competitive Advantage and Corporate
Social Responsibility,” Harvard Business Review 84, no. 12 (December 2006), pp. 78–92.
25 N. Craig Smith, “Corporate Responsibility: Whether and How,” California Management Review 45, no. 4 (Summer
2003), p. 63.
26 Jeb Brugmann and C. K. Prahalad, “Cocreating Business’s New Social Compact,” Harvard Business Review 85, no. 2
(February 2007), pp. 80–90.
27 Wallace N. Davidson, Abuzar El-Jelly, and Dan L. Worrell, “Influencing Managers to Change Unpopular Corporate
Behavior through Boycotts and Divestitures: A Stock Market Test,” Business and Society 34, no. 2 (1995), pp. 171–196.
28 Tom McCawley, “Racing to Improve Its Reputation: Nike Has Fought to Shed Its Image as an
Exploiter of Third-World Labor Yet It Is Still a Target of Activists,” Financial Times, December 2000, p. 14.
29 Michael E. Porter and Mark Kramer, “Creating Shared Value,” Harvard Business Review 89, no. 1–2 (January–
February 2011).
30 James C. Collins and Jerry I. Porras, Built to Last: Successful Habits of Visionary Companies, 3rd ed. (London:
HarperBusiness, 2002).
31 Joshua D. Margolis and Hillary A. Elfenbein, “Doing Well by Doing Good: Don’t Count on It,” Harvard Business Review
86, no. 1 (January 2008), pp. 19–20; Lee E. Preston, Douglas P. O’Bannon, Ronald M. Roman, Sefa Hayibor, and
Bradley R. Agle, “The Relationship between Social and Financial Performance: Repainting a Portrait,” Business and
Society 38, no. 1 (March 1999), pp. 109–125.
32 Leonard L. Berry, Ann M. Mirobito, and William B. Baun, “What’s the Hard Return on Employee Wellness Programs?”
Harvard Business Review 88, no. 12 (December 2010), p. 105.
http://www.institutehrb.org/blogs/guest/iso_26000_a_new_standard_for_human_rights.html?gclid=CJih7NjN2aICFVs65QodrVOdyQ
http://greenbiz.com/
http://www.greenbiz.com/news/2010/06/30/-pge%E2%80%94claims-industry-first-supply-chain-carbon-footprint-project
page 296
chapter 10
Building an Organization Capable
of Good Strategy Execution
People, Capabilities, and Structure
Learning Objectives
After reading this chapter, you should be able to:
LO 10-1 Understand what managers must do to execute
strategy successfully.
LO 10-2 Understand why hiring, training, and retaining the right
people constitute a key component of the strategy
execution process.
LO 10-3 Recognize that good strategy execution requires
continuously building and upgrading the organization’s
resources and capabilities.
LO 10-4 Identify and establish a strategy-supportive
organizational structure and organize the work effort.
LO 10-5 Comprehend the pros and cons of centralized and
decentralized decision making in implementing the
chosen strategy.
page 297
Richard Schneider/Getty Images
Strategies most often fail because they aren’t executed well.
Larry Bossidy and Ram Charan
Former CEO of Honeywell; Author and Consultant
page 298
I try to motivate people and align our individual incentives with organizational incentives. And
then let people do their best.
John D. Liu—CEO, Essex Equity Management
People are not your most important asset. The right people are.
Jim Collins—Professor and author
Once managers have decided on a strategy, the emphasis turns to converting it into
actions and good results. Putting the strategy into place and getting the organization to
execute it will call for different sets of managerial skills rather than crafting strategy.
Whereas crafting strategy is largely an analysis-driven activity focused on market
conditions and the company’s resources and capabilities, executing strategy is primarily
operations-driven, revolving around the management of people, resources, business
processes, and organizational structure. Successful strategy execution depends on
doing a good job of working with and through others; building and strengthening
competitive capabilities; creating an appropriate organizational structure; allocating
resources; instituting strategy-supportive policies, processes, and systems; and instilling
a discipline of getting things done. Executing strategy is an action-oriented task that
tests a manager’s ability to direct organizational change, achieve improvements in day-
to-day operations, create and nurture a culture that supports good strategy execution,
and meet or beat performance targets.
Experienced managers are well aware that it is much easier to develop a sound
strategic plan than it is to execute the plan and achieve targeted outcomes. A study of
400 CEOs in the United States, Europe, and Asia found that executional excellence
was the number-one challenge facing their companies.1 According to one executive,
“It’s been rather easy for us to decide where we wanted to go. The hard part is to get
the organization to act on the new priorities.”2 It takes adept managerial leadership to
convincingly communicate the reasons for a new strategy and overcome pockets of
doubt, secure the commitment of key personnel, build consensus for how to implement
the strategy, and move forward to get all the pieces into place and deliver results. Just
because senior managers announce a new strategy doesn’t mean that organization
members will embrace it and move forward enthusiastically to implement it. Company
personnel must understand—in their heads and hearts—why a new strategic direction
is necessary and where the new strategy is taking them.3 Instituting change is, of
course, easier when the problems with the old strategy have become obvious and/or
the company has spiraled into a financial crisis.
But the challenge of successfully implementing new strategic initiatives goes well
beyond managerial adeptness in overcoming resistance to change. What really make
executing strategy a tougher, more time-consuming management challenge than
crafting strategy are the wide array of managerial activities that must be
attended to, the many ways to put new strategic initiatives in place and
keep things moving, and the number of bedeviling issues that always crop up and have
to be resolved. It takes first-rate “managerial smarts” to zero in on what exactly needs to
be done and how to get good results in a timely manner. Excellent people-management
skills and perseverance are needed to get a variety of initiatives underway and to
integrate the efforts of many different work groups into a smoothly functioning whole.
Depending on how much consensus building and organizational change is involved, the
process of implementing strategy changes can take several months to several years.
And executing the strategy with real proficiency takes even longer.
Like crafting strategy, executing strategy is a job for a company’s whole management
team—not just a few senior managers. While the chief executive officer and the heads
of major units (business divisions, functional departments, and key operating units) are
ultimately responsible for seeing that strategy is executed successfully, the process
typically affects every part of the firm—all value chain activities and all work groups.
Top-level managers must rely on the active support of middle and lower managers to
institute whatever new operating practices are needed in the various operating units to
achieve proficient strategy execution. Middle- and lower-level managers must ensure
that frontline employees perform strategy-critical value chain activities proficiently
enough to allow companywide performance targets to be met. Consequently, all
company personnel are actively involved in the strategy execution process in one way
or another.
A FRAMEWORK FOR EXECUTING
STRATEGY
• LO 10-1
Understand what
managers must do
to execute strategy
successfully.
The managerial approach to executing a strategy always has to be customized
to fit the particulars of a company’s situation. Making minor changes in an
existing strategy differs from implementing radical strategy changes. The
techniques for successfully executing a low-cost leader strategy are different
from those for executing a high-end differentiation strategy. Implementing a
new strategy for a struggling company in the midst of a financial crisis is a
different job from improving strategy execution in a company that is doing
relatively well. Moreover, some managers are more adept than others at using
particular approaches to achieving certain kinds of organizational changes.
Hence, there’s no definitive managerial recipe for successful strategy
execution that cuts across all company situations and strategies or that works
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for all managers. Rather, the specific actions required to execute a strategy—
the “to-do list” that constitutes management’s action agenda—always
represent management’s judgment about how best to proceed in light of
prevailing circumstances.
CORE
CONCEPT
Good strategy
execution requires a
team effort. All
managers have
strategy-executing
responsibility in their
areas of authority,
and all employees
are active
participants in the
strategy execution
process.
The Principal Components of the Strategy
Execution Process
Despite the need to tailor a company’s strategy-executing approaches to the
situation at hand, certain managerial bases must be covered no matter what
the circumstances. These include 10 basic managerial tasks (see Figure 10.1):
1. Staffing the organization with managers and employees capable of
executing the strategy well.
2. Developing the resources and organizational capabilities required for
successful strategy execution.
3. Creating a strategy-supportive organizational structure.
4. Allocating sufficient resources (budgetary and otherwise) to the strategy
execution effort.
5. Instituting policies and procedures that facilitate strategy execution.
6. Adopting business management processes that drive continuous
improvement in how value chain activities are performed.
7. Installing information and operating systems that support strategy
implementation activities.
8. Tying rewards directly to the achievement of performance objectives.
9. Fostering a corporate culture that promotes good strategy execution.
10. Exercising the leadership needed to propel strategy execution forward.
When strategies fail,
it is often because of
poor execution.
Strategy execution
is therefore a critical
managerial
endeavor.
How well managers perform these 10 tasks has a decisive impact on
whether the outcome of the strategy execution effort is a spectacular success,
a colossal failure, or something in between.
The two best signs
of good strategy
execution are
whether a company
is meeting its
performance targets
and whether it has
attained real
proficiency in
performing strategy-
critical value chain
activities.
In devising an action agenda for executing strategy, managers should start
by conducting a probing assessment of what the organization must do
differently to carry out the strategy successfully. Each manager needs to ask
the question “What needs to be done in my area of responsibility to
implement our part of the company’s strategy, and what should I do to get
these things accomplished in a timely fashion?” It is then incumbent on every
manager to determine precisely how to make the necessary internal changes.
Strong managers have a knack for diagnosing what their organizations need
to do to execute the chosen strategy well and figuring out how to get these
things done efficiently. They are masters in promoting results-oriented
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behaviors on the part of company personnel and following through on
making the right things happen to achieve the target outcomes.4
When strategies fail, it is often because of poor execution. Strategy
execution is therefore a critical managerial endeavor. The two best signs of
good strategy execution are whether a company is meeting its performance
targets and whether it is performing value chain activities in a manner that is
conducive to companywide operating excellence. In big organizations with
geographically scattered operating units, senior executives’ action agenda
mostly involves communicating the case for change, building consensus for
how to proceed, installing strong managers to move the process forward in
key organizational units, directing resources to the right places, establishing
deadlines and measures of progress, rewarding those who achieve
implementation milestones, and personally leading the strategic change
process. Thus, the bigger the organization, the more that successful strategy
execution depends on the cooperation and implementation skills of operating
managers who can promote needed changes at the lowest organizational
levels and deliver results. In small organizations, top managers can deal
directly with frontline managers and employees, personally orchestrating the
action steps and implementation sequence, observing firsthand how
implementation is progressing, and deciding how hard and how fast to push
the process along. Whether the organization is large or small and whether
strategy implementation involves sweeping or minor changes, effective
leadership requires a keen grasp of what to do and how to do it in light of the
organization’s circumstances. Then it remains for company personnel in
strategy-critical areas to step up to the plate and produce the desired results.
What’s Covered in Chapters 10, 11, and 12 In the remainder of this
chapter and in the next two chapters, we discuss what is involved in
performing the 10 key managerial tasks that shape the process of executing
strategy. This chapter explores the first three of these tasks (highlighted in
blue in Figure 10.1): (1) staffing the organization with people
capable of executing the strategy well, (2) developing the resources
and organizational capabilities needed for successful strategy execution, and
(3) creating an organizational structure supportive of the strategy execution
process. Chapter 11 concerns the tasks of allocating resources (budgetary and
otherwise), instituting strategy-facilitating policies and procedures,
employing business process management tools installing operating and
information systems, and tying rewards to the achievement of good results
(highlighted in green in Figure 10.1). Chapter 12 deals with the two
remaining tasks: instilling a corporate culture conducive to good strategy
execution, and exercising the leadership needed to drive the execution
process forward (highlighted in purple).
FIGURE 10.1 The 10 Basic Tasks of the Strategy Execution
Process
BUILDING AN ORGANIZATION
CAPABLE OF GOOD STRATEGY
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EXECUTION: THREE KEY ACTIONS
Proficient strategy execution depends foremost on having in place an
organization capable of the tasks demanded of it. Building an execution-
capable organization is thus always a top priority. As shown in Figure 10.2,
three types of organization-building actions are paramount:
FIGURE 10.2 Building an Organization Capable of Proficient
Strategy Execution: Three Key Actions
page 302
1. Staffing the organization—putting together a strong
management team, and recruiting and retaining employees with the needed
experience, technical skills, and intellectual capital.
2. Acquiring, developing, and strengthening the resources and capabilities
required for good strategy execution—accumulating the required
resources, developing proficiencies in performing strategy-critical value
chain activities, and updating the company’s capabilities to match
changing market conditions and customer expectations.
3. Structuring the organization and work effort—organizing value chain
activities and business processes, establishing lines of authority and
reporting relationships, and deciding how much decision-making authority
to delegate to lower-level managers and frontline employees.
Implementing a strategy depends critically on ensuring that strategy-
supportive resources and Organizational capabilities are in place, ready to be
deployed. These include the skills, talents, experience, and knowledge of the
company’s human resources (managerial and otherwise)—see Figure 10.2.
Proficient strategy execution depends heavily on competent
personnel of all types, but because of the many managerial tasks
involved and the role of leadership in strategy execution, assembling a strong
management team is especially important.
If the strategy being implemented is a new strategy, the company may need
to add to its resource and capability mix in other respects as well. But
renewing, upgrading, and revising the organization’s resources and
capabilities is a part of the strategy execution process even if the strategy is
fundamentally the same, since strategic assets depreciate and conditions are
always changing. Thus, augmenting and strengthening the firm’s core
competencies and seeing that they are suited to the current strategy are also
top priorities.
Structuring the organization and work effort is another critical aspect of
building an organization capable of good strategy execution. An organization
structure that is well matched to the strategy can help facilitate its
implementation; one that is not well suited can lead to higher bureaucratic
costs and communication or coordination breakdowns.
STAFFING THE ORGANIZATION
• LO 10-2
Understand why
hiring, training, and
retaining the right
people constitute a
key component of
the strategy
execution process.
No company can hope to perform the activities required for successful
strategy execution without attracting and retaining talented managers and
employees with suitable skills and intellectual capital.
Putting Together a Strong Management Team
Assembling a capable management team is a cornerstone of the organization-
building task.5 While different strategies and company circumstances often
call for different mixes of backgrounds, experiences, management styles, and
know-how, the most important consideration is to fill key managerial slots
with smart people who are clear thinkers, good at figuring out what needs to
be done, skilled in managing people, and accomplished in delivering good
results.6 The task of implementing challenging strategic initiatives must be
assigned to executives who have the skills and talents to handle them and
who can be counted on to get the job done well. Without a capable, results-
oriented management team, the implementation process is likely to be
hampered by missed deadlines, misdirected or wasteful efforts, and
managerial ineptness. Weak executives are serious impediments to getting
optimal results—the caliber of work done under their supervision suffers.7 In
contrast, managers with strong strategy implementation capabilities
understand how to drive organizational change, and know how to motivate
and lead the company down the path for first-rate strategy execution. They
have a talent for asking tough, incisive questions and know enough about the
details of the business to ensure the soundness of the decisions of the people
around them—they can discern whether the resources people are asking for to
put the strategy in place make sense. They are good at getting things done
through others, partly by making sure they have the right people under them,
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assigned to the right jobs and partly because they know how to motivate and
inspire people. They have strong social skills and high emotional intelligence.
They consistently follow through on issues, monitor progress carefully, make
adjustments when needed, and keep important details from slipping through
the cracks.
Sometimes a company’s existing management team is up to the task. At
other times it may need to be strengthened by promoting qualified people
from within or by bringing in outsiders whose experiences, talents, and
leadership styles better suit the situation. In turnaround and rapid-growth
situations, and in instances when company managers lack the requisite know-
how, filling key management slots from the outside is a standard
organization-building approach. In all situations, it is important
to identify and replace managers who are incapable, for whatever reason, of
making the required changes in a timely and cost-effective manner. For a
management team to be truly effective at strategy execution, it must be
composed of managers who recognize that organizational changes are needed
and who are both capable and ready to get on with the process.
Putting together a
talented
management team
with the right mix of
experiences, skills,
and abilities to get
things done is one of
the first steps to take
in launching the
strategy-executing
process.
The overriding aim in building a management team should be to assemble
a critical mass of talented managers who can function as agents of change
and spearhead excellent strategy execution. Every manager’s success is
enhanced (or limited) by the quality of his or her managerial colleagues and
the degree to which they freely exchange ideas, debate ways to make
operating improvements, and join forces to tackle issues and solve problems.
When a first-rate manager enjoys the help and support of other first-rate
managers, it’s possible to create a managerial whole that is greater than the
sum of individual efforts—talented managers who work well together as a
team can produce organizational results that are dramatically better than what
one or two star managers acting individually can achieve.8
Illustration Capsule 10.1 describes Deloitte’s highly effective approach to
developing employee talent and a top-caliber management team.
Recruiting, Training, and Retaining Capable
Employees
Assembling a capable management team is not enough. Staffing the
organization with the right kinds of people must extend to all kinds of
company personnel for value chain activities to be performed competently.
The caliber of an organization’s people is always an essential ingredient of
successful strategy execution. Companies like Mercedes-Benz, Alphabet,
SAS, Boston Consulting Group, Edward Jones, Quicken Loans, Genentech,
Intuit, Salesforce.com, and Goldman Sachs make a concerted effort to recruit
the best and brightest people they can find and then retain them with
excellent compensation packages, opportunities for rapid advancement and
professional growth, and interesting assignments. Having a pool of “A
players” with strong skill sets and lots of brainpower is essential to their
business.
In many industries,
adding to a
company’s talent
base and building
intellectual capital
are more important
to good strategy
execution than are
additional
investments in
capital projects.
Facebook makes a point of hiring the very brightest and most talented
programmers it can find and motivating them with both good monetary
incentives and the challenge of working on cutting-edge technology projects.
McKinsey & Company, one of the world’s premier management consulting
firms, recruits only cream-of-the-crop MBAs at the nation’s top-10 business
schools; such talent is essential to McKinsey’s strategy of performing high-
http://salesforce.com/
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level consulting for the world’s top corporations. The leading global
accounting firms screen candidates not only on the basis of their accounting
expertise but also on whether they possess the people skills needed to relate
well with clients and colleagues. Zappos goes to considerable lengths to hire
people who can have fun and be fun on the job; it has done away with
traditional job postings and instead asks prospective hires to join a social
network called Zappos Insiders where they will interact with current
employees and have opportunities to demonstrate their passion for joining the
company. Zappos is so selective about finding people who fit their culture
that only about 1.5 percent of the people who apply are offered jobs.
In high-tech companies, the challenge is to staff work groups with gifted,
imaginative, and energetic people who can bring life to new ideas quickly
and inject into the organization what one Dell executive calls “hum.”9 The
saying “People are our most important asset” may seem trite, but it fits high-
technology companies precisely. Besides checking closely for functional and
technical skills, Dell tests applicants for their tolerance of
ambiguity and change, their capacity to work in teams, and their
ability to learn on the fly. Companies like LinkedIn, Credit Suisse, IDEO,
Amazon.com, Google, and Cisco Systems have broken new ground in
recruiting, hiring, cultivating, developing, and retaining talented employees—
almost all of whom are in their 20s and 30s. Cisco goes after the top 10
percent, raiding other companies and endeavoring to retain key people at the
companies it acquires. Cisco executives believe that a cadre of star engineers,
programmers, managers, salespeople, and support personnel is the backbone
of the company’s efforts to execute its strategy and remain the world’s
leading provider of Internet infrastructure products and technology.
ILLUSTRATION
CAPSULE 10.1 Management Development at
Deloitte Touche Tohmatsu Limited
http://amazon.com/
Kent Johansson/Shutterstock
Hiring, retaining, and cultivating talent are critical activities at Deloitte, the world’s largest
professional services firm. By offering robust learning and development programs,
Deloitte has been able to create a strong talent pipeline to the firm’s partnership.
Deloitte’s emphasis on learning and development, across all stages of the employee life
cycle, has led to recognitions such as being ranked number-one on Chief Executives’s
list of “Best Private Companies for Leaders” and being listed among Fortune’s “100 Best
Companies to Work For.” The following programs contribute to Deloitte’s successful
execution of its talent strategy:
Clear path to partnership. During the initial recruiting phase and then throughout an
employee’s tenure at the firm, Deloitte lays out a clear career path. The path indicates
the expected timeline for promotion to each of the firm’s hierarchy levels, along with
the competencies and experience required. Deloitte’s transparency on career paths,
coupled with its in-depth performance management process, helps employees clearly
understand their performance. This serves as a motivational tool for top performers,
often leading to career acceleration.
Formal training programs. Like other leading organizations, Deloitte has a program to
ensure that recent college graduates are equipped with the necessary training and
tools for succeeding on the job. Yet Deloitte’s commitment to formal training is evident
at all levels within the organization. Each time an employee is promoted, he or she
attends “milestone” school, a weeklong simulation that replicates true business
situations employees would face as they transition to new stages of career
development. In addition, Deloitte institutes mandatory training hours for all of its
employees to ensure that individuals continue to further their professional
development.
Special programs for high performers. Deloitte also offers fellowships and programs to
help employees acquire new skills and enhance their leadership development. For
example, the Global Fellows program helps top performers work with senior leaders in
page 305
the organization to focus on the realities of delivering client service across borders.
Deloitte has also established the Emerging Leaders Development program, which
utilizes skill building, 360-degree feedback, and one-on-one executive coaching to
help top-performing managers and senior managers prepare for partnership.
Sponsorship, not mentorship. To train the next generation of leaders, Deloitte has
implemented formal mentorship programs to provide leadership development support.
Deloitte, however, uses the term sponsorship to describe this initiative. A sponsor is
tasked with taking a vested interest in an individual and advocating on his or her
behalf. Sponsors help rising leaders navigate the firm, develop new competencies,
expand their network, and hone the skills needed to accelerate their career.
Note: Developed with Heather Levy.
Sources: Company websites; www.accountingweb.com/article/leadership-
development-community-service-integral-deloitte-university/220845 (accessed
February 2014).
In recognition of the importance of a talented and energetic
workforce, companies have instituted a number of practices aimed at staffing
jobs with the best people they can find:
The best companies
make a point of
recruiting and
retaining talented
employees—the
objective is to make
the company’s entire
workforce
(managers and
rank-and-file
employees) a
genuine competitive
asset.
1. Spending considerable effort on screening and evaluating job applicants—
selecting only those with suitable skill sets, energy, initiative, judgment,
aptitude for learning, and personality traits that mesh well with the
company’s work environment and culture.
2. Providing employees with training programs that continue throughout their
careers.
http://www.accountingweb.com/article/leadership-development-community-service-integral-deloitte-university/220845
3. Offering promising employees challenging, interesting, and skill-stretching
assignments.
4. Rotating people through jobs that span functional and geographic
boundaries. Providing people with opportunities to gain experience in a
variety of international settings is increasingly considered an essential part
of career development in multinational companies.
5. Making the work environment stimulating and engaging so that employees
will consider the company a great place to work.
6. Encouraging employees to challenge existing ways of doing things, to be
creative in proposing better ways of operating, and to push their ideas for
new products or businesses. Progressive companies work hard at creating
an environment in which employees are made to feel that their views and
suggestions count.
7. Striving to retain talented, high-performing employees via promotions,
salary increases, performance bonuses, stock options and equity
ownership, benefit packages including health insurance and retirement
packages, and other perks, such as flexible work hours and onsite day care.
8. Coaching average performers to improve their skills and capabilities, while
weeding out underperformers.
DEVELOPING AND BUILDING
CRITICAL RESOURCES AND
ORGANIZATIONAL CAPABILITIES
• LO 10-3
Recognize that good
strategy execution
requires
continuously building
and upgrading the
organization’s
resources and
capabilities.
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High among the organization-building priorities in the strategy execution
process is the need to build and strengthen the company’s portfolio of
resources and capabilities with which to perform strategy-critical value chain
activities. As explained in Chapter 4, a company’s chances of gaining a
sustainable advantage over its market rivals depends on the caliber of its
resource portfolio. In the course of crafting strategy, managers may well have
well have identified the strategy-critical resources and capabilities it needs.
But getting the strategy execution process underway requires acquiring or
developing these resources and capabilities, putting them into place,
upgrading them as needed, and then modifying them as market conditions
evolve.
If the strategy being implemented has important new elements, company
managers may have to acquire new resources, significantly broaden or
deepen certain capabilities, or even add entirely new competencies in order to
put the strategic initiatives in place and execute them proficiently. But even
when a company’s strategy has not changed materially, good strategy
execution still involves continually upgrading the firm’s resources and
capabilities to keep them in top form and perform value chain activities ever
more proficiently.
Three Approaches to Building and Strengthening
Organizational Capabilities
Building the right kinds of organizational capabilities and keeping them
finely honed is a time-consuming, managerially challenging exercise. While
some assistance can be gotten from discovering how best-in-industry or best-
in-world companies perform a particular activity, trying to replicate and then
improve on the capabilities of other companies is easier said than done—for
the same reasons that one is unlikely to ever become a world-class halfpipe
snowboarder just by studying legendary Olympic gold medalist Shaun White.
Building new
organizational
capabilities is a
multistage process
that occurs over a
period of months
and years. It is not
something that is
accomplished
overnight.
With deliberate effort, well-orchestrated organizational actions, and
continued practice, however, it is possible for a firm to become proficient at
capability building despite the difficulty. Indeed, by making capability-
building activities a routine part of their strategy execution endeavors, some
firms are able to develop dynamic capabilities that assist them in managing
resource and capability change, as discussed in Chapter 4. The most common
approaches to capability building include (1) developing and strengthening
capabilities internally, (2) acquiring capabilities through mergers and
acquisitions, and (3) developing new organizational capabilities via
collaborative partnerships.
Developing Organizational Capabilities Internally Internal efforts to
create or upgrade organizational capabilities is an evolutionary process that
entails a series of deliberate and well-orchestrated steps as organizations
search for solutions to their problems. The process is a complex one, since
capabilities are the product of bundles of skills and know-how that are
integrated into organizational routines and deployed within activity systems
through the combined efforts of teams that are often cross-functional in
nature, spanning a variety of departments and locations. For instance, the
capability of speeding new products to market involves the collaborative
efforts of personnel in R&D, engineering and design, purchasing, production,
marketing, and distribution. Similarly, the capability to provide superior
customer service is a team effort among people in customer call centers
(where orders are taken and inquiries are answered), shipping and delivery,
billing and accounts receivable, and after-sale support. The process of
building an organizational capability begins when managers set an objective
of developing a particular capability and organize activity around that
objective.10
Because the process is incremental, the first step is to develop the ability to
do something, however imperfectly or inefficiently. This entails selecting
people with the requisite skills and experience, enabling them to upgrade
their abilities as needed, and then molding the efforts of individuals into a
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joint effort to create an organizational ability. At this stage, progress can be
fitful since it depends on experimenting, actively searching for alternative
solutions, and learning through trial and error.11
A company’s
capabilities must be
continually refreshed
to remain aligned
with changing
customer
expectations, altered
competitive
conditions, and new
strategic initiatives.
As experience grows and company personnel learn how to perform the
activities consistently well and at an acceptable cost, the ability evolves into a
tried-and-true competence. Getting to this point requires a continual
investment of resources and systematic efforts to improve processes and solve
problems creatively as they arise. Improvements in the functioning of an
organizational capability come from task repetition and the resulting learning
by doing of individuals and teams. But the process can be accelerated by
making learning a more deliberate endeavor and providing the incentives that
will motivate company personnel to achieve the desired ends.12 This can be
critical to successful strategy execution when market conditions are changing
rapidly.
It is generally much easier and less time-consuming to update
and remodel a company’s existing capabilities as external conditions and
company strategy change than it is to create them from scratch. Maintaining
organizational capabilities in top form may simply require exercising them
continually and fine-tuning them as necessary. Similarly, augmenting a
capability may require less effort if it involves the recombination of well-
established company capabilities and draws on existing company resources.
For example, Williams-Sonoma first developed the capability to expand sales
beyond its brick-and-mortar location in 1970, when it launched a catalog that
was sent to customers throughout the United States. The company extended
its mail-order business with the acquisitions of Hold Everything, a garden
products catalog, and Pottery Barn, and entered online retailing in 2000 when
it launched e-commerce sites for Pottery Barn and Williams-Sonoma. The
ongoing renewal of these capabilities has allowed Williams-Sonoma to
generate revenues of more than $5.6 billion in 2019 and become one of the
largest online retailers in the United States. Toyota, en route to overtaking
General Motors as the global leader in motor vehicles, aggressively upgraded
its capabilities in fuel-efficient hybrid engine technology and constantly fine-
tuned its famed Toyota Production System to enhance its already proficient
capabilities in manufacturing top-quality vehicles at relatively low costs.
Managerial actions to develop competitive capabilities generally take one
of two forms: either strengthening the company’s base of skills, knowledge,
and experience or coordinating and integrating the efforts of the various work
groups and departments. Actions of the first sort can be undertaken at all
managerial levels, but actions of the second sort are best orchestrated by
senior managers who not only appreciate the strategy-executing significance
of strong capabilities but also have the clout to enforce the necessary
cooperation and coordination among individuals, groups, and departments.13
Acquiring Capabilities through Mergers and Acquisitions Sometimes
the best way for a company to upgrade its portfolio of capabilities is by
acquiring (or merging with) another company with attractive resources and
capabilities.14 An acquisition aimed at building a stronger portfolio of
resources and capabilities can be every bit as valuable as an acquisition
aimed at adding new products or services to the company’s lineup of
offerings. The advantage of this mode of acquiring new capabilities is
primarily one of speed, since developing new capabilities internally can, at
best, take many years of effort and, at worst, come to naught. Capabilities-
motivated acquisitions are essential (1) when the company does not have the
ability to create the needed capability internally (perhaps because it is too far
afield from its existing capabilities) and (2) when industry conditions,
technology, or competitors are moving at such a rapid clip that time is of the
essence.
At the same time, acquiring capabilities in this way is not without
difficulty. Capabilities involve tacit knowledge and complex routines that
cannot be transferred readily from one organizational unit to another. This
may limit the extent to which the new capability can be utilized. For example,
Facebook acquired Oculus VR, a company that makes virtual reality
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headsets, to add capabilities that might enhance the social media experience.
Transferring and integrating these capabilities to other parts of the Facebook
organization may prove easier said than done, however, as many technology
acquisitions fail to yield the hoped-for benefits. Integrating the capabilities of
two companies is particularly problematic when there are underlying
incompatibilities in their supporting systems or processes. Moreover, since
internal fit is important, there is always the risk that under new management
the acquired capabilities may not be as productive as they had been. In a
worst-case scenario, the acquisition process may end up
damaging or destroying the very capabilities that were the object
of the acquisition in the first place.
Accessing Capabilities through Collaborative Partnerships A third way
of obtaining valuable resources and capabilities is to form collaborative
partnerships with suppliers, competitors, or other companies having the
cutting-edge expertise. There are three basic ways to pursue this course of
action:
1. Outsource the function in which the company’s capabilities are deficient to
a key supplier or another provider. Whether this is a wise move depends
on whether developing the capabilities internally are key to the company’s
long-term success. But if this is not the case, then outsourcing may be a
good choice especially for firms that are too small and resource-
constrained to execute all the parts of their strategy internally.
2. Collaborate with a firm that has complementary resources and capabilities
in a joint venture, strategic alliance, or other type of partnership
established for the purpose of achieving a shared strategic objective. This
requires launching initiatives to identify the most attractive potential
partners and to establish collaborative working relationships. Since the
success of the venture will depend on how well the partners work together,
potential partners should be selected as much for their management style,
culture, and goals as for their resources and capabilities. In the past 15
years, close collaboration with suppliers to achieve mutually beneficial
outcomes has become a common approach to building supply chain
capabilities.
3. Engage in a collaborative partnership for the purpose of learning how the
partner does things, internalizing its methods and thereby acquiring its
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capabilities. This may be a viable method when each partner has
something to learn from the other and can achieve an outcome beneficial to
both partners. For example, firms sometimes enter into collaborative
marketing arrangements whereby each partner is granted access to the
other’s dealer network for the purpose of expanding sales in geographic
areas where the firms lack dealers. But if the intended gains are only one-
sided, the arrangement more likely involves an abuse of trust. In
consequence, it not only puts the cooperative venture at risk but also
encourages the firm’s partner to treat the firm similarly or refuse further
dealings with the firm.
Collaborative arrangements tend to be less risky when the partnership
involves companies from different industries. In racing to develop motor
vehicles with self-driving capability, most all vehicle manufacturers are
supplementing their own internal efforts with collaborative partnerships with
one or more of the growing number of hardware and software firms operating
in the driverless vehicle space. These include those developing self-driving
software (Alphabet’s Waymo, Aurora Innovation, Tesla, Oxbotica, Zoox),
makers of the two competing radar systems to spot road obstacles and read
traffic signs and signals (RADAR, LiDAR), computing platforms (Nvidia,
Qualcomm, Intel), and driverless car technology systems (Mobileye, Bosch,
Aptiv).
Nike entered into a strategic partnership with Swiss company Bluesign
Technologies for the purpose of making two innovative Bluesign tools
available to the hundreds of textile manufacturers supplying the contract
factories making Nike products. The tools enable the textile manufacturers to
access more than 30,000 materials produced with chemicals that have
undergone rigorous assessment for safe use in apparel products. In these
types of cases, working together to achieve a capability-related outcome can
be beneficial to all the partners.
The Strategic Role of Employee Training
Training and retraining are important when a company shifts to a strategy
requiring different skills, competitive capabilities, and operating methods.
Training is also strategically important in organizational efforts to build skill-
based competencies. And it is a key activity in businesses where technical
know-how is changing so rapidly that a company loses its ability to compete
unless its employees have cutting-edge knowledge and expertise. Successful
strategy implementation requires that the training function is both adequately
funded and effective. If better execution of the chosen strategy calls for new
skills, deeper technological capability, or the building and deploying of new
capabilities, training efforts need to be placed near the top of the action
agenda.
The strategic importance of training has not gone unnoticed. Over 4,000
companies around the world have established internal “universities” to lead
the training effort, facilitate continuous organizational learning, and upgrade
their company’s knowledge resources. General Electric has long been known
for the excellence of its management training program at Crotonville, outside
of New York City. McDonald’s maintains a 130,000-square-foot training
facility that they call Hamburger University.
Many companies conduct orientation sessions for new employees, fund an
assortment of competence-building training programs, and reimburse
employees for tuition and other expenses associated with obtaining additional
college education, attending professional development courses, and earning
professional certification of one kind or another. A number of companies
offer online training courses that are available to employees around the clock.
Increasingly, companies are expecting employees at all levels are expected to
take an active role in their own professional development and assume
responsibility for keeping their skills up to date and in sync with the
company’s needs.
Strategy Execution Capabilities and Competitive
Advantage
As firms get better at executing their strategies, they develop capabilities in
the domain of strategy execution much as they build other organizational
capabilities. Superior strategy execution capabilities allow companies to get
the most from their other organizational resources and competitive
capabilities. In this way they contribute to the success of a firm’s business
model. But excellence in strategy execution can also be a more direct source
of competitive advantage, since more efficient and effective strategy
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execution can lower costs and permit firms to deliver more value to
customers. Superior strategy execution capabilities may also enable a
company to react more quickly to market changes and beat other firms to the
market with new products and services. This can allow a company to profit
from a period of uncontested market dominance. See Illustration Capsule
10.2 for an example of Zara’s route to competitive advantage.
Because strategy execution capabilities are socially complex capabilities
that develop with experience over long periods of time, they are hard to
imitate. And there is no substitute for good strategy execution. (Recall the
tests of resource advantage from Chapter 4.) As such, they may be as
important a source of sustained competitive advantage as the core
competencies that drive a firm’s strategy. Indeed, they may be a far more
important avenue for securing a competitive edge over rivals in situations
where it is relatively easy for rivals to copy promising strategies. In such
cases, the only way for firms to achieve lasting competitive advantage is to
out-execute their competitors.
Superior strategy
execution
capabilities are the
only source of
sustainable
competitive
advantage when
strategies are easy
for rivals to copy.
ILLUSTRATION
CAPSULE 10.2 Zara’s Strategy Execution
Capabilities
monticello/Shutterstock
Zara, a major division of Inditex Group, is a leading “fast fashion” retailer. As soon as
designs are seen in high-end fashion houses such as Prada, Zara’s design team sets to
work altering the clothing designs so that it can produce high fashion at mass-retailing
prices. Zara’s strategy is clever, but by no means unique. The company’s competitive
advantage is in strategy execution. Every step of Zara’s value chain execution is geared
toward putting fashionable clothes in stores quickly, realizing high turnover, and
strategically driving traffic.
The first key lever is a quick production process. Zara’s design team uses inspiration
from high fashion and nearly real-time feedback from stores to create up-to-the-minute
pieces. Manufacturing largely occurs in factories close to headquarters in Spain, northern
Africa, and Turkey, all areas considered to have a high cost of labor. Placing the factories
strategically close allows for more flexibility and greater responsiveness to market needs,
thereby outweighing the additional labor costs. The entire production process, from
design to arrival at stores, takes only two weeks, while other retailers take six months.
Whereas traditional retailers commit up to 80 percent of their lines by the start of the
season, Zara commits only 50 to 60 percent, meaning that up to half of the merchandise
to hit stores is designed and manufactured during the season. Zara purposefully
manufactures in small lot sizes to avoid discounting later on and also to encourage
impulse shopping, as a particular item could be gone in a few days. From start to finish,
Zara has engineered its production process to maximize turnover and turnaround time,
creating a true advantage in this step of strategy execution.
Zara also excels at driving traffic to stores. First, the small lot sizes and frequent
shipments (up to twice a week per store) drive customers to visit often and purchase
quickly. Zara shoppers average 17 visits per year, versus four to five for The Gap. On
average, items stay in a Zara store only 11 days. Second, Zara spends no money on
advertising, but it occupies some of the most expensive retail space in town, always near
the high-fashion houses it imitates. Proximity reinforces the high-fashion association,
while the busy street drives significant foot traffic. Overall, Zara has managed to create
competitive advantage in every level of strategy execution by tightly aligning design,
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production, advertising, and real estate with the overall strategy of fast fashion: extremely
fast and extremely flexible.
Note: Developed with Sara Paccamonti.
Sources: Suzy Hansen, “How Zara Grew into the World’s Largest Fashion Retailer,” The
New York Times, November 9, 2012, www.nytimes.com/2012/11/11/magazine/how-
zara-grew-into-the-worlds-largest-fashion-retailer.html?pagewanted=all (accessed
February 5, 2014); Seth Stevenson, “Polka Dots Are In? Polka Dots It Is!” Slate, June 21,
2012,
www.slate.com/articles/arts/operations/2012/06/zara_s_fast_fashion_how_the_com
pany_gets_new_styles_to_stores_so_quickly.html (accessed February 5, 2014).
MATCHING ORGANIZATIONAL
STRUCTURE TO THE STRATEGY
• LO 10-4
Identify and
establish a strategy-
supportive
organizational
structure and
organize the work
effort.
While there are few hard-and-fast rules for organizing the work effort to
support good strategy execution, there is one: A firm’s organizational
structure should be matched to the particular requirements of implementing
the firm’s strategy. Every company’s strategy is grounded in its own set of
organizational capabilities and value chain activities. Moreover, every firm’s
organizational chart is partly a product of its particular situation,
reflecting prior organizational patterns, varying internal
circumstances, and executive judgments about how to best structure reporting
relationships. Thus, the determinants of the fine details of each firm’s
organizational structure are unique. But some considerations in organizing
the work effort are common to all companies. These are summarized in
Figure 10.3 and discussed in the following sections.
http://www.slate.com/articles/arts/operations/2012/06/zara_s_fast_fashion_how_the_company_gets_new_styles_to_stores_so_quickly.html
FIGURE 10.3 Structuring the Work Effort to Promote
Successful Strategy Execution
Deciding Which Value Chain Activities to Perform
Internally and Which to Outsource
Aside from the fact that an outsider, because of its expertise and specialized
know-how, may be able to perform certain value chain activities better or
cheaper than a company can perform them internally (as discussed in Chapter
6), outsourcing can also sometimes contribute to better strategy execution.
Outsourcing the performance of selected activities to outside vendors enables
a company to heighten its strategic focus and concentrate its full energies on
performing those value chain activities that are at the core of its strategy,
where it can create unique value. For example, 83 percent of the top 10
pharmaceutical companies outsource tactical roles such as clinical data
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management and trial monitoring; they are much less likely to outsource
more strategic functions, such as new product planning. Broadcom, (now part
of semiconductor maker Avago Technologies) outsources the manufacture of
its chips, thus freeing company personnel to focus their full energies on
R&D, new chip design, and marketing. Nike concentrates on design,
marketing, and distribution to retailers, while outsourcing virtually all
production of its shoes and sporting apparel. Interestingly, e-
commerce powerhouse Alibaba got its start by outsourcing web
development (a key function) to a U.S. firm; but this was due to the fact that
China lacked sufficient development talent at the time. Illustration Capsule
10.3 describes Apple’s decisions about which activities to outsource and
which to perform in-house.
A company’s
organizational
structure should be
matched to the
particular
requirements of
implementing the
firm’s strategy.
ILLUSTRATION
CAPSULE 10.3 Which Value Chain Activities
Does Apple Outsource and Why?
DAVID CHANG/EPA-EFE/Shutterstock
Innovation and design are core competencies for Apple and the drivers behind the
creation of winning products such as the iPod, iPhone, and iPad. In consequence, all
activities directly related to new product development and product design are performed
internally. For example, Apple’s Industrial Design Group is responsible for creating the
look and feel of all Apple products—from the MacBook Air to the iPhone, and beyond to
future products.
Producing a continuing stream of great new products and product versions is key to the
success of Apple’s strategy. But executing this strategy takes more than innovation and
design capabilities. Manufacturing flexibility and speed are imperative in the production of
Apple products to ensure that the latest ideas are reflected in the products and that the
company meets the high demand for its products—especially around launch.
For these capabilities, Apple turns to outsourcing, as do the majority of its competitors
in the consumer electronics space. Apple outsources the manufacturing of products like
its iPhone to Asia, where contract manufacturing organizations (CMOs) create value
through their vast scale, high flexibility, and low cost. Perhaps no company better
epitomizes the Asian CMO value proposition than Foxconn, a company that assembles
not only for Apple but for Hewlett-Packard, Motorola, Amazon.com, and Samsung as
well. Foxconn’s scale is incredible, with 1.3 million people on its payroll as of 2017. Such
scale offers companies a significant degree of flexibility, as Foxconn has the ability to hire
3,000 employees on practically a moment’s notice. Apple, more so than its competitors,
is able to capture CMO value creation by leveraging its immense sales volume and
strong cash position to receive preferred treatment. While outsourcing has allowed Apple
to reap the benefits of lower cost and more flexible manufacturing, the lack of direct
control has proven to be a challenge. Working conditions at Foxconn were so bad at one
point that Foxconn installed suicide prevention nets below its windows. Apple responded
by tightening its supplier standards and increasing its efforts at monitoring conditions and
http://amazon.com/
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enforcing its standards. Apple now conducts over 700 comprehensive site audits each
year to ensure compliance.
Note: Developed with Margaret W. Macauley.
Sources: Company website; Charles Duhigg and Keith Bradsher, “How the U.S. Lost Out
on iPhone Work,” The New York Times, January 21, 2012,
www.nytimes.com/2012/01/22/business/apple-america-and-a-squeezed-middle-
class.html?pagewanted=all&_r=0 (accessed March 5, 2012).
Such heightened focus on performing strategy-critical activities can yield
three important execution-related benefits:
Wisely choosing
which activities to
perform internally
and which to
outsource can lead
to several strategy-
executing
advantages—lower
costs, heightened
strategic focus, less
internal bureaucracy,
speedier decision
making, and a better
arsenal of
organizational
capabilities.
The company improves its chances for outclassing rivals in the
performance of strategy-critical activities and turning a competence into a
distinctive competence. At the very least, the heightened focus on
performing a select few value chain activities should promote more
effective performance of those activities. This could materially enhance
competitive capabilities by either lowering costs or improving
product or service quality. Businesses that get a lot of inquiries
from customers or that have to provide 24/7 technical support to users of
their products around the world often find that it is considerably less
expensive to outsource these functions to specialists (often located in
foreign countries where skilled personnel are readily available and worker
compensation costs are much lower) than to operate their own call centers.
Many businesses also outsource IT functions such as desktop support,
disaster recovery, help desk, and data center operations, which often results
in cost savings due to the economies of scale available to service providers.
The streamlining of internal operations that flows from outsourcing often
acts to decrease internal bureaucracies, flatten the organizational
structure, speed internal decision making, and shorten the time it takes to
respond to changing market conditions. In consumer electronics, where
advancing technology drives new product innovation, organizing the work
effort in a manner that expedites getting next-generation products to market
ahead of rivals is a critical competitive capability. The world’s motor
vehicle manufacturers have found that they can shorten the cycle time for
new models by outsourcing the production of many parts and components
to independent suppliers. They then work closely with the suppliers to
swiftly incorporate new technology and to better integrate individual parts
and components to form engine cooling systems, transmission systems,
electrical systems, and so on.
Partnerships with outside vendors can add to a company’s arsenal of
capabilities and contribute to better strategy execution. Outsourcing
activities to vendors with first-rate capabilities can enable a firm to
concentrate on strengthening its own complementary capabilities
internally; the result will be a more powerful package of organizational
capabilities that the firm can draw upon to deliver more value to customers
and attain competitive success. Soft-drink and beer manufacturers cultivate
their relationships with their bottlers and distributors to strengthen access to
local markets and build loyalty, support, and commitment for corporate
marketing programs, without which their own sales and growth would be
weakened. Similarly, fast-food enterprises like Wendy’s and Burger King
find it essential to work hand in hand with franchisees on outlet cleanliness,
consistency of product quality, in-store ambience, courtesy and friendliness
of store personnel, and other aspects of store operations. Unless franchisees
continuously deliver sufficient customer satisfaction to attract repeat
business, a fast-food chain’s reputation, sales, and competitive standing
will quickly suffer. Companies like Boeing, Dell, and Apple have learned
that their central R&D groups cannot begin to match the innovative
capabilities of a well-managed network of supply chain partners.
However, as emphasized in Chapter 6, a company must guard against
going overboard on outsourcing and becoming overly dependent on outside
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suppliers. A company cannot be the master of its own destiny unless it
maintains expertise and resource depth in performing those value chain
activities that underpin its long-term competitive success.15
Aligning the Firm’s Organizational Structure with
Its Strategy
The design of the firm’s organizational structure is a critical aspect of the
strategy execution process. The organizational structure comprises the formal
and informal arrangement of tasks, responsibilities, and lines of authority and
communication by which the firm is administered.16 It specifies the linkages
among parts of the organization, the reporting relationships, the
direction of information flows, and the decision-making processes.
It is a key factor in strategy implementation since it exerts a strong influence
on how well managers can coordinate and control the complex set of
activities involved.17
CORE
CONCEPT
A firm’s
organizational
structure comprises
the formal and
informal
arrangement of
tasks,
responsibilities, lines
of authority, and
reporting
relationships by
which the firm is
administered.
A well-designed organizational structure is one in which the various parts
(e.g., decision-making rights, communication patterns) are aligned with one
another and also matched to the requirements of the strategy. With the right
structure in place, managers can orchestrate the various aspects of the
implementation process with an even hand and a light touch. Without a
supportive structure, strategy execution is more likely to become bogged
down by administrative confusion, political maneuvering, and bureaucratic
waste.
Good organizational design may even contribute to the firm’s ability to
create value for customers and realize a profit. By enabling lower
bureaucratic costs and facilitating operational efficiency, it can lower a firm’s
operating costs. By facilitating the coordination of activities within the firm,
it can improve the capability-building process, leading to greater
differentiation and/or lower costs. Moreover, by improving the speed with
which information is communicated and activities are coordinated, it can
enable the firm to beat rivals to the market and profit from a period of
unrivaled advantage.
Making Strategy-Critical Activities the Main Building Blocks of the
Organizational Structure In any business, some activities in the value
chain are always more critical to successful strategy execution than others.
For instance, ski apparel companies like Sport Obermeyer, Arc’teryx, and
Spyder must be good at styling and design, low-cost manufacturing,
distribution (convincing an attractively large number of dealers to stock and
promote the company’s brand), and marketing and advertising (building a
brand image that generates buzz among ski enthusiasts). For brokerage firms
like Charles Schwab Corporation and TD Ameritrade, the strategy-critical
activities are fast access to information, accurate order execution, efficient
record keeping and transaction processing, and full-featured customer
service. With respect to such core value chain activities, it is important for
management to build its organizational structure around proficient
performance of these activities, making them the centerpieces or main
building blocks in the enterprise’s organizational structure.
The rationale is compelling: If activities crucial to strategic success are to
have the resources, decision-making influence, and organizational impact
they need, they must be centerpieces in the enterprise’s organizational
scheme. Making them the focus of structuring efforts will also facilitate their
coordination and promote good internal fit—an essential attribute of a
winning strategy, as summarized in Chapter 1 and elaborated in Chapter 4. To
the extent that implementing a new strategy entails new or altered key
activities or capabilities, different organizational arrangements may be
required.
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Matching Type of Organizational Structure to Strategy Execution
Requirements Organizational structures can be classified into a limited
number of standard types. Which type makes the most sense for a given firm
depends largely on the firm’s size and business makeup, but not so much on
the specifics of its strategy. As firms grow and their needs for structure
evolve, their structural form is likely to evolve from one type to another. The
four basic types are the simple structure, the functional structure, the
multidivisional structure, and the matrix structure, as described next.
1. Simple Structure A simple structure is one in which a central
executive (often the owner-manager) handles all major decisions and
oversees the operations of the organization with the help of a small staff.18
Simple structures are also known as line-and-staff structures, since a central
administrative staff supervises line employees who conduct the operations of
the firm, or flat structures, since there are few levels of hierarchy. The simple
structure is characterized by limited task specialization; few rules; informal
relationships; minimal use of training, planning, and liaison devices; and a
lack of sophisticated support systems. It has all the advantages of simplicity,
including low administrative costs, ease of coordination, flexibility, quick
decision making, adaptability, and responsiveness to change. Its informality
and lack of rules may foster creativity and heightened individual
responsibility.
CORE
CONCEPT
A simple structure
consists of a central
executive (often the
owner-manager)
who handles all
major decisions and
oversees all
operations with the
help of a small staff.
Simple structures
are also called line-
and-staff structures
or flat structures.
Simple organizational structures are typically employed by small firms and
entrepreneurial startups. The simple structure is the most common type of
organizational structure since small firms are the most prevalent type of
business. As an organization grows, however, this structural form becomes
inadequate to the demands that come with size and complexity. In response,
growing firms tend to alter their organizational structure from a simple
structure to a functional structure.
2. Functional Structure A functional structure is one that is organized
along functional lines, where a function represents a major component of the
firm’s value chain, such as R&D, engineering and design, manufacturing,
sales and marketing, logistics, and customer service. Each functional unit is
supervised by functional line managers who report to the chief executive
officer and a corporate staff. This arrangement allows functional managers to
focus on their area of responsibility, leaving it to the CEO and headquarters
to provide direction and ensure that the activities of the functional managers
are coordinated and integrated. Functional structures are also known as
departmental structures, since the functional units are commonly called
departments, and unitary structures or U-forms, since a single unit is
responsible for each function.
CORE
CONCEPT
A functional
structure is
organized into
functional
departments, with
departmental
managers who
report to the CEO
and small corporate
staff. Functional
structures are also
called departmental
structures and
unitary structures or
U-forms.
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In large organizations, functional structures lighten the load on top
management, in comparison to simple structures, and enable more efficient
use of managerial resources. Their primary advantage, however, is greater
task specialization, which promotes learning, enables the realization of scale
economies, and offers productivity advantages not otherwise available. Their
chief disadvantage is that the departmental boundaries can inhibit the flow of
information and limit the opportunities for cross-functional cooperation and
coordination.
The primary
advantage of a
functional structure
is greater task
specialization, which
promotes learning,
enables the
realization of scale
economies, and
offers productivity
advantages not
otherwise available.
It is generally agreed that a functional structure is the best organizational
arrangement when a company is in just one particular business (irrespective
of which of the five generic competitive strategies it opts to pursue). For
instance, a technical instruments manufacturer may be organized around
research and development, engineering, supply chain management, assembly,
quality control, marketing, and technical services. A discount retailer, such as
Dollar General or Family Dollar, may organize around such functional units
as purchasing, warehousing, distribution logistics, store operations,
advertising, merchandising and promotion, and customer service. Functional
structures can also be appropriate for firms with high-volume production,
products that are closely related, and a limited degree of vertical integration.
For example, General Motors now manages all of its brands (Cadillac, GMC,
Chevrolet, Buick, etc.) under a common functional structure designed to
promote technical transfer and capture economies of scale.
As firms continue to grow, they often become more diversified and
complex, placing a greater burden on top management. At some point, the
centralized control that characterizes the functional structure
becomes a liability, and the advantages of functional specialization begin to
break down. To resolve these problems and address a growing need for
coordination across functions, firms generally turn to the multidivisional
structure.
3. Multidivisional Structure A multidivisional structure is a
decentralized structure consisting of a set of operating divisions organized
along market, customer, product, or geographic lines, along with a central
corporate headquarters, which monitors divisional activities, allocates
resources, performs assorted support functions, and exercises overall control.
Since each division is essentially a business (often called a single business
unit or SBU), the divisions typically operate as independent profit centers
(i.e., with profit and loss responsibility) and are organized internally along
functional lines. Division managers oversee day-to-day operations and the
development of business-level strategy, while corporate executives attend to
overall performance and corporate strategy, the elements of which were
described in Chapter 8. Multidivisional structures are also called divisional
structures or M-forms, in contrast with U-form (functional) structures.
CORE
CONCEPT
A multidivisional
structure is a
decentralized
structure consisting
of a set of operating
divisions organized
along business,
product, customer
group, or geographic
lines and a central
corporate
headquarters that
allocates resources,
provides support
functions, and
monitors divisional
activities.
Multidivisional
structures are also
called divisional
structures or M-
forms.
Multidivisional structures are common among companies pursuing some
form of diversification strategy or international strategy, with operations in a
number of businesses or countries. When the strategy is one of unrelated
diversification, as in a conglomerate, the divisions generally represent
businesses in separate industries. When the strategy is based on related
diversification, the divisions may be organized according to industries,
customer groups, product lines, geographic regions, or technologies. In this
arrangement, the decision about where to draw the divisional lines depends
foremost on the nature of the relatedness and the strategy-critical building
blocks, in terms of which businesses have key value chain activities in
common. For example, a company selling closely related products to
business customers as well as two types of end consumers—online buyers
and in-store buyers—may organize its divisions according to customer
groups since the value chains involved in serving the three groups differ.
Another company may organize by product line due to commonalities in
product development and production within each product line.
Multidivisional structures are also common among vertically integrated
firms. There the major building blocks are often divisional units performing
one or more of the major processing steps along the value chain (e.g., raw-
material production, components manufacture, assembly, wholesale
distribution, retail store operations).
Multidivisional structures offer significant advantages over functional
structures in terms of facilitating the management of a complex and diverse
set of operations.19 Putting business-level strategy in the hands of division
managers while leaving corporate strategy to top executives reduces the
potential for information overload and improves the quality of decision
making in each domain. This also minimizes the costs of coordinating
division-wide activities while enhancing top management’s ability to control
a diverse and complex operation. Moreover, multidivisional structures can
help align individual incentives with the goals of the corporation and spur
productivity by encouraging competition for resources among the different
divisions.
But a multidivisional structure can also present some problems to a
company pursuing related diversification, because having independent
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business units—each running its own business in its own way—inhibits
cross-business collaboration and the capture of cross-business synergies,
which are critical for the success of a related diversification strategy, as
Chapter 8 explains. To solve this type of problem, firms turn to more
complex structures, such as the matrix structure.
4. Matrix Structure A matrix structure is a combination structure in
which the organization is organized along two or more dimensions at once
(e.g., business, geographic area, value chain function) for the purpose of
enhancing cross-unit communication, collaboration, and coordination. In
essence, it overlays one type of structure onto another type. Matrix structures
are managed through multiple reporting relationships, so a middle manager
may report to several bosses. For instance, in a matrix structure based on
product line, region, and function, a sales manager for plastic containers in
Georgia might report to the manager of the plastics division, the head of the
southeast sales region, and the head of marketing.
CORE
CONCEPT
A matrix structure
is a combination
structure that
overlays one type of
structure onto
another type, with
multiple reporting
relationships. It is
used to foster cross-
unit collaboration.
Matrix structures are
also called
composite structures
or combination
structures.
Matrix organizational structures have evolved from the complex, over-
formalized structures that were popular in the late 20th century but often
produced inefficient, unwieldy bureaucracies. The modern incarnation of the
matrix structure is generally a more flexible arrangement, with a single
primary reporting relationship that can be overlaid with a temporary
secondary reporting relationship as need arises. For example, a software
company that is organized into functional departments (software design,
quality control, customer relations) may assign employees from those
departments to different projects on a temporary basis, so an employee
reports to a project manager as well as to his or her primary boss (the
functional department head) for the duration of a project.
Matrix structures are also called composite structures or combination
structures. They are often used for project-based, process-based, or team-
based management. Such approaches are common in businesses involving
projects of limited duration, such as consulting, architecture, and engineering
services. The type of close cross-unit collaboration that a flexible matrix
structure supports is also needed to build competitive capabilities in
strategically important activities, such as speeding new products to market,
that involve employees scattered across several organizational units.20
Capabilities-based matrix structures that combine process departments (like
new product development) with more traditional functional departments
provide a solution.
An advantage of matrix structures is that they facilitate the sharing of plant
and equipment, specialized knowledge, and other key resources. Thus, they
lower costs by enabling the realization of economies of scope. They also have
the advantage of flexibility in form and may allow for better oversight since
supervision is provided from more than one perspective. A disadvantage is
that they add another layer of management, thereby increasing bureaucratic
costs and possibly decreasing response time to new situations.21 In addition,
there is a potential for confusion among employees due to dual reporting
relationships and divided loyalties. While there is some controversy over the
utility of matrix structures, the modern approach to matrix structures does
much to minimize their disadvantages.22
Determining How Much Authority to Delegate
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• LO 10-5
Comprehend the
pros and cons of
centralized and
decentralized
decision making in
implementing the
chosen strategy.
Under any organizational structure, there is room for considerable variation
in how much authority top-level executives retain and how much is delegated
to down-the-line managers and employees. In executing strategy and
conducting daily operations, companies must decide how much authority to
delegate to the managers of each organizational unit—especially the heads of
divisions, functional departments, plants, and other operating units—and how
much decision-making latitude to give individual employees in performing
their jobs. The two extremes are to centralize decision making at the top or to
decentralize decision making by giving managers and employees at all levels
considerable decision-making latitude in their areas of responsibility. As
shown in Table 10.1, the two approaches are based on sharply different
underlying principles and beliefs, with each having its pros and cons.
TABLE 10.1 Advantages and Disadvantages of Centralized
versus Decentralized Decision Making
Centralized Organizational Structures Decentralized Organizational Structures
Centralized Organizational Structures Decentralized Organizational Structures
Basic tenets
Decisions on most matters of
importance should be in the hands of
top-level managers who have the
experience, expertise, and judgment to
decide what is the best course of
action.
Lower-level personnel have neither the
knowledge, time, nor inclination to
properly manage the tasks they are
performing.
Strong control from the top is a more
effective means for coordinating
company actions.
Basic tenets
Decision-making authority should be
put in the hands of the people closest
to, and most familiar with, the situation.
Those with decision-making authority
should be trained to exercise good
judgment.
A company that draws on the
combined intellectual capital of all its
employees can outperform a
command-and-control company.
Chief advantages
Fixes accountability through tight
control from the top.
Eliminates potential for conflicting
goals and actions on the part of lower-
level managers.
Facilitates quick decision making and
strong leadership under crisis
situations.
Chief advantages
Encourages company employees to
exercise initiative and act responsibly.
Promotes greater motivation and
involvement in the business on the part
of more company personnel.
Spurs new ideas and creative thinking.
Allows for fast response to market
change.
Entails fewer layers of management.
Primary disadvantages
Lengthens response times by those
closest to the market conditions
because they must seek approval for
their actions.
Does not encourage responsibility
among lower-level managers and rank-
and-file employees.
Discourages lower-level managers and
rank-and-file employees from
exercising any initiative.
Primary disadvantages
May result in higher-level managers
being unaware of actions taken by
empowered personnel under their
supervision.
Can lead to inconsistent or conflicting
approaches by different managers and
employees.
Can impair cross-unit collaboration.
Centralized Decision Making: Pros and Cons In a highly centralized
organizational structure, top executives retain authority for most strategic and
operating decisions and keep a tight rein on business unit heads, department
heads, and the managers of key operating units. Comparatively little
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discretionary authority is granted to frontline supervisors and rank-and-file
employees. The command-and-control paradigm of centralized decision
making is based on the underlying assumptions that frontline personnel have
neither the time nor the inclination to direct and properly control the work
they are performing and that they lack the knowledge and judgment to make
wise decisions about how best to do it—hence the need for prescribed
policies and procedures for a wide range of activities, close supervision, and
tight control by top executives. The thesis underlying centralized structures is
that strict enforcement of detailed procedures backed by rigorous managerial
oversight is the most reliable way to keep the daily execution of strategy on
track.
One advantage of a centralized structure, with tight control by the manager
in charge, is that it is easy to know who is accountable when things do not go
well. This structure can also reduce the potential for conflicting decisions and
actions among lower-level managers who may have differing
perspectives and ideas about how to tackle certain tasks or
resolve particular issues. For example, a manager in charge of an engineering
department may be more interested in pursuing a new technology than is a
marketing manager who doubts that customers will value the technology as
highly. Another advantage of a command-and-control structure is that it can
facilitate strong leadership from the top in a crisis situation that affects the
organization as a whole and can enable a more uniform and swift response.
But there are some serious disadvantages as well. Hierarchical command-
and-control structures do not encourage responsibility and initiative on the
part of lower-level managers and employees. They can make a large
organization with a complex structure sluggish in responding to changing
market conditions because of the time it takes for the review-and-approval
process to run up all the layers of the management bureaucracy. Furthermore,
to work well, centralized decision making requires top-level managers to
gather and process whatever information is relevant to the decision. When the
relevant knowledge resides at lower organizational levels (or is technical,
detailed, or hard to express in words), it is difficult and time-consuming to
get all the facts in front of a high-level executive located far from the scene of
the action—full understanding of the situation cannot be readily copied from
one mind to another. Hence, centralized decision making is often impractical
—the larger the company and the more scattered its operations, the more that
decision-making authority must be delegated to managers closer to the scene
of the action.
Decentralized Decision Making: Pros and Cons In a highly
decentralized organization, decision-making authority is pushed down to the
lowest organizational level capable of making timely, informed, competent
decisions. The objective is to put adequate decision-making authority in the
hands of the people closest to and most familiar with the situation and train
them to weigh all the factors and exercise good judgment. At Starbucks, for
example, employees are encouraged to exercise initiative in promoting
customer satisfaction—there’s the oft-repeated story of a store employee
who, when the computerized cash register system went offline, offered free
coffee to waiting customers, thereby avoiding customer displeasure and
damage to Starbucks’s reputation.23
The ultimate goal of
decentralized
decision making is
to put authority in
the hands of those
persons closest to
and most
knowledgeable
about the situation.
The case for empowering down-the-line managers and employees to make
decisions related to daily operations and strategy execution is based on the
belief that a company that draws on the combined intellectual capital of all its
employees can outperform a command-and-control company.24 The
challenge in a decentralized system is maintaining adequate control. With
decentralized decision making, top management maintains control by placing
limits on the authority granted to company personnel, installing
companywide strategic control systems, holding people accountable for their
decisions, instituting compensation incentives that reward people for doing
their jobs well, and creating a corporate culture where there’s strong peer
pressure on individuals to act responsibly.25
Decentralized organizational structures have much to recommend them.
Delegating authority to subordinate managers and rank-and-file employees
encourages them to take responsibility and exercise initiative. It shortens
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organizational response times to market changes and spurs new ideas,
creative thinking, innovation, and greater involvement on the part of all
company personnel. At TJX Companies Inc., parent company of T.J.Maxx,
Marshalls, and five other fashion and home decor retail store chains, buyers
are encouraged to be intelligent risk takers in deciding what items to purchase
for TJX stores—there’s the story of a buyer for a seasonal product category
who cut her own budget to have dollars allocated to other
categories where sales were expected to be stronger. In worker-
empowered structures, jobs can be defined more broadly, several tasks can be
integrated into a single job, and people can direct their own work. Fewer
managers are needed because deciding how to do things becomes part of each
person’s or team’s job. Further, today’s online communication systems and
smartphones make it easy and relatively inexpensive for people at all
organizational levels to have direct access to data, other employees,
managers, suppliers, and customers. They can access information quickly
(via the Internet or company network), readily check with superiors or
whomever else as needed, and take responsible action. Typically, there are
genuine gains in morale and productivity when people are provided with the
tools and information they need to operate in a self-directed way.
But decentralization also has some disadvantages. Top managers lose an
element of control over what goes on and may thus be unaware of actions
being taken by personnel under their supervision. Such lack of control can be
problematic in the event that empowered employees make decisions that
conflict with those of others or that serve their unit’s interests at the expense
of other parts of the company. Moreover, because decentralization gives
organizational units the authority to act independently, there is risk of too
little collaboration and coordination between different units.
Many companies have concluded that the advantages of decentralization
outweigh the disadvantages. Over the past several decades, there’s been a
decided shift from centralized, hierarchical structures to flatter, more
decentralized structures that stress employee empowerment. This shift
reflects a strong and growing consensus that authoritarian, hierarchical
organizational structures are not well suited to implementing and executing
strategies in an era when extensive information and instant communication
are the norm and when a big fraction of the organization’s most valuable
assets consists of intellectual capital that resides in its employees’
capabilities.
Capturing Cross-Business Strategic Fit in a Decentralized Structure
Diversified companies striving to capture the benefits of synergy between
separate businesses must beware of giving business unit heads full rein to
operate independently. Cross-business strategic fit typically must be captured
either by enforcing close cross-business collaboration or by centralizing the
performance of functions requiring close coordination at the corporate
level.26 For example, if businesses with overlapping process and product
technologies have their own independent R&D departments—each pursuing
its own priorities, projects, and strategic agendas—it’s hard for the corporate
parent to prevent duplication of effort, capture either economies of scale or
economies of scope, or encourage more collaborative R&D efforts. Where
cross-business strategic fit with respect to R&D is important, one solution is
to centralize the R&D function and have a coordinated corporate R&D effort
that serves the interests of both the individual businesses and the company as
a whole. Likewise, centralizing the related activities of separate businesses
makes sense when there are opportunities to share a common sales force, use
common distribution channels, rely on a common field service organization,
use common e-commerce systems, and so on. Another structural solution to
realizing the benefits of strategic fit is to create business groups consisting of
those business units with common strategic-fit opportunities.
Efforts to
decentralize
decision making and
give company
personnel some
leeway in
conducting
operations must be
tempered with the
need to maintain
adequate control
and cross-unit
coordination.
Providing for Internal Cross-Unit Coordination
page 321
Close cross-unit collaboration is usually needed to build capabilities in such
strategically important activities as speeding new products to market and
providing superior customer service. This is because these activities
involve collaboration among the efforts of company personnel who
work in different departments or organizational units (and perhaps the
employees of outside strategic partners or specialty vendors). For example,
being first-to-market with new products involves coordinating the efforts of
personnel in R&D (to develop a stream of new products with appealing
attributes), design and engineering (to prepare a cost-efficient design and set
of specifications), purchasing (to obtain the needed parts and components),
manufacturing (to carry out all the production activities), and sales and
marketing (to secure orders, arrange for introductory advertising and the
distribution of product information, and get the products on retailers’
shelves). Achieving the simple strategic objective of filling customer orders
accurately and promptly involves personnel from sales (to win the order);
finance (to check credit terms or approve special financing); production (to
produce the goods and replenish warehouse inventories as needed); and
warehousing and shipping (to verify whether the items are in stock, pick the
order from the warehouse, package it for shipping, and choose the best carrier
to deliver the goods).
To achieve tight coordination when pieces of execution-critical tasks are
performed in multiple organizational units, company executives typically
emphasize the necessity of cross-unit teamwork and cooperation and the
importance of frequent back-and-forth communication among key people in
the various related organizational units to resolve problems, avoid delays, and
keep things moving along. The executives supervising the units performing
parts of the execution-critical task typically make it clear that the relevant
department heads and key personnel are all expected to work closely together
and coordinate their actions. There are meetings to discuss schedules and set
deadlines, often ending with the verbal commitments of everyone involved to
stick close to the agreed-upon schedule, coordinate their activities, and meet
the established deadlines. Gaining such commitments is almost always
imperative, along with ensuring that everyone lives up to their commitments.
Normally, the supervising executives follow up, check on progress, and, in
many cases, visit the different units to personally determine how well things
are going and solicit the views of numerous people about what problems exist
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and what they think should be done to resolve them. They seldom hesitate to
intervene to make corrective adjustments and to reiterate their expectations of
teamwork, close communication, effective collaboration, and cooperation to
resolve issues, avoid delays, and achieve the needed degree of cross-unit
coordination. Such executive interventions, together with added executive
pressure on the managers of units where close collaboration and coordinated
action is lacking, may suffice. If it does, then all is well and good. But if such
efforts fail, execution suffers and it becomes the responsibility of executives
to determine the causes and take corrective action.
In many instances, the chief cause of ineffective cross-unit coordination in
building capabilities rests with departmental-level managers and other key
operating personnel who, for assorted reasons, don’t or won’t spend the time
and effort needed to partner with other organizational units in the capability-
building process. But it also has to be recognized that top-executive urging
that departmental managers and their staff voluntarily place high priority on
coordinating their respective activities poses significant challenges in
achieving effective cross-unit coordination. This is especially true in
decentralized organizational structures where department heads are delegated
a high degree of decision-making authority in running their respective units
and, thus, have a natural tendency to place a lower priority on cooperating
closely with other organizational units than on ensuring that the activities
under their direct supervision are done well. The weakness of heavily
depending on the largely voluntary efforts of personnel for the
development of critical cross-unit capabilities has prompted
many companies to supplement such efforts by forming cross-functional
committees, project management teams, and centralized project management
offices to forge better cross-unit working relationships and improve
coordination across multiple organizational units. While these arrangements
have proved helpful in a number of organizations, more effective solutions
involve creating incentive compensation systems where the payouts are tied
to effective group performance of cross-unit tasks.
Facilitating Collaboration with External Partners
and Strategic Allies
Organizational mechanisms—whether formal or informal—are also required
to ensure effective working relationships with each major outside
constituency involved in strategy execution. Strategic alliances, outsourcing
arrangements, joint ventures, and cooperative partnerships can contribute
little of value without active management of the relationship. Unless top
management sees that constructive organizational bridge building with
external partners occurs and that productive working relationships emerge,
the potential value of cooperative relationships is lost and the company’s
power to execute its strategy is weakened. For example, if close working
relationships with suppliers are crucial, then supply chain management must
enter into considerations of how to create an effective organizational
structure. If distributor, dealer, or franchisee relationships are important, then
someone must be assigned the task of nurturing the relationships with such
forward-channel allies.
Getting managers of
execution-critical
activities to live up to
their commitments
to coordinate closely
with sister
organizational unit is
a key factor in
achieving good
internal cross-unit
coordination.
Building organizational bridges with external partners and strategic allies
can be accomplished by appointing “relationship managers” with
responsibility for making particular strategic partnerships generate the
intended benefits. Relationship managers have many roles and functions:
getting the right people together, promoting good rapport, facilitating the
flow of information, nurturing interpersonal communication and cooperation,
and ensuring effective coordination.27 Multiple cross-organization ties have
to be established and kept open to ensure proper communication and
coordination. There has to be enough information sharing to make the
relationship work and periodic frank discussions of conflicts, trouble spots,
and changing situations.
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Organizing and managing a network structure provides a mechanism for
encouraging more effective collaboration and cooperation among external
partners. A network structure is the arrangement linking a number of
independent organizations involved in some common undertaking. A well-
managed network structure typically includes one firm in a more central role,
with the responsibility of ensuring that the right partners are included and the
activities across the network are coordinated. The high-end Italian
motorcycle company Ducati operates in this manner, assembling its
motorcycles from parts obtained from a handpicked integrated network of
parts suppliers.
CORE
CONCEPT
A network
structure is a
configuration
composed of a
number of
independent
organizations
engaged in some
common
undertaking, with
one firm typically
taking on a more
central role.
Further Perspectives on Structuring the Work
Effort
All organizational designs have their strategy-related strengths and
weaknesses. To do a good job of matching structure to strategy, strategy
implementers first have to pick a basic organizational design and modify it as
needed to fit the company’s particular business lineup. They must then (1)
supplement the design with appropriate coordinating mechanisms (cross-
functional task forces, special project teams, self-contained work teams, etc.)
and (2) institute whatever networking and communications arrangements are
necessary to support effective execution of the firm’s strategy.
Some companies may avoid setting up “ideal” organizational
arrangements because they do not want to disturb existing reporting
relationships or because they need to accommodate other situational
idiosyncrasies, yet they must still work toward the goal of building a
competitively capable organization.
What can be said unequivocally is that building a capable organization
entails a process of consciously knitting together the efforts of individuals
and groups. Organizational capabilities emerge from establishing and
nurturing cooperative working relationships among people and groups to
perform activities in a more efficient, value-creating fashion. While an
appropriate organizational structure can facilitate this, organization building
is a task in which senior management must be deeply involved. Indeed,
effectively managing both internal organizational processes and external
collaboration to create and develop competitively valuable organizational
capabilities remains a top challenge for senior executives in today’s
companies.
KEY POINTS
1. Executing strategy is an action-oriented, operations-driven activity
revolving around the management of people, business processes, and
organizational structure. In devising an action agenda for executing
strategy, managers should start by conducting a probing assessment of
what the organization must do to carry out the strategy successfully. They
should then consider precisely how to go about this.
2. Good strategy execution requires a team effort. All managers have
strategy-executing responsibility in their areas of authority, and all
employees are active participants in the strategy execution process.
3. Ten managerial tasks are part of every company effort to execute strategy:
(1) staffing the organization with the right people, (2) developing and
augmenting the necessary resources and organizational capabilities, (3)
creating a supportive organizational structure, (4) allocating sufficient
resources (budgetary and otherwise), (5) instituting supportive policies and
procedures, (6) adopting processes for continuous improvement, (7)
installing systems that enable proficient company operations, (8) tying
incentives to the achievement of desired targets, (9) instilling the right
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corporate culture, and (10) exercising the leadership needed to propel
strategy execution forward.
4. The two best signs of good strategy execution are that a company is
meeting or beating its performance targets and is performing value chain
activities in a manner that is conducive to companywide operating
excellence. Shortfalls in performance signal weak strategy, weak
execution, or both.
5. Building an organization capable of good strategy execution entails three
types of actions: (1) staffing the organization—assembling a talented
management team and recruiting and retaining employees with the needed
experience, technical skills, and intellectual capital; (2) acquiring,
developing, and strengthening strategy-supportive resources and
capabilities—accumulating the required resources, developing
proficiencies in performing strategy-critical value chain activities, and
updating the company’s capabilities to match changing market conditions
and customer expectations; and (3) structuring the organization and work
effort—instituting organizational arrangements that facilitate good strategy
execution, deciding how much decision-making authority to delegate,
facilitating cross-unit coordination, and managing external relationships.
6. Building competitive capabilities is a time-consuming, managerially
challenging exercise that can be approached in three ways: (1) developing
capabilities internally, (2) acquiring capabilities through mergers and
acquisitions, and (3) accessing capabilities via collaborative partnerships.
7. In building capabilities internally, the first step is to develop the ability to
do something, through experimenting, actively searching for alternative
solutions, and learning by trial and error. As experience grows and
company personnel learn how to perform the activities consistently well
and at an acceptable cost, the ability evolves into a tried-and-true
capability. The process can be accelerated by making learning a more
deliberate endeavor and providing the incentives that will motivate
company personnel to achieve the desired ends.
8. As firms get better at executing their strategies, they develop capabilities in
the domain of strategy execution. Superior strategy execution capabilities
allow companies to get the most from their resources and capabilities. But
excellence in strategy execution can also be a more direct source of
LO 10-1
competitive advantage, since more efficient and effective strategy
execution can lower costs and permit firms to deliver more value to
customers. Because they are socially complex capabilities, superior
strategy execution capabilities are hard to imitate and have no good
substitutes. As such, they can be an important source of sustainable
competitive advantage. Anytime rivals can readily duplicate successful
strategies, making it impossible to out-strategize rivals, the chief way to
achieve lasting competitive advantage is to out-execute them.
9. Structuring the organization and organizing the work effort in a strategy-
supportive fashion has five aspects: (1) deciding which value chain
activities to perform internally and which ones to outsource; (2) aligning
the firm’s organizational structure with its strategy; (3) deciding how much
authority to centralize at the top and how much to delegate to down-the-
line managers and employees; (4) providing for the internal cross-unit
coordination needed to build and strengthen capabilities; and (5)
facilitating the necessary collaboration and coordination with external
partners and strategic allies.
10. To align the firm’s organizational structure with its strategy, it is important
to make strategy-critical activities the main building blocks. There are four
basic types of organizational structures: the simple structure, the functional
structure, the multidivisional structure, and the matrix structure. Which is
most appropriate depends on the firm’s size, complexity, and strategy.
ASSURANCE OF LEARNING EXERCISES
1. The heart of Zara’s strategy in the apparel industry
is to outcompete rivals by putting fashionable
clothes in stores quickly and maximizing the
frequency of customer visits. Illustration Capsule
10.2 discusses the capabilities that the company has
developed in the execution of its strategy. How do
its capabilities lead to a quick production process
and new apparel introductions? How do these
capabilities encourage customers to visit its stores
every few weeks? Does the execution of the
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LO 10-2
LO 10-2, 10-3
LO 10-4
company’s site selection capability also contribute to
its competitive advantage? Explain.
2. Search online to read about Jeff Bezos’s
management of his new executives. Specifically,
explore Amazon.com’s “S-Team” meetings
(management.fortune.cnn.com/2012/11/16/jeff-
bezos-amazon/). Why does Bezos begin meetings
of senior executives with 30 minutes of
silent reading? How does this focus the
group? Why does Bezos insist new ideas must be
written and presented in memo form? How does this
reflect the founder’s insistence on clear, concise, and
innovative thinking in his company? And does this
exercise work as a de facto crash course for new
Amazon executives? Explain why this small but
crucial management strategy reflects Bezos’s
overriding goal of cohesive and clear idea
presentation.
3. Review Facebook’s Careers page
(www.Facebook.com/careers/). The page
emphasizes Facebook’s core values and explains
how potential employees could fit that mold. Bold
and decisive thinking and a commitment to
transparency and social connectivity drive the page
and the company as a whole. Then research
Facebook’s internal management training programs,
called “employee boot camps,” using a search
engine like Google or Bing. How do these programs
integrate the traits and stated goals on the Careers
page into specific and tangible construction of
employee capabilities? Boot camps are open to all
Facebook employees, not just engineers. How does
this internal training prepare Facebook employees of
all types to “move fast and break things”?
4. Review Valve Corporation’s company handbook
online:
http://amazon.com/
http://management.fortune.cnn.com/2012/11/16/jeff-bezos-amazon/
http://www.facebook.com/careers/
LO 10-5
LO 10-5
www.valvesoftware.com/company/Valve_Handbo
ok_LowRes . Specifically, focus on Valve’s
corporate structure. Valve has hundreds of
employees but no managers or bosses at all. Valve’s
gaming success hinges on innovative and
completely original experiences like Portal and
Half-Life. Does it seem that Valve’s corporate
structure uniquely promotes this type of gaming
innovation? Why or why not? How would you
characterize Valve’s organizational structure? Is it
completely unique, or could it be characterized as a
multidivisional, matrix, or functional structure?
Explain your answer.
5. Johnson & Johnson, a multinational health care
company responsible for manufacturing medical,
pharmaceutical, and consumer goods, has been a
leader in promoting a decentralized management
structure. Perform an Internet search to gain some
background information on the company’s products,
value chain activities, and leadership. How does
Johnson & Johnson exemplify (or not exemplify) a
decentralized management strategy? Describe the
advantages and disadvantages of a decentralized
system of management in the case of Johnson &
Johnson. Why was it established in the first place?
Has it been an effective means of decision making
for the company?
EXERCISES FOR SIMULATION PARTICIPANTS
1. How would you describe the organization of your
company’s top-management team? Is some decision
making decentralized and delegated to individual
managers? If so, explain how the decentralization
works. Or are decisions made more by consensus,
with all co-managers having input? What do you see
http://www.valvesoftware.com/company/Valve_Handbook_LowRes .
LO 10-3
LO 10-1
page 326
as the advantages and disadvantages of the decision-
making approach your company is employing?
2. What specific actions have you and your co-
managers taken to develop core competencies or
competitive capabilities that can contribute to good
strategy execution and potential competitive
advantage? If no actions have been taken, explain
your rationale for doing nothing.
3. What value chain activities are most crucial to good
execution of your company’s strategy? Does your
company have the ability to outsource any value
chain activities? If so, have you and your co-
managers opted to engage in outsourcing? Why or
why not?
ENDNOTES
1 Donald Sull, Rebecca Homkes, and Charles Sull, “Why Strategy Execution Unravels—and What to Do About It,”
Harvard Business Review 93, no. 3 (March 2015), p. 60.
2 Steven W. Floyd and Bill Wooldridge, “Managing Strategic Consensus: The Foundation of Effective Implementation,”
Academy of Management Executive 6, no. 4 (November 1992), p. 27.
3 Jack Welch with Suzy Welch, Winning (New York: HarperBusiness, 2005).
4 Larry Bossidy and Ram Charan, Execution: The Discipline of Getting Things Done (New York: Crown Business, 2002).
5 Christopher A. Bartlett and Sumantra Ghoshal, “Building Competitive Advantage through People,” MIT Sloan
Management Review 43, no. 2 (Winter 2002), pp. 34–41.
6 Justin Menkes, “Hiring for Smarts,” Harvard Business Review 83, no. 11 (November 2005), pp. 100–109; Justin
Menkes, Executive Intelligence (New York: HarperCollins, 2005).
7 Menkes, Executive Intelligence, pp. 68, 76.
8 Jim Collins, Good to Great (New York: HarperBusiness, 2001).
9 John Byrne, “The Search for the Young and Gifted,” Businessweek, October 4, 1999, p. 108.
10 C. Helfat and M. Peteraf, “The Dynamic Resource-Based View: Capability Lifecycles,” Strategic Management Journal
24, no. 10 (October 2003), pp. 997–1010.
11 G. Dosi, R. Nelson, and S. Winter (eds.), The Nature and Dynamics of Organizational Capabilities (Oxford, England:
Oxford University Press, 2001).
12 S. Winter, “The Satisficing Principle in Capability Learning,” Strategic Management Journal 21, no. 10–11 (October–
November 2000), pp. 981–996; M. Zollo and S. Winter, “Deliberate Learning and the Evolution of Dynamic Capabilities,”
Organization Science 13, no. 3 (May–June 2002), pp. 339–351.
13 Robert H. Hayes, Gary P. Pisano, and David M. Upton, Strategic Operations: Competing through Capabilities (New
York: Free Press, 1996); Jonas Ridderstrale, “Cashing In on Corporate Competencies,” Business Strategy Review 14,
no. 1 (Spring 2003), pp. 27–38; Danny Miller, Russell Eisenstat, and Nathaniel Foote, “Strategy from the Inside Out:
Building Capability-Creating Organizations,” California Management Review 44, no. 3 (Spring 2002), pp. 37–55.
14 S. Karim and W. Mitchell, “Path-Dependent and Path-Breaking Change: Reconfiguring Business Resources Following
Acquisitions in the US Medical Sector, 1978–1995,” Strategic Management Journal 21, no. 10–11 (October–November
2000), pp. 1061–1082; L. Capron, P. Dussauge, and W. Mitchell, “Resource Redeployment Following Horizontal
page 327
Acquisitions in Europe and North America, 1988–1992,” Strategic Management Journal 19, no. 7 (July 1998), pp. 631–
662.
15 Gary P. Pisano and Willy C. Shih, “Restoring American Competitiveness,” Harvard Business Review 87, no. 7–8 (July–
August 2009), pp. 114–125.
16 A. Chandler, Strategy and Structure (Cambridge, MA: MIT Press, 1962).
17 E. Olsen, S. Slater, and G. Hult, “The Importance of Structure and Process to Strategy Implementation,” Business
Horizons 48, no. 1 (2005), pp. 47–54; H. Barkema, J. Baum, and E. Mannix, “Management Challenges in a New Time,”
Academy of Management Journal 45, no. 5 (October 2002), pp. 916–930.
18 H. Mintzberg, The Structuring of Organizations (Englewood Cliffs, NJ: Prentice Hall, 1979); C. Levicki, The Interactive
Strategy Workout, 2nd ed. (London: Prentice Hall, 1999).
19 O. Williamson, Market and Hierarchies (New York: Free Press, 1975); R. M. Burton and B. Obel, “A Computer
Simulation Test of the M-Form Hypothesis,” Administrative Science Quarterly 25 (1980), pp. 457–476.
20 J. Baum and S. Wally, “Strategic Decision Speed and Firm Performance,” Strategic Management Journal 24 (2003),
pp. 1107–1129.
21 C. Bartlett and S. Ghoshal, “Matrix Management: Not a Structure, a Frame of Mind,” Harvard Business Review, July–
August 1990, pp. 138–145.
22 M. Goold and A. Campbell, “Structured Networks: Towards the Well Designed Matrix,” Long Range Planning 36, no. 5
(2003), pp. 427–439.
23 Iain Somerville and John Edward Mroz, “New Competencies for a New World,” in Frances Hesselbein, Marshall
Goldsmith, and Richard Beckard (eds.), The Organization of the Future (San Francisco: Jossey-Bass, 1997), p. 70.
24 Stanley E. Fawcett, Gary K. Rhoads, and Phillip Burnah, “People as the Bridge to Competitiveness: Benchmarking the
‘ABCs’ of an Empowered Workforce,” Benchmarking: An International Journal 11, no. 4 (2004), pp. 346–360.
25 Robert Simons, “Control in an Age of Empowerment,” Harvard Business Review 73 (March–April 1995), pp. 80–88.
26 Jeanne M. Liedtka, “Collaboration across Lines of Business for Competitive Advantage,” Academy of Management
Executive 10, no. 2 (May 1996), pp. 20–34.
27 Rosabeth Moss Kanter, “Collaborative Advantage: The Art of the Alliance,” Harvard Business Review 72, no. 4 (July–
August 1994), pp. 96–108.
page 328
chapter 11
Managing Internal Operations
Actions That Promote Good
Strategy Execution
Learning Objectives
After reading this chapter, you should be able to:
LO 11-1 Explain why resource allocation should always be
based on strategic priorities.
LO 11-2 Comprehend how well-designed policies and
procedures can facilitate good strategy execution.
LO 11-3 Understand how process management tools drive
continuous improvement in the performance of value
chain activities.
LO 11-4 Recognize the role of information systems and
operating systems in enabling company personnel to
carry out their strategic roles proficiently.
LO 11-5 Explain how and why the use of well-designed
incentives can be management’s single most powerful
tool for promoting adept strategy execution.
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Matt Herring/Ikon Images/Media Bakery
Processes underpin business capabilities, and capabilities underpin strategy execution.
Pearl Zhu
Pay your people the least possible and you’ll get the same from them.
Malcolm Forbes—late Publisher of Forbes Magazine
Apple is a very disciplined company, and we have great processes. But that’s not what it’s about.
Process makes you more efficient.
Steve Jobs—Cofounder of Apple, Inc.
page 330
In Chapter 10, we emphasized that proficient strategy execution begins with three types
of managerial actions: staffing the organization with the right people; acquiring,
developing, and strengthening the firm’s resources and capabilities; and structuring the
organization in a manner supportive of the strategy execution effort.
In this chapter, we discuss five additional managerial actions that advance the cause
of good strategy execution:
Allocating ample resources to the strategy execution effort.
Instituting policies and procedures that facilitate good strategy execution.
Employing process management tools to drive continuous improvement in how value
chain activities are performed.
Installing information and operating systems that support strategy implementation
activities.
Tying rewards and incentives to the achievement of performance objectives.
ALLOCATING RESOURCES TO THE
STRATEGY EXECUTION EFFORT
• LO 11-1
Explain why
resource allocation
should always be
based on strategic
priorities.
Early in the strategy implementation process, managers must determine what
resources (in terms of funding, people, and so on) will be required and how
they should be distributed across the company’s various organizational units.
This includes carefully screening requests for more people and new facilities
and equipment, approving those that will contribute to the strategy execution
effort, and turning down those that don’t. Should internal cash flows prove
insufficient to fund the planned strategic initiatives, then management must
raise additional funds through borrowing or selling additional shares of stock
to investors.
A company’s ability to marshal the resources needed to support new
strategic initiatives has a major impact on the strategy execution process. Too
little funding and an insufficiency of other types of resources slow progress
and impede the efforts of organizational units to execute their pieces of the
strategic plan competently. Too much funding of particular organizational
units and value chain activities wastes organizational resources and reduces
financial performance. Both of these scenarios argue for managers to become
deeply involved in reviewing budget proposals and directing the proper kinds
and amounts of resources to strategy-critical organizational units.
A company’s
strategic priorities
must drive how
capital allocations
are made and the
size of each unit’s
operating budgets.
A change in strategy nearly always calls for budget reallocations and
resource shifting. Previously important units with a lesser role in the new
strategy may need downsizing. Units that now have a bigger strategic role
may need more people, new equipment, additional facilities, and above-
average increases in their operating budgets. Implementing new strategy
initiatives requires managers to take an active and sometimes forceful role in
shifting resources, not only to better support activities now having a higher
priority but also to capture opportunities to operate more cost-effectively.
This requires putting enough resources behind new strategic initiatives to fuel
their success and making the tough decisions to kill projects and activities
that are no longer justified.
Visible actions to reallocate operating funds and move people into new
organizational units signal a determined commitment to strategic change.
Such actions can catalyze the implementation process and give it credibility.
Microsoft has made a practice of regularly shifting hundreds of programmers
to new high-priority programming initiatives within a matter of weeks or
even days. Fast-moving developments in many markets are prompting
companies to abandon traditional annual budgeting and resource allocation
cycles in favor of resource allocation processes supportive of more rapid
adjustments in strategy. In response to rapid technological change in the
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communications industry, AT&T has prioritized investments and acquisitions
that have allowed it to offer its enterprise customers faster, more flexible
networks and provide innovative new customer services, such as its
Sponsored Data plan.
Merely fine-tuning the execution of a company’s existing strategy seldom
requires big shifts of resources from one area to another. In contrast, new
strategic initiatives generally require not only big shifts in resources but a
larger allocation of resources to the effort as well. However, there are times
when strategy changes or new execution initiatives need to be made without
adding to total company expenses. In such circumstances, managers have to
work their way through the existing budget line by line and activity by
activity, looking for ways to trim costs and shift resources to activities that
are higher-priority in the strategy execution effort. In the event
that a company needs to make significant cost cuts during the
course of launching new strategic initiatives, managers must be especially
creative in finding ways to do more with less. Indeed, it is common for
strategy changes and the drive for good strategy execution to be aimed at
achieving considerably higher levels of operating efficiency and, at the same
time, making sure the most important value chain activities are performed as
effectively as possible.
INSTITUTING POLICIES AND
PROCEDURES THAT FACILITATE
STRATEGY EXECUTION
• LO 11-2
Comprehend how
well-designed
policies and
procedures can
facilitate good
strategy execution.
A company’s policies and procedures can either support or hinder good
strategy execution. Anytime a company moves to put new strategy elements
in place or improve its strategy execution capabilities, some changes in work
practices are usually needed. Managers are thus well advised to carefully
consider whether existing policies and procedures fully support such changes
and to revise or discard those that do not.
As shown in Figure 11.1, well-conceived policies and operating procedures
facilitate strategy execution in two significant ways:
FIGURE 11.1 How Policies and Procedures Facilitate Good
Strategy Execution
1. By providing top-down guidance regarding how things need to be done.
Policies and procedures provide company personnel with a set of
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guidelines for how to perform organizational activities, conduct various
aspects of operations, solve problems as they arise, and accomplish
particular tasks. They clarify uncertainty about how to proceed in
executing strategy and align the actions and behavior of company
personnel with the requirements for good strategy execution. Moreover,
they place limits on ineffective independent action. When they are well
matched with the requirements of the strategy implementation plan, they
channel the efforts of individuals along a path that supports the plan. When
existing ways of doing things pose a barrier to strategy execution
initiatives, actions and behaviors have to be changed. Under these
conditions, the managerial role is to establish and enforce new policies and
operating practices that are more conducive to executing the strategy
appropriately. Policies are a particularly useful way to counteract
tendencies for some people to resist change. People generally refrain from
violating company policy or going against recommended practices and
procedures without gaining clearance or having strong justification.
2. By helping ensure consistency in how execution-critical activities are
performed. Policies and procedures serve to standardize the way that
activities are performed. In essence, they represent a store of
organizational or managerial knowledge about efficient and effective ways
of doing things—a set of well-honed routines for running the company.
This can be important for ensuring the quality and reliability of the strategy
execution process. It helps align and coordinate the strategy execution
efforts of individuals and groups throughout the organization—a feature
that is particularly beneficial when there are geographically scattered
operating units. For example, eliminating significant differences in the
operating practices of different plants, sales regions, or customer service
centers or in the individual outlets in a chain operation helps a
company deliver consistent product quality and service to
customers. Good strategy execution nearly always entails an ability to
replicate product quality and the caliber of customer service at every
location where the company does business—anything less blurs the
company’s image and lowers customer satisfaction.
A company’s
policies and
procedures provide
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a set of well-honed
routines for running
the company and
executing the
strategy.
3. By promoting the creation of a work climate that facilitates good strategy
execution. A company’s policies and procedures help set the tone of a
company’s work climate and contribute to a common understanding of
“how we do things around here.” Because abandoning old policies and
procedures in favor of new ones invariably alters the internal work climate,
managers can use the policy-changing process as a powerful lever for
changing the corporate culture in ways that better support new strategic
initiatives. The trick here, obviously, is to come up with new policies or
procedures that catch the immediate attention of company personnel and
prompt them to quickly shift their actions and behaviors in the desired
ways.
To ensure consistency in product quality and service behavior patterns,
McDonald’s policy manual spells out detailed procedures that personnel in
each McDonald’s unit are expected to observe. For example, “Cooks must
turn, never flip, hamburgers. If they haven’t been purchased, Big Macs must
be discarded in 10 minutes after being cooked and French fries in
7 minutes. Cashiers must make eye contact with and smile at
every customer.” Retail chain stores and other organizational chains (e.g.,
hotels, hospitals, child care centers) similarly rely on detailed policies and
procedures to ensure consistency in their operations and reliable service to
their customers. Video game developer Valve Corporation prides itself on a
lack of rigid policies and procedures; its 37-page handbook for new
employees details how things get done in such an environment—an ironic
tribute to the fact that all types of companies need policies.
One of the big policy-making issues concerns what activities need to be
strictly prescribed and what activities ought to allow room for independent
action on the part of personnel. Few companies need thick policy manuals to
prescribe exactly how daily operations are to be conducted. Too much policy
can be as obstructive as wrong policy and as confusing as no policy. There is
wisdom in a middle approach: Prescribe enough policies to give organization
members clear direction and to place reasonable boundaries on their
actions; then empower them to act within these boundaries in pursuit of
company goals. Allowing company personnel to act with some degree of
freedom is especially appropriate when individual creativity and initiative are
more essential to good strategy execution than are standardization and strict
conformity. Instituting policies that facilitate strategy execution can therefore
mean policies more policies, fewer policies, or different policies. It can mean
policies that require things be done according to a precisely defined standard
or policies that give employees substantial leeway to do activities the way
they think best.
There is wisdom in a
middle-ground
approach: Prescribe
enough policies to
give organization
members clear
direction and to
place reasonable
boundaries on their
actions; then
empower them to
act within these
boundaries in
pursuit of company
goals.
EMPLOYING BUSINESS PROCESS
MANAGEMENT TOOLS
• LO 11-3
Understand how
process
management tools
drive continuous
improvement in the
performance of
value chain
activities.
page 334
Company managers can significantly advance the cause of competent
strategy execution by using business process management tools to drive
continuous improvement in how internal operations are conducted. Process
management tools are used to model, control, measure, and optimize a
variety of organizational activities that may span departments, functions,
value chain systems, employees, customers, suppliers, and other partners in
support of company goals. They also provide corrective feedback, allowing
managers to change and improve company operations in an ongoing manner.
Promoting Operating Excellence: Three Powerful
Business Process Management Tools
Three of the most powerful management tools for promoting operating
excellence and better strategy execution are business process reengineering,
total quality management (TQM) programs, and Six Sigma quality control
programs. Each of these merits discussion since many companies around the
world use these tools to help execute strategies tied to cost reduction, defect-
free manufacture, superior product quality, superior customer service, and
total customer satisfaction.
Business Process Reengineering Companies searching for ways to
improve their operations have sometimes discovered that the execution of
strategy-critical activities is hampered by a disconnected organizational
arrangement whereby pieces of an activity are performed in several different
functional departments, with no one manager or group being accountable for
optimal performance of the entire activity. This can easily occur in
such inherently cross-functional activities as customer service
(which can involve personnel in order filling, warehousing and shipping,
invoicing, accounts receivable, after-sale repair, and technical support),
particularly for companies with a functional organizational structure.
To address the suboptimal performance problems that can arise from this
type of situation, a company can reengineer the work effort, pulling the
pieces of an activity out of different departments and creating a cross-
functional work group or single department (often called a process
department) to take charge of the whole process. The use of cross-functional
teams has been popularized by the practice of business process
reengineering, which involves radically redesigning and streamlining the
workflow (typically enabled by cutting-edge use of online technology and
information systems), with the goal of achieving quantum gains in
performance of the activity.1
CORE
CONCEPT
Business process
reengineering
involves radically
redesigning and
streamlining how an
activity is performed,
with the intent of
achieving quantum
improvements in
performance.
The reengineering of value chain activities has been undertaken at many
companies in many industries all over the world, with excellent results being
achieved at some firms.2 Hallmark reengineered its process for developing
new greeting cards, creating teams of mixed-occupation personnel (artists,
writers, lithographers, merchandisers, and administrators) to work on a single
holiday or greeting card theme. The reengineered process speeded
development times for new lines of greeting cards by up to 24 months,
reduced costs, and increased customer satisfaction.3 In the order-processing
section of General Electric’s circuit breaker division, elapsed time from order
receipt to delivery was cut from three weeks to three days by consolidating
six production units into one, reducing a variety of former inventory and
handling steps, automating the design system to replace a human custom-
design process, and cutting the organizational layers between managers and
workers from three to one. Productivity rose 20 percent in one year, and unit
manufacturing costs dropped 30 percent. In the health care industry, business
process reengineering is being used to lower health care costs and improve
patient outcomes in a variety of ways. South Africa is attempting to
reengineer its primary health care system, which is in need of significant
reform. Similar initiatives are ongoing in India. In the United States,
exemplary health care providers, such as Mayo Clinic, are using
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reengineering tools on a continuous basis to achieve outcomes such as fewer
hospitalizations, improved patient–physician interactions, and the delivery of
lower cost health care.
While business process reengineering has been criticized as an excuse for
downsizing, it has nonetheless proved itself a useful tool for streamlining a
company’s work effort and moving closer to operational excellence. It has
also inspired more technologically based approaches to integrating and
streamlining business processes, such as enterprise resource planning, a
software-based system implemented with the help of consulting companies
such as SAP (the leading provider of business software).
Total Quality Management Programs Total quality management
(TQM) is a management approach that emphasizes continuous improvement
in all phases of operations, 100 percent accuracy in performing tasks,
involvement and empowerment of employees at all levels, team-based work
design, benchmarking, and total customer satisfaction.4 While TQM
concentrates on producing quality goods and fully satisfying customer
expectations, it achieves its biggest successes when it is extended to
employee efforts in all departments—human resources, billing, accounting,
and information systems—that may lack pressing, customer-driven incentives
to improve. It involves reforming the corporate culture and shifting to a
continuous-improvement business philosophy that permeates every facet of
the organization.5 TQM aims at instilling enthusiasm and
commitment to doing things right from the top to the bottom of the
organization. Management’s job is to kindle an organizationwide search for
ways to improve that involves all company personnel exercising initiative
and using their ingenuity. TQM doctrine preaches that there’s no such thing
as “good enough” and that everyone has a responsibility to participate in
continuous improvement. TQM is thus a race without a finish. Success comes
from making little steps forward each day, a process that the Japanese call
kaizen.
CORE
CONCEPT
Total quality
management
(TQM) entails
creating a total
quality culture,
involving managers
and employees at all
levels, bent on
continuously
improving the
performance of
every value chain
activity.
TQM takes a fairly long time to show significant results—very little
benefit emerges within the first six months. The long-term payoff of TQM, if
it comes, depends heavily on management’s success in implanting a culture
within which the TQM philosophy and practices can thrive. But it is a
management tool that has attracted numerous users and advocates over
several decades, and it can deliver good results when used properly.
Six Sigma Quality Control Programs Six Sigma programs offer another
way to drive continuous improvement in quality and strategy execution. This
approach entails the use of advanced statistical methods to identify and
remove the causes of defects (errors) and undesirable variability in
performing an activity or business process. When performance of an activity
or process reaches “Six Sigma quality,” there are no more than 3.4 defects
per million iterations (equal to 99.9997 percent accuracy).6
CORE
CONCEPT
Six Sigma
programs utilize
advanced statistical
methods to improve
quality by reducing
defects and
variability in the
performance of
business processes.
There are two important types of Six Sigma programs. The Six Sigma
process of define, measure, analyze, improve, and control (DMAIC,
pronounced “de-may-ic”) is an improvement system for existing processes
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falling below specification and needing incremental improvement. The Six
Sigma process of define, measure, analyze, design, and verify (DMADV,
pronounced “de-mad-vee”) is used to develop new processes or products at
Six Sigma quality levels. DMADV is sometimes referred to as Design for Six
Sigma, or DFSS. Both Six Sigma programs are overseen by personnel who
have completed Six Sigma “master black belt” training, and they are
executed by personnel who have earned Six Sigma “green belts” and Six
Sigma “black belts.” According to the Six Sigma Academy, personnel with
black belts can save companies approximately $230,000 per project and can
complete four to six projects a year.7
The statistical thinking underlying Six Sigma is based on the following
three principles: (1) All work is a process, (2) all processes have variability,
and (3) all processes create data that explain variability.8 Six Sigma’s
DMAIC process is a particularly good vehicle for improving performance
when there are wide variations in how well an activity is performed. For
instance, airlines striving to improve the on-time performance of their flights
have more to gain from actions to curtail the number of flights that are late by
more than 30 minutes than from actions to reduce the number of flights that
are late by less than five minutes. Six Sigma quality control programs are of
particular interest for large companies, which are better able to shoulder the
cost of the large investment required in employee training, organizational
infrastructure, and consulting services. For example, to realize a cost savings
of $4.4 billion from rolling out its Six Sigma program, GE had to invest $1.6
billion and suffer losses from the program during its first year.9
Since the programs were first introduced, thousands of companies and
nonprofit organizations around the world have used Six Sigma to promote
operating excellence. For companies at the forefront of this movement, such
as Motorola, General Electric (GE), Ford, and Honeywell (Allied Signal), the
cost savings as a percentage of revenue varied from 1.2 to 4.5 percent,
according to data analysis conducted by iSixSigma (an organization that
provides free articles, tools, and resources concerning Six
Sigma). More recently, there has been a resurgence of interest in
Six Sigma practices, with companies such as Siemens, Coca-Cola, Ocean
Spray, GEICO, and Merrill Lynch turning to Six Sigma as a vehicle to
improve their bottom lines. In the first five years of its adoption, Six Sigma at
Bank of America helped the bank reap about $2 billion in revenue gains and
cost savings; the bank holds an annual “Best of Six Sigma Expo” to celebrate
the teams and the projects with the greatest contribution to the company’s
bottom line. GE, one of the most successful companies implementing Six
Sigma training and pursuing Six Sigma perfection across the company’s
entire operations, estimated benefits of some $10 billion during the first five
years of implementation—its Lighting division, for example, cut invoice
defects and disputes by 98 percent.10
Six Sigma has also been used to improve processes in health care.
Froedtert Hospital in Milwaukee, Wisconsin, used Six Sigma to improve the
accuracy of administering the proper drug doses to patients. DMAIC analysis
of the three-stage process by which prescriptions were written by doctors,
filled by the hospital pharmacy, and then administered to patients by nurses
revealed that most mistakes came from misreading the doctors’ handwriting.
The hospital implemented a program requiring doctors to enter the
prescription on the hospital’s computers, which slashed the number of errors
dramatically. In recent years, Pfizer embarked on 85 Six Sigma projects to
streamline its R&D process and lower the cost of delivering medicines to
patients in its pharmaceutical sciences division.
Illustration Capsule 11.1 describes Charleston Area Medical Center’s use
of Six Sigma as a health care provider coping with the current challenges
facing this industry.
Despite its potential benefits, Six Sigma is not without its problems. There
is evidence, for example, that Six Sigma techniques can stifle innovation and
creativity. The essence of Six Sigma is to reduce variability in processes, but
creative processes, by nature, include quite a bit of variability. In many
instances, breakthrough innovations occur only after thousands of ideas have
been abandoned and promising ideas have gone through multiple iterations
and extensive prototyping. Alphabet Executive Chairman of the Board Eric
Schmidt has declared that applying Six Sigma measurement and control
principles to creative activities at Google would choke off innovation
altogether.11
A blended approach to Six Sigma implementation that is gaining in
popularity pursues incremental improvements in operating efficiency, while
R&D and other processes that allow the company to develop new ways of
offering value to customers are given freer rein. Managers of these
ambidextrous organizations are adept at employing continuous
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improvement in operating processes but allowing R&D to operate under a set
of rules that allows for exploration and the development of breakthrough
innovations. However, the two distinctly different approaches to managing
employees must be carried out by tightly integrated senior managers to
ensure that the separate and diversely oriented units operate with a common
purpose. Ciba Vision, now part of eye care multinational Alcon, dramatically
reduced operating expenses through the use of continuous-improvement
programs, while simultaneously and harmoniously developing a new series of
contact lens products that have allowed its revenues to increase by 300
percent over a 10-year period.12 An enterprise that systematically and wisely
applies Six Sigma methods to its value chain, activity by activity, can make
major strides in improving the proficiency with which its strategy is executed
without sacrificing innovation. As is the case with TQM, obtaining
managerial commitment, establishing a quality culture, and fully involving
employees are all of critical importance to the successful implementation of
Six Sigma quality programs.13
CORE
CONCEPT
Ambidextrous
organizations are
adept at employing
continuous
improvement in
operating processes
while allowing R&D
and other areas
engaged in
development of new
ideas freer rein.
ILLUSTRATION
CAPSULE 11.1 Charleston Area Medical
Center’s Six Sigma Program
Caiaimage/Robert Daly/Getty Images
Established in 1972, Charleston Area Medical Center (CAMC) is West Virginia’s largest
health care provider in terms of beds, admissions, and revenues. In 2000, CAMC
implemented a Six Sigma program to examine quality problems and standardize care
processes. Performance improvement was important to CAMC’s management for a
variety of strategic reasons, including competitive positioning and cost control.
The United States has been evolving toward a pay-for-performance structure, which
rewards hospitals for providing quality care. CAMC has utilized its Six Sigma program to
take advantage of these changes in the health care environment. For example, to
improve its performance in acute myocardial infarction (AMI), CAMC applied a Six Sigma
DMAIC (define-measure-analyze-improve-control) approach. Nursing staff members
were educated on AMI care processes, performance targets were posted in nursing units,
and adherence to the eight Hospital Quality Alliance (HQA) indicators of quality care for
AMI patients was tracked. As a result of the program, CAMC improved its compliance
with HQA-recommended treatment for AMI from 50 to 95 percent. Harvard researchers
identified CAMC as one of the top-performing hospitals reporting comparable data.
Controlling cost has also been an important aspect of CAMC’s performance
improvement initiatives due to local regulations. West Virginia is one of two states where
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medical services rates are set by state regulators. This forces CAMC to limit expenditures
because the hospital cannot raise prices. CAMC first applied Six Sigma in an effort to
control costs by managing the supply chain more effectively. The effort created a one-
time $150,000 savings by working with vendors to remove outdated inventory. As a result
of continuous improvement, CAMC managed to achieve supply chain management
savings of $12 million in just four years.
Since CAMC introduced Six Sigma, over 100 quality improvement projects have been
initiated. A key to CAMC’s success has been instilling a continuous improvement mindset
into the organization’s culture. Dale Wood, chief quality officer at CAMC, stated: “If you
have people at the top who completely support and want these changes to occur, you
can still fall flat on your face. . . . You need a group of networkers who can carry change
across an organization.” Due to CAMC’s performance improvement culture, the hospital
ranks high nationally in ratings for quality of care and patient safety, as reported on the
Centers for Medicare and Medicaid Services (CMS) website.
Note: Developed with Robin A. Daley.
Sources: CAMC website; Martha Hostetter, “Case Study: Improving Performance at
Charleston Area Medical Center,” The Commonwealth Fund, November–December
2007, www.commonwealthfund.org/publications/newsletters/quality-
matters/2007/november-december/case-study-improving-performance-at-
charleston-area-medical-center (accessed January 2016); J. C. Simmons, “Using Six
Sigma to Make a Difference in Health Care Quality,” The Quality Letter, April 2002.
The Difference between Business Process Reengineering and
Continuous-Improvement Programs Like Six Sigma and TQM
Whereas business process reengineering aims at quantum gains on the order
of 30 to 50 percent or more, total quality programs like TQM and Six Sigma
stress ongoing incremental progress, striving for inch-by-inch gains again
and again in a never-ending stream. The two approaches to improved
performance of value chain activities and operating excellence are not
mutually exclusive; it makes sense to use them in tandem. Reengineering can
be used first to produce a good basic design that yields quick,
dramatic improvements in performing a business process. TQM or
Six Sigma programs can then be used as a follow-on to reengineering and/or
best-practice implementation to deliver incremental improvements over a
longer period of time.
Business process
reengineering aims
at one-time quantum
improvement, while
continuous-
http://www.commonwealthfund.org/publications/newsletters/quality-matters/2007/november-december/case-study-improving-performance-at-charleston-area-medical-center
improvement
programs like TQM
and Six Sigma aim
at ongoing
incremental
improvements.
Capturing the Benefits of Initiatives to Improve
Operations
The biggest beneficiaries of process improvement initiatives, reengineering,
TQM, and Six Sigma are companies that view such programs not as ends in
themselves but as tools for implementing company strategy more effectively.
The least rewarding payoffs occur when company managers seize on the
programs as novel ideas that might be worth a try. In most such instances,
they result in strategy-blind efforts to simply manage better.
There’s an important lesson here. Business process management tools all
need to be linked to a company’s strategic priorities to contribute effectively
to improving the strategy’s execution. Only strategy can point to which value
chain activities matter and what performance targets make the most sense.
Without a strategic framework, managers lack the context in which to fix
things that really matter to business unit performance and competitive
success.
To get the most from initiatives to execute strategy more proficiently,
managers must have a clear idea of what specific outcomes really matter. Is it
high on-time delivery, lower overall costs, fewer customer complaints,
shorter cycle times, a higher percentage of revenues coming from recently
introduced products, or something else? Benchmarking best-in-industry and
best-in-world performance of targeted value chain activities provides a
realistic basis for setting internal performance milestones and longer-range
targets. Once initiatives to improve operations are linked to the company’s
strategic priorities, then comes the managerial task of building a total quality
culture that is genuinely committed to achieving the performance outcomes
that strategic success requires.14
Managers can take the following action steps to realize full value from
TQM, reengineering, or Six Sigma initiatives and promote a culture of
operating excellence15:
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1. Demonstrating visible, unequivocal, and unyielding commitment to total
quality and continuous improvement, including specifying measurable
objectives for increasing quality and making continual progress.
2. Nudging people toward quality-supportive behaviors by
a. Screening job applicants rigorously and hiring only those with attitudes
and aptitudes that are right for quality-based performance.
b. Providing quality training for employees.
c. Using teams and team-building exercises to reinforce and nurture
individual effort. (The creation of a quality culture is facilitated when
teams become more cross-functional, multitask-oriented, and
increasingly self-managed.)
d. Recognizing and rewarding individual and team efforts to improve
quality regularly and systematically.
e. Stressing prevention (doing it right the first time), not correction
(instituting ways to undo or overcome mistakes).
3. Empowering employees so that authority for delivering great service or
improving products is in the hands of those who do the job rather than their
managers: improving quality has to be seen as part of everyone’s job.
4. Using online systems to provide all relevant parties with the
latest best practices, thereby speeding the diffusion and adoption
of best practices throughout the organization. Online systems can also
allow company personnel to exchange data and opinions about how to
upgrade the prevailing best-in-company practices.
5. Emphasizing that performance can and must be improved, because
competitors are not resting on their laurels and customers are always
looking for something better.
In sum, initiatives to improve operations, like business process
reengineering, TQM, and Six Sigma techniques all need to be seen and used
as part of a bigger-picture effort to execute strategy proficiently. Used
properly, all of these tools are capable of improving the proficiency with
which an organization performs its value chain activities. Not only do
improvements from such initiatives add up over time and strengthen
organizational capabilities, but they also help build a culture of operating
excellence. All this lays the groundwork for gaining a competitive
advantage.16 While it is relatively easy for rivals to also implement process
management tools, it is much more difficult and time-consuming for them to
instill a deeply ingrained culture of operating excellence (as occurs when
such techniques are religiously employed and top management exhibits
lasting commitment to operational excellence throughout the organization).
The purpose of
using business
process
management tools,
such as business
process
reengineering, TQM,
and Six Sigma
programs is to
improve the
performance of
strategy-critical
activities and
thereby enhance
strategy execution.
INSTALLING INFORMATION AND
OPERATING SYSTEMS
• LO 11-4
Recognize the role
of information
systems and
operating systems in
enabling company
personnel to carry
out their strategic
roles proficiently.
Company strategies can’t be executed well without a number of internal
systems for business operations. American Airlines, Delta, Ryanair,
Lufthansa, and other successful airlines cannot hope to provide passenger-
pleasing service without a user-friendly online reservation system, an
accurate and speedy baggage-handling system, and a strict aircraft
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maintenance program that minimizes problems requiring at-the-gate service
that delays departures. FedEx has internal communication systems that allow
it to coordinate its over 100,000 vehicles in handling a daily average of 12.1
million shipments to more than 220 countries and territories. Its leading-edge
flight operations systems allow a single controller to direct as many as 200 of
FedEx’s 659 aircraft simultaneously, overriding their flight plans should
weather problems or other special circumstances arise. FedEx also has
created a series of e-business tools for customers that allow them to ship and
track packages online, create address books, review shipping history,
generate custom reports, simplify customer billing, reduce internal
warehousing and inventory management costs, purchase goods and services
from suppliers, and respond to their own quickly changing customer
demands. All of FedEx’s systems support the company’s strategy of
providing businesses and individuals with a broad array of package delivery
services and enhancing its competitiveness against United Parcel Service,
DHL, and the U.S. Postal Service.
Amazon.com ships customer orders from a global network of some 707
technologically sophisticated order fulfillment and distribution centers. Using
complex picking algorithms, computers initiate the order-picking process by
sending signals to workers’ wireless receivers, telling them which items to
pick off the shelves in which order. Computers also generate data on mix-
boxed items, chute backup times, line speed, worker productivity, and
shipping weights on orders. Systems are upgraded regularly, and productivity
improvements are aggressively pursued. Amazon has been experimenting
with drone delivery in order to lower costs and speed package delivery; more
recently it has begun marketing a pilot project called “Seller
Flex” as part of its effort to develop its own delivery service.
Otis Elevator, the world’s largest manufacturer of elevators, with more
than 2.6 million elevators and escalators installed worldwide, has a 24/7
remote electronic monitoring system that can detect when an elevator or
escalator installed on a customer’s site has any of 325 problems. If the
monitoring system detects a problem, it analyzes and diagnoses the cause and
location, then makes the service call to an Otis mechanic at the nearest
location, and helps the mechanic (who is equipped with a web-enabled cell
phone) identify the component causing the problem. The company’s
maintenance system helps keep outage times under three hours—the
http://amazon.com/
elevators are often back in service before people even realize there was a
problem. All trouble-call data are relayed to design and manufacturing
personnel, allowing them to quickly alter design specifications or
manufacturing procedures when needed to correct recurring problems. All
customers have online access to performance data on each of their Otis
elevators and escalators.
Well-conceived state-of-the-art operating systems not only enable better
strategy execution but also strengthen organizational capabilities—enough at
times to provide a competitive edge over rivals. For example, a company
with a differentiation strategy based on superior quality has added capability
if it has systems for training personnel in quality techniques, tracking product
quality at each production step, and ensuring that all goods shipped meet
quality standards. If these quality control systems are better than those
employed by rivals, they provide the company with a competitive advantage.
Similarly, a company striving to be a low-cost provider is competitively
stronger if it has an unrivaled benchmarking system that identifies
opportunities to implement best-in-the-world practices and drive costs out of
the business faster than rivals. Fast-growing companies get an important
assist from having capabilities in place to recruit and train new employees in
large numbers and from investing in infrastructure that gives them the
capability to handle rapid growth as it occurs, rather than having to scramble
to catch up to customer demand.
Instituting Adequate Information Systems,
Performance Tracking, and Controls
Accurate and timely information about daily operations is essential if
managers are to gauge how well the strategy execution process is proceeding.
Companies everywhere are capitalizing on today’s technology to install real-
time data-generating capability. Most retail companies now have automated
online systems that generate daily sales reports for each store and maintain
up-to-the-minute inventory and sales records on each item. Manufacturing
plants typically generate daily production reports and track labor productivity
on every shift. Transportation companies have elaborate information systems
to provide real-time arrival information for buses and trains that is
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automatically sent to digital message signs and platform audio address
systems.
Siemens Healthcare, one of the largest suppliers to the health care industry,
uses a cloud-based business activity monitoring (BAM) system to
continuously monitor and improve the company’s processes across more than
190 countries. Customer satisfaction is one of Siemens’s most important
business objectives, so the reliability of its order management and services is
crucial. Caesars Entertainment, owner of casinos and hotels, uses a
sophisticated customer relationship database that records detailed information
about its customers’ gambling habits. When a member of Caesars’s Total
Rewards program calls to make a reservation, the representative can review
previous spending, including average bet size, to offer an upgrade or
complimentary stay at Caesars Palace or one of the company’s
other properties. At Uber, the popular ridesharing service, there
are systems for locating vehicles near a customer and real-time demand
monitoring to price fares during high-demand periods.
Information systems need to cover five broad areas: (1) customer data, (2)
operations data, (3) employee data, (4) supplier and/or strategic partner data,
and (5) financial performance data. All key strategic performance indicators
must be tracked and reported in real time whenever possible. Real-time
information systems permit company managers to stay on top of
implementation initiatives and daily operations and to intervene if things
seem to be drifting off course. Tracking key performance indicators,
gathering information from operating personnel, quickly identifying and
diagnosing problems, and taking corrective actions are all integral pieces of
the process of managing strategy execution and overseeing operations.
Statistical information gives managers a feel for the numbers, briefings and
meetings provide a feel for the latest developments and emerging issues, and
personal contacts add a feel for the people dimension. All are good
barometers of how well things are going and what operating aspects need
management attention. Managers must identify problem areas and deviations
from plans before they can take action to get the organization back on course
by either improving the approaches to strategy execution or fine-tuning the
strategy. Jeff Bezos, Amazon.com’s CEO, is an ardent proponent of
managing by the numbers. As he puts it, “Math-based decisions always
trump opinion and judgment. The trouble with most corporations is that they
http://amazon.com/
make judgment-based decisions when data-based decisions could be
made.”17
Having state-of-the-
art operating
systems, information
systems, and real-
time data is integral
to superior strategy
execution and
operating
excellence.
Monitoring Employee Performance Information systems also provide
managers with a means for monitoring the performance of empowered
workers to see that they are acting within the specified limits.18 Leaving
empowered employees to their own devices in meeting performance
standards without appropriate checks and balances can expose an
organization to excessive risk.19 Instances abound of employees’ decisions or
behavior going awry, sometimes costing a company huge sums or producing
lawsuits and reputation-damaging publicity.
Scrutinizing daily and weekly operating statistics is one of the ways in
which managers can monitor the results that flow from the actions of
subordinates without resorting to constant over-the-shoulder supervision; if
the operating results look good, then it is reasonable to assume that
empowerment is working. But close monitoring of operating performance is
only one of the control tools at management’s disposal. Another valuable
lever of control in companies that rely on empowered employees, especially
in those that use self-managed work groups or other such teams, is peer-based
control. Because peer evaluation is such a powerful control device,
companies organized into teams can remove some layers of the management
hierarchy and rely on strong peer pressure to keep team members operating
between the white lines. This is especially true when a company has the
information systems capability to monitor team performance daily or in real
time.
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USING REWARDS AND INCENTIVES
TO PROMOTE BETTER STRATEGY
EXECUTION
• LO 11-5
Explain how and
why the use of well-
designed incentives
can be
management’s
single most powerful
tool for promoting
adept strategy
execution.
It is essential that company personnel be enthusiastically committed to
executing strategy successfully and achieving performance targets. Enlisting
such commitment typically requires use of an assortment of motivational
techniques and rewards. Indeed, an effectively designed incentive
and reward structure is the single most powerful tool management
has for mobilizing employee commitment to successful strategy execution.
But incentives and rewards do more than just strengthen the resolve of
company personnel to succeed—they also focus employees’ attention on the
accomplishment of specific strategy execution objectives. Not only do they
spur the efforts of individuals to achieve those aims, but they also help
coordinate the activities of individuals throughout the organization by
aligning their personal motives with the goals of the organization. In this
manner, reward systems serve as an indirect type of control mechanism that
conserves on the more costly control mechanism of supervisory oversight.
To win employees’ sustained, energetic commitment to the strategy
execution process, management must be resourceful in designing and using
motivational incentives—both monetary and nonmonetary. The more a
manager understands what motivates subordinates and the more he or she
relies on motivational incentives as a tool for achieving the targeted strategic
and financial results, the greater will be employees’ commitment to good
day-in, day-out strategy execution and the achievement of performance
targets.20
Incentives and Motivational Practices That
Facilitate Good Strategy Execution
Financial incentives generally head the list of motivating tools for gaining
wholehearted employee commitment to good strategy execution and focusing
attention on strategic priorities. Generous financial rewards always catch
employees’ attention and produce high-powered incentives for individuals to
exert their best efforts. A company’s package of monetary rewards typically
includes some combination of base-pay increases, performance bonuses,
profit-sharing plans, stock awards, company contributions to employee
401(k) or retirement plans, and piecework incentives (in the case of
production workers). But most successful companies and managers also
make extensive use of nonmonetary incentives. Some of the most important
nonmonetary approaches companies can use to enhance employee motivation
include the following21:
A properly designed
incentive and reward
structure is
management’s
single most powerful
tool for gaining
employee
commitment to
successful strategy
execution and
excellent operating
results.
CORE
CONCEPT
Financial rewards
provide high-
powered
incentives when
rewards are tied to
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specific outcome
objectives.
Providing attractive perks and fringe benefits. The various options include
coverage of health insurance premiums, wellness programs, college tuition
reimbursement, generous paid vacation time, onsite child care, onsite
fitness centers and massage services, opportunities for getaways at
company-owned recreational facilities, personal concierge services,
subsidized cafeterias and free lunches, casual dress every day, personal
travel services, paid sabbaticals, maternity and paternity leaves, paid leaves
to care for ill family members, telecommuting, compressed workweeks
(four 10-hour days instead of five 8-hour days), flextime (variable work
schedules that accommodate individual needs), college scholarships for
children, and relocation services.
Giving awards and public recognition to high performers and showcasing
company successes. Many companies hold award ceremonies to honor top-
performing individuals, teams, and organizational units and to celebrate
important company milestones and achievements. Others make a special
point of recognizing the outstanding accomplishments of individuals,
teams, and organizational units at informal company gatherings or in the
company newsletter. Such actions foster a positive esprit de corps within
the organization and may also act to spur healthy competition among units
and teams within the company.
Relying on promotion from within whenever possible. This
practice helps bind workers to their employer, and employers to
their workers. Moreover, it provides strong incentives for good
performance. Promoting from within also helps ensure that people in
positions of responsibility have knowledge specific to the business,
technology, and operations they are managing.
Inviting and acting on ideas and suggestions from employees. Many
companies find that their best ideas for nuts-and-bolts operating
improvements come from the suggestions of employees. Moreover,
research indicates that giving decision-making power to down-the-line
employees increases their motivation and satisfaction as well as their
productivity. The use of self-managed teams has much the same effect.
Creating a work atmosphere in which there is genuine caring and mutual
respect among workers and between management and employees. A
“family” work environment where people are on a first-name basis and
there is strong camaraderie promotes teamwork and cross-unit
collaboration.
Stating the strategic vision in inspirational terms that make employees feel
they are a part of something worthwhile in a larger social sense. There’s
strong motivating power associated with giving people a chance to be part
of something exciting and personally satisfying. Jobs with a noble purpose
tend to inspire employees to give their all. As described in Chapter 9, this
not only increases productivity but reduces turnover and lowers costs for
staff recruitment and training as well.
Sharing information with employees about financial performance, strategy,
operational measures, market conditions, and competitors’ actions. Broad
disclosure and prompt communication send the message that managers
trust their workers and regard them as valued partners in the enterprise.
Keeping employees in the dark denies them information useful to
performing their jobs, prevents them from being intellectually engaged,
saps their motivation, and detracts from performance.
Providing an appealing working environment. An appealing workplace
environment can have decidedly positive effects on employee morale and
productivity. Providing a comfortable work environment, designed with
ergonomics in mind, is particularly important when workers are expected to
spend long hours at work. But some companies go beyond the mundane to
design exceptionally attractive work settings. The workspaces and
surrounding parklands of Apple’s new multibillion dollar campus
headquarters were designed to inspire Apple’s people, foster innovative
collaboration, while also benefiting the environment. Employees have
access to a 100,000 square foot fitness center, two miles of walking and
running paths, an orchard, meadow, and pond as well as community
bicycles, electric golf carts, and commuter shuttles for getting around.
Facebook and defense contractor Oshkosh Corporation also have dramatic
headquarters projects underway.
For a specific example of the motivational tactics employed by one of the
best companies to work for in America, see Illustration Capsule 11.2 on the
page 344
supermarket chain Wegmans.
Striking the Right Balance between Rewards and
Punishment
While most approaches to motivation, compensation, and people
management accentuate the positive, companies also make it clear that
lackadaisical or indifferent effort and subpar performance can result in
negative consequences. At General Electric, McKinsey &
Company, several global public accounting firms, and other
companies that look for and expect top-notch individual performance, there’s
an “up-or-out” policy—managers and professionals whose performance is
not good enough to warrant promotion are first denied bonuses and stock
awards and eventually weeded out. At most companies, senior executives and
key personnel in underperforming units are pressured to raise performance to
acceptable levels and keep it there or risk being replaced.
ILLUSTRATION
CAPSULE 11.2 How Wegmans Rewards and
Motivates its Employees
JHVEPhoto/Shutterstock
Companies use a variety of tools and strategies designed to motivate employees and
engender superior strategy execution. In this respect, Wegmans Food Markets, Inc.
serves as an exemplar. With approximately 49,000 employees spread across more than
100 stores across the Northeast and Mid-Atlantic, Wegmans stands out as an
organization that delivers above average results in an industry known for its low margins,
low wages, and challenging employee relationships. Guided by a philosophy of
employees first, Wegmans employs an array of programs that enables the company to
attract and retain the best people.
Since the creation of its broad benefits program for full-time employees in the 1950s,
Wegmans has had a strong benefits philosophy. Today, flexible or compressed schedules
are common, and policies extend to same-sex partners. Regarding financial
compensation, wages are above average for the grocery retail industry, which also has
an added benefit of keeping its workforce nonunionized.
In addition to the traditional elements of compensation and benefits, Wegmans invests
considerably in the training and education of its employees. Known for its strength in
employee development, upwards of $50 million annually is spent on employee learning.
Since 1984, the company has awarded nearly $110 million in tuition assistance and over
$50 million in scholarships.
Another crucial aspect of employee motivation is feeling heard. Employees see their
ideas put into action through a series of programs designed to capture and implement
their ideas. Wegmans deploys a series of programs, including open-door days, team
huddles, focus groups, and two-way Q&As with senior management.
With the recognition that employees are critical to delivering a great customer
experience, Wegmans directs a considerable amount of resources to its biggest asset, its
people. Its suite of programs and benefits, along with a policy of filling at least half of its
open opportunities internally, lead to one of the lowest turnover rates in its industry. They
page 345
have also resulted in Wegmans placing among the top five firms on Fortune’s list of The
100 Best Companies to Work For year after year.
Note: Developed with Sadé M. Lawrence.
Sources: Company website; Boyle, M., The Wegmans Way, January 24, 2005,
http://archive.fortune.com/magazines/fortune/fortune_archive/2005/01/24/8234048/i
ndex.htm; “Great Place to Work,” Wegmans Food Markets, Inc.—Great Place to Work
Reviews, February 14, 2018, http://reviews.greatplacetowork.com/wegmans-food-
markets-inc.
As a general rule, it is unwise to take off the pressure for good
performance or play down the adverse consequences of shortfalls in
performance. There is scant evidence that a no-pressure, no-adverse-
consequences work environment leads to superior strategy execution or
operating excellence. As the CEO of a major bank put it, “There’s a
deliberate policy here to create a level of anxiety. Winners
usually play like they’re one touchdown behind.”22 A number of
companies deliberately give employees heavy workloads and tight deadlines
to test their mettle—personnel are pushed hard to achieve “stretch” objectives
and are expected to put in long hours (nights and weekends if need be). High-
performing organizations nearly always have a cadre of ambitious people
who relish the opportunity to climb the ladder of success, love a challenge,
thrive in a performance-oriented environment, and find some competition and
pressure useful to satisfy their own drives for personal recognition,
accomplishment, and self-satisfaction.
However, if an organization’s motivational approaches and reward
structure induce too much stress, internal competitiveness, job insecurity, and
fear of unpleasant consequences, the impact on workforce morale and
strategy execution can be counterproductive. Evidence shows that managerial
initiatives to improve strategy execution should incorporate more positive
than negative motivational elements because when cooperation is positively
enlisted and rewarded, rather than coerced by orders and threats (implicit or
explicit), people tend to respond with more enthusiasm, dedication, creativity,
and initiative.23
Linking Rewards to Achieving the Right
Outcomes
http://archive.fortune.com/magazines/fortune/fortune_archive/2005/01/24/8234048/index.htm
http://reviews.greatplacetowork.com/wegmans-food-markets-inc
To create a strategy-supportive system of rewards and incentives, a company
must reward people for accomplishing results, not for just dutifully
performing assigned tasks. Showing up for work and performing assignments
do not, by themselves, guarantee results. To make the work environment
results-oriented, managers need to focus jobholders’ attention and energy on
what to achieve as opposed to what to do.24 Employee productivity among
employees at Best Buy’s corporate headquarters rose by 35 percent after the
company began to focus on the results of each employee’s work rather than
on employees’ willingness to come to work early and stay late.
Ideally, every organizational unit, every manager, every team or work
group, and every employee should be held accountable for achieving
outcomes that contribute to good strategy execution and business
performance. If the company’s strategy is to be a low-cost leader, the
incentive system must reward actions and achievements that result in lower
costs. If the company has a differentiation strategy focused on delivering
superior quality and service, the incentive system must reward such outcomes
as Six Sigma defect rates, infrequent customer complaints, speedy order
processing and delivery, and high levels of customer satisfaction. If a
company’s growth is predicated on a strategy of new product innovation,
incentives should be tied to such metrics as the percentages of revenues and
profits coming from newly introduced products.
Incentives must be
based on
accomplishing
results, not on
dutifully performing
assigned tasks.
Incentive compensation for top executives is typically tied to such
financial measures as revenue and earnings growth, stock price performance,
return on investment, and creditworthiness or to strategic measures such as
market share growth. However, incentives for department heads, teams, and
individual workers tend to be tied to performance outcomes more closely
related to their specific area of responsibility. For instance, in manufacturing,
it makes sense to tie incentive compensation to such outcomes as unit
manufacturing costs, on-time production and shipping, defect rates, the
number and extent of work stoppages due to equipment breakdowns, and so
page 346
on. In sales and marketing, incentives tend to be based on achieving dollar
sales or unit volume targets, market share, sales penetration of each target
customer group, the fate of newly introduced products, the frequency of
customer complaints, the number of new accounts acquired, and
measures of customer satisfaction. Which performance measures
to base incentive compensation on depends on the situation—the priority
placed on various financial and strategic objectives, the requirements for
strategic and competitive success, and the specific results needed to keep
strategy execution on track.
Illustration Capsule 11.3 provides a vivid example of how one company
has designed incentives linked directly to outcomes reflecting good
execution.
The first principle in
designing an
effective incentive
compensation
system is to tie
rewards to
performance
outcomes directly
linked to good
strategy execution
and the
achievement of
financial and
strategic objectives.
Additional Guidelines for Designing Incentive Compensation Systems
It is not enough to link incentives to the right kinds of results—performance
outcomes that signal that the company’s strategy and its execution are on
track. For a company’s reward system to truly motivate organization
members, inspire their best efforts, and sustain high levels of productivity, it
is also important to observe the following additional guidelines in designing
and administering the reward system:
Make the performance payoff a major, not minor, piece of the total
compensation package. Performance bonuses must be at least 10 to 12
percent of base salary to have much impact. Incentives that amount to 20
percent or more of total compensation are big attention-getters, likely to
really drive individual or team efforts. Incentives amounting to less than
five percent of total compensation have a comparatively weak motivational
impact. Moreover, the payoff for high-performing individuals and teams
must be meaningfully greater than the payoff for average performers, and
the payoff for average performers meaningfully bigger than that for below-
average performers.
Have incentives that extend to all managers and all workers, not just top
management. It is a gross miscalculation to expect that lower-level
managers and employees will work their hardest to hit performance targets
if only senior executives qualify for lucrative rewards.
Administer the reward system with scrupulous objectivity and fairness. If
performance standards are set unrealistically high or if individual and
group performance evaluations are not accurate and well documented,
dissatisfaction with the system will overcome any positive benefits.
Ensure that the performance targets set for each individual or team involve
outcomes that the individual or team can personally affect. The role of
incentives is to enhance individual commitment and channel behavior in
beneficial directions. This role is not well served when the performance
measures by which company personnel are judged are outside their arena
of influence.
Keep the time between achieving the performance target and receiving the
reward as short as possible. Nucor, a leading producer of steel products,
has achieved high labor productivity by paying its workers weekly bonuses
based on prior-week production levels. Annual bonus payouts work best for
higher-level managers and for situations where the outcome target relates
to overall company profitability.
Avoid rewarding effort rather than results. While it is tempting to reward
people who have tried hard, gone the extra mile, and yet fallen short of
achieving performance targets because of circumstances beyond their
control, it is ill advised to do so. The problem with making exceptions for
unknowable, uncontrollable, or unforeseeable circumstances is that once
“good excuses” start to creep into justifying rewards for subpar results, the
door opens to all kinds of reasons why actual performance has failed to
match targeted performance. A “no excuses” standard is more evenhanded,
easier to administer, and more conducive to creating a results-oriented
work climate.
page 347
ILLUSTRATION
CAPSULE 11.3 Nucor Corporation: Tying
Incentives Directly to Strategy Execution
The strategy at Nucor Corporation, the largest steel producers in the United States, is to
be the low-cost producer of steel products. Because labor costs are a significant fraction
of total cost in the steel business, successful implementation of Nucor’s low-cost
leadership strategy entails achieving lower labor costs per ton of steel than competitors’
costs. Nucor management uses an incentive system to promote high worker productivity
and drive labor costs per ton below those of rivals. Each plant’s workforce is organized
into production teams (each assigned to perform particular functions), and weekly
production targets are established for each team. Base-pay scales are set at levels
comparable to wages for similar manufacturing jobs in the local areas where Nucor has
plants, but workers can earn a one percent bonus for each one percent that their output
exceeds target levels. If a production team exceeds its weekly production target by 10
percent, team members receive a 10 percent bonus in their next paycheck; if a team
exceeds its quota by 20 percent, team members earn a 20 percent bonus. Bonuses, paid
every two weeks, are based on the prior two weeks’ actual production levels measured
against the targets.
Nucor’s piece-rate incentive plan has produced impressive results. The production
teams put forth exceptional effort; it is not uncommon for most teams to beat their weekly
production targets by 20 to 50 percent. When added to employees’ base pay, the
bonuses earned by Nucor workers make Nucor’s workforce among the highest paid in
the U.S. steel industry. From a management perspective, the incentive system has
resulted in Nucor having labor productivity levels 10 to 20 percent above the average of
the unionized workforces at several of its largest rivals, which in turn has given Nucor a
significant labor cost advantage over most rivals.
Westend61/Getty Images
After years of record-setting profits, Nucor struggled in the last major economic
downturn, along with the manufacturers and builders who buy its steel. But while bonuses
dwindled, Nucor showed remarkable loyalty to its production workers, avoiding layoffs by
having employees get ahead on maintenance, perform work formerly done by
contractors, and search for cost savings. Morale at the company remained high, and
Nucor’s CEO at the time, Daniel DiMicco, was inducted into Industry-Week magazine’s
Manufacturing Hall of Fame because of his no-layoff policies. As industry growth
resumed, Nucor was in the position of having a well-trained workforce, more committed
than ever to achieving the kind of productivity for which Nucor is justifiably famous.
DiMicco had good reason to expect Nucor to be “first out of the box” following the crisis,
and although he has since stepped aside, the company’s culture of making its employees
think like owners has not changed.
Sources: Company website (accessed March 2012); N. Byrnes, “Pain, but No Layoffs at
Nucor,” BusinessWeek, March 26, 2009; J. McGregor, “Nucor’s CEO Is Stepping Aside,
but Its Culture Likely Won’t,” The Washington Post Online, November 20, 2012
(accessed April 3, 2014).
For an organization’s incentive system to work well, the details of the
reward structure must be communicated and explained. Everybody needs to
understand how his or her incentive compensation is calculated and how
individual and group performance targets contribute to organizational
performance targets. The pressure to achieve the targeted financial and
strategic performance objectives and continuously improve on strategy
execution should be unrelenting. People at all levels must be held
page 348accountable for carrying out their assigned parts of the strategic
plan, and they must understand that their rewards are based on
the caliber of results achieved. But with the pressure to perform should come
meaningful rewards. Without an attractive payoff, the system breaks down,
and managers are left with the less workable options of issuing orders, trying
to enforce compliance, and depending on the goodwill of employees.
The unwavering
standard for judging
whether individuals,
teams, and
organizational units
have done a good
job must be whether
they meet or beat
performance targets
that reflect good
strategy execution.
KEY POINTS
1. Implementing a new or different strategy calls for managers to identify the
resource requirements of each new strategic initiative and then consider
whether the current pattern of resource allocation and the budgets of the
various subunits are suitable.
2. Company policies and procedures facilitate strategy execution when they
are designed to fit the strategy and its objectives. Anytime a company
alters its strategy, managers should review existing policies and operating
procedures and replace those that are out of sync. Well-conceived policies
and procedures aid the task of strategy execution by (1) providing top-
down guidance to company personnel regarding how things need to be
done and what the limits are on independent actions; (2) enforcing
consistency in the performance of strategy-critical activities, thereby
improving the quality of the strategy execution effort and coordinating the
efforts of company personnel, however widely dispersed; and (3)
promoting the creation of a work climate conducive to good strategy
execution.
LO 11-1
page 349
3. Competent strategy execution entails visible unyielding managerial
commitment to continuous improvement. Business process management
tools, such as reengineering, total quality management (TQM), and Six
Sigma programs are important process management tools for promoting
better strategy execution.
4. Company strategies can’t be implemented or executed well without well-
conceived internal systems to support daily operations. Real-time
information systems and control systems further aid the cause of good
strategy execution. In some cases, state-of-the-art operating and
information systems strengthen a company’s strategy execution
capabilities enough to provide a competitive edge over rivals.
5. Strategy-supportive motivational practices and reward systems are
powerful management tools for gaining employee commitment and
focusing their attention on the strategy execution goals. The key to creating
a reward system that promotes good strategy execution is to make
measures of good business performance and good strategy execution the
dominating basis for designing incentives, evaluating individual and group
efforts, and handing out rewards. While financial rewards provide high-
powered incentives, nonmonetary incentives are also important. For an
incentive compensation system to work well, (1) the performance payoff
should be a major percentage of the compensation package, (2) the use of
incentives should extend to all managers and workers, (3) the system
should be administered with objectivity and fairness, (4) each individual’s
performance targets should involve outcomes the person can personally
affect, (5) rewards should promptly follow the achievement of
performance targets, and (6) rewards should be given for results and not
just effort.
ASSURANCE OF LEARNING EXERCISES
1. Implementing a new or different strategy calls for
new resource allocations. Using your university’s
library resources search for recent articles that
discuss how a company has revised its pattern of
LO 11-2
LO 11-3
LO 11-3
LO 11-4
LO 11-5
resource allocation and divisional budgets to support
new strategic initiatives.
2. Netflix avoids the use of formal policies and
procedures to better empower its employees to
maximize innovation and productivity. The
company goes to great lengths to hire, reward, and
tolerate only what it considers mature, “A” player
employees. How does the company’s selection
process affect its ability to operate without formal
travel and expense policies, a fixed number of
vacation days for employees, or a formal employee
performance evaluation system?
3. Illustration Capsule 11.1 discusses Charleston Area
Medical Center’s use of Six Sigma practices. List
three tangible benefits provided by the program.
Explain why a commitment to quality control is
particularly important in the hospital industry. How
can the use of a Six Sigma program help medical
providers survive and thrive in the current industry
climate?
4. Read some of the recent Six Sigma articles posted at
www.isixsigma.com. Prepare a one-page report to
your instructor detailing how Six Sigma is being
used in two companies and what benefits the
companies are reaping as a result. Further, discuss
two to three criticisms of, or potential difficulties
with, Six Sigma implementation.
5. Company strategies can’t be executed well without a
number of support systems to carry on business
operations. Using your university’s library
resources, search for recent articles that discuss how
a company has used real-time information systems
and control systems to aid the cause of good strategy
execution.
6. Illustration Capsule 11.2 provides a description of
the motivational practices employed by Wegmans
LO 11-1
LO 11-2, LO 11-3
LO 11-4
LO 11-3
LO 11-3
page 350
LO 11-2, LO 11-3
LO 11-4
LO 11-5
Food Markets, a supermarket chain that is routinely
listed as among the top five companies to work for
in the United States. Discuss how rewards and
practices at Wegman’s aid in the company’s strategy
execution efforts.
EXERCISES FOR SIMULATION PARTICIPANTS
1. What are the ways that resource allocation
contributes to good strategy execution and improved
company performance.
2. What actions, if any, is your company taking to
pursue continuous improvement in how it performs
certain value chain activities?
3. Are benchmarking data available in the simulation
exercise in which you are participating? If so, do
you and your co-managers regularly study the
benchmarking data to see how well your company is
doing? Do you consider the benchmarking
information provided to be valuable? Why or why
not? Cite three recent instances in which your
examination of the benchmarking statistics has
caused you and your co-managers to take corrective
actions to improve operations and boost company
performance.
4. What hard evidence can you cite that indicates your
company’s management team is doing a better or
worse job of achieving operating excellence and
executing strategy than are the management teams at
rival companies?
5. Are you and your co-managers consciously trying to
achieve operating excellence? Explain how you are
doing this and how you will track the
progress you are making.
6. What are ways that incentive compensation can
affect productivity gains and lower labor cost per
unit?
ENDNOTES
1 M. Hammer and J. Champy, Reengineering the Corporation: A Manifesto for Business Revolution (New York:
HarperCollins, 1993).
2 James Brian Quinn, Intelligent Enterprise (New York: Free Press, 1992); Ann Majchrzak and Qianwei Wang, “Breaking
the Functional Mind-Set in Process Organizations,” Harvard Business Review 74, no. 5 (September–October 1996), pp.
93–99; Stephen L. Walston, Lawton R. Burns, and John R. Kimberly, “Does Reengineering Really Work? An
Examination of the Context and Outcomes of Hospital Reengineering Initiatives,” Health Services Research 34, no. 6
(February 2000), pp. 1363–1388; Allessio Ascari, Melinda Rock, and Soumitra Dutta, “Reengineering and Organizational
Change: Lessons from a Comparative Analysis of Company Experiences,” European Management Journal 13, no. 1
(March 1995), pp. 1–13; Ronald J. Burke, “Process Reengineering: Who Embraces It and Why?” The TQM Magazine 16,
no. 2 (2004), pp. 114–119.
3 www.answers.com (accessed July 8, 2009); “Reengineering: Beyond the Buzzword,” Businessweek, May 24, 1993,
www.businessweek.com (accessed July 8, 2009).
4 M. Walton, The Deming Management Method (New York: Pedigree, 1986); J. Juran, Juran on Quality by Design (New
York: Free Press, 1992); Philip Crosby, Quality Is Free: The Act of Making Quality Certain (New York: McGraw-Hill,
1979); S. George, The Baldrige Quality System (New York: Wiley, 1992); Mark J. Zbaracki, “The Rhetoric and Reality of
Total Quality Management,” Administrative Science Quarterly 43, no. 3 (September 1998), pp. 602–636.
5 Robert T. Amsden, Thomas W. Ferratt, and Davida M. Amsden, “TQM: Core Paradigm Changes,” Business Horizons
39, no. 6 (November–December 1996), pp. 6–14.
6 Peter S. Pande and Larry Holpp, What Is Six Sigma? (New York: McGraw-Hill, 2002); Jiju Antony, “Some Pros and
Cons of Six Sigma: An Academic Perspective,” TQM Magazine 16, no. 4 (2004), pp. 303–306; Peter S. Pande, Robert P.
Neuman, and Roland R. Cavanagh, The Six Sigma Way: How GE, Motorola and Other Top Companies Are Honing Their
Performance (New York: McGraw-Hill, 2000); Joseph Gordon and M. Joseph Gordon, Jr., Six Sigma Quality for Business
and Manufacture (New York: Elsevier, 2002); Godecke Wessel and Peter Burcher, “Six Sigma for Small and Medium-
Sized Enterprises,” TQM Magazine 16, no. 4 (2004), pp. 264–272.
7 www.isixsigma.com (accessed November 4, 2002); www.villanovau.com/certificate-programs/six-sigma-
training.aspx (accessed February 16, 2012).
8 Kennedy Smith, “Six Sigma for the Service Sector,” Quality Digest Magazine, May 2003; www.qualitydigest.com
(accessed September 28, 2003).
9 www.isixsigma.com/implementation/-financial-analysis/six-sigma-costs-and-savings/ (accessed February 23,
2012).
10 Pande, Neuman, and Cavanagh, The Six Sigma Way, pp. 5–6.
11 “A Dark Art No More,” The Economist 385, no. 8550 (October 13, 2007), p. 10; Brian Hindo, “At 3M, a Struggle
between Efficiency and Creativity,” Businessweek, June 11, 2007, pp. 8–16.
12 Charles A. O’Reilly and Michael L. Tushman, “The Ambidextrous Organization,” Harvard Business Review 82, no. 4
(April 2004), pp. 74–81.
13 Terry Nels Lee, Stanley E. Fawcett, and Jason Briscoe, “Benchmarking the Challenge to Quality Program
Implementation,” Benchmarking: An International Journal 9, no. 4 (2002), pp. 374–387.
14 Milan Ambroé, “Total Quality System as a Product of the Empowered Corporate Culture,” TQM Magazine 16, no. 2
(2004), pp. 93–104; Nick A. Dayton, “The Demise of Total Quality Management,” TQM Magazine 15, no. 6 (2003), pp.
391–396.
15 Judy D. Olian and Sara L. Rynes, “Making Total Quality Work: Aligning Organizational Processes, Performance
Measures, and Stakeholders,” Human Resource Management 30, no. 3 (Fall 1991), pp. 310–311; Paul S. Goodman and
Eric D. Darr, “Exchanging Best Practices Information through Computer-Aided Systems,” Academy of Management
Executive 10, no. 2 (May 1996), p. 7.
16 Thomas C. Powell, “Total Quality Management as Competitive Advantage,” Strategic Management Journal 16 (1995),
pp. 15–37; Richard M. Hodgetts, “Quality Lessons from America’s Baldrige Winners,” Business Horizons 37, no. 4 (July–
August 1994), pp. 74–79; Richard Reed, David J. Lemak, and Joseph C. Montgomery, “Beyond Process: TQM Content
and Firm Performance,” Academy of Management Review 21, no. 1 (January 1996), pp. 173–202.
17 Fred Vogelstein, “Winning the Amazon Way,” Fortune 147, no. 10 (May 26, 2003), pp. 60–69.
18 Robert Simons, “Control in an Age of Empowerment,” Harvard Business Review 73 (March–April 1995), pp. 80–88.
19 David C. Band and Gerald Scanlan, “Strategic Control through Core Competencies,” Long Range Planning 28, no. 2
(April 1995), pp. 102–114.
http://www.answers.com/
http://www.businessweek.com/
http://www.villanovau.com/certificate-programs/six-sigma-training.aspx
http://www.qualitydigest.com/
page 351
20 Stanley E. Fawcett, Gary K. Rhoads, and Phillip Burnah, “People as the Bridge to Competitiveness: Benchmarking the
‘ABCs’ of an Empowered Workforce,” Benchmarking: An International Journal 11, no. 4 (2004), pp. 346–360.
21 Jeffrey Pfeffer and John F. Veiga, “Putting People First for Organizational Success,” Academy of Management
Executive 13, no. 2 (May 1999), pp. 37–45; Linda K. Stroh and Paula M. Caliguiri, “Increasing Global Competitiveness
through Effective People Management,” Journal of World Business 33, no. 1 (Spring 1998), pp. 1–16; articles in Fortune
on the 100 best companies to work for (various issues).
22 As quoted in John P. Kotter and James L. Heskett, Corporate Culture and Performance (New York: Free Press, 1992),
p. 91.
23 Clayton M. Christensen, Matt Marx, and Howard Stevenson, “The Tools of Cooperation and Change,” Harvard
Business Review 84, no. 10 (October 2006), pp. 73–80.
24 Steven Kerr, “On the Folly of Rewarding A While Hoping for B,” Academy of Management Executive 9, no. 1 (February
1995), pp. 7–14; Doran Twer, “Linking Pay to Business Objectives,” Journal of Business Strategy 15, no. 4 (July–August
1994), pp. 15–18.
page 352
chapter 12
Corporate Culture and Leadership
Keys to Good Strategy Execution
Learning Objectives
After reading this chapter, you should be able to:
LO 12-1 Understand the key features of a company’s corporate
culture and the role of a company’s core values and ethical
standards in building corporate culture.
LO 12-2 Explain how and why a company’s culture can aid the drive
for proficient strategy execution.
LO 12-3 Identify the kinds of actions management can take to
change a problem corporate culture.
LO 12-4 Recognize what constitutes effective managerial leadership
in achieving superior strategy execution.
page 353
Fanatic Studio/Alamy Stock Photo
I came to see, in my time at IBM, that culture isn’t just one aspect of the game, it is
the game.
Louis Gerstner— Former Chairman and CEO of IBM
As we look ahead into the next century, leaders will be those who empower others.
page 354
Bill Gates—Cofounder and former CEO and chair of Microsoft
A genuine leader is not a searcher for consensus but a molder of consensus.
Martin Luther King, Jr.—Civil Rights Leader
In the previous two chapters, we examined eight of the managerial tasks that drive good
strategy execution: staffing the organization, acquiring the needed resources and
capabilities, designing the organizational structure, allocating resources, establishing
policies and procedures, employing process management tools, installing operating
systems, and providing the right incentives. In this chapter, we explore the two
remaining managerial tasks that contribute to good strategy execution: creating a
supportive corporate culture and leading the strategy execution process.
INSTILLING A CORPORATE CULTURE
CONDUCIVE TO GOOD STRATEGY
EXECUTION
CORE
CONCEPT
Corporate culture
refers to the shared
values, ingrained
attitudes, core
beliefs, and
company traditions
that determine
norms of behavior,
accepted work
practices, and styles
of operating.
Every company has its own unique corporate culture—the shared values,
ingrained attitudes, and company traditions that determine norms of behavior,
accepted work practices, and styles of operating.1 The character of a
company’s culture is a product of the core values and beliefs that executives
espouse, the standards of what is ethically acceptable and what is not, the
“chemistry” and the “personality” that permeate the work environment, the
company’s traditions, and the stories that get told over and over to illustrate
and reinforce the company’s values, business practices, and traditions. In a
very real sense, the culture is the company’s automatic, self-replicating
“operating system” that defines “how we do things around here.”2 It can be
thought of as the company’s psyche or organizational DNA.3 A company’s
culture is important because it influences the organization’s actions and
approaches to conducting business. As such, it plays an important role in
strategy execution and may have an appreciable effect on business
performance as well.
• LO 12-1
Understand the key
features of a
company’s corporate
culture and the role
of a company’s core
values and ethical
standards in building
corporate culture.
Corporate cultures vary widely. For instance, the bedrock of Walmart’s
culture is zealous pursuit of low costs and frugal operating practices, a strong
work ethic, ritualistic headquarters meetings to exchange ideas and review
problems, and company executives’ commitment to visiting stores, listening
to customers, and soliciting suggestions from employees. The culture at
Apple is customer-centered, secretive, and highly protective of company-
developed technology. Apple employees share a common goal of making the
best products for the consumer; the aim is to make the customer feel delight,
surprise, and connection to each Apple device. The company expects creative
thinking and inspired solutions from everyone—as the company puts it,
“We’re perfectionists. Idealists. Inventors. Forever tinkering with products
and processes, always on the lookout for better.” According to a former
employee, “Apple is one of those companies where people work on an almost
religious level of commitment.” To spur innovation and creativity, the
company fosters extensive collaboration and cross-pollination among
different work groups. But it does so in a manner that demands secrecy—
employees are expected not to reveal anything relevant about what new
page 355
project they are working on, not to employees outside their immediate work
group and especially not to family members or other outsiders; it is common
for different employees working on the same project to be assigned different
project code names. The different pieces of a new product launch often come
together like a puzzle at the last minute.4 W. L. Gore & Associates, best
known for GORE-TEX, credits its unique culture for allowing the company
to pursue multiple end-market applications simultaneously, enabling rapid
growth from a niche business into a diversified multinational company. The
company’s culture is team-based and designed to foster personal initiative,
with no traditional organizational charts, no chains of command, no
predetermined channels of communication. The culture encourages
multidiscipline teams to organize around opportunities, and in the process,
leaders emerge. At Nordstrom, the corporate culture is centered on delivering
exceptional service to customers, where the company’s motto is “Respond to
unreasonable customer requests,” and each out-of-the-ordinary request is
seen as an opportunity for a “heroic” act by an employee that can further the
company’s reputation for unparalleled customer service. Nordstrom makes a
point of promoting employees noted for their heroic acts and dedication to
outstanding service.
Identifying the Key Features of a Company’s
Corporate Culture
A company’s corporate culture is mirrored in the character or “personality” of
its work environment—the features that describe how the company goes
about its business and the workplace behaviors that are held in high esteem.
Some of these features are readily apparent, and others operate quite subtly.
The chief things to look for include:
The values, business principles, and ethical standards that management
preaches and practices—these are the key to a company’s culture, but
actions speak much louder than words here.
The company’s approach to people management and the official policies,
procedures, and operating practices that provide guidelines for the behavior
of company personnel.
The atmosphere and spirit that pervades the work climate—whether the
workplace is competitive or cooperative, innovative or resistant to change,
collegial or politicized, all business or fun-loving, and the like.
How managers and employees interact and relate to one another—whether
there is heavy or weak reliance on collaboration and teamwork, whether
communications among employees are free-flowing or restrictive and
infrequent, whether employees are empowered to exercise their initiative or
whether actions are directed mostly by higher authority, whether co-
workers spend little or lots of time together outside the workplace, and so
on.
The strength of peer pressure to do things in particular ways and conform
to expected norms.
The actions and behaviors that management explicitly encourages and
rewards and those that are frowned upon.
The company’s revered traditions and oft-repeated stories about “heroic
acts” and “how we do things around here.”
The manner in which the company deals with external stakeholders—
whether it treats suppliers as business partners or prefers hard-nosed,
arm’s-length business arrangements and whether its commitment to
corporate citizenship and environmental sustainability is strong and
genuine.
The values, beliefs, and practices that undergird a company’s culture can
come from anywhere in the organizational hierarchy. Typically, key elements
of the culture originate with a founder or certain strong leaders who
articulated them as a set of business principles, company policies, operating
approaches, and ways of dealing with employees, customers, vendors,
shareholders, and local communities where the company has operations.
They also stem from exemplary actions on the part of company personnel and
evolving consensus about “how we ought to do things around here.”5 Over
time, these cultural underpinnings take root, come to be accepted by company
managers and employees alike, and become ingrained in the way the
company conducts its business.
A company’s culture
is grounded in and
shaped by its core
page 356
values and ethical
standards.
The Role of Core Values and Ethics The foundation of a company’s
corporate culture nearly always resides in its dedication to certain core values
and the bar it sets for ethical behavior. The culture-shaping significance of
core values and ethical behaviors accounts for why so many companies have
developed a formal value statement and a code of ethics. Many executives
want the work climate at their companies to mirror certain values and ethical
standards, partly because of personal convictions but mainly
because they are convinced that adherence to such principles will
promote better strategy execution, make the company a better performer, and
positively impact its reputation.6 Not incidentally, strongly ingrained values
and ethical standards reduce the likelihood of lapses in ethical behavior that
mar a company’s public image and put its financial performance and market
standing at risk.
A company’s value
statement and code
of ethics
communicate
expectations of how
employees should
conduct themselves
in the workplace.
As depicted in Figure 12.1, a company’s stated core values and ethical
principles have two roles in the culture-building process. First, they can
foster a work climate in which company personnel share strongly held
convictions about how the company’s business is to be conducted. Second,
they provide company personnel with guidance about the manner in which
they are to do their jobs—which behaviors and ways of doing things are
approved (and expected) and which are out-of-bounds. These value-based
and ethics-based cultural norms serve as yardsticks for gauging the
appropriateness of particular actions, decisions, and behaviors, thus helping
steer company personnel toward both doing things right and doing the right
thing.
FIGURE 12.1 The Two Culture-Building Roles of a
Company’s Core Values and Ethical Standards
Embedding Behavioral Norms in the Organization and Perpetuating the
Culture Once values and ethical standards have been formally adopted,
they must be institutionalized in the company’s policies and practices and
embedded in the conduct of company personnel. This can be advanced in a
number of different ways.7 Tradition-steeped companies with a rich folklore
rely heavily on word-of-mouth indoctrination and the power of tradition to
instill values and enforce ethical conduct. But most companies employ a
variety of techniques, drawing on some or all of the following:
1. Screening applicants and hiring those who will mesh well with the culture.
2. Incorporating discussions of the company’s culture and behavioral norms
into orientation programs for new employees and training courses for
managers and employees.
3. Having senior executives frequently reiterate the importance and role of
company values and ethical principles at company events and in internal
communications to employees.
page 3574. Expecting managers at all levels to be cultural role models and
exhibit the advocated cultural norms in their own behavior.
5. Making the display of cultural norms a factor in evaluating each person’s
job performance, granting compensation increases, and offering
promotions.
6. Stressing that line managers all the way down to first-level supervisors
give ongoing attention to explaining the desired cultural traits and
behaviors in their areas and clarifying why they are important.
7. Encouraging company personnel to exert strong peer pressure on co-
workers to conform to expected cultural norms.
8. Holding periodic ceremonies to honor people who excel in displaying the
company values and ethical principles.
To deeply ingrain the stated core values and high ethical standards,
companies must turn them into strictly enforced cultural norms. They must
make it unequivocally clear that living up to the company’s values and ethical
standards has to be “a way of life” at the company and that there will be little
toleration for errant behavior.
The Role of Stories Frequently, a significant part of a company’s culture is
captured in the stories that get told over and over again to illustrate to
newcomers the importance of certain values and the depth of commitment
that various company personnel have displayed. One of the folktales at
Zappos, known for its outstanding customer service, is about a customer who
ordered shoes for her ill mother from Zappos, hoping the shoes would
remedy her mother’s foot pain and numbness. When the shoes didn’t work,
the mother called the company to ask how to return them and explain why
she was returning them. Two days later, she received a large bouquet of
flowers from the company, along with well wishes and a customer upgrade
giving her free expedited service on all future orders. Specialty food market
Trader Joe’s is similarly known for its culture of going beyond the call of
duty for its customers. When a World War II veteran was snowed in without
any food for meals, his daughter called several supermarkets to see if they
offered grocery delivery. Although Trader Joe’s technically doesn’t offer
delivery, it graciously helped the veteran, even recommending items for his
low-sodium diet. When the store delivered the groceries, the veteran wasn’t
charged for either the groceries or the delivery. Stories of employees at Ritz
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Carlton going the extra mile for customers both showcase and reinforce its
customer-centric culture. Recently, a family arrived at a Ritz-Carlton only to
find that the specialized eggs and milk they had brought along for their son
had spoiled. (The child suffered from food allergies.) When the products
could not be found locally, the hotel’s staff had the products flown in from
Singapore, approximately 1,050 miles away!
Forces That Cause a Company’s Culture to Evolve Despite the role of
time-honored stories and long-standing traditions in perpetuating a
company’s culture, cultures are far from static—just like strategy and
organizational structure, they evolve. New challenges in the marketplace,
revolutionary technologies, and shifting internal conditions—especially an
internal crisis, a change in company direction, or top-executive turnover—
tend to breed new ways of doing things and, in turn, drive cultural evolution.
An incoming CEO who decides to shake up the existing business and take it
in new directions often triggers a cultural shift, perhaps one of major
proportions. Likewise, diversification into new businesses, expansion into
foreign countries, rapid growth that brings an influx of new employees, and
the merger with or acquisition of another company can all precipitate
significant cultural change.
The Presence of Company Subcultures Although it is common to speak
about corporate culture in the singular, it is not unusual for companies to have
multiple cultures (or subcultures). Values, beliefs, and practices within a
company sometimes vary significantly by department, geographic location,
division, or business unit. Subcultures can exist because a company has
recently acquired other companies. Global and multinational companies tend
to be at least partly multicultural because cross-country organization units
have different operating histories and work climates, as well as members who
speak different languages, have grown up under different social customs and
traditions, and have different sets of values and beliefs. The problem with
subcultures is that they can clash, or at least not mesh well, particularly if
they embrace conflicting business philosophies or operating approaches, if
key executives employ different approaches to people management, or if
important differences between a company’s culture and those of recently
acquired companies have not yet been ironed out. On a number of occasions,
companies have decided to pass on acquiring particular companies because of
culture conflicts they believed would be hard to resolve.
Nonetheless, the existence of subcultures does not preclude important
areas of commonality and compatibility. Company managements are quite
alert to the importance of cultural compatibility in making acquisitions and
the need to integrate the cultures of newly acquired companies. Indeed,
cultural due diligence is often as important as financial due diligence in
deciding whether to go forward on an acquisition or merger. Also, in today’s
globalizing world, multinational companies are learning how to make
strategy-critical cultural traits travel across country boundaries and create a
workably uniform culture worldwide. AES, a sustainable energy company
with more than 10,000 employees and operations on four continents, has
found that people in most countries readily embrace the five core values that
underlie its culture—putting safety first, acting with integrity, remaining
nimble, having fun through work, and striving for excellence. Moreover, AES
tries to define and practice its cultural values the same way in all of its
locations while still being sensitive to differences that exist among various
peoples and groups around the world. Top managers at AES have expressed
the view that people across the globe are more similar than different and that
the company’s culture is as meaningful in Brazil, Vietnam, or Kazakhstan as
in the United States.
Strong versus Weak Cultures
Company cultures vary widely in strength and influence. Some are strongly
embedded and have a big influence on a company’s operating practices and
the behavior of company personnel. Others are weakly ingrained and have
little effect on behaviors and how company activities are conducted.
Strong-Culture Companies The hallmark of a strong-culture company
is the dominating presence of certain deeply rooted values, business
principles, and behavioral norms that “regulate” the conduct of company
personnel and determine the climate of the workplace.8 In strong-culture
companies, senior managers make a point of explaining and reiterating why
these values, principles, norms, and operating approaches need to govern how
the company conducts its business and how they ultimately lead to better
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business performance. Furthermore, they make a conscious effort to display
these values, principles, and behavioral norms in their own actions—they
walk the talk. An unequivocal expectation that company personnel will act
and behave in accordance with the adopted values and ways of
doing business leads to two important outcomes: (1) Over time, the
professed values come to be widely shared by rank-and-file employees—
people who dislike the culture tend to leave—and (2) individuals encounter
strong peer pressure from co-workers to observe the culturally approved
norms and behaviors. Hence, a strongly implanted corporate culture ends up
having a powerful influence on behavior because so many company
personnel are accepting of the company’s culturally approved traditions and
because this acceptance is reinforced by both management expectations and
co-worker peer pressure to conform to cultural norms.
CORE
CONCEPT
In a strong-culture
company, deeply
rooted values and
norms of behavior
are widely shared
and regulate the
conduct of the
company’s business.
Strong cultures emerge only after a period of deliberate and rather
intensive culture building that generally takes years (sometimes decades).
Two factors contribute to the development of strong cultures: (1) a founder or
strong leader who established core values, principles, and practices that are
viewed as having contributed to the success of the company; and (2) a
sincere, long-standing company commitment to operating the business
according to these established traditions and values. Continuity of leadership,
low workforce turnover, geographic concentration, and considerable
organizational success all contribute to the emergence and sustainability of a
strong culture.9
In strong-culture companies, values and behavioral norms are so ingrained
that they can endure leadership changes at the top—although their strength
can erode over time if new CEOs cease to nurture them or move aggressively
to institute cultural adjustments. The cultural norms in a strong-culture
company typically do not change much as strategy evolves, either because
the culture constrains the choice of new strategies or because the dominant
traits of the culture are somewhat strategy-neutral and compatible with
evolving versions of the company’s strategy. As a consequence, strongly
implanted cultures provide a huge assist in executing strategy because
company managers can use the traditions, beliefs, values, common bonds, or
behavioral norms as levers to mobilize commitment to executing the chosen
strategy.
Weak-Culture Companies In direct contrast to strong-culture companies,
weak-culture companies lack widely shared and strongly held values,
principles, and behavioral norms. As a result, they also lack cultural
mechanisms for aligning, constraining, and regulating the actions, decisions,
and behaviors of company personnel. In the absence of any long-standing top
management commitment to particular values, beliefs, operating practices,
and behavioral norms, individuals encounter little pressure to do things in
particular ways. Such a dearth of companywide cultural influences and
revered traditions produces a work climate where there is no strong employee
allegiance to what the company stands for or to operating the business in
well-defined ways. While individual employees may well have some bonds
of identification with and loyalty toward their department, their colleagues,
their union, or their immediate boss, there’s neither passion about the
company nor emotional commitment to what it is trying to accomplish—a
condition that often results in many employees’ viewing their company as
just a place to work and their job as just a way to make a living.
As a consequence, weak cultures provide little or no assistance in
executing strategy because there are no traditions, beliefs, values, common
bonds, or behavioral norms that management can use as levers to mobilize
commitment to executing the chosen strategy. Without a work climate that
channels organizational energy in the direction of good strategy execution,
managers are left with the options of either using compensation incentives
and other motivational devices to mobilize employee commitment,
supervising and monitoring employee actions more closely, or trying to
establish cultural roots that will in time start to nurture the strategy execution
process.
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Why Corporate Cultures Matter to the Strategy
Execution Process
Even if a company has a strong culture, the culture and work climate may or
may not be compatible with what is needed for effective implementation of
the chosen strategy. When a company’s present culture promotes attitudes,
behaviors, and ways of doing things that are in sync with the chosen strategy
and conducive to first-rate strategy execution, the culture functions as a
valuable ally in the strategy execution process. For example, a corporate
culture characterized by frugality and thrift prompts employee actions to
identify cost-saving opportunities—the very behavior needed for successful
execution of a low-cost leadership strategy. A culture that celebrates taking
initiative, exhibiting creativity, taking risks, and embracing change is
conducive to successful execution of product innovation and technological
leadership strategies.10
• LO 12-2
Explain how and
why a company’s
culture can aid the
drive for proficient
strategy execution.
A culture that is grounded in actions, behaviors, and work practices that
are conducive to good strategy implementation supports the strategy
execution effort in three ways:
1. A culture that is well matched to the chosen strategy and the requirements
of the strategy execution effort focuses the attention of employees on what
is most important to this effort. Moreover, it directs their behavior and
serves as a guide to their decision making. In this manner, it can align the
efforts and decisions of employees throughout the firm and minimize the
need for direct supervision.
2. Culture-induced peer pressure further induces company personnel to do
things in a manner that aids the cause of good strategy execution. The
stronger the culture (the more widely shared and deeply held the values),
the more effective peer pressure is in shaping and supporting the strategy
execution effort. Research has shown that strong group norms can shape
employee behavior even more powerfully than can financial incentives.
3. A company culture that is consistent with the requirements for good
strategy execution can energize employees, deepen their commitment to
execute the strategy flawlessly, and enhance worker productivity in the
process. When a company’s culture is grounded in many of the needed
strategy-executing behaviors, employees feel genuinely better about their
jobs, the company they work for, and the merits of what the company is
trying to accomplish. Greater employee buy-in for what the company is
trying to accomplish boosts motivation and marshals organizational energy
behind the drive for good strategy execution. An energized workforce
enhances the chances of achieving execution-critical performance targets
and good strategy execution.
In sharp contrast, when a culture is in conflict with the chosen strategy or
what is required to execute the company’s strategy well, the culture becomes
a stumbling block.11 Some of the very behaviors needed to execute the
strategy successfully run contrary to the attitudes, behaviors, and operating
practices embedded in the prevailing culture. Such a clash poses a real
dilemma for company personnel. Should they be loyal to the culture and
company traditions (to which they are likely to be emotionally attached) and
thus resist or be indifferent to actions that will promote better strategy
execution—a choice that will certainly weaken the drive for good strategy
execution? Alternatively, should they go along with management’s strategy
execution effort and engage in actions that run counter to the culture—a
choice that will likely impair morale and lead to a less-than-enthusiastic
commitment to good strategy execution? Neither choice leads to desirable
outcomes. Culture-bred resistance to the actions and behaviors needed for
good strategy execution, particularly if strong and widespread, poses a
formidable hurdle that must be cleared for a strategy’s execution to be
successful.
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A strong culture that
encourages actions,
behaviors, and work
practices that are in
sync with the
chosen strategy is a
valuable ally in the
strategy execution
process.
The consequences of having—or not having—an execution-
supportive corporate culture says something important about the task of
managing the strategy execution process: Closely aligning corporate culture
with the requirements for proficient strategy execution merits the full
attention of senior executives. The culture-building objective is to create a
work climate and style of operating that mobilize the energy of company
personnel squarely behind efforts to execute strategy competently. The more
deeply management can embed execution-supportive ways of doing things,
the more management can rely on the culture to automatically steer company
personnel toward behaviors and work practices that aid good strategy
execution and veer from doing things that impede it. Moreover, culturally
astute managers understand that nourishing the right cultural environment not
only adds power to their push for proficient strategy execution but also
promotes strong employee identification with, and commitment to, the
company’s vision, performance targets, and strategy.
It is in
management’s best
interest to dedicate
considerable effort
to establishing a
corporate culture
that encourages
behaviors and work
practices conducive
to good strategy
execution.
Healthy Cultures That Aid Good Strategy
Execution
A strong culture, provided it fits the chosen strategy and embraces execution-
supportive attitudes, behaviors, and work practices, is definitely a healthy
culture. Two other types of cultures exist that tend to be healthy and largely
supportive of good strategy execution: high-performance cultures and
adaptive cultures.
High-Performance Cultures Some companies have so-called high-
performance cultures where the standout traits are a “can-do” spirit, pride in
doing things right, no-excuses accountability, and a pervasive results-oriented
work climate in which people go all out to meet or beat stretch objectives.12
In high-performance cultures, there’s a strong sense of involvement on the
part of company personnel and emphasis on individual initiative and effort.
Performance expectations are clearly delineated for the company as a whole,
for each organizational unit, and for each individual. Issues and problems are
promptly addressed; there’s a razor-sharp focus on what needs to be done.
The clear and unyielding expectation is that all company personnel, from
senior executives to frontline employees, will display high-performance
behaviors and a passion for making the company successful. Such a culture—
permeated by a spirit of achievement and constructive pressure to achieve
good results—is a valuable contributor to good strategy execution and
operating excellence.13
Epic Systems, a company well-known by healthcare providers for the
excellence of their record-keeping software, attributes much of its success to
their strong, high-performance culture. By emphasizing the importance of the
company’s “Ten Commandments” and guiding principles, Epic has created a
work climate in which employees have an overarching standard that helps
guide and coordinate their actions. Epic fosters this high-performance culture
from the get-go. They target top tier universities to hire entry-level talent,
focusing on skills rather than personality. A rigorous training and orientation
program indoctrinates each new employee. This culture positively affects
Epic’s strategy execution because employees are focused on the most
important actions, there is peer pressure to contribute to Epic’s success, and
employees are genuinely excited to be involved. Epic’s faith in its ability to
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acculturate new team members and remain true to its core values has helped
sustain its status as a premier provider of healthcare IT systems over many
years.
The challenge in creating a high-performance culture is to inspire high
loyalty and dedication on the part of employees, such that they are energized
to put forth their very best efforts. Managers have to take pains to reinforce
constructive behavior, reward top performers, and purge habits and behaviors
that stand in the way of high productivity and good results. They
must work at knowing the strengths and weaknesses of their
subordinates to better match talent with task and enable people to make
meaningful contributions by doing what they do best. They have to stress
learning from mistakes and must put an unrelenting emphasis on moving
forward and making good progress—in effect, there has to be a disciplined,
performance-focused approach to managing the organization. Illustration
Capsule 12.1 describes the attention that Puma gives toward maintaining its
high-performance culture.
ILLUSTRATION
CAPSULE 12.1 PUMA’s High-Performance
Culture
nexusby/Shutterstock
As the third largest sportswear manufacturer in the world, PUMA is racing to catch up
with its competitors, Nike and Adidas. Its mission, encapsulated in the phrase “Forever
Faster”, speaks to its drive to out-innovate and out-pace its formidable rivals. But the
more consequential driver of PUMA’s speed and agility is its high performance culture.
In 2020, PUMA won Glassdoor’s award for the Best Place to Work in Germany, where
the company is headquartered. To inspire and energize employees at the headquarters,
PUMA offers a fast-paced, fun work environment, centered on a sporting lifestyle.
Employees are encouraged to enjoy the company’s organic canteen, state-of-the-art
gym, nature running trails, soccer fields, and basketball courts. This not only helps
workers to form strong bonds with one another but it provides a kind of test lab for the
company’s latest innovations and designs.
As a multinational company, with nearly 15,000 employees and three international
hubs outside of Germany (Hong Kong; Somerville, MA; Ho Chi Minh City, Vietnam),
PUMA’s challenge has been to ensure that this culture spans the entire reach of the
company and unites the parts. This requires much more than ensuring that every hub has
a sports driven campus like the one in Germany. It begins with hiring practices to attract
and retain those people whose values, drive, and passion for sports match those of
others in the company. Accordingly, PUMA is a youthful company, with the average age
of its employees hovering just above 30. New employees are exposed to the company
culture through learning videos and literature that support their working with “Speed and
Spirit” from day one. Rookies are matched with a veteran to show them the ropes and
facilitate their becoming acculturated quickly. Talent management and training at PUMA
(including International Leadership Programs) contribute similarly to the company’s high-
performance culture. High potential and high performance individuals are identified and
promoted regardless of level and across functions in the belief that successful teams and
led by successful leaders.
In their annual survey of employees across many companies, Glassdoor reports that
PUMA’s employees rave about the speed and spirit ethos that they experience at PUMA.
page 363
From its flexible hours, generous benefits, personal development opportunities, on-site
recreational facilities, team-spiritedness, and commitment to work-life balance, PUMA
demonstrates that it puts its people first. For that is ultimately the only sure foundation of
a high-performance culture.
Sources: Glassdoor.com/employers/blog/puma-2020, by Amy Elissa Jackson, December
11, 2019; Company website, accessed 4/1/20.
Adaptive Cultures The hallmark of adaptive corporate cultures is
willingness on the part of organization members to accept change and take on
the challenge of introducing and executing new strategies. Company
personnel share a feeling of confidence that the organization can deal with
whatever threats and opportunities arise; they are receptive to risk taking,
experimentation, innovation, and changing strategies and practices. The work
climate is supportive of managers and employees who propose or initiate
useful change. Internal entrepreneurship (often called
intrapreneurship) on the part of individuals and groups is
encouraged and rewarded. Senior executives seek out, support, and promote
individuals who exercise initiative, spot opportunities for improvement, and
display the skills to implement them. Managers openly evaluate ideas and
suggestions, fund initiatives to develop new or better products, and take
prudent risks to pursue emerging market opportunities. As in high-
performance cultures, the company exhibits a proactive approach to
identifying issues, evaluating the implications and options, and moving ahead
quickly with workable solutions. Strategies and traditional operating
practices are modified as needed to adjust to, or take advantage of, changes in
the business environment.
As a company’s
strategy evolves, an
adaptive culture is a
definite ally in the
strategy-
implementing,
strategy-executing
process as
compared to
cultures that are
resistant to change.
http://glassdoor.com/employers/blog/puma-2020
But why is change so willingly embraced in an adaptive culture? Why are
organization members not fearful of how change will affect them? Why does
an adaptive culture not break down from the force of ongoing changes in
strategy, operating practices, and behavioral norms? The answers lie in two
distinctive and dominant traits of an adaptive culture: (1) Changes in
operating practices and behaviors must not compromise core values and long-
standing business principles (since they are at the root of the culture); and (2)
changes that are instituted must satisfy the legitimate interests of key
constituencies—customers, employees, shareholders, suppliers, and the
communities where the company operates. In other words, what sustains an
adaptive culture is that organization members perceive the changes that
management is trying to institute as legitimate, in keeping with the core
values, and in the overall best interests of stakeholders.14 Not surprisingly,
company personnel are usually more receptive to change when their
employment security is not threatened and when they view new duties or job
assignments as part of the process of adapting to new conditions. Should
workforce downsizing be necessary, it is important that layoffs be handled
humanely and employee departures be made as painless as possible.
Technology companies, software companies, and Internet-based companies
are good illustrations of organizations with adaptive cultures. Such
companies thrive on change—driving it, leading it, and capitalizing on it.
Companies like Amazon, Google, Apple, Facebook, Adobe, Groupon, Intel,
and Yelp cultivate the capability to act and react rapidly. They are avid
practitioners of entrepreneurship and innovation, with a demonstrated
willingness to take bold risks to create altogether new products, new
businesses, and new industries. To create and nurture a culture that can adapt
rapidly to shifting business conditions, they make a point of staffing their
organizations with people who are flexible, who rise to the challenge of
change, and who have an aptitude for adapting well to new circumstances.
Wayfair, the largest online retailer of home furnishings in the United States,
attributes its rapid growth to an entrepreneurial and collaborative culture that
encourages employee innovation. They hire individuals who are willing to
solve problems creatively and develop new initiatives, and empower them to
take measured risks.
In fast-changing business environments, a corporate culture that is
receptive to altering organizational practices and behaviors is a virtual
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necessity. However, adaptive cultures work to the advantage of all
companies, not just those in rapid-change environments. Every company
operates in a market and business climate that is changing to one degree or
another and that, in turn, requires internal operating responses and new
behaviors on the part of organization members.
Unhealthy Cultures That Impede Good Strategy
Execution
The distinctive characteristic of an unhealthy corporate culture is the
presence of counterproductive cultural traits that adversely impact the work
climate and company performance. Five particularly unhealthy cultural traits
are hostility to change, heavily politicized decision making, insular
thinking, unethical and greed-driven behaviors, and the presence of
incompatible, clashing subcultures.
Change-Resistant Cultures Change-resistant cultures—where fear of
change and skepticism about the importance of new developments are the
norm—place a premium on not making mistakes, prompting managers to
lean toward safe, conservative options intended to maintain the status quo,
protect their power base, and guard their immediate interests. When such
companies encounter business environments with accelerating change, going
slow on altering traditional ways of doing things can be a serious liability.
Under these conditions, change-resistant cultures encourage a number of
unhealthy behaviors—avoiding risks, not capitalizing on emerging
opportunities, taking a lax approach to both product innovation and
continuous improvement in performing value chain activities, and responding
more slowly than is warranted to market change. In change-resistant cultures,
proposals to do things differently face an uphill battle and people who
champion them may be seen as something of a nuisance or a troublemaker.
Instead, a lot of energy goes into justifying what the company is presently
doing, with little discussion of what it should consider doing differently—
there is strong aversion to bold action. Executives who don’t value managers
or employees with initiative and new ideas put a damper on product
innovation, experimentation, and efforts to improve.
Hostility to change is most often found in companies with stodgy
bureaucracies that have enjoyed considerable market success in years past
and that are wedded to the “We have done it this way for years” syndrome.
Sears, and Eastman Kodak are classic examples of companies whose change-
resistant bureaucracies have damaged their market standings and financial
performance; clinging to what made them successful, they were reluctant to
alter operating practices and modify their business approaches when signals
of market change first sounded. As strategies of “hold-the-course” won out
over bold innovation, they lost market share to rivals that quickly moved to
institute changes more in tune with evolving market conditions and buyer
preferences. In consequence, both of these companies ultimately ended up in
bankruptcy court.
Politicized Cultures What makes a politicized internal environment so
unhealthy is that political infighting consumes a great deal of organizational
energy, often with the result that what’s best for the company takes a backseat
to political maneuvering. In companies where internal politics pervades the
work climate, empire-building managers pursue their own agendas and
operate the work units under their supervision as autonomous “fiefdoms.”
The positions they take on issues are usually aimed at protecting or
expanding their own turf. Collaboration with other organizational units is
viewed with suspicion, and cross-unit cooperation occurs grudgingly. The
support or opposition of politically influential executives and/or coalitions
among departments with vested interests in a particular outcome tends to
shape what actions the company takes. All this political maneuvering takes
away from efforts to execute strategy with real proficiency and frustrates
company personnel who are less political and more inclined to do what is in
the company’s best interests.
Insular, Inwardly Focused Cultures Sometimes a company reigns as an
industry leader or enjoys great market success for so long that its personnel
start to believe they have all the answers or can develop them on their own.
There is a strong tendency to neglect what customers are saying and how
their needs and expectations are changing. Such confidence in the correctness
of how the company does things and an unflinching belief in its competitive
superiority breed arrogance, prompting company personnel to discount the
merits of what outsiders are doing and to see little payoff from studying best-
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in-class performers. Insular thinking, internally driven solutions, and a must-
be-invented-here mindset come to permeate the corporate culture.
An inwardly focused corporate culture gives rise to managerial
inbreeding and a failure to recruit people who can offer fresh thinking and
outside perspectives. The big risk of insular cultural thinking is that the
company can underestimate the capabilities of rival companies while
overestimating its own—all of which diminishes a company’s
competitiveness over time.
Unethical and Greed-Driven Cultures Companies that have little regard
for ethical standards or are run by executives driven by greed and ego
gratification are scandals waiting to happen. Executives exude the negatives
of arrogance, ego, greed, and an “ends-justify-the-means” mentality in
pursuing overambitious revenue and profitability targets.15 Senior managers
wink at unethical behavior and may cross over the line to unethical (and
sometimes criminal) behavior themselves. They are prone to adopt
accounting principles that make financial performance look better than it
really is. Legions of companies have fallen prey to unethical behavior and
greed, most notably Turing Pharmaceuticals (whose name was changed to
Vyera in the wake of scandal) and Mylan, both known for their
unconscionable price hikes on life-saving medications. Notorious others
include Enron, BP, AIG, Countrywide Financial, and JPMorgan Chase,
Deutsche Bank, and HSBC (Europe’s biggest bank) with executives being
indicted and/or convicted of criminal behavior.
Incompatible, Clashing Subcultures Company subcultures are unhealthy
when they embrace conflicting business philosophies, support inconsistent
approaches to strategy execution, and encourage incompatible methods of
people management. Clashing subcultures can prevent a company from
coordinating its efforts to craft and execute strategy and can distract company
personnel from the business of business. Internal jockeying among the
subcultures for cultural dominance impedes teamwork among the company’s
various organizational units and blocks the emergence of a collaborative
approach to strategy execution. Such a lack of consensus about how to
proceed is likely to result in fragmented or inconsistent approaches to
implementing new strategic initiatives and in limited success in executing the
company’s overall strategy.
page 366
Changing a Problem Culture
When a culture is unhealthy or otherwise out of sync with the actions and
behaviors needed to execute the strategy successfully, the culture must be
changed as rapidly as can be managed. This means eliminating any
unhealthy or dysfunctional cultural traits as fast as possible and aggressively
striving to ingrain new behaviors and work practices that will enable first-rate
strategy execution. The more entrenched the unhealthy or mismatched
aspects of a company culture, the more likely the culture will impede strategy
execution and the greater the need for change.
• LO 12-3
Identify the kinds of
actions management
can take to change a
problem corporate
culture.
Changing a problem culture is among the toughest management tasks
because of the heavy anchor of ingrained behaviors and attitudes. It is natural
for company personnel to cling to familiar practices and to be wary of
change, if not hostile to new approaches concerning how things are to be
done. Consequently, it takes concerted management action over a period of
time to root out unwanted behaviors and replace an unsupportive culture with
more effective ways of doing things. The single most visible factor that
distinguishes successful culture-change efforts from failed attempts is
competent leadership at the top. Great power is needed to force major
cultural change and overcome the stubborn resistance of entrenched cultures
—and great power is possessed only by the most senior executives, especially
the CEO. However, while top management must lead the change effort, the
tasks of marshaling support for a new culture and instilling the
desired cultural behaviors must involve a company’s whole
management team. Middle managers and frontline supervisors play a key role
in implementing the new work practices and operating approaches, helping
win rank-and-file acceptance of and support for changes, and instilling the
desired behavioral norms.
As shown in Figure 12.2, the first step in fixing a problem culture is for top
management to identify those facets of the present culture that are
dysfunctional and pose obstacles to executing strategic initiatives. Second,
managers must clearly define the desired new behaviors and features of the
culture they want to create. Third, they must convince company personnel of
why the present culture poses problems and why and how new behaviors and
operating approaches will improve company performance—the case for
cultural reform has to be persuasive. Finally, and most important, all the talk
about remodeling the present culture must be followed swiftly by visible,
forceful actions to promote the desired new behaviors and work practices—
actions that company personnel will interpret as a determined top-
management commitment to bringing about a different work climate and new
ways of operating. The actions to implant the new culture must be both
substantive and symbolic.
FIGURE 12.2 Changing a Problem Culture
Making a Compelling Case for Culture Change The way for
management to begin a major remodeling of the corporate culture is by
selling company personnel on the need for new-style behaviors and work
practices. This means making a compelling case for why the culture-
remodeling efforts are in the organization’s best interests and why company
personnel should wholeheartedly join the effort to do things somewhat
differently. This can be done by
Explaining why and how certain behaviors and work practices in the
current culture pose obstacles to good strategy execution.
Explaining how new behaviors and work practices will be more
advantageous and produce better results. Effective culture-change leaders
are good at telling stories to describe the new values and desired behaviors
and connect them to everyday practices.
page 367Citing reasons why the current strategy has to be modified, if the
need for cultural change is due to a change in strategy. This
includes explaining why the new strategic initiatives will bolster the
company’s competitiveness and performance and how a change in culture
can help in executing the new strategy.
It is essential for the CEO and other top executives to talk personally to
personnel all across the company about the reasons for modifying work
practices and culture-related behaviors. For the culture-change effort to be
successful, frontline supervisors and employee opinion leaders must be won
over to the cause, which means convincing them of the merits of practicing
and enforcing cultural norms at every level of the organization, from the
highest to the lowest. Arguments for new ways of doing things and new work
practices tend to be embraced more readily if employees understand how they
will benefit company stakeholders (particularly customers, employees, and
shareholders). Until a large majority of employees accept the need for a new
culture and agree that different work practices and behaviors are called for,
there’s more work to be done in selling company personnel on the whys and
wherefores of culture change. Building widespread organizational support
requires taking every opportunity to repeat the message of why the new work
practices, operating approaches, and behaviors are good for company
stakeholders and essential for the company’s future success.
Substantive Culture-Changing Actions No culture-change effort can get
very far when leaders merely talk about the need for different actions,
behaviors, and work practices. Company executives must give the culture-
change effort some teeth by initiating a series of actions that company
personnel will see as unmistakably indicative of the seriousness of
management’s commitment to cultural change. The strongest signs that
management is truly committed to instilling a new culture include
Replacing high-profile executives and managers who are allied with the old
culture and either openly or covertly oppose needed organizational and
cultural changes.
Promoting individuals who have stepped forward to spearhead the shift to a
different culture and who can serve as role models for the desired cultural
behavior.
page 368
Appointing outsiders with the desired cultural attributes to influential
positions—bringing in new-breed managers sends an unambiguous
message that a new era is dawning.
Screening all candidates for new positions carefully, hiring only those who
appear to fit in with the new culture. For example, a company that stresses
operating with integrity and fairness must hire people who themselves have
integrity and place a high value on fair play. A company whose culture
revolves around creativity, product innovation, and leading change must
screen new hires for their ability to think outside the box, generate new
ideas, and thrive in a climate of rapid change and ambiguity.
Mandating that all company personnel attend culture-training programs to
better understand the new culture-related actions and behaviors that are
expected.
Designing compensation incentives that boost the pay of teams and
individuals who display the desired cultural behaviors. Company personnel
are much more inclined to exhibit the desired kinds of actions and
behaviors when it is in their financial best interest to do so.
Letting word leak out that generous pay raises have been awarded to
individuals who have stepped out front, led the adoption of the desired
work practices, displayed the new-style behaviors, and achieved pace-
setting results.
Revising policies and procedures in ways that will help drive cultural
change.
Executives must launch enough companywide culture-change actions at
the outset to leave no room for doubt that management is dead serious about
changing the present culture and that a cultural transformation is inevitable.
Management’s commitment to cultural change in the company
must be made credible. The series of actions initiated by top
management must command attention, get the change process off to a fast
start, and be followed by unrelenting efforts to firmly establish the new work
practices, desired behaviors, and style of operating as “standard.”
The most important
symbolic cultural-
changing action that
top executives can
take is to lead by
example.
Symbolic Culture-Changing Actions There’s also an important place for
symbolic managerial actions to alter a problem culture and tighten the
strategy–culture fit. The most important symbolic actions are those that top
executives take to lead by example. For instance, if the organization’s
strategy involves a drive to become the industry’s low-cost producer, senior
managers must display frugality in their own actions and decisions. Examples
include inexpensive decorations in the executive suite, conservative expense
accounts and entertainment allowances, a lean staff in the corporate office,
scrutiny of budget requests, few executive perks, and so on. At Walmart, all
the executive offices are simply decorated; executives are habitually frugal in
their own actions, and they are zealous in their efforts to control costs and
promote greater efficiency. At Nucor, one of the world’s low-cost producers
of steel products, executives fly coach class and use taxis at airports rather
than limousines. Top executives must be alert to the fact that company
personnel will be watching their behavior to see if their actions match their
rhetoric. Hence, they need to make sure their current decisions and actions
will be construed as consistent with the new cultural values and norms.16
Another category of symbolic actions includes holding ceremonial events
to single out and honor people whose actions and performance exemplify
what is called for in the new culture. Such events also provide an opportunity
to celebrate each culture-change success. Executives sensitive to their role in
promoting strategy–culture fit make a habit of appearing at ceremonial
functions to praise individuals and groups that exemplify the desired
behaviors. They show up at employee training programs to stress strategic
priorities, values, ethical principles, and cultural norms. Every group
gathering is seen as an opportunity to repeat and ingrain values, praise good
deeds, expound on the merits of the new culture, and cite instances of how
the new work practices and operating approaches have produced good results.
Ceremonial events can also be used to drive home the commitment to
changing culture. The late Steve Jobs, visionary co-founder of Apple, once
countered resistance to change by dramatizing the death of “the old” with a
coffin.
The use of symbols in culture building is widespread. Numerous
businesses have employee-of-the-month awards. The military has a long-
page 369
standing custom of awarding ribbons and medals for exemplary actions.
Mary Kay Cosmetics awards an array of prizes ceremoniously to its beauty
consultants for reaching various sales plateaus, including the iconic pink
Cadillac.
How Long Does It Take to Change a Problem Culture? Planting the
seeds of a new culture and helping the culture grow strong roots require a
determined, sustained effort by the chief executive and other senior
managers. Changing a problem culture is never a short-term exercise; it takes
time for a new culture to emerge and take root. And it takes even longer for a
new culture to become deeply embedded. The bigger the organization and the
greater the cultural shift needed to produce an execution-supportive fit, the
longer it takes. In large companies, fixing a problem culture and instilling a
new set of attitudes and behaviors can take two to five years. In fact, it is
usually tougher to reform an entrenched problematic culture than it is to
instill a strategy-supportive culture from scratch in a brand-new organization.
Illustration Capsule 12.2 discusses the approaches used at Goldman Sachs
to change a culture that was impeding its efforts to recruit the best young
talent.
ILLUSTRATION
CAPSULE 12.2 Driving Cultural Change at
Goldman Sachs
Goldman Sachs was long considered one of the best financial services companies to
work for, due to its prestige, high salaries, bonuses, and perks. Yet by 2014, Goldman
was beginning to have trouble recruiting the best and brightest MBAs at top business
schools. Part of this was due to the banking crisis of 2008–2009 and the scandals that
continued to plague the industry year after year, tarnishing the industry’s reputation. But
another reason was a change in the values and aspirations of the younger generation
that made banking culture far less appealing than that of consulting, technology, and
start-up companies. Newly minted MBAs were no longer as willing to accept the grueling
hours and unpredictable schedules that were the norm in investment banking. They
wanted to derive meaning and purpose from their work and prized work/life balance over
monetary gain. The tech industry was known for fun, youth-oriented, and collaborative
working environments, while the excitement and promise of entrepreneurial ventures
offered much appeal. Goldman found itself competing with Amazon, Google, Microsoft,
and Facebook as well as with start-ups for the best young talent—and losing out.
Goldman’s problem was compounded by the fact that its culture was regarded as stuffy
and stodgy—qualities not likely to appeal to the young, particularly when contrasted with
the hip cultures of tech and start-up companies. Further, it had always been slow-moving
in terms of implementing organizational change. Recognizing the problem, the leadership
at Goldman attempted to pivot sharply, asking its executives to think of Goldman as a
tech company, complete with the associated values. The Chief Learning Office at
Goldman Sachs was put in charge of the effort to transform its culture and began taking
deliberate steps to enact changes. Buy-in was sought from the full C-suite—the
leadership team at the very top of the firm. To foster a more familial atmosphere at work,
the company began with small steps, such as setting up sports leagues and encouraging
regular team happy hours. More significantly, they instituted more employee-friendly work
schedules and policies, more accommodating of work-life balance. They liberalized their
parental leave policies, provided greater flexibility in work schedules, and enacted
protections for interns and junior bankers designed to limit their working hours. They also
overhauled their performance review and promotion systems as well as their recruiting
practices and policies regarding diversity. Although cultural change never comes swiftly,
by 2017 results were apparent even to outside observers. That year, the career website
Vault.com named Goldman Sachs as the best banking firm to work for, noting that when it
came to workplace policies, Goldman led the industry.
JUSTIN LANE/EPA-EFE/Shutterstock
Sources: http://www.goldmansachs.com/careers/blog/posts/goldman-sachs-vault-
2017.html; http://sps.columbia.edu/news/how-goldman-sachs-drives-culture-
change-in-the-financial-industry.
http://vault.com/
http://www.goldmansachs.com/careers/blog/posts/goldman-sachs-vault-2017.html
http://sps.columbia.edu/news/how-goldman-sachs-drives-culture-change-in-the-financial-industry
page 370
LEADING THE STRATEGY EXECUTION
PROCESS
For an enterprise to execute its strategy in truly proficient fashion, top
executives must take the lead in the strategy implementation process and
personally drive the pace of progress. They have to be out in the field, seeing
for themselves how well operations are going, gathering information
firsthand, and gauging the progress being made. Proficient strategy execution
requires company managers to be diligent and adept in spotting problems,
learning what obstacles lay in the path of good execution, and then clearing
the way for progress—the goal must be to produce better results
speedily and productively. There must be constructive, but
unrelenting, pressure on organizational units to (1) demonstrate excellence in
all dimensions of strategy execution and (2) do so on a consistent basis—
ultimately, that’s what will enable a well-crafted strategy to achieve the
desired performance results.
• LO 12-4
Recognize what
constitutes effective
managerial
leadership in
achieving superior
strategy execution.
The specifics of how to implement a strategy and deliver the intended
results must start with understanding the requirements for good strategy
execution. Afterward comes a diagnosis of the organization’s preparedness to
execute the strategic initiatives and decisions on how to move forward and
achieve the targeted results.17 In general, leading the drive for good strategy
execution and operating excellence calls for three actions on the part of the
managers in charge:
Staying on top of what is happening and closely monitoring progress.
Putting constructive pressure on the organization to execute the strategy
well and achieve operating excellence.
Initiating corrective actions to improve strategy execution and achieve the
targeted performance results.
Staying on Top of How Well Things Are Going
To stay on top of how well the strategy execution process is going, senior
executives have to tap into information from a wide range of sources. In
addition to communicating regularly with key subordinates and reviewing the
latest operating results, watching the competitive reactions of rival firms, and
visiting with key customers and suppliers to get their perspectives,
they usually visit various company facilities and talk with many different
company personnel at many different organizational levels—a technique
often labeled management by walking around (MBWA). Most managers
attach great importance to spending time with people at company facilities,
asking questions, listening to their opinions and concerns, and gathering
firsthand information about how well aspects of the strategy execution
process are going. Facilities tours and face-to-face contacts with operating-
level employees give executives a good grasp of what progress is being
made, what problems are being encountered, and whether additional
resources or different approaches may be needed. Just as important, MBWA
provides opportunities to give encouragement, lift spirits, focus attention on
key priorities, and create some excitement—all of which generate positive
energy and help boost strategy execution efforts.
CORE
CONCEPT
Management by
walking around
(MBWA) is one of
the techniques that
effective leaders use
to stay informed
about how well the
strategy execution
process is
progressing.
Jeff Bezos, Amazon’s CEO, is noted for his practice of MBWA, firing off a
battery of questions when he tours facilities, and insisting that Amazon
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managers spend time in the trenches with their people to prevent getting
disconnected from the reality of what’s happening. Walmart executives have
had a long-standing practice of spending two to three days every week
visiting Walmart’s stores and talking with store managers and employees.
Sam Walton, Walmart’s founder, insisted, “The key is to get out into the store
and listen to what the associates have to say.” Jack Welch, the highly
effective former CEO of General Electric, not only made it a priority to
personally visit GE operations and talk with major customers but also
routinely spent time exchanging information and ideas with GE managers
from all over the world who were attending classes at the company’s
leadership development center near GE’s headquarters.
Many manufacturing executives make a point of strolling the factory floor
to talk with workers and meeting regularly with union officials. Some
managers operate out of open cubicles in big spaces filled with open cubicles
for other personnel so that they can interact easily and frequently
with co-workers. Managers at some companies host weekly get-
togethers (often on Friday afternoons) to create a regular opportunity for
information to flow freely between down-the-line employees and executives.
Mobilizing the Effort for Excellence in Strategy
Execution
Part of the leadership task in mobilizing organizational energy behind the
drive for good strategy execution entails nurturing a results-oriented work
climate, where performance standards are high and a spirit of achievement is
pervasive. Successfully leading the effort is typically characterized by such
leadership actions and managerial practices as
Treating employees as valued partners. Some companies symbolize the
value of individual employees and the importance of their contributions by
referring to them as cast members (Disney), crew members (McDonald’s),
job owners (Graniterock), partners (Starbucks), or associates (Walmart,
LensCrafters, W. L. Gore, Edward Jones, Publix Supermarkets, and
Marriott International). Very often, there is a strong company commitment
to training each employee thoroughly, offering attractive compensation and
benefits, emphasizing promotion from within and promising career
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opportunities, providing a high degree of job security, and otherwise
making employees feel well treated and valued.
Fostering an esprit de corps that energizes organization members. The task
here is to skillfully use people-management practices calculated to build
morale, foster pride in working for the company, promote teamwork and
collaborative group effort, win the emotional commitment of individuals
and organizational units to what the company is trying to accomplish, and
inspire company personnel to do their best in achieving good results.18
Using empowerment to help create a fully engaged workforce. Top
executives—and, to some degree, the enterprise’s entire management team
—must seek to engage the full organization in the strategy execution effort.
A fully engaged workforce, where individuals bring their best to work
every day, is necessary to produce great results.19 So is having a group of
dedicated managers committed to making a difference in their organization.
The two best things top-level executives can do to create a fully engaged
organization are (1) delegate authority to middle and lower-level managers
to get the strategy execution process moving and (2) empower rank-and-
file employees to act on their own initiative. Operating excellence requires
that everybody contribute ideas, exercise initiative and creativity in
performing his or her work, and have a desire to do things in the best
possible manner.
Nurturing a results-oriented work climate and clearly communicating an
expectation that company personnel are to give their best in achieving
performance targets. Managers must make it abundantly clear that they
expect all company personnel to put forth every effort to meet performance
targets. But executives cannot expect directives to “try harder” to produce
the desired outcomes in the absence of a results-oriented work climate. Nor
can they expect innovative improvements in operations if they do no more
than exhort people to “be creative.” Rather, they must foster a strong
culture with high performance standards and where innovative ideas and
experimentation with new ways of doing things can blossom and thrive.
Using the tools of benchmarking, best practices, business process
reengineering, TQM, and Six Sigma to focus attention on
continuous improvement. These are proven approaches to getting better
operating results and facilitating better strategy execution.
Using the full range of motivational techniques and compensation
incentives to inspire company personnel and reward high performance.
Individuals and groups should be strongly encouraged to brainstorm, let
their imaginations fly in all directions, and come up with proposals for
improving the way that things are done. This means giving company
personnel enough autonomy to stand out, excel, and contribute. And it
means that the rewards for successful champions of new ideas and
operating improvements should be large and visible. It is particularly
important that people who champion an unsuccessful idea are not punished
or sidelined but, rather, encouraged to try again. Finding great ideas
requires taking risks and recognizing that many ideas won’t pan out.
Celebrating individual, group, and company successes. Top management
should miss no opportunity to express respect for individual employees and
appreciation of extraordinary individual and group effort.20 Companies like
Google, Mary Kay, Tupperware, and McDonald’s actively seek out reasons
and opportunities to give pins, ribbons, buttons, badges, and medals for
good showings by average performers—the idea being to express
appreciation and give a motivational boost to people who stand out in
doing ordinary jobs. At Kimpton Hotels and Restaurants, employees who
create special moments for guests are rewarded with “Kimpton Moment”
tokens that can be redeemed for paid days off, gift certificates to
restaurants, flat-screen TVs, and other prizes. Cisco Systems and 3M
Corporation make a point of ceremoniously honoring individuals who
believe so strongly in their ideas that they take it on themselves to hurdle
the bureaucracy, maneuver their projects through the system, and turn them
into improved services, new products, or even new businesses.
While leadership efforts to instill a results-oriented, high-performance
culture usually accentuate the positive, negative consequences for poor
performance must be in play as well. Managers whose units consistently
perform poorly must be replaced. Low-performing employees must be
weeded out or at least employed in ways better suited to their aptitudes.
Average performers should be candidly counseled that they have limited
career potential unless they show more progress in the form of additional
effort, better skills, and improved ability to execute the strategy well and
deliver good results.
page 373
Leading the Process of Making Corrective
Adjustments
There comes a time at every company when managers have to fine-tune or
overhaul the approaches to strategy execution since no action plan for
executing strategy can foresee all the problems that will arise. Clearly, when
a company’s strategy execution effort is not delivering good results, it is the
leader’s responsibility to step forward and initiate corrective actions,
although sometimes it must be recognized that unsatisfactory performance
may be due as much or more to flawed strategy as to weak strategy
execution.21
Success in making corrective adjustments hinges on (1) a thorough
analysis of the situation, (2) the exercise of good business judgment in
deciding what actions to take, and (3) good implementation of the corrective
actions that are initiated. Successful managers are skilled in getting an
organization back on track rather quickly. They (and their staffs)
are good at discerning what adjustments to make and in bringing
them to a successful conclusion. Managers who struggle to show measurable
progress in implementing corrective actions in a timely fashion are
candidates for being replaced.
The process of making corrective adjustments in strategy execution varies
according to the situation. In a crisis, taking remedial action quickly is of the
essence. But it still takes time to review the situation, examine the available
data, identify and evaluate options (crunching whatever numbers may be
appropriate to determine which options are likely to generate the best
outcomes), and decide what to do. When the situation allows managers to
proceed more deliberately in deciding when to make changes and what
changes to make, most managers seem to prefer a process of incrementally
solidifying commitment to a particular course of action.22 The process that
managers go through in deciding on corrective adjustments is essentially the
same for both proactive and reactive changes: They sense needs, gather
information, broaden and deepen their understanding of the situation, develop
options and explore their pros and cons, put forth action proposals, strive for
a consensus, and finally formally adopt an agreed-on course of action. The
time frame for deciding what corrective changes to initiate can be a few
hours, a few days, a few weeks, or even a few months if the situation is
particularly complicated.
The challenges of making the right corrective adjustments and leading a
successful strategy execution effort are, without question, substantial.23
There’s no generic, by-the-books procedure to follow. Because each instance
of executing strategy occurs under different organizational circumstances, the
managerial agenda for executing strategy always needs to be situation-
specific. But the job is definitely doable. Although there is no prescriptive
answer to the question of exactly what to do, any of several courses of action
may produce good results. As we said at the beginning of Chapter 10,
executing strategy is an action-oriented task that challenges a manager’s
ability to lead and direct organizational change, create or reinvent business
processes, manage and motivate people, and achieve performance targets. If
you now better understand what the challenges are, what tasks are involved,
what tools can be used to aid the managerial process of executing strategy,
and why the action agenda for implementing and executing strategy sweeps
across so many aspects of managerial work, then the discussions in Chapters
10, 11, and 12 have been a success.
A FINAL WORD ON LEADING THE
PROCESS OF CRAFTING AND
EXECUTING STRATEGY
In practice, it is hard to separate leading the process of executing strategy
from leading the other pieces of the strategy process. As we emphasized in
Chapter 2, the job of crafting and executing strategy consists of five
interrelated and linked stages, with much looping and recycling to fine-tune
and adjust the strategic vision, objectives, strategy, and implementation
approaches to fit one another and to fit changing circumstances. The process
is continuous, and the conceptually separate acts of crafting and executing
strategy blur together in real-world situations. The best tests of good strategic
leadership are whether the company has a good strategy (given its internal
and external situation), whether the strategy is being competently executed,
and whether the enterprise is meeting or beating its performance targets. If
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these three conditions exist, then there is every reason to conclude that the
company has good strategic leadership and is a well-managed enterprise.
KEY POINTS
1. Corporate culture is the character of a company’s internal work climate—
the shared values, ingrained attitudes, core beliefs and company traditions
that determine norms of behavior, accepted work practices, and styles of
operating. A company’s culture is important because it influences the
organization’s actions, its approaches to conducting business, and
ultimately its performance in the marketplace. It can be thought of as the
company’s organizational DNA.
2. The key features of a company’s culture include the company’s values and
ethical standards, its approach to people management, its work atmosphere
and company spirit, how its personnel interact, the strength of peer
pressure to conform to norms, the behaviors awarded through incentives
(both financial and symbolic), the traditions and oft-repeated “myths,” and
its manner of dealing with stakeholders.
3. A company’s culture is grounded in and shaped by its core values and
ethical standards. Core values and ethical principles serve two roles in the
culture-building process: (1) They foster a work climate in which
employees share common and strongly held convictions about how
company business is to be conducted; and (2) they provide company
personnel with guidance about the manner in which they are to do their
jobs—which behaviors and ways of doing things are approved (and
expected) and which are out-of-bounds. They serve as yardsticks for
gauging the appropriateness of particular actions, decisions, and behaviors.
4. Company cultures vary widely in strength and influence. Some cultures are
strong and have a big impact on a company’s practices and behavioral
norms. Others are weak and have comparatively little influence on
company operations.
5. Strong company cultures can have either positive or negative effects on
strategy execution. When they are in sync with the chosen strategy and
well matched to the behavioral requirements of the company’s strategy
page 375
implementation plan, they can be a powerful aid to strategy execution. A
culture that is grounded in the types of actions and behaviors that are
conducive to good strategy execution assists the effort in three ways:
By focusing employee attention on the actions that are most important in
the strategy execution effort.
By inducing peer pressure for employees to contribute to the success of
the strategy execution effort.
By energizing employees, deepening their commitment to the strategy
execution effort, and increasing the productivity of their efforts
It is thus in management’s best interest to dedicate considerable effort to
establishing a strongly implanted corporate culture that encourages
behaviors and work practices conducive to good strategy execution.
6. Strong corporate cultures that are conducive to good strategy execution are
healthy cultures. So are high-performance cultures and adaptive cultures.
The latter are particularly important in dynamic environments. Strong
cultures can also be unhealthy. The five types of unhealthy cultures are
those that are (1) change-resistant, (2) heavily politicized, (3) insular and
inwardly focused, (4) ethically unprincipled and infused with greed, and
(5) composed of incompatible, clashing subcultures. All five impede good
strategy execution.
7. Changing a company’s culture, especially a strong one with traits
that don’t fit a new strategy’s requirements, is a tough and often
time-consuming challenge. Changing a culture requires competent
leadership at the top. It requires making a compelling case for cultural
change and employing both symbolic actions and substantive actions that
unmistakably indicate serious and credible commitment on the part of top
management. The more that culture-driven actions and behaviors fit what’s
needed for good strategy execution, the less managers must depend on
policies, rules, procedures, and supervision to enforce what people should
and should not do.
8. Leading the drive for good strategy execution and operating excellence
calls for three actions on the part of the manager in charge:
Staying on top of what is happening and closely monitoring progress.
This is often accomplished through management by walking around
LO 12-1
LO 12-2
LO 12-1, LO 12-2
LO 12-3
(MBWA).
Mobilizing the effort for excellence in strategy execution by putting
constructive pressure on the organization to execute the strategy well.
Initiating corrective actions to improve strategy execution and achieve
the targeted performance results.
ASSURANCE OF LEARNING EXERCISES
1. Salesforce.com earned the top spot on Fortune’s list
of the Best Companies to Work for in 2018, having
been on the list for over 10 years. Use your
university library’s resources to see what their
company culture and values might have to do with
this. What are the key features of its culture? Do
features of Salesforce.com’s culture influence the
company’s ethical practices? If so, how?
2. Based on what you learned about Salesforce.com
from answering the previous question, how do you
think the company’s culture affects its ability to
execute strategy and operate with excellence?
3. Illustration Capsule 12.2 discusses culture change at
Goldman Sachs. How had its organizational culture
become an obstacle to its effectiveness? What
substantive culture-changing actions were
undertaken at Goldman Sachs? What evidence
suggests that the culture change has been effective at
Goldman Sachs?
4. If you were an executive at a company that had a
pervasive yet problematic culture, what steps would
you take to change it? Using Google Scholar or your
university library’s access to EBSCO, LexisNexis,
or other databases, search for recent articles in
business publications on “culture change.” What
role did the executives play in the culture change?
How does this differ from what you would have
done to change the culture?
http://salesforce.com/
http://salesforce.com/
http://salesforce.com/
LO 12-4
LO 12-1, LO 12-2
LO 12-2
LO 12-3, LO 12-4
LO 12-4
page 376
5. Leading the strategy execution process involves
staying on top of the situation and monitoring
progress, putting constructive pressure on the
organization to achieve operating excellence, and
initiating corrective actions to improve the execution
effort. Using your university library’s resources
discuss a recent example of how a company’s
managers have demonstrated the kind of effective
internal leadership needed for superior strategy
execution.
EXERCISEs FOR SIMULATION PARTICIPANTS
1. If you were making a speech to company personnel,
what would you tell employees about the kind of
corporate culture you would like to have at your
company? What specific cultural traits would you
like your company to exhibit? Explain.
2. What core values would you want to ingrain in your
company’s culture? Why?
3. Following each decision round, do you and your co-
managers make corrective adjustments in either your
company’s strategy or the way the strategy is being
executed? List at least three such adjustments you
made in the most recent decision round. What hard
evidence (in the form of results relating to your
company’s performance in the most recent year) can
you cite that indicates that the various corrective
adjustments you made either succeeded at
improving or failed to improve your company’s
performance?
4. What would happen to your company’s performance
if you and your co-managers stick with the status
quo and fail to make any corrective adjustments
after each decision round?
ENDNOTES
1 Jennifer A. Chatham and Sandra E. Cha, “Leading by Leveraging Culture,” California Management Review 45, no. 4
(Summer 2003), pp. 20–34; Edgar Shein, Organizational Culture and Leadership: A Dynamic View (San Francisco, CA:
Jossey-Bass, 1992).
2 T. E. Deal and A. A. Kennedy, Corporate Cultures: The Rites and Rituals of Corporate Life (Harmondsworth, UK:
Penguin, 1982).
3 Joanne Reid and Victoria Hubbell, “Creating a Performance Culture,” Ivey Business Journal 69, no. 4 (March–April
2005), p. 1.
4 Ibid.
5 John P. Kotter and James L. Heskett, Corporate Culture and Performance (New York: Free Press, 1992), p. 7. See also
Robert Goffee and Gareth Jones, The Character of a Corporation (New York: HarperCollins, 1998).
6 Joseph L. Badaracco, Defining Moments: When Managers Must Choose between Right and Wrong (Boston: Harvard
Business School Press, 1997); Joe Badaracco and Allen P. Webb, “Business Ethics: A View from the Trenches,”
California Management Review 37, no. 2 (Winter 1995), pp. 8–28; Patrick E. Murphy, “Corporate Ethics Statements:
Current Status and Future Prospects,” Journal of Business Ethics 14 (1995), pp. 727–740; Lynn Sharp Paine, “Managing
for Organizational Integrity,” Harvard Business Review 72, no. 2 (March–April 1994), pp. 106–117.
7 Emily F. Carasco and Jang B. Singh, “The Content and Focus of the Codes of Ethics of the World’s Largest
Transnational Corporations,” Business and Society Review 108, no. 1 (January 2003), pp. 71–94; Patrick E. Murphy,
“Corporate Ethics Statements: Current Status and Future Prospects,” Journal of Business Ethics 14 (1995), pp. 727–
740; John Humble, David Jackson, and Alan Thomson, “The Strategic Power of Corporate Values,” Long Range
Planning 27, no. 6 (December 1994), pp. 28–42; Mark S. Schwartz, “A Code of Ethics for Corporate Codes of Ethics,”
Journal of Business Ethics 41, no. 1–2 (November–December 2002), pp. 27-43.
8 Terrence E. Deal and Allen A. Kennedy, Corporate Cultures (Reading, MA: Addison-Wesley, 1982); Terrence E. Deal
and Allen A. Kennedy, The New Corporate Cultures: Revitalizing the Workplace after Downsizing, Mergers, and
Reengineering (Cambridge, MA: Perseus, 1999).
9 Vijay Sathe, Culture and Related Corporate Realities (Homewood, IL: Irwin, 1985).
10 Avan R. Jassawalla and Hemant C. Sashittal, “Cultures That Support Product-Innovation Processes,” Academy of
Management Executive 16, no. 3 (August 2002), pp. 42–54.
11 Kotter and Heskett, Corporate Culture and Performance, p. 5.
12 Reid and Hubbell, “Creating a Performance Culture,” pp. 1–5.
13 Jay B. Barney and Delwyn N. Clark, Resource-Based Theory: Creating and Sustaining Competitive Advantage (New
York: Oxford University Press, 2007), chap. 4.
14 Rosabeth Moss Kanter, “Transforming Giants,” Harvard Business Review 86, no. 1 (January 2008), pp. 43–52.
15 Kurt Eichenwald, Conspiracy of Fools: A True Story (New York: Broadway Books, 2005).
16 Judy D. Olian and Sara L. Rynes, “Making Total Quality Work: Aligning Organizational Processes, Performance
Measures, and Stakeholders,” Human Resource Management 30, no. 3 (Fall 1991), p. 324.
17 Larry Bossidy and Ram Charan, Confronting Reality: Doing What Matters to Get Things Right (New York: Crown
Business, 2004); Larry Bossidy and Ram Charan, Execution: The Discipline of Getting Things Done (New York: Crown
Business, 2002); John P. Kotter, “Leading Change: Why Transformation Efforts Fail,” Harvard Business Review 73, no. 2
(March–April 1995), pp. 59–67; Thomas M. Hout and John C. Carter, “Getting It Done: New Roles for Senior Executives,”
Harvard Business Review 73, no. 6 (November–December 1995), pp. 133–145; Sumantra Ghoshal and Christopher A.
Bartlett, “Changing the Role of Top Management: Beyond Structure to Processes,” Harvard Business Review 73, no. 1
(January–February 1995), pp. 86–96.
18 For a more in-depth discussion of the leader’s role in creating a results-oriented culture that nurtures success, see
Benjamin Schneider, Sarah K. Gunnarson, and Kathryn Niles-Jolly, “Creating the Climate and Culture of Success,”
Organizational Dynamics, Summer 1994, pp. 17–29.
19 Michael T. Kanazawa and Robert H. Miles, Big Ideas to Big Results (Upper Saddle River, NJ: FT Press, 2008).
20 Jeffrey Pfeffer, “Producing Sustainable Competitive Advantage through the Effective Management of People,”
Academy of Management Executive 9, no.1 (February 1995), pp. 55–69.
21 Cynthia A. Montgomery, “Putting Leadership Back into Strategy,” Harvard Business Review 86, no. 1 (January 2008),
pp. 54–60.
22 James Brian Quinn, Strategies for Change: Logical Incrementalism (Homewood, IL: Irwin, 1980).
23 Daniel Goleman, “What Makes a Leader,” Harvard Business Review 76, no. 6 (November–December 1998), pp. 92–
102; Ronald A. Heifetz and Donald L. Laurie, “The Work of Leadership,” Harvard Business Review 75, no. 1 (January–
February 1997), pp. 124–134; Charles M. Farkas and Suzy Wetlaufer, “The Ways Chief Executive Officers Lead,”
Harvard Business Review 74, no. 3 (May–June 1996), pp. 110–122; Michael E. Porter, Jay W. Lorsch, and Nitin Nohria,
“Seven Surprises for New CEOs,” Harvard Business Review 82, no. 10 (October 2004), pp. 62–72.
page C-1
PART 2 Cases in
Crafting and
Executing
Strategy
A
page C-2
CASE 1
Airbnb in 2020
Copyright ©2021 by John D. Varlaro and John E. Gamble. All rights reserved.
John D. Varlaro
Johnson & Wales University
John E. Gamble
Texas A&M University-Corpus Christi
irbnb was started in 2008 when Brian Chesky and a friend decided to
rent their apartment to guests for a local convention. To accommodate
the guests, they used air mattresses and referred to it as the “Air Bed &
Breakfast.” It was that weekend when the idea—and the potential viability—
of a peer-to-peer room-sharing business model was born. During its 12-year
existence, Airbnb has experienced immense growth and success. With a
planned IPO at some point during 2020, Airbnb had been in a strong position
to continue revolutionizing the hotel and tourism industry through its
business model that allowed hosts to offer spare rooms or entire homes to
potential guests in a peer-reviewed digital marketplace; yet, a global
pandemic in the first half of 2020 seemed ready to derail Airbnb’s success.
In 2018, the room-sharing company was in approximately 190 countries
with more than 4 million listed properties and had an estimated valuation of
$31 billion. By 2020, Airbnb had entered over 220 countries with more than
7 million locations. Airbnb’s business model has been successful by
page C-3
leveraging what is known as the sharing economy. As it grew, however,
Airbnb’s business model was met with resistance. City officials and owners
and operators of hotels, motels, and bed and breakfasts complained that,
unlike traditional brick-and-mortar establishments that were subject to
regulations and taxation, Airbnb hosts were able to circumvent and avoid
such liabilities due to participation in Airbnb’s digital marketplace. In other
instances, Airbnb hosts had encountered legal issues due to city and state
ordinances governing hotels and apartment leases. Yet, an existential crisis
for Airbnb now loomed due to the spread of the coronavirus (COVID-19).
Many hosts were using Airbnb revenue to either subsidize their mortgage
payments or had purchased properties that depended solely on the revenue
driven through booked accommodations. As people across the world
sheltered in-place and travel restrictions were implemented to mitigate the
spread of COVID-19, Airbnb and its hosts were left to navigate an uncertain
travel and accommodation market with a business model that depends on
everyday people sharing their own, at times, private homes.
OVERVIEW OF ACCOMMODATION MARKET
Hotels, motels, and bed and breakfasts competed within the larger, tourist
accommodation market. All businesses operating within this sector offered
lodging but were differentiated by their amenities. Hotels and motels were
defined as larger facilities accommodating guests in single or multiple
rooms. Motels specifically offered smaller rooms with direct parking lot
access from the unit and amenities such as laundry facilities to travelers who
were using their own transportation. Motels might also be located closer to
roadways, providing guests quicker and more convenient access to
highways. It was also not uncommon for motel guests to segment a longer
road trip as they commuted to a vacation destination, thereby potentially
staying at several motels during their travel. Hotels, however, invested
heavily in additional amenities as they competed for all segments of
travelers. Amenities, including on-premise spa facilities and fine
dining, were often offered by the hotel. Further, properties offering
spectacular views, bolstering a hotel as the vacation destination, may
contribute to significant operating costs. In total, wages, property, and
utilities, as well as purchases such as food, accounted for 78 percent of the
12%
industry’s total costs—see Exhibit 1. The primary market segments of hotels
and motels are presented in Exhibit 2.
EXHIBIT 1 Hotel, Motel, and Bed & Breakfast Industry
Estimated Costs as Percentage of Revenue, 2020
Costs Hotels/Motels Bed &Breakfasts
Wages 26% 28%
Purchases 18% 12%
Depreciation 9% 5%
Marketing 2% 2%
Rent and
Utilities 7% 10%
Other 27% 40%
Source: www.ibisworld.com.
EXHIBIT 2 Major Market Segments for Hotels/Motels in the
US, 2020
Market Segment Hotels
Recreation 70%*
Business 18%
Other,
including
meetings
Total 100%
*17% of recreational travel within the US was attributed to international travelers.
Source: www.ibisworld.com.
Bed and breakfasts, however, were much smaller, usually where owner-
operators offered a couple of rooms within their own home to accommodate
guests. The environment of the bed and breakfast—one of a cozy, home-like
ambiance—was what the guest desired when booking a room. Contrasted
with the hotel or motel, a bed and breakfast offered a more personalized,
quieter atmosphere. Further, many bed and breakfast establishments were in
http://www.ibisworld.com/
http://www.ibisworld.com/
page C-4
rural areas where the investment to establish a larger hotel may have been
cost prohibitive, yet the location itself could be an attraction to tourists. In
these areas individuals invested in a home and property, possibly with a
historical background, to offer a bed and breakfast with great allure and
ambience for the guests’ experiences. Thus, the bed and breakfast competed
through offering an ambiance associated with a more rural, slower pace
through which travelers connected with their hosts and the surrounding
community.
While differing in size and target consumer, all hotels, motels, and bed
and breakfasts were subject to city, state, and federal regulations. These
regulations covered areas such as the physical property and food safety,
access for persons with disabilities, and even alcohol distribution. Owners
and operators were subject to paying fees for different licenses to operate.
Due to operating as a business, these properties and the associated revenues
were also subject to state and federal taxation.
In addition to regulations, the need to construct physical locations
prevented hotels and motels from expanding quickly, especially in new
international markets. Larger chains tended to expand by purchasing pre-
existing physical locations or through mergers and acquisitions, such as
Marriott International Inc.’s acquisition of Starwood Hotels and Resorts
Worldwide in 2016.
A BUSINESS MODEL FOR THE SHARING,
HEALTHY ECONOMY
Startup companies have been functioning in a space commonly referred to as
the “sharing economy” for several years. According to Chesky, the previous
model for the economy was based on ownership.1 Thus, operating a business
first necessitated ownership of the assets required to do business. Any spare
capacity the business faced—either within production or service—was a
direct result of the purchase of hard assets in the daily activity of conducting
business.
Airbnb and other similar companies, however, operated
through offering a technological platform, where individuals
with spare capacity could offer their services. By leveraging the ubiquitous
usage of smartphones and the continual decrease in technology costs, these
companies provided a platform for individuals to instantly share a number of
resources. Thus, a homeowner with a spare room could offer it for rent, or
the car owner with spare time could offer his or her services a couple of
nights a week as a taxi service. The individual simply signed up through the
platform and began to offer the service or resource. The company then
charged a small transaction fee as the service between both users was
facilitated.
Within its business model, Airbnb received a percentage of what the host
received for the room. For Airbnb, its revenues were decoupled from the
considerable operating expenses of traditional lodging establishments and
provided it with significantly smaller operating costs than hotels, motels, and
bed and breakfasts. Rather than expenses related to owning and operating
real estate properties, Airbnb’s expenses were that of a technology company.
Airbnb’s business model, therefore, was based on the revenue-cost-margin
structure of an online marketplace, rather than a lodging establishment. With
an estimated 11 percent fee per room stay, it was reported that Airbnb
achieved profitability for a first time in 2016,2 and in 2017 Airbnb
announced in an annual investors’ meeting that the company had recorded
nearly $3 billion in revenue and earned over $90 million in profit.3
A CHANGE IN THE CONSUMER EXPERIENCE
Airbnb, however, had not just been leveraging technology. It had also
leveraged the change in how the current consumer interacted with
businesses. In conjunction with this change seemed to be how the consumer
had deemphasized ownership. Instead of focusing on ownership, consumers
seemed to prefer sharing or renting. Other startup companies have been
targeting these segments through subscription-based services and on-demand
help. From luxury watches to clothing, experiencing—and not owning—
assets seemed to be on the rise. Citing a more experiential-based economy,
Chesky believed Airbnb guests desired a community and a closer
relationship with the host—and there seemed to be support for this
assertion.4 A recent Goldman Sachs study showed that, once someone used
Airbnb, their preference for a traditional accommodation was greatly
reduced.5 The appeal of the company’s value proposition with customers had
allowed it to readily raise capital to support its growth, including an $850
page C-5
million cash infusion in 2016 that raised its estimated valuation to $30
billion. A comparison of Airbnb’s 2018 and 2020 estimated market
capitalization to the world’s largest hoteliers is presented in Exhibit 3.
EXHIBIT 3 Market Capitalization Comparison, 2018 to 2020
(in billions)
Competitor
Market
Capitalization,
2018
Market
Capitalization,
2020
Marriot
International
Inc.
$49 $29
Airbnb $31 $26
Hilton
Worldwide
Holdings.
$25 $21
Intercontinental
Hotels Group $11 $ 8
Source: Yahoo Finance (accessed April 2018 and May 2020); “Airbnb Announces It Won’t
Go Public in 2018,” Business Insider, http://www.businessinsider.com/airbnb-announces-
it-wont-go-public-in-2018-2018-2 (accessed April 20, 2018); “Airbnb Raises $1 Billion to
Stockpile Cash in Pandemic,” The New York Times,
(accessed May 21, 2020).
Recognizing this shift in consumer preference, traditional brick-and-
mortar operators responded. Hilton was considering offering a hostel-like
option to travelers.6 Other entrepreneurs were constructing urban properties
to specifically leverage Airbnb’s platform and offer rooms only to Airbnb
users, such as in Japan7 where rent and hotel costs were extremely high.
To govern the community of hosts and guests, Airbnb instituted a rating
system. Popularized by companies such as Amazon, eBay, and Yelp, peer-to-
peer ratings helped police quality. Both guests and hosts rated each other in
Airbnb. This approach incentivized hosts to provide quality service, while
encouraging guests to leave a property as they found it. Further, the peer-to-
peer rating system greatly minimized the otherwise significant
task and expense of Airbnb employees assessing and rating each
individual participant within Airbnb’s platform.
http://www.businessinsider.com/airbnb-announces-it-wont-go-public-in-2018-2018-2
NOT PLAYING BY THE SAME RULES
Local and global businesses criticized Airbnb for what they claimed were
unfair business practices and lobbied lawmakers to force the company to
comply with lodging regulations. These concerns illuminated how, due to its
business model, Airbnb and its users seemed not to abide by these same
regulations. This could have been concerning on many levels. For the guest,
regulations exist for protection from unsafe accommodations. Fire codes and
occupation limits all exist to prevent injury and death. Laws also exist to
prevent discrimination, as traditional brick-and-mortar accommodations are
barred from not providing lodging to guests based on race and other
protected classes, but there seemed to be evidence that Airbnb guests had
faced such discrimination from hosts.8
Hosts might also expose themselves to legal and financial problems from
accommodating guests. There had been stories of hosts needing to evict
guests who would not leave, and, due to local ordinances, the guests were
actually protected as apartment lessees. Other stories highlighted rooms and
homes being damaged by huge parties given by Airbnb guests. Hosts might
also be exposed to liability issues in the instance of an injury or even a death
of a guest.
Finally, there were accusations of businesses using Airbnb’s marketplace
to own and operate accommodations without obtaining the proper licenses.
These locations appeared to be individuals on the surface but were actually
businesses. And, because of Airbnb’s platform, these pseudo-businesses
could operate and generate revenue without meeting regulations or claiming
revenues for taxation.
Airbnb continued to respond to some of these issues. Airbnb released a
report in 2015 detailing both discrimination on its platform and how it would
be mitigated. Airbnb also settled its lawsuit with San Francisco in early
2017. The city was demanding Airbnb enforce a city regulation requiring
host registration or incur significant fines. As part of the settlement, Airbnb
agreed to offer more information on its hosts within the city.9 And in 2018,
Airbnb began partnering with local municipalities to help collect taxes
automatically for rentals within their jurisdictions, helping to potentially
recoup millions in lost tax revenue.10, 11
page C-6
Recognizing that countries and local municipalities were responding to
the local business owner and their constituents’ concerns, Chesky and
Airbnb had focused on mobilizing and advocating for consumers and
business owners who utilize the app. Airbnb’s website provided support for
guests and hosts who wished to advocate for the site. A focal point of the
advocacy emphasized how those particularly hit hard at the height of the
recession in 2009 relied on Airbnb to establish a revenue stream and prevent
the inevitable foreclosure and bankruptcy. “We wish to be regulated; this
would legitimize us,” Chesky remarked to Trevor Noah in an interview on
The Daily Show.12
A BUSINESS MODEL FOR THE COVID
ECONOMY
In 2019, Airbnb finally announced that the long-awaited IPO would occur
during 2020, and Airbnb’s revenues were estimated to reach over $2 billion
—see Exhibit 4. However, Airbnb dampened expectations with the
announcement that it had experienced a net loss of over $300
million through September 2019 due to increases in operating costs.13 Then,
in the spring of 2020, the pandemic and efforts by the subsequent state and
local governments to stop the spread of COVID-19 presented a significant
threat to Airbnb and its business model. Instead of preparing for the IPO,
Airbnb had to raise $2 billion in private equity funding and debt to support
operations during the pandemic.14, 15 And in May 2020, Airbnb announced
1900 employees, or about one quarter of the workforce, would be let go.16
EXHIBIT 4 Airbnb Estimated Revenue and Bookings
Growth, 2010–2020 (in millions)
Source: Ali Rafat, “Airbnb’s Revenues Will Cross Half Billion Mark in 2015,” Analysts
Estimate, March 25, 2015, skift.com/2015/03/25/airbnbs-revenues-will-cross-half-billion-
http://skift.com/2015/03/25/airbnbs-revenues-will-cross-half-billion-mark-in-2015-analysts-estimate/
mark-in-2015-analysts-estimate/ (accessed May 21, 2020).
Quickly, Airbnb tried to adjust its business operations. As guests cancelled
their stays with hosts, Airbnb adjusted its cancellation policy. Normally,
hosts had discretion over how to handle cancellations. Due to travel
restrictions imposed by state and local governments, guests were forced to
cancel their stays. Yet some hosts were still charging these guests based on
their own cancellation policies. In response, Airbnb adjusted the policy by
offering refunds for reservations made prior to March 14, 2020, through the
end of June 2020.
Airbnb also offered safety and cleaning guidelines for its hosts. Given the
nature of the pandemic, it had become paramount to ensure cleanliness. A
guest or a host contracting COVID-19 due to an Airbnb stay could most
certainly make people reluctant to use Airbnb in the future.
For the hosts, however, the loss of the revenue streams seemed to be the
most immediate problem. Many hosts depended on their revenue from
rentals to afford the properties they owned, either as private homes or as
short-term rental properties. Over the years, many hosts had built their
finances around the anticipated revenue from guests. Since the pandemic
began, some hosts reported they had experienced monetary losses in the tens
of thousands of dollars. To support hosts, Airbnb established a $17 million
fund to help support hosts that had acquired long-term status with Airbnb.17
To confront the challenges of the pandemic, Airbnb expanded its sharing-
economy model by entering the “Online Experiences” market. Virtual
experiences, such as cigar tastings and virtual guided tours of cities were all
being offered for patrons to book and experience from their own home–
whether or not they were under stay-at-home orders. It was clear that in
2020, if Airbnb was going to successfully navigate the pandemic, it would
have to consider what else people may be willing to share, albeit virtually, in
a pandemic economy.
ENDNOTES
1 Interview with Airbnb founder and CEO Brian Chesky, The Daily Show with Trevor Noah, Comedy Central, February
24, 2016.
2 B. Stone and O. Zaleski, “Airbnb Enters the Land of Profitability,” Bloomberg, January 26, 2017,
https://www.bloomberg.com/news/articles/2017-01-26/airbnb-enters-the-land-of-profitability (accessed June 20,
2017).
http://skift.com/2015/03/25/airbnbs-revenues-will-cross-half-billion-mark-in-2015-analysts-estimate/
https://www.bloomberg.com/news/articles/2017-01-26/airbnb-enters-the-land-of-profitability
3 O. Zaleski, “Inside Airbnb’s Battle to Stay Private,” Bloomberg.Com, February 6, 2018,
https://www.bloomberg.com/news/articles/2018-02-06/inside-airbnb-s-battle-to-stay-private (accessed April 20,
2018).
4 Interview with Airbnb founder and CEO Brian Chesky, The Daily Show with Trevor Noah, Comedy Central, February
24, 2016.
5 J. Verhage, “Goldman Sachs: More and More People Who Use Airbnb Don’t Want to Go Back to Hotels,” Bloomberg,
February 26, 2016, www.bloomberg.com/news/articles/2016-02-16/goldman-sachs-more-and-more-people-who-
use-airbnb-don-t-want-to-go-back-to-hotels.
6 D. Fahmy, “Millennials Spending Power Has Hilton Weighing a ‘Hostel-Like’ Brand,” March 8, 2016, Bloomberg
Businessweek, www.bloomberg.com/businessweek.
7 Y. Nakamura and M. Takahashi, “Airbnb Faces Major Threat in Japan, Its Fastest-Growing Market,” Bloomberg,
February 18, 2016, www.bloomberg.com/news/articles/2016-02-18/fastest-growing-airbnb-market-under-threat-
as-japan-cracks-down.
8 R. Greenfield, “Study Finds Racial Discrimination by Airbnb Hosts,” Bloomberg, December 10, 2015,
www.bloomberg.com/news/articles/2015-12-10/study-finds-racial-discrimination-by-airbnb-hosts.
9 K. Benner, “Airbnb Adopts Rules to Fight Discrimination by Its Hosts,” New York Times, (September 8, 2016)
http://www.nytimes.com/2016/09/09/technology/airbnb-anti-discrimination-rules.html (accessed June 20, 2017).
10 S. Cameron, “New TN Agreement Ensures $13M in Airbnb Rental Taxes Collected,” wjhl.com, April 20, 2018,
http://www.wjhl.com/local/new-tn-agreement-ensures-13m-in-airbnb-rental-taxes-collected/1131192392
(accessed April 20, 2018).
11 “Duluth, Airbnb Make Deal on Lodging Tax Collection,” TwinCitiesPioneerPress, April 19, 2018,
https://www.twincities.com/2018/04/19/duluth-airbnb-make-deal-on-lodging-tax-collection/ (accessed April 20,
2018).
12 Interview with Airbnb founder and CEO Brian Chesky, The Daily Show with Trevor Noah, Comedy Central, February
24, 2016.
13 J. Eaglesham, M. Farrell, & K. Grind. “Airbnb Swings to a Loss as Costs Climb Ahead of IPO,” The Wall Street
Journal, https://www.wsj.com/articles/airbnb-swings-to-a-loss-as-costs-climb-ahead-of-ipo-11581443123
(accessed May 21, 2020).
14 E. Griffith. “Airbnb Raises $1 Billion to Stockpile Cash in Pandemic,” The New York Times, April 6, 2020,
https://www.nytimes.com/2020/04/06/technology/airbnb-coronavirus-valuation.html (accessed May 21, 2020).
15 E. Wollman. “Airbnb Gets $1 Billion Loan, Bringing Coronavirus Funding to $2 Billion,” The Wall Street Journal, April
15, 2020, https://www.wsj.com/articles/airbnb-gets-1-billion-loan-bringing-coronavirus-funding-to-2-billion-
11586929819?mod=article_inline (accessed May 21, 2020).
16 D. Bosa, & S. Rodriguez. “Airbnb to lay off nearly 1,900 people, 25% of company,” CNBC, May 5, 2020,
https://www.cnbc.com/2020/05/05/airbnb-to-lay-off-nearly-1900-people-25percent-of-company.html (accessed
May 21, 2020).
17 T. Mickle, & P. Rana. “A Bargain with the Devil–Bill Comes Due for Overextended Airbnb Hosts,” The Wall Street
Journal, April 28, 2020, https://www.wsj.com/articles/a-bargain-with-the-devilbill-comes-due-for-overextended-
airbnb-hosts-11588083336 (accessed May 21, 2020).
http://bloomberg.com/
https://www.bloomberg.com/news/articles/2018-02-06/inside-airbnb-s-battle-to-stay-private
http://www.bloomberg.com/news/articles/2016-02-16/goldman-sachs-more-and-more-people-who-use-airbnb-don-t-want-to-go-back-to-hotels
http://www.bloomberg.com/businessweek
http://www.bloomberg.com/news/articles/2016-02-18/fastest-growing-airbnb-market-under-threat-as-japan-cracks-down
http://www.bloomberg.com/news/articles/2015-12-10/study-finds-racial-discrimination-by-airbnb-hosts
http://wjhl.com/
http://www.wjhl.com/local/new-tn-agreement-ensures-13m-in-airbnb-rental-taxes-collected/1131192392
https://www.wsj.com/articles/airbnb-swings-to-a-loss-as-costs-climb-ahead-of-ipo-11581443123
https://www.wsj.com/articles/airbnb-gets-1-billion-loan-bringing-coronavirus-funding-to-2-billion-11586929819?mod=article_inline
https://www.cnbc.com/2020/05/05/airbnb-to-lay-off-nearly-1900-people-25percent-of-company.html
https://www.wsj.com/articles/a-bargain-with-the-devilbill-comes-due-for-overextended-airbnb-hosts-11588083336
L
page C-7
CASE 2
Competition in the Craft Beer
Industry in 2020
Copyright ©2021 by John D. Varlaro and John E. Gamble. All rights reserved.
John D. Varlaro
Johnson & Wales University
John E. Gamble
Texas A&M University–Corpus Christi
ocally produced or regional craft beers caused a seismic shift in the U.S.
beer industry during the early 2010s with the gains of the small, regional
newcomers coming at the expense of such well-known brands as Budweiser,
Miller, Coors, and Bud Light. Craft breweries, which by definition sold
fewer than 6 million barrels (bbls) per year, expanded rapidly with the
deregulation of intrastate alcohol distribution and retail laws and a change in
consumer preferences toward unique and high-quality beers. The growing
popularity of craft beers led to an approximate four percent annualized rate
of growth in industry revenue between 2015 and 2020.1
Despite the continued growth in craft beer popularity, the overall beer
industry remained flat in 2019 with total beer sales dropping by almost two
percent in the United States.2 The craft beer industry, too, had begun to show
signs of a slowdown going into 2020. Annual growth for the next five years
was projected to be a little over two percent; approximately half of what it
had been for the past five years.3 Part of the slowdown was due to shifting
consumer trends away from beer and towards lower calorie alternatives,
such as hard seltzers, or even abstaining from alcohol completely. Still, there
did not seem to be a slowdown in the number of new craft brewers entering
the market. In addition, consolidation continued. Led most notably by AB
InBev’s acquisition of several craft breweries, Grupo Modelo, and its
acquisition of SABMiller—macrobrewers were continuing to battle for the
craft beer market share. Established craft brewers responded in kind, as
Boston Beer Company Inc. acquired Dogfish Head Brewery.
Yet, the most pressing threat to craft brewers may not have been
competition, but the coronavirus (COVID-19). Beginning in early 2020,
COVID-19 spread across the world, leading governments to restrict travel
and to order citizens to remain at home to try to contain the spread of the
virus. Within the United States, shutdowns had led to over 40 states
experiencing record-setting unemployment rates.4 For the small, local craft
brewers who relied on local bars, tasting events, and other intimate settings
to drive awareness and revenue, COVID-19 and social distancing could be
the biggest threat in 2020.
THE BEER MARKET
The total economic impact of the beer market was estimated to be almost 2.0
percent of total U.S. GDP in 2018.5 Total revenue for the craft beer industry
was estimated at almost $8 billion in 20206, up almost $2 billion from $6
billion in 2017.7 Exhibit 1 presents annual per production statistics for the
United States between 2006 and 2019.
Although U.S. production had declined since 2008, consumption was
increasing elsewhere in the world, resulting in a forecasted global market of
over $700 billion in sales by 2022.8 Global growth seemed to be fueled by
the introduction of differing styles of beer to regions where consumers had
not previously had access and the expansion of demographics not normally
known for consuming beer. Thus, exported beer to both developed and
developing regions helped drive future growth. As an example, China
recently saw a number of domestic craft breweries producing beer as well as
page C-8experimenting with locally and regionally known flavors,
enticing the domestic palette with flavors such as green tea.
EXHIBIT 1 Barrels of Beer Produced in the United States,
2006–2019 (millions of barrels)
Year Barrels produced (in millions)*
2006 198
2007 200
2008 200
2009 197
2010 195
2011 193
2012 196
2013 192
2014 193
2015 191
2016 190
2017 186
2018 183
2019 180
*Rounded to the nearest million.
Source: Alcohol and Tobacco Tax and Trade Bureau website
The Brewers Association, a trade association for brewers, suppliers, and
others within the industry, designated a brewery as a craft brewer when
output was less than 6 million barrels annually and the ownership was more
than 75 percent independent of another non-craft beer producer or entity.
The rapid increase in popularity for local beers led to the number of U.S.
brewers to reach over 8,000 in 2019—nearly quadruple the number in 2012.9
Of these breweries, 99 percent were identified as craft breweries with
distribution ranging from local to national. While large global breweries
occupied the top positions among the largest U.S. breweries, three craft
breweries were ranked among the top-10 largest U.S. brewers in 2019—see
page C-9Exhibit 2. Exhibit 3 shows the production volume of the 10
largest beer producers worldwide from 2014 to 2018. The
number of craft breweries in each U.S. state in 2015, 2017, and 2019 are
presented in Exhibit 4.
EXHIBIT 2 Top 10 U.S. Breweries in 2019
Rank Brewery
1 Anheuser-Busch, Inc
2 MolsonCoors
3 Constellation
4 Heineken USA
5 Pabst Brewing Company
6 Diageo
7 D.G. Yuengling
8 FIFCO USA
9 Boston Beer Company
10 Sierra Nevada BrewingCompany
Source: Brewers Association.
EXHIBIT 3 Top 10 Global Beer Producers by Volume, 2014–
2018 (millions of barrels)*
* Originally reported as hectoliters. Computed using 1 hL = .852 barrel for comparison; to
nearest million bbl.
** Now includes SABMiller; previous volumes for SABMiller in years 2014 and 2015 prior to
acquisition were 249 and 353, respectively, ranking it as second for both years.
*** Not in top 10 for years with N/A.
N/A: Not available.
Source: AB InBev 20-F SEC Document, 2015, 2016, 2017, 2018, 2019.
EXHIBIT 4 Number of Craft Brewers by State, 2015, 2017 &
2019
State 2015 2017 2019
Alabama 24 34 51
Alaska 27 36 45
Arizona 78 96 127
Arkansas 26 35 42
California 518 764 907
Colorado 284 348 425
Connecticut 35 60 104
Delaware 15 21 27
Florida 151 243 329
Georgia 45 69 111
Hawaii 13 18 24
Idaho 50 54 73
Illinois 157 200 284
Indiana 115 137 192
Iowa 58 76 105
Kansas 26 36 59
Kentucky 24 52 69
Louisiana 20 33 40
Maine 59 99 133
Maryland 60 73 112
Massachusetts 84 129 175
Michigan 205 330 400
Minnesota 105 158 196
State 2015 2017 2019
Mississippi 8 12 14
Missouri 71 91 140
Montana 49 75 92
Nebraska 33 49 55
Nevada 34 40 45
New Hampshire 44 58 91
New Jersey 51 90 127
New Mexico 45 67 94
New York 208 329 423
North Carolina 161 257 333
North Dakota 9 12 22
Ohio 143 225 311
Oklahoma 14 27 55
Oregon 228 266 311
Pennsylvania 178 282 401
Rhode Island 14 17 33
South Carolina 36 61 88
South Dakota 14 16 33
Tennessee 52 82 108
Texas 189 251 341
Utah 22 30 42
Vermont 44 55 68
Virginia 124 190 290
Washington 305 369 423
West Virginia 12 23 28
Wisconsin 121 160 205
Wyoming 23 24 41
Source: Brewers Association.
THE BEER PRODUCTION PROCESS
page C-10
The beer production process involves the fermentation of grains. The cereal
grain barley is the most common grain used in the production of beer. Before
fermentation, however, barley must be malted and milled. Malting allows the
barley to germinate and produce the sugars that would be fermented by the
yeast, yielding the sweetness of beer. By soaking the barley in water, the
barley germinates, or grows, as it would when planted in the ground. This
process is halted through the introduction of hot air and drying after
germination has begun.
After malting, the barley is milled to break open the husk while also
cracking the inner seed that has begun to germinate. Once milled, the barley
is mashed, or added to hot water. The addition of the hot water produces
sugar from the grain. This mixture is then filtered, resulting in the wort. The
wort is then boiled, which sterilizes the beer. It is at this stage that hops are
added. The taste and aroma of beer depend on the variety of hops and when
the hops were added.
After boiling, the wort is cooled and then poured into the fermenter, where
yeast is added. The sugar created in the previous stages is broken down by
the yeast through fermentation. The different styles of beer depend on the
type of yeast used, typically either an ale or lager yeast. The time for this
process could take a couple of weeks to a couple of months. After
fermentation, the yeast is removed. The process is completed after carbon
dioxide is added and the product is packaged.
Beer is a varied and differentiated product, with over 70
styles in 15 categories. Each style is dependent on a number of variables.
These variables are controlled by the brewer through the process, and could
include the origin of raw materials, approach to fermentation, and yeast
used. For example, Guinness referenced on its website how barley purchased
by the brewer was not only grown locally, but was also toasted specifically
after malting, lending to its characteristic taste and color. As another
example of differentiation through raw materials, wheat beers, such as
German-style hefeweizen, are brewed with a minimum of 50 percent wheat
instead of barley grain.
DEVELOPMENT OF MICROBREWERIES AND
ECONOMICS OF SCALE
Although learning the art of brewing takes time, beer production lends itself
to scalability and variety. For example, an amateur, or home brewer, could
brew beer for home consumption. There had been a significant increase in
the interest in homebrewing, with over 1 million people pursuing the hobby
in 2017.10 It was also not uncommon for a home brewer to venture into
entrepreneurship and begin brewing for commercial sales. However, beer
production was highly labor intensive with much of the work done by hand.
A certain level of production volume was necessary to achieve breakeven
and make the micro-brewery a successful commercial operation.
A small nanobrewery may brew a variety of flavor experiences and
compete in niche markets, while the macrobrewery may focus on economies
of scale and mass produce one style of beer. Both may attract consumers
across segments and were attributed to the easily scalable yet highly variable
process of brewing beer. In contrast, a global producer such as AB InBev
could produce beer for millions of consumers worldwide with factory-
automated processes.
LEGAL ENVIRONMENT OF BREWERIES
As beer is an alcoholic beverage, the industry is subject to much regulation.
Further, these regulations can vary by state and municipality. One such
regulation was regarding sales and distribution.
Distribution could be distinguished through direct sales (or self-
distribution), and two-tier and three-tier systems. Regulations permitting
direct sales allow the brewery to sell directly to the consumer. Growers,
bottle sales, and taprooms were all forms of direct, or retail, sales. There
were usually requirements concerning direct sales, including limitations on
volume sold to the consumer.
Even where self-distribution was legal, the legal volumes could be very
small and limited. Very few brewers were exempt from distributing through
wholesalers, referred to as a three-tier distribution system. And often to be
operationally viable, brewers need access to this distribution system to
generate revenue. In a three-tier system, the brewery must first sell to a
page C-11
wholesaler—the liquor or beer distributor. This distributor then sells to the
retailer, who then ultimately sells to the consumer.
This distribution structure, however, had ramifications for the consumer,
as much of what was available at retail outlets and restaurants were impacted
by the distributor. This was further impacted by whether a brewery bottles or
cans its beer or distributes through kegs. While restaurants and bars could
carry kegs, retail shelves at a local liquor store needed to have cans and
bottles, as a relatively small number of consumers could accommodate kegs
for home use. Thus, there may only be a few liquor stores or restaurants
where a consumer may find a locally-brewed beer. In states that do not allow
self-distribution or on-premise sales, distribution and exposure to consumers
could represent a barrier for breweries, especially those that were small or
new.
The Alcohol and Tobacco Tax and Trade Bureau (TTB) was the main
federal agency for regulating this industry. As another example of
regulations, breweries were required to have labels for beers approved by the
federal government, ensuring they meet advertising guidelines. In some
instances, the TTB may need to approve the formula used for brewing the
specific beer prior to the label receiving approval. Given the approval
process, and the growth of craft breweries, the length of time this takes could
reach several months. For a small, microbrewery first starting, the delay in
sales could potentially impact cash flow.
Employment law was another area impacting breweries. The Affordable
Care Act (ACA) and changes to the Fair Labor Standards Act (FLSA)
greatly affected labor cost in the industry. Where the ACA mandated health
care coverage by employers, the FLSA changed overtime rules
for employees previously classified as exempt or salaried.
Finally, many states and municipalities passed or were considering passing,
increases to minimum wage. These changes in regulations could lead to
significant increases in business costs, potentially impacting a brewery’s
ability to remain viable or competitive.
Lawsuits might also impact breweries’ operations. Trademark
infringement lawsuits regarding brewery and beer names were common.
Further, food-related lawsuits could occur. In 2017, there were potential
lawsuits against breweries distributing in California that did not meet the
May 2016 requirement of providing an additional sign warning against
pregnancy and BPA (Bisphenyl-A) consumption. BPA was commonly found
in both cans and bottle caps, and thus breweries were potentially legally
exposed, exemplifying the potential legal exposure to any brewery.
SUPPLIERS TO BREWERIES
The main suppliers to the industry were those who supply grain and hops.
Growers might sell directly to breweries or distribute through wholesalers.
Brewers who wish to produce a grain-specific beer would be required to
procure the specific grain. Further, recipes might call for a variety of grains,
including rye, wheat, and corn. As previously mentioned, the definition of
craft was changed not only to include a higher threshold for annual
production, but it also changed to not exclude producers who used other
grains, such as corn, in their production. Finally, origin-specific beers, such
as German- or Belgian-styles might also require specific grains.
The more specialized the grain or hop, the more difficult it was to obtain.
Those breweries, then, competing based on specialized brewing would be
required to identify such suppliers. Conversely, larger, global producers of
single-style beers were able to utilize economies of scale and demand lower
prices from suppliers. Organically-grown grains and hops suppliers would
also fall into this category of providing specialized ingredients, and specialty
brewers tend to use such ingredients.
Hops production within the United States grew to almost $640 million in
2019, representing an approximate 10 percent increase over 2018
production,11 which seemed to follow the growing demand due to the
increased number of breweries. Hops were grown in the Pacific Northwest
states of Idaho, Washington, and Oregon. Washington’s Yakima Valley was
probably one of the more recognizable geographic-growing regions. There
were numerous varieties of hops, however, and each contributes a different
aroma and flavor profile. Hop growers have also trademarked names and
varieties of hops. Further, as with grains, some beer-styles require specific
hops. Farmlands that were formerly known for hops have started to see a
rejuvenation of this crop, such as in New England. In other areas, farmers
were introducing hops as a new, cash crop. Some hops farms were also dual
purpose, combining the growing operations with brewing, thus serving as
both a supplier of hops to breweries while also producing their own beer for
page C-12
retail. Recent news reports, however, were citing current and future
shortages of hops due to the increased number of breweries. Rising
temperatures in Europe led to a diminished yield in 2018, further impacting
hops supplies.12 For breweries using recipes that require these specific hops,
shortages could be detrimental to production. In some instances, larger beer
producers had vertically integrated into hops farming to protect their supply.
Suppliers to the industry also include manufacturers and distributors of
brewing equipment, such as fermentation tanks and refrigeration equipment.
Purification equipment and testing tools were also necessary, given the
brewing process and the need to ensure purity and safety of the product.
Depending on distribution and the distribution channel, breweries might
need bottling or canning equipment. Thus, breweries might invest heavily in
automated bottling capabilities to expand capacity. Recently, however, there
have been shortages in the 16-ounce size of aluminum cans.
HOW BREWERIES COMPETE: INNOVATION
AND QUALITY VERSUS PRICE
The consumer might seek out a specific beer or brewery’s name or purchase
the lower-priced globally known brand. For some, beer drinking might also
be seasonal, as tastes change with the seasons. Lighter beers were consumed
in hotter months, while heavier beers were consumed in the colder months.
Consumers might associate beer styles with the time of year or season.
Oktoberfest and German-style beers were associated with fall,
following the German-traditional celebration of Oktoberfest.
Finally, any one consumer might enjoy several styles, or choose to be
brewery or brand loyal.
The brewing process and the multiple varieties and styles of beer allow for
breweries to compete across the strategy spectrum—low price and high
volume, or higher price and low volume. Industry competitors, then, might
target both price-point and differentiation. The home brewer, who decided to
invest several thousand dollars in a small space to produce very small
quantities of their beer and start a nanobrewery, might utilize a niche
competitive strategy. The consumer might patronize the brewery on location
or seek it out on tap at a restaurant given the quality and the style of beer
brewed. If allowed by law, the brewery might offer tastings or sell onsite to
visitors. Further, the nanobrewer was free to explore and experiment with
unusual flavors. To drive awareness, the brewer might enter competitions,
attend beer festivals, or host tastings and “tap takeovers” at local restaurants.
If successful, the brewer might invest in larger facilities and equipment to
increase capacity with growing demand.
The larger, more established craft brewers, especially those considered
regional breweries, might compete through marketing and distribution, while
offering a higher value compared to the mass production of macrobreweries.
However, the consumer might at times be sensitive to and desire the craft
beer experience through smaller breweries—so much so that even craft
breweries who by definition were craft might draw the ire of the consumer
due to its size and scope. Boston Beer Company was one such company.
Even though James Koch had started it as a microbrewery, pioneering the
craft beer movement in the 1980s, some craft beer consumers do not view it
as authentically craft.
Larger, macrobreweries mass produced and competed using economies of
scale and established distribution systems. Thus, low cost preserves margins
as lower price points drive volume sales. Many of these brands were sold en
masse at sporting and entertainment venues, as well as larger restaurant
chains, driving volume sales.
Companies like AB InBev possessed brands within the portfolio that were
sold under the perception of craft beer, in what Boston Beer Company deems
the better beer category—beer with a higher price point, but also of higher
quality. For example, Blue Moon, a Belgian-style wheat ale, was produced
by MillerCoors. Blue Moon’s market share had increased significantly since
2006 following the rise in craft beer popularity, competing against Boston
Beer Company’s Sam Adams in this better beer segment. AB InBev had also
acquired larger better-known craft breweries, including Goose Island, in
2011. With a product portfolio that included both low-price and premium
craft beer brands, macrobreweries were competing across the spectrum and
putting pressure on breweries within the better and craft beer segments—
segments demanding a higher price point due to production.
However, a lawsuit claimed the marketing of Blue Moon was misleading
and its marketing obscured the ownership structure. Although the case was
dismissed, it further illustrated consumer sentiment regarding what was
page C-13
perceived as craft beer. It also illustrated the power of marketing and how a
macrobrewery might position a brand within these segments.
CONSOLIDATIONS AND ACQUISITIONS
In 2015 AB InBev offered to purchase SABMiller for $108 billion, which
was approved by the European Union in May 2016 and finalized in 2016. To
allow for the acquisition, many of SABMiller’s brands were required to be
divested. Asahi Group Holdings Ltd. purchased the European brands Peroni
and Grolsch from SABMiller. Molson Coors purchased SABMiller’s 58
percent ownership in MillCoors LLC—originally a joint venture between
Molson Coors and SABMiller. This transaction provided Molson Coors 100
percent ownership of MillerCoors. It should be noted that AB InBev and
MillerCoors represented over 80 percent of the beer produced in the United
States for domestic consumption. AB InBev had also actively acquired other
brands and breweries since the 1990s, including Labatt in 1995, Beck’s in
2002, Anheuser-Bush in 2008, and Grupo Modelo in 2013.
Purchases of craft breweries by larger companies had also increased
during the 2010s. AB InBev had purchased numerous craft breweries since
2011, including Goose Island, Blue Point and Devil’s Backbone Brewing.
MillerCoors—whose brands already included Killian’s Irish Red,
Leinenkugel’s, and Foster’s—acquired Saint Archer Brewing
Company. Ballast Point Brewing & Spirits was acquired by
Constellations Brands. Finally, Heineken NV purchased a stake in Lagunitas
Brewing Company.
In May 2019, Boston Beer Company acquired Dogfish Head Brewery.
Founded in 1995 by Sam and Mariah Calagione as Delaware’s first brewpub,
Dogfish Head Brewery was also America’s smallest brewery at the time.13
Since its founding, Dogfish Head Brewery had become one of the best-
known craft breweries in the United States. The acquisition by Boston Beer
Company may have been a response to the macrobreweries push into craft
beer. It would seem that craft beer and breweries had not only gained the
attention of the consumer, but also the larger multinational breweries and
corporations. Craft brewers, however, seemed to be taking a page out of the
macrobreweries’ playbook by establishing larger companies that could
harness economies of scale, while maintaining the smaller, more intimate
brand presence in the market.
PROFILES OF BEER PRODUCERS
Anheuser-Busch InBev
As the world’s largest producer by volume, AB InBev had 170,000
employees globally. The product portfolio included the production,
marketing, and distribution of over 500 beers, malt beverages, as well as soft
drinks in more than 150 countries. These brands included Budweiser, Stella
Artois, Leffe, and Hoegaarden.
AB InBev managed its product portfolio through three tiers. Global
brands, such as Budweiser, Stella Artois, and Corona, were distributed
throughout the world. International brands (Beck’s, Hoegaarden, Leffe) were
found in multiple countries. Local champions (i.e., local brands) represented
regional or domestic brands acquired by AB InBev, such as Goose Island in
the United States and Cass in South Korea. While some of the local brands
were found in different countries, it was due to geographic proximity and the
potential to grow the brand larger.
AB InBev reported its 2019 revenues grew four percent, with its largest
growth in revenue experienced in the Middle Americas (7.2 percent) and
South America (9.0 percent).14 Its strength in brand recognition and focused
marketing drove its global brands to grow by almost 10 percent outside their
respective domestic markets. AB InBev had been focused on growing these
brands outside of their respective home markets since 2017.
Consumer preferences towards lower calorie alcoholic beverages had
bolstered the market share of the Michelob Ultra and Michelob Ultra Pure
Gold brands within the United States. AB InBev, however, reported that
overall market share within the United States had declined due to the change
in consumer preference for hard seltzers. In response, Natural Light Seltzer
was launched during August of 2019 in North America featuring two
flavors, “Catalina Lime Mixer” and Aloha Beaches.” Bud Light Seltzer was
also launched in 2019. Pursuing the flavored malt beverage (FMB) trend,
AB InBev had launched Skol Puro Malte in South American early 2019. AB
InBev, however, also experienced success within the U.S. craft beer market
as its craft portfolio within the United States grew more than 20 percent in
2019.
AB InBev invested heavily in sponsorships to bolster marketing and brand
recognition globally. In pursuing the craft beer market outside the United
States, AB InBev’s Camden Town Brewery was the official beer partner in
the United Kingdom and Ireland for Arsenal FC™. Non-craft beer brands
continued to be heavily marketed as well. Budweiser would be a sponsor for
the 2022 FIFA World Cup™, as it had been for the 2014 and 2018
competitions. Bud Light would be the official sponsor of the National
Football League through 2022, as AB InBev had paid $1.4 billion for the
sponsorship.15
Acquisitions provided AB InBev greater market share and penetration
through combining marketing and operations to all brands. The reacquisition
of the Oriental Brewery in 2014 was a good example of the potential
synergies garnered. Cass was the leading beer in Korea and was produced by
Oriental Brewery; however, while Cass represented the local brand for AB
InBev in Korea, Hoegaarden was distributed in Korea along with the global
brands of Budweiser, Corona, and Stella Artois. These acquisitions also
allowed AB InBev to scale-up craft beer, hard seltzer, and other products
within their portfolio from locally-recognized beverages to regional and
globally-recognized brands.
A summary of AB InBev’s financial performance from 2016 to 2019 is
presented in Exhibit 5.
EXHIBIT 5 Financial Summary for AB InBev, 2016–2019 (in
millions of $)
Source: AB InBev Annual Reports, 2017, 2019.
page C-14
Boston Beer Company
Boston Beer Company was the second largest craft brewer by volume in the
United States16 and reported sales of more than 5 million barrels in 2019.
The company had experienced a revenue decline in 2017, but experienced
increases in both 2018 and 2019. Most notably, 2019 shipment volume had
increased by approximately 24 percent from 2018, driven by both the
acquisition of Dogfish Head in 2019, and Boston Beer’s ‘Beyond Beer’
portfolio of hard seltzers and teas, which had been launched as early as 2001
with the Twisted Tea brand. Boston Beer had dropped from the fifth largest
overall brewer in the United States in 2015 to ninth in 2017, but remained in
that position through 2019—see Exhibit 2.
The company history states the recipe for Sam Adams was actually
company founder Jim Koch’s great-great-grandfather’s recipe. The story of
Boston Beer Company and Jim Koch’s success was referenced at times as
the beginning of the craft beer movement, often citing how Koch originally
sold his beer to bars with the beer and pitching on the spot.
This beginning seemed to underpin much of Boston Beer Company’s
strategy as it competed in the higher value and higher price point category it
refers to as the better beer segment. Focusing on quality and taste, Boston
Beer Company marketed Samuel Adams Boston Lager as the original beer
Koch first discovered. The company also produced several Sam Adams
seasonal beers, such as Sam Adams Summer Ale and Sam Adams
Octoberfest. Other seasonal Sam Adams beers have limited release in
seasonal variety packs, including Samuel Adams Harvest Pumpkin and
Samuel Adams Holiday Porter. In addition, there was also a Samuel Adams
Brewmaster’s Collection, a much smaller, limited release set of beers at
much higher points, including the Small Batch Collection and Barrel Room
Collection. Utopia—its highest priced beer—was branded as highly
experimental and under very limited release. In the spirit of craft beer and
innovation, Boston Beer Company launched a craft brew incubator,
Alchemy and Science.
This history also seems to have been the impetus for the acquisition of
Dogfish Head Brewery, as both Boston Beer Company and Dogfish Head
page C-15
Brewery pride themselves as innovators and champions within the
industry.17 Both represented a formidable share of the craft beer market in
the United States in 2019, as Boston Beer Company was ranked second,
while Dogfish Head was ranked 13th among craft brewing companies.18
Boston Beer Company offered three non-beer brands. The Twisted Tea
brand was launched in 2001, and the Angry Orchard originated in 2011.
Truly Spiked & Sparkling is a percent alcohol sparkling water launched in
2016. As these other brands and products compete in the FMB and hard
cider categories, Boston Beer Company was well positioned to compete for
the changing consumer preferences during 2019.
A summary of Boston Brewing Company’s financial performance from
2016 to 2019 is presented in Exhibit 6.
EXHIBIT 6 Financial Summary for Boston Brewing
Company, 2016–2019 (in thousands of $)
Source: Boston Beer Company Annual Report, 2019.
Craft Brew Alliance
Craft Brew Alliance was ranked thirteenth for overall brewing by volume in
2019.19 Founded in 2008, it resulted from the mergers between
Redhook Brewery, Widmer Brothers Brewing, and Kona Brewing
Company. Each with substantial history, the decision to merge was to help
assist with growth and meeting demand. In 2019, The Craft Brew Alliance
was composed of eight other craft beer brands, including Omission Brewing
Co., Cisco Brewers, and Square Mile Cider Company. In addition to these
page C-16
brands, Craft Brew Alliance operated five brewpubs. Per its annual report,
there were 655 people employed at Craft Brew Alliance across its
operations, including brewpubs and production. Its products included craft
beer, gluten-free beer, hard ciders and seltzers.
Craft Brew Alliance utilized automated brewing equipment, contract
brewing and distributed nationally through the Anheuser-Busch wholesaler
network alliance, leveraging many of the logistics and thus cost advantages
associated. In November 2019 Craft Brew Alliance and Anheuser-Busch
announced an expansion of the partnership that would result in a merger.
The merger was approved by Craft Brew Alliance’s shareholders in February
2020.20 Finalization of the merger was slated for later in 2020 and was in the
process of review by the U.S. Justice Department.
A summary of Craft Brew Alliance’s financial performance from 2016 to
2019 is presented in Exhibit 7.
EXHIBIT 7 Financial Summary for Craft Brew Alliance,
2016–2019 (in thousands of $)
Source: Craft Brew Alliance Annual Report, 2019.
STRATEGIC ISSUES CONFRONTING CRAFT
BREWERIES IN 2020
The vast majority of the craft breweries might produce only enough beer for
the local population in their area. Many of these breweries started the same
way as the larger breweries—home brewers or hobbyists decided to start to
brew and sell their own beer. Many obtained startup capital through their
own savings or solicited investments from friends and family.
Given their entrepreneurial beginnings, these microbreweries and even
smaller nanobreweries were usually located in industrial spaces. They were
solely operated by the brewer-turned-entrepreneur, or a small staff of two or
three. This staff would help with brewing and production, as well as
potentially brewery tours and visits—probably the most common marketing
and consumer relations tactic utilized by smaller breweries. While almost all
breweries offered tours and tastings, these became ever more critical to the
smaller brewery with limited capital for marketing and advertising. If onsite
sales were available, the brewer could sell growlers to visitors.
Social media websites also offered significant exposure for free and had
become a foundational element of brewery marketing. These websites
helped the brewery reach the craft beer consumer, who tended to seek out
and follow new and upcoming breweries. There were also mobile phone
applications specific to the craft beer industry that could help a startup gain
exposure. Participating in craft beer festivals, where local and regional
breweries were able to offer samples to attendees, was another opportunity
to gain exposure.
Some small microbreweries did not have enough employees for bottling
and labeling and had been known to solicit volunteers through social media.
To gain exposure and boost sales, the brewery might host events at local
restaurants, such as tap-takeovers, where several of its beers are featured on
draft. If enough consumers were engaged, local restaurants were enticed to
purchase more beer from the distributor of the brewery. However, any
number of variables—raw material shortages, tight retail competition, price-
sensitive consumers—could dramatically impact future viability.
The number of beers available to the consumer throughout all segments
and price points had continued to steadily climb since the mid-2000s. While
the overall beer industry had seemed to plateau, the significant growth
appeared to be in the craft beer, or better beer segments. Further, larger
macrobreweries and regional craft breweries were seizing the opportunity to
acquire other breweries as a method of obtaining distribution and branding
synergies, while also mitigating the amount of direct competition.
Complicating the competitive landscape were increasing availability and
price fluctuations of raw materials. These sporadic shortages might impact
page C-17
the industry’s growth and affect the production stability of breweries,
especially those smaller operations that did not have capacity to purchase in
bulk or outbid larger competitors.
Overall, the growth in the consumers’ desire for craft beer was likely to
continue to attract more entrants, while encouraging larger breweries to seek
additional acquisitions of successful craft beer brands. However, the shift of
consumer trends towards low-calorie alcoholic beverages and beer/wine
alternatives presented not only opportunity for expansion but also a threat to
those producers who either relied exclusively on beer sales or could not
produce hard ciders and seltzers.
Yet, the pandemic still loomed large over the entire craft beer industry.
The Brewers Association had announced almost a quarter of its staff would
be laid-off, while others would experience salary cuts.21 As craft brewers
prepared to open taprooms and begin brewing under social distancing
regulations, it appeared the significant growth and expansion of small and
medium-sized craft breweries could come to an abrupt stop during 2020.
ENDNOTES
1 IBIS World Industry Report 0D4302 Craft Beer Production in the U.S., April 2020.
2 Brewers Association, National Beer Sales and Production Data, https://www.brewersassociation.org/statistics-
and-data/national-beer-stats/ (accessed May 23, 2020).
3 IBIS World Industry Report 0D4302 Craft Beer Production in the U.S., April 2020.
4 T. Luhby. “43 States Have Record Unemployment. See Where Your State Ranks” CNN.com, May 22, 2020,
https://www.cnn.com/2020/05/22/economy/state-unemployment-record-data-error/index.html (accessed May 23,
2020).
5 “Beer Serves America: A Study of the U.S. Beer Industry’s Economic Contribution in 2018,” The Beer Institute and
The National Beer Wholesalers Association, May 2019, http://beerservesamerica.org/ (accessed May 23, 2020).
6 IBIS World Industry Report 0D4302 Craft Beer Production in the U.S., April 2020.
7 IBIS World Industry Report 0D4302 Craft Beer Production in the U.S., December 2017.
8 Research, Z. M. “Global Beer Market Predicted to Reach by $750.00 Billion in 2022,” March 2, 2018,
http://globenewswire.com/news-release/2018/03/02/1414335/0/en/Global-Beer-Market-Predicted-to-Reach-by-
750-00-Billion-in-2022.html.
9 Brewers Association, National Beer Sales & Production Data, https://www.brewersassociation.org/statistics-and-
data/national-beer-stats/ (accessed May 23, 2020).
10 American Homebrewers Association, Homebrewing Stats,
https://www.homebrewersassociation.org/membership/homebrewing-stats/ (accessed May 23, 2020).
11 USDA, National Hop Report, https://www.usahops.org/img/blog_pdf/267 (accessed May 23, 2020).
12 Deutscher Hopfenwirtschaftsverband e.V., Market Review July 2019,
https://www.usahops.org/img/blog_pdf/235 (accessed May 23, 2020).
13 T. Acitelli, “Dogfish Head Turns 20” All About Beer Magazine, May 13, 2015, http://allaboutbeer.com/dogfish-head-
and-its-extreme-beers-turns-20/ (accessed May 23, 2020).
14 Anheuser-Busch InBev 2019 Annual Report.
http://cnn.com/
https://www.cnn.com/2020/05/22/economy/state-unemployment-record-data-error/index.html
http://beerservesamerica.org/
http://globenewswire.com/news-release/2018/03/02/1414335/0/en/Global-Beer-Market-Predicted-to-Reach-by-750-00-Billion-in-2022.html
https://www.usahops.org/img/blog_pdf/267
https://www.usahops.org/img/blog_pdf/235
15 D. Roberts, “Bud Light Will Remain NFL’s Official Beer Until 2022” Fortune.com, November 4, 2015.
https://fortune.com/2015/11/04/bud-light-nfl-deal/ (accessed May 23, 2020).
16 “Brewers Association Announces Top 50 Brewing Companies By Sales Volume of 2019,” April 1, 2020,
https://www.brewersassociation.org/press-releases/brewers-association-announces-top-50-brewing-
companies-by-sales-volume-of-2019/ (accessed May 23, 2020).
17 “Boston Beer Update: The Boston Beer Company and Dogfish Head Brewery to Merge, creating the Most Dynamic
American-Owned Platform for Craft Beer and Beyond,” Boston Beer Company Website, May 9, 2019,
http://www.bostonbeer.com/boston-beer-update (accessed May 23, 2020).
18 “Brewers Association Announces Top 50 Brewing Companies By Sales Volume of 2019,” April 1, 2020,
https://www.brewersassociation.org/press-releases/brewers-association-announces-top-50-brewing-
companies-by-sales-volume-of-2019/ (accessed May 23, 2020).
19 Ibid.
20 J. Kendall., & J. Infante., “Craft Brew Alliance Shareholders Vote in Favor of Merger with Anheuser-Busch InBev,”
Brewbound, February 25, 2020, https://www.brewbound.com/news/craft-brew-alliance-shareholders-vote-in-
favor-of-merger-with-anheuser-busch-inbev (accessed May 23, 2020).
21 C. Furnari., “Brewers Association Cuts 23% of Staff” Forbes.com, April 30, 2020,
https://www.forbes.com/sites/chrisfurnari/2020/04/30/brewers-association-cuts-23-of-staff/#3fdde6044094
(accessed May 23, 2020).
http://fortune.com/
https://fortune.com/2015/11/04/bud-light-nfl-deal/
Brewers Association Announces Top 50 Brewing Companies by Sales Volume of 2019
http://www.bostonbeer.com/boston-beer-update
Brewers Association Announces Top 50 Brewing Companies by Sales Volume of 2019
https://www.brewbound.com/news/craft-brew-alliance-shareholders-vote-in-favor-of-merger-with-anheuser-busch-inbev
http://forbes.com/
https://www.forbes.com/sites/chrisfurnari/2020/04/30/brewers-association-cuts-23-of-staff/#3fdde6044094
E
page C-18
CASE 3
Costco Wholesale in 2020:
Mission, Business Model, and
Strategy
Copyright ©2021 by Arthur A. Thompson. All rights reserved.
Arthur A. Thompson Jr.
The University of Alabama
ight years after turning the leadership of Costco Wholesale over to a new
CEO, Jim Sinegal, Costco’s co-founder and chief executive officer
(CEO) from 1983 until year-end 2011, had ample reason to be pleased with
the company’s ongoing revenue growth and competitive standing as one of
the world’s biggest and best consumer goods merchandisers. Sinegal had
been the driving force behind Costco’s 37-year evolution from a startup
entrepreneurial venture into the third largest retailer in the United States and
the world (behind Wal-Mart and Amazon.com) and the undisputed leader of
the discount warehouse and wholesale club segment of the North American
retailing industry. Since January 2012, when then-president Craig Jelinek
took the reins as Costco Wholesale’s president and CEO, the company had
prospered, growing from annual revenues of $89 billion and 598
membership warehouses at year-end fiscal 2011 to annual revenues of
$152.7 billion and 782 membership warehouses at year-end fiscal 2019
http://amazon.com/
page C-19
(September 1, 2019). Costco’s growth continued in the first six months of
fiscal 2020; six-month revenues were $76.1 billion, up 8.0 percent over the
first six months of fiscal 2019, and the company had opened five additional
warehouses as of April 2020. As of March 2020, Costco had continued to
maintain its ranking as the third largest retailer in both the United States and
the world.
COMPANY BACKGROUND
The membership warehouse concept was pioneered by discount
merchandising sage Sol Price, who opened the first Price Club in a
converted airplane hangar on Morena Boulevard in San Diego in 1976. Price
Club lost $750,000 in its first year of operation, but by 1979 it had two
stores, 900 employees, 200,000 members, and a $1 million profit. Years
earlier, Sol Price had experimented with discount retailing at a San Diego
store called Fed-Mart. Jim Sinegal got his start in retailing at the age of 18,
loading mattresses for $1.25 an hour at Fed-Mart while attending San Diego
Community College. When Sol Price sold Fed-Mart, Sinegal left with Price
to help him start the San Diego Price Club store; within a few years, Sol
Price’s Price Club emerged as the unchallenged leader in member warehouse
retailing, with stores operating primarily on the West Coast.
Although Price originally conceived Price Club as a place where small
local businesses could obtain needed merchandise at economical prices, he
soon concluded that his fledgling operation could achieve far greater sales
volumes and gain buying clout with suppliers by also granting membership
to individuals—a conclusion that launched the deep-discount warehouse
club industry on a steep growth curve.
When Sinegal was 26, Sol Price made him the manager of the original San
Diego store, which had become unprofitable. Price saw that Sinegal had a
special knack for discount retailing and for spotting what a store was doing
wrong (usually either not being in the right merchandise categories or not
selling items at the right price points)—the very things that Sol Price was
good at and that were at the root of Price Club’s growing success in the
marketplace. Sinegal soon got the San Diego store back into the black. Over
the next several years, Sinegal continued to build his prowess and talents for
discount merchandising. He mirrored Sol Price’s attention to
detail and absorbed all the nuances and subtleties of his mentor’s style of
operating—constantly improving store operations, keeping operating costs
and overhead low, stocking items that moved quickly, and charging ultra-low
prices that kept customers coming back to shop. Realizing that he had
mastered the tricks of running a successful membership warehouse business
from Sol Price, Sinegal decided to leave Price Club and form his own
warehouse club operation.
Sinegal and Seattle entrepreneur Jeff Brotman founded Costco, and the
first Costco store began operations in Seattle in 1983—the same year that
Walmart launched its warehouse membership format, Sam’s Club. By the
end of 1984, there were nine Costco stores in five states serving over
200,000 members. In December 1985, Costco became a public company,
selling shares to the public and raising additional capital for expansion.
Costco became the first ever U.S. company to reach $1 billion in sales in less
than six years. In October 1993, Costco merged with Price Club. Jim Sinegal
became CEO of the merged company, presiding over 206 PriceCostco
locations, with total annual sales of $16 billion. Jeff Brotman, who had
functioned as Costco’s chairman since the company’s founding, became vice
chairman of PriceCostco in 1993 and was elevated to chairman of the
company’s board of directors in December 1994, a position he held until his
unexpected death in 2017.
In January 1997, after the spin-off of most of its non-warehouse assets to
Price Enterprises Inc., PriceCostco changed its name to Costco Companies
Inc. When the company reincorporated from Delaware to Washington in
August 1999, the name was changed to Costco Wholesale Corporation. The
company’s headquarters was in Issaquah, Washington, not far from Seattle.
Jim Sinegal’s Leadership Style
Sinegal was far from the stereotypical CEO. He dressed casually and
unpretentiously, often going to the office or touring Costco stores wearing an
open-collared cotton shirt that came from a Costco bargain rack and sporting
a standard employee name tag that said, simply, “Jim.” His informal dress
and unimposing appearance made it easy for Costco shoppers to mistake him
for a store clerk. He answered his own phone, once telling ABC News
page C-20
reporters, “If a customer’s calling and they have a gripe, don’t you think they
kind of enjoy the fact that I picked up the phone and talked to them?”1
Sinegal spent considerable time touring Costco stores, using the company
plane to fly from location to location and sometimes visiting eight to 10
stores daily (the record for a single day was 12). Treated like a celebrity
when he appeared at a store (the news “Jim’s in the store” spread quickly),
Sinegal made a point of greeting store employees. He observed, “The
employees know that I want to say hello to them, because I like them. We
have said from the very beginning: ‘We’re going to be a company that’s on a
first-name basis with everyone.’”2 Employees genuinely seemed to like
Sinegal. He talked quietly, in a commonsensical manner that suggested what
he was saying was no big deal.3 He came across as kind yet stern, but he was
prone to display irritation when he disagreed sharply with what people were
saying to him.
In touring a Costco store with the local store manager, Sinegal was very
much the person-in-charge. He functioned as producer, director, and
knowledgeable critic. He cut to the chase quickly, exhibiting intense
attention to detail and pricing, wandering through store aisles firing a
barrage of questions at store managers about sales volumes and stock levels
of particular items, critiquing merchandising displays or the position of
certain products in the stores, commenting on any aspect of store operations
that caught his eye, and asking managers to do further research and get back
to him with more information whenever he found their answers to his
questions less than satisfying. Sinegal had tremendous merchandising savvy,
demanded much of store managers and employees, and definitely set the
tone for how the company operated its discounted retailing business.
Knowledgeable observers regarded Jim Sinegal’s merchandising expertise as
being on a par with Walmart’s legendary founder, Sam Walton.
In September 2011, at the age of 75, Jim Sinegal informed Costco’s Board
of Directors of his intention to step down as CEO of the company effective
January 2012. The Board elected Craig Jelinek, Costco’s President and Chief
Operating Officer since February 2010, to succeed Sinegal and hold the titles
of both President and CEO. At the time, Jelinek was a highly experienced
retail executive with 37 years in the industry, 28 of them at Costco, where he
started as one of the Company’s first warehouse managers in 1984. He had
served in every major role related to Costco’s business
operations and merchandising activities during his tenure. When he stepped
down as CEO, Sinegal retained his position on the company’s Board of
Directors and, at the age of 79, was re-elected to another three-year term on
Costco’s board in December 2015; he retired from Costco’s Board at the end
of his term in January 2018.
COSTCO WHOLESALE IN 2020
In April 2020, Costco was operating 787 warehouses, including 547 in the
United States and Puerto Rico, 100 in Canada, 39 in Mexico, 29 in the
United Kingdom, 26 in Japan, 16 in Korea, 13 in Taiwan, 12 in Australia,
two in Spain, and one each in Iceland, France, and China. Costco also
operated e-commerce sites in the United States, Canada, the United
Kingdom, Mexico, Korea, Taiwan, Japan, and Australia; e-commerce sales
represented about four percent of total net sales in 2019. Over 100 million
cardholders were entitled to shop at Costco as of January 2020; in fiscal year
2019, membership fees generated over $3.35 billion in revenues for the
company. Headed into 2020, shopper traffic at Costco’s warehouse locations
averaged over 3.1 million members per day. Annual sales per store averaged
about $190 million ($3.7 million per week) in 2019, an amount that was 93
percent higher than the $98.2 million per year and $1.9 million per week
averages for Sam’s Club, Costco’s chief competitor. In 2019, Costco was the
only national retailer in the history of the United States that could boast of
average annual revenue in excess of $190 million per location.
Exhibit 1 contains a financial and operating summary for Costco for fiscal
years 2016 through 2019.
EXHIBIT 1 Selected Financial and Operating Data for
Costco Wholesale Corp., Fiscal Years 2016–2019 ($ in
millions, except for per share data)
page C-21
a At the beginning of Costco’s 2011 fiscal year, the operations of 32 warehouses in Mexico
that were part of a 50 percent-owned joint venture were consolidated and reported as part of
Costco’s total operations.
Note: Some totals may not add due to rounding and to not including some line items of minor
significance in the company’s statement of income.
Sources: Company 10-K reports for fiscal years 2017 and 2019.
page C-22
COSTCO’S MISSION, BUSINESS MODEL, AND
STRATEGY
Costco’s stated mission in the membership warehouse business was: “To
continually provide our members with quality goods and services at the
lowest possible prices.”4 However, in a “Letter to Shareholders” in the
company’s 2011 Annual Report, Costco’s three top executives—Jeff
Brotman, Jim Sinegal, and Craig Jelinek—provided a more expansive view
of Costco’s mission, stating:
The company will continue to pursue its mission of bringing the highest quality goods and
services to market at the lowest possible prices while providing excellent customer service and
adhering to a strict code of ethics that includes taking care of our employees and members,
respecting our suppliers, rewarding our shareholders, and seeking to be responsible corporate
citizens and environmental stewards in our operations around the world.” 5
In the company’s 2017 Annual Report, Craig Jelinek elaborated on how
environmental sustainability fit into Costco’s mission:
Sustainability to us is remaining a profitable business while doing the right thing. We are
committed to lessening our environmental impact, decreasing our carbon footprint, sourcing our
products responsibly, and working with our suppliers, manufacturers, and farmers to preserve
natural resources. This will remain at the forefront of our business practices.6
The centerpiece of Costco’s business model was a powerful value
proposition that featured a combination of (1) ultra-low prices on a limited
selection of nationally branded and Costco’s private-label Kirkland
Signature products in a wide range of merchandise categories, (2) very good
to excellent product quality, and (3) intriguing product selection that
included both everyday items and ongoing special purchases from a big
variety of merchandise suppliers that turned shopping at Costco into a
money-saving treasure hunt. Ever since the company’s founding, Costco
management had strived diligently to ensure that shopping at Costco
delivered enough value to keep existing members returning frequently to a
nearby warehouse and to spur membership growth every year, thereby
generating high sales volumes and rapid inventory turnover at each
warehouse and creating opportunities to open new warehouses both
domestically and internationally.
page C-23
Big sales volumes and rapid inventory turnover—when combined with the
low operating costs achieved by volume purchasing, efficient distribution,
and reduced handling of merchandise in no-frills, self-service warehouse
facilities—enabled Costco to operate profitably at significantly lower gross
margins than traditional wholesalers, mass merchandisers, supermarkets, and
supercenters. Membership fees were a critical element of Costco’s business
model because they provided sufficient supplemental revenues to boost the
company’s overall profitability to acceptable levels. Indeed, Costco’s
revenues from membership fees typically exceeded 100 percent of the
company’s net income, meaning that the rest of Costco’s worldwide business
operated on a slightly below breakeven basis (see Exhibit 1)—which
translated into Costco’s prices being exceptionally competitive when
compared to the prices that Costco members paid when shopping elsewhere.
Another important business model element was that Costco’s high sales
volume and rapid inventory turnover generally allowed it to sell and receive
cash for inventory before it had to pay many of its merchandise vendors,
even when vendor payments were made in time to take advantage of early
payment discounts. Thus, Costco was able to finance a big percentage of its
merchandise inventory through the payment terms provided by vendors
rather than by having to maintain sizable working capital (defined as current
assets minus current liabilities) to enable timely payment of suppliers.
Costco’s Strategy
The key elements of Costco’s strategy were ultra-low prices, a limited
selection of nationally branded and top-quality Kirkland Signature products
covering diverse merchandise categories, a “treasure hunt” shopping
environment that stemmed from a constantly-changing inventory of about
900 “while-they-last specials,” strong emphasis on low operating costs, and
ongoing expansion of its geographic network of store locations.
Pricing Costco’s philosophy was to keep customers coming in to shop by
wowing them with low prices and thereby generating big sales volumes.
Examples of Costco’s 2015 sales volumes that contributed to low
prices in particular product categories included 156,000 carats of
diamonds (up to 400,00 carats in 2019), meat sales of $6.4 billion, seafood
sales of $1.3 billion, television sales of $1.8 billion, fresh produce sales of
$5.8 billion (sourced from 44 countries), 83 million rotisserie chickens, 7.9
million tires, 41 million prescriptions, 6 million pairs of glasses, and 128
million hot dog/soda pop combinations. Costco was the world’s largest seller
of fine wines ($965 million out of total 2015 wine sales of $1.7 billion).
For many years, a key element of Costco’s pricing strategy had been to
cap its markup on brand-name merchandise at 14 percent (compared to 25
percent and higher markups for other discounters and most supermarkets and
50 percent and higher markups for department stores). Markups on Costco’s
private-label Kirkland Signature items were a maximum of 15 percent, but
the sometimes fractionally higher markups still resulted in Kirkland
Signature items being priced about 20 percent below comparable name-
brand items. Except for Walmart, Costco’s prices for fresh foods and grocery
items ranged 20 to 30 percent below of the leading supermarket chains.
Aside from being lower-priced, Costco’s Kirkland Signature products—
which included vitamins, juice, bottled water, coffee, spices, olive oil,
canned salmon and tuna, nuts, laundry detergent, baby products, dog food,
luggage, cookware, trash bags, batteries, wines and spirits, paper towels and
toilet paper, and clothing—were designed to be of equal or better quality
than national brands.
As a result of its low markups, Costco’s prices were just fractionally
above breakeven levels, producing net sales revenues (not counting
membership fees) that exceeded all operating expenses by only $1.0 billion
to $1.4 billion in fiscal years 2016–2019. As can be verified from Exhibit 1,
Costco’s revenues from membership fees accounted for 69 to 72 percent of
the company’s operating profits in fiscal years 2016 to 2019 and exceeded
the company’s net income after taxes in every fiscal year shown in Exhibit 1
except for fiscal year 2019—outcomes that were a direct result of the
company’s ultra-low pricing strategy and practice of capping the margins on
branded goods at 14 percent and private-label goods at 15 percent.
Jim Sinegal explained the company’s approach to pricing:
We always look to see how much of a gulf we can create between ourselves and the competition.
So that the competitors eventually say, “These guys are crazy. We’ll compete somewhere else.”
Some years ago, we were selling a hot brand of jeans for $29.99. They were $50 in a department
store. We got a great deal on them and could have sold them for a higher price but we went down
to $29.99. Why? We knew it would create a riot.7
page C-24
At another time, he said:
We’re very good merchants, and we offer value. The traditional retailer will say: “I’m selling this
for $10. I wonder whether we can get $10.50 or $11.” We say: “We’re selling this for $9. How do
we get it down to $8?” We understand that our members don’t come and shop with us because of
the window displays or the Santa Claus or the piano player. They come and shop with us because
we offer great values.8
Indeed, Costco’s markups and prices were so fractionally above the level
needed to cover company-wide operating costs and interest expenses that
Wall Street analysts had criticized Costco management for going all out to
please customers at the expense of increasing profits for shareholders. One
retailing analyst said, “They could probably get more money for a lot of the
items they sell.”9 During his tenure as CEO, Sinegal had never been
impressed with Wall Street calls for Costco to abandon its ultra-low pricing
strategy, commenting: “Those people are in the business of making money
between now and next Tuesday. We’re trying to build an organization that’s
going to be here 50 years from now.”10 He went on to explain why Costco’s
approach to pricing would remain unaltered during his tenure:
When I started, Sears, Roebuck was the Costco of the country, but they allowed someone else to
come in under them. We don’t want to be one of the casualties. We don’t want to turn around and
say, “We got so fancy we’ve raised our prices, and all of a sudden a new competitor comes in and
beats our prices.”11
Product Selection Whereas typical supermarkets stocked about 40,000
items and a Walmart Supercenter or a SuperTarget might have 125,000 to
150,000 items for shoppers to choose from, Costco’s merchandising strategy
was to provide members with a selection of approximately 3,700 active
items that could be priced at bargain levels and thus provide members with
significant cost savings. Of these, about 75 percent were quality brand-name
products and 25 percent carried the company’s private-label Kirkland
Signature brand. The Kirkland Signature label appeared on everything from
men’s dress shirts to laundry detergent, pet food to toilet paper, canned foods
to cookware, olive oil to beer, automotive products to health and
beauty aids. According to Craig Jelinek, “The working rule
followed by Costco buyers is that all Kirkland Signature products must be
equal to or better than the national brands, and must offer a savings to our
members.” Management believed that there were opportunities to increase
the number of Kirkland Signature selections and gradually build sales
penetration of Kirkland-branded items to at least 30 percent of total sales—
in 2018 Kirkland-brand sales exceeded 28 percent of total sales. Costco
executives in charge of sourcing Kirkland Signature products constantly
looked for ways to make all Kirkland Signature items better than their brand
name counterparts and even more attractively priced. Costco members were
very much aware that one of the great perks of shopping at Costco was the
opportunity to buy top quality Kirkland Signature products at prices
substantially lower than name brand products.
Costco’s product range covered a broad spectrum—rotisserie chicken, all
types of fresh meats, seafood, fresh and canned fruits and vegetables, paper
products, cereals, coffee, dairy products, cheeses, frozen foods, flat-screen
televisions, cell phones and assorted other electronics products, jewelry,
fresh flowers, fine wines, baby strollers, toys and games, musical
instruments, ceiling fans, vacuum cleaners, books, apparel, cleaning
supplies, DVDs, light bulbs, batteries, cookware, electric toothbrushes,
vitamins, office supplies, and home appliances—but the selection in each
product category was deliberately limited to fast-selling models, sizes, and
colors. Many consumable products like detergents, canned goods, office
supplies, and soft drinks were sold only in big-container, case, carton, or
multiple-pack quantities. In a few instances, the selection within a product
category was restricted to a single offering. For example, Costco stocked
only a 325-count bottle of Advil—a size many shoppers might find too large
for their needs. Sinegal explained the reasoning behind limited selections:
If you had 10 customers come in to buy Advil, how many are not going to buy any because you
just have one size? Maybe one or two. We refer to that as the intelligent loss of sales. We are
prepared to give up that one customer. But if we had four or five sizes of Advil, as most grocery
stores do, it would make our business more difficult to manage. Our business can only succeed if
we are efficient. You can’t go on selling at these margins if you are not.12
In the last several years, organics had become a fast-growing category in
both the fresh produce section and the grocery items section, and Costco
buyers were devoting increased attention to growing the selection of organic
items. In the fresh meats category, Costco was pursuing increased vertical
integration, constructing a second meat plant in Illinois and a state-of-the-art
poultry plant in Nebraska capable of processing 2 million chickens per week
—in fiscal 2019 Costco warehouses sold almost 100 million rotisserie
chickens annually at a very attractive price of $4.99. A baking commissary
page C-25
had been opened in Canada that supplied warehouses in much of Canada and
the United States with bread and cookie dough for on-premise baking. The
approximate percentage of net sales accounted for by each major category of
items stocked by Costco is shown in Exhibit 2.
EXHIBIT 2 Costco’s Sales by Major Product Category,
2016–2019
Source: Company 10-K reports, 2017 and 2019.
Management believed that Costco’s ancillary offerings gave members
reasons to shop at Costco more frequently and make Costco
more of a one-stop shopping destination. Headed into fiscal
2020, over 600 warehouses had inside food courts, pharmacies, photo
centers, and optical centers. Costco’s pharmacies were highly regarded by
members because of the low prices. The company’s practice of selling
gasoline at discounted prices (often as much as 20 to 30 cents per gallon) at
those store locations where there was sufficient space to install gas pumps
had boosted the frequency with which nearby members shopped at Costco
and made in-store purchases (only members were eligible to buy gasoline at
Costco’s stations). Almost all new Costco locations in the United States and
Canada were opening with gas stations; globally, gas stations were being
added at locations where local regulations and space permitted. Costco
operated 593 gas stations as of September 2019; the steep discounts on
gasoline generated about 11 percent of Costco’s total net sales in fiscal 2019
(Costco did not sell gasoline in South Korea, France, or China).13
Treasure-Hunt Merchandising While Costco’s product line consisted of
approximately 3,700 active items, some 20 to 25 percent of its product
offerings were constantly changing. Costco’s merchandise buyers were
continuously making one-time purchases of items that would appeal to the
company’s clientele and likely to sell out quickly. A sizable number of these
featured specials were high-end or luxury-brand products that carried big
price tags; examples included $1,000 to $4,500 big-screen TVs, $800
espresso machines, expensive jewelry and diamond rings (priced from
$10,000 to $400,000+), Omega watches, Waterford Crystal, exotic cheeses,
Coach bags, cashmere sports coats, $1,500 digital pianos, $800 treadmills,
$2,500 memory foam mattresses, and Dom Perignon champagne. Many of
the featured specials came and went quickly, sometimes in several days or a
week—like Italian-made Hathaway shirts priced at $29.99 and $800 leather
sectional sofas. The strategy was to entice shoppers to spend more than they
might by offering irresistible deals on big-ticket items or name-brand
specials and, further, to keep the mix of featured and treasure-hunt items
constantly changing so that bargain-hunting shoppers would go to Costco
more frequently rather than only for periodic “stock up” trips.
Costco members quickly learned that they needed to go ahead and buy
treasure-hunt specials that interested them because the items would very
likely not be available on their next shopping trip. In many cases, Costco did
not obtain its upscale treasure hunt items directly from high-end
manufacturers like Calvin Klein or Waterford (who were unlikely to want
their merchandise marketed at deep discounts at places like Costco); rather,
Costco buyers searched for opportunities to source such items legally on the
gray market from other wholesalers or distressed retailers looking to get rid
of excess or slow-selling inventory.
Management believed that these practices kept its marketing expenses low
relative to those at typical retailers, discounters, and supermarkets.
Low-Cost Emphasis Keeping operating costs at a bare minimum was a
major element of Costco’s strategy and a key to its low pricing. As first
explained by Jim Sinegal and later reiterated by Craig Jelinek:
Costco is able to offer lower prices and better values by eliminating virtually all the frills and costs
historically associated with conventional wholesalers and retailers, including salespeople, fancy
page C-27
page C-26
buildings, delivery, billing, and accounts receivable. We run a tight operation with extremely low
overhead which enables us to pass on dramatic savings to our members. 14
While Costco management made a point of locating warehouses on high-
traffic routes in or near upscale suburbs that were easily accessible by small
businesses and residents with above-average incomes, it avoided prime real
estate sites in order to contain land costs.
Because shoppers were attracted principally by Costco’s low prices and
merchandise selection, most warehouses were of a metal pre-engineered
design, with concrete floors and minimal interior décor. Floor plans were
designed for economy and efficiency in use of selling space, the handling of
merchandise, and the control of inventory. Merchandise was often stored on
racks above the sales floor and/or displayed on pallets containing large
quantities of each item, thereby reducing labor required for handling and
stocking. In-store signage was done mostly on laser printers; there were no
shopping bags at the checkout counter—merchandise was put directly into
the shopping cart or sometimes loaded into empty boxes. Costco warehouses
ranged in size from 73,000 to 205,000 square feet; the average size was
about 146,000 square feet. Newer units were usually in the 150,000- to
205,000-square-foot range, but the world’s largest Costco warehouse was a
235,000 square-foot store in Salt Lake City that opened in 2015.
Warehouses generally operated on a seven-day, 70-hour
week, typically being open between 10:00 a.m. and 8:30 p.m. weekdays,
with earlier closing hours on the weekend; the gasoline operations outside
many stores usually had extended hours. The shorter hours of operation as
compared to those of traditional retailers, discount retailers, and
supermarkets resulted in lower labor costs relative to the
volume of sales. By strictly controlling the entrances and exits of its
warehouses and using a membership format, Costco had inventory losses
(shrinkage) well below those of typical retail operations.
EXHIBIT 3 Images of Costco’s Warehouses
Source: Supplied by Costco and used with Costco’s permission.
Growth Strategy Costco’s growth strategy was to increase sales at
existing stores by five percent or more annually and to open additional
warehouses, both domestically and internationally. Average annual growth at
stores open at least a year was 10 percent in fiscal 2011, six percent in both
fiscal 2013 and 2014, seven percent in fiscal 2015, four percent in 2016 and
2017, seven percent in 2018, and six percent in 2019.
Costco had been aggressive in opening new warehouses and entering new
geographic areas. As of December 2000, the Company operated a chain of
349 warehouses in 32 states (251 locations), nine Canadian provinces (59
locations), the United Kingdom (11 locations, through an 80 percent-owned
subsidiary), South Korea (four locations), Taiwan (three locations, through a
55 percent-owned subsidiary), and Japan (two locations), as well as 19
warehouses in Mexico through a 50 percent joint venture partner. Ten years
later, in December 2010, Costco was operating 585 warehouses in 42 states
(425 locations), nine Canadian provinces (80 locations), Mexico (32
locations), the United Kingdom (22 locations), Japan (nine locations), South
Korea (seven locations), Taiwan (six locations), and Australia (one location).
Some nine years and three months later, Costco had opened an additional
203 warehouses, had 546 warehouses in 45 states, and 236 warehouses in 11
countries, including a recently-opened warehouse in Shanghai, China.
Exhibit 4 shows a breakdown of Costco’s geographic operations for fiscal
years 2017–2019.
EXHIBIT 4 Selected Geographic Operating Data, Costco
Wholesale Corporation, Fiscal Years 2017–2019 ($ in
millions)
Note: The dollar numbers shown for the “Other International” categories represent only
Costco’s ownership share, since all foreign operations were joint ventures (although Costco
was the majority owner of these ventures). Countries with warehouses in the Other
International category at the end of fiscal 2019 included Mexico, United Kingdom, Japan,
South Korea, Taiwan, Australia, Spain, Iceland, France, and China; Costco’s two
warehouses in Puerto Rico were included in the United States Operations category.
Source: Company 10-K reports, 2017–2019.
Marketing and Advertising
Costco’s low prices and its reputation for making shopping at Costco
something of a treasure-hunt made it unnecessary to engage in extensive
advertising or sales campaigns. Marketing and promotional activities were
generally limited to monthly coupon mailers to members, periodic e-mails to
members from Costco.com publicizing “hot deals” and other special
promotional offerings and sales events at warehouses, occasional direct mail
to prospective new members, and regular direct marketing programs (such as
The Costco Connection, a magazine published for members), in-store
product sampling, and special campaigns for new warehouse openings.
For new warehouse openings, marketing teams personally contacted
businesses in the area that were potential wholesale members; these contacts
were supplemented with direct mailings during the period immediately prior
to opening. Potential Gold Star (individual) members were contacted by
direct mail or by promotions at local employee associations and businesses
with large numbers of employees. After a membership base was established
in an area, most new memberships came from word of mouth (existing
members telling friends and acquaintances about their shopping experiences
at Costco), follow-up messages distributed through regular payroll or other
organizational communications to employee groups, and ongoing direct
solicitations to prospective business and Gold Star members.
Website Sales
Costco operated websites in the United States, Canada, Mexico, the United
Kingdom, Taiwan, and South Korea—both to enable members to shop for
many in-store products online and to provide members with a means of
obtaining a much wider variety of value-priced products and services that
were not practical to stock at the company’s warehouses. New websites in
Japan and Australia were expected to be operational by early 2020. Craig
Jelinek was committed to a website strategy that provided exceptional
http://costco.com/
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service and value to Costco members who wanted to shop online. In recent
years, online merchandise offerings had expanded significantly, and the
company was continuously exploring opportunities to deliver added value to
members via a broader array of online offerings. Examples of value-priced
items that members could buy online included sofas, beds, mattresses,
entertainment centers and TV lift cabinets, outdoor furniture, office
furniture, kitchen appliances, billiard tables, and hot tubs. Members could
also use the company’s websites for such services as digital photo
processing, prescription fulfillment, travel, the Costco auto
program (for purchasing selected new vehicles with discount
prices through participating dealerships), and other membership services. In
2018, Costco sold 650,000 vehicles through its 3,000 dealer partners (up 25
percent over the 520,000 vehicles sold in 2017); the big attraction to
members of buying a new or used vehicle through Costco’s auto program
was being able to skip the hassle of bargaining with the dealer over price
and, instead, paying an attractively low price pre-arranged by Costco. At
Costco’s online photo center, customers could upload images and pick up the
prints at their local warehouse in little over an hour. Website sales accounted
for four percent of Costco’s total net sales in fiscal 2019, versus three
percent in 2014.
In 2017, Costco made improvements in website functionality, search
capability, checkout, and delivery times. New offerings were added at
Costco Travel, and the company introduced hotel-only booking reservations.
Costco Travel’s rental car rates were consistently some of the lowest in the
marketplace and in 2017 car rentals became available to members in Canada
and the United Kingdom. Additionally, the annual two percent reward for
Executive members was extended to apply to Costco Travel purchases in the
United States and Canada. Lastly, the company launched Costco Grocery, a
two-day delivery on dry grocery items, and a same-day delivery offering
both fresh and dry grocery items through partnering with Instacart.
In 2018, Costco began opening business centers in selected warehouses; at
the end of fiscal 2019, it had opened 18 business centers in the United States
and two in Canada. As many as 40 new business centers were planned for
2020.
Supply Chain and Distribution
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Costco bought the majority of its merchandise directly from manufacturers,
routing it either directly to its warehouse stores or to one of the company’s
cross-docking depots that served as distribution points for nearby
stores and for shipping orders to members making online
purchases. In 2018, Costco had more than 20 geographically-scattered cross-
docking depots with a combined space exceeding 11 million square feet in
the United States, Canada, and various other international locations. Depots
received container-based shipments from manufacturers, transferred the
goods to pallets, and then shipped full-pallet quantities of several types to
goods to individual warehouses via rail or semi-trailer trucks, generally in
less than 24 hours. This maximized freight volume and handling efficiencies.
Depots were also used to ship bulky merchandise to members that had been
ordered online; members often picked up online orders that would fit in their
vehicles at nearby warehouses.
When merchandise arrived at a warehouse, forklifts moved the full pallets
straight to the sales floor and onto racks and shelves (without the need for
multiple employees to touch the individual packages/cartons on the pallets)
—the first time most items were physically touched at a warehouse was
when shoppers reached onto the shelf/rack to pick it out of a carton and put
it into their shopping cart. Very little incoming merchandise was stored in
locations off the sales floor in order to minimize receiving and handling
costs.
Costco had direct buying relationships with many producers of national
brand-name merchandise and with manufacturers that supplied its Kirkland
Signature products. Costco’s merchandise buyers were always alert for
opportunities to add products of top quality manufacturers and vendors on a
one-time or ongoing basis. No one manufacturer supplied a significant
percentage of the merchandise that Costco stocked. Costco had not
experienced difficulty in obtaining sufficient quantities of merchandise, and
management believed that if one or more of its current sources of supply
became unavailable, the company could switch its purchases to alternative
manufacturers without experiencing a substantial disruption of its business.
Costco’s Membership Base and Member Demographics
Costco attracted the most affluent customers in discount retailing—the
average annual income of Costco members was approximately $100,000 (in
page C-30
2015 Costco management believed the 8.6 million subscribers to the
company’s monthly Costco Connection magazine had an average annual
income of $156,000).15 Many members were affluent urbanites, living in
nice neighborhoods not far from Costco warehouses. One loyal Executive
member, a criminal defense lawyer, said, “I think I spend over $20,000 to
$25,000 a year buying all my products here from food to clothing—except
my suits. I have to buy them at the Armani stores.”16 Another Costco loyalist
said, “This is the best place in the world. It’s like going to church on Sunday.
You can’t get anything better than this. This is a religious experience.”17
Costco had two primary types of memberships: Business and Gold Star
(individual). Business memberships were limited to businesses, but included
individuals with a business license, retail sales license, or other evidence of
business existence. A business membership also included a free household
card (a significant number of business members shopped at Costco for their
personal needs). Business members also had the ability to purchase “add-on”
membership cards for up to six partners or associates in the business.
Costco’s current annual fee for Business and Gold Star memberships was
$60 in the United States and Canada and varied by country in its Other
International operations. Individuals in the United States and Canada who
did not qualify for business membership could purchase a Gold Star
membership, which included a household card for another family member
(additional add-on cards could not be purchased by Gold Star members). All
types of members (including household card members) could shop at any
Costco warehouse.
Business, Business add-on, and Gold Star members in the United States
and Canada could upgrade to Executive membership for an additional $60
(an annual membership fee of $120); upgrade fees to Executive
memberships elsewhere varied by country. The primary appeal of upgrading
to Executive membership was eligibility for a two percent annual reward
(rebate) on qualified pre-tax purchases. Reward certificates were issued
annually and could be used toward purchases of most merchandise at the
front-end registers of Costco warehouses—rebate awards could not be used
to purchase alcohol and tobacco products, gasoline, postage stamps, and
food court items. The two percent rebate for Executive members was capped
at $1,000 for any 12-month period in the United States and Canada
(equivalent to annual qualified pre-tax purchases of $50,000);
the maximum rebate varied in other countries. Executive members also were
eligible for savings and benefits on various business and consumer services
offered by Costco, including merchant credit card processing, small-business
loans, auto and home insurance, long-distance telephone service, check
printing, and real estate and mortgage services; these services were mostly
offered by third-party providers and varied by state—Executive members
did not receive two percent rebate credit on purchases of these ancillary
services. In fiscal 2019, Executive members represented 39 percent of
Costco’s cardholders (including add-ons, but not holders of household cards)
and accounted for approximately two-thirds of total company sales. Costco’s
member renewal rate was 91 percent in the United States and Canada, and
88 percent on a worldwide basis at the end of fiscal 2019. Recent trends in
membership are shown at the bottom of Exhibit 1.
In general, with variations by country, Costco members could pay for their
purchases with certain debit and credit cards, co-branded Costco credit
cards, cash, or checks; in the United States and Puerto Rico, members could
use a co-branded Citi/Costco Visa Anywhere credit card for purchases at
Costco and elsewhere, Costco Cash cards, and all Visa cards. Since the June
2016 launch of Citi/Costco Visa® Anywhere Card, 1.8 million new member
accounts (approximately 2.4 million new credit cards) were opened. The
enhanced cash-back Visa Anywhere rewards included earning four percent
on gas; three percent on restaurant, hotel, and eligible travel; two percent at
Costco and Costco.com; and one percent on all other purchases, exceeding
the company’s previous co-branded credit card offering with American
Express. Executive Members using the new Visa Anywhere card continued
to earn a two percent rebate on qualified purchases.
Costco accepted merchandise returns when members were dissatisfied
with their purchases. Losses associated with dishonored checks were
minimal because any member whose check had been dishonored was
prevented from paying by check or cashing a check at the point of sale until
restitution was made. The membership format facilitated strictly controlling
the entrances and exits of warehouses, resulting in limited inventory losses
of less than two-tenths of one percent of net sales—well below those of
typical discount retail operations.
Warehouse Management
http://costco.com/
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Costco warehouse managers were delegated considerable authority over
store operations. In effect, warehouse managers functioned as entrepreneurs
running their own retail operation. They were responsible for coming up
with new ideas about what items would sell in their stores, effectively
merchandising the ever-changing lineup of treasure-hunt products, and
orchestrating in-store product locations and displays to maximize sales and
quick turnover. In experimenting with what items to stock and what in-store
merchandising techniques to employ, warehouse managers had to know the
clientele who patronized their locations—for instance, big-ticket diamonds
sold well at some warehouses but not at others. Costco’s best managers kept
their finger on the pulse of the members who shopped their warehouse
location to stay in sync with what would sell well, and they had a flair for
creating a certain element of excitement, hum, and buzz in their warehouses.
Such managers spurred above-average sales volumes—sales at Costco’s top-
volume warehouses ran about $5 million to $7 million a week, with sales
exceeding $1 million on many days. Successful managers also thrived on the
rat race of running a high-traffic store and solving the inevitable crises of the
moment.
Compensation and Workforce Practices
As of September 2019, Costco had 149,000 full-time employees and
105,000 part-time employees. Approximately 16,000 hourly employees at
locations in California, Maryland, New Jersey, and New York, as well as at
one warehouse in Virginia, were represented by the International
Brotherhood of Teamsters. All remaining employees were non-union.
In March 2019, Costco raised its minimum wage for hourly employees to
$15 per hour and also bumped up pay scales for a variety of other jobs,
including supervisory positions. Hourly pay scales for warehouse jobs
ranged from $15 to $19 in the second half of 2019. The highest paid full-
time warehouse employees could earn close to $25.00 per hour after four
years. Front-end supervisors averaged about $26 per hour. Compensation
averaged $16-$18 per hour for pharmacy technicians and $62.56 per hour for
licensed pharmacists., and about $146,000 annually for
pharmacy managers.18
Salaried Costco employees earned anywhere from $30,000 to close to
$200,000 annually, depending on job type.19 For example, salaries for
merchandise managers, membership managers, and meat department
managers reportedly were in the $55,000 to $85,000 range; salaries for
supervisors ranged from $45,000 to $75,000; salaries for database, computer
systems, and software applications developers/analysts/project managers
were in the $85,000 to $125,000 range. Average salaries for pharmacy
managers were in the $146,000 range. Average total compensation
(including bonuses) for assistant general managers of warehouses ranged
from $78,000 to $97,000 and reportedly averaged about $88,000.20 Average
total pay for general managers of warehouses ranged from $90,000 to
$180,000 and reportedly averaged about $135,000.21
Employees enjoyed the full spectrum of benefits. Salaried employees were
eligible for benefits on the first of the second month after the date of hire.
Full-time hourly employees were eligible for benefits on the first day of the
second month after completing 250 eligible paid hours; part-time hourly
employees became benefit-eligible on the first day of the second month after
completing 450 eligible paid hours. The benefit package included the
following:
Health care plans for full-time and part-time employees that included
coverage for mental illness, substance abuse, and professional counseling
for assorted personal and family issues.
A choice of a core dental plan or a premium dental plan.
A pharmacy plan that entailed (1) co-payments of $3 for generic drugs and
$10 to $50 for brand-name prescriptions filled at a Costco warehouse or
online pharmacy and (2) co-payments of $15 to $50 for generic or brand-
name prescriptions filled at all other pharmacies.
A vision program that paid up to $60 for a refraction eye exam (the
amount charged at Costco’s Optical Centers) and had $175 annual
allowances for the purchase of glasses and contact lenses at Costco Optical
Centers. Employees located more than 25 miles from a Costco Optical
Center could visit any provider of choice for annual eye exams and could
purchase eyeglasses from any in-network source and submit claim forms
for reimbursement.
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A hearing aid benefit of up to $1,750 every four years (available only to
employees and their eligible dependents enrolled in a Costco medical plan,
and the hearing aids had to be supplied at a Costco Hearing Aid Center).
A 401(k) plan open to all employees who had completed 90 days of
employment. Costco matched hourly employee contributions by 50 cents
on the dollar for the first $1,000 annually (the maximum company match
was $500 per year). The company’s union employees on the West Coast
qualified for matching contributions of 50 cents on the dollar up to a
maximum company match of $250 a year. In addition to the matching
contribution, Costco also normally made a discretionary contribution to
the accounts of eligible employees based on the number of years of service
with the company (or in the case of union employees based on the straight-
time hours worked). For other than union employees, this discretionary
contribution was a percentage of the employee’s compensation that ranged
from a low of three percent (for employees with one to one years of
service) to a high of nine percent (for employees with 25 or more years of
service). Company contributions to all the various employee 410(k) plans
were $489 million in 2016, $543 million in 2017, $578 million in 2018,
and $614 million in 2019.
A dependent care reimbursement plan in which Costco employees whose
families qualified could pay for day care for children under 13 or adult day
care with pretax dollars and realize savings of anywhere from $750 to
$2,000 per year.
Long-term and short-term disability coverage.
Generous life insurance and accidental death and dismemberment
coverage, with benefits based on years of service and whether the
employee worked full-time or part-time. Employees could elect to
purchase supplemental coverage for themselves, their spouses, or their
children.
An employee stock purchase plan allowing all employees to buy Costco
stock via payroll deduction so as to avoid commissions and fees.
Although Costco’s longstanding practice of paying good wages and good
benefits was contrary to conventional wisdom in discount
retailing, co-founder and former CEO Jim Sinegal, who
originated the practice, firmly believed that having a well-compensated
workforce was very important to executing Costco’s strategy successfully.
He said, “Imagine that you have 120,000 loyal ambassadors out there who
are constantly saying good things about Costco. It has to be a significant
advantage for you. . . . Paying good wages and keeping your people working
with you is very good business.”22 When a reporter asked him about why
Costco treated its workers so well compared to other retailers (particularly
Walmart, which paid lower wages and had a skimpier benefits package),
Sinegal replied: “Why shouldn’t employees have the right to good wages
and good careers. . . . It absolutely makes good business sense. Most people
agree that we’re the lowest-cost producer. Yet we pay the highest wages. So
it must mean we get better productivity. Its axiomatic in our business—you
get what you pay for.”23
Good wages and benefits were said to be why employee turnover at
Costco typically averaged about 5 percent or less after the first year of
employment. Some Costco employees had been with the company since its
founding in 1983. Many others had started working part-time at Costco
while in high school or college and opted to make a career at the company.
One Costco employee told an ABC 20/20 reporter, “It’s a good place to
work; they take good care of us.”24 A Costco vice president and head baker
said working for Costco was a family affair: “My whole family works for
Costco, my husband does, my daughter does, my new son-in-law does.”25
Another employee, a receiving clerk who made about $40,000 a year, said,
“I want to retire here. I love it here.”26 An employee with over two years of
service could not be fired without the approval of a senior company officer.
Selecting People for Open Positions Costco’s top management wanted
employees to feel that they could have a long career at Costco. It was
company policy to fill the vast majority of its higher-level openings by
promotions from within; at one recent point, the percentage ran close to 98
percent, which meant that the majority of Costco’s management team
members (including warehouse, merchandise, administrative, membership,
front end, and receiving managers) had come up through the ranks. Many of
the company’s vice presidents had started in entry-level jobs. According to
Jim Sinegal, “We have guys who started pushing shopping carts out on the
parking lot for us who are now vice presidents of our company.”27 Costco
made a point of recruiting at local universities; Sinegal explained why:
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“These people are smarter than the average person, hardworking, and they
haven’t made a career choice.”28 On another occasion, he said, “If someone
came to us and said he just got a master’s in business at Harvard, we would
say fine, would you like to start pushing carts?”29 Those employees who
demonstrated smarts and strong people management skills moved up
through the ranks.
But without an aptitude for the details of discount retailing, even up-and-
coming employees stood no chance of being promoted to a position of
warehouse manager. Top Costco executives who oversaw warehouse
operations insisted that candidates for warehouse managers be top-flight
merchandisers with a gift for the details of making items fly off the shelves.
Based on his experience as CEO, Sinegal said, “People who have a feel for it
just start to get it. Others, you look at them and it’s like staring at a blank
canvas. I’m not trying to be unduly harsh, but that’s the way it works.”30
Most newly appointed warehouse managers at Costco came from the ranks
of assistant warehouse managers who had a track record of being shrewd
merchandisers and tuned into what new or different products might sell well
given the clientele that patronized their particular warehouse. Just having the
requisite skills in people management, crisis management, and cost-effective
warehouse operations was not enough.
Executive Compensation Executives at Costco did not earn the
outlandish salaries that had become customary over the past decade at most
large corporations. In Jim Sinegal’s last two years as Costco’s CEO, he
received a salary of $350,000 and a bonus of $190,400 in fiscal 2010 and a
salary of $350,000 and a bonus of $198,400 in fiscal 2011. Craig Jelinek’s
salary as President and CEO in fiscal 2019 was $930,000 (which was
increased to $1 million for calendar year 2019), and he received a bonus of
$190,400 and a stock award worth $6.7 million; Richard Galanti’s salary as
Executive Vice-President and Chief Financial Officer in fiscal 2019 was
$784,146, and he received a bonus of $76,160 and a stock award
worth nearly $3.2 million. Other Costco executive officers
received salaries in the $662,000 to $737,000 range, bonuses of about
$76,000, and stock awards worth nearly $3.2 million in fiscal 2019.
Asked why executive compensation at Costco was only a fraction of the
amounts typically paid to top-level executives at other corporations with
revenues and operating scale comparable to Costco’s, Sinegal replied: “I
figured that if I was making something like 12 times more than the typical
person working on the floor, that that was a fair salary.”31 To another
reporter, he said: “Listen, I’m one of the founders of this business. I’ve been
very well rewarded. I don’t require a salary that’s 100 times more than the
people who work on the sales floor.”32 During his tenure as CEO, Sinegal’s
employment contract was only a page long and provided that he could be
terminated for cause.
However, while executive salaries and bonuses were modest in
comparison with those at other companies Costco’s size, Costco did close
the gap via an equity compensation program that featured awarding
restricted stock units (RSUs) to executives based on defined performance
criteria. The philosophy at Costco was that equity compensation should be
the largest component of compensation for all executive officers and be tied
directly to achievement of pre-tax income targets.
Costco’s Business Philosophy, Values, and Code of Ethics
Jim Sinegal, who was the son of a steelworker, had ingrained five simple and
down-to-earth business principles into Costco’s corporate culture and the
manner in which the company operated. The following are excerpts of these
principles and operating approaches:33
1. Obey the law—The law is irrefutable! Absent a moral imperative to
challenge a law, we must conduct our business in total compliance with
the laws of every community where we do business. We pledge to:
Comply with all laws and other legal requirements.
Respect all public officials and their positions.
Comply with safety and security standards for all products sold.
Exceed ecological standards required in every community where we do
business.
Comply with all applicable wage and hour laws.
Comply with all applicable antitrust laws.
Conduct business in and with foreign countries in a manner that is legal
and proper under United States and foreign laws.
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Not offer, give, ask for, or receive any form of bribe or kickback to or
from any person or pay to expedite government action or otherwise act
in violation of the Foreign Corrupt Practices Act or the laws of other
countries.
Promote fair, accurate, timely, and understandable disclosure in reports
filed with the Securities and Exchange Commission and in other public
communications by the Company.
2. Take care of our members—Costco membership is open to business
owners, as well as individuals. Our members are our reason for being—
the key to our success. If we don’t keep our members happy, little else that
we do will make a difference. There are plenty of shopping alternatives
for our members, and if they fail to show up, we cannot survive. Our
members have extended a trust to Costco by virtue of paying a fee to shop
with us. We will succeed only if we do not violate the trust they have
extended to us, and that trust extends to every area of our business. We
pledge to:
Provide top-quality products at the best prices in the market.
Provide high-quality, safe, and wholesome food products by requiring
that both vendors and employees be in compliance with the highest food
safety standards in the industry.
Provide our members with a 100 percent satisfaction guaranteed
warranty on every product and service we sell, including their
membership fee.
Assure our members that every product we sell is authentic in make and
in representation of performance.
Make our shopping environment a pleasant experience by making our
members feel welcome as our guests.
Provide products to our members that will be ecologically sensitive.
Provide our members with the best customer service in the
retail industry.
Give back to our communities through employee volunteerism and
employee and corporate contributions to United Way and Children’s
Hospitals.
3. Take care of our employees—Our employees are our most important
asset. We believe we have the very best employees in the warehouse club
industry, and we are committed to providing them with rewarding
challenges and ample opportunities for personal and career growth. We
pledge to provide our employees with:
Competitive wages.
Great benefits.
A safe and healthy work environment.
Challenging and fun work.
Career opportunities.
An atmosphere free from harassment or discrimination.
An Open-Door Policy that allows access to ascending levels of
management to resolve issues.
Opportunities to give back to their communities through volunteerism
and fundraising.
4. Respect our suppliers—Our suppliers are our partners in business and
for us to prosper as a company, they must prosper with us. To that end, we
strive to:
Treat all suppliers and their representatives as we would expect to be
treated if visiting their places of business.
Honor all commitments.
Protect all suppliers’ property assigned to Costco as though it were our
own.
Not accept gratuities of any kind from a supplier.
If in doubt as to what course of action to take on a business matter that
is open to varying ethical interpretations, TAKE THE HIGH ROAD
AND DO WHAT IS RIGHT.
If we do these four things throughout our organization, then we will
achieve our ultimate goal, which is to:
5. Reward our shareholders—As a company with stock that is traded
publicly on the NASDAQ stock exchange, our shareholders are our
business partners. We can only be successful so long as we are providing
them with a good return on the money they invest in our company. . . . We
page C-35
pledge to operate our company in such a way that our present and future
stockholders, as well as our employees, will be rewarded for our efforts.
Environmental Sustainability and Responsible Sourcing of
Meat and Dairy Products
In recent years, Costco management had undertaken a series of initiatives to
invest in various environmental and energy saving systems, the use of
packaging that could be recycled or composted, reduction of both packaging
materials and food waste, greater sourcing of sustainable seafood products
from wild fisheries and farmed aquaculture, working with recognized
experts and suppliers to increase the percentage of cage-free eggs it sold, and
compliance with best practices in dairy farming, animal care, and animal
well-being. The stated objective was to ensure that the company’s carbon
footprint grew at a slower rate than the company’s sales growth and that
Costco was a responsible steward of the animals, land, and other
environmental resources utilized in the products it sold.
Costco’s metal warehouse design, which included use of recycled steel,
was consistent with the requirements of the Silver Level LEED Standard—
the certification standards of the organization Leadership in Energy and
Environmental Design (LEED) were nationally accepted as a benchmark
green building design and construction. Costco’s recently-developed non-
metal designs for warehouses had resulted in the ability to meet Gold Level
LEED Standards.
All new facilities were being designed and constructed to be more energy
efficient; this included using LED lighting and energy-efficient mechanical
systems for heating, cooling, and refrigeration in both new and existing
facilities. In 2016, Costco began retrofitting existing facilities with LED
lighting; as of year-end fiscal 2018, 1,166 retrofits had been completed,
resulting in a total estimated energy savings of 206 million kilowatt-hours
per year.34 All lighting in new construction utilized LED technology. At the
end of fiscal 2018, Costco had rooftop solar photovoltaic systems in
operation at 109 of its warehouses; some warehouses used solar power to
light their parking lots. In 2017, Costco began piloting the use
of fuel cells as an alternate source of electricity at a handful of
locations and was continuing to evaluate their use in future facilities. So far,
Costco had found the fuel cells at test sites had resulted in lower combined
power and natural gas expenses. The company was also exploring use of
new HVAC and refrigerant systems that were more energy efficient and
increasing its use of refrigerants that further reduced global warming
potential and greenhouse gas emissions.
Another energy-saving initiative had been to install Internet-based energy
management systems at all Costco warehouses in North America and at
some international locations, giving Costco the ability to regulate energy
usage on an hourly basis. These, along with installation of LED lighting and
warehouse skylights, had reduced the lighting loads on Costco’s sales floors
by over 50 percent since 2001. Costco had undertaken a series of initiatives
at company facilities worldwide to reduce water usage, reduce or remove
potential chemical harm to humans and to the environment, use recycled
asphalt for paving most warehouse parking lots, and use best practices to
irrigate landscapes and manage groundwater runoff. Empty store cartons
were given to members to carry their purchases home. Costco had been an
active member of the Environmental Protection Agency’s Energy Star and
Climate Protection Partnerships since 2002 and was a major retailer of
Energy Star qualified compact florescent lamp (CFL) bulbs and LED light
bulbs.
Costco was committed to sourcing all of the seafood it sold from
responsible and environmentally sustainable sources that were certified by
the Marine Stewardship Council; in no instances did Costco sell seafood
species that were classified as environmentally endangered and it monitored
the aquaculture practices of its suppliers that farmed seafood. The company
had long been committed to enhancing the welfare and proper handling of all
animals used in food products sold at Costco. According to the company’s
official statement on animal welfare, “This is not only the right thing to do, it
is an important moral and ethical obligation we owe to our members,
suppliers, and most of all to the animals we depend on for products that are
sold at Costco.”35 As part of the company’s commitment, Costco had
established an animal welfare audit program that utilized recognized audit
standards and programs conducted by trained, certified auditors and that
reviewed animal welfare both on the farm and at slaughter.
COMPETITION
page C-36
According to IBISWorld, the Warehouse Clubs and Supercenters industry—
defined as companies that provided a range of general merchandise
including food and beverages, furniture and appliances, health and wellness
products, apparel and accessories, fuel and ancillary services—was expected
to have sales of about $514 billion in the United States alone in 2020.36
There were three main wholesale club competitors—Costco Wholesale,
Sam’s Club, and BJ’s Wholesale Club. Going into 2020, these three rivals
had over 1,600 warehouse locations across the United States and Canada;
most every major metropolitan area had one, if not several, warehouse clubs.
The combined 2019 sales of Costco, Sam’s Club, and BJ’s Wholesale in the
United States and Canada was $224.4 billion. Costco had a 68 percent share
of warehouse club sales across the United States and Canada, with Sam’s
Club (a division of Walmart) having just over a 26 percent share and BJ’s
Wholesale Club and several small warehouse club competitors close to a 6
percent share.
Competition among the warehouse clubs was based on such factors as
price, merchandise quality and selection, location, and member service.
However, warehouse clubs also competed with a wide range of other types
of retailers, including retail discounters like Walmart and Dollar General,
supermarkets, general merchandise chains, specialty chains, gasoline
stations, and Internet retailers. Not only did Walmart, the world’s largest
retailer, compete directly with Costco via its Sam’s Club subsidiary, but its
Walmart Supercenters sold many of the same types of merchandise at
attractively low prices as well. Target, Kohl’s, Kroger, and Amazon.com
had emerged as significant retail competitors in certain general merchandise
categories. Low-cost operators selling a single category or narrow range of
merchandise—such as Trader Joe’s, Lowe’s, Home Depot, Office Depot,
Staples, Best Buy, PetSmart, and Barnes & Noble—had significant market
shares in their respective product categories. Notwithstanding the
competition from other retailers and discounters, the low prices and
merchandise selection found at Costco, Sam’s Club, and BJ’s
Wholesale were attractive to small business owners, individual
households (particularly bargain-hunters and those with large families),
churches and nonprofit organizations, caterers, and small restaurants. The
internationally located warehouses faced similar types of competitors.
http://amazon.com/
Brief profiles of Costco’s two primary competitors in North America are
presented in the following sections.
Sam’s Club
The first Sam’s Club opened in 1984, and Walmart management in the
ensuing years proceeded to grow the warehouse membership club concept
into a significant business and major Walmart division. The concept of the
Sam’s Club format was to sell merchandise at very low profit margins,
resulting in low prices to members. The mission of Sam’s Club was “to
make savings simple for members by providing them with exciting, quality
merchandise and a superior shopping experience, all at a great value.”37 The
target market at Sam’s Club was small businesses and suburban families
with incomes of $75,000 to $125,000.
In early 2020, Sam’s Club operated 599 locations in 44 states and Puerto
Rico, many of which were adjacent to Walmart Supercenters, and about 100
Sam’s Club locations in Mexico, Brazil, and China. (Financial and operating
data for the Sam’s Club locations in Mexico, Brazil, and China were not
separately available because Walmart grouped its reporting of all store
operations in 26 countries outside the United States into a segment called
Walmart International that did not break out the international operations of
Sam’s Club.) In fiscal year 2020 (ending January 31, 2020), the Sam’s Club
locations in the United States and Puerto Rico and operations at
www.samsclub.com had record revenues of $59.2 billion (including
membership fees), making it the eighth largest retailer in the United States.
Sam’s Clubs generally ranged between 94,000 and 168,000 square feet,
with an average at the end of fiscal 2020 of approximately 134,000 square
feet; several newer locations were as large as 190,000 square feet. All Sam’s
Club warehouses had concrete floors, sparse décor, and goods displayed on
pallets, simple wooden shelves, or racks in the case of apparel. In 2009 and
2010, Sam’s Club began a long-term warehouse remodeling program for its
older locations. During fiscal 2018, management closed 67 underperforming
Sam’s Club locations.
Exhibit 5 provides financial and operating highlights for selected years
from 2016 to 2020.
http://www.samsclub.com/
page C-37
EXHIBIT 5 Selected Financial and Operating Data for Sam’s
Club, Fiscal Years 2016–2020
a The net sales figure does not include membership fees and is only for warehouses in the
United States and Puerto Rico. For financial reporting purposes, Walmart consolidates the
operations of all foreign-based stores into a single “international” segment figure. Thus,
separate financial information for the foreign-based Sam’s Club locations in Mexico, China,
and Brazil is not separately available.
Source: Walmart’s 10-K reports and annual reports, fiscal years 2020, 2018, and 2016.
Merchandise Offerings
Sam’s Club warehouses stocked about 4,000 items, a big fraction of which
were standard and a small fraction of which represented special buys and
one-time offerings. The treasure-hunt items at Sam’s Club tended to be less
upscale and less expensive than those at Costco. The merchandise selection
included brand-name merchandise in a variety of categories and a selection
of private-label items sold under the “Member’s Mark,” “Daily Chef,” and
“Sam’s Club” brands. Most club locations had fresh-foods departments that
included bakery, meat, produce, floral products, and a Sam’s Café. Most
locations also had a one-hour photo processing department, a pharmacy that
filled prescriptions, hearing aid and optical departments, tire and battery
centers, and self-service gasoline pumps; car wash services were available at
about 40 locations. Sam’s Club guaranteed it would beat any price for
branded prescriptions. Members could shop for a wider assortment of
merchandise (about 59,000 items) and services online at
www.samsclub.com; e-commerce sales were $3.6 billion in fiscal 2020 and
$2.7 billion in fiscal 2019. samsclub.com had an average of about 20.4
million unique visitors per month and provided members the option of pick-
up at local Sam’s Club locations or direct-to-home delivery.
The percentage composition of sales (including ecommerce sales) across
major merchandise categories was:
2020 2019 2018
Grocery and consumables (dairy, meat,
bakery, deli, produce, dry, chilled or frozen
packaged foods, alcoholic and nonalcoholic
beverages, floral, snack foods, candy, other
grocery items, health and beauty aids, paper
goods, laundry and home care, baby care, pet
supplies, and other consumable items)
60% 58% 58%
Fuel and other categories (gasoline, tobacco,
tools and power equipment, and tire and
battery centers)
19% 21% 21%
Technology, office and entertainment
(electronics, wireless, software, video games,
movies, books, music, toys, office supplies,
office furniture, photo processing, and gift
cards)
6% 6% 6%
Home and apparel (home improvement,
outdoor living, grills, gardening, furniture,
apparel, jewelry, housewares, toys, seasonal
items, mattresses, and small appliances)
9% 9% 9%
Health and wellness (pharmacy, hearing and
optical services, and over-the-counter drugs) 6% 6% 6%
Source: Walmart’s fiscal year 2020 10-K report.
Membership and Hours of Operation The annual fee for Sam’s Club
members was $45 for a Club membership card, with a spouse card available
at no additional cost. Club members could purchase up to eight “add-on”
memberships for an additional $40 each. Alternatively, members could
purchase a “Plus” membership for $100, and up to 16 “add-on”
memberships for $40 each. Plus members were eligible for free shipping on
http://www.samsclub.com/
http://samsclub.com/
page C-38
ecommerce orders and for Cash Rewards, a benefit that provided 2 percent
back for qualifying Sam’s Club purchases up to an annual maximum cash
reward of $500. Cash-back rewards could be used for purchases,
membership fees, or redeemed for cash. About 600,000 members shopped at
Sam’s Club weekly. Income from membership fees was a significant
percentage of the operating income earned by Sam’s Club.
Regular hours of operations were Monday through Friday from 10:00 a.m.
to 8:30 p.m., Saturday from 9:00 a.m. to 8:30 p.m., and Sunday from 10:00
a.m. to 6:00 p.m.; all Plus cardholders had the ability to shop before the
regular operating hours Monday through Saturday, starting at 7:00 a.m. All
club members could use a variety of payment methods, including Visa credit
and debit cards, American Express cards, and a co-branded Sam’s Club
“Cash-Back” Mastercard. Sam’s Club also offered “Scan and Go,” a mobile
checkout and payment solution, which allowed members to bypass the
checkout line. The pharmacy and optical departments accepted payments for
products and services through members’ health benefit plans.
Distribution Approximately 73 percent of the non-fuel merchandise at
Sam’s Club was shipped either from some 25 distribution facilities dedicated
to Sam’s Club operations that were strategically located across the
continental United States or, in the case of perishable and certain other
items, from nearby Walmart grocery distribution centers; the balance was
shipped by suppliers direct to Sam’s Club locations. Like Costco, Sam’s
Club distribution centers employed cross-docking techniques whereby
incoming shipments were transferred immediately to outgoing trailers
destined for Sam’s Club locations; shipments typically spent less than 24
hours at a cross-docking facility and in some instances were there only an
hour. A combination of company-owned trucks and independent trucking
companies were used to transport merchandise from distribution centers to
club locations. Sam’s Club shipped merchandise purchased on
samsclub.com and through its mobile commerce applications by a number
of methods including shipments made directly from Clubs, nine dedicated
eCommerce fulfillment centers, two dedicated import facilities, and other
distribution centers.
http://samsclub.com/
Employment In early 2020, Sam’s Club employed about 90,000 people
across all aspects of its operations in the United States. While the people
who worked at Sam’s Club warehouses were in all stages of life, a sizable
fraction had accepted job offers because they had minimal skill levels and
were looking for their first job, or needed only a part-time job, or were
wanting to start a second career. Approximately 75 percent of the
management staff at Sam’s Club had begun their careers at Sam’s Club as
hourly warehouse employees and had moved up through the ranks to their
present positions.
BJ’s Wholesale Club
BJ’s Wholesale Club introduced the member warehouse concept to the
northeastern United States in the mid-1980s and, as of April 2020, operated
218 warehouses and 145 BJ’s gas locations in 17 eastern states extending
from Maine to Florida. In its core New England market region, BJ’s had
about three times the number of locations compared to its next largest
warehouse club competitor. Approximately 85 percent of BJ’s warehouse
clubs had at least one Costco or Sam’s Club warehouse operating in their
trading areas (within a distance of 10 miles or less). Six distribution centers
served BJ’s existing locations and had the capacity to support up to 100
additional clubs along the East Coast of the United States. BJ’s warehouse
clubs ranged in size from 63,000 square feet to 163,000 square feet; newer
clubs were typically about 85,000 square feet. BJ’s market target was price-
sensitive households with an average annual income of approximately
$75,000.
In late June 2011, BJ’s Wholesale agreed to a buyout offer from two
private equity firms and shortly thereafter became a privately held company.
However, in May 2018, the private company (recently renamed BJ’s
Wholesale Club Holdings) announced its intent to become a public company
again and filed the necessary registration for an initial public offering of
common stock with the Securities and Exchange Commission. In late June
2018, BJ’s became a public company with an initial public offering of 37.5
million shares at a public offering price of $17 per share; its stock traded on
the New York Stock Exchange under the ticker symbol BJ. In the next three
years, BJ’s hired Chris Baldwin as Chairman, President and Chief Executive
Officer and made multiple senior management hires and changes to give its
leadership team more experience in consumer-packaged goods, digital
know-how, and consulting experience. The new management team
implemented significant cultural and operational changes that included
transforming how BJ’s used data to improve member experience, instilling a
culture of cost discipline, adopting a more proactive approach to growing its
membership base, building a much more comprehensive collection of online
merchandise offerings, installing the capability to deliver products to
members’ homes or office, and introducing a mobile app that enabled
members to save coupon offers directly onto the app and self-checkout. In
2018 BJ’s began same-day delivery of orders at a fixed fee. One of the new
management team’s strategic priorities was to make shopping at BJ’s easier
and more convenient for members.
Exhibit 6 shows selected financial and operating data for BJ’s Wholesale
Club Holdings, Inc. for the four most recent fiscal years.
EXHIBIT 6 Selected Financial and Operating Data, BJ’s
Wholesale Club Holdings, Inc., Fiscal Years 2017–2020
page C-39
page C-40
Source: Company form S-1 registration statement, May 17, 2018; 2019 10-K report; and
2020 10-K report.
Product Offerings and Merchandising Like Costco and Sam’s Club,
BJ’s Wholesale sold high-quality, brand-name merchandise at prices that
were significantly lower than the prices found at supermarkets, discount
retail chains, department stores, drugstores, and specialty retail
stores like Best Buy. Its merchandise lineup of about 7,200 items
included consumer electronics, prerecorded media, small
appliances, tires, jewelry, health and beauty aids, household products,
computer software, books, greeting cards, apparel, furniture, toys, seasonal
items, frozen foods, fresh meat and dairy products, beverages, dry grocery
items, fresh produce, flowers, canned goods, and household products. About
70 percent of BJ’s product line could be found in supermarkets. Sales of the
company’s two private-label brands, Wellsley Farms® and Berkley Jensen®,
accounted for about 20 percent of total net sales. BJ’s prices of a
representative basket of 100 items were consistently about 25 percent below
comparable brand name products sold by its four leading supermarket
competitors. Members could purchase thousands of additional products at
the company’s website, www.bjs.com.
BJ’s warehouses had a number of specialty services that were designed to
enable members to complete more of their shopping at BJ’s and to encourage
more frequent trips to the clubs. Like Costco and Sam’s Club, BJ’s sold
gasoline at a discounted price as a means of displaying a low-price image to
prospective members and providing added value to existing members; in
April 2020, there were gas station operations at 145 BJ’s locations. Other
specialty services included full-service optical centers; tire installation
services; a propane tank filling service; home improvement services; travel
services; a car rental service; cell phone kiosks; and product protection plans
for appliances, electronics, and jewelry. Most of these services were
provided by outside operators in space leased from BJ’s. In early 2007, BJ’s
abandoned prescription filling and closed all of its 46 in-club pharmacies.
Membership BJ’s Wholesale Club had more than 5.5 million paid
memberships as of early 2020 and a total of 10 million cardholders that
generated membership fee revenues of $302 million in fiscal 2020.
Individuals could become Inner Circle members for a fee of $55 per year
that included a second card for a household member; cards for up to three
other family members and friends could be added to an Inner Circle
member’s account for an additional $30 per card. A primary business
membership cost $55 per year and included one free supplemental
membership; business members could purchase up to eight additional
supplemental business memberships at $30 each. U.S. military personnel—
active and veteran—who enrolled at a BJ’s club location could do so for a
https://www.bjs.com/
page C-41
reduced membership fee. Individuals and businesses could upgrade to BJ’s
Perks/Rewards card for $110; Perks/Reward members received a free second
card for a household member and could add up to three additional members
for $30 each. BJ’s Perks Rewards members earned two percent cash back on
in-club and online purchases; cash awards were issued in $20 increments
and could be used for in-store purchases; awards expired six months from
the date issued. Non-members could purchase online access to www.bjs.com
for $10 per year, which provided the benefits of member pricing for online
purchases. Members could apply for a BJ’s Perks Plus® or BJ’s Perks Elite®
credit card (MasterCard) that had no annual credit card fee and served as a
membership card. The Perks Plus® card earned three percent cash back on
eligible in-club and online purchases made with the credit card, while BJ’s
Perks Elite® cardholders earned five percent cash back on eligible in-club
and online purchases made with the card. Both Plus and Elite cardholders
received 10 cents off per gallon at BJ’s gas stations when using their card to
pay for fuel purchases, two percent cash back on non-BJ’s gasoline
purchases and eligible dining out purchases, and one percent cash back on
all non-BJ’s purchases everywhere else MasterCard was accepted. Fuel
purchases made with these credit cards were not eligible for further cash
back rewards; moreover, members with the $30 supplemental Business
memberships had to upgrade to the $55 primary membership category to be
eligible for a BJ’s Plus or Elite credit card. Since fiscal year 2014, BJ’s had
grown co-branded Mastercard® holders by 527 percent. In fiscal year 2019,
BJ’s Perks Rewards members and co-branded Mastercard® members
accounted for 28 percent of members and 43 percent of spend, compared to
25 percent of members and 39 percent of spend in fiscal year 2018. BJ’s
accepted MasterCard, Visa, Discover, and American Express cards at all
locations; members could also pay for purchases by cash, check, or
magnetically encoded Electronic Benefit Transfer cards (issued by state
welfare departments). Manufacturer’s coupons were accepted for
merchandise purchased at the register in any Club where the product was
sold. BJ’s accepted returns of most merchandise within 30 days
after purchase.
BJ’s leadership team believed that members could save over
ten times their $55 Inner Circle membership fee versus what they would
http://www.bjs.com/
have paid at traditional supermarket competitors if they spent $2,500 or
more per year at BJ’s on manufacturer-branded groceries.
Marketing and Promotion BJ’s increased customer awareness of its
clubs primarily through social media, direct mail, public relations efforts,
community involvement programs, marketing programs for newly opened
clubs, and various publications mailed to members throughout the year. BJ’s
also had dedicated marketing personnel who solicited potential business
members and who contacted other selected organizations to increase the
number of members. Periodically, it also ran free promotional membership
and initially discounted membership promotions to attract new members,
with the objective of converting them to paid members.
Warehouse Club Operations BJ’s warehouses were located in both
freestanding locations and shopping centers. Construction and site
development costs for a full-sized owned BJ’s club were in the $6 million to
$10 million range; land acquisition costs ranged from $3 million to $10
million but could be significantly higher in some locations. Each warehouse
generally had an investment of $3 to $4 million for fixtures and equipment;
other pre-opening expenses at a new club were usually in the $1.0 to $2.0
million range. Including space for parking and gas station operations, a
typical full-sized BJ’s club required 13 to 14 acres of land; smaller clubs
typically required about eight acres.
Merchandise purchased from manufacturers was routed either to a BJ’s
cross-docking facility or directly to clubs. Personnel at the cross-docking
facilities broke down truckload quantity shipments from manufacturers and
reallocated goods for shipment to individual clubs, generally within 24
hours. BJ’s worked closely with manufacturers to minimize the amount of
handling required once merchandise is received at a club. BJ’s contracted
with a third party to operate three perishables distribution centers and deliver
perishable products to its warehouse locations.
Merchandise in BJ’s warehouses was generally displayed on pallets
containing large quantities of each item, thereby reducing labor required for
handling, stocking, and restocking. Backup merchandise was generally
stored in steel racks above the sales floor. Most merchandise was pre-marked
by the manufacturer so it did not require ticketing at the club. Full-sized
page C-42
clubs had approximately $4 million in inventory. Management was able to
limit inventory shrinkage to a small fraction of one percent of net sales by
strictly controlling the exits of clubs, generally limiting customers to
members, and using state-of-the-art electronic article surveillance
technology.
ENDNOTES
1 As quoted in Alan B. Goldberg and Bill Ritter, “Costco CEO Finds Pro-Worker Means Profitability,” an ABC News
original report on 20/20, August 2, 2006, http://abcnews.go.com/2020/Business/story?id=1362779 (accessed
November 15, 2006).
2 Ibid.
3 As described in Nina Shapiro, “Company for the People,” Seattle Weekly, December 15, 2004,
www.seattleweekly.com (accessed November 14, 2006).
4 See, for example, Costco’s “Code of Ethics,” posted in the investor relations section of Costco’s website under a link
entitled “Corporate Governance and Citizenship” (accessed on February 4, 2016).
5 Costco Wholesale, 2011 Annual Report for the year ended August 28, 2011, p. 5.
6 Costco Wholesale, 2017 Annual Report for the year ended September 3, 2017, p. 3.
7 As quoted in ibid., pp. 128–29.
8 Steven Greenhouse, “How Costco Became the Anti-Wal-Mart,” The New York Times, July 17, 2005,
www.wakeupwalmart.com/news (accessed November 28, 2006).
9 As quoted in Greenhouse, “How Costco Became the Anti-Wal-Mart,” The New York Times, July 17, 2005,
www.wakeupwalmart.com/news (accessed November 28, 2006).
10 As quoted in Shapiro, “Company for the People,” Seattle Weekly, December 15, 2004, www.seattleweekly.com
(accessed November 14, 2006).
11 As quoted in Greenhouse, “How Costco Became the Anti-Wal-Mart,” The New York Times, July 17, 2005,
www.wakeupwalmart.com/news (accessed November 28, 2006).
12 Boyle, “Why Costco Is So Damn Addictive,” Fortune, October 30, 2006, p. 132.
13 Costco 10-K Reports, 2015 and 2017.
14 Sinegal’s explanation appeared in the company’s 2005 Annual Report; this same statement was also attributed to
Craig Jelinek in Costco’s “Corporate Profile,” posted on its Investor Relations website, accessed October 16, 2019.
15 Jeremy Bowman, “Who Is Costco’s Favorite Customer?” The Motley Fool, June 17, 2016, www.fool.com (accessed
June 5, 2017); J. Max Robins, “Costco’s Surprisingly Large-Circulation Magazine,” MediaPost, March 6, 2015,
www.mediapost.com (accessed June 5, 2017).
16 As quoted in Goldberg and Ritter, “Costco CEO Finds Pro-Worker Means Profitability,” an ABC News original report
on 20/20, August 2, 2006, http://abcnews.go.com/2020/Business/story?id=1362779 (accessed November 15,
2006).
17 Ibid.
18 Information posted at www.indeed.com (accessed October 16, 2019).
19 Based on information posted at www.glassdoor.com (accessed February 28, 2012).
20 Information posted at www.glassdoor.com (accessed October 16, 2019).
21 Ibid.
22 Ibid.
23 Nina Shapiro, “Company for the People,” Seattle Weekly, December 15, 2004, www.seattleweekly.com (accessed
November 14, 2006).
24 As quoted in Goldberg and Ritter, “Costco CEO Finds Pro-Worker Means Profitability,” an ABC News original report
on 20/20, August 2, 2006, http://abcnews.go.com/2020/Business/story?id=1362779 (accessed November 15,
2006).
http://abcnews.go.com/2020/Business/story?id=1362779
http://www.wakeupwalmart.com/news
http://www.wakeupwalmart.com/news
http://www.wakeupwalmart.com/news
http://www.fool.com/
http://www.mediapost.com/
http://abcnews.go.com/2020/Business/story?id=1362779
http://www.indeed.com/
http://www.glassdoor.com/
http://www.glassdoor.com/
http://abcnews.go.com/2020/Business/story?id=1362779
25 Ibid.
26 As quoted in Greenhouse, “How Costco Became the Anti-Wal-Mart,” The New York Times, July 17, 2005,
www.wakeupwalmart.com/news (accessed November 28, 2006).
27 As quoted in Goldberg and Ritter, “Costco CEO Finds Pro-Worker Means Profitability,” an ABC News original report
on 20/20, August 2, 2006, http://abcnews.go.com/2020/Business/story?id=1362779 (accessed November 15,
2006).
28 Boyle, “Why Costco Is So Damn Addictive,” Fortune, October 30, 2006, p. 132.
29 As quoted in Shapiro, “Company for the People,” Seattle Weekly, December 15, 2004, www.seattleweekly.com
(accessed November 14, 2006).
30 Ibid.
31 As quoted in Goldberg and Ritter, “Costco CEO Finds Pro-Worker Means Profitability,” an ABC News original report
on 20/20, August 2, 2006, http://abcnews.go.com/2020/Business/story?id=1362779 (accessed November 15,
2006).
32 As quoted in Shapiro, “Company for the People,” Seattle Weekly, December 15, 2004, www.seattleweekly.com
(accessed November 14, 2006).
33 Costco Code of Ethics, last updated March 2010, posted in the Governance Documents section of Costco’s investor
relations website, accessed October 16, 2019.
34 Information posted in the environmental sustainability section of Costco’s Investor relations website, accessed
October 17, 2019.
35 Mission Statement on Animal Welfare,” posted at www.costco.com in the Investor Relations section (accessed
February 8, 2016).
36 According to information in “Warehouse Clubs and Supercenters in the U.S.: Industry Statistics,” posted at
www.ibisworld.com, accessed June 15, 2020.
37 Walmart 2010 Annual Report, p. 8.
http://www.wakeupwalmart.com/news
http://abcnews.go.com/2020/Business/story?id=1362779
http://abcnews.go.com/2020/Business/story?id=1362779
http://www.costco.com/
http://www.ibisworld.com/
A
page C-43
CASE 4
Ford Motor Company: Will the
Company’s Strategic Moves
Restore its Competitiveness and
Financial Performance?
Copyright ©2021 by Marlene M. Reed, Baylor University and Rochelle R. Brunson, Baylor
University. All rights reserved.
Marlene M. Reed
Baylor University
Rochelle R. Brunson
Baylor University
report by Road Show on CNET, dated June 5, 2019, suggested that the
Ford Fusion 2020 model would be the last car Ford would produce. The
discontinuation of the Fusion was said to be a part of Ford’s shifting
strategic focus away from passenger cars toward crossovers and SUVs—
many with electrified powertrains.1 Observers wondered if Ford could
essentially abandon the market for automobiles as car sales had been its
lifeblood since 1908 when Henry Ford revolutionized passenger
transportation with production of the Model T. Industry analysts also
page C-44
wondered if the American love affair with the SUV and trucks would
continue if the price of gasoline began to escalate as the United
States, Russia, and the United Arab Emirates. engaged in tactics
to alter energy prices around the world. Exhibit 1 below outlines key
milestones in the history of the Ford Motor Company.
EXHIBIT 1 History of the Ford Motor Company
1896–Henry Ford built the Quadricycle, the forerunner of the
automobile.
1899–Henry Ford joins a group that founded the Detroit
Automobile Company.
1901–Henry Ford defeats the top racecar driver of the era in his
26. The victory led to Sweepstakes. The victory led to Ford’s
second short-lived attempt at auto manufacture—the Henry
Ford Company.
1903–The Ford Motor Company is incorporated with an initial
12 investors and 1,000 shares. The company had spent almost
all of its $28,000 cash investment by the time it sold the first
Ford Model A on July 23. By October, the company had turned
a profit of $37,000.
1904–Ford Motor Company of Canada is founded. The plant
was built in Windsor, Ontario, across the river from Ford’s
existing facilities. The company was created to sell vehicles not
just in Canada but also all across the British Empire.
1907–Ford introduces the scripted typeface of its trademark.
1908–Ford introduces the Model T. Ford sold 15 million of this
model before ceasing production in May 1927. It became the
most famous car in the world.
1913–Ford introduces the integrative moving assembly line to
auto production. This innovation reduced the Model T’s chassis
assembly line from 12.5 to 1.5 hours and brought about a
revolution in manufacturing.
1914–Ford institutes the famous “$5 Day.” This wage payment
to Ford’s employees was double the existing rate for factory
workers. The company also reduced the workday from 9 to 8
hours. The day after this wage rate was announced, 10,000
people lined up hoping to be hired by Ford.
1917–Ford produces its first truck. The truck was called the
Ford Model TT based on the Model T car but with a reinforced
chassis and rear axle.
1919–Edsel Ford succeeds Henry Ford as president of the
company.
1922–Ford acquires the Lincoln Motor Company.
1925–Ford begins production of the Ford Tri-Motor airplanes.
The “Tin Goose” was the first airplane used by America’s early
commercial airlines.
1927–Ford begins selling the 1928 Model A. The company
closed plants all over the world to spend six months retooling
factories and perfecting the design of the car.
1936–Ford begins selling the Lincoln Zephr line. Lincoln Zephr’s
sleek, aerodynamic shapes helped make the brand a sales
success, but when auto production ceased during World War II,
the Zephr name was dropped as well.
1941–Ford begins producing Jeeps for the U.S. military.
1942–Ford halts production of automobiles in the United States
to produce military equipment.
1948–Ford produces the F-Series line of trucks. The company
ceased building trucks on car platforms and used a purpose-
built truck platform instead.
1954–Ford introduces the Thunderbird. This car would become
a classic.
1956–Ford becomes a publicly-traded company.
1959–Ford Credit is established. The company offered loans
and leases to car buyers.
1964–The Ford Mustang goes on sale. The car was a huge
success and has remained one of the fastest-selling vehicles in
history.
1965–Ford-Philco engineers unveil the Mission Control Center
used to put a man on the moon.
1976–Ford of Europe introduces the Ford Fiesta.
1986–Ford introduces the modular assembly line at its St. Louis
assembly plant. This made use of automated ancillary assembly
lines to produce vehicle subassemblies.
1990–Ford introduces the Explorer. With this model, Ford
helped launch the SUV market. This became one of Ford’s most
successful models.
1996–Ford introduces the Ford Ranger Electric Vehicle. This
was a forerunner of today’s electric vehicles and hybrid energy
systems.
1998–The Lincoln Navigator is introduced and spurs rapid
growth in the luxury SUV segment.
2011–Ford discontinues the Mercury line to concentrate all of its
efforts on the Ford and Lincoln brands.
2016–Ford Mobility, LLC is created. This focused on changing
the way the world moves. Ford Smart Mobility was designed to
take the company to the next level in connectivity, mobility,
autonomous vehicles, the customer experience and data
analytics.
Ford’s Strategic Situation in 2020
By 2020, Ford employed over 200,000 people worldwide in 70 plants
producing midsize cars, SUVs, and pickup trucks. Since the recession of
2008, the company’s revenues had rebounded due to increased disposable
income levels, falling unemployment, and a renewed demand for big-ticket
purchases. However, the company reported falling sales in some of its
established markets in 2019 and 2020—partially due to the spread of the
COVID-19 virus in early 2020. Exhibit 2 presents Ford’s stock performance
between April 2015 and April 2020. The company’s consolidated income
statements for 2017 through 2019 are presented in Exhibit 3. Ford Motor
Company’s consolidated balance sheets for 2018 and 2019 are presented in
Exhibit 4.
EXHIBIT 2 Performance of Ford Motor Company’s Stock
Price, April 2015 to April 2020
page C-45
Ford’s New Product Strategy
William Clay Ford, Jr., Executive Chairman of Ford, suggests that 115 years
ago, when the company began, the company’s mission was to make people’s
lives better by making mobility accessible and affordable. By 2020, the
company was moving toward manufacturing “smart vehicles for a smart
world.” The world plan focused on four pillars: (1) A winning portfolio; (2)
new propulsion options; (3) a high-level autonomous business built on the
most trusted self-driving systems; and (4) cloud-based mobility experiences
that deliver recurring revenue.
page C-46
page C-47
The winning portfolio in 2020 was envisioned to be the Escape,
Expedition, Explorer, Ranger, F-150 Hybrid, Bronco, and the Mustang
Shelby GT500. The Ford Bronco was produced between 1966 and 1996 and
was discontinued when the smaller two-door Bronco II suffered from a
tipping problem. The reintroduced Bronco will be modular with a removable
top and doors.
EXHIBIT 3 Consolidated Income Statements for the Ford
Motor Company, 2017–2019 ($ in millions except per share
amounts)
Source: Ford Motor Company 2019 10-K.
EXHIBIT 4 Ford Motor Company Consolidated Balance
Sheets, 2018–2019 ($ amounts in millions)
December 31,
2018
December 31,
2019
ASSETS
Cash and cash equivalents $ 16,718 $ 17,504
Marketable securities 17,233 17,147
Ford Credit finance receivables, net 54,353 53,651
Trade and other receivables, less allowances of
$94 and $63 11,195 9,237
Inventories 11,220 10,786
Assets held for sale — 2,383
Other assets 3,930 3,339
Total current assets 114,649 114,047
Ford Credit finance receivables, net 55,544 53,703
Net investment in operating leases 29,119 29,230
Net property 36,178 36,469
Equity in net assets of affiliated companies 2,709 2,519
Deferred income taxes 10,412 11,863
Other assets 7,929 10,706
Total assets $ 256,540 $ 258,537
LIABILITIES
Payables $ 21,520 $ 20,673
Other liabilities and deferred revenue 20,556 22,987
Automotive debt payable within one year 2,314 1,445
Ford Credit debt payable within one year 51,179 52,371
Other debt payable within one year — 130
Liabilities held for sale — 526
Total current liabilities 95,569 98,132
Other liabilities and deferred revenue 23,588 25,324
page C-48
December 31,
2018
December 31,
2019
Automotive long-term debt 11,233 13,233
Ford Credit long-term debt 88,887 87,658
Other long-term debt 600 470
Deferred income taxes 597 490
Total liabilities 220,474 225,307
Redeemable noncontrolling interest 100 —
EQUITY
Common Stock, par value $.01 per share (4,011
million shares issued of 6 billion authorized) 40 40
Class B Stock, par value $.01 per share (71
million shares issued of 530 million authorized) 1 1
Capital in excess of par value of stock 22,006 22,165
Retained earnings 22,668 20,320
Accumulated other comprehensive income/(loss) (7,366) (7,728)
Treasury stock (1,417) (1,613)
Total equity attributable to Ford Motor Company 35,932 33,185
Equity attributable to noncontrolling interests 34 45
Total equity 35,966 33,230
Total liabilities and equity $ 256,540 $ 258,537
Source: Ford Motor Company 2019 10-K.
Two years before the Bronco was discontinued, the
automobile gained a great deal of attention when Al Cowlings drove O.J.
Simpson down a Los Angeles freeway after Simpson was charged with the
murders of his ex-wife and her friend. More than 95 million people across
the United States watched the two-hour pursuit on television while crowds
gathered on overpasses to cheer on the NFL football legend.2
Ford Credit Company
Although the company experienced profitability difficulties in 2018 and
2019, its financial arm, Ford Credit Company, posted its best results in 2019
of the past nine years. Their profits jumped to $3 billion before taxes. The
result was that this arm of the company accounted for 50 percent of Ford’s
profits. This was up from 15 to 20 percent in the past. Ford Motor Company
had, thus, been able to subsidize Ford’s losses and allowed the company to
maintain a high dividend yield. Unfortunately, data released by the New
York Federal Reserve Bank in late 2019, indicated that the volume of 90+
days delinquent loans had risen sharply. The value of the overall auto loan
and lease balances had surged to $1.33 trillion that year. In addition,
subprime loans reached $66 billion in the final quarter of 2019.3
There were several risks for the company in the 2020s regarding the Ford
Credit Company. One risk was that this financial arm of the company could
experience higher-than-expected credit losses, lower-than-anticipated
residual values on higher-than-expected return volumes for leased vehicles.
Another risk was that Ford Credit could face increased competition from
financial institutions or other third parties seeking to increase their share of
financing Ford vehicles. Finally, Ford Credit could be subject to new or
increased credit regulations, consumer or data protection regulations or other
types of regulations.
Challenges for 2020
The automotive industry is affected by macroeconomic conditions over
which the companies have little control. Vehicles are durable goods, and
consumers exert strong choices about when and if they will buy a new car.
This decision is influenced by such factors as slower economic growth,
geopolitical events and other factors such as the COVID-19 virus threat in
2020.
Some of the greatest challenges to Ford in 2020 identified by management
included the following:
1. Acceptance of new and existing products by the market.
2. Sales of more profitable larger vehicles, especially in the United States.
3. Increased price competition resulting from industry excess capacity.
4. Fluctuations in commodity prices, foreign exchange rates, and interest
rates.
page C-49
5. Global macroeconomic factors such as protectionist trade policies and
other events including Brexit.
6. The company’s ability to maintain a competitive cost structure.
7. Pension and other post-retirement liabilities.
8. Defects that result in delays in new model launches.
9. Operational systems could be affected by cyber incidents.4
Ford and the Coronavirus Pandemic.
In early 2020, a new virus called the coronavirus or COVID-19 began to
cause serious illness and death around the world. Because of an increasing
incidence of this disease in the United States, many states declared a “shelter
in place” order intended to prevent the spread of the virus by forcing people
to work from home. Ford, on March 31, stated that it was delaying the restart
of a car plant in Mexico as well as four truck, SUV and van plants in the
United States “to help protect its workers.”5 This postponement came just
two days after President Donald Trump extended the national social-
distancing guidelines through the end of April 2020. The shutting down of
the economy resulted in the loss of more jobs than had occurred since the
Great Depression and the stoppage of purchasing non-essential goods.
Because of a shortage of ventilators to treat coronavirus patients, Ford and
General Electric’s Health Care Division announced on March 30 that they
together planned to produce 50,000 ventilators over the next 100 days. Ford
planned to use a plant in Rawsonville, Michigan, and about 500 workers to
make 30,000 ventilators a month. GE had licensed the design of
the ventilator from Airon Corporation of Melbourne, Florida.
The device works on air pressure and does not need electricity. Both Ford
and GE announced that Ford would help increase production of another
ventilator based on a design from GE Healthcare.6
Global Automobile Status
A survey of the range of products and services provided by the global
automobile manufacturing industry is shown below in Exhibit 5.
EXHIBIT 5 Global Automobile Industry Products and
Services Segmentation, 2018
Product Percentage of Market
Cars 36.6%
Cross utility vehicles (CUVs) 32.1%
Pickup trucks 10.8%
Sports utility vehicles (SUVs) 6.9%
Other 13.6%
Total 100%
Source: Oelkan, Ediz (February 2020). Ibisworld.com, Global Car & Automobile Mfg.
Although the production of cars accounts for 36.6 percent of global
industry revenue, this was lower than its production volume because cars
normally sell at a lower price than SUVs and commercial vehicles.
Therefore, they contribute less to revenue on a per-unit basis. The car
segment had been growing as consumers opted for more fuel efficiency.
Ford sales in the United States, however, showed a lower total sales of cars
than trucks or SUVs—see Exhibit 6.
EXHIBIT 6 2018 U.S. Retail Sales Volume Segregated by
Product Type
U.S. Retail Sales Percentage
Trucks 1,139,079 45.6%
SUVs 872,215 34.9%
Cars 486,024 19.4%
Total 100%
Source: Annual Report of the Ford Motor Company, 2018
Generally, Germany, Japan, the United States, and Canada are expected to
be the world’s largest exporters of cars and automobiles (SUVs, trucks, etc.).
On the other hand, Germany, China, the United Kingdom, and Belgium are
expected to be the largest destinations for automobile products.7 The historic
methodology for manufacturing automotive vehicles was to assemble cars at
http://ibisworld.com/
page C-50
a domestic plant and then export them to their final destinations. However,
the supply chain has become more complex. The shift has been toward
manufacturing cars close to their final destination to save on logistics costs.
Another part of this strategy is to focus on very specific branding devices to
appeal to the customer. An example of this is the logo “Made in America.”
A Future Strategy
By 2020, the Ford Motor Company Board had some difficult decisions to
make. Although the developing economies of the world primarily demanded
smaller automobiles, the developed economies preferred the larger
crossovers, SUVs, and trucks. The company had already made a decision to
discontinue the Ford Fusion, its largest automobile, and the public wondered
if they would drop selling all of their cars except for the Mustang in the
United States.
Another question that arose was: What would happen to large vehicle
sales if the price of petroleum rose to alarming rates again? That had seemed
to be a remote possibility until the United States, Russia, and the United
Arab Emirates decided in the spring of 2020 to limit the daily production of
petroleum. There was also the question of what would happen if people
began financing their vehicles at some place other than Ford Credit, and
what could they do about that? The Board had much to think about as they
put their strategic plan together.
ENDNOTES
1 Ewing, Steve (June 5, 2019). All Ford Fusion models will go out of production in 2020. Road Show by CNET.
2 Noble, Breanna (March 5, 2020). Ford Bronco poised to return: It’s like a cult vehicle,” The Detroit News.
3 Singh, Ayush (March 2, 2020). Here’s why Ford Motor Company still can’t avoid bankruptcy, Business News.
https://www.ccn.com/heres-why-ford-motor-company-still-cant-avoid-bankruptcy/.
4 Annual Report of the Ford Motor Company, 2018.
5 Wayland, Michael (March 31, 2020). Ford postpones reopening “key” plants due to coronavirus pandemic.
https://www.cnbc.com/2020/03/31/ford-postpones-reopening-key-plants-due-to-coronavirus-pandemic.html.
6 The New York Times (March 30, 2020). Ford joins effort to make ventilators.
https://www.nytimes.com/2020/03/30/business/stock-market-today-coronavirus-html#link-310e3984/.
7 Ozelkan, Ediz (February 2020). Global car and manufacturing, Ibisworld.com, 1999–2020.
https://www.ccn.com/heres-why-ford-motor-company-still-cant-avoid-bankruptcy/
https://ww/
http://w.cnbc.com/2020/03/31/ford-postpones-reopening-key-plants-due-to-coronavirus-pandemic.html
https://www.nytimes.com/2020/03/30/business/stock-market-today-coronavirus-html#link-310e3984/
http://ibisworld.com/
T
page C-51
CASE 5
Macy’s, Inc.: Will Its Strategy
Allow It to Survive in the Changing
Retail Sector?
Copyright ©2021 by Alen Badal and John E. Gamble. All rights reserved.
Alen Badal
University of Liverpool
John E. Gamble
Texas A&M University-Corpus Christi
he retail landscape in the United States in early 2020 may have been best
characterized as rapidly changing with an uncertain future. The COVID-
19 pandemic and stay-at-home orders by state and local governments had
created unprecedented challenges for all retailers, but traditional brick-and-
mortar retailers had under pressure for at least a decade. The convenience of
shopping for nearly every type of consumer good at Amazon or other online
retailer sites had radically transformed the retail industry. Consumer needs
continued to allow for variations in strategy that allowed for distinctive
retailer approaches to meeting customer expectations. But consumers had
become to expect even the most highly differentiated retailers to have an
online presence in addition to their prestigious brick-and-mortar locations.
page C-52
The change in consumer shopping preferences had especially impacted
mall-based department stores. Nearly all shopping malls relied on strong
department store anchor tenants to draw vast numbers of shoppers, who
would also patronize smaller specialized retailers during their visits to a
mall. The transition to online shopping had greatly damaged the business
model of many shopping malls as smaller retailers failed along with
department stores, both of whom had experienced a decline in sales per
square foot resulting from reduced customer traffic.
Macy’s, Inc. had particularly struggled to adapt its business model to the
online shopping environment with sales declining each year since its record
sales of $28.1 billion generated in 2014. In 2018, Macy’s turned to 34-year
company veteran Jeff Gennette to lead the company’s turnaround and
transformation as CEO. In early 2020, Gennette was in the second year of
his five-point strategic plan designed to reinvent the company’s business
model and generate retail innovations. The key feature of the plan was its
Growth50 initiative which strived for product and merchandising
innovations in 50 stores that would establish a new retailing standard that
could be rolled out to 50 to 100 additional stores per year. The company also
implemented a direct vendor fulfillment model for online sales that nearly
doubled the number of SKUs offered online since inventory could be
maintained by vendors, not Macy’s.
The third element of the turnaround plan was to allow customers to order
items online and pick up merchandise in a nearby store location. Gennette
also wished to expand the number of the company’s off-price Macy’s
Backstage stores from approximately 150 to more than 200. Macy’s
management had determined that the off-price store locations were less
vulnerable to competition from online retailers than its core Macy’s stores.
Expanding the company’s loyalty plan to encourage repeat business, making
online sales available through its new mobile app, and better utilizing its
strongest product categories like housewares and women’s apparel to draw
customers to its stores were less sweeping changes that rounded out the plan.
As of early-2020, the plan had produced few positive results
with some analysts suggesting that the strategy was better aligned with the
retail environment of 2010 than of 2020. In February 2020, Macy’s
announced that it would close 125 store locations. By March 18, the
company’s COVID-19 response resulted in it closing all 775 store locations.
The company began reopening stores on May 4 and expected to have 270
stores open by the 2020 Memorial Day Weekend. The combined effect of the
company’s ongoing poor performance and COVID-19 store closes was
expected to result in a first quarter 2020 loss of $905 million to $1.1 billion.
Company Background
Headquartered in Cincinnati, Ohio, Macy’s, Inc. was the second-largest
department store chain with a market share of approximately 16.3 percent in
2020. The company operated about 551 Macy’s department stores, 53
Bloomingdales, and 171 Bluemercury businesses in early-2020, and its
retailing portfolio also included Bloomingdale’s The Outlet, Macy’s
Backstage, and STORY and online businesses macys.com,
bloomingdales.com, and bluemercury.com. The company also licensed
Bloomingdale’s stores in Dubai and Kuwait for operation by Al Tayer
Group.
Beginning in 2018, CEO Gennette and his chief lieutenants launched a
five-point turnaround plan to improve the company’s performance. The
Growth50 initiative was focused on 50 Macy’s department stores to
revitalize in 2018, including store remodels, improved customer service, and
increased product assortment. The addition of STORY retail locations in
2018 supported sales growth for the company as well. STORY locations
were much smaller stores with an inventory assortment that was refreshed
with new items every six to eight weeks. The value proposition of the
STORY business was keyed to engaging consumers through an opportunity
to interact with products and collaborate. The value proposition for The
Market @ Macy’s was similar, but entailed departments located within select
Macy’s stores rather than operating as standalone locations.
Revitalization of the customer experience at Bloomingdale’s and
Blumercury were also important elements of the turnaround efforts. Like
Bloomingdale’s, the Bluemercury business operated standalone stores but
also was comprised of store-within-store locations inside Macy’s stores. The
Bluemercury division had achieved impressive sales growth for the company
and an addition of 26 standalone locations. Additionally, Bluemercury online
sales increased by greater than 50 percent, accounting for double-digit
increases in total sales. The Bluemercury division increased its private
http://macys.com/
http://bloomingdales.com/
http://bluemercury.com/
brands Lune+Aster and M-61, which accounted for greater than 10 percent
of total sales at Bluemercury per company.
A focus on improvements in the online and mobile shopping experience
was a second primary element of the plan and resulted in mobile
representing the fastest growing channel for the company. The new practice
of allowing Macy’s customers to make purchases online and pick-up
merchandise in the store or buy online and ship to a store for pick-up
resonated with consumers. The third primary element of the company’s
turnaround plan included an expansion of its loyalty program to increase
customer traffic and average purchase amount. In 2018, Macy’s Platinum
customers generated about 30 percent of store sales, shopped with more
frequency, and spent 10 percent more per store visit than other customers.
The company launched a new Bronze loyalty level in 2018, which yielded 3
million new customers for Macy’s by year-end.
The company’s off-price retail brands Backstage and Bloomingdale’s The
Outlet were the fourth major element of the turnaround plan because of their
ability to defend against online retailers. Macy’s management planned to add
up to 50 Backstage locations within existing Macy’s store locations and
construct seven free-standing stores, all to be opened by 2020. Direct vendor
fulfillment was the fifth major element of the plan and was directed at
reducing distribution costs across all Macy’s retail operations. Engaging
customers through destination departments such as housewares, furniture,
and women’s apparel were additional turnaround initiatives designed to keep
customers shopping once inside store locations.
Exhibit 1 presents Macy’s, Inc.’s Income Statements for 2015 through
2019 and reflect the company’s difficulty in sustaining a consistent
improvement in performance. The company’s Results of Operations shown
in Exhibit 2 and Balance sheets shown in Exhibit 3 provide additional
operating and financial results.
EXHIBIT 1 Macy’s, Inc.’s Income Statements, 2015–2019 ($
in millions, except per share amounts)
*53 weeks
Source: Macy’s, Inc. 2019 10-K.
EXHIBIT 2 Macy’s, Inc.’s Results of Operations, 2017–2019
($ in millions, except per share amounts)
Source: Macy’s, Inc. 2019 10-K.
EXHIBIT 3 Macy’s, Inc.’s Balance Sheets, 2018–2019 ($ in
millions)
February 1, 2020 February 2, 2019
ASSETS
Current Assets:
528 620
714 726
81 168
February 1, 2020 February 2, 2019
Cash and cash equivalents $ 685 $ 1,162
Receivables 409 400
Merchandise inventories 5,188 5,263
Prepaid expenses and other current
assets
Total Current Assets 6,810 7,445
Property and Equipment–net 6,633 6,637
Right of Use Assets 2,668 —
Goodwill 3,908 3,908
Other Intangible Assets–net 439 478
Other Assets
Total Assets $21,172 $19,194
LIABILITIES AND SHAREHOLDERS’
EQUITY
Current Liabilities:
Short-term debt $ 539 $ 43
Merchandise accounts payable 1,682 1,655
Accounts payable and accrued liabilities 3,448 3,366
Income taxes
Total Current Liabilities 5,750 5,232
Long-Term Debt 3,621 4,708
Long-Term Lease Liabilities 2,918 —
Deferred Income Taxes 1,169 1,238
Other Liabilities 1,337 1,580
Shareholders’ Equity:
Common stock (309.0 and 307.5 shares
outstanding) 3 3
Additional paid-in capital 621 652
Accumulated equity 7,989 8,050
Treasury stock (1,241) (1,318)
Accumulated other comprehensive loss (995) (951)
— —
6,377 6,436
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page C-55
February 1, 2020 February 2, 2019
Total Macy’s, Inc. Shareholders’ Equity 6,377 6,436
Noncontrolling interest
Total Shareholders’ Equity
Total Liabilities and Shareholders’ Equity $21,172 $19,194
Source: Macy’s, Inc. 2019 10-K.
Overview of the Department Store Industry
The department store industry was under pressure not only from e-
commerce, but also from discount retailers whose product lines encroached
on traditional department store product categories. Exhibit 4
shows that women’s clothing and footwear and home goods and
appliances made up the two largest categories of products sold in
department stores in 2019. Drugs and cosmetics made up the third
largest category of department store sales in 2019. Men’s clothing and
footwear, children’s clothing and footwear, nongrocery food items, and toys
and hobbies were all products that could be purchased at supercenter
discount retailers such as Walmart and Target or wholesale clubs such as
Sam’s or Costco. The proliferation of such product categories both online
and available in brick-and-mortar stores required mall-based department
stores to offer a highly differentiated experience or distinctive product line.
The shopping mall experience. The business model of online-only
retailers such as Amazon that involved low costs for land and buildings, real
estate leases, inventory, store furnishings and merchandise displays, and
personnel put tremendous pricing pressure on brick-and-mortar retailers. The
low prices offered by many online retailers coupled with consumers’ desire
for the convenience of online shopping has dramatically altered the value
proposition for shopping malls and resulting customer experience. Malls,
which once were a popular place to visit, shop, and pass time, were
challenged as the closings of prestigious anchor stores and specialty stores
made shopping at a mall less exciting for consumers.
Physical malls were also expensive to build and just as costly to remodel
as many had been open for some time. The aging nature of many malls also
decreased consumer desire to visit a mall. There were some locations that
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were characterized by extreme temperatures that made shopping indoors
more appealing, such as the Mall of America in Minneapolis, Minnesota.
The most viable malls in 2020 tended to be upscale outdoor lifestyle malls
that featured beautiful architecture and landscaping along with a strong mix
of aspirational luxury brands. The overall ambiance of such malls recreated
the excitement of shopping in a mall that had been common in the 1970s and
1980s. Other malls that remained popular in 2020 were outdoor outlet malls
that were located near major highways that provided deep discounts on such
highly sought after brands as Gucci, North Face, Coach, Abercrombie &
Fitch, Under Armour, Ralph Lauren Polo, and Tori Burch.
Changing consumer demographics. A declining birthrate in the United
States and many developed countries resulted in fewer shoppers for an
increasing number of goods. The peak of the baby boom in 1957 saw 122.7
births per 1,000 U.S. women, while the U.S. birth rate in 2017 had fallen to
60.3 per 1,000 women. Baby boomers had driven sharp demand
increases in industries and products such as mountain bikes, golf
courses and equipment, SUVs and Harley-Davidson motorcycles in the
1980s and 1990s and still made up the largest group of consumers in 2020.
By 2024, the 65 and older demographic in the United States was projected to
exceed 65 million consumers. Older consumers maintained tremendous
purchasing power resulting from decades of career advancements and
savings. The 60+ demographic was the most highly educated generation and
wealthiest generation in U.S. history. Much of baby boomer spending was on
the purchase of goods and services for their children and grandchildren,
which drove sales of products for all age demographics. The impact of
purchases by grandparents as gifts to children and grandchildren had given
rise to the term “grandparent economy” by many in the retail industry.1
Generation X and early- and late-Millennial shoppers were also important
consumer groups with approximately 40 million to 45 million consumers in
the age groups aged 25–34, 35–44, and 45–54. The focus by consumers on
convenience and low prices grew stronger as age demographics declined in
age. Online shopping met the discount pricing and 24-hour availability and
convenience desired by Millennial shoppers. Smartphone applications
greatly enhanced the ability of consumers to make purchases from any
location at any time of the day. Walmart had achieved considerable success
in online and mobile selling by closely studied demographics when adding
services like Jetblack personal shopping, buy-online-pickup-in-store and
curbside pickup services. Walmart also recognized the desire of Generation
X and Millennial shoppers to focus on quality and brand prestige even
though low prices remained an important consideration in purchasing
decisions. The acquisitions of Bonobos, Lord & Taylor, and Bobbi Brown
were made by Walmart to improve the quality of products offered in its
stores and online.
Retail sector growth and the impact of COVID-19. The retail trade
sector had grown at an average annual rate of 0.7 percent in the years 2015–
2020 to reach $5.3 trillion in industry revenues. In 2020, the U.S. retail
sector was made up of 2.8 million enterprises and employed 17.6 million
Americans. Total wages in the industry exceeded $476 billion. The growth
rate in retail trade had also allowed for a 3.1 percent increase in retailer
profit margins in 2020 and an 8.9 percent increase in wages as a share of
revenues in 2020.
The onset of the coronavirus in early-2020 was projected to lead to a 3.3
percent decline in revenues for the entire 2020 calendar year as retailers
were required to temporarily close stores. Also, the spike in unemployment
resulting from COVID-19 stay-at-home orders and store closures was
projected to result in an overall decrease in consumer spending which would
harm the U.S. department store industry and other consumer sectors.
Analysts believe that the retail sector would return to a strong 1.8 percent
annual growth rate for 2021 through 2025 as COVID-19 became contained
and mitigated. Industry revenues were projected to increase to nearly $5.9
trillion by 2025.
The declining sales of the department store segment of the retail
industry. The $100 billion department store segment of the retail sector
had fared far less well than retailers such as discount supercenters, wholesale
clubs, and specialty retailers during the mid-2010s. While the entire retail
sector had enjoyed a 0.7 percent annual growth rate between 2015 and 2020,
the department store segment of the retail sector had declined 11 percent
annually during those years. The number of department stores declined
4.9 percent between 2015 and 2020, with COVID-19 hastening the decay of
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the industry with a projected 27.4 percent decline in department store
revenues and a 3.2 percent decrease in profit margins for the industry
segment. Analysts projected that the department store segment of the retail
industry would continue to decline by 7.5 percent annually, falling from
$100 billion in 2020 to $67.7 billion in 2025.
Profiles of the Largest U.S. Department Store Chains
Target Corporation Target Corporation was the largest U.S. department
store chain in 2020 with a market share of 50.1 percent and 2019 sales of
$50.1 billion. Target has achieved explosive growth between 2015 and 2020,
allowing its market share to increase from approximately 34 percent in 2015
to 50 percent in 2020. The company operated 1,868 stores across the United
States and recorded sales of $78.1 billion in fiscal 2020. A large portion of
the company’s sales was comprised of groceries, which lowered its sales of
department store items to $50.1 billion. In fact, the company’s
sales of department store items had declined at an annual rate of
2.2 percent between 2015 and 2020.
The company had been able to increase overall sales in its supercenter
locations through a reimaging plan that included store remodeling projects
and the introduction of perishable and nonperishable foods to more store
locations. This introduction of grocery items produced a comparable store
sales growth of 5 percent. Gains in every market category was achieved
coupled with a record high earnings per share increases.
Key elements of Target Corporation’s retail strategy included:
Becoming the first U.S. retailer to offer same-day and drive-up fulfillment
capabilities, coast-to-coast.
Remodeled more than 400 store locations by 2019.
In 2018, opened more than 24 small-store formats, with 30 more planned
in 2019, in high-traffic urban locations and college campuses.
Focused on better guest services: increased minimum wage to $12/hour;
raising again in 2019 to $13/hour, with a goal of $15/hour by the end of
2020.
Focused on digital channels, where in 2018 comparable digital sales grew
36 percent.
Introduction of more brands, more than doubling a goal of more than a
dozen in 2017, which was one reason Target Corporation was named by
Fast Company as one of the world’s most innovative companies.
Nordstrom, Inc. Nordstrom Inc. was the third largest department store
chain in the United States with 380 total stores in 2020. Nordstrom Inc. had
a diverse mix of retailing formats with 136 fill-line Nordstrom department
stores, 244 off-price Nordstrom Rack stores, and multiple e-commerce sites.
The company’s greatest store concentration of Nordstrom department stores
was in California with 35 full-price locations followed by Texas with 10.
While Nordstrom was best known for its luxurious department stores, the
company’s innovative online retailing platforms accounted for 46 percent of
Nordstrom Holdings’ total sales of $15.1 billion. HauteLook was a rapidly
growing online retailing site owned by Nordstrom Holdings that was an
online private sales site. Truck Club was another personalized site that
allowed men to purchase personalized clothing. The company had other
small-format online retailing sites such as The Black Tux that allowed men
to order high-quality, tailored tuxes that could be tried on at home and
returned for further alterations. The Black Tux rentals could also be taken to
a Nordstrom department store for alterations.
The addition of specialty online retailing sites had allowed Nordstrom
Holdings to achieve overall growth, its department store specific sales had
declined by 5.8 percent annually between 2015 and 2020. The profitability
of its department stores had also declined to less than a one percent margin
in fiscal 2020.
Sears Holdings Corporation Sears Holdings Corporation resulted from
the 2005 merger between Sears Roebuck and Company and Kmart Holding
Corporation. The merger produced a company with a network of
approximately 1,000 Sears department stores and Kmart discount stores.
Sears department stores were primarily mall-based, and Kmart locations
were largely standalone stores. The merger was designed to strengthen two
retail brands that had each been declining rapidly for decades. For nearly
100 years, Sears held commanding market shares in nearly every department
store product category, from women’s, men’s, and children’s apparel to large
appliances and even automobile tires and batteries. Sears’s loss of sales in
the department store industry began in the 1980s as a result of poor strategic
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positioning that prevented it from effectively competing with cost leaders
such as Walmart and Target or with mid-tier competitors such as Macy’s or
J.C. Penny.
Similarly, Kmart had struggled since the 1980s to effectively compete
against Walmart on price and merchandise availability. The introduction of
the Walmart Supercenter in 1988 exposed problems at Kmart that included
old, small store locations that were no longer located in high traffic shopping
areas, supply chain inefficiencies and frequent out-of-stock store inventory,
low employee morale, corrupt executive leadership, and a lack of price
competitiveness.
Sears Holdings filed Chapter 11 bankruptcy in 2018 to contend with its 21
percent annual sales decline, operating losses estimated at 6.7 percent of
revenues, and outstanding $5 billion debt. Sears Holdings closed more than
500 store locations in the first year of its bankruptcy protection and operated
only 182 stores in 2020. The company closed all stores in April 2020
because of the COVID-19 pandemic and had reopened 25 stores in May
2020.
J.C. Penny Company, Inc. J.C. Penny Company operated
846 store locations in the United States and Puerto Rico and achieved total
revenues of $10.7 billion in fiscal 2019. The company’s sales had declined
steadily from a high of $20 billion in 2006 as a result of poor merchandising
strategies and ineffective leadership. The company’s descent accelerated
during the Great Recession of the late-2000s as CEO Myron Ullman failed
to adapt pricing to the diminished purchasing power of consumers suffering
the effects of the recession. J.C. Penny’s financial troubles grew worse under
the leadership of former Apple CEO Ron Johnson who was hired in 2011 to
turnaround the failing company.
CEO Johnson envisioned a J.C. Penny that would compete with more
upscale retailers. His strategy was based on instinct and, without market
testing, Johnson change the company’s store designs, logo, advertisements,
and pricing model to appeal to wealthier shoppers. Under Johnson, the
company dropped its popular private label brands that were very profitable
and had a loyal following among low- and middle-income customers.
Johnson also ended J.C. Penny’s history of using coupons and clearance
sales to attract shoppers. By 2012, with sales plunging 25 percent and the
company deeply in debt, it was clear that Johnson’s strategy had failed to
attract wealthy customers and had driven away its formerly loyal customers.
In 2013, J.C. Penny turned to former CEO Ullman in to begin a
turnaround plan and, in 2015, selected Marvin Ellison as CEO. Ellison had
led the appliance division at Home Depot and expected to position J.C.
Penny to take advantage of the collapse of Sears to increase sales of
appliances at J.C. Penny. The plan failed to achieve success, with Ellison
leaving to lead Lowe’s. The company continued to struggle to develop a
value proposition that resonated with consumers and filed for Chapter 11
bankruptcy in May 2020. The company’s restructuring plan would involve
the permanent closing of 30 percent of its store locations, but analysts
believe it was quite possible that J.C. Penny would be liquidated and go out
of business permanently.
Macy’s, Inc. Strategic Situation in Mid-2020
With the company reporting a year-over-year sales decline of more than 45
percent from approximately $5.5 billion in Q1 2019 to approximately $3
billion in Q1 2020, there was tremendous uncertainty about the effectiveness
of Macy’s turnaround and its ability to absorb the impact of COVID-19 on
the retail industry. However, in comments to analysts following the
company’s announcement of its First Quarter 2020 results, CEO Gennette
saw several bright spots. A portion of the company’s loss in Q1 2020 was a
result of a $300 million charge on inventory that would have been marked
down as sale items if stores had been open. Also, CEO Gennette believed
that the company would be able to right-size its inventory during the second
quarter of 2020 to reduce overhead. Macy’s management was particularly
encouraged by the company’s 80 percent increase in online sales during the
month of May 2020 as consumers were forced to shop online during stay-at-
home orders. Gennette had commented to analysts that while sales might not
stabilize until 2021 or 2022, the company would be able to retire $1 billion
in debt by 2022. With so much unpredictability, coupled with changing
consumer wants and needs, the retail arena was surely one that will continue
to be a challenge moving forward.
ENDNOTES
1 Pamela N. Danziger, “Four Demographic Trends that Many Retailers Missed, but not Walmart,” Forbes, May 5, 2019,
https://www.forbes.com/sites/pamdanziger/2019/05/05/four-demographic-trends-that-many-retailers-missed-
but-not-walmart/#17cc4c465c81 (accessed May 29, 2020).
https://www.forbes.com/sites/pamdanziger/2019/05/05/four-demographic-trends-that-many-retailers-missed-but-not-walmart/#17cc4c465c81
W
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CASE 6
TOMS Shoes: Expanding Its Successful One For
One Business Model
Used by permission of Tuck School of Business at Dartmouth
Margaret A. Peteraf
Tuck School of Business at Dartmouth
Sean Zhang and Carry S. Resor
Research Assistants, Dartmouth College
hile traveling in Argentina in 2006, Blake Mycoskie witnessed the hardships that children without shoes
experienced and became committed to making a difference. Rather than focusing on charity work, Mycoskie
sought to build an organization capable of sustainable, repeated giving, where children would be guaranteed shoes
throughout their childhood. He established TOMS Shoes, with a unique business model known as “One for One”.
For every pair of shoes TOMS sold, TOMS would donate a pair to a child in need. By June 2020, TOMS had
given away nearly 100 million pairs of shoes in over 85 different countries.1
The business model was a success and TOMS experienced consistent and rapid growth, despite the global
recession that began in 2009. By 2015, TOMS had matured into an organization with nearly 600 employees and
almost $400 million in revenues. TOMS shoes could be found in several major retail stores such as Nordstrom,
Bloomingdale’s, and Urban Outfitters.
Encouraged by this success and wanting to make an even greater difference in the world, Mycoskie started
several new initiatives associated with the TOMS brand and the One-for-One business model. In 2011, he
launched TOMS Eyewear to help provide prescription glasses and eye surgery to those in need. In 2014, he
launched TOMS Roasting Co. as a way to expand access to safe drinking water around the world. By 2020,
TOMS had enabled over 780,000 sight restorations and had provided over 722,000 weeks of safe water for
communities without this basic necessity. In response to the COVID-19 pandemic, the company pledged to give
one-third of their net profits toward funding mental health support, handwashing, and medical supplies for those
on the frontlines of the crisis. For an overview of how quickly TOMS grew, see Exhibit 1.
EXHIBIT 1 TOMS’ Growth Since 2006
2020 2016 2014 2012 2010 2008 2006
Total Employees 750 650 550 320 72 33 4
Thousands of Pairs of Shoes
Sold 95,000* 60,000* 10,000 2,700 1,000 110 10
*Estimated based on shoes donated.
Source: PrivCo, Private Company Financial Report, TOMS website; craft.co, toms-shoes company profile, accessed June 4, 2020.
COMPANY BACKGROUND
http://craft.co/
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page C-61
While attending Southern Methodist University, Blake Mycoskie founded the first of his six start-ups, a laundry
service company that encompassed seven colleges and staffed over 40 employees.2 Four start-ups and a short stint
on The Amazing Race later, Mycoskie found himself vacationing in Argentina where he not only learned about the
Alpargata shoe originally used by local peasants in the 14th century, but also witnessed the extreme
poverty in rural Argentina.
Determined to make a difference, Mycoskie believed that providing shoes could more directly impact the
children in these rural communities than delivering medicine or food. Aside from protecting children’s feet from
infections, parasites, and diseases, shoes were often required for a complete school uniform. In addition, research
had shown that shoes were found to significantly increase children’s self-confidence, help them develop into more
active community members, and lead them to stay in school. Thus, by ensuring access to shoes, Mycoskie could
effectively increase children’s access to education and foster community activism, raising the overall standard of
living for people living in poor Argentinian rural areas.
Dedicated to his mission, Mycoskie purchased 250 pairs of Alpargatas and returned home to Los Angeles,
where he subsequently founded TOMS Shoes. He built the company on the promise of “One for One,” donating a
pair of shoes for every pair sold. With an initial investment of $300,000, Mycoskie’s business concept of social
entrepreneurship was simple: sell both the shoe and the story behind it. Building on a simple slogan that
effectively communicated his goal, Mycoskie championed his personal experiences passionately and established
deep and lasting relationships with customers.
Operating from his apartment with three interns he found on Craigslist, Mycoskie quickly sold out his initial
inventory and expanded considerably, selling 10,000 pairs of shoes by the end of his first year. With family and
friends, Mycoskie ventured back to Argentina, where they hand-delivered 10,000 pairs of shoes to children in
need. Because he followed through on his mission statement, Mycoskie was able to subsequently attract investors
to support his unique business model and expand his venture significantly.
In 2014, Bain Capital bought a 50 percent stake in the company, hoping to cash in on the company’s success.
INDUSTRY BACKGROUND
Even though Mycoskie’s vision for his company was a unique one, vying for a position in global footwear
manufacturing was a risky and difficult venture. The industry was both stable and mature—one in which large and
small companies competed on the basis of price, quality, and service. Competitive pressures came from foreign as
well as domestic companies and new entrants needed to fight for access to downstream retailers.
Further, the cost of supplies was forecasted to increase between 2017 and 2022. Materials and wages constituted
almost 80 percent of industry costs—clearly a sizable concern for competitors. Supply purchases included leather,
rubber, plastic compounds, foam, nylon, canvas, laces, etc. While the price of leather rose steadily each year, the
price of natural and synthetic rubber was also expected to rise over the next five years. In addition, wages as a
share of revenue were expected to increase at a rate of 5.5 percent over a five-year period, from 17.1 percent in
2017 to an estimated 17.8 percent in 2022.3
In order to thrive in the footwear manufacturing industry, firms needed to differentiate their products in a
meaningful way. Selling good quality products at a reasonable price was rarely enough; they needed to target a
niche market that desired a certain image. Product innovation and advertising campaigns therefore became the
most successful competitive weapons. For example, Clarks adopted a sophisticated design, appealing to a
wealthier, more mature customer base. Nike, adidas, and Skechers developed athletic footwear and aggressively
marketed their brands to reflect that image. Achieving economies of scale, increasing technical efficiency, and
developing a cost-effective distribution system were also essential elements for success.
Despite the presence of established incumbents, global footwear manufacturing was an attractive industry to
potential entrants based on the prediction of increased demand and therefore sales revenue. Moreover, the industry
offered incumbents one of the highest profit margins in the fashion industry. But because competitors were likely
to open new locations and expand their brands in order to discourage competition, new companies’ only option
was to attempt to undercut them on cost. Acquiring capital equipment and machinery to manufacture footwear on
a large scale was expensive. Moreover, potential entrants also needed to launch costly large-scale marketing
campaigns to promote brand awareness. Thus, successful incumbents were traditionally able to maintain an
overwhelming portion of the market.
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Building the TOMS Brand
Due to its humble beginnings, TOMS struggled to gain a foothold in the footwear industry. While companies like
Nike had utilized high-profile athletes like Michael Jordan and Tiger Woods to establish brand recognition, TOMS
had relatively limited financial resources and tried to appeal to a more socially conscious consumer. Luckily,
potential buyers enjoyed a rise in disposable income over time as the economy recovered from the recession. As a
result, demand for high-quality footwear increased for affluent shoppers, accompanied by a desire to act (and be
seen acting) charitably and responsibly.
While walking through the airport one day, Mycoskie encountered a girl wearing TOMS shoes. Mycoskie
recounts:
I asked her about her shoes, and she went on to tell me this amazing story about TOMS and the model that it uses and my personal story. I realized
the importance of having a story today is what really separates companies. People don’t just wear our shoes, they tell our story. That’s one of my
favorite lessons that I learned early on.
Moving forward, TOMS focused more on selling the story behind the shoe rather than product features or
celebrity endorsements. Moreover, rather than relying primarily on mainstream advertising, TOMS emphasized a
grassroots approach using social media and word-of-mouth. With over 4 million Facebook “Likes” and nearly 2
million Twitter “Followers” in 2020, TOMS’ social media presence eclipsed that of its much larger rivals. Based
on 2020 data, TOMS had fewer “Followers” and fewer “Likes” than Skechers, Nike, and adidas. However, TOMS
had more “Followers” and “Likes” per dollar of revenue. So when taking company size into account, TOMS also
had a greater media presence than the industry’s leading competitors (see Exhibit 2 for more information).
EXHIBIT 2 TOMS’ Use of Social Media Compared to Selected Footwear Competitors
2019 Revenue (Mil.
of $) Facebook “Likes”
“Likes” per Mil. of $
in revenue Twitter “Followers”
“Followers” per mil.
of $ in revenue
TOMS $ 67.7 4,200,000 62,038 1,800,000 2,659
Skechers 185.2 6,100,000 32,937 47,800 258
adidas 597.3 37,000,000 61,945 946,700 1,585
Nike 4,053.8 34,000,000 8,387 4,600,000 1,135
Source: Author data from Facebook and Twitter May 2, 2018; revenue numbers obtained from Ecommercedb.com.
TOMS’ success with social media advertising can be attributed to the story crafted and championed by
Mycoskie. Industry incumbents generally dedicated a substantial portion of revenue and effort to advertising since
they were simply selling a product. TOMS, on the other hand, used its mission to ask customers to buy into a
cause, limiting their need to devote resources to brand-building. TOMS lets their charitable work and social media
presence generate interest for them organically. This strategy also increased the likelihood that consumers would
place repeat purchases and share the story behind their purchases with family and friends. TOMS’ customers took
pride in supporting a grassroots cause instead of a luxury footwear supplier and encouraged others to share in the
rewarding act.
A BUSINESS MODEL DEDICATED TO SOCIALLY RESPONSIBLE
BEHAVIOR
Traditionally, the content of advertisements for many large apparel companies focused on the attractive aspects of
the featured products. TOMS’ advertising, on the other hand, showcased its charitable contributions and the story
of its founder Blake Mycoskie. While the CEOs of Nike, adidas, and Clarks rarely appeared in their companies’
advertisements, TOMS ran as many ads with its founder as it did without him, emphasizing the inseparability of
the TOMS product from Mycoskie’s story. In all of his appearances, Mycoskie was dressed in casual and friendly
attire so that customers could easily relate to Blake and his mission. This advertising method conveyed
a small-company feel and encouraged consumers to connect personally with the TOMS brand. It also
worked to increase buyer patronage through differentiating the TOMS product from others. Consumers were
convinced that every time they purchased a pair of TOMS, they became instruments of the company’s charitable
work.
http://ecommercedb.com/
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As a result (although statistical measures of repeating-buying and total product satisfaction among TOMS’
customers were not publicly available), the volume of repeat purchases and buyer enthusiasm likely fueled
TOMS’ success in a critical way. One reviewer commented, “This is my third pair of TOMS and I absolutely love
them!. . . I can’t wait to buy more!”4 Another wrote, “Just got my 25th pair! Love the color! They. . .are my all-
time favorite shoe for comfort, looks & durability. AND they are for a great cause!! Gotta go pick out my next
pair. . . .”5
Virtually all consumer reports on TOMS shoes shared similar themes. Though not cheap, TOMS footwear was
priced lower than rivals’ products, and customers overwhelmingly agreed that the value was worth the cost.
Reviewers described TOMS as comfortable, true to size, lightweight, and versatile (“go with everything”). The
shoes had “cute shapes and patterns” and were made of canvas and rubber that molded to customers’ feet with
wear. Because TOMS products were appealing and trendy yet also basic and comfortable, they were immune to
changing fashion trends and consistently attracted a variety of consumers. (see Exhibit 3).
EXHIBIT 3 Representative Advertisement for TOMS Shoes Company
©John M. Heller/Getty Images
In addition to offering a high-quality product that people valued, TOMS was able to establish a positive
repertoire with its customers through efficient distribution. Maintaining an online shop helped TOMS save money
on retail locations but also allowed it to serve a wide geographic range. Further, the company negotiated with
well-known retailers like Nordstrom and Neiman Marcus to assist in distribution. Through thoughtful planning
and structured coordination, TOMS limited operation costs and provided prompt service for its customers.
Giving Partners
As it continued to grow, TOMS sought to improve its operational efficiency by teaming up with “Giving
Partners,” nonprofit organizations that helped to distribute the shoes that TOMS donated. By teaming up with
Giving Partners, TOMS streamlined its charity operations by shifting many of its distributional responsibilities to
organizations that were often larger, more resourceful, and able to distribute TOMS shoes more
efficiently. Moreover, these organizations possessed more familiarity and experience dealing with the
communities that TOMS was interested in helping and could therefore better allocate shoes that suited the needs
of children in the area. Giving Partners also provided feedback to help TOMS improve upon its giving and
distributional efforts.
Each Giving Partner also magnified the impact of TOMS’ shoes by bundling their distribution with other
charity work that the organization specialized in. For example, Partners in Health, a nonprofit organization that
spent almost $100 million in 2012 on providing healthcare for the poor (more than TOMS’ total revenue that
year), dispersed thousands of shoes to schoolchildren in Rwanda and Malawi while also screening them for
malnutrition. Cooperative giving further strengthened the TOMS brand by association with well-known and highly
regarded Giving Partners. Complementary services expanded the scope of TOMS’ mission, enhanced the impact
page C-64
that each pair of TOMS had on a child’s life, and increased the number of goodwill and business opportunities
available to TOMS.
In order to ensure quality of service and adherence to its fundamental mission, TOMS maintained five criteria
for Giving Partners:
Repeat Giving: Giving partners must be able to work with the same communities in multi-year commitments,
regularly providing shoes to the same children as they grow.
High Impact: Shoes must aid Giving Partners with their existing goals in the areas of health and education,
providing children with opportunities they would not have otherwise.
Considerate of Local Economy: Providing shoes cannot have negative socioeconomic effects on the
communities where shoes are given.
Large Volume Shipments: Giving Partners must be able to accept large shipments of giving pairs.
Health/Education Focused: Giving Partners must only give shoes in conjunction with health and education
efforts.6
As of 2020, TOMS had built relationships with over 100 Giving Partners, including Save the Children, U.S. Fund
for UNICEF, and IMA World Health. In order to remain accountable to their mission in these joint ventures,
TOMS also performed unannounced audit reports that ensured shoes were distributed according to the One for
One model.
Building a Relationship with Giving Partners
Having Giving Partners offered TOMS the valuable opportunity to shift some of its philanthropic costs onto other
parties. However, TOMS also proactively maintained strong relationships with their Giving Partners. Kelly
Gibson, the program director of National Relief Charities (NRC), a Giving Partner and nonprofit organization
dedicated to improving the lives of Native Americans, highlighted the respect with which TOMS treated its
Giving Partners:
TOMS treats their Giving Partners (like us) and the recipients of their giveaway shoes (the Native kids in this case) like customers. We had a terrific
service experience with TOMS. They were meticulous about getting our shoe order just right. They also insist that the children who receive shoes
have a customer-type experience at distributions.
From customizing Giving Partners’ orders to helping pick up the tab for transportation and distribution, TOMS
treated its Giving Partners as valuable customers and generated a sense of goodwill that extended beyond its
immediate One for One mission. By ensuring that their Giving Partners and recipients of shoes were treated
respectfully, TOMS developed a unique ability to sustain business relationships that other for-profit organizations
more concerned with the financial bottom line did not.
MAINTAINING A DEDICATION TO CORPORATE SOCIAL
RESPONSIBILITY
Although TOMS manufactured its products in Argentina, China, and Ethiopia (countries which have all been cited
as areas with a high degree of child and forced labor by the Bureau of International Labor Affairs), regular third-
party factory audits and a Supplier Code of Conduct helped to ensure compliance with fair labor standards.7
Audits were conducted on both an announced and unannounced basis while the Supplier Code of Conduct was
publicly posted in the local language of every work site. The Supplier Code of Conduct enforced
standards such as minimum work age, requirement of voluntary employment, non-discrimination,
maximum work week hours, and right to unionize. It also protected workers from physical, sexual, verbal, or
psychological harassment in accordance with a country’s legally mandated standards. Workers were encouraged to
report violations directly to TOMS, and suppliers found in violation of TOMS’ Supplier Code of Conduct faced
termination.
In addition to ensuring that suppliers met TOMS’ ethical standards, TOMS also emphasized its own dedication
to ethical behavior in a number of ways. TOMS was a member of the American Apparel and Footwear
Association (AAFA) and was registered with the Fair Labor Association (FLA). Internally, TOMS educated its
own employees on human trafficking and slavery prevention and partnered with several organizations dedicated to
raising awareness about such issues, including Hand of Hope.8
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Giving Trips
Aside from material shoe contributions, TOMS also held a series of “Giving Trips” that supported the broader
notion of community service. Giving Trips were first-hand opportunities for employees of TOMS and selected
TOMS customers to partake in the delivery of TOMS shoes. These trips increased the transparency of TOMS’
philanthropic efforts, further engaging customers and employees. They generated greater social awareness as well,
since participants on these trips often became more engaged in local community service efforts at home.
From a business standpoint, Giving Trips also represented a marketing success. First, a large number of
participants were customers and journalists unassociated with TOMS who circulated their stories online through
social media upon their return. Second, TOMS was able to motivate participants and candidates to become more
involved in their mission by increasing public awareness. In 2013, instead of internally selecting customers to
participate on the Giving Trips, TOMS opted to hold an open voting process that encouraged candidates to reach
out to their known contacts and ask them to vote for their inclusion. This contest drew thousands of contestants
and likely hundreds of thousands of voters, although the final vote tallies were not publicly released.
Environmental Sustainability
Dedicated to minimizing its environmental impact, TOMS pursued a number of sustainable practices that included
offering vegan shoes, incorporating recycled bottles into its products, and printing with soy ink. TOMS also used a
blend of organic canvas and post-consumer, recycled plastics to create shoes that were both comfortable and
durable. By utilizing natural hemp and organic cotton, TOMS eliminated pesticide and insecticide use that
adversely affected the environment.
In addition, TOMS supported several environmental organizations like Surfers Against Sewage, a movement
that raised awareness about excess sewage discharge in the United Kingdom. Formally, TOMS was a member of
the Textile Exchange, an organization dedicated to textile sustainability and protecting the environment. The
company also participated actively in the AAFA’s Environmental Responsibility Committee.
Creating the TOMS Workforce
When asked what makes a great employee, Mycoskie blogged,
As TOMS has grown, we’ve continued to look for these same traits in the interns and employees that we hire. Are you passionate? Can you
creatively solve problems? Can you be resourceful without resources? Do you have the compassion to serve others? You can teach a new hire just
about any skill . . . but you absolutely cannot inspire creativity and passion in someone that doesn’t have it.9
The company’s emphasis on creativity and passion was part of the reason why TOMS relied so heavily on
interns and new hires rather than experienced workers. By hiring younger, more inexperienced employees, TOMS
was able to be more cost-effective in terms of personnel. The company could also recruit young and energetic
individuals who were more likely to think innovatively and out of the box. These employees were placed in
specialized teams under the leadership of strong, experienced managerial talent. This human intellectual capital
generated a competitive advantage for the TOMS brand.
Together with these passionate individuals, Mycoskie strove to create a family-like work atmosphere where
openness and collaboration were celebrated. With his cubicle located in one of the most highly-
trafficked areas of the office (right next to customer service), Mycoskie made a point to interact with
his employees on a daily basis, in all-staff meetings, and through weekly personal e-mails while traveling.
Regarding his e-mails, Mycoskie reflected,
I’m a very open person, so I really tell the staff what I’m struggling with and what I’m happy about. I tell them what I think the future of TOMS is. I
want them to understand what I’m thinking. It’s like I’m writing to a best friend.10
This notion of “family” was further solidified through company dinners, ski trips, and book clubs where TOMS
employees were encouraged to socialize in informal settings. These casual opportunities to interact with
colleagues created a “balanced” work atmosphere where employees celebrated not only their own successes, but
the successes of their co-workers.
Diversity and inclusion were also emphasized at TOMS. For example, cultural traditions like the Chinese Lunar
New Year were celebrated publicly on the TOMS’ company blog. Moreover, as TOMS began expanding and
distributing globally, the company increasingly sought to recruit a more diverse workforce by hiring multilingual
page C-66
individuals who were familiar with TOMS’ diverse customer base and could communicate with their giving
communities.11
The emphasis that Mycoskie placed on each individual employee was one of the key reasons why employees at
TOMS often felt “lucky” to be part of the movement.12 Coupled with the fact that TOMS employees knew their
efforts fostered social justice, these “Agents of Change,” as they referred to themselves, were generally quite
satisfied with their work, making TOMS Forbes’s 4th Most Inspiring Company in 2014. Overall, the culture
allowed TOMS to recruit and retain high-quality employees invested in achieving its social mission.
TEN YEARS OF REMARKABLE GROWTH
By 2016, global footwear manufacturing had developed into an industry worth nearly $240 billion.13 While
TOMS remained a privately held company with limited financial data, the estimated growth rate of TOMS’
revenue was astounding. In the seven years after his company’s inception, Mycoskie was able to turn his initial
$300,000 investment into a company with over $200 million in yearly revenues. As Exhibit 4 shows, the average
growth rate of TOMS on a yearly basis was 145 percent, even excluding its first major spike of 457 percent.
During the same period, Nike experienced a growth rate of roughly 8.5 percent, with a decline in revenues from
2009 to 2010.
EXHIBIT 4 Revenue Comparison for TOMS Shoes and the Footwear Industry, 2006–2016
2016 2015 2014 2013 2012 2011 2010 2009 2008 2007 2006
TOMS (in
Mils. of
$s)
Revenue $416 $390 $370.9 $285 $101.8 $46.9 $25.1 $8.4 $3.1 $1.2 $0.2
Growth
(%) 6.7% 5.1% 30.1% 180% 117% 86.9% 199% 171% 158.3% 500%
Industry
(in Bil. of
$s)
Revenue $239.8 $229.4 $230.6 $221.0 $210.2 $208.1 $179.6 $162.4 $159.3 $145.8
Growth
(%) 4.5%
−
0.5% 4.3% 5.1% 1.0% 15.9% 10.6% 1.9% 9.3% 0.0%
Source: PrivCo and “Global Footwear Manufacturing,” IBISWorld, April 18, 2016.
http://clients1.ibisworld.com/reports/gl/industry/currentperformance.aspx?entid=500.
The fact that TOMS was able to experience consistent growth despite financial turmoil post-2008 illustrates the
strength of the One for One Movement to survive times of recession. Mycoskie attributed his success during the
recession to two factors: (1) As consumers became more conscious of their spending during recessions, products
like TOMS that gave to others actually became more appealing (according to Mycoskie); (2) The giving model
that TOMS employed is not “priced in.” Rather than commit a percentage of profits or revenues to charity,
Mycoskie noted that TOMS simply gave away a pair for every pair it sold. This way, socially-
conscious consumers knew exactly where their money was going without having to worry that
TOMS would cut-back on its charity efforts in order to turn a profit.14
Production at TOMS
Although TOMS manufactured shoes in Argentina, Ethiopia, and China, only shoes made in China were brought
to the retail market. Shoes made in Argentina and Ethiopia were strictly used for donation purposes. TOMS
retailed its basic Alpargata shoes in the $50 price range, even though the cost of producing each pair was
estimated at around $9.15 Estimates for the costs of producing TOMS’ more expensive lines of shoes were
unknown, but they retailed for upwards of $150.
In comparison, manufacturing the average pair of Nike shoes in Indonesia cost around $20, and they were
priced at around $70.16 Factoring in the giving aspect, TOMS seemed to have a slightly smaller mark-up than
http://clients1.ibisworld.com/reports/gl/industry/currentperformance.aspx?entid=500
page C-67
companies like Nike, yet it still maintained considerable profit margins. More detailed information on trends in
TOMS’ production costs and practices is limited due to the private nature of the company.
Expanding the Mission
In an effort to broaden its mission and product offerings, TOMS began to expand both its consumer base and
charitable-giving product lines. For its customers, TOMS started offering stylish wedges, ballet flats, and even
wedding apparel in an effort to reach more customers and satisfy the special needs of current ones. For the
children it sought to help, TOMS expanded past its basic black canvas shoe offerings to winter boots in order to
help keep children’s feet dry and warm during the winter months in cold climate countries.
On another front, TOMS entered the eyewear market in hopes of restoring vision to the 285 million blind or
visually-impaired individuals around the world. For every pair of TOMS glasses sold, TOMS restored vision to
one individual either through donating prescription glasses or offering medical treatment for those suffering from
cataracts and eye infections. TOMS began by focusing its vision-related efforts in Nepal but by 2020 TOMS had
teamed up with 16 Giving Partners to help restore sight to nearly 800,000 individuals in 14 countries.
Through TOMS’ additional product launches of coffee and bags, the company has been able to expand giving
efforts to the global issues of clean water and safe birth. With each pound of TOMS Roasting Co. Coffee, TOMS
gives a week’s supply of safe water—140 liters—to a person in need. They have currently given over 722,000
weeks of safe water. With the sale of its bags, TOMS has supported safe birth services in parts of the world where
there is dire need. This includes helping its Giving Partners with the vital materials and training necessary for a
safe birth. In 2018, TOMS launched its Impact Grant program to fund short term projects with measurable goals
pertaining to global issues such as gun violence and mental health. By 2020, they had awarded $6.5 million in
Impact Grants to 14 of their Giving Partners.
A CHALLENGING FUTURE
In December 2019, the coronavirus now known as COVID-19 struck Wuhan, China, and swiftly spread around the
world. Among the devastating effects of the pandemic were the recessionary economic consequences. The retail
sector was especially hard hit as stores closed, workers lost their jobs, and discretionary spending plunged. For
TOMS, this came at a particularly bad time in their corporate history. Sales had already started trending downward
as the digital revolution reshaped buying behavior and new competition entered the industry with appealing
storytelling that rivaled TOMS’s. Moreover, the partnership with Bain failed to bring about the growth that was
expected. Earnings dropped significantly in 2017 through 2019, leaving TOMS with a debt load that it was
unsustainable.
Fortunately for TOMS, their creditors came to the rescue just before the coronavirus outbreak, agreeing to take
over the ownership of TOMS from Bain Capital and Mycoskie in exchange for restructuring the company’s debt.17
This move gave TOMS some necessary relief at a critical time. With the right strategic moves, TOMS might yet
regain its strong position in the industry. But what are the right strategic moves? Were TOMS’s problems the result
of the more traditional and expensive marketing strategy that Bain had advocated, as Mycoskie believed?18 Were
they due to not enough diversification or too much unrelated diversification, as TOMS entered businesses far from
their strength in footwear (such as coffee roasting). Was TOMS’s One-for-One business model one
that could continue to be utilized successfully in a variety of industries, or was it a model that
depended upon the freshness of its story? Would the uncertain trajectory of the COVID-19 pandemic present a
challenge for retailers beyond the reach of even the most farsighted strategy-making? Only time would tell.
ENDNOTES
1 TOMS Shoes company website, April 23, 2018 www.toms.com/what-we-give-shoes.
2 Mycoskie, Blake, Web log post, The Huffington Post, May 26, 2013, www.huffingtonpost.com/blake-mycoskie.
3 “Global Footwear Manufacturing,” IBISWorld. July 2017, http://clients1.ibisworld.com/reports/gl/industry/industryoutlook.aspx?entid=500.
4 Post by “Alexandria,” TOMS website, June 2, 2013, www.toms.com/red-canvas-classics-shoes-1.
5 Post by “Donna Brock,” TOMS website, January 13, 2014, www.toms.com/women/bright-blue-womens-canvas-classics.
6 TOMS website, June 2, 2013, www.toms.com/our-movement-giving-partners.
7 Trafficking Victims Protection Reauthorization Act, United States Department of Labor, June 2, 2013, www.dol.gov/ilab/programs/ocft/tvpra.htm; TOMS website, June 2,
2013, www.toms.com/corporate-responsibility.
8 Hand of Hope, “Teaming Up with TOMS Shoes,” Joyce Meyer Ministries, June 2, 2013, www.studygs.net/citation/mla.htm.
9 Mycoskie, Blake, “Blake Mycoskie’s Blog,” Blogspot, June 2, 2013, http://blakemycoskie.blogspot.com/.
http://www.toms.com/what-we-give-shoes
http://www.huffingtonpost.com/blake-mycoskie
http://clients1.ibisworld.com/reports/gl/industry/industryoutlook.aspx?entid=500
http://www.toms.com/red-canvas-classics-shoes-1
http://www.toms.com/women/bright-blue-womens-canvas-classics
http://www.toms.com/our-movement-giving-partners
http://www.dol.gov/ilab/programs/ocft/tvpra.htm
http://www.toms.com/corporate-responsibility
http://www.studygs.net/citation/mla.htm
http://blakemycoskie.blogspot.com/
10 Schweitzer, Tamara, “The Way I Work: Blake Mycoskie of TOMS Shoes,” Inc. June 2, 2013. www.inc.com/magazine/20100601/the-way-i-work-blake-mycoskie-of-toms-
shoes.html.
11 TOMS Jobs website, June 2, 2013, www.toms.com/jobs/l.
12 Daniela, “Together We Travel,” TOMS Company Blog, June 3, 2013, http://blog.toms.com/post/36075725601/together-we-travel.
13 “Global—Footwear,” Marketline: Advantage, April 18, 2016, http://advantage.marketline.com/Product?pid=MLIP0948-0013.
14 Zimmerman, Mike. “The Business of Giving: TOMS Shoes,” Success, June 2, 2013, http://www.success.com/articles/852-the-business-of-giving-toms-shoes.
15 Fortune, Brittney, “TOMS Shoes: Popular Model with Drawbacks,” The Falcon, June 2, 2013, http://www.thefalcononline.com/article.php?id=159.
16 Behind the Swoosh, Dir. Keady, Jim, 1995. Film.
17 https://www.cnbc.com/2019/12/30/toms-shoes-creditors-to-take-over-the-company.html
18 https://footwearnews.com/2019/business/retail/toms-blake-mycoskie-interview-business-sales-mission-1202764082/
http://www.inc.com/magazine/20100601/the-way-i-work-blake-mycoskie-of-toms-shoes.html
http://www.toms.com/jobs/l
http://blog.toms.com/post/36075725601/together-we-travel
http://advantage.marketline.com/Product?pid=MLIP0948-0013
http://www.success.com/articles/852-the-business-of-giving-toms-shoes
http://www.thefalcononline.com/article.php?id=159
https://www.cnbc.com/2019/12/30/toms-shoes-creditors-to-take-over-the-company.html
I
page C-68
CASE 7
lululemon athletica’s Strategy in
2020: Is the Recent Growth in
Retail Stores, Revenues, and
Profitability Sustainable?
Copyright ©2021 by Arthur A. Thompson and Randall D. Harris. All rights reserved.
Arthur A. Thompson
The University of Alabama
Randall D. Harris
Texas A&M University-Corpus Christi
n May 2020, shareholders of lululemon athletica—a designer and retailer
of high-tech athletic apparel sold under the lululemon athletica and ivivva
athletica brand names—were highly pleased with the remarkable turnaround
in the company’s performance since January 2016. Calvin McDonald, who
became the company’s CEO in August 2018, had proven highly adept in
continuing to grow the company and boost its profitability somewhat faster
than his predecessor had done during 2016 and 2017. Since the end of fiscal
2016 on January 31, 2016, lululemon’s revenues had almost doubled and net
profits were up 243 percent. The number of company-operated stores had
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increased from 368 stores in 9 countries in February 2016 to 491 stores in 17
countries as of February 2020, and the company’s stock price had risen from
$60.75 in early February 2016 to an all-time high of $343.74 in early August
2020. Average annual sales at lululemon’s retail stores open at least
12 months, which had dropped from a record high of $5.83 million per store
in 2012 to $4.57 million in 2015 (a 21.6 percent decline), had climbed back
to $5.2 million in fiscal 2020, ending February 2, 2020, while online sales
rose from $401 million in the fiscal year ending January 31, 2016, to
$1.14 billion in the fiscal year ending February 2, 2020.
Going into June 2020, the question lurking for shareholders, given the
falloff in retail store sales and customer traffic that most apparel chain
retailers were struggling to overcome not only during the peak months of the
COVID-19 pandemic but also from the propensity of many buyers to shift
their purchases of apparel and other products online, was how much longer
lululemon would be able to sustain its recent rates of growth in retail stores,
revenues, and profitability.
COMPANY BACKGROUND
A year after selling his eight-store surf-, skate-, and snowboard-apparel
chain called Westbeach Sports, Chip Wilson took the first commercial yoga
class offered in Vancouver, British Columbia, and found the result
exhilarating. But he found the cotton clothing used for sweaty, stretchy
power yoga completely inappropriate. Wilson’s passion was form-fitting
performance fabrics and in 1998 he opened a design studio for yoga clothing
that also served as a yoga studio at night to help pay the rent. He designed a
number of yoga apparel items made of moisture-wicking fabrics that were
light, form-fitting, and comfortable and asked local yoga instructors to wear
the products and give him feedback. Gratified by the positive response,
Wilson opened lululemon’s first real store in the beach area of Vancouver in
November of 2000.
While the store featured yoga clothing designed by Chip Wilson and his
wife Shannon, Chip Wilson’s vision was for the store to be a
community hub where people could learn and discuss the
physical aspects of healthy living—from yoga and diet to running and
cycling, plus the yoga-related mental aspects of living a powerful life of
possibilities. But the store’s clothing proved so popular that dealing with
customers crowded out the community-based discussions and training about
the merits of living healthy lifestyles. Nonetheless, Chip Wilson and store
personnel were firmly committed to healthy, active lifestyles, and Wilson
soon came to the conclusion that for the store to provide staff members with
the salaries and opportunities to experience fulfilling lives, the one-store
company needed to expand into a multi-store enterprise. Wilson believed
that the increasing number of women participating in sports, and specifically
yoga, provided ample room for expansion, and he saw lululemon athletica’s
yoga-inspired performance apparel as a way to address a void in the
women’s athletic apparel market. Wilson also saw the company’s mission as
one of providing people with the components to live a longer, healthier, and
more fun life.
Several new stores were opened in the Vancouver area, with operations
conducted through a Canadian operating company, initially named
Lululemon Athletica, Inc. and later renamed lululemon Canada, Inc. In
2002, the company expanded into the United States and formed a sibling
operating company, Lululemon Athletica USA Inc. (later renamed as
lululemon USA, inc), to conduct its operations in the United States. Both
operating companies were wholly-owned by affiliates of Chip Wilson. In
2004, the company contracted with a franchisee to open a store in Australia
as a means of more quickly disseminating the lululemon athletica brand
name, conserving on capital expenditures for store expansion (since the
franchisee was responsible for the costs of operating and operating the
store), and boosting revenues and profits. The company wound up its fiscal
year ending January 31, 2005, with 14 company-owned stores, 1 franchised
store, and net revenues of $40.7 million. A second franchised store was
opened in Japan later in 2005. Franchisees paid lululemon a one-time
franchise fee and an ongoing royalty based on a specified percentage of net
revenues; lululemon supplied franchised stores with garments at a discount
to the suggested retail price.
Five years after opening the first retail store, it was apparent that
lululemon apparel was fast becoming something of a cult phenomenon and a
status symbol among yoga fans in areas where lululemon stores had opened.
Avid yoga exercisers were not hesitating to purchase $120 color-coordinated
lululemon yoga outfits that felt comfortable and made them look good. Mall
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developers and mall operators quickly learned about lululemon’s success and
began actively recruiting lululemon to lease space for stores in their malls.
In December 2005, with 27 company-owned stores, 2 franchised stores,
and record sales approaching $85 million annually, Chip Wilson sold
48 percent of his interest in the company’s capital stock to two private equity
investors: Advent International Corporation, which purchased 38.1 percent
of the stock, and Highland Capital Partners, which purchased a 9.6 percent
ownership interest. In connection with the transaction, the owners formed
lululemon athletica inc. to serve as a holding company for all of the
company’s related entities, including the two operating subsidiaries,
lululemon Canada Inc. and lululemon USA Inc. Robert Meers, who had 15
years’ experience at Reebok and was Reebok’s CEO from 1996–1999,
joined lululemon as CEO in December 2005. Chip Wilson headed the
company’s design team and played a central role in developing the
company’s strategy and nurturing the company’s distinctive corporate
culture; he was also Chairman of the company’s Board of Directors, a
position he had held since founding the company in 1998. Wilson and Meers
assembled a management team with a mix of retail, design, operations,
product sourcing, and marketing experience from such leading apparel and
retail companies as Abercrombie & Fitch, Limited Brands, Nike, and
Reebok.
Brisk expansion ensued. The company ended fiscal 2006 with 41
company-owned stores, 10 franchised stores, net revenues of $149 million,
and net income of $7.7 million. In 2007, the company’s owners elected to
take the company public. The initial public offering took place on August 2,
2007, with the company selling 2,290,909 shares to the public and various
stockholders selling 15,909,091 shares of their personal holdings. Shares
began trading on the NASDAQ under the symbol LULU and on the Toronto
Exchange under the symbol LLL.
In 2007, the company’s announced growth strategy had five key elements:
1. Grow the company’s store base in North America. The strategic
objective was to add new stores to strengthen the company’s
presence in locations where it had existing stores and then
selectively enter new geographic markets in the United States and Canada.
Management believed that the company’s strong sales in U.S. stores
demonstrated the portability of the lululemon brand and retail concept.
2. Increase brand awareness. This initiative entailed leveraging the
publicity surrounding the opening of new stores with grassroots marketing
programs that included organizing events and partnering with local fitness
practitioners.
3. Introduce new product technologies. Management intended to continue
to focus on developing and offering products that incorporated
technology-enhanced fabrics and performance features that differentiated
lululemon apparel and helped broaden the company’s customer base.
4. Broaden the appeal of lululemon products. This initiative entailed (1)
adding a number of apparel items for men, (2) expanding product
offerings for women and young females in such categories as athletic
bags, undergarments, outerwear, and sandals, and (3) adding products
suitable for additional sports and athletic activities.
5. Expand beyond North America. In the near term, the company planned to
expand its presence in Australia and Japan and then, over time, pursue
opportunities in other Asian and European markets that offered similar,
attractive demographics.
The company grew rapidly. Fitness-conscious women began flocking to
the company’s stores not only because of the fashionable products but also
because of the store ambience and attentive, knowledgeable store personnel.
Dozens of new lululemon athletic retail stores were opened annually, and the
company pursued a strategy of embellishing its product offerings to create a
comprehensive line of apparel and accessories designed for athletic pursuits
such as yoga; running and general fitness; technical clothing for active
female youths; and a selection of fitness and recreational items for men.
Revenues topped $1 billion in fiscal 2011, $2 billion fiscal 2016, and $3
billion in fiscal 2018.
For fiscal year 2019, lululemon revenues grew by 21 percent over fiscal
2018 to just under $4 billion. lululemon products could be bought at its 368
retail stores in the United States and Canada, 38 stores in the People’s
Republic of China, 38 stores in Australia and New Zealand, and 47 stores in
the rest of the world. The company’s e-commerce web site,
www.lululemon.com, was available to customers worldwide. In the
http://www.lululemon.com/
page C-71
company’s most recent fiscal year ending February 2, 2020, retail store sales
accounted for 62.8 percent of company revenues, web site sales accounted
for 28.6 percent, and sales in all other channels (sales at outlet centers,
showroom sales, sales from temporary locations, licensing revenues, and
wholesale sales to premium yoga studios, health clubs, fitness centers, and a
few other retailers) accounted for 8.6 percent.
Exhibit 1 presents highlights of the company’s performance for fiscal
years 2015–2019. Exhibit 2 shows lululemon’s revenues by business
segment and geographic region for the same period.
lululemon’s Evolving Senior Leadership Team
In January 2008, Christine M. Day joined the company as Executive Vice
President, Retail Operations. Previously, she had worked at Starbucks,
functioning in a variety of capacities and positions, including President, Asia
Pacific Group (July 2004- February 2007); Co-President for Starbucks
Coffee International (July 2003 to October 2003); Senior Vice President,
North American Finance & Administration; and Vice President of Sales and
Operations for Business Alliances. In April 2008, Day was appointed as
lululemon’s President and Chief Operating Officer and was named Chief
Executive Officer and member of the Board of Directors in July 2008.
During her tenure as CEO, Day expanded and strengthened the company’s
management team to support its expanding operating activities and
geographic scope, favoring the addition of people with relevant backgrounds
and experiences at such companies as Nike, Abercrombie & Fitch, The Gap,
and Speedo International. She also spent a number of hours each week in the
company’s stores observing how customers shopped, listening to their
comments and complaints, and using the information to tweak product
offerings, merchandising, and store operations.
Company founder Chip Wilson stepped down from his executive role as
lululemon’s Chief Innovation and Branding Officer effective January 29,
2012, and moved his family to Australia; however, he continued on in his
role of Chairman of the company’s Board of Directors and
focused on becoming a better Board Chairman, even going so
far as to take a four-day course on board-governance at Northwestern
University.1 Christine Day promoted Sheree Waterson, who had joined the
company in 2008 and had over 25 years of consumer and retail industry
experience, as Chief Product Officer to assume responsibility for product
design, product development, and other executive tasks that Wilson had been
performing. Shortly after the quality problems with the black Luon bottoms
occurred, Sheree Waterson resigned her position and left the company. In
October 2013, lululemon announced that Tara Poseley had been appointed to
its Senior Leadership Team as Chief Product Officer and would have
responsibility for overseeing lululemon’s design team, product design
activities, merchandising, inventory activities, and strategic planning.
Previously, Poseley held the position of Interim President at Bebe Stores,
Inc, President of Disney Stores North America (The Children’s Place), CEO
of Design Within Reach (DWR), and a range of senior merchandising and
design management positions during her 15-year tenure at Gap Inc.
EXHIBIT 1 Financial and Operating Highlights, lululemon
athletica, Fiscal Years 2015–2019 (in millions of $, except per
share data)
page C-72
Source: Company 10-K reports for fiscal years 2015, 2016, 2017, 2018, and 2019.
EXHIBIT 2 lululemon athletica’s Revenues and
Income from Operations, by Business Segment,
Geographic Region, and Product Category. Fiscal Years
2015–2019 (dollars in millions)
page C-73
*The “All other channels” category included showroom sales, sales at lululemon outlet
stores, sales from temporary store locations, licensing revenues, and wholesale sales to
premium yoga studios, health clubs, fitness centers, and other wholesale accounts.
Source: Company 10-K Reports, Fiscal Years, 2017 and 2019.
In the aftermath of the pants recall in March 2013, the working
relationship between Christine Day and Chip Wilson deteriorated. Wilson
made it clear that he would have handled the product recall incident
differently and that he did not think there were problems with the design of
the product or the quality of the fabric. But the differences between Day and
Wilson went beyond the events of March 2013, especially when some
consumers began to complain about the quality of the replacement pants.
Wilson returned from Australia in May 2013, and weeks later Christine Day
announced she would step down as CEO when her successor was named. A
lengthy search for Day’s replacement ensued.
In the meantime, Chip Wilson triggered a firestorm when, in an interview
with Bloomberg TV in November 2013, he defended the company’s design
of the black Luon bottoms, saying “Quite frankly, some women’s bodies just
actually don’t work” with the pants. Although a few days later he publicly
apologized for his remarks suggesting that the company’s product quality
issues back in March 2013 were actually the fault of overweight women, his
apology was not well received. In December 2013, Wilson resigned his
position as Chairman of lululemon’s board of directors and took on the lesser
role of non-executive Chairman. A few months later, Wilson announced that
he intended to give up his position as non-executive Chairman prior to the
company’s annual stockholders meeting in June 2014 but continue on as a
member of the company’s Board of Directors (in 2013–2014, Wilson was
the company’s largest stockholder and controlled 29.2 percent of the
company’s common stock).
In early December 2013, lululemon announced that its Board of Directors
had appointed Laurent Potdevin as the company’s Chief Executive Officer
and a member of its Board of Directors; Potdevin stepped into his role in
January 2014, and, to help ensure a smooth transition, Christine Day
remained with lululemon through the end of the company’s fiscal year
(February 2, 2014). Potdevin came to lululemon having most recently served
as President of TOMS Shoes, a company founded on the mission that it
would match every pair of shoes purchased with a pair of new shoes given to
a child in need. Prior to TOMS, Potdevin held numerous positions at Burton
Snowboards for more than 15 years, including President and CEO from
2005–2010; Burton Snowboards, headquartered in Burlington, Vermont, was
considered to be the world’s premier snowboard company, with a product
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line that included snowboards and accessories (bindings, boots, socks,
gloves, mitts, and beanies); men’s, women’s, and youth snowboarding
apparel; and bags and luggage. Burton’s grew significantly under Potdevin’s
leadership, expanding across product categories and opening additional retail
stores.
Tension between Chip Wilson and lululemon’s board of directors erupted
at the company’s annual shareholders’ meeting in June 2014 when he voted
his entire shares against re-election of the company’s chairman and another
director. In February 2015, after continuing to disagree with lululemon
executives and board members over the company’s strategic direction and
ongoing dissatisfaction with how certain lululemon activities were being
managed, Wilson resigned his position on lululemon’s board of directors. In
August 2014, he sold half of his ownership stake to a private equity firm. In
June 2015, lululemon filed documents with the Securities and Exchange
Commission enabling Wilson to sell his remaining 20.1 million shares (equal
to a 14.6 percent ownership stake worth about $1.3 billion) in the event he
wished to do so. As of April 2020, Chip Wilson owned 10.7 million shares
of lululemon’s common stock, equal to an ownership stake of about 8.1
percent. Wilson, together with his wife and son, in 2014 formed a new
company, Kit and Ace, that specialized in high-end clothing for men and
women made from a machine-washable, high performance, cashmere fabric;
the innovative clothing line was designed for all-day wear and included a
range of items suitable for running errands or attending an evening event. In
2016, there were some 60 Kit and Ace stores in the United States, Canada,
Australia, Britain, and Japan; however, in 2020, the company only had 8
locations, all in Canada.
In 2018, lululemon CEO Laurent Potdevin resigned as CEO following
allegations of misconduct. Potdevin was replaced by Calvin McDonald as
Chief Executive Officer in August 2018. McDonald had previously served
for five years as the President and CEO of Sephora America, a division of
the LVMH Group. Mr. McDonald had been very successful in his previous
position, a period during which Sephora America grew annually by double
digits. McDonald was also an endurance athlete who had
competed in both triathlons and marathons.2 In April 2020, the
Chief Financial Officer (CFO) for lululemon, Patrick Guido, resigned as
CFO. Guido had not been replaced as of June 17, 2020.
THE YOGA MARKETPLACE
According to the most recent study on the practice of yoga in the United
States, a “Yoga in America” study funded by the Yoga Journal, in 2015 there
were 36.7 million people in the United States who had practiced yoga in the
last six months in a group or private class setting, up from 20.4 million in
2012 and 15.8 million in 2008.3 Worldwide, it was estimated that were about
300 million yoga practitioners.4 About 72 percent of the people who
engaged in group or class yoga exercises were women, and close to
62 percent of all yoga practitioners were in the age range of 18–49.5 The
level of yoga expertise varied considerably: 56 percent of yoga practitioners
considered themselves as beginners, 42 percent considered themselves as
“intermediate,” and two percent considered themselves to be in the
expert/advanced category. Spending on yoga classes, yoga apparel,
equipment, and accessories was an estimated $16.8 billion, up from
$10.3 billion in 2012, and $5.7 billion in 2008.6
The market for sports and fitness apparel was considerably larger, of
course, than just the market for yoga apparel. The global market for all types
of sportswear, activewear, and athletic apparel was estimated to be about
$250 billion in 2020 and was forecast to grow at roughly five percent
annually through 2026.7 Sales of various types of sports apparel was among
the fastest-growing segments in the $3 trillion global apparel market. In the
United States, sales of activewear and all types of gym and fitness apparel,
which included both items made with high-tech performance fabrics that
wicked away moisture and items made mostly of cotton, polyester, stretch
fabrics, and selected other manmade fibers that lacked moisture-wicking and
other high performance features, were the fastest growing segment of the
apparel industry.8
LULULEMON’S STRATEGY AND BUSINESS IN
2020
Lululemon athletica viewed its core mission as “creating components for
people to live longer, healthier, fun lives.”9 The company’s primary target
customer was
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“a sophisticated and educated woman who understands the importance of an active, healthy
lifestyle. She is increasingly tasked with the dual responsibilities of career and family and is
constantly challenged to balance her work, life and health. We believe she pursues exercise to
achieve physical fitness and inner peace.”10
In the company’s early years, lululemon’s strategy was predicated on
management’s belief that other athletic apparel companies were not
effectively addressing the unique style, fit and performance needs of women
who were embracing yoga and a variety of other fitness and athletic
activities. Lululemon sought to address this void in the marketplace by
incorporating style, feel-good comfort, and functionality into its yoga-
inspired apparel products and by building a network of lululemon retail
stores, along with an online store at the company’s website, to market its
apparel directly to these women. However, while the company was founded
to address the unique needs and preferences of women, it did not take long
for management to recognize the merits of broadening the company’s market
target to include fitness apparel for activities other than yoga and apparel for
population segments other than adult women.
In 2009, lululemon opened its first ivviva-branded store in Vancouver,
British Columbia, to sell high quality, premium-priced dance-inspired
apparel to female youth (ivviva was a word that lululemon made up). The
Vancouver store was soon profitable, and 11 additional company-owned
ivviva stores were opened in Canada and the United States during 2010–13.
In 2014–15, the opening of new ivviva stores accelerated. However, in June
2019, lululemon announced the closure of all but seven of the company’s
ivviva stores. Sales of many ivviva branded products were moved online to
the lululemon website, and sales of some ivviva products continued through
other retailers, including Target and Amazon.com. In September 2019,
lululemon announced it would close the seven remaining ivviva stores by
mid-2020.
In 2013–14, the company began designing and marketing products for
men who appreciated the technical rigor and premium quality of athletic and
fitness apparel. Management also believed that participation in athletic and
fitness activities was destined to climb as people over 60 years of age
became increasingly focused on living longer, healthier, active
lives in their retirement years and engaged in regular exercise
and recreational activities. Another demand-enhancing factor was that
http://amazon.com/
consumer decisions to purchase athletic, fitness, and recreational apparel
were being driven not only by an actual need for functional products but also
by a desire to create a particular lifestyle perception through the apparel they
wore. Consequently, senior executives had transitioned lululemon’s strategy
from one of focusing exclusively on yoga apparel for women to one aimed at
designing and marketing a wider range of healthy lifestyle-inspired apparel
and accessories for women and men and dance-inspired apparel for girls. In
2019, men’s product lines became a major focus of growth for the company.
In early 2019, lululemon announced a new five-year “Power of Three”
strategic plan featuring three growth initiatives:
Product Innovation. The company sought to pursue a disruptive
innovation strategy in its core apparel markets, using what management
called a Science of Feel™ approach to product development that
emphasized using fabrics and technologies that provided both excellent
technical performance and feel-good comfort, to introduce new products
with innovative features and maintain a fresh and growing lineup of yoga,
running, and training products for both women and men. The plan also
called for the company to continue its product collaborations, expand its
popular Office/Travel/Commute line, and pursue new opportunities such
as selfcare.
Omni Guest Experiences. The company sought to become “an
experiential brand” and use all of the company’s marketing channels to
grow and deepen its relationship with the guests who patronized its stores
and the consumers who shopped its website, and, further, to create a series
of ongoing experiential moments and opportunities where local
community members striving to live the “sweatlife” and lead a healthy,
mindful lifestyle could connect and come together. The company’s
concept of integrated “omni guest experiences” thus went beyond just the
experiences customers had in shopping, purchasing, and using the
company products to include creating and hosting a variety of local
community events, an innovative membership program, partnerships with
local yoga studios and running clubs, and unique store formats (like a
25,000 square-foot store in Chicago which had a yoga studio, meditation
space, a healthy food and juice bar, and areas for community gatherings).
In addition, management intended for the company’s digital ecosystem to
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become a greater source of information and communication and a means
of inspiring and igniting community building.
Continuing to Add lululemon Retail Stores in Both Its Core North
American Market and Internationally. Outside North America, China
was the company’s primary focus for new store openings, with 16 new
stores added in the 2019 fiscal year and more planned for 2020. One to
two new company-operated stores were being opened in several countries
across Europe (notably in the United Kingdom, France, Germany, the
Netherlands, and the Scandinavian countries), and in selected countries in
the Asia-Pacific (Australia, Japan, Malaysia, Singapore, and South Korea).
lululemon reported significant progress on its strategic goals in early
2020, stating that the company’s performance was on track to achieve its
five-year strategic plan goals to double online sales, double sales of men’s
products, and quadruple international revenues by year-end 2023 and was
well-ahead of its previously set target to reach $4 billion in annual revenue
in fiscal 2020.
Product Line Strategy
In 2020, lululemon offered a diverse and growing selection of premium-
priced performance apparel and accessories for women, female youths and
men that were designed for healthy lifestyle activities such as yoga,
swimming, running, cycling, and general fitness. Currently, the company’s
range of offerings included:
If you are not familiar with lululemon products, it would be useful to
spend a few minutes browsing the company’s e-store at
www.lululemon.com.
lululemon’s Strategy of Offering Only a Limited Range of Apparel
Sizes. In the months following the product recall of the too-sheer bottom
pants in March 2013, lululemon officially revealed in a posting on its
Facebook page that it did not offer clothing in plus-sizes because focusing
on sizes 12 and below was an integral part of its business strategy;
according to the company’s posting and to the postings of
lululemon personnel who responded to comments made by Facebook
members who read the lululemon posting:11
http://www.lululemon.com/
EXHIBIT 3 lululemon athletica’s Product Offerings for
Women and Men, Representative Sample, 2020
Women Men
Sports bras Swimwear Tops
Tanks Socks andunderwear Jackets and hoodies
Sweaters and wraps Scarves Pants and shorts
Jackets and hoodies Gear bags Gear bags andbackpacks
Long-sleeve and short-
sleeve tops and tees
Caps and
headbands Caps and gloves
Pants and crops Sweat cuffs andgloves Swimwear
Shorts Water bottles Socks and underwear
Skirts and dresses Yoga mats andprops Run accessories
Outerwear Instructional yogaDVDs
Yoga mats, props, and
instructional DVDs
Our product and design strategy is built around creating products for our target guest in our size
range of 2–12. While we know that doesn’t work for everyone and recognize fitness and health
come in all shapes and sizes, we’ve built our business, brand and relationship with our guests on
this formula.
We agree that a beautiful healthy life is not measured by the size you wear. We want to be
excellent at what we do, so this means that we can’t be everything to everybody and need to focus
on specific areas. Our current focuses are in innovating our women’s design, men’s brand, and
building our international market.
At this time, we don’t have plans to change our current sizing structure which is 2–12 for
women.
In 2016, the largest size appearing in the size guide for women on
lululemon’s website was 12, which was said to be suitable for a 40” bust,
32.5” waist, and 43” hips. In 2020, the largest women’s size appearing on
the company’s website was 14 (but size 12 was the largest offered for most
products). Some women’s products were offered in sizes ranging from
XXXS (for a 21” waist, 29” bust, and 32” hips) to XXL (for a 35” waist, 42”
bust, and 45” hips), but most such products were sized XS to XL.
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Retail Distribution and Store Expansion Strategy
After several years of experience in establishing and working with
franchised stores in the United States, Australia, Japan, and Canada, top
management in 2010 determined that having franchised stores was not in
lululemon’s best long-term strategic interests. A strategic initiative was
begun to either acquire the current stores of franchisees and operate them as
company stores or convert the franchised stores to a joint venture
arrangement where lululemon owned the controlling interest in the store and
the former franchisee owned a minority interest. By year-end 2011, all
lululemon stores were company-operated.
As of February 2020, lululemon had 491 company-operated stores in 17
countries:
305 stores in the United States (including 19 factory outlet stores in
discount malls).
63 stores in Canada, including seven ivviva stores slated for closure later
on in 2020.
38 stores in the People’s Republic of China, inclusive of six stores in Hong
Kong, two stores in Macau, and one store in Taiwan.
31 stores in Australia.
14 stores in the United Kingdom.
Seven stores in Japan, seven stores in New Zealand, six stores in Germany,
five stores in South Korea, four stores in Singapore, three stores in France,
two stores in Malaysia, two stores in Sweden, and one store in each of the
Netherlands, Ireland, Norway, and Switzerland.
In fiscal year 2020, management had announced that in new store
openings would come primarily from company-operated store openings in
Asia and the United States. Management reported that the company’s real
estate strategy going forward would be to focus on (1) the opening of new
company-operated stores, and (2) expansion of the company’s
overall retail square footage through store expansions and store
relocations.12 With sales per square foot of $1,657 in lululemon retail stores
in fiscal 2019, management believed its sales revenues per square foot of
retail space were close to the best in the retail apparel sector. By way of
comparison, the stores of specialty fashion retailers like Old Navy, Banana
Republic, The Gap, and Abercrombie & Fitch typically had 2015 annual
sales averaging less than $500 per square foot of store space.
lululemon’s Retail Stores: Locations, Layout, and Merchandising. The
company’s retail stores were located primarily on street locations, in upscale
strip shopping centers, in lifestyle centers, and in malls. Typically, stores
were leased and ranged from 2,500 to 3,500 square feet in size. Most stores
included space for product display and merchandising, checkout, fitting
rooms, a restroom, and an office/storage area. While the leased nature of the
store spaces meant that each store had its own customized layout and
arrangement of fixtures and displays, each store was carefully decorated and
laid out in a manner that projected the ambience and feel of a homespun
local apparel boutique rather than the more impersonal, cookie-cutter
atmosphere of many apparel chain stores.
The company’s merchandising strategy was to sell all of the items in its
retail stores at full price.13 Special colors and seasonal items were in stores
for only a limited time—such products were on 3, 6, or 12-week life cycles
so that frequent shoppers could always find something new. Store
inventories of short-cycle products were deliberately limited to help foster a
sense of scarcity, condition customers to buy when they saw an item rather
than wait, and avoid any need to discount unsold items. In one instance, a
hot-pink color that launched in December was supposed to have a two-
month shelf life, but supplies sold out in the first week. However, supplies of
core products that did not change much from season to season were more
ample to minimize the risk of lost sales due to items being out-of-stock.
Approximately 95 percent of the merchandise in lululemon stores was sold
at full price.14 When certain styles, colors, and sizes of apparel items at
lululemon retail stores were selling too slowly to clear out the inventories of
items ordered from contract manufacturers, lululemon typically shipped the
excess inventories to one or more of the 19 lululemon Factory Outlet stores
in North America to be sold at discounted prices.
One unique feature of lululemon’s retail stores was that the floor space
allocated to merchandising displays and customer shopping could be
sufficiently cleared to enable the store to hold an in-store yoga class before
or after regular shopping hours. Every store hosted a complimentary yoga
class each week that was conducted by a professional yoga instructor from
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the local community who had been recruited to be a “store ambassador;”
when the class concluded, the attendees were given a 15 percent-off coupon
to use in shopping for products in the store. From time to time, each store’s
yoga ambassadors demonstrated their moves in the store windows and on the
sales floor. Exhibit 4 shows the exteriors and interiors of representative
lululemon athletica stores.
lululemon’s Showroom Strategy. Over the years, lululemon had opened
“showrooms” in numerous locations both inside and outside North America
as a means of introducing the lululemon brand and culture to a community,
developing relationships with local fitness instructors and fitness enthusiasts,
and hosting community-related fitness events, all in preparation for the
grand opening of a new lululemon athletica retail store in weeks ahead.
Showroom personnel:
Hosted get-acquainted parties for fitness instructors and fitness
enthusiasts.
Recruited a few well-regarded fitness instructors in the local area to be
“store ambassadors” for lululemon products and periodically conduct in-
store yoga classes when the local lululemon retail store opened.
Advised people visiting the showroom on where to find great yoga or
Pilates classes, fitness centers, and health and wellness information and
events.
Solicited a select number of local yoga studios, health clubs, and fitness
centers to stock and retail a small assortment of lululemon’s products.
Showrooms were only open part of the week so that showroom personnel
could be out in the community meeting people, building relationships with
yoga and fitness instructors, participating in local yoga and fitness classes
and talking with attendees before and after class, promoting attendance at
local fitness and wellness events, and stimulating interest in the soon-to-
open retail store. lululemon used showrooms as a means of “pre-seeding” the
opening of a lululemon retail store primarily in those locations where no
other lululemon retail stores were nearby.
Wholesale Sales Strategy
lululemon also marketed its products to select premium yoga studios, health
clubs, and fitness centers as a way to gain the implicit endorsement of local
fitness personnel for lululemon branded apparel, familiarize their customers
with the lululemon brand, and give them an opportunity to conveniently
purchase lululemon apparel.
lululemon management did not want to grow wholesale sales to these
types of establishments into a significant revenue contributor. Rather, the
strategic objective of selling lululemon apparel to yoga studios, health clubs,
and fitness centers was to build brand awareness, especially in new
geographic markets both in North America and other international locations
where the company intended to open new stores. Wholesale sales to outlet
stores were made only to dispose of excess inventories and thereby avoid in-
store markdowns on slow-selling items.
lululemon had entered into license and supply arrangements with partners
in the Middle East and Mexico to operate lululemon athletica branded retail
locations in the United Arab Emirates, Kuwait, Qatar, Oman, Bahrain and
Mexico. lululemon retained the rights to sell lululemon products through
their e-commerce websites in these countries. Under the arrangement,
lululemon supplied their partners with lululemon products, training, and
other support. As of February 2020, there were four licensed retail locations
in Mexico, three in the United Arab Emirates, and one in Qatar, none of
which were included in the company-operated store numbers in Exhibit 1.
The company’s wholesale sales to all these channels accounted for $340
million in sales, or 8.6 percent of total net revenues in fiscal 2019, versus 9.2
percent of total net revenues for the company in fiscal 2018.
Direct-to-Consumer Sales Strategy
In 2009, lululemon launched its e-commerce website, www.lululemon.com,
to enable customers to make online purchases, supplement its already-
functioning phone sales activities, and greatly extend the company’s
geographic market reach. Management saw online sales as having three
strategic benefits: (1) providing added convenience for core customers, (2)
securing sales in geographic markets where there were no lululemon stores,
and (3) helping build brand awareness, especially in new markets, including
those outside of North America. As of May 2020, the company website
reached 6 continents and 84 separate countries in North America, South
http://www.lululemon.com/
America, Africa, Asia, Europe, and the Middle East. lululemon provided
free standard shipping (2–6 business day delivery) on all lululemon to
customers in North America; a flat $30 shipping fee (5–10 business day
delivery) was charged to buyers located in international destinations.
The merchandise selection that lululemon offered to online buyers
differed somewhat from what was available in the company’s retail stores. A
number of the items available in stores were not sold online; a few online
selections were not available in the stores. Styles and colors available for
sale online were updated weekly. On occasion, the company marked down
the prices of some styles and colors sold online to help clear out the
inventories of items soon to be out-of-season and make way for newly-
arriving merchandise—online customers could view the discounted
merchandise by clicking on a “we made too much” link.
In addition to making purchases, website visitors could browse
information about what yoga was, what the various types of yoga were, and
their benefits; learn about fabrics and technologies used in lululemon’s
products; read recent posts on lululemon’s yoga blog; and stay abreast of
lululemon activities in their communities. The company planned to continue
to develop and enhance its e-commerce websites in ways that would provide
a distinctive online shopping experience and strengthen its brand reputation.
Direct-to-consumer sales at the company’s websites had become an
increasingly important part of the company’s business, with e-commerce
sales climbing from $106.3 million in fiscal 2011 (10.6 percent of total net
revenues) to $1.14 billion in fiscal 2019 (28.6 percent of total revenues)—
equal to a compound annual growth rate of 34.5 percent. In April 2020,
when the majority of lululemon’s retail stores in North America and
elsewhere were closed due to COVID-19, e-commerce became a vital link
between the company and the consumer. Exhibit 4 shows the growth in
quarterly e-commerce sales for fiscal years 2018 and 2019 and the first
quarter of 2020.
EXHIBIT 4 lululemon’s Quarterly E-commerce Sales, Q1
2018 through Q1 2020
Online Sales Quarter 1 Quarter 2 Quarter 3 Quarter 4
2018 $157.8 million $167.4 million $189.4 million $344.2 million
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Online Sales Quarter 1 Quarter 2 Quarter 3 Quarter 4
2019 209.8 million 217.6 million 246.7 million 463.7 million
2020 352.0 million
Source: Quarterly Financial Results, posted in the Investor Relations section at
www.lululemon.com.
Product Design and Development Strategy
lululemon’s product design efforts were led by a team of designers based in
Vancouver, British Columbia partnering with various international designers.
The design team included athletes and users of the company’s
products who embraced lululemon’s design philosophy and
dedication to premium quality. Design team members regularly visited retail
stores in a proactive effort to solicit feedback on existing products from store
customers and fitness ambassadors and to gather their ideas for product
improvements and new products. In addition, the design team used various
market intelligence sources to identify and track market trends. On occasion,
the team hosted meetings in several geographic markets to discuss the
company’s products with local athletes, trainers, yogis, and members of the
fitness industry. The design team incorporated all of this input to make fabric
selections, develop new products, and make adjustments in the fit, style, and
function of existing products.
The design team worked closely with its apparel manufacturers to
incorporate innovative fabrics that gave lululemon garments such
characteristics as stretch ability, moisture-wicking capability, color fastness,
feel-good comfort, and durability. Fabric quality was evaluated via actual
wear tests and by a leading testing facility. Before bringing out new products
with new fabrics, lululemon used the services of leading independent
inspection, verification, testing, and certification companies to conduct a
battery of tests on fabrics for such performance characteristics as pilling,
shrinkage, abrasion resistance, and colorfastness. Lastly, lululemon design
personnel worked with leading fabric suppliers to identify opportunities to
develop fabrics that lululemon could trademark and thereby gain added
brand recognition and brand differentiation.
Where appropriate, product designs incorporated convenience features,
such as pockets to hold credit cards, keys, digital audio players, and clips for
http://www.lululemon.com/
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heart rate monitors and long sleeves that covered the hands for cold-weather
exercising. Product specifications called for the use of advanced sewing
techniques, such as flat seaming, that increased comfort and functionality,
reduced chafing and skin irritation, and strengthened important seams. All of
these design elements and fabric technologies were factors that management
believed enabled lululemon to price its high-quality technical athletic
apparel at prices above those of traditional athletic apparel.
Typically, it took 8 to 10 months for lululemon products to move from the
design stage to availability in its retail stores; however, the company had the
capability to bring select new products to market in as little as two months.
Management believed its lead times were shorter than those of most apparel
brands due to the company’s streamlined design and development process,
the real-time input received from customers and ambassadors at its store
locations, and the short times it took to receive and approve samples from
manufacturing suppliers. Short lead times facilitated quick responses to
emerging trends or shifting market conditions.
lululemon management believed that its design process enhanced the
company’s capabilities to develop top quality products and was a
competitive strength.
Sourcing and Manufacturing
Production was the only value chain activity that lululemon did not perform
internally. Lululemon did not own or operate any manufacturing facilities to
produce fabrics or make garments. In 2019, fabrics were sourced from a
group of approximately 76 fabric manufacturers, with five fabric
manufacturers supplying 59 percent of the total and the largest single fabric
manufacturer supplying 32 percent of the fabric used. During fiscal year
2019, approximately 46 percent of the required fabrics were sourced from
suppliers in Taiwan, 14 percent from suppliers in mainland China,
19 percent from manufacturers in Sri Lanka, and the remainder
from other regions. Other raw materials used in lululemon products, such as
content labels, elastics, buttons, clasps, and drawcords, were obtained from
suppliers located predominantly in the Asia Pacific region.
Garments were sourced from approximately 39 contract manufacturers,
five of which produced approximately 56 percent of the company’s products
in fiscal 2019, with the largest of these producing about 17 percent of the
total. During fiscal 2019, approximately 33 percent of the company’s
products were produced in Vietnam, 16 percent in Cambodia, 15 percent in
Sri Lanka, 11 percent in China (including two percent in Taiwan), and the
remainder in other countries. The company deliberately refrained from
entering into long-term contracts with any of its fabric suppliers or
manufacturing sources, preferring instead to transact business on an order-
by-order basis and rely on the close working relationships it had developed
with its various suppliers over the years. lululemon maintained production
relationships with several manufacturers in North America that provided the
company with the capability to speed select products to market and respond
quickly to changing trends and unexpectedly high buyer demand for certain
products.
lululemon took great care to ensure that its manufacturing suppliers shared
lululemon’s commitment to quality and ethical business conduct. All
manufacturers were required to adhere to a vendor code of ethics regarding
quality of manufacturing, working conditions, environmental responsibility,
fair wage practices, and compliance with child labor laws, among others.
lululemon utilized the services of a leading inspection and verification firm
to closely monitor each supplier’s compliance with applicable law,
lululemon’s vendor code of ethics, and other business practices that could
reflect badly on lululemon’s choice of suppliers.
Distribution Facilities
lululemon shipped products to its stores from owned or leased distribution
facilities in the United States, Canada, and Australia. The company owned a
310,000 square-foot distribution center in Columbus, Ohio and operated a
leased 156,000 square-foot distribution center in Vancouver, British
Columbia, a leased 250,000 square-foot distribution facility in Toronto,
Ontario, and a leased 150,000 square-foot facility in Sumner, Washington.
All four were modern and cost-efficient. In 2011, the company began
operations at a leased 54,000 square-foot distribution center in Melbourne,
Australia, to supply its stores in Australia and New Zealand. Third-party
logistics providers in China and the Netherlands were used to warehouse and
distribute finished products from their warehouse locations to supply the
company’s retail stores in China and Europe. Merchandise was typically
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shipped to retail stores through third-party delivery services multiple times
per week, thus providing stores with a steady flow of new inventory.
lululemon’s Community-Based Marketing Approach and
Brand-Building Strategy
One of lululemon’s differentiating characteristics was its community-based
approach to building brand awareness and customer loyalty. Local fitness
practitioners chosen to be ambassadors introduced their fitness class
attendees to the lululemon brand, thereby leading to interest in the brand,
store visits, and word-of-mouth marketing. Each yoga-instructor ambassador
was also called upon to conduct a complimentary yoga class every four to
six weeks at the local lululemon store they were affiliated with. In return for
helping drive business to lululemon stores and conducting classes,
ambassadors were periodically given bags of free products, and large
portraits of each ambassador wearing lululemon products and engaging in
physical activity at a local landmark were prominently displayed on the
walls their local lululemon store as a means of helping ambassadors expand
their clientele.
Every lululemon store had a dedicated community coordinator who
developed a customized plan for organizing, sponsoring, and participating in
local athletic, fitness, and philanthropic events. In addition, each store had a
community events bulletin board for posting announcements of upcoming
activities, providing fitness education information and brochures, and
promoting the local yoga studios and fitness centers of ambassadors. There
was also a chalkboard in each store’s fitting room area where customers
could scribble comments about lululemon products or their yoga class
experiences or their appreciation of the assistance/service provided by
certain store personnel; these comments were relayed to lululemon
headquarters every two weeks. Customers could use a
lululemon micro website to track their progress regarding
fitness or progress toward life goals.
lululemon made little use of traditional advertising print or television
advertisements, preferring instead to rely on its various grassroots,
community-based marketing efforts and the use of social media (like
Facebook and Twitter) to increase brand awareness, reinforce its premium
brand image, and broaden the appeal of its products.
Store Personnel
As part of the company’s commitment to providing customers with an
inviting and educational store environment, lululemon’s store sales
associates, who the company referred to as “educators,” were coached to
personally engage and connect with each guest who entered the store.
Educators, many of whom had prior experience as a fitness practitioner or
were avid runners or yoga enthusiasts, received approximately 30 hours of
in-house training within the first three months of their employment. Training
was focused on (1) teaching educators about leading a healthy and balanced
life, exercising self-responsibility, and setting lifestyle goals, (2) preparing
them to explain the technical and innovative design aspects of all lululemon
products, and (3) providing the information needed for educators to serve as
knowledgeable references for customers seeking information on fitness
classes, instructors, and events in the community. New hires that lacked
knowledge about the intricacies of yoga were given subsidies to attend yoga
classes so they could understand the activity and better explain the benefits
of lululemon’s yoga apparel.
People who shopped at lululemon stores were called “guests,” and store
personnel were expected to “educate” guests about lululemon apparel, not
sell to them. To provide a personalized, welcoming, and relaxed experience,
store educators referred to their guests on a first name basis in the fitting and
changing area, allowed them to use store restrooms, and offered them
complimentary fresh-filtered water. Management believed that such a soft-
sell, customer-centric environment encouraged product trial, purchases, and
repeat visits.
Core Values and Culture
Consistent with the company’s mission of “providing people with the
components to live a longer, healthier and more fun life,” lululemon
executives sought to promote and ingrain a set of core values centered on
developing the highest-quality products, operating with integrity, leading a
healthy balanced life, and instilling in its employees a sense of self
responsibility and the value of goal setting. The company sought to provide
employees with a supportive and goal-oriented work environment; all
employees were encouraged to set goals aimed at reaching their full
professional, health, and personal potential. The company offered personal
development workshops and goal-coaching to assist employees in achieving
their goals. Many lululemon employees had a written set of professional,
health, and personal goals. All employees had access to a “learning library”
of personal development books that included Steven Covey’s The Seven
Habits of Highly Effective People, Rhonda Byrne’s The Secret, and Brian
Tracy’s The Psychology of Achievement.
Chip Wilson had been the principal architect of the company’s culture and
core values, and the company’s work climate through 2013 reflected his
business and lifestyle philosophy. Wilson had digested much of his
philosophy about life in general and personal development into a set of
statements and prescriptions that he called “the lululemon manifesto.” The
manifesto was considered to be a core element of lululemon’s culture. Senior
executives believed the company’s work climate and core values helped it
attract passionate and motivated employees who were driven to succeed and
who would support the company’s vision of “elevating the world from
mediocrity to greatness”—a phrase coined by Chip Wilson in the company’s
early years. For a number of years, the company’s shopping bags were
emblazoned with a full print of the manifesto, as a means of sharing its
culture and beliefs about life in general with customers, the local
community, and the public at large.
In 2018, to celebrate the company’s 20th year in business, lululemon’s
Brand Creative Director Rémi Paringaux headed an effort to create a freshly
designed manifesto showcasing lululemon’s long-standing brand values
across nine themes: Integrity, Personal Responsibility, Social Impact,
Honesty/Authenticity, Overcoming Fear, Greatness, Purpose, Elevating the
World (even on hard days), and Fun + Laughter, Sweat + The Practice of
Yoga. Each phrase included in the Manifesto, both the original devised by
Chip Wilson and the revised version, was intentionally designed to inspire,
provoke thought, and spark conversation. Excerpts from the Manifesto are
shown in Exhibit 5.
page C-82
EXHIBIT 5 Excepts from The lululemon Manifesto, as
Revised in 2018
Breathe deeply
Hope is not a strategy
Put away your phone. The real world is not on hold.
Creativity is maximized when you are living in the moment
Your biggest opportunity for growth is when it all hits the fan
Gratitude is contagious
That which matters most should never give way to that which matters least
Reconnect with nature. The better you know it the less you take it for granted
The most important answers will never be found in a search bar
Open your ears, eyes and heart &Open your mind
Jealousy works the opposite way you want it to
Replace the word Try with Will and watch the magic happen
The pursuit of happiness is the source of unhappiness
Before speaking, ask yourself: Is it kind? Is it necessary? Is it true?
You attract love when you love yourself
Treat goals like coconuts. Hit them hard, crack them open, celebrate
Do one thing a day that scares you
Life is full of setbacks; success is determined by how you handle setbacks
This is not your practice life. This is all there is
Stress is related to 99% of all illness
Friends are more important than money
Vulnerability makes a good leader great
Source: The lululemon expert, “The lululemon Manifesto: The Controversies (!) and also my
favorite Manifesto-printed items,” www.lululemonexpert.com, September 6, 2019,
accessed May 26, 2020.
COMPETITION IN ATHLETIC APPAREL
Competition in the market for athletic and fitness apparel was fierce.
Companies competed principally on product quality, performance features,
innovation, fit and style, distribution capabilities, brand image and
recognition, and price. Rivalry among competing brands was global,
http://www.lululemonexpert.com/
vigorous, and involved both established companies who were expanding
their production and marketing of performance products and recent entrants
attracted by the growth opportunities.
lululemon competed with wholesalers and direct sellers of premium
performance athletic apparel made of high-tech fabrics, most especially
Nike, The adidas Group AG (which marketed athletic and sports apparel
under its adidas and Reebok brands), and Under Armour. Nike had a
powerful and well-known global brand name, an extensive and diverse line
of athletic and sports apparel, and 2019 global sales of $39.1 billion ($15.9
billion in North America). Nike’s sales outside of North America accounted
for just over 57 percent of its worldwide revenues in fiscal 2019. Not only
was Nike the world’s largest seller of athletic footwear (its footwear sales
exceeded $26 billion in fiscal 2019), but it was also the world’s largest sports
apparel brand, with 2019 sales of $11.6 billion. Sales of Nike products to
women totaled $7.4 billion in 2019. The company had selling arrangements
with independent distributors and licensees in over 190 countries; its retail
account base for sports apparel in the United States included a mix of
sporting goods stores, athletic specialty stores, department stores, and tennis
and golf shops, plus it had a network of factory outlet stores (217 in the
United States and 648 across the rest of the world) and Nike and
NIKETOWN retail stores (29 in the United States and 57 in the rest of the
world). Nike also had a strong online sales presence with websites in 46
countries; in fiscal year 2019, its Nike Direct revenues were $5.0 billion in
North America and $7.1 billion worldwide.
The adidas Group, with its adidas and Reebok brands, was a global
company headquartered in Germany that had worldwide sales of
€23.6 billion ($26.0 billion) in 2019. Worldwide sports apparel revenues for
the company were €9.0 billion ($9.9 billion) in 2019; its product lines
consisted of high-tech performance garments for a wide variety of sports and
fitness activities, as well as recreational sportswear. The adidas Group sold
products in virtually every country of the world. In 2019, its extensive
product offerings were marketed through third-party retailers (sporting
goods chains, department stores, independent sporting goods retailer buying
groups, lifestyle retailing chains, and Internet retailers), 2,500 company-
owned adidas and Reebok retail stores, 15,000 franchised stores, and
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through the company’s e-commerce websites at www.adidas.com and
www.reebok.com.
Under Armour, an up-and-coming designer and marketer of performance
sports apparel, had total sales of $5.3 billion in 2019, of which $3.58 billion
was in apparel. Like lululemon, Under Armour’s apparel
products were made entirely of technically-advanced, high
performance fabrics and were designed to be aesthetically appealing, as well
as highly functional and comfortable. Under Armour regularly upgraded its
products as next-generation fabrics with better performance characteristics
became available. Under Armour’s product line included apparel for men,
women, and children. Under Armour’s sales in North America unexpectedly
plateaued at $4.0 in 2016, then dropped to $3.8 billion in 2017, $3.74 billion
in 2018, and $3.66 billion in 2019. The company reported net losses $48.3
million in 2017 and $46.3 million in 2018. While roughly 70 percent of
Under Armour’s sales revenues in 2019 were in North America, the
company’s revenues were growing in the other regions of the world where
its products were sold, particularly in the EMEA (Europe-Middle East-
Africa) region and the Asia-Pacific region. The majority of Under Armour’s
sales were made through wholesale channels, including sporting goods
stores, independent and specialty retailers, department stores, institutional
athletic departments, and sports leagues and teams. However, the company
also operated 169 factory outlet stores and 19 Brand House stores in North
America and 104 factory outlet stores and 96 Brand House stores in
international locations as of January 2020. Under Armour had direct-to-
consumer sales of about $1.8 billion annually at its e-commerce website,
www.underarmour.com.
Nike, The adidas Group, and Under Armour all aggressively marketed and
promoted their high-performance apparel products to women and men and
spent heavily to grow consumer awareness of their brands and build brand
loyalty. All three sponsored numerous athletic events, provided uniforms and
equipment with their logos to collegiate and professional sports teams, and
paid millions of dollars annually to numerous high-profile male and female
athletes to endorse their products. Like lululemon, they designed their own
products but outsourced the production of their garments to contract
manufacturers.
http://www.adidas.com/
http://www.reebok.com/
http://www.underarmour.com/
New Entrants into the Sports and Fitness Apparel Market for
Women. Retailers responded to the growing market for women’s sports
and fitness apparel by introducing brands and product lines to compete in
this segment. Entrants into this segment of the apparel market included The
Gap, Nordstrom, and Victoria’s Secret.
The Gap had total sales of $16.4 billion in 2019 and was the
owner/operator of three well-known retail chains: The Gap, Banana
Republic, and Old Navy. Product offerings at the 1,033 worldwide Gap-
branded stores included a GapFit collection of fitness and lifestyle products
for women. In 2008, The Gap spent $150 million to acquire Athleta, whose
product line consisted of yoga, running, skiing, snowboarding, and surfing
apparel that was sold online and through catalogs, and proceeded to turn it
into a retail chain to compete head-on against lululemon in the market for
comfortable, fashionable, high-performance women’s apparel for workouts,
sports, physically-active recreational activities, and leisure wear. Going into
2020, Athleta had grown to 190 retail stores in North America Athleta stores
open at least 12 months had sales growth of 16 percent, 9 percent, and 5
percent in 2017, 2018, and 2019, respectively. The Gap planned to continue
opening Athleta stores in 2020 and beyond. In addition to its retail stores,
Athleta collected substantial revenues from sales at its e-commerce website
www.athleta.gap.com. Athleta also had a social media website,
www.athleta.net/chi, that connected women with interests in sports and
fitness, nutrition and health, tutorials and training plans, and travel and
adventure.
Athleta’s expanding product line included swimwear, tops, bras, jackets,
sweaters, pants, tights, shorts, tee shirt dresses, performance footwear,
sneakers, sandals, bags, headwear, and gear. Items were colorful, stylish, and
functional. As of May 2020, Athleta offered 391 different items under
“activity” line of products at its e-commerce website. Athleta apparel items
were typically available in sizes XXS, XS, S, M, L, XL, and plus sizes 1X
and 2X. Athleta utilized well-known women athletes and local fitness
instructors to serve as brand ambassadors by posting blogs on Athleta’s
website, teaching classes at local stores, and testing Athleta garments. In
2016, Athleta introduced Athleta Girl, which introduced fashion and
accessories for younger women. In 2019, Athleta announced a partnership
with decorated track and field athlete Allyson Felix.
http://www.athleta.gap.com/
http://www.athleta.net/chi
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A number of other national and regional retailers of women’s apparel,
seeking to capitalize on growing sales of activewear made of high-tech
fabrics, were marketing one or more brands of fitness apparel suitable for
yoga, running, gym exercise, and leisure activities. A few were selling these
items under their own labels. For example, Nordstrom, a
nationally-respected department store retailer, was
merchandising its own Zella line of attire for yoga, cross-training, workouts,
swimming, and “beyond the workout;” many of the initial products in the
Zella collection were designed by a former member of lululemon’s design
team. Zella-branded products were offered in regular sizes (XXS, XS, S, M,
L, XL, and XXL) and plus sizes (1X, 2X, and 3X). Nordstrom was also
marketing several other brands of activewear for women, men, and juniors,
including Nike, Under Armour, Patagonia, Reebok, and Adidas. In 2019,
Nordstrom’s activewear offerings could be purchased at 136 Nordstrom full-
line department stores (typically 140,000 to 250,000 square-feet in size) and
242 Nordstrom Rack stores (typically 30,000 to 50,000 square-feet in size)
in 36 states, at Nordstrom’s website (www.nordstrom.com), and at the
Nordstrom Rack website, www.nordstromrack.com.
Victoria’s Secret also marketed its own line of women’s fitness apparel
under the Sport label. As of May 2020, Victoria’s Secret offered 118 separate
Sport brand items on the company’s e-commerce
website, www.victoriassecret.com. Offerings included sports bras, bottoms,
yoga pants, sweatshirts, and hoodies.
Typically, the items in the Athleta, GapFit, Zella, and Sport collections
were priced 10 percent to 25 percent below similar kinds of lululemon
products. Likewise, Nike, Under Armour, adidas, and Reebok apparel items
were usually less expensive than comparable lululemon-branded items.
GLOBAL PANDEMIC FORCES TEMPORARY
CLOSURE OF MANY RETAIL STORES
ACROSS THE WORLD
An outbreak of the COVID-19 disease, also known as the coronavirus,
began in China in December 2019, spread to other countries in the first
several months of 2020, and was declared a global pandemic by the World
Health Organization in March 2020. Mounting concerns about the potential
http://www.nordstrom.com/
http://www.nordstromrack.com/
http://www.victoriassecret.com/
for the coronavirus to infect a large percentage of the population and
overwhelm local hospitals and health professionals, prompted government
officials in many countries during February-April 2020 to issue “stay-at-
home” orders to the general public, urge companies to allow employees to
work from home where feasible, and mandate the closure of retail stores and
all “non-essential” local businesses until the daily/weekly number of people
in their locales being newly diagnosed with COVID-19 began to flatten out
or subside. People were urged to practice “social distancing” and wear face
masks when grocery-shopping, picking up to “to-go orders” from local food
establishments, or otherwise venturing out beyond the confines of their
homes to run errands. However, by the end of May 2020, widespread
concerns about the long-term economic damage the business shutdowns
were causing and signs that the spread of the virus was being contained in a
growing number of locations prompted government officials to begin
reopening their local economies. A growing percentage of retail stores had
re-opened or partially re-opened in much of Asia, and limited re-openings
were occurring in Europe and North America.
The global pandemic had a devastating impact on most apparel retailers.
In North America, luxury retailer Neiman Marcus, apparel retailer J Crew,
and department store retailer J.C. Penney filed for bankruptcy in May 2020.
Nordstrom announced on May 5, 2020, that it would soon permanently close
16 department store locations. The Gap, Inc. was also struggling in the new
environment; the price of the company’s stock had plummeted since January
2020, and most of its stores in the United States remained closed as of late
May 2020. Back in February 2019, The Gap announced it would close some
230 of its stores over the next two years. L Brands announced it would not
be making rent payments while its Victoria’s Secret and Bath and Body
Works stores were closed. Many other retail and restaurant chains, also
running short on cash, told landlords that they would be unable to make their
rent payments until their stores and their cash flows improved. Headed into
June 2020, most all chain retailers and millions of local businesses in North
America, Europe, and elsewhere were wrestling with the uncertainty created
by the global pandemic, store closures, how long it would take for customer
traffic to return to former levels, and the extent to which consumer buying
and shopping patterns would be affected both in the short term and the long
term.
page C-85
Retailers with robust e-commerce sales were better able to weather the
global pandemic crisis. Nike, the global sports apparel leader, had a strong
digital presence and was expected to experience only a modest
and fairly short-lived downturn in apparel revenues. forecast to
weather the storm. Further, with the re-opening of the company’s Nike stores
in China in May 2020, the company saw signs of sales improvement in Asia,
pointing the way to a possible strong recovery in Europe and North
America.15 The adidas Group, number two globally and financially strong,
was also expected to come through the pandemic in a competitively strong
position. Under Armour’s situation, already weakened by sales troubles in
North America, was made worse by the pandemic. Many investors and
industry analysts believed the near-term hit to the company’s sales could be
as much as 30 percent in 2020. As of May 2020, the company had
announced layoffs, pay cuts for remaining employees, and the postponement
of plans for an Under Armour flagship store in New York City.16
LOOKING AHEAD AT LULULEMON
In a March 26, 2020, conference call to discuss the company’s Q4 and full-
year 2019 performance with Wall Street analysts, lululemon CEO Craig
McDonald commented on the impacts of the coronavirus pandemic:17
. . . .we are seeing virus-related impact on performance across our markets. In North America and
Europe, our stores have been closed since March 16. Stores in New Zealand are closed at this
time, while Australia is operating on reduced hours. In China, all of our stores except our location
in Wuhan are open with most operating on regular schedules. Our stores also remained open in
other Asian markets, except for Malaysia, where our two locations are currently closed. In
addition, we are closely monitoring our supply chain and staying in constant contact with our
vendors as they too navigate this situation.
. . . .the underlying health of our business is strong. . . . we are confident in our abilities to
navigate the near-term while working to realize the opportunities over the longer term. . . we have
early learnings from China which show us that our business will bounce back. We are not yet back
to pre-closing volumes, but the business is getting stronger week by week.
Although we do not know exactly when the current situation will pass, what we do know is that
our stores will reopen. We know that initially the business will be lower than it was pre-COVID-
19, but we believe that each day and each week, it will keep building. We are planning for
multiple scenarios, but in any one of these we know that our brand is strong and has unique pillars
of strength that will keep driving our momentum forward.
As of May 21, 2020, lululemon had reopened more than 150 stores across
five continents. Plans called for reopening another 200 stores over the
following two weeks. Modified store hours, store employee face coverings,
physical distancing, enhanced store cleaning and sanitization, and a more
relaxed return policy were being instituted at all reopened stores.
ENDNOTES
1 Beth Kowitt and Colleen Leahey, “LULULEMON: In an Uncomfortable Position,” Fortune, September 16, 2013, p. 118.
2 Biography of Calvin McDonald, posted at www.investor.lululemon.com (accessed May 18, 2020).
3 2016 Yoga in America Study, conducted by Yoga Journal and Yoga Alliance, January 2016, posted at
www.yogaalliance.org in 2016 (accessed May 22, 2020 and April 29, 2016); and “Yoga in America” Yoga Journal,
press release dated December 5, 2012, posted at www.yogajournal.com (accessed April 7, 2014).
4 “Yoga Statistics,” compiled by The Good Body and last updated in November 2018, posted at
www.thegoodbody.com (accessed May 22, 2020).
5 2016 Yoga in America Study, conducted by Yoga Journal and Yoga Alliance, January 2016, posted at
www.yogaalliance.org (accessed April 29, 2016).
6 Allied Market Research, “Sports Apparel Market—Report,” published October 2019,
www.alliedmarketresearch.com.
7 Allied Market Research, “Sports Apparel Market—Report,” published October 2019,
www.alliedmarketresearch.com.
8 Renee Frojo, “Yoga clothing retailers go to the mat for market share,” San Francisco Business Times, December 28,
2012, posted at www.bizjournals.com/sanfrancisco (accessed April 10, 2014).
9 As posted on www.lululemon.com (accessed May 2, 2016).
10 Company 10-K Report for the fiscal year ending January 31, 2016, p. 1.
11 Kim Basin, “Lululemon Admits Plus-Size Clothing Is Not Part of Its ‘Formula’” posted at www.huffingtonpost.com,
August 2, 2013 (accessed April 7, 2014).
12 Company 10-K Report for fiscal year 2019.
13 Dana Mattoili, “Lululemon’s Secret Sauce,” The Wall Street Journal, March 22, 2012, pp. B1–B2.
14 Ibid.
15 ValueLine, “Nike, Inc.” April 24, 2020, accessed at www.valueline.com, May 19, 2020.
16 ValueLine, “UnderArmour, Inc.” April 24, 2020, accessed at www.valueline.com, May 19, 2020.
17 Lululemon Athletica Inc. Earnings Call, March 26, 2020, posted at www.seekingalpha.com (accessed May 19,
2020).
http://www.investor.lululemon.com/
http://www.yogaalliance.org/
http://www.yogaalliance.org/
http://www.alliedmarketresearch.com/
http://www.alliedmarketresearch.com/
http://www.bizjournals.com/sanfrancisco
http://www.lululemon.com/
http://www.huffingtonpost.com/
http://www.valueline.com/
http://www.valueline.com/
http://www.seekingalpha.com/
G
page C-86
CASE 8
Under Armour’s Strategy in 2020:
Can It Revive Sales and
Profitability in Its Core North
American Market?
Copyright ©2021 by Arthur A. Thompson. All rights reserved.
Arthur A. Thompson,
The University of Alabama
oing into 2020, Under Armour was headed into its fifth consecutive
year of sales difficulties in its core North American market which
accounted for over two-thirds of the company’s annual sales revenues. The
troubles began in 2016 and undermined Under Armour’s reputation as an
up-and-coming growth company in the sports apparel business. Starting in
the second-quarter of 2010 and continuing through the third-quarter of 2016,
Under Armour achieved revenue growth of 20+ percent for 26 consecutive
quarters. In announcing the company’s 2016 third-quarter financial results,
Chairman and chief executive officer (CEO) Kevin Plank said:1
Over the past 20 years, we have established ourselves as a premium global brand with a track
record of strong financial results. Looking back over the past nine months, it has never been more
evident that we are at a pivotal moment in time, where the investments we are making today will
fuel our growth and drive our industry leadership position for years to come. As a growth
page C-87
company with an expanding global footprint and businesses like footwear and women’s each
approaching a billion dollars this year, we have never been more focused on the long-term success
of our Brand.
But despite Plank’s optimism about Under Armour’s future prospects, he
went on to announce a reduced sales and earnings outlook for the fourth
quarter of 2016 and weakening demand for Under Armour products in North
America. So far in 2016, UA’s quarterly revenue growth in North America
over the same quarter of 2015 slowed from 25.7 percent in Q1 of 2016 to
21.5 percent in Q2 to 15.6 percent in Q3.
But in January 2017, Under Armour’s report of its 2016 fourth quarter and
full-year results rang louder alarm bells, despite record annual revenues of
$4.8 billion for full-year 2016, up 22 percent over 2015, and record net
profits of $259 million, up 10.5 percent over 2015. There were some obvious
cracks in Under Armour’s record-setting 2016 performance:
Fourth-quarter revenues rose only 11.7 percent over fourth-quarter 2105
revenues, by far the lowest percentage fourth-quarter increase since 2010,
which had ranged from a high of 35.5 percent in 2010 to a low of 25.5
percent in 2012.
Fourth-quarter 2016 income from operations dropped 6.1 percent from the
same quarter a year earlier and fourth-quarter 2016 net income dropped
0.67 percent.
Fourth-quarter 2016 revenues in North America were up only 5.9 percent
and operating income in North America dropped 15.0 percent.
Full-year operating income in North America dropped from $461 million
in 2015 to just $411.3 million in 2016.
To make matters worse, Plank said the company’s outlook for full-year
2017 was gloomy—expected revenue growth of 11 to 12 percent (the lowest
annual growth rate since the company became a “C” corporation in 2002)
and a $97.5 million decline in operating income to approximately
$320 million, attributed mainly to “strategic investments in the company’s
fastest growing businesses.”2 Nonetheless, Kevin Plank
reiterated his confidence that the company’s resources and
capabilities would enable it to cope with the challenges ahead:3
We are incredibly proud that in 2016, we once again posted record revenue and earnings; however,
numerous challenges and disruptions in North American retail tempered our fourth quarter results.
The strength of our Brand, an unparalleled connection with our consumers, and the continuation
of investments in our fastest growing businesses—footwear, international and direct-to-consumer
—give us great confidence in our ability to navigate the current retail environment, execute
against our long-term growth strategy, and create value to our shareholders.
Under Armour’s financial performance in 2017 turned out to be worse
than expected. A year after growing North American sales from almost
$1.0 billion in 2012 to $4.0 billion in 2016 (a compound growth rate of 41.4
percent), Under Armour’s 2017 sales in North America dropped
$200 million. Total revenues worldwide were up a meager 3.1 percent;
operating income dropped by $290 million to just $27.8 million; and the
company reported a net loss of $48.3 million. The big drops in operating
income and the net loss were partly attributable to management’s
announcement in August 2017 that it would pursue a $140 to $150 million
restructuring plan to address operating inefficiencies, transition to a product
category management structure, and reengineer the company’s go-to-market
process (product innovation and design, vendor relationships, delivery times
of seasonal products, inventory management, profit margin control, and
speed of response to shifting consumer preferences and market conditions).
In addition, the plan called for a global workforce reduction of about 300
people, inventory reductions and write-downs, and charges for asset
impairments, facility and lease terminations, and contract terminations.
But part of Under Armour’s problems in North America in 2017 stemmed
from an unexpected competitive offensive by Germany-based The adidas
Group. In 2015, Under Armour overtook adidas (pronounced ah-di-dahs) to
become the second largest seller of sports apparel, active wear, and athletic
footwear in North America.4, 5 But top executives at adidas launched an
unusually strong series of strategic initiatives in 2017 to increase the
company’s share of the sports apparel, active wear, and athletic footwear
market in North America from an estimated 10 percent to around 15 to 20
percent. The results were impressive, Sales of adidas-branded products in
North America grew by a resounding 25 percent in 2017, allowing adidas to
reclaim second place in the overall North American sportswear market and
dropping Under Armour back into third place.
Despite the sizable restructuring efforts undertaken at Under Armour in
the last four months of 2017 and continuing into early 2018, Under Armour
executives did not foresee a quick turnaround in North America. Their 2018
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outlook for North American revenues was a mid-single-digit decline,
although international sales were expected to grow 25 percent. Operating
income was projected to be $20 million to $30 million partly because, after
additional review, management decided to pursue a second restructuring plan
in 2018 to further optimize operations. This plan entailed cash related
charges of up to $150 million for facility and lease terminations, contract
terminations, and other restructuring charges, up to $25 million in non-cash
charges related to inventory write-downs and asset-related impairments that
were expected to produce a minimum of $75 million in savings annually in
2019 and beyond.
But, again, Under Armour failed to achieve the modest revenue gains and
return to profitability that management expected. While revenues for 2018
rose just over four percent to $5.2 billion, operating income plummeted by
over $50 million, resulting in an operating loss of $25 million and a net loss
of $46.3 million. A sizable portion of the decline in profitability stemmed
from price discounting aimed at boosting sales volumes in North America;
the price discounting failed to attract sufficient customer purchases to
prevent a further two percent erosion of North American revenues.
Nonetheless, Under Armour Chairman and CEO Kevin Plank put a good
face on the year, saying:6
Our 2018 results demonstrate significant progress against our multi-year transformation toward
becoming an even stronger brand and more operationally excellent company,” said Under Armour
Chairman and CEO Kevin Plank. “As we look ahead to 2019, our accelerated innovation agenda,
disciplined go-to-market process and powerful consumer-centric approach gives us increasingly
greater confidence in our ability to deliver for Under Armour athletes, customers and
shareholders.”
UA management’s outlook for 2019 was flat sales in North America, a
low double-digit increase in international revenues, a four percent
increase in total revenues, operating income in the range of $220 million to
$230 million, and earnings per share of about $0.33. While
closer to the mark, Under Armour’s 2019 performance
remained weak, Revenue was up one percent to $5.27 billion, revenues in
North America declined a further $78 million to $3.66 billion, operating
income was $237 million, and net income of $92 million translated in
earning per share of $0.20, after special charges equal to an EPS impact of
$0.14. In announcing the results, newly appointed President and CEO Patrik
Frisk said:7
Under Armour is an operationally better company following our transformation over the past few
years, with a clearly defined and focused strategy, enhanced go-to-market process, cleaner
inventories, and a stronger balance sheet. However, ongoing demand challenges and the need to
drive greater efficiencies in our business requires us to further prioritize our investments to put our
company in the best position possible to achieve sustainable, profitable growth over the long-term.
The company’s initial 2020 outlook included an estimated negative impact
of the coronavirus outbreak in China of approximately $50 million to
$60 million in sales related to the first quarter of 2020. A low single-digit
percentage decline in total revenues was expected, which included a high
single-decline in North America revenues and a low double-digit increase in
international revenues. Operating income was expected to be in the range of
$105 million to $125 million, with diluted EPS of $0.10 to $0.13.
Management also announced it was currently evaluating a potential 2020
restructuring initiative to rebalance its cost base to further improve
profitability and cash flow generation. In connection with this potential
restructuring, the company was considering $325 million to $425 million in
estimated pre-tax charges for 2020, including approximately $225 million to
$250 million related to foregoing opening a flagship store in New York City
while pursuing options to sublease the space under the long-term lease
already in place.
Exhibit 1 shows selected financial statement data for Under Armour for
2016 through 2019.
EXHIBIT 1 Selected Financial Data for Under Armour, Inc.,
2016–2019 (in millions)
*Working capital is defined as current assets minus current liabilities.
Note: Some totals may not add up due to rounding and to the omission of some line items in
the company’s income statement and consolidated balance sheet.
Source: Company 10-K report for 2019, pp. 28–29 and pp. 55–59.
Exhibit 2 shows Under Armour’s revenues and operating income for each
of its four geographic regions and its connected fitness business for 2016
through 2019.
EXHIBIT 2 Under Armour’s Revenues and Operating
Income for Its Four Geographic Regions and Its Connected
Fitness Business, 2016–2019
A. Net revenues by geographic region (in millions of $)
*Europe–Middle East–Africa.
B. Operating income (loss) by geographic region (in millions of $)
*Europe–Middle East–Africa.
Note: Totals do not add because numbers for the “Corporate Other” non-operating segment
were omitted; these relate to currency hedge gains and losses, restructuring charges, and
various “intersegment eliminations” not directly pertinent to UA’s net revenues and operating
income by geographic region.
Source: Company 10-K reports, 2019 and 2018.
Company Background
Founded in 1996 by former University of Maryland football player Kevin
Plank, Under Armour was the originator of sports apparel made with
performance-enhancing fabrics—gear engineered to wick moisture from the
body, regulate body temperature, and enhance comfort regardless of weather
conditions and activity levels. Plank’s initial plan was to make a T-shirt that
provided compression and wicked perspiration off the wearer’s skin, thereby
avoiding the discomfort of sweat-absorbed apparel—and sell the T-shirt to
athletes and sports teams.
He worked the phone and, with a trunk full of shirts in the back of his car,
visited schools and training camps in person to show his products. Plank’s
sales successes were soon good enough that he convinced Kip Fulks, who
played lacrosse at Maryland, to become a partner in his enterprise.
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Operations were conducted on a shoestring budget out of the basement of
Plank’s grandmother’s house in Georgetown, a Washington, D.C. suburb. In
1998, the company’s sales revenues and growth prospects were sufficient to
secure a $250,000 small-business loan, enabling the company to move
operations to a facility in Baltimore. Ryan Wood, one of Plank’s
acquaintances from high school, joined the company in 1999 and became a
partner.
KP Sports’ sales grew briskly as it expanded its product line to include
high-tech undergarments tailored for athletes in different sports and for cold
as well as hot temperatures, plus jerseys, team uniforms, socks, and other
accessories. Increasingly, the company was able to secure deals not just to
provide gear for one team at a particular school but for most or all of a
school’s sports teams. However, the company’s partners came to recognize
the merits of tapping the retail market for high-performance apparel and
began making sales calls on sports apparel retailers. In 2000, Scott Plank,
Kevin’s older brother, joined the company as Vice President of Finance and
certain other operational and strategic responsibilities. When Galyan’s, a
large retail chain that has since been acquired by Dick’s Sporting Goods,
signed on to carry KP Sports’ expanding line of performance apparel for
men, women, and youth in 2000, sales to other sports apparel retailers began
to explode. By the end of 2000, the company’s products were available in
some 500 retail locations.
Prompted by growing operational complexity, increased financial
requirements, and plans for further geographic expansion, KP Sports
revoked its “S” corporation status and became a “C” corporation on January
1, 2002. The company opened a Canadian sales office in 2003
and began selling its products in the United Kingdom in 2005.
At year-end 2005, about 90 percent of the company’s revenues
came from sales to some 6,000 retail stores in the United States and 2,000
stores in Canada, Japan, and the United Kingdom. In addition, sales were
being made to high profile professional athletes and teams, most notably in
the National Football League, Major League Baseball, the National Hockey
League, and some 400 men’s and women’s sports teams at NCAA Division
1-A colleges and universities.
In late 2005, KP Sports changed its name to Under Armour and became a
public company with an initial public offering of common stock that
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generated net proceeds of nearly $115 million. Under Armour immediately
began pursuing a long-term strategy to grow its product line, establish a
market presence in a growing number of countries across the world, and
build public awareness of the Under Armour brand and its interlocking “U”
and “A” logo.
Stock Price, Ownership, and Management Changes at Under
Armour 2016–2020
Since early 2016 and continuing into early 2020, Under Armour’s stock
price remained below the $105 per share achieved in July 2015, with most of
the decline coming in 2016—at year-end 2016, the price was $27, and at the
end of February 2020, it was $13 per share due to the company’s weak
outlook for the remainder of 2020. Aside from the company’s poor financial
performance, the stock price declines were also a reflection of investor
concerns about whether the Under Armour brand was in deep trouble in
North America—the experiences of other troubled brands had demonstrated
it was extremely difficult to rebuild a brand once it had fallen out of favor
with the public. Investors had also been unnerved in November 2017 when
analysts at 24/7 Wall St. had ranked Kevin Plank fourth on its list of “20
Worst CEOs in America 2017.”8 Plank had been under the microscope since
a controversial split of the company’s stock in April 2016 into Class A (vote-
entitled), Class B, and Class C (no voting power) shares, that resulted in
Kevin Plank having 65 percent of the total shareholder voting power on
every shareholder vote taken.
Since the stock split, Plank had sold some of his Class C shares to fund
the creation of Plank Industries, a privately-held investment company with
ownership interests in commercial real estate, hospitality, food and beverage,
venture capital, and thoroughbred horse racing. Plank’s critics had claimed
the new venture was absorbing too much of his time. In addition, Plank’s
time in dealing with UA’s operating issues and sales slowdown was
constrained by his involvement in helping spearhead a 25-year, $5.5 billion
project (being partially financed with bonds issued by the City of
Baltimore’s Baltimore Development Corp.) to develop waterfront property
in South Baltimore into a mini-city called Port Covington that would create
thousands of jobs and drive demand for office buildings,
houses, shops and restaurants. Plank Industries’ Sycamore Development Co.
was the lead private developer of the Port Covington project. Sycamore had
completed a number of properties in the project, including a $24 million
renovation of a former Sam’s Club into a 170,000 square-foot facility for
Under Armour, tentatively named Building 37 (Plank’s number on his
University of Maryland football jersey was 37). Building 37 was on acreage
Under Armour had purchased for $70.3 million in 2014 and was being
leased by Sycamore to Under Armour for $1.1 million annually. Building 37
was the first phase of Under Armour’s plan to create a 50-acre global
headquarters campus that would include a new headquarters building on the
site of Building 37, additional Under Armour facilities and manufacturing
space, a man-made lake, and a small stadium—a layout designed to house as
many as 10,000 Under Armour employees (UA employed approximately
2,100 people in Baltimore in early 2018, some 600 of which were housed in
Building 37).
To compensate for the time he was spending on outside interests, Plank
engineered the appointment of Patrik Frisk, formerly CEO of the ALDO
Group, a global footwear and accessories company, as President and Chief
Operating Officer (COO) of Under Armour in June 2017. Frisk had 30 years
of experience in the apparel, footwear, and retail industry, holding top
management positions with responsibility for such brands as The North
Face®, Timberland®, JanSport®, lucy®, and SmartWool®. As president
and COO, Frisk was assigned responsibility for Under Armour’s go-to-
market strategy and the successful execution of its long-term growth plan.
Kevin Plank’s titles were Chairman of the Board and CEO. Then in October
2019, Under Armour announced that Frisk would become CEO, President,
and a member of Under Armour’s Board of Directors, effective January 1,
2020, and that Kevin Plank would become Executive Chairman of the Board
and Brand Chief. Frisk would report directly to Kevin Plank.
In 2008, Plank voluntarily reduced his salary from $500,000 to
$26,000,000, which was his approximate salary when he founded Under
Armour. As UA’s largest stockholder, Plank believed he should be
compensated for his services based primarily on the company’s annual
incentive plan tied to the company’s performance and on annual
performance-based equity awards. Plank’s $26,000 salary remained in place
in 2020.
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UNDER ARMOUR’S STRATEGY IN 2020
Until 2018, Under Armour’s mission was “to make all athletes better
through passion, design, and the relentless pursuit of innovation.” A
reworded mission—“Under Armour Makes You Better”—was publicly
announced in early 2018. Kevin Plank said the new wording was meant to
better convey that “in every way we connect, through the products we create,
the experience we deliver and the inspiration we provide, we simply make
you better.”9 In late 2018, Kevin Plank told a gathering of investors and Wall
Street analysts that Under Armour’s vision was “to inspire you with
performance solutions you never knew you needed and can’t imagine living
without.”
The company’s principal business activities in 2020 were the
development, marketing, and distribution of branded performance apparel,
footwear, and related sports accessories for men, women, and youth. The
brand’s moisture-wicking apparel and footwear products were engineered in
many designs and styles for wear in nearly every climate to provide a
performance alternative to traditional products. Under Armour sports apparel
was worn by athletes at all levels, from youth to professional, and by
consumers with active lifestyles. The company generated revenues from the
sale of its products globally through two primary channels: (1) sales to
national, regional, independent and specialty wholesalers and distributors in
many countries across the world and (2) direct-to-consumer sales (sales at
the company’s ecommerce websites in various geographic regions and at its
company-owned brick-and-mortar Brand Houses and factory outlet stores).
In the company’s earlier years, revenue growth was achieved primarily by
growing wholesale sales to retailers of sports apparel, athletic footwear, and
sports equipment and accessories in North America. Starting in 2010, Under
Armour began increasing its global footprint by expanding its wholesale and
online sales to countries in Europe, the Middle East, and Africa (EMEA), the
Asia-Pacific, and Latin America.
In 2013, Under Armour acquired MapMyFitness, a provider of website
services and mobile apps to fitness-minded consumers across
the world; Under Armour used this acquisition, along with
several follow-on acquisitions in 2014 and 2015, to create what it termed a
“connected fitness” business offering digital fitness subscriptions and
licenses, mobile apps, and other fitness-tracking and nutritional-tracking
solutions to athletes and fitness-conscious individuals across the world.
During 2016–2019, the company’s connected fitness business experienced
strong revenue growth and strategic initiative to become a major revenue
driver in the years to come.
Exhibit 3 shows Under Armour’s revenues for its three main product
categories plus revenues associated with its licensing arrangements and its
connected fitness business for 2016 through 2019.
EXHIBIT 3 Under Armour’s Revenues, by Product Category
2016–2019 (in millions of $)
Note: Percentages do not add to 100% due to not including numbers for “Corporate Other”
which relate to currency hedge gains and losses and various “intersegment eliminations” not
directly pertinent to UA’s net revenues by product category.
Source: Company 10-K reports, 2019 and 2018.
Growth Strategy
Under Armour’s growth strategy in 2020 was centered on five strategic
initiatives:
Rejuvenating sales growth and profitability in North America, via an
enhanced e-commerce platform, improved shelf space visibility in retail
stores, reduced price discounting, increased support of retailer efforts to
merchandise Under Armour products without having to resort to off-price
sales promotions, and greater emphasis on brand advertising and
promotional activities that increase customer willingness to pay full price
for Under Armour products and help restore UA’s image as a premium-
priced brand.
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Continuing to bring authenticity to the brand through innovative products
and providing customers with new solutions and appealing experiences
that they quickly discover are so beneficial as to merit “must have” status.
Exerting the efforts necessary to continue to grow Under Armour’s
revenues in the Latin America, EMEA, and Asia-Pacific regions.
Continued emphasis on using the endorsements of athletes and other brand
influencers to enhance global awareness of the Under Armour brand name
and strengthen Under Armour’s image as a premium-priced provider of
high-performance apparel, footwear, and accessories.
Growing the company’s connected fitness business via securing more
digital subscriptions and selling additional digital advertising on its
MapMyFitness, MyFitnessPal, and Endomondo platforms.
Product Line Strategy
For a number of years, expanding the company’s product offerings and
marketing them at multiple price points had been a key element of Under
Armour’s strategy. The goal for each new item added to the line-up of
offerings was to provide consumers with a product that was a superior
alternative to the traditional products of rivals—striving to always introduce
a superior product would, management believed, help foster and nourish a
culture of innovation among all company personnel. According to
Kevin Plank, “we focus on creating products you don’t know you
need yet, but once you have them, you won’t remember how you lived
without them.”10
Apparel The company designed and merchandised three lines of apparel
gear intended to regulate body temperature and enhance comfort, mobility,
and performance regardless of weather conditions: HEATGEAR® for hot
weather conditions; COLDGEAR® for cold weather conditions; and
ALLSEASONGEAR® for temperature conditions between the extremes.
HeatGear. HeatGear was designed to be worn in warm to hot temperatures under
equipment or as a single layer. The company’s first compression T-shirt was the original HeatGear
product and was still one of the company’s signature styles in 2015. In sharp contrast to a sweat
soaked cotton T-shirt that could weigh two to three pounds, HeatGear was engineered with a
microfiber blend featuring what Under Armour termed a “Moisture Transport System” that
ensured the body would stay cool, dry, and light. HeatGear was offered in a variety of tops and
bottoms in a broad array of colors and styles for wear in the gym or outside in warm weather.
ColdGear. Under Armour high performance fabrics were appealing to people participating
in cold-weather sports and vigorous recreational activities like snow skiing who needed both
warmth and moisture-wicking protection from becoming overheated. ColdGear was designed to
wick moisture from the body while circulating body heat from hotspots to maintain core body
temperature. All ColdGear apparel provided dryness and warmth in a single light layer that could
be worn beneath a jersey, uniform, protective gear or ski-vest, or other cold weather outerwear.
ColdGear products generally were sold at higher price points than other Under Armour gear lines.
AllSeasonGear. AllSeasonGear was designed to be worn in temperatures between the
extremes of hot and cold and used technical fabrics to keep the wearer cool and dry in warmer
temperatures while preventing a chill in cooler temperatures.
Each of the three apparel lines contained three fit types: compression
(tight fit), fitted (athletic fit), and loose (relaxed). Some of Under Armour’s
apparel and footwear products contained MicroThread, a fabric technology
that used elastomeric (stretchable) thread to create a cool moisture-wicking
microclimate, prevented clinging and chafing, and allowed garments to dry
30 percent faster and be 70 percent more breathable than similar Lycra
construction. Under Armour had also introduced a collection of workout
gear, headwear, and footwear with an exclusive CoolSwitch coating on the
inside of the fabric that pulled heat away from the skin, allowing the wearer
to feel cooler and perform longer.
Most recently, Under Armour had introduced Rush™ or Recover™
products designed to increase blood flow.
Products within each gear line were offered in three fit types: compression
(tight fit), fitted (athletic fit), and loose (relaxed). In 2016, Under Armour
introduced apparel items containing MicroThread, a fabric technology that
used elastomeric (stretchable) thread to create a cool moisture-wicking
microclimate, prevented clinging and chafing, allowed garments to dry 30
percent faster and be 70 percent more breathable than similar Lycra
construction, and were so lightweight as to “feel like nothing.” It also began
using a newly developed insulation called Reactor in selected ColdGear
items and introduced a new apparel collection with an exclusive CoolSwitch
coating on the inside of the fabric that pulled heat away from the skin,
allowing the wearer to feel cooler and perform longer.
Footwear Under Armour began marketing athletic footwear for men,
women, and youth in 2006 and expanded its footwear line every year since.
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Its 2019 offerings included footwear models specifically designed for
performance training, running, footwear, basketball, golf, and outdoor wear,
plus football, baseball, lacrosse, softball, and soccer cleats. Under Armour’s
footwear models were light, breathable, and built with performance
attributes specific to their intended use. Over the past five years, a stream of
innovative technologies had been incorporated in the ongoing generations of
footwear models/styles to improve stabilization, cushioning, moisture
management, comfort, directional control, and performance. As of 2020,
Under Armour footwear was designed with under-foot cushioning
technologies labeled UA HOVR™, UA Micro G®, and Charged
Cushioning®, engineered to a specific sport with advanced outsole
construction.
New footwear collections for men, women, and youth were introduced
annually, sometimes seasonally. Most new models and styles incorporated
fresh technological features of one kind or another. Since 2012, Under
Armour had more than tripled the number of footwear
styles/models priced above $100 per pair. Its best-selling
offerings were in the basketball and running shoe categories.
To capitalize on a recently signed long-term endorsement contract with
pro basketball superstar Stephen Curry, Under Armour began marketing a
Stephen Curry Signature line of basketball shoes in 2014; the so-called
Curry One models had a price point of $120. This was followed by a Curry
Two collection in 2015 at a price point of $130, a Curry 2.5 collection at a
price point of $135 during the NBA playoffs in May and June 2016, a Curry
Three collection in Fall 2016, a Curry 4 collection at a price point of $130 in
Fall 2017, a Curry 5 collection at a price point of $130 at the start of the
NBA playoffs in May 2018, a Curry 6 collection at a price point of $130 in
December 2018, and a Curry 7 collection at a price point of $140 in
November 2019.
After signing pro golfer Jordan Spieth to a 10-year endorsement contract
in early 2015—Spieth had a spectacular year on the Professional Golf
Association (PGA) tour in 2015 and was named 2015 PGA Tour Player of
the Year—Under Armour promptly sought to leverage the signing by
introducing an all-new 2016 golf shoe collection in April 2016. The
collection had 3 styles, ranging in price from $160 to $220. A new Spieth
One Signature collection was introduced in early 2017 with much the same
price points, followed by a Spieth Two collection in early 2018, which was
accompanied by a Spieth Tour™ golf glove, and a Spieth 3 collection in
early 2019.
Under Armour debuted its first “smart shoe” (called the SpeedForm
Gemini 2 Record Equipped) at a price point of $150 in 2016; smart shoe
models were equipped with the capability to connect automatically to UA’s
connected fitness website and record certain activities in the wearer’s fitness
tracking account.
In 2018, using freshly-developed connected fitness technologies and
several other innovations, Under Armour debuted a new, multi-featured
HOVR™ running shoe, which Kevin Plank hailed as a new product that hit
what the company called “the trifecta—style, performance, and fit.” HOVR
models were priced from $100 to $140; all models used compression mesh
and a special molded foam that provided a “zero gravity feel,” gave the
runner return energy with each step to reduce impact, and claimed to deliver
“unmatched comfort.” The higher-priced “Connected” HOVR models had
built-in Under Armour Record Sensor™ technology that could be paired
with a mobile phone and used to track, analyze, and store almost every
known running metric, enabling runners to know what they needed to do to
get better. Plank believed the HOVR was “a home run” and a reflection of
the company’s growing capabilities to churn out innovative products. In
2020, HOVR models were available for running, training, basketball, golf,
and casual wear; a number of the HOVR models for running had connected
technology features.
Growing numbers of Under Armour’s footwear models in 2019–2020
featured such recently developed technologies as Anafoam (which provided
a chafe-free, body-mapped fit and lightweight structure and support) and
Charged Cushioning® (which provided stabilization, directional cushioning,
and moisture management, engineered to maximize comfort and control).
UA’s Clutch Fit® technology used in some footwear models flexed and
responded “like your second skin.”11 Shoppers could also design their own
customized footwear, using uploaded images, customizable patterns, an
assortment of styles and technologies, and a giant array of color options.
wanted
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Accessories Under Armour’s accessory line in 2019 included gloves,
socks, hats and headwear, belts, backpacks and bags, eyewear, protective
gear, headphones, phone cases and mounts, water bottles and coolers, and an
assortment of sports equipment. All of these accessories featured
performance advantages and functionality similar to other Under Armour
products. For instance, the company’s baseball batting, football, golf, and
running gloves included HEATGEAR®, COLDGEAR®, and Clutch Fit®
technologies and were designed with advanced fabrics to provide various
high-performance attributes that differentiated Under Armour gloves from
those of rival brands.
Connected Fitness In December 2013, Under Armour acquired
MapMyFitness, which served one of the largest fitness communities in the
world at its website and offered a diverse suite of websites and mobile
applications under its flagship brands, MapMyRun and MapMyRide.
Utilizing GPS and other advanced technologies, MapMyFitness
provided users with the ability to map, record, and share their
workouts. Under Armour acquired European fitness app Endomondo and
food-logging app MyFitnessPal in 2015, enabling UA to create a
multifaceted connected fitness dashboard that used four independently
functioning apps (MapMyFitness, MyFitnessPal, Endomondo, and UA
Record™) to enable subscribers to log workouts, runs, and foods eaten, and
to use a digital dashboard to review measures relating to their sleep, fitness,
activity, and nutrition. Next, UA introduced a Connected Fitness System
called Under Armour HealthBox™ that consisted of a multifunctional
wristband (that measured sleep, resting heart rate, steps taken, and workout
intensity), heart rate strap, and a smart scale (that tracked bodyweight, body
fat percentage, and progress toward a weight goal); the wristband was water
resistant, could be worn 24/7, and had Bluetooth connectivity with UA
Record.
Kevin Plank was so enthusiastic about the long-term potential of Under
Armour’s Connected Fitness business that he had boosted the company’s
team of engineers and software developers from 20 to over 350 during 2014
and 2015. In 2016, Under Armour organized all of its digital and fitness
technologies and products into a new business division called Connected
Fitness, under the leadership of a senior vice president of digital revenue. By
December 2018, Under Armour believed it had created the world’s largest
digital health and fitness community. More than 250 million people had
downloaded one of the company’s digital fitness apps. Many users were
quite active, with more than 2 million workouts and 30 million foods being
logged daily across the world. Under Armour had learned that members of
its digital ecosystem purchased 36 percent more Under Armour products
than other consumers and that their brand preference for Under Armour
products was significantly higher.12
While Connected Fitness sales grew rapidly, the business initially
lost millions of dollars annually and achieved profitability in 2018—see
Exhibits 2A and 2B. As part of the 2017 restructuring program, Under
Armour merged its core connect fitness digital products, digital engineering,
and digital media under the direction of a chief technology officer; this
management arrangement evolved further in early 2018 with the
appointment of a new senior vice president, digital product, who reported to
the chief technology officer and had responsibility for leading the strategy
for all digital product development in collaboration with executive
management, product category heads, marketing, and creative/design. In
Under Armour’s February 2018 earnings announcement, the Connected
Fitness business reported its first-ever positive operating income (almost
$800,000) for the fourth quarter of 2017; for full-year 2018, the connected
fitness business reported operating income of $5.9 million. Under Armour
reported that premium subscription revenue for its Connected Fitness
business grew about 56 percent during 2018. UA’s MyFitnessPal was the
number one grossing health and fitness app in the Apple App Store; in 2018,
users of this app had over 9 billion foods and burned more than 440 billion
calories. Users of various Connected Fitness apps participated in social
media communities on Instagram, WeChat, Snap, YouTube, Facebook, and
other platforms.
Licensing Under Armour had licensing agreements with a number of
firms to produce and market Under Armour apparel, accessories, and
equipment. Under Armour product, marketing, and sales teams were actively
involved in all steps of the design process for licensed products in order to
maintain brand standards and consistency. During 2018–2020, licensees sold
UA-branded collegiate, National Football League and National Basketball
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Association apparel and accessories, baby and kids’ apparel, team uniforms,
socks, water bottles, eyewear, and other hard goods equipment that featured
performance advantages and functionality similar to Under Armour’s other
product offerings. Under Armour pre-approved all products manufactured
and sold by its licensees, and the company’s quality assurance team strived
to ensure that licensed products met the same quality and compliance
standards as company-sold products.
Marketing, Promotion, and Brand Management Strategies
Under Armour had an in-house marketing and promotions department that
designed and produced most of its advertising campaigns to drive consumer
demand for its products and build awareness of Under Armour as a leading
performance athletic brand. The company’s total marketing expenses were
$579.0 million in 2019, $543.8 million in 2018, $565.1 million in 2017, and
$477.5 million in 2016. These totals included the costs of
sponsoring events and various sports teams, the costs of athlete
endorsements, and ads placed in a variety of television, print, radio, and
social media outlets. All were included as part of selling, general, and
administrative expenses shown in Exhibit 1.
Sports Marketing Under Armour’s sports marketing and promotion
strategy began with promoting the sales and use of its products to high-
performing athletes and teams on the high school, collegiate, and
professional levels. This strategy was executed by entering into outfitting
agreements with a variety of collegiate and professional sports teams,
sponsoring and hosting an assortment of collegiate and professional sports
events, entering into endorsement agreements with individual athletes, and
selling Under Armour products directly to team equipment managers and to
individual athletes. As a result, UA products were seen on the playing field
(typically with the Under Armour logo prominently displayed), giving them
exposure to various consumer audiences attending live sports events or
watching these events on television and through other media (pictures and
videos accessed via the Internet and social media, magazines, and print).
Management believed such exposure helped the company establish the on-
field authenticity of the Under Armour brand with consumers. In addition,
UA hosted combines, camps, and clinics for athletes in many sports at
regional sites across the United States and was the title sponsor of a
collection of high school All-America Games that created significant on-
field and media exposure of its products and brand.
Going into 2020, Under Armour was the official outfitter of men’s and
women’s athletic teams at such collegiate institutions as Notre Dame,
UCLA, Boston College, Northwestern, Texas Tech, Maryland, South
Carolina, the U.S. Naval Academy, Wisconsin, Indiana, California, Utah,
and Auburn. All told, it was the official outfitter of close to 100 men’s and
women’s collegiate athletic teams, growing numbers of high school athletic
teams, and it supplied sideline apparel and fan gear for many collegiate
teams as well. Under Armour had been the official supplier of competition
suits, uniforms, and training resources for a number of U.S. teams in the
2014 Winter Olympics, 2016 Summer Olympics, 2018 Winter Olympics,
and 2020 Summer Olympics.
Under Armour was quite active in negotiating agreements to supply
products to high profile professional athletes and professional sports teams,
most notably in the National Football League (NFL) and the National
Basketball Association (NBA). Under Armour had been an official supplier
of football cleats to all NFL teams since 2006, the official supplier of gloves
to NFL teams beginning in 2011, and a supplier of training apparel for
athletes attending NFL tryout camps beginning in 2012. In 2011 Under
Armour became the official supplier of performance footwear to all 30 MLB
teams; in 2016, Under Armour signed a 10-year deal with MLB to extend its
role as official supplier for all 30 teams from just footwear to include
uniforms, performance apparel, and connected fitness products and to also
be an official sponsor of Major League Baseball. However, in 2018 UA
exited its 2016 agreement with MLB, but retained its rights to supply
performance footwear and be an MLB sponsor. In 2018, Under Armour
worked with a manufacturing and distribution partner to sell MLB-licensed
fan wear at retail.
Internationally, Under Armour sponsored and sold its products to several
Canadian, European, and Latin American soccer and rugby teams to help
drive brand awareness in various countries and regions across the world. In
Canada, it had been the official supplier of performance apparel to Rugby
Canada and Hockey Canada. In Europe, Under Armour was the official
supplier of performance apparel to two professional soccer teams and the
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Welsh Rugby Union. In 2014 and 2015, Under Armour became the official
match-day and training wear supplier for the Colo-Colo soccer club in Chile,
the Cruz Azul soccer team in Mexico, and the São Paulo soccer team in
Brazil.
In addition to sponsoring teams and events, Under Armour’s brand-
building strategy in the United States was to secure the endorsement of
individual athletes. One facet of this strategy was to sign endorsement
contracts with newly emerging sports stars—examples included Jacksonville
Jaguars running back Leonard Fournette, Milwaukee Bucks point guard
Brandon Jennings, Philadelphia 76ers center Joel Embiid, Charlotte Bobcats
point guard Kemba Walker, 2012 National League (baseball) Most Valuable
Player Buster Posey, 2012 National League Rookie of the Year Bryce
Harper, tennis phenom Sloane Stephens, WBC super-welterweight boxing
champion Camelo Alvarez, and PGA golfer Jordan Spieth. But the
company’s endorsement roster also included established stars: NFL football
players Tom Brady, and Anquan Boldin; Golden State Warriors
point guard Stephen Curry; professional baseball players Ryan
Zimmerman and Clayton Kershaw; U.S. Women’s National Soccer Team
players Heather Mitts and Lauren Cheney; U.S. Olympic and professional
volleyball player Nicole Branagh; and U.S. Olympic swimmer Michael
Phelps. In 2015, Under Armour negotiated 10-year extensions of its
endorsement contracts with Stephen Curry and Jordan Spieth; both deals
included grants of stock in the company. Recently, Under Armour had
signed celebrities outside the sports world to multi-year contracts, including
ballerina soloist Misty Copeland and fashion model Giselle Bündchen;
wrestler, actor, and producer Dwayne “The Rock” Johnson; and rapper
A$AP Rocky (Rakim Mayers). Copeland was featured in one of Under
Armour’s largest advertising campaigns for women’s apparel offerings.
Johnson was playing an integral role in promoting UA’s connected fitness,
apparel, footwear, and accessory products. Mayers was expected to have his
own line of premium clothing in a forthcoming Under Armour Sportswear
collection. In addition to signing endorsement agreements with prominent
sports figures and celebrities in the United States, Under Armour had
become increasingly active in using endorsement agreements with well-
known athletes to help build public awareness of the Under Armour brand in
those foreign countries where it was striving to build a strong market
presence. As of early 2019, Under Armour had signed endorsement
agreements with several hundred international athletes in a wide variety of
sports.
Under Armour’s strategy of signing high-profile sports figures to
endorsement contracts, sponsoring a variety of sports events, and supplying
products to sports teams emblazoned with the company’s logo had long been
used by Nike and The adidas Group. Both rivals had far larger rosters of
sports figure endorsements than Under Armour and supplied their products
to more collegiate and professional sports teams than Under Armour.
Nonetheless, Under Armour’s aggressive entry into the market for
securing such endorsement agreements had spawned intense competition
among the three rivals to win the endorsement of athletes and teams with
high profiles and high perceived public appeal had caused the costs of
winning such agreements to spiral upward. In 2014, Under Armour
reportedly offered between $265 million and $285 million to entice NBA
star Kevin Durant, who plays for the Golden State Warriors, away from
Nike; Nike matched the offer and Durant elected to stay with Nike.13 In
2015, adidas bested Nike in a bidding war to sign Houston Rockets star and
runner-up NBA most valuable player James Harden to a 13-year
endorsement deal, when Nike opted not to match adidas’ offer of
$200 million. The deal with Harden was said to be a move by adidas to
reclaim its number- two spot in sports apparel sales in North America behind
Nike, months after being surpassed by Under Armour.14 In 2016, it took
$280 million for Under Armour to secure a 16-year deal with UCLA to
outfit all of UCLA’s men’s and women’s athletic teams. In 2018, Under
Armour enticed Joel Embiid to switch from adidas to Under Armour for a
five-year apparel and footwear endorsement deal that made him the highest-
earning center in the NBA (the exact terms were not disclosed).
Under Armour spent roughly $120 million for athlete and superstar
endorsements, various team and league sponsorships, athletic events, and
other marketing commitments, compared to about $126.2 million in 2018,
$150.4 million in 2017, and $176.1 million in 2016.15 The company was
contractually obligated to spend about $350 million for endorsements,
sponsorships, events, and other marketing commitments from 2020 to
2023.16 Under Armour did not know precisely what its future endorsement
and sponsorship costs would be because its contractual agreements with
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most athletes were subject to certain performance-based variables and
because it was actively engaged in efforts to sign additional endorsement
contracts and sponsor additional sports teams and athletic events.
Retail Marketing and Product Presentation The primary thrust of
Under Armour’s retail marketing strategy was to increase the floor space
exclusively dedicated to Under Armour products in the stores of its major
retail accounts. The key initiative here was to design and fund point of sale
displays and Under Armour “concept shops”—including flooring, lighting,
walls, displays, and images—within the stores of its major retail customers.
This shop-in-shop approach was seen as an effective way to gain the
placement of Under Armour products in prime floor space and create a more
engaging and sales-producing way for consumers to shop for Under Armour
products.
In stores that did not have Under Armour concept shops, Under Armour
worked with retailers to establish sales-enhancing placement of
its products and various point-of-sale displays. In “big-box”
sporting goods stores, it was important to be sure that Under Armour’s
growing variety of products gained visibility in all of the various
departments (hunting apparel in the hunting goods department, footwear and
socks in the footwear department, and so on). Except for the retail stores
with Under Armour concept shops, company personnel worked with retailers
to employ in-store fixtures, life-size mannequins, and displays that
highlighted the UA logo and conveyed a performance-oriented, athletic look.
The merchandising strategy was not only to enhance the visibility of Under
Armour products and drive sales but also grow consumer awareness that
Under Armour products delivered performance-enhancing advantages.
Media and Promotion Under Armour advertised in a variety of national
digital, broadcast, and print media outlets, as well as social and mobile
media. Its advertising campaigns were of varying lengths and formats and
frequently included prominent athletes and personalities. Advertising and
promotional campaigns in 2015–2017 featured Michael Phelps, Stephen
Curry, Jordan Spieth, Tom Brady, Lindsey Vonn, Misty Copeland, and
Dwayne Johnson. In 2018, UA had a digitally-led marketing approach for
the launch of its UA HOVR™ running shoe models, which included a
variety of content on various social media platforms.
Distribution Strategy
Under Armour products were available in roughly 17,000 retail store
locations worldwide in 2018–2019. In many foreign countries, Under
Armour relied on independent marketing and sales agents, instead of its own
marketing staff, to recruit retail accounts and solicit orders from retailers for
UA merchandise. Under Armour also sold its products directly to consumers
through its own Brand House stores, factory outlet stores, and various
geographic websites.
Wholesale Distribution In 2018, Under Armour had about 13,500 points
of distribution in North America, just under 40 percent of the 35,000 places
that consumers could buy athletic apparel and footwear.17 The company’s
biggest retail account was Dick’s Sporting Goods, which in 2018 accounted
for 10 percent of the company’s net revenues. Until its bankruptcy and
subsequent store liquidation in 2016, The Sports Authority had been UA’s
second largest retail account; the loss of this account was a principal factor
in Under Armour’s struggle to grow wholesale sales to retailers in North
America. Other important retail accounts included Academy Sports and
Outdoors, Hibbett Sporting Goods, Modell’s Sporting Goods, Bass Pro
Shops, Cabela’s, Footlocker, The Army and Air Force Exchange Service,
and such well-known department store chains as Macy’s, Nordstrom, Belk,
Dillard’s, and Kohl’s. In Canada, the company’s important retail accounts
included Sport Chek and Hudson’s Bay. Roughly 75 percent of all sales
made to retailers were to large-format national and regional retail chains.
The remaining 25 percent of wholesale sales were to lesser-sized outdoor
and specialty retailers, institutional athletic departments, leagues, teams, and
fitness specialists. Independent and specialty retailers were serviced by a
combination of in-house sales personnel and third-party commissioned
manufacturer’s representatives.
Direct-to-Consumer Sales In 2018, about 38 percent of Under Armour’s
net revenues were generated through direct-to-consumer sales, versus 23
percent in 2010 and six percent in 2005; the direct-to-consumer channel
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included sales of discounted merchandise at Under Armour’s factory outlet
stores and full-price sales at Under Armour Brand Houses, and various
country websites. The factory outlet stores gave Under Armour added brand
exposure and helped familiarize consumers with Under Armour’s product
lineup while also functioning as an important channel for selling
discontinued, out-of-season, and/or overstocked products at discount prices
without undermining the prices of Under Armour merchandise being sold at
retail stores, Brand Houses, and company websites. Going into 2020, Under
Armour was operating 169 stores in factory outlet malls in North America;
these stores attracted about 75 million shoppers in 2018.
During the past several years, Under Armour had opened company-owned
Brand House stores in high-traffic retail locations in the United States to
showcase its branded apparel and sell its products direct-to-consumers at
retail prices. In early 2020, the company was operating 19 Under Armour
Brand House stores in North America.
UA management’s e-commerce strategy called for sales at
www.underarmour.com (and 26 other in-country websites as
of 2016) to be one of the company’s principal vehicles for sales
growth in upcoming years. To help spur e-commerce sales, the company had
enhanced its efforts to drive traffic to its websites, improve its online
merchandising techniques, and do a better job of storytelling about the many
different Under Armour products sold on its sites. In 2017–2019, UA had
made frequent use of discounted price promotions to spur online sales, but
top executives decided that discount-pricing had been overdone and
damaged the company’s image as a premium brand. In 2020, the strategy at
UA websites was to cut back on discounted price promotions and, instead,
utilize marketing and advertising efforts that portrayed Under Armour as a
premium brand with an attractive line-up of top-quality, high performance
products well worth paying a premium price to own.
To begin reshaping its marketing approaches, in 2019 and early 2020
Under Armour started including much more user-generated content on its e-
commerce website to help tell the story about UA products. This user-
generated content included customer ratings and reviews, Instagram
snapshots and videos of shoppers and well-known athletes wearing UA
products, feedback from prelaunch “wear-testers”, and quotes from athletes
and spokespeople like Stephen Curry, Dwayne Johnson, and other endorsers
http://www.underarmour.com/
of the company’s products. Management believed that the opinions of what
shoppers and athletes said about Under Armour’s performance-driven
products carried more weight with prospective buyers than what Under
Armour said in its product descriptions.
To better compete with Amazon and other online sellers of performance
sports apparel and athletic footwear, the company offered free three to five
business day shipping on orders over $60 and free three business day
shipping on orders over $150. From time-to-time, free limited-time shipping
was offered on overstocked items. Free shipping on returns within 60 days
was standard.
Distribution outside North America Under Armour’s first strategic
move to gain international distribution occurred in 2002 when it established
a relationship with a Japanese licensee, Dome Corporation, to be the
exclusive distributor of Under Armour products in Japan. The relationship
evolved, with Under Armour making a minority equity investment in Dome
Corporation in 2011 and Dome gaining distribution rights for South Korea.
Dome sold Under Armour branded apparel, footwear, and accessories to
professional sports teams, large sporting goods retailers, and several
thousand independent retailers of sports apparel in Japan and South Korea.
Under Armour worked closely with Dome to develop variations of Under
Armour products to better accommodate the different sports interests and
preferences of Japanese and Korean consumers.
In 2006, Under Armour opened a headquarters in Amsterdam, The
Netherlands, to conduct and oversee sales, marketing, and logistics activities
across Europe. The strategy was to first sell Under Armour products directly
to teams and athletes and then leverage visibility in the sports segment to
access broader audiences of potential consumers. By 2011, Under Armour
had succeeded in selling products to Premier League Football clubs and
multiple running, golf, and cricket clubs in the United Kingdom; soccer
teams in France, Germany, Greece, Ireland, Italy, Spain, and Sweden; as
well as First Division Rugby clubs in France, Ireland, Italy, and the United
Kingdom. Sales to European retailers quickly followed on the heels of gains
being made in the sports team segment. By year-end 2012, Under Armour
had 4,000 retail customers in Austria, France, Germany, Ireland, and the
United Kingdom and was generating revenues from sales to independent
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distributors who resold Under Armour products to retailers in Italy, Greece,
Scandinavia, and Spain. Sales in EMEA countries in 2019 totaled
$621 million (see Exhibit 2A). Adidas strongly defended its industry-leading
position with European retailers, and Under Armour frequently found itself
embroiled in hotly contested price-cutting battles with adidas and Nike to
win orders from retailers in many EMEA locations.
In 2010 and 2011, Under Armour began selling its products in parts of
Latin America and Asia. In Latin America, Under Armour sold directly to
retailers in some countries and in other countries sold its products to
independent distributors who then were responsible for securing sales to
retailers. In 2014, Under Armour launched efforts to make Under Armour
products available in over 70 of Brazil’s premium points of sale and e-
commerce hubs; expanded sales efforts were also initiated in Chile and
Mexico. While sales were trending upward in Latin America, the company
had reported operating losses in the region each of the past four years (see
Exhibit 3).
In 2011, Under Armour opened a retail showroom in Shanghai, China—
the first of a series of steps to begin the long-term process of
introducing Chinese athletes and consumers to the Under
Armour brand, showcase Under Armour products, and learn about Chinese
consumers. Additional retail locations in Shanghai and Beijing soon
followed (some operated by local partners). By April 2014, there were five
company-owned and franchised retail locations in mainland China that
merchandised Under Armour products; additionally, the Under Armour
brand had been recently introduced in Hong Kong through a partnership
with leading retail chain GigaSports.
Under Armour began selling its branded apparel, footwear, and
accessories to independent distributors in Australia, New Zealand, and
Taiwan in 2014; these distributors were responsible for securing retail
accounts to merchandise Under Armour products to consumers. The
distribution of Under Armour products to retail accounts across Asia was
handled by a third-party logistics provider based in Hong Kong.
In 2013, Under Armour organized its international activities into four
geographic regions—North America (the United States and Canada), Latin
America, Asia-Pacific, and Europe/Middle East/Africa (EMEA). In the
company’s 2013 Annual Report, Kevin Plank said, “We are committed to
being a global brand with global stories to tell, and we are on our way.”18
Sales of Under Armour products in EMEA, the Asia-Pacific, and Latin
America accounted for 27.6 percent of Under Armour’s total net revenues in
2019, up from 15.3 percent in 2016, and 8.7 percent in 2014 (Exhibit 2A).
Under Armour saw growth in foreign sales as the company’s biggest market
opportunity in upcoming years, chiefly because of the sheer number of
people residing outside the United States who could be attracted to patronize
the Under Armour brand. In 2019 Nike generated just over 57 percent of its
revenues outside North America, and adidas got about 77 percent outside of
North America—these big international sales percentages for Nike and
adidas were a big reason why Under Armour executives were confident that
growing UA’s international sales represented an enormous market
opportunity for the company, despite the stiff competition it could expect
from its two bigger global rivals.
One of Under Armour’s chief initiatives to build international awareness
of the Under Armour brand and rapidly grow its sales internationally was to
open growing numbers of stores in popular factory outlet malls and to locate
Brand Houses in visible, high-traffic locations in major cities. UA had 104
factory outlet stores and 96 Brand House stores in international locations as
of year-end 2019, up from 37 factory outlet and 35 Brand House stores in
various international locations at year-end 2017. In October 2018, UA sold
its Brazilian subsidiary and entered into a license and distribution agreement
with a third party to continue to sell UA products in Brazil.
Product Design and Development
Top executives believed that product innovation—as concerns both technical
design and aesthetic design—was the key to driving Under Armour’s sales
growth and building a stronger brand name. UA products were manufactured
with technically advanced specialty fabrics produced by third parties. The
company’s product development team collaborated closely with fabric
suppliers to ensure that the fabrics and materials used in UA’s products had
the desired performance and fit attributes. Under Armour regularly upgraded
its products as next-generation fabrics with better performance
characteristics became available and as the needs of athletes changed.
Product development efforts also aimed at broadening the company’s
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product offerings in both new and existing product categories and market
segments. An effort was made to design products with “visible technology,”
utilizing color, texture, and fabrication that would enhance customers’
perception and understanding of the use and benefits of Under Armour
products.
Under Armour’s product development team had significant prior industry
experience at leading fabric and other raw material suppliers and branded
athletic apparel and footwear companies throughout the world. The team
worked closely with Under Armour’s sports marketing and sales teams as
well as professional and collegiate athletes to identify product trends and
determine market needs. Collaboration among the company’s product
development, sales, and sports marketing team had proved important in
identifying the opportunity and market for three recently launched product
lines and fabric technologies:
CHARGED COTTON™ products, which were made from natural cotton
but performed like the products made from technically advanced synthetic
fabrics, drying faster and wicking moisture away from the body.
COLDGEAR® Infrared, a ceramic print technology applied to
the inside of garments that provided wearers with lightweight
warmth.
UA HOVR™, a proprietary underfoot cushioning wrapped in a mesh web,
equipped with a MapMyRun powered sensor designed to deliver energy
return and real-time coaching.
In 2017, Under Armour opened its newest center for footwear
performance innovation located in Portland, Oregon, bringing together
footwear design and development teams in a centralized location.
Sourcing, Manufacturing, and Quality Assurance
Many of the high-tech specialty fabrics and other raw materials used in UA
products were developed by third parties and sourced from a limited number
of pre-approved specialty fabric manufacturers; no fabrics were
manufactured in-house. Under Armour executives believed outsourcing
fabric production enabled the company to seek out and utilize whichever
fabric suppliers were able to produce the latest and best performance-
oriented fabrics to Under Armour’s specifications, while also freeing more
time for UA’s product development staff to concentrate on upgrading the
performance, styling, and overall appeal of existing products and expanding
the company’s overall lineup of product offerings.
In 2019, approximately 42 percent of the fabric used in UA products came
from five suppliers, with primary locations in Malaysia, Taiwan, Vietnam,
China, and the United States. Because a big fraction of the materials used in
UA products were petroleum-based synthetics, fabric costs were subject to
crude oil price fluctuations. The cotton fabrics used in the CHARGED
COTTON™ products were also subject to price fluctuations and varying
availability based on cotton harvests.
In 2019, substantially all UA products were made by 37 primary contract
manufacturers, operating in 15 countries; 10 manufacturers produced
approximately 55 percent of UA’s products. Approximately 55 percent of
UA’s apparel and accessories products were manufactured in Jordan,
Vietnam, China, and Malaysia. Under Armour’s footwear products were
made by six primary contract manufacturers operating primarily in Vietnam,
China, and Indonesia; these five manufacturers produced approximately 96
percent of the company’s footwear products.
All contract manufacturers making Under Armour apparel products
purchased the fabrics they needed from fabric suppliers pre-approved by
Under Armour. All of the makers of UA products across all divisions were
evaluated for quality systems, social compliance, and financial strength by
Under Armour’s quality assurance team, prior to being selected and also on
an ongoing basis. The company strived to qualify multiple manufacturers for
particular product types and fabrications and to seek out contractors that
could perform multiple manufacturing stages, such as procuring raw
materials and providing finished products, which helped UA control its cost
of goods sold. All contract manufacturers were required to adhere to a code
of conduct regarding quality of manufacturing, working conditions, and
other social concerns. However, the company had no long-term agreements
requiring it to continue to use the services of any manufacturer, and no
manufacturer was obligated to make products for UA on a long-term basis.
UA had subsidiaries strategically located near its manufacturing partners to
support its manufacturing, quality assurance, and sourcing efforts for its
products.
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Under Armour had a 17,000 square-foot Special Make-Up Shop located at
one of its distribution facilities in Maryland where it had the capability to
make and ship customized apparel products on tight deadlines for high-
profile athletes and teams. While these apparel products represented a tiny
fraction of Under Armour’s revenues, management believed the facility
helped provide superior service to select customers.
Inventory Management
Under Armour based the amount of inventory it needed to have on hand for
each item in its product line on existing orders, anticipated sales, and the
rapid delivery requirements of customers. Its inventory strategy was focused
on (1) having sufficient inventory to fill incoming orders promptly and (2)
putting strong systems and procedures in place to improve the efficiency
with which it managed its inventories of individual products and total
inventory. The amounts of seasonal products it ordered from manufacturers
were based on current bookings, the need to ship seasonal items at the start
of the shipping window in order to maximize the floor space
productivity of retail customers, the need to adequately stock its
Factory House and Brand House stores, and the need to fill customer orders.
Excess inventories of particular products were either shipped to its Factory
House stores or earmarked for sale to third-party liquidators.
However, the growing number of individual items in UA’s product line
and uncertainties surrounding upcoming consumer demand for individual
items made it difficult to accurately forecast how many units to order from
manufacturers and what the appropriate stocking requirements were for
many items. New inventory management practices were instituted in 2012 to
better cope with stocking requirements for individual items and avoid
excessive inventory buildups. Year-end inventories of $1.16 billion in 2017
equated to 154.6 days of inventory and inventory turnover of 2.36 turns per
year. UA’s description of its restructuring plans in 2017 signaled that
inventory reduction initiatives were included. Year-end inventories of
$892.3 million in 2019 equated to 116.5 days of inventory and inventory
turnover of 3.13 turns per year.
UNDER ARMOUR’S WEAK PERFORMANCE IN
THE FIRST QUARTER OF 2020
Under Armour reported revenues of $930 million for the first quarter of
2020, down 23 percent from the first quarter of 2019, with approximately
15 percentage points of the decline related to COVID-19 impacts. North
American revenues decreased 28 percent to $603 million (compared to the
same quarter in 2019), but international revenues fell only 12 percent to
$287 million. Revenues fell in all three product categories, with apparel
revenues down 23 percent to $598 million, footwear revenues down 28
percent to $210 million, and accessories revenue down 17 percent to
$68 million. The company reported an operating loss of $558 million, of
which $446 million was due to the impact of the company’s restructuring
plan, and a net loss of $590 million, which included restructuring and other
charges—the adjusted net loss was $152 million.
To counter the impact of COVID-19, which accelerated dramatically in
mid-March 2020 in North America and the EMEA region (partly due to
retail store closures) and the ongoing negative impacts anticipated in the
upcoming two quarters, management began a series of initiatives to reduce
its planned operating expenses by $325 million; these included cutting back
on marketing expenditures, temporarily laying off workers in Under
Armour’s retail stores, and U.S.-based distribution centers, reducing
incentive compensation, postponing $60 million in planned capital
expenditures, and curtailing hiring, travel and contract services.
Investors’ response to the report of the company’s Q1 2020 performance
was understandably negative; the price of the company’s Class A shares
dropped from about $20 in mid-February to $7.80 in mid-May 2020. One
Wall Street analyst said:19
The Covid-19 crisis has exacerbated the existing problems facing the Under Armour brand. UA
does not have the brand consideration or compelling product assortment necessary to reaccelerate
sales post the current crisis. Elevated inventory levels should pressure the gross margin for the
balance of the year and stymie UA’s ability to introduce new product. UA could continue to lose
market share to Nike, adidas, and others who garner greater brand consideration and have more
financial flexibility.
The analyst lowered his price target for the stock price to $4 per share.
COMPETITION
The $280 billion global market for sports apparel, athletic footwear, and
related accessories was fragmented among some 25 brand-name competitors
with diverse product lines and varying geographic coverage and numerous
small competitors with specialized-use apparel lines that usually operated
within a single country or geographic region. Industry participants included
athletic and leisure shoe companies, athletic and leisure apparel companies,
sports equipment companies, and large companies having diversified lines of
athletic and leisure shoes, apparel, and equipment. The global market for
athletic footwear was projected to reach $114.8 billion by 2022, growing at a
CAGR of 2.1 percent during the period 2016 to 2022.20 The global market
for sports apparel was forecast to grow about 5.1 percent annually from 2019
to 2026 and reach about $248 billion by 2020.21 Exhibit 4 shows a
representative sample of the best-known companies and brands in selected
segments of the sports apparel, athletic footwear, and sports equipment
industry.
EXHIBIT 4 Major Competitors and Brands in Selected
Segments of the Sports Apparel, Athletic Footwear, and
Accessory Industry, 2019
Performance Apparel for Sports
(baseball, football, basketball,
softball, volleyball, hockey,
lacrosse, soccer, track & field,
and other action sports)
Performance-Driven
Athletic Footwear
Training/Fitness
Clothing
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Performance Apparel for Sports
(baseball, football, basketball,
softball, volleyball, hockey,
lacrosse, soccer, track & field,
and other action sports)
Performance-Driven
Athletic Footwear
Training/Fitness
Clothing
Nike
Under Armour
adidas
Eastbay
Russell
Nike
adidas
New Balance
Reebok
Saucony
Puma
Rockport
Converse
Ryka
Asics
Li Ning
Nike
Under Armour
adidas
Puma
Fila
Lululemon athletica
Champion
Asics
Eastbay
SUGOI
Li Ning
Performance Activewear and
Sports-Inspired Lifestyle
Apparel
Performance Skiwear Performance GolfApparel
Polo Ralph Lauren
Lacoste
Izod
Cutter & Buck
Timberland
Columbia
Puma
Li Ning
Many others
Salomon
North Face
Descente
Columbia
Patagonia
Marmot
Helly Hansen
Bogner
Spyder
Many others
Footjoy
Nike
adidas
Under Armour
Polo Golf
Ashworth
Cutter & Buck
Greg Norman
Puma
Many others
In 2017–19, consumers across the world shopped for the
industry’s products digitally (online) or physically in stores. And they
shopped either for a favorite brand or for multi-brand. The trend was for
more consumers to shop digitally and for a brand deemed to be the best or
their favorite. Multi-brand shoppers typically wanted to explore and compare
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the options, either through a dot.com experience or in stores where shoppers
could view the products firsthand, get advice or personalized assistance,
and/or get the product immediately.
As Exhibit 4 indicates, the sporting goods industry consisted of many
distinct product categories and market segments. Because the product mixes
of different companies varied considerably, it was common for the product
offerings of industry participants to be extensive in some segments,
moderate in others, and limited to nonexistent in still others. Consequently,
the leading competitors and the intensity of competition varied significantly
from market segment to market segment. Nonetheless, competition tended
to be intense in almost every segment with substantial sales volume and
typically revolved around performance and reliability, the breadth of product
selection, new product development, price, brand name strength and identity
through marketing and promotion, the ability of companies to convince
retailers to stock and effectively merchandise their brands, and the
capabilities of the various industry participants to sell directly to consumers
through their own retail/factory outlet stores and/or at their company
websites. It was common for the leading companies selling athletic footwear,
sports uniforms, and sports equipment to actively sponsor sporting events
and clinics and to contract with prominent and influential athletes, coaches,
professional sports teams, colleges, and sports leagues to endorse their
brands and use their products.
Nike was the clear global market leader in the sporting goods industry,
with a global market share in athletic footwear of about 25 percent and a
sports apparel share of five percent. The adidas Group, with
businesses that produced athletic footwear, sports uniforms,
fitness apparel, sportswear, and a variety of sports equipment and marketed
them across the world, was the second largest global competitor. These two
major competitors of Under Armour are profiled as follows.
Nike, Inc.
Incorporated in 1968, Nike was the dominant global leader in the design,
development, and worldwide marketing and selling of footwear, sports
apparel, sports equipment, and accessory products. Nike was a truly global
brand, with a broader and deeper portfolio of products, models, and styles
than any other industry participant. The company had global sales of $39.1
http://dot.com/
billion and net income of $4.0 billion in fiscal year ending May 31, 2019.
Nike was the world’s largest seller of footwear with Nike-branded sales of
$24.2 billion and Converse-branded sales of $1.9 billion; it held the number
one market share in all markets and in all categories of athletic footwear.
Nike’s footwear line included some 1,500 models/styles. Nike was also the
world’s largest sports apparel brand, with 2019 sales of $11.6 billion. Sales
of Nike products to women reached $7.4 billion in 2019.
Nike’s strategy in 2019–2020 was driven by three core beliefs. One was
that the growing popularity of sports and active lifestyles reflected a desire
to lead healthier lives. As a result, companies like Nike were becoming more
relevant for more moments in people’s lives because of their growing
participation in calorie-burning, wellness, and fitness activities and because
active lifestyles stimulated greater interest in sports-related activities and
sports events. Moreover, streaming of sports events and social media were
changing the ways people consumed sports content. The NBA, for example,
had over 1.3 billion social media followers across the league, teams, and
player pages. The growth of watching streamed events on mobile phones
was exploding. Second, in a connected, mobile-led world, consumers had
become infinitely better informed and, thus, more powerful because of the
information they could access in seconds and the options this opened up
—“powered consumers” were prone to consult their phones (or conduct
Internet searches on other devices) for price comparisons and availability
before deciding where to shop or what to purchase online. Third, the world
was operating at faster speeds and the numbers of powered consumers was
about to explode. Nike’s CEO expected over 2 billion digitally connected
people in markets in China, India, and Latin America would join the middle
class by 2030. In North America, Nike estimated that its primary consumer
base was 50 million people, but that if population trends in China continued
at the expected rate, Nike’s projected consumer base in China would be
more than 500 million people by 2030.
For years, the heart and soul of Nike’s strategy had been creating
innovative products and powerful storytelling that produced an emotional
connection with consumers and caused them to gravitate to purchase Nike
products. But at the same time Nike executives understood that brand
strength had to be earned every day by satisfying consumer needs and
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meeting, if not exceeding, their expectations. Exhibit 5 shows Nike’s
worldwide retail and distribution network at the end of fiscal 2019.
EXHIBIT 5 Nike’s Worldwide Retail and Distribution
Network, 2019
United States Foreign Countries
~15,000 retail accounts
217 Nike factory outlet stores
29 Nike and NIKETOWN stores
109 Converse retail and factory outlet
stores
29 Hurley stores
6 Primary distribution centers
Company website (www.nike.com)
~15,000 retail accounts
648 Nike factory outlet stores
57 Nike and NIKETOWN stores
63 Converse retail and factory outlet
stores
—
67 Distribution centers
Independent distributors and licensees
in over 190 countries
Websites in 45 countries
In October 2017, Nike CEO Mark Parker provided a brief overview of the
company’s “Triple Double” strategy that had three components: 2X
Innovation, 2X Speed, and 2X Direct:
In 2X Innovation, we will lead with more distinct platforms, moving from seeding to scaling a lot
faster. We’ll . . . give consumers better choices to match their preferences. And we’ll set a new
expectation for style, creating a new aesthetic to wear in all moments of their lives. To the
consumer, there is no trade-off between sport and style. We know that more than half of the
athletic footwear and apparel is bought for non-sport activities, and we have even
more room to grow in this market.
In 2X Speed, we’re investing in digital end to end to serve this insatiable consumer demand for
new and fresh products. To use a sports analogy, you can’t run an up-tempo offense if only half
your plays are designed for speed. So we’re building new capabilities and analytics to deliver
personalized products in real time, and we’re engaging with more partners companywide to move
faster against our goals. In our supply chain, we’ve joined forces with leading robotics and
automation companies, and we’re serving millions of athletes and sports fans faster through
manufacturing bases that are closer to our North American consumer. 2X Speed is really all about
delivering the right product in the moment, 100 percent of the time.
We never ever take the strength of our brand and premium product for granted. They are indeed
our most valuable assets. With 2X Direct [to Consumer], we want as many Nike touch points as
possible to live up to those expectations, and that’s why we are investing heavily in our own
channel and leading with digital. And with our strategic partners, we’ll move resources away from
undifferentiated retail and toward environments where we can better control with distinct
consumer experiences.22
http://www.nike.com/
Principal Products Nike’s 1,500 athletic footwear models and styles
were designed primarily for specific athletic use, although many were worn
for casual or leisure purposes. Running, training, basketball, soccer, sport-
inspired casual shoes, and kids’ shoes were the company’s top-selling
footwear categories. It also marketed footwear designed for baseball,
football, golf, lacrosse, cricket, outdoor activities, tennis, volleyball,
walking, and wrestling. The company designed and marketed Nike-branded
sports apparel and accessories for most all of these same sports categories, as
well as sports-inspired lifestyle apparel, athletic bags, and accessory items.
Footwear, apparel, and accessories were often marketed in “collections” of
similar design or for specific purposes. It also marketed apparel with
licensed college and professional team and league logos. Nike-brand
offerings in sports equipment included bags, socks, sport balls, eyewear,
timepieces, electronic devices, bats, gloves, protective equipment, and golf
clubs. Nike was also the owner of the Converse brand of athletic footwear
and the Hurley brand of swimwear, assorted other apparel items, and surfing
gear.
Exhibit 6 shows a breakdown of Nike’s sales of footwear, apparel, and
equipment by geographic region for fiscal years 2017 to 2019.
EXHIBIT 6 Nike’s Sales of Nike Brand Footwear, Apparel,
and Equipment, by Geographic Region and by Wholesale and
Nike Direct, Fiscal Years 2017–2019
Note: The revenue and earnings figures for all geographic regions include the effects of
currency exchange fluctuations. The Nike Brand revenues for equipment include the Hurley
brand, and the Nike Brand revenues for footwear include the Jordan brand. The earnings
before interest and taxes figures associated with Total Nike Brand Revenues include those
for the Hurley and Jordan brands.
Source: Nike’s 10-K Report for Fiscal Year 2019, pp. 727–31 and 10-K Report for Fiscal Year
2018, pp. 22, 27–31.
Marketing, Promotions, and Endorsements Nike responded to trends
and shifts in consumer preferences by (1) adjusting the mix of existing
product offerings, (2) developing new products, styles, and categories, and
(3) striving to influence sports and fitness preferences through aggressive
marketing, promotional activities, sponsorships, and athlete endorsements.
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page C-107
Nike spent $3.75 billion in fiscal 2019 (as compared to $2.75 billion in 2013
for) what it termed “demand creation expense” that included the
costs of advertising, promotional activities, and endorsement
contracts. Well over 500 professional, collegiate, club, and
Olympic sports teams in football, basketball, baseball, ice hockey, soccer,
rugby, speed skating, tennis, swimming, and other sports wore Nike
uniforms with the Nike swoosh prominently visible. There were over 1,000
prominent professional athletes with Nike endorsement contracts in 2011–
2019, including former basketball great Michael Jordan, NFL player Drew
Brees, NBA players LeBron James, Kobe Bryant, Kevin Durant, and
Dwayne Wade; professional golfers Tiger Woods and Michelle Wie; soccer
player Cristiano Ronaldo; and professional tennis players Venus and Serena
Williams, Roger Federer, and Rafael Nadal. When Tiger Woods turned pro,
Nike signed him to a 5-year $100 million endorsement contract and made
him the centerpiece of its campaign to make Nike a factor in the golf
equipment and golf apparel marketplace. Nike’s long-standing endorsement
relationship with Michael Jordan led to the introduction of the highly
popular line of Air Jordan footwear and, more recently, to the launch of the
Jordan brand of athletic shoes, clothing, and gear. In 2003 LeBron James
signed an endorsement deal with Nike worth $90 million over 7 years, and in
2015 he signed a lifetime deal with Nike. Because soccer was such a popular
sport globally, Nike had more endorsement contracts with soccer athletes
than with athletes in any other sport; track and field athletes had the second
largest number of endorsement contracts.
Resources and Capabilities Nike had an incredibly deep pool of valuable
resources and capabilities that enhanced its competitive power in the
marketplace and helped spur product innovation, shorten speed-to-market,
enable customers to use digital tools to customize the colors and styling of
growing numbers of Nike products, and thereby drive strong brand
attachment and sales growth. Examples of these included the following:23
The company’s Nike APP and the SNKRS app were in more than 20
countries across North America and Europe, plus China and Japan,
countries that drove close to 90 percent of Nike’s growth. These apps
provided easy access to Nike products and were becoming a popular way
for customers to shop Nike products and make online purchases. The Nike
App was the number one mono-brand retail app in the United States.
Nike’s apps and growing digital product ecosystem were key components
of the company’s 2X Speed strategy to operate faster and get innovative
products in the hands of consumers faster.
The creation and ongoing enhancement of the NikePlus membership
program which in 2017 connected 100 million consumers to Nike—
NikePlus members who used the company’s mobile apps spent more than
three times as much time on nike.com as other site visitors. Starting in
2018, NikePlus members were entitled to “reserved-for-you service” that
used machine learning-powered algorithms to set aside products in a
member’s size that the algorithms predicted members would like.
Members could also use a “reserved-by-you” service to gain guaranteed
access to products they wanted; this newly developed capability was
deemed especially valuable to members wanting a recently-introduced
product in high demand. In 2018, Nike began accelerating invitations to
NikePlus members to personalized events and experiences and extending
benefits and offers from NikePlus partners like Apple Music, Headspace,
and Class Pass. Special Nike Unlock offers were sent to members once a
month. Nike expected that NikePlus membership would triple over the
next five years. Nike executives anticipated that converting consumers
into NikePlus members would heighten their relationship to and
connection with Nike.
The establishment of an Advanced Product Creation Center charged with
keeping the pipeline flowing with product innovations, new digital
products, and manufacturing innovations to make 2X Speed a reality. Nike
was aggressively investing in 3D modeling and other related technology to
quickly create prototypes of new products; with traditional technology, it
often took four-to-six months to go from new idea to design to product
prototype. So far, Nike had been able to go from design, to prototyping, to
manufacturing, to delivery in less than months, as compared to nine to 12
months. Nike’s goal was to improve its rapid prototyping capabilities to
the point where 100 percent of new product innovations could be rapid-
prototyped at the Advanced Product Creation Center in Portland, Oregon.
Employee athletes, athletes engaged under sports marketing contracts, and
other athletes wear-tested and evaluated products during the development
and prototyping process.
http://nike.com/
page C-108A relaunch of all 40+ nike.com websites in late 2017 that
featured a new design with better visual appeal and
functionality, more storytelling, eye-catching product displays, and better
product descriptions—all aimed at generating more visitor traffic, longer
shopping times, increased online sales, and achieving 2X Direct.
Implementing robot-assisted manufacturing capabilities and other
recently-developed manufacturing innovations (such as oscillating knives,
laser cutting and trimming, phylon mold transfer, and computerized
stitching) on a broad scale. In one instance, the use of advanced robotics
and digitization techniques was generating a continuous, automated flow
of the upper portion of a footwear model with 30 percent fewer steps,
50 percent less labor, and less waste in just 30 seconds per shoe—a total of
1,200 automated robots had been installed to perform an assortment of
activities at various manufacturing facilities in 2017. In another instance,
Nike had made manufacturing breakthroughs in producing the bottoms of
its footwear (the midsoles and outsoles) using innovative techniques
capable of delivering a pair of midsoles and outsoles, on average, in
2.5 minutes, compared to more than 50 minutes with previously-used
techniques. This new process used 75 percent less energy, entailed
50 percent less tooling cost, and enabled a 60 percent reduction in labor.
Revamped supply chain practices that had shortened the lead times from
manufacturing to market availability from 60 days to 10 days in one
instance and from six to nine months to three months in other instances.
Creating a digital technology called Nike iD, whereby customers could go
to Nike iD, design their own customized version of a product (say a pair of
Free Run Flyknit shoes), view a prototype in an hour or so, have the shoes
knitted to order, and get them delivered in 10 days or less.
All of Nike’s competitively valuable resources and capabilities were being
dynamically managed; enhancements were made as fast as ways to improve
could be developed and instituted and new capabilities were being added in
an effort (1) to provide customers with a better “Nike Experience” and (2) to
respond faster to ongoing changes in consumer preferences and expectations.
Collaborative efforts were underway in Nike’s organizational units to
transfer new or enhanced resources and capabilities to all seven of the
company’s product categories and also extend them to all of geographic
http://nike.com/
page C-109
regions and countries where Nike had a market presence. The goal was to
mobilize Nike’s resources and capabilities to produce an enduring
competitive advantage over rivals and give customers the best possible
experience in purchasing and using Nike products.
Manufacturing In fiscal year 2019, Nike sourced its athletic footwear
from 112 factories in 12 countries. About 93 percent of Nike’s footwear was
produced by independent contract manufacturers in Vietnam (49 percent),
China (23 percent), and Indonesia (21 percent) but the company had
manufacturing agreements with independent factories in Argentina and
India, to manufacture footwear for sale primarily within those countries.
Nike-branded apparel was manufactured outside of the United States by 334
independent contract manufacturers located in 36 countries; about 59 percent
of the apparel production occurred in China (27 percent), Vietnam
(22 percent), and Thailand (10 percent). The top five contract manufacturers
accounted for approximately 49 percent of NIKE Brand apparel production.
The adidas Group
The mission of The adidas Group was to be the best sports company in the
world. Headquartered in Germany, its primary businesses and brands going
into 2020 consisted of:
adidas—a designer and marketer of active sportswear, uniforms, footwear,
and sports products in football, basketball, soccer, running, training,
outdoor, and six other categories (91 percent of Group sales in 2019). The
mission at adidas was to be the best sports brand in the world.
Reebok—a well-known global provider of athletic footwear for multiple
uses, sports and fitness apparel, and accessories (nine percent of Group
sales in 2019). The mission at Reebok was to be the best fitness brand in
the world.
The Group had four main objectives:
1. Grow sales significantly faster than the industry average.
2. Win additional market share across key product categories and geographic
markets.
3. Substantially improve the company’s profitability.
4. Increase returns to shareholders.
Exhibit 7 shows the company’s financial highlights for 2017–2019. In
2016–2017, the company divested five businesses—TaylorMade Golf,
Adams Golf, Ashworth brand sports apparel, CCR Hockey, and Rockport
brand shoes—to focus all of its resources on achieving faster and more
profitable sales growth in both its a didas and Reebok businesses.
EXHIBIT 7 Financial Highlights for The adidas Group,
2017–2019 (in millions of €)
*The company redefined the countries included in the Asia Pacific Region in 2018.
**Consists mainly of countries in the Middle East and Africa.
Source: Company annual report, 2019.
The company sold products in virtually every country of the world. In
2019, its extensive product offerings were marketed through thousands of
third-party retailers (sporting goods chains, department stores, independent
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sporting goods retailer buying groups, and lifestyle retailing chains—with a
combined total of 150,000 locations worldwide, and Internet retailers), 2,500
company-owned retail stores, 15,000 franchised adidas and Reebok branded
stores with varying formats, adidas and Reebok e-commerce stores, and an
adidas app reaching over 30 countries across all major markets that linked
directly to the adidas e-commerce store.
Like Under Armour and Nike, both adidas and Reebok were actively
engaged in sponsoring major sporting events, teams, and leagues and in
using athlete endorsements to promote their products. Recent high-profile
sponsorships and promotional partnerships included numerous professional
soccer and rugby teams, sports teams at the University of Miami, Arizona
State University, and Texas A&M University; FIFA World Cup events; the
Summer and Winter Olympics; the Boston and Berlin
Marathons; and the Arsenal Football Club. It was the official
outfitter of items for assorted professional sports leagues and the national
soccer teams of seven countries. High-profile athletes that were under
contract to endorse adidas and Reebok products included NBA players
James Harden, Derrick Rose, and Damian Lillard; soccer players David
Beckham and Lionel Messi; NFL players Aaron Rodgers, Patrick Mahomes,
and JuJu Smith-Schuster; MLB players Chase Utley, brothers B.J. and Justin
Upton, Carlos Correa, Josh Harrison, and Chris Bryant; and tennis star
Naomi Osaka. It had also signed non-sports celebrities Kanye West and
Pharrell. In 2003, soccer star David Beckham, who had been wearing adidas
products since the age of 12, signed a $160 million lifetime endorsement
deal with adidas that called for an immediate payment of $80 million and
subsequent payments said to be worth an average of $2 million annually for
the next 40 years.24 Adidas was anxious to sign Beckham to a lifetime deal
not only to prevent Nike from trying to sign him but also because soccer was
considered the world’s most lucrative sport and adidas management believed
that Beckham’s endorsement of adidas products resulted in more sales than
all of the company’s other athlete endorsements combined. Companywide
expenditures for marketing (advertising, event sponsorships, athlete
endorsements, public relations, and point-of-sale activities) were
€3.04 billion in 2019 (12.9 percent of net sales), €3.00 billion in 2018 (13.7
percent of net sales), and €2.72 billion in 2017 (12.8 percent of net sales).
In 2015–2017, adidas launched a number of initiatives to become more
America-centric and regain its #2 market position lost to Under Armour in
2015. This included a campaign to sign up to 250 National Football League
players and 250 Major League Baseball players over the next three years. It
had secured 1,100 new retail accounts that involved prominent displays of
freshly styled adidas products and newly introduced running shoes with
high-tech features. The adidas brand regained its #2 position in the United
States in 2017.
Research and development activities commanded considerable emphasis
at The adidas Group. Management had long stressed the critical importance
of innovation in improving the performance characteristics of its products.
New apparel and footwear collections featuring new fabrics, colors, and the
latest fashion were introduced on an ongoing basis to heighten consumer
interest, as well as to provide performance enhancements—indeed, 77
percent of sales at adidas came from products launched in 2019 (versus 74
percent in 2018 and 79 percent in 2017), while only 3 percent of sales were
generated by products introduced three or more years earlier; at Reebok, 67
percent of footwear sales came from products launched in both 2019 and
2018 (versus 69 percent in 2017), with only 11 percent of footwear sales
being generated by products introduced three or more years earlier.
Some 1,007 people (1.8 percent of total employees) were engaged in
research and development (R&D) activities in 2019; in addition, the
company drew upon the services of well-regarded researchers at universities
in Canada, the United States, England, and Germany. R&D expenditures in
2019 were €152 versus €153 million in 2018, €187 million in 2017,
€149 million in 2016, and €139 million in 2015.
In 2019, almost 100 percent of production was outsourced to 138
independent contract manufacturers that produced in 336 manufacturing
facilities; these manufacturing sites were located in China and other Asian
countries (73 percent), the Americas (17 percent) and Europe, the Middle
East, and Africa (9 percent). In 2019, 98 percent of the Group’s production
of footwear was performed in Asia (43% of total volume was sourced in
Vietnam); the annual volume sourced from footwear suppliers was a record
448 million pairs in 2019, up from 409 million pairs in 2018 and 301 million
pairs in 2015. In 2019, 91 percent of total apparel volume was produced in
Asia, with Cambodia being the largest sourcing country (23 percent)
page C-111
followed by China and Vietnam with 19 percent each. In 2019, apparel
production was a record 528 million units, up from 457 million units in 2018
and 364 million units in 2015. The production of hardware products was a
record 127 million units in 2019, up from a range of 109 to 113 million units
during 2015–2018.
The company was stepping up its investments in company-owned, robot-
intensive micro-factories to speed certain products to key geographic
markets in Europe and the United States much faster and to also lower
production costs and boost gross profit margins. At the same time, the
company had begun reengineering its existing supply chain and production
processes to enable the company to respond quicker to shifts in buyer
preferences, be able to reorder seasonal products and sell them to buyers
within the season, and to reduce the time it took to get freshly designed
products manufactured and into the marketplace.
ENDNOTES
1 Company press release, October 25, 2016.
2 Company press release, January 31, 2017.
3 Ibid.
4 Sara Germano, “Under Armour Overtakes adidas in the U.S. Sportswear Market,” Wall Street Journal, January 8,
2015, www.wsj.com (accessed April 19, 2016).
5 Sara Germano, “Under Armour Overtakes adidas in the U.S. Sportswear Market,” Wall Street Journal, January 8,
2015, www.wsj.com (accessed April 19, 2016).
6 Company press release, February 12, 2019.
7 Company press release, February 11, 2020.
8 Douglas A. McIntyre and Jon C. Ogg, “20 Worst CEOs in America 2017,” December 26, 2017, https//247wallst.com
(accessed February 22, 2017).
9 Transcript of Quarter 4 2017 Earnings Conference Call, February 13, 2018.
10 Under Armour’s Q4 2015 Earnings Call Transcript, January 26, 2016, www.seekingalpha.com (accessed on
March 30, 2016).
11 According to the website descriptions of Under Armour products that incorporated the use of Clutch Fit® technology.
12 Presentation by Paul Phipps, UA’s Chief Technology and Digital Officer, at Under Armour’s Investor Day, December
12, 2018.
13 Dennis Green, “Kevin Durant: ‘No one wants to play in Under Armour’ shoes,” Business Insider, August 30, 2017,
www.businessinsider.com (accessed February 22, 2018).
14 Nate Scott, “James Harden signs 13-year, $200 million deal with adidas after Nike opts not to match,” USA Today,
August 13, 2015, www.usatoday.com (accessed February 21, 2018).
15 Company 10-K Reports, 2016, 2017, 2018, and 2019.
16 Company 10-K report for 2019, p. 43.
17 Presentation by Jason LaRose, UA’s President-North America Region, at Under Armour’s Investor Day, December
12, 2018.
18 Letter to Shareholders, 2013 Annual Report.
http://www.wsj.com/
http://www.wsj.com/
http://247wallst.com/
http://www.seekingalpha.com/
http://www.businessinsider.com/
http://www.usatoday.com/
19 Quote attributed to market analyst Sam Poser at Susquehanna Bancshares, in a Seeking Alpha report, posted at
www.seekingalpha.com/news/3573162, May 11, 2020 (accessed May 14, 2020).
20 According to Allied Market Research, “Athletic Footwear Market—Report” published June 2016,
www.alliedmarketresearch.com.
21 Allied Market Research, “Sports Apparel Market—Report,” published October 2019,
www.alliedmarketresearch.com.
22 Transcript of “Nike Investor Day 2017,” October 25, 2017, posted in the Investor Relations section of www.nike.com
(accessed February 24, 2018).
23 Transcript of presentations by Nike’s top executives at “Nike Investor Day 2017,” October 25, 2017, posted in the
Investor Relations section of www.nike.com (accessed February 24, 2018).
24 Steve Seepersaud, “5 of the Biggest Athlete Endorsement Deals,” www.askmen.com (accessed February 5, 2012).
http://www.seekingalpha.com/news/3573162
http://www.alliedmarketresearch.com./
http://www.alliedmarketresearch.com./
http://www.nike.com/
http://www.nike.com/
http://www.askmen.com/
B
page C-112
CASE 9
Spotify in 2020: Can the Company
Remain Competitive?
Copyright ©2021 by Diana R. Garza. All rights reserved.
Diana R. Garza
University of the Incarnate Word
efore streaming music, many consumers may have been using file sharing services
Napster, LimeWire, Pirate Bay, and other companies to download music. Using these
services, cost the music industry billions each year by downloading and redistributing
music (what we know as music piracy and, in legal terms, copyright infringement).
According to the Recording Industry Association of America (RIAA), piracy of recorded
music has cost the recording industry billions in lost revenues and profits (2020). It is
estimated that the U.S. economy loses $12.5 billion in total output as a consequence of
music theft, and approximately 71,000 jobs in the U.S. economy are lost.
Daniel Ek, one of the two founders of Spotify, has not only transformed himself in the
last 14 years, his transformation is also reflective of his beloved offspring—the world’s
fasted growing streaming music service—Spotify. Ek and Spotify came to revolutionize
the music industry, Daniel Ek knows well that to remain competitive, the company needs
to differentiate its products and services. In the race to remain competitive, Spotify paid
more than $340 million just in the past year acquiring podcast companies. Streaming
services and the subscription market will continue to grow from approximately $8 billion
in 2019 to over $17 billion by 2024. Spotify has entered a race where the pace is
quickening with Spotify’s average monthly users growing faster over the last three
quarters but also other music services adding podcasts and retooling themselves to remain
strong rivals.
Spotify’s growth strategies include an ad-based business model allowing for both a free
and paid subscription, global expansion into different markets exponentially growing its
number of subscribers, multiple acquisitions that add new competencies and capabilities,
and brand-name partnerships with industry leaders such as Disney, Xbox, and Samsung
page C-113
among others. Spotify’s ongoing transformation is based on the rapid adoption of
streaming music and subscription services and its leverage with smartphones, tablets,
smart TVs, and high-speed internet access. As early as 2015, digital streaming became the
primary revenue stream for recorded music, surpassing physical format sales of CDs.
Spotify knows its user’s preferences perhaps better than subscribers themselves. The
company relies on its analytical capabilities to create a competitive advantage. Through
the use of analysis, machine learning algorithms, and its vast amounts of data, subscribers
are presented with personalized playlists and other recommendations. The use of AI has
also created value for artists allowing them to understand and visualize (through Spotify
graphs) user engagement, monthly/daily listeners, metrics, and demographic details. An
added advantage of using data analytics is being able to customize specific ads to different
regions.
Company History
Founded in 2006, Spotify took the streaming music industry by surprise with its
unprecedented growth in the last six years. Daniel Ek and Martin Lorentzon founded
Spotify as a small startup in Stockholm, Sweden. Their startup music platform was in
response to a growing piracy problem in the music industry. Ek and Loretzon knew there
had to be a better way for artists to monetize their music and give consumers a
legitimate and simpler way to listen to music. In 2008, Spotify transformed
music listening when it launched its streaming service, offering listeners access to a
library of music rather than making users pay for downloading albums or tracks. The
music industry, which had been suffering from spending declines, resisted this new
business model of offering “unlimited access,” and favored the current digital download
model used by Apple iTunes. Spotify began by offering its free subscription by invitation
only as a way to manage growth; paid subscriptions were open to everyone. At the same
time, Spotify also announced licensing deals with music labels.
In early 2009, Spotify opened its free registration tier to the public in the United
Kingdom only. Due to a surge in registrations following the Spotify mobile app’s release,
Spotify closed its open registration in late 2009 and returned to invitation only. In 2010,
Spotify integrated with Shazam to figure out who was singing a particular song and would
then populate a playlist. Spotify was launched in the United States in July 2011, allowing
users a six-month free ad-supported trial period to listen to unlimited music. By 2012, the
trial period expired, and users were limited to ten hours of music each month and five-
song replays. By March of 2012, Spotify removed all limits and introduced its free ad-
supported tier.
In 2014, Spotify pushed its two-sided business model by offering a free ad-supported
service to attract new users with the goal of converting them into paid subscribers. The
company was able to convert 10 million users to premium subscribers from its
approximately 40 million active users. At about the same time, music artist Taylor Swift
pulled her music off Spotify, claiming a rapid decline in sales.
In 2017, the company announced expansion plans to move to the United States in lower
Manhattan, New York City, adding approximately 1,000 jobs. In November 2018, Spotify
announced a total of 13 new markets in the MENA region (the Middle East and North
Africa), including a new Arabic hub and several playlists.
Spotify’s success has also seen a few bumps along the way. Taylor Swift was one of the
first artists to speak out against the company and its unfair compensation to artists, calling
the music platform an “experiment.” Three years later, the feud between Spotify and
Taylor Swift ended, and the artist put her music back on the platform. Jay Z, a hip-hop
music mogul, also claimed unfair compensation to artists and launched Tidal in 2016 as
his own music platform, becoming Spotify’s competitor. Other artists who kept their
music off Spotify included The Beatles, Adele, and Pink Floyd.
Growth Year by Year
By March of 2011, Spotify had a customer base of 1 million paid subscribers across
Europe, and by the end of September of 2011, the number had doubled. By August of
2012, the company reported 15 million active users, of which 4 million were paid
subscribers. By 2013, the company reported 20 million active users with one million
customers in the United States. The growth for Spotify has been exponential year after
year reaching 286 million users, this includes 130 million subscribers across 79 markets,
with 50+ million tracks, 1 million+ podcast titles, and 4 billion+ playlists as of March
2020.
IPOs Are Too Expensive and Cumbersome
On February 28, 2018, Spotify filed a Direct Public Offering with the SEC. Barry
McCarthy, Chief Financial Officer of Spotify, stated in an interview with the Financial
Times that the company opted for a Direct Public Offering (DPO), also known as a direct
listing instead of an IPO because “the U.S. initial public offering market is broken.” A
DPO is a way for companies to become public without a bank-backed initial public
offering. Spotify opted for what they called a free-market approach by selling shares
directly to the public without paying an underwriter. The financial benefits for Spotify
were savings in underwriter fees and avoiding the IPO discount.
Growth through Acquisitions
Spotify has strengthened their competitive position through a series of targeted and timely
acquisitions. Each acquisition has resulted in a stronger competitive position and new
market opportunities. A list of Spotify’s acquisitions between 2013 and 2020 are presented
in Exhibit 1.
EXHIBIT 1 Spotify’s Acquisitions between 2013 and 2020
Company Year Company Business
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Company Year Company Business
Tunigo 2013 Users find, create, and share music and playlists.
The Echo Nest 2014 Music intelligence and data platform companydevelops music applications.
Seed Scientific 2015 Data science consulting firm
Crowd Album 2015 Company collects photos and videos ofperformances.
Cord Project 2016 Social messaging and sharing
Soundwave 2016 Social app focused on finding and sharing music
Preact 2016 Cloud-based service focused on helpingcompanies acquire and retain subscribers.
Sonalytic 2017 Audio detection technology company
MIghtyTV 2017 Company provides video recommendations
MediaChain Labs 2017 Company focused on leveraging blockchaintechnology to solve problems with attribution.
Niland 2017 Company provides search and recommendationoptions for music.
Soundtrap 2017 Online Music Studio
Loudr 2018 A music licensing platform
Gimlet 2019 Podcast Network
Parcast 2019 Podcast Network
Anchor 2019 Podcast Network
SoundBetter 2019 Music and Audio production and collaborationmarketplace.
The Ringer 2020 Sports and Entertainment Podcast
Source: Businesswire–https://www.businesswire.com/portal/site/home/.
2014–2016. In March 2014, Spotify acquired The Echo Nest. The Echo Nest was a
music intelligence and data platform for developers and media companies. The company
developed and personalized music applications. In June 2015, Spotify also
acquired Seed Scientific, a data science consulting firm, to lead an advanced
analytics unit within the company. CrowdAlbum, a startup that collected photos and
videos of performances and shared them on social media, was acquired in 2016. The work
created by CrowdAlbum would enhance and tighten the connection between artists and
their fans. In 2016, Spotify acquired Cord Project and Soundwave, these companies
focused on messaging and sharing. These acquisitions would allow users to share new
music, build profiles, and message friends and followers without leaving the Spotify app.
Preact was the last acquisition of 2016. Preact was acquired to find trends and behavior
patterns through machine learning and analytics to grow the premium customer base.
https://www.businesswire.com/portal/site/home/
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2017. In March 2017, Spotify acquired Sonalytic. Sonalytic was an audio detection
technology that identified songs, mixed content, and audio clips and tracked copyright-
protected materials. This acquisition improved the company’s personalized playlists and
the company’s publishing data system. MightyTV was a startup company focusing on
video recommendations. The company was acquired and shut down. As part of the deal,
MightyTV’s founder and CEO Brian Adams became Spotify’s VP of Technology,
focusing on marketing and advertising. In the same year, Spotify acquired MediaChain, a
startup that focused on leveraging blockchain technology. The goal for this company was
to develop technology to connect artists and other rights holders with the tracks hosted on
Spotify’s service. Niland was Spotify’s fourth acquisition of 2017. Niland was an A.I.
company focused on providing personalized recommendations for users. SoundTrap, an
online music studio startup, was Spotify’s last acquisition of 2017. SoundTrap, was the
maker of the freemium (paid and free) cloud-based, collaborative music podcast recording
studio. Spotify’s plans for the company were to assist artists by using its platform,
including offering real-time streaming data through a mobile app.
2018–2019. In 2018, Spotify acquired Loudr, a music licensing platform that built
products and services for content creators and digital music services to identify, track, and
pay royalties to music publishers providing a more transparent and efficient music
publishing industry. In 2019, Spotify acquired the podcast networks Gimlet Media and
Anchor FM Inc., establishing itself as a significant player in podcasting. Gimlet added its
best-in-class podcast studio, production, and advertising capabilities. Anchor added its
platform of tools for podcast creators. Later that year, Spotify also acquired Parcast, a
podcast that specializes in crime, mystery, and science fiction shows. Parcast added its
curated library of highly produced shows and its loyal audiences. To round off
the year, the company acquired SoundBetter, a music production marketplace
where people in the music industry collaborate on projects and distribute music tracks for
licensing. SoundBetter brought with it a strong reputation and committment to support all
creators worldwide; the company joined Spotify with 180,000 registered users in 176
countries.
2020. Spotify’s latest acquisition was Bill Simmon’s The Ringer in February 2020. The
Ringer was a creator of sports, entertainment, and pop culture content. The addition of The
Ringer expanded Spotify’s content offering and audience reach. This acquisition is one
more example of Spotify’s growth strategy.
Growth through Partnerships
Spotify’s Partnerships have also strengthened the company’s competitive position by
expanding its market access and strategic collaborations mostly through bundling of
services. A list of Spotify’s partnerships between 2011 and 2020 are presented in Exhibit
2.
EXHIBIT 2 Spotify’s Partnerships between 2011–2020
Company Year Company Collaboration Scope
Facebook 2011 Integrated into the Facebook page, users canlisten simultaneously with friends.
Shazam 2011 Leading mobile discovery company
SoundHound 2011 Sound and discovery search company
Coca-Cola 2012 Global partnership to share music with consumersaround the world.
Harman 2014 Premium global audio and Infotainment group.
BandPage 2014 Artists and groups engage directly with fans
Sony 2015 Added to Sony PlayStation 3 & 4 and XperiaConsoles
Starbucks 2015 Integrated into Starbucks App
Uber 2014 Riders can listen to their playlists while riding inan Uber
Adidas 2015 Integrated into the Adidas Go app wherestreaming music was fused with fitness metrics.
Tencent 2017 Spotify and Tencent acquired shares from eachother
Microsoft 2017 Provide access to streaming music
South by Southwest 2017 Access to SXSW genre-specific curated playlistson Spotify hub
Waze 2017 Users can access Spotify playlists from Wazenavigation
WNYC Studios 2017 Podcast available through Spotify
Discord 2018 Users can highlight and share music
Hulu 2018 Premium bundle of music and TV
Ellen DeGeneres 2018 Create opportunities for undiscovered talent
Samsung 2019 Spotify preinstalled in new Samsung devices
AT&T 2019
Collaboration allows AT&T Unlimited & More
customers to choose Spotify Premium as an
entertainment option.
Xbox 2019 Spotify can be played in the background whileplaying videogames
Bouygues Telecom 2019 In France, Spotify and Bouygues offered a sixmonth free trial for customers of Bouygues.
Magalu Conecta 2019 Brazilian customers of Magalu Conecta wereoffered a free four-month trial of Spotify premium.
Vodafone 2019
Eligible Vodafone Australian users received a free
30-day trial of Spotify premium added to their
mobile plan.
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Company Year Company Collaboration Scope
Disney 2019 Disney Playlists on Spotify aimed at boostingfamily memberships
ESPN 2020
Spotify created music and podcast playlists for
viewers to watch after The Last Dance docuseries
of former Chicago Bulls player Michael Jordan.
The Joe Rogan
Experience 2020
Popular podcasts in diverse topics such as
neuroscience, sports, comedy, health, and ever-
changing culture.
Source: Various Spotify press releases. https://www.businesswire.com/portal/site/home/.
2014–2015. Spotify’s partnership with Uber started in 2014. Riders were allowed to
control the driver’s sound system by connecting to their Spotify accounts and streaming
their tunes while riding in an Uber. In 2017, Spotify considered ending its partnership with
Uber after mounting scandals concerning Uber’s CEO. Also, in 2014, Spotify joined
forces with the musician profile service BandPage so artists and groups could engage
more directly with their fans and offer concert tickets, merchandise, and VIP experiences.
In January 2015, Sony announced a new platform, PlayStation Music, a new music
service with Spotify as an exclusive partner. With this partnership, Spotify was included
into Sony’s PlayStation 3 and PlayStation 4 gaming consoles and Sony Xperia devices.
The platform was introduced in 41 markets around the world. This partnership allowed
subscribers the convenience to link their accounts between PlayStation and Spotify, or
sign up and subscribe.
In the same year, Spotify also partnered with Starbucks and was integrated into the
Starbucks app. The Starbucks and Spotify partnership encouraged active participation
among members who could create their own in-store playlists. Spotify and adidas also
formed a strategic partnership to create a premium app called Adidas go that tracked
running metrics and selected music based on running speed. At the time, the app
introduced a 7-day trial period to Spotify Premium with the goal to convert runners to
premium subscribers.
2017. In March 2017, Spotify partnered with South by Southwest (SXSW). Users were
able to access SXSW genre-specific curated playlists on Spotify SXSW 2017 hub in
“browse” on desktop and mobile devices as well as the SXSW Go App. Two more
partnerships were announced in March, one with WNYC Studios and one with Waze.
WNYC was the most listened to public radio station and mother station for podcasts like
Radiolab, Studio 360, and Freakonomics. Waze was a navigation app that allows users to
access Spotify playlists from its app. In October of the same year, Microsoft and Spotify
entered into a new partnership. Microsoft ended its collaboration with Groove allowing
subscribers to move their playlists and music collections to Spotify. This partnership
allowed Spotify to be downloaded to Windows for P.C., including Xbox gaming consoles.
https://www.businesswire.com/portal/site/home/
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In December 2017, Spotify and China-based Tencent agreed to partner by acquiring
shares from each other. Tencent operated the largest social media platform in China and
provided an extensive catalog of music services to hundreds of millions of users.
2018. In April 2018, Spotify partnered with the gaming-oriented voice chat service
Discord to be displayed on desktop clients. This partnership allowed users to display their
currently-playing songs as a presence on their profile and invite other premium Spotify
users to group “listening parties”.
In April of the same year, Spotify and Hulu announced a partnership. The two
companies bundled their services and offered them through a single subscription plan of
$12.99-a-month bundle. This partnership was the first time Spotify partnered with
streaming TV platform, and it came at a time when the company was rethinking its video
offerings. With Tom Calderone, head of video and podcasts, departing the company,
Spotify decided to focus on expanding video offerings on Spotify playlists. In August
2018, the company introduced an upgraded Spotify Premium for Students plan bundled
with Hulu’s streaming library and SHOWTIME’s premium entertainment content for
$4.99.
2019. A groundbreaking partnership was that of Spotify with Ellen DeGeneres in late
2019. Ellen DeGeneres is known for not only loving music but also for creating
opportunities for new talent. This partnership expanded these opportunities and tapped
into new markets. Also, in 2019, Spotify and Samsung announced the expansion of their
collaboration. Samsung provided users with access to Spotify on Samsung mobile devices,
and all new Samsung mobile devices globally would include the Spotify app preinstalled.
The new devices included the Galaxy S10, S10+, S10e, S10 5G. Galaxy Fold, and select
Galaxy A series. Eligible Samsung owners qualified for six months of free Spotify
Premium. Following this partnership, Spotify and AT&T teamed up in a new relationship
that allowed AT&T Unlimited &More Premium Wireless customers to choose Spotify
Premium as their entertainment option, initially in a trial period and afterward at a rate
of $9.99.
In 2019, Spotify also entered into four global partnerships; the first was with Xbox.
Xbox and Spotify teamed up to deliver value in gaming and music. Spotify offered gamers
in the United States and United Kingdom who joined Xbox Game Pass Ultimate or Xbox
Game Pass for P.C. (Beta) for the first time a six months trial of Spotify
premium. The company also entered into partnerships with French company
Bouygues Telecom Broadband company; customers on mobile tariffs of > 1GB could add
Spotify Premium to their existing mobile plan. A second partnership included Brazilian
Magalu Conecta, a country top retailer that offered technical support, cloud storage, phone
protection, and Wi-Fi spots; customers received a free four-month Spotify Premium trial.
The last global partnership was with Vodafone, Australian largest mobile network;
customers received a free 30-day trial of Spotify Premium.
To boost family membership, Spotify and Disney entered into a partnership that would
create a Disney Hub with Disney playlists with liked soundtracks from Disney, Pixar, and
Marvel movies, Star Wars instrumentals, classics, sing-alongs, and more.
2020. On May 1, 2020, Spotify, ESPN, and Netflix teamed up to curate podcasts around
Netflix’s The Last Dance docuseries of former Chicago Bulls player Michael Jordan. The
partnership built on every brand’s respective strengths, and for Spotify, it was on content
curation and playlists. Spotify’s latest partnership was with “The Joe Rogan Experience,”
a podcast with a loyal and engaged fanbase around the world. The podcast debuted on
September 1, 2020.
The many strategic acquisitions and partnerships Spotify formed strengthen the
company’s competitive position as the most significant and leading music streaming
global platform. Through market penetration, the company has been able to grow its
number of users. Economies of scale are evident as new users and artists are added.
Product development is also part of Spotify’s growth strategy and can be seen in the latest
acquisitions of Podcast companies.
Spotify’s use of Big Data
Spotify is continuously looking for new “habits in their streaming intelligence” to learn
more about how people stream. The company calls this “understanding people through
music.” The company’s use of innovation and technology creates superior products and
services to meet the growing demand of existing and potential subscribers. Spotify
introduced Spotify.me, a data analytics program to capture a subscriber’s listening habits.
The captured data allows the company to generate content that users consider in line with
their tastes, creating a unique user experience, and keeping users engaged. Spotify’s use of
artificial intelligence and machine learning algorithms has been a driving force behind the
company’s success.
It all began in 2012 with the company’s “Discover” feature, which started as a playlist
of a user’s favorite artists and soon became a sort of recommendation engine. In 2019,
Spotify updated to “Discover Weekly,” a feature that creates custom playlists unique to
each listener’s activity, which is curated by machine learning algorithms. The algorithm
further analyzes other users’ playlists to find common music themes and use that
information to develop new playlists. Users also have a “taste profile” of microgenres that
are used to further customize playlists. It is not only about what music users listen to, it is
about the user’s interaction with the song. Spotify’s program is able to recognize if a user
changes the track within 30 seconds giving it a thumbs down and removing it from the
playlist, or, if a user adds a song to a playlist and listens to the entire song, the song is
aligned with the “user’s taste,” a factor that helps the algorithm develop the user’s overall
taste profile.
Aside from “Discover Weekly,” Spotify also uses a function called “Daily Mixes,”
these are playlists separated by genres that the user gravitated towards and includes songs
the user either saved or added to a playlist, are written by the same artist, or are from new
artists or albums the user does not know of yet. Spotify algorithms change the songs of
these playlists as well as introduce a few extra new songs.
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Not only does Spotify use analytics to understand a user’s music tastes, they also use
data to improve customer experiences. The data generated by consumers is used for ad
campaigns and to better target consumers. The company uses what they have learned from
users to develop ads that strategically target an ideal audience. The company has seen the
impact of using listener data to develop ad campaigns that increase their sales and user
engagement. Some examples of successful ad campaigns include a display ad in
Williamsburg, New York, where the company used listening history to develop funny ads,
the first ad, read “Sorry, Not Sorry Williamsburg, Bieber’s hit trended highest in this zip
code.” This ad was displayed in a “hipster area” known for its notoriously high
concentration of music snobs. Some popular campaigns included holiday ads, a set of
2018 Goal ads, and a set of “meme-inspired” ads.
As of April 2018, Spotify announced that free users would have access to explore 15 of
Spotify’s most popular playlists, including “RapCaviar” and “Discover
Weekly.” While this was great news for free users, the company had a data-
driven reason behind this decision. Spotify would now generate data from the listening
habits of over 124 million more users allowing for better-customized experience using
data and algorithms.
Data leads the way to understand trends, and this includes the music industry. Music
streaming has outranked music purchases, and the only way to understand how the public
is responding to music, artists, and albums is through the use of data. Spotify understands
this well and continues to focus on meeting user preferences through unique, differentiated
services based on what the company has learned through user data.
Spotify’s Competitors
Apple Music. Although a newcomer, Apple music is one of Spotify’s biggest rivals,
with an extensive library, human-touch radio, and full integration into Apple’s iOS
ecosystem. Apple reached over 60 million premium subscribers worldwide as of mid-
2019. The company claims to have over 60 million songs outdoing contenders such as
Amazon Prime Music and Jay-Z’s Tidal. With Apple Music, users can listen to local radio
stations around the world, download and stream music to an Apple Watch, enjoy music in
a car with CarPlay, and ask Siri (Apple’s A.I.) to search for songs. Apple offers three
subscriptions, a student, an individual, and a family tier. Because Apple does not have a
free tier, other than its initial 3-month free trial, they have secured more exclusives with
artists.
Amazon Prime Music. Amazon Prime Music gives users access to over 60 million
songs. The company has an individual, family, student plan, and a single device plan (echo
or fire tv). A Prime Music subscription is free with Amazon Prime membership with
access to 2 million songs, and Prime Unlimited is its paid subscription with access to up to
60 million songs.
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Pandora. Pandora is a leading music and podcast discovery platform. They are a
subsidiary of Sirius XM and boast of being the largest streaming music provider in the
United States with an industry-leading digital audio advertising platform. They offer their
more than 70 million users a highly personalized listening experience through a
proprietary Music Genome Project® and Podcast Genome Project® Technology through
its mobile app. Pandora experienced a year-on-year decline in monthly active users
(MAUs) between 2018 and 2019 of 8.7 percent. According to the company’s quarterly
financial results, Pandora has nearly 6.2 million paid subscribers, up 9.5 percent Y/Y.
Pandora offers two tiers, Pandora Plus and Pandora premium with discounts for families,
students, and the military. The free tier is ad-supported and asks users to view video ads, a
drawback for many users.
Tidal. Tidal is a streaming music service owned by hip-hop mogul Jay Z. Artist
empowerment is a core tenant of this platform and was created in response to Spotify’s
perceived unfair payout to artists. The company claims to have over 60 million tracks in
lossless audio quality and 250,000 videos. They offer subscribers exclusive music and
videos, behind the scenes documentaries, and events including live experiences, pre-sales,
and ticket giveaways. As with most companies, subscribers get a 30-day free trial. The
company’s subscription tiers include a premium family plan, and a student and military
plan at discounted rates. The company also has HiFi subscription tiers at higher rates. The
number of Tidal subscribers was not disclosed by the company.
YouTube Music. YouTube Music is a streaming music service that allows subscribers
to find albums, live performances, and remixes by searching lyrics or describing songs.
Subscribers receive recommendations based on their tastes and searches. YouTube
premium allows users to listen to music ad-free, offline, and while their devices’ screen is
locked (desktop or phone). YouTube Music has two tiers, the free ad-supported tier, and
the premium music service which includes benefits like background play, ad-free music,
and audio-only mode. YouTube Music is the successor to Google Play Music who decided
to put its marketing emphasis on the YouTube Music platform since YouTube has billions
of viewers. YouTube Music has over 20 million subscribers
Originals & Exclusives (“O&E”) Content
As of June 2019, Spotify introduced a new version of its library to premium users that
mixes form with functions. Users are able to get their content faster and stay up to date
with podcasts on Spotify. Podcasts can be managed in three distinct sections:
episodes, downloads, and shows. The Episodes tab allows users to find or
resume podcasts. The downloads tab serves as a repository for downloaded podcast
episodes that users can listen to them offline. The shows tab allows for users to quickly
manage podcasts they follow.
The company launched 78 Originals & Exclusives (“O&E”) podcasts globally and
completed its latest acquisition of The Ringer; The Ringer is a platform rich in popular
sports and media podcasts. Gimlet was acquired by Spotify in early 2019; they are a
Swedish digital media podcast network that focuses on narrative podcasts. The company
brought with it a dedicated I.P. development team, production, and advertising
capabilities. Parcast is a premier storytelling-driven podcast studio based in Los Angles,
California popular for Unsolved Murders, Cult, Serial Killers, and Conspiracy podcasts.
Spotify acquired Parcast in the second quarter of 2019.
Spotify now has over 1 million podcasts available on its platform, with more than 70
percent powered by Anchor. Anchor is a podcasting platform that has added its suite of
tools for podcast creation, distribution, and monetization to Spotify’s community of more
than 200 million users. Anchor joined Spotify in early 2019 after discussions of joining
forces and the similarities of their company mission statements: “to unlock the potential of
human creativity.”
Spotify experienced a shift in listening patterns in the first quarter of 2020 due to
COVID-19, but the company remained excited about its growth trajectory and adoption of
podcasts at a global level. The company saw an increase of 3% from Q4’19 to Q1’20 in
podcast engagement, and consumption continued to grow at triple-digit rates year after
year. Spotify positioned itself to become the premier producer of podcasts and the leading
platform for podcast creators.
Spotify’s Web Image Matters
Spotify takes the design of their website very seriously. The company believes in
designing for belonging. The company knows that millions of people around the globe
open Spotify, so its focus is on localizing content. People in India can easily find
Bollywood in India, Malay Pop in Malaysia, and Sertanejo in Brazil. While playlists may
share a theme, they feature different songs in different parts of the world, so happy songs
in the United States are different from those in Taiwan. Every word on Spotify is also
translated into the local language(s) whenever possible. Spotify wants to “look just right”
no matter where users access the app. The company spends time making sure users relate
with the images, they focus on the emotional content of images, the approach to cultural
sensitivities, and how they handle image localization. It is about the Spotify experience of
allowing people to feel that they belong.
Music unites people and yet it is highly localized and a personal experience; therefore,
Spotify’s focus is on delivering a country-to-country, culture-to-culture, and person-to-
person unique experience that varies but is equal in measure. A group of editors works
together to minimize localization challenges. The Spotify relevance starts with translating
the experience into the appropriate language(s), followed by using the same or different
images based on the country. Connections are created when users open Spotify and find
images that are relevant and resonate with them. For Spotify, representation matters, this
could be the connection to a particular playlist and added users.
Royalties, Artist Compensation & Spotify
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Spotify was created in response to protect artists from piracy and to compensate them for
their work. But the road to a business model that makes sense for Labels, music producers,
and recording artists has been challenging.
As of December 31, 2019, Spotify had paid more than $16 billion in royalties to labels,
publishers, and collecting societies for distribution to songwriters and recording artists, an
increase of 30 person from 2018. Spotify has become the biggest driver of growth in the
music industry, and the biggest source of overall music revenue in many places.
Performance Royalties. Performance royalties are payments made to a songwriter or
publisher for a public performance. Public performance refers to playing a song on the
radio, television, in bars, nightclubs, concerts, and other public places. The Performance
rights organizations collect the songwriting royalties from music users and distribute them
to the legal owners. These organizations include ASCAP in North America and SACEM
internationally.
Mechanical Royalties. A mechanical royalty is earned through the reproduction of a
copyrighted work either in digital or physical form. The scope of mechanical
reproductions covers any copyrighted audio composition that is rendered
mechanically and includes: compact discs, vinyl records, tape recordings, music videos,
ringtones, MIDI files, DVDs, computer games, and downloaded tracks.
By 2019, music streaming accounted for 80% of the music industry revenue and
included industry leaders such as Pandora, Apple Music, Spotify, and others. The Industry
Association of America reported total revenues of $5.4 billion in the first half of 2019.
The increase in revenue can be traced back to more consumers signing up for subscription
services and sales from downloads. Streams generate both mechanical and performance
royalties.
Streaming Payouts. Most streaming services use a “platform-centric” payout
distribution model. Digital streaming providers negotiate payout rates with content
owners, mainly major labels. The negotiated rate is then applied to all services revenue
resulting in the total sum that the streaming service will pay to right holders. Spotify does
not pay artists directly, rather they pay distribution companies and Performance Rights
Organizations. Payout, however, depends on multiple factors such as how many ways the
royalty is divided and in what country the stream occurred.
On average, the per-stream payout will vary depending on the types of streams the artist
gets; this payout is also dependent on the artist’s contracts with labels and distributors. If a
stream payout is calculated at .00437, and a song has 1000 streams on Spotify, then the
rights-holder(s) of the musical work will earn $4.37
Spotify. Spotify’s largest expense has been royalties paid to different companies. The
company was once ranked as the worst royalty payer but increased its payments, and as of
2019, they began paying between $0.00331 and $0.00437 per stream to rights holders
(Digital Music News, n.d). It has been estimated that it takes approximately 500,000 ad-
supported streams to generate $100 in mechanical royalties and 180,000 premium tier
streams to generate a monthly minimum wage in the United States.
Spotify for Artists and “Music for You Platform”
Supporting artists on the Spotify platform has become a focus for the company. Spotify
has built a powerful suite of tools for artists to maximize their presence and help them find
and connect with an audience.
The company launched “Spotify for Artists” page in 2017; it was a place where artist
teams, labels, and distributors could manage their profiles, see, and analyze their data, and
pitch playlists. Artists and their teams come together to make decisions about release
strategies, tour schedules, and to connect with fans. Spotify Analytics was also launched
for labels and distributors to access and create playlists as they support their artists. Artist
picks, a separate tool, allows artists to know who is playing their music and where they are
listening. After music is released, artists can see streams in real-time and watch their fan
base grow.
Spotify’s innovative ideas continue to surprise the music industry. At the end of 2019,
the company announced that record companies would soon be able to pay to have their
artists promoted to targeted fans within the Spotify platform via “Music For You” visual
pop-up ads. The goal of the ads was to alert fans of new releases, and for Labels to
manipulate which fans see what by digging into their wallets. Premium users could turn
off the alerts, but free users would not have this option. Recommendations would be based
on listening tastes. This paid-for promotion began as a test in the United States only. This
new source of income from advertising comes from Spotify’s biggest suppliers of music.
Charging record companies to promote their artists on the platform increases the
company’s profit margin generated at the end of the year (Exhibit 3).
EXHIBIT 3 Spotify Total Monthly Active Users by Region, 2020
Source: Spotify Technology S.A. Announces Financial Results for First Quarter 2020.
https://www.businesswire.com/news/home/20200429005216/en/Spotify-Technology-S.A.-Announces-
https://www.businesswire.com/news/home/20200429005216/en/Spotify-Technology-S.A.-Announces-Financial-Results-Quarter.
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Financial-Results-Quarter.
Spotify’s Financial Performance
Despite the global uncertainty around COVID-19 in the first quarter of 2020, Spotify met
or exceeded its forecast. With more than €1.8 billion in liquidity, the company remained
optimistic about its underlying growth. Figure 3 shows Spotify’s first quarter of 2020
growth by region. Monthly active users (MAUs) grew faster in first quarter 2020 than it
did in first quarter 2019, with growth in North America showing a second consecutive
quarter growth followed by Europe, Latin America, and the rest of the world. Exhibit 4
was a snapshot of the company’s user and financial metrics. The decline in first quarter
2020 of MAU’s was traced back to the COVID hard hit markets like Spain and Italy.
Car, Wearable, and Web platforms dropped by double digits. However, TV and game
console use increased over 50 percent over the same period. Ad-supported MAUs in the
United States game consoles were a top two or three platform in consumption in March
and April 2020. While Car and Commute consumption had changed dramatically due to
an increase of work-from-home, there was an increase in podcast listening. Two in five
people surveyed in the United States stated they listened to music to manage stress, which
explained the increase in podcasts related to wellness and meditation.
Monthly Active Users (MAUs). Total MAUs grew 31 percent year-over-year to
286 million between 2019 and 2020. Spotify’s first quarter 2020 was the third consecutive
quarter, with growth above 30 percent. North America region showed accelerated growth,
with the United States being the best performer. Europe grew by 35 percent, Latin
American region by 22 percent, and the Rest of the World by 17 percent–see Exhibit 4.
EXHIBIT 4 Summary User and Financial Metrics for Spotify Technology
S.A., Q1 2019, Q4 2019, and Q1 2020
% Change
USERS (M) Q1 2019 Q4 2019 Q1 2020 Y/Y Q/Q
Total Monthly Active Users (“MAUs”) 217 271 286 31% 5%
Premium Subscribers 100 124 130 31% 5%
Ad-Supported MAUs 123 153 163 32% 7%
FINANCIALS
Premium €1,385 €1,638 €1,700 23% 4%
Ad-Supported 126 217 148 17% (32)
Total Revenue €1,511 €1,855 €1,848 22% 0
Gross Profit 373 474 472 27% (1)
https://www.businesswire.com/news/home/20200429005216/en/Spotify-Technology-S.A.-Announces-Financial-Results-Quarter.
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% Change
USERS (M) Q1 2019 Q4 2019 Q1 2020 Y/Y Q/Q
Gross Margin 24.7% 25.6% 25.5% – –
Operating (Loss) Income € (47) € (77) € (17) – –
Operating Margin −3.1% −4.1% −0.9% – –
Net Cash Flows (used in)/from
operating activities
€
209 € 203 € (9) – –
Free Cash Flow 173 169 (21) – –
Source: Spotify Technology S.A. Announces Financial Results for First Quarter 2020.
https://investors.spotify.com/financials/press-release-details/2020/Spotify-Technology-SA-
Announces-Financial-Results-for-First-Quarter-2020/default.aspx.
Premium Subscribers. At the end of first quarter2020, Spotify had 130 million
premium subscribers globally; this is an increase of 31 percent Y/Y. The Spotify Family
Plan was a driver for this increase. Spotify Kids, a stand-alone app designed for children,
was launched in eight additional markets: Australia, the United Kingdom, Mexico, Brazil,
Argentina, the United States, Canada, and France. The Duo Plan, premium plans for two
people, was further introduced in three more markets: Canada, France, and Japan. This
plan already existed in 23 markets (Exhibit 4).
Revenue. Total revenue of €1,848 million grew 22 percent Y/Y in first quarter 2020.
Premium revenue grew 23 percent Y/Y to €1,700 million, which was in line
with expectations. Ad-supported revenues grew 17 percent Y/Y but fell short
of expectations, according to the company, this decline was a result of COVID-19. Ad-
supported revenues of €148 million were below the company forecast by more than 20
percent. March 2020 saw several previously booked businesses cancel and buyers pulling
back, leading to this decline.
EXHIBIT 5 Spotify Technology S.A. Annual Income Statements, 2015–
2019 (in EUR millions, except share and per share data)
2019 2018 2017 2016 2015
Revenue €6,764 €5,259 €4,090 €2,952 €1,940
Cost of services (5,042)
(3,906)
(3,241)
(2,551)
(1,714)
Gross profit 1722 1353 849 401 226
Research &
development
expenses
(615) (493) (396) (207) (136)
Sales & marketing
expenses (826) (620) (567) (368) (219)
https://investors.spotify.com/financials/press-release-details/2020/Spotify-Technology-SA-Announces-Financial-Results-for-First-Quarter-2020/default.aspx
2019 2018 2017 2016 2015
General &
administrative
expenses
(354)
(283)
(264) (175) (106)
Total operating
expenses
(1,795)
(1,396)
(1,227) (750) (461)
Operating income
(loss) (73) (43) (378) (349) (235)
Interest income 31 25 19 5 2
Finance income 275 455 118 152 36
Finance costs (333) (584) (974) (336) (26)
Share in
(losses)/earnings of
associates & joint
ventures
– – 1 (2) –
Finance
income/(costs)–net (58) (130) (855) (186) 10
Profit (loss) before
tax (131) (173) (1,233) (535) (225)
Income tax
(expense) benefit
55
(95) 2 4 5
Net income (loss)
attributable to
owners of the
parent
€(186) €(78) €(1,235) €(539) €(230)
Net loss attributable
to owners of the
parent per share
Basic €(1.03) €(0.44) €(8.14) €(3.63) €(1.62)
Diluted €(1.03) €(0.51) €(8.14) €(3.63) €(1.62)
Weighted average
shares
outstanding–basic
180,960,579 177,154,405 151,668,769 148,368,720 141,946,600
Weighted average
shares
outstanding–diluted
180,960,579 181,210,292 151,668,769 148,368,720 141,946,600
Consolidated
Statement of Cash
Flows Data
Net cash flows
from/(used in)
operating activities
€573 €344 €179 €101 €(38)
Net cash flows
used in investing
activities
(218) (22) (435) (827) (67)
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2019 2018 2017 2016 2015
Net cash flows
(used in)/from
financing activities
(203) 92 34 916 476
Net
increase/(decrease)
in cash and cash
equivalents
152 414 (222) 190 371
Selected Other
Data (unaudited)
EBITDA 14 (11) (324) (311) (205)
Free Cash Flow 440 209 109 73 (92)
Spotify
Consolidated
Statement of
Financial Position
Data
Cash and cash
equivalents 1,065 891 477 755 597
Short term
investments 692 915 1,032 830 –
Working capital (208) 97 38 689 73
Total Assets 5,122 4,336 3,107 2,100 1,051
Convertible Notes – – 944 1,106
Total Equity/(deficit)
attributable to
owners of the
parent
2,037 2,094 238 (240) 229
Source: Spotify. Investors: Financials–Annual Report 2019 AR.
https://investors.spotify.com/financials/default.aspx.
Gross Margin. Gross margin finished as 25.5 percent in quarter one, exceeding
company expectations. The driver of this performance was the core royalty component
due to product mix. Spotify renewed its global licensing partnership with Warner Music
Group. This renewed partnership covered existing countries and a few additional ones, it
was not expected that this deal would impact music economies. Premium gross margin
increased to 28.3 percent in quarter one 2020 from 27.4 in quarter four 2019. Ad-
supported gross margin declined to 6.6 in quarter one 2020 from 11.6 in quarter four 2019.
Operating Expenses/Income (loss). Operating expenses totaled €489 million in quarter
one, an increase of 16 percent from quarter one 2019 but below expectations.
https://investors.spotify.com/financials/default.aspx
At the end of quarter one 2020, Spotify had €1.8 billion in cash, cash equivalents,
restricted cash, and short-term investments on its balance sheet and no indebtedness.
In the race for market domination, Spotify has been busy hiring talent, making
acquisitions and forming partnerships, and as CEO Daniel Ek stated in a Feb. 5, 2019
interview, “the company is focused on its goal of being the world’s No. 1 audio
platform.”1 Reid Hoffman, founder of LinkedIn and partner at Venture Capital firm
Greylock Partners described Spotify’s growth as “blitzscaling,” a term coined by Hoffman
that typically applies to young companies but as Hoffman stated, “Spotify isn’t acting its
age.”2
ENDNOTES
1 As quoted in “Why Spotify Is Still Sprinting for Maximum Market Share,” Billboard, March 4, 2020,
www.billboard.com/articles/business/streaming/9325846/spotify-strategy-market-share-analysis.
2 As quoted in “Why Spotify Is Still Sprinting for Maximum Market Share,” Billboard, March 4, 2020,
www.billboard.com/articles/business/streaming/9325846/spotify-strategy-market-share-analysis.
http://www.billboard.com/articles/business/streaming/9325846/spotify-strategy-market-share-analysis
http://www.billboard.com/articles/business/streaming/9325846/spotify-strategy-market-share-analysis
G
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CASE 10
Beyond Meat, Inc.
Copyright ©2021 by Arthur A. Thompson. All rights reserved.
Arthur A. Thompson
The University of Alabama
oing into 2020, Beyond Meat, a producer and marketer of plant-based protein products
intended as a substitute for animal-based meat products, had evolved into one of the fastest
growing food companies in the United States. Company revenues had increased from $8.8
million in 2015 to $32.6 million in 2017 to $88 million in 2018 to $298 million in 2019, equal to
a compound annual growth rate of 102 percent. Its portfolio of plant-based meats had expanded
from just plant-based burger patties to include several varieties of Beyond Sausages, a Beyond
Breakfast Sausage, one-pound packages of ground Beyond Beef, and two flavors of Beyond Beef
crumbles found on the frozen meat aisle at supermarkets. The company’s Beyond Chicken frozen
grilled chicken strips, introduced in 2018, generated only modest customer acceptance and was
quietly discontinued; however, the company immediately put a team of chefs and scientists to
work on getting a better, tastier version of a Beyond Chicken product back on retail shelves and
restaurant menus. In August 2019 Beyond Meat partnered with KFC, to conduct a one-day test of
new “Beyond Fried Chicken” at a single Atlanta location. This taste test of what KFC advertised
as “a Kentucky Fried Miracle” attracted so many customers that the store sold out of the faux
chicken in less than five hours.1 As of May 2020, Beyond Meat had not introduced a second
version of its Beyond Chicken product.
Beyond Meat’s brand commitment, “Eat What You Love,” reflected a belief that by eating its
plant-based meat offerings, consumers could enjoy more of their favorite protein dishes while
helping address concerns related to human health, animal welfare, resource conservation, and
climate change. As of March 31, 2020, the company’s fresh and frozen plant-based protein
products were being sold at some 94,000 grocery stores, restaurants, hotels, and other foodservice
outlets in more than 65 countries worldwide, up from 77,000 at year-end 2019.
COMPANY BACKGROUND
Beyond Meat was founded in 2009 by Ethan Brown, and then later incorporated in Delaware in
April 2011 under the name “J Green Natural Foods Co.” In October 2011, the company changed
its corporate name to “Savage River, Inc.,” with “Beyond Meat” being its “doing business as”
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name. In September 2018, the corporate name was changed to “Beyond Meat, Inc.” Beyond
Meat’s principal executive offices were located in El Segundo, California. Ethan Brown was
President and Chief Executive Officer of Beyond Meat and had served in this capacity throughout
all of the corporate transitions since the original company was founded. Brown grew up on a
family farm in Maryland that specialized in dairy operations and became fascinated with animal
agriculture, meat-raising practices, and animal protein consumption. But he also started to wrestle
with a question that continued to nag him for many years to come: Do we need animals to
produce meat? During the course of his business and industry career, Brown held a variety of
positions in the energy business that provided him with growing familiarity about clean energy
technologies, the impacts of animal meat consumption on human health, and the effects of
livestock on greenhouse gas emissions, along with the related burdens on land, energy, and water.
These experiences expanded his understanding of animal meat. The key
understanding he learned was that it was not necessary to limit the definition of meat to just cows,
pigs, and poultry; rather, meat could just as accurately be defined in terms of its composition and
structure—amino acids, lipids, trace minerals, vitamins, and water woven together in the
assembly of muscle (or meat). None of these core elements of meat was exclusive to animals;
they were abundant in the plant kingdom. While animals served as a bioreactor, consuming
vegetation and water and using their digestive system to organize these inputs into meat, it was
equally feasible to take the constituent parts of meat from plants and, together with water,
organize them into the same basic architecture as animal-based meat, thereby bypassing the need
for animals and the cholesterol associated with consuming animal meat.
Then, as climate change issues moved into the public spotlight, Brown became increasingly
troubled by studies reporting that the livestock industry was estimated to contribute 18 to 51
percent of global greenhouse gas emissions, depending on the methodology used. And there were
numerous studies in the medical journals about the adverse impacts of eating red meat on human
health, which heightened his concerns about satisfying his children’s protein requirements totally
with animal meat. In 2009, driven by the health and environmental implications of intensive
animal protein production and consumption, Brown decided to found Beyond Meat and begin the
process of producing and marketing nutritious and good-tasting plant-based meat products.
Brown’s vision for Beyond Meat was to perfectly build a plant-based meat. Believing that there
was a better way to feed the planet than by relying so heavily on animal meat, Brown’s mission
for Beyond Meat was “to create The Future of Protein® – delicious plant-based burgers, beef,
sausage, crumbles, and more.”2 The goal was “to deliver a consumer experience that is
indistinguishable from that provided by animal-based meats.”3 Brown saw four socially
beneficial outcomes associated with Beyond Meat’s efforts to try to shift a significant portion of
the world’s protein requirements from animal to plant-based meat: improving human health,
positively impacting climate change, addressing global resource constraints, and improving
animal welfare.
Beyond Meat’s Early Successes
To begin the process of learning how to build a delicious tasting plant-based meat, Brown opened
the company’s first operation in a small commercial kitchen in Maryland to develop and test
recipes for plant-based meat products using (1) proteins from peas, mung beans, fava beans,
brown rice, and sunflower seeds, (2) various fats (cocoa butter, coconut oil, sunflower oil, and
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canola oil), (3) such minerals as calcium, iron, salt, and potassium chloride, and (4) beet juice
extract, apple extract, and assorted other natural flavors. Ethan Brown began working extensively
with two researchers at the University of Missouri’s Bioengineering and Food Science
Department and faculty and students in the University of Maryland’s Nutrition & Food Science
Department. Ultimately, the company ultimately licensed a process developed by the researchers
that combined proteins from plants into a basic structure resembling animal muscle, or meat, and
used this as an initial foundation for Beyond Meat products.4 With this basic protein platform and
an understanding that the balance of parts of meat, namely lipids, trace minerals, and water, were
also present in abundance outside the animal, it became clear that with appropriate resources,
building meat from plants was indeed possible.
The young company began selling an early plant-based product to Whole Foods Markets in the
Mid-Atlantic region. It quickly discovered that traditional veggie burgers and soy-based meat had
limited appeal to traditional meat eaters, who commonly criticized their inferior taste.5 Its own
market research with consumers revealed that, when choosing among plant-based meat options,
taste was definitely the single most important product attribute for plant-based foods. Legacy
vegetarian brands typically aimed to compensate for poor taste appeal by positioning their
products as a noble sacrifice—something consumers should do for the benefit of their health, the
environment, and/or animal welfare.
A “The Future of Protein” marketing campaign was launched in the summer of 2015.6 The
goal was to mobilize brand ambassadors to help raise brand awareness and make Beyond Meat
products aspirational. A joint announcement with Leonardo DiCaprio about his becoming a
Beyond Meat brand ambassador in October 2017 generated over 378 million earned media
impressions, including a viral video that drew more than 8.5 million views.
Beyond Meat launched its flagship Beyond Burger in 2016 and used an unprecedented
marketing approach for a vegetarian meat product.7 Instead of marketing and merchandising The
Beyond Burger to vegans and vegetarians (who represented less than five percent of
the population in the United States), the company requested that the product be sold
in the meat case at grocery retailers where meat-loving consumers were accustomed to shopping
for center-of-plate proteins. In May 2016, the Rocky Mountain Division of Whole Foods Market
became the first grocery chain to place The Beyond Burger in its meat section alongside animal-
based equivalents; soon other Whole Foods Market regions followed. In April 2017, Safeway of
Northern California and several Kroger divisions began to do the same. In the Southern
California division of Ralph’s, a Kroger subsidiary, The Beyond Burger was the number one
selling packaged burger patty by unit in the meat case for the 12-week period ending August 4,
2018. Marketing personnel at Beyond Meat believed merchandising in the meat case in the retail
channel had helped drive greater brand awareness with consumers.
During 2017–2019, many restaurant, hotel, and other foodservice customers choose to
prominently feature the Beyond Meat/Beyond Burger name on their menu and within item
descriptions, in addition to displaying Beyond Meat branded signage. Beyond Meat used its sales
to foodservice businesses as a form of paid trial for its products to help drive additional retail
demand and create greater brand awareness for Beyond Meat through the on-menu and in-store
publicity it received.8 Top executives believed that Beyond Meat had established its brand as one
with “halo” benefits to its partners as evidenced by the speed of adoption by key partners. For
example, Beyond Meat was the fastest new-product launch in the history of TGI Friday’s and
A&W Canada (more than 90,000 patties were sold in the first three days). In January 2018, A&W
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conducted concept and focus group testing to gauge consumers’ appetite for The Beyond Burger.
The results of the consumer testing were very positive, indicating that the concept of a plant-
based burger that tasted like real meat, but without its health baggage, held strong appeal. In the
taste testing, Beyond Meat’s burger received high marks from surprised consumers. A&W CEO,
Susan Senecal commented, “We were blown away by the flavor and taste and delicious
‘burgerness’ of Beyond.”9 On the strength of these results and reports from store managers that
guest counts were up, A&W Canada began investing significant amounts of money across
television, digital media and press to promote the addition of The Beyond Burger to its menu.
By late 2018, the Beyond Burger was being merchandised in approximately 17,000
supermarkets and retail groceries across the United States, and food service distributors were
delivering the Beyond Burger to approximately 11,000 restaurant and foodservice outlets in the
United States. The Beyond Burger launched in Europe in August 2018 through contracts with
three major distributors, with strong expressions of interest from some of Europe’s largest grocery
and restaurant chains. Beyond Meat’s revenues from international markets (excluding Canada)
represented 13 percent of net revenues in the first half of 2019, up from 2 percent in the first half
of 2018. The company expected to begin production of its plant-based products in Europe in 2020
at a new co-manufacturing facility constructed in the Netherlands by Zandbergen World’s Finest
Meat. In 2018, Zandbergen started distributing Beyond Meat’s products throughout Europe across
both foodservice and retail grocery channels. For several years, Beyond Meat had maintained a
presence and generated brand awareness in Asia through a local distributor in Hong Kong.
Further expansion in Asia was expected in 2020 and beyond.
Throughout 2017–18 and continuing into 2019, Beyond Meat relied primarily on its growing
number of brand ambassadors (celebrities and influencers), free sampling of its products from
food trucks at over 300 special events, a digital newsletter (with over 200,000 subscribers as of
Sept 2018), visits to the company’s website, strong social marketing, and consumer word-of-
mouth as the cornerstones of a campaign to promote greater consumer awareness of the Beyond
Meat brand name. As of Spring 2019, the company’s website had drawn approximately 5 million
visitors; the website featured packages of the company’s products, provided information on where
they could be purchased, highlighted nutritional facts and news about the company, and offered
an assortment of recipes for using the products.
Meanwhile, Beyond Meat continued to invest heavily in research, development, and innovation
—spending about 10.9 percent of net revenue of R&D in fiscal year 2019 and 6.9 percent in fiscal
2019.10 In 2018, the company opened its state-of-the-art 30,000 square-foot Manhattan Beach
Project Innovation Center as a part of its world headquarters complex in El Segundo, California.
The Innovation Center included 5 laboratories, a pilot plant, and a test kitchen, staffed with a
team of scientists, engineers, and cooking specialists focused on improving the company’s
existing products and developing new products that better replicated the sensory experience of
animal meats—from the look of the package to the sizzle on grills and in skillets, and the
satisfaction of eating one of the company’s products. A second-version plant-based chicken
product was the top new product priority following the market testing at the Atlanta
KFC unit in August 2019.
As of 2018, Beyond Meat operated approximately 100,000 square feet of production space in
two facilities in Columbia, Missouri, where it manufactured the woven protein that was the key
ingredient of its products. This woven protein was then converted according to the company’s
proprietary formulas and specifications into a packaged product, either at the facilities in
Columbia, Missouri, or by a network of co-manufacturers. All third-party co-manufacturers
$11.5 million $31.5 million $ 98.5 million
signed non-disclosure agreements to ensure that Beyond Meat’s proprietary intellectual property
and trade secrets were protected. Management believed that the partnering with co-manufacturers
(who produced Beyond Meat products in facilities alongside their own products) was a capital
efficient production model that allowed Beyond Meat to scale production more quickly and cost-
effectively to supply the rapidly increasing demand for its products. Plans called for the company
to continue expanding its internal production facilities domestically and abroad to produce the
needed volume of woven protein while forming additional strategic relationships with co-
manufacturers to complete the production of the items comprising Beyond Meat’s product line.
In 2018, the United Nations officially called attention to the trailblazing accomplishments of
Beyond Meat and Ethan Brown, awarding them its highest environmental accolade, “Champion
of the Earth.”
Beyond Meat Becomes a Public Company
Shortly after the corporate name change to Beyond Meat in September 2018, the company filed
Form S-1 with the Securities and Exchange Commission in November 2018 seeking approval to
conduct an initial public offering of its common stock. On May 1, 2019, the company announced
(1) the pricing of its initial public offering of 9,625,000 shares of common stock at a price to the
public of $25.00 per share and (2) the company’s decision to grant the underwriters a 30-day
option to purchase up to 1,443,750 additional shares of common stock to cover over-allotments, if
any, at the initial public offering price less underwriting discounts and commissions. Beyond
Meat shares began trading on the Nasdaq Global Select Market on May 2, 2019, under the ticker
symbol “BYND.” The opening trade for the stock was $46.00 and trading on the first day closed
at $65.75, 163 percent above the IPO price. Buoyed by investor enthusiasm over the company’s
long-term prospects, the stock price climbed steadily higher in the ensuing weeks and months,
reaching a peak of $234.90 on July 22, 2019. Various analysts estimated that the market for plant-
based protein products could reach $85 billion in sales by 2030. But investor excitement and
aggressive buying of Beyond Meat stock started cooling off as scrappy rival Impossible Foods
announced major new grocery and restaurant chain customers for its plant-based Impossible
Burger and as major meat producers Tyson Foods, Smithfield Foods, Perdue Farms, Nestlé,
Hormel Foods, and Maple Leaf Foods all announced introductions of variously-formulated plant-
based meat alternatives and began shipping an array of plant-based burgers, ground meat,
sausage, and chicken products to their supermarket customers for display in both fresh and frozen
meat sections. By late October 2019, Beyond Meat’s stock price had plummeted to the low 80s
and by December 2019 was trading in the mid-70s.
Exhibit 1 shows the rapid growth of Beyond Meat’s quarterly revenues from 2017 forward to
Q2 of 2020. Exhibit 2 shows the company’s recent financial performance.
EXHIBIT 1 Beyond Meat’s Quarterly Net Revenues, 2017 through Q2 2020
2017 2018 2019 2020
Quarter 1 $ 6.2 million $12.8 million $ 40.2 million $ 97.1 million
Quarter 2 $ 5.6 million $17.4 million $ 67.3 million $113.3 million
Quarter 3 $ 9.4 million $26.3 million $ 92.0 million
Quarter 4
2017 2018 2019 2020
Annual
Total $32.7 million $88.0 million $297.9 million
Sources: Presentation at Barclay’s Global Consumer Staples Conference, September 5, 2019, posted in the Investor
Relations section at www.beyondmeat.com, accessed December 10, 2019; company press release, February 27,
2020; and company press release, May 5, 2020.
EXHIBIT 2 Selected Financial Data for Beyond Meat, 2016–2019 (in
thousands)
Years Ended December 31
Selected Income Statement Data 2016 2017 2018 2019
Net Revenues $ 16,182 $ 32,581 $ 87,934 $297,897
Cost of goods sold 22,494 34,772 70,360 198,141
Gross profit (loss) (6,312) (2,191) 17,574 99,756
Research and development 5,782 5,722 9,587 20,650
Selling, general, and administrative
expenses 12,672 17,143 34,461 74,726
Restructuring expenses —– 3,509 1,515 4,869
Total operating expenses 18,454 26,374 45,563 100,245
Profit (loss) from operations (24,766) (28,565) (27,989) (489)
Other income (expense), net
Interest expense (380) (1,002) (1,128) (3,071)
Remeasurement of warrant liability (1,120) (12,503)
Other, net —- (812) 352 3,629
Total other (income) expense, net (380) (1,814) (1,896) (11,945)
Loss before taxes (25,146) (30,379) (29,885) (12,434)
Income tax (benefit) expense 3 5 1 9
Net profit (loss) $(25,149) $(30,384) $(29,886) $(12,443)
Weighted average shares of common
stock outstanding 6,850 8,186 6,287 42,275
Selected Balance Sheet Data
Cash and cash equivalents $ 16,998 $ 39,035 $ 54,271 $275,988
Inventory 6,185 8,144 30,257 81,596
Total current assets 24,499 102,826 403,594
Property, plant, and equipment, net 10,277 14,188 30,527 47,474
Total assets 34,935 66,463 133,749 451,923
Total current liabilities 5,134 12,150 25,167 47,697
Total long-term liabilities 2,570 2,032 20,136 30,792
Total stockholders’ equity (deficit) $(66,573) $(95,913) $(121,750) $384,090
http://www.beyondmeat.com/
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Years Ended December 31
Selected Income Statement Data 2016 2017 2018 2019
Selected Cash Flow Data
Cash flows (used in) provided by operating
activities $(23,495) $(25,273) $ (37,721) $ (46,995)
Capital expenditures 4,955 7,908 22,228 23,795
Net cash provided by financing activities 31,914 55,425 76,199 294,876
Sources: Beyond Meat, Form S-1, November 16, 2018, pp. F3–F8; Company 10-K Report, 2019.
BEYOND MEAT’S STRATEGY
During 2016–2019, Beyond Meat’s revenue growth was driven largely by two factors: expanding
its lineup of plant-based protein products and securing additional retail grocery customers to
stock and merchandise its products and additional foodservice firms (chiefly restaurants) to
include its Beyond Meat burgers on their menus. The company’s plant-based burger patties had
been its best-selling product since they were first introduced in 2016; there were two 4-ounce
patties per package, and the typical retail price was about $5.99. A marbled, meatier-
tasting burger patty was introduced in June 2019, replacing two earlier versions.
Starting in 2020 eight-patty packages were available for $14.99. The company’s second biggest
seller was Beyond Sausage, introduced in 2018, which was available in two varieties, Bratwurst
and Italian; four-link packages were normally priced at $8.99. Frozen Beyond Beef Crumbles,
available in two flavors—Beefy and Feisty, became widely available in early 2018 and retailed
for about $5.99 per 10-ounce package; these crumbles could be used in chili, tacos, spaghetti,
lasagna, pizza toppings, and other recipes calling for ground meat. In mid-2019, the company
introduced a one-pound plastic-sealed package of ground plant-based beef that could be used in
any ground beef recipe, including chili, spaghetti sauce, meatballs, burgers, and tacos. This
product was very similar in appearance to the branded one-pound ground beef packages found in
the fresh meat cases at supermarkets and grocery stores. The company’s Beyond Breakfast
Sausage patties began hitting retail grocery shelves in March 2020. Beyond Meat’s next-version
plant-based chicken product was expected to be introduced sometime in 2020.
Growth Strategy
Going into 2020, Beyond Meat executives believed there was significant opportunity to expand
beyond the company’s current market footprint in the retail grocery and foodservice channels,
both domestically and internationally. As of March 31, 2020, the company had secured 94,000
points of distribution worldwide, including 25,000 stores in the grocery channel across the United
States, 34,000 foodservice outlets (chiefly restaurants), in the United States, and 18,000 outlets in
the international retail grocery channel, and 17,000 international foodservice outlets. Major
supermarket chains marketing Beyond Meat products in 2019–2020 included Kroger/City
Market, Albertson’s, Publix, Whole Foods Market, Target, Walmart, Costco, Giant, Hannaford,
Stop & Shop, Safeway, Harris Teeter, Natural Grocers, Jewel-Osco, Food Lion, Ralph’s,
Wegmans, Sprouts Farmer’s Market, The Fresh Market, Mariano’s, Loblaws, and Sobeys.
Restaurant and foodservice outlets offering Beyond Meat products in North America included
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Denny’s, Dunkin Brands, Subway, Del Taco, Carl’s Jr. (approximately 1,100 units), TGI Friday’s,
BurgerFi, Tim Horton’s, Chronic Tacos, Hello Fresh, Bareburger, WhiteSpot, A&W, Cinemark
Theaters, Disney World, Marriott and Hilton hotels, and foodservice distributor Sysco. The
company was aggressively developing more relationships with international partners; current
customers included grocery chains Tesco (Great Britain and 6 other countries in Central Europe
and Asia), Kesko (Finland), Edeka (Germany), Lidl (28 European countries), Albert
(Netherlands), Coles (Australia), and Ahold Delhaize (Netherlands, Belgium, 5 other European
countries, Greece, Indonesia).
McDonald’s Begins Experimenting with Plant-Based Burgers Starting in 2017,
McDonald’s began offering McVegan® burgers, a soy-based sandwich created with Swedish
vegan food company Anamma, at its restaurants in Sweden and Finland; in these two countries,
vegetarianism was well entrenched, as many consumers shunned meat due to high prices and
concerns about climate change. In April 2019, McDonalds introduced a Big Vegan® burger, a soy
and wheat patty colored with beet juice, intended as a permanent addition to its menu offerings, at
all 1,500 locations in Germany. The Big Vegan utilized a plant-based “Incredible Burger” made
by Nestlé, the world’s largest food and beverage company, headquartered in Switzerland.
In late September 2019, in collaboration with Beyond Meat, McDonald’s began a test run of a
plant-based burger called the Beyond Meat P.L.T., short for plant, lettuce, and tomato, at 28
Canada locations; McDonald’s described the P.L.T. as “juicy, delicious, perfectly dressed;” it
contained no artificial colors, flavors, or preservatives. Beyond Meat’s CEO and Founder, Ethan
Brown, said in a statement: “Being of service to McDonald’s has been a central and defining goal
of mine since founding Beyond Meat over a decade ago. It comes after a long and productive
collaboration to make a delicious plant-based patty that fits seamlessly into McDonald’s
menu. . . .”11
In January 2020, McDonald’s expanded its test run of the P.L.T. to 52 Canadian locations for a
12-week period starting January 14, 2020. Industry observers believed this more extensive market
test would provide management with a clearer picture of whether the addition of a Beyond Meat
plant-based burger to its menu offering would catch on sufficiently with customers to increase
store traffic and drive sales growth. McDonald’s announcement of the expanded
test with Beyond Meat prompted management at rival Impossible Foods to
discontinue efforts to persuade McDonald’s to conduct a market trial of its plant-based Impossible
Burger. News of the bigger test also prompted investors to bid up the price of Beyond Meat
common stock by 25 percent.
In late January 2020, Denny’s Corp. announced it would give away free Beyond Meat Burgers,
dressed with sliced tomatoes, lettuce, onions, pickles, All-American sauce, and American cheese
on a multi-grain bun, with the purchase of any beverage on January 30 from 11am to 10pm while
supplies lasted. The promotion, following on the heels of a highly successful market test of the
Beyond Burger in Denny’s restaurants in Los Angeles, served to launch the Beyond Burger menu
item nationwide at all 1,700-plus Denny’s locations in the United States and Canada. Denny’s
announcement triggered a rush on the part of investors to purchase Beyond Meat shares, driving
the stock price up another 8 percent to $129 per share.
In April 2020, Starbucks debuted a new menu in its 4,200 stores in China that included Beyond
Meat’s plant-based beef products in pasta and lasagna selections.
Distribution Strategy
page C-131
Meat was the largest category in food. The size of the global meat category was estimated to be
$1.4 trillion in 2019; the estimated size of the market for meat in the United States was $270
billion. The most common sources of meat were domesticated animal species such as cattle, pigs,
poultry, and, to a lesser extent, buffaloes, sheep, and goats. In some regions of the world, other
animal species such as camels, yaks, horses, ostriches and game animals, crocodiles, snakes, and
lizards were also eaten as meat. Pork was the most widely eaten meat in the world accounting for
roughly 36 percent of the world meat intake, followed by poultry and beef with about 35 percent
and 22 percent respectively.12
Because the market for meat was so large, company executives saw ample room for Beyond
Meat to become and remain the major disruptor in the meat category worldwide for some years to
come. To achieve this role as a major disruptor and change agent in the market for meat, it was
essential for Beyond Meat to sustain its efforts and successes in securing additional distribution
points in the North American and international grocery and foodservice channels in 2020 and
beyond. However, because the United States had the highest level of animal meat consumption
per person of any country in the world, management considered the United States as the
company’s core target market from a geographical standpoint and believed that over time plant-
based meats could become a $35 billion food category.13 Market research firm CFRA forecasted
that the global alternative meat industry would grow to $100 billion in sales by 2030, up from
about $19 billion in 2018.14 As of October 2019, analysts had estimated that sales of plant-based
meat products in the United States were only about $2.4 billion.
In the grocery channel, Beyond Meat’s strategic objective was to capitalize on the company’s
success as the first plant-based protein offering in supermarket meat cases not only by growing
the number of grocery stores carrying Beyond Meat’s products but also by (1) adding more plant-
based meat products to its offerings in supermarket fresh and frozen meat cases and (2) helping
drive increases in the overall size of the plant-based protein category, as more consumers shifted
their diets away from animal-based proteins. At the same time, it was strategically important for
Beyond Meat to further disrupt the meat offerings in the restaurant channel by getting its products
on more restaurant menus across an ever wider geographic area and in more dishes on these
menus. This meant devoting more resources to outcompeting rival Impossible Meats and other
new entrants in the plant-based meat category in convincing restaurants to use its branded
products in their plant-based meat offerings rather than the brands of other makers of plant-based
meats.
Growing penetration of the foodservice channel was yet another component of Beyond Meat’s
strategy; this channel included food distributors who supplied food products to the food
operations at hospitals, schools, hotels, entertainment and hospitality vendors, country clubs,
banquet facilities, sporting events, and other such venues where food was served. In 2019–20,
having received significant interest from several prominent foodservice enterprises, Beyond Meat
was aggressively working to expand its distribution through foodservice enterprises and food
distributors in a number of different geographic locations across the world, particularly Europe,
Australia, New Zealand, Israel, South Korea, Taiwan, South Africa, and parts of the Middle East.
The company had recently increased its staffing of experienced employees in
sales and marketing to achieve its distribution objectives in the grocery and foodservice channels.
Shipping Retail products sold in the grocery fresh meat sections as part of Beyond Meat’s
“fresh” platform, such as The Beyond Burger and Beyond Sausage, were shipped to the customer
frozen. Foodservice customers were provided instructions on ‘slacking,’ which was typically
done by moving frozen products to a refrigerator to allow them to slowly and safely thaw before
being cooked. Retail grocery stores merchandising burgers and sausage in refrigerated fresh meat
cases had to apply a “use by date” sticker of seven days for Beyond Sausage or ten days for The
Beyond Burger. In addition to or as a substitute for their fresh meat displays of Beyond Meat
products, some supermarkets and smaller groceries sold Beyond Burger patties and Beyond
Sausage products in their frozen meat cases alongside various branded packages of frozen
chicken and animal meat patties; this was done partly (sometimes mainly) to avoid spoilage
losses of unsold products—the frozen versions required no use-by dates.
R&D Strategy
Beyond Meat had invested significant resources in building its capabilities to develop plant-based
meat alternatives to popular animal-based meat products. In 2020, the company’s innovation team
consisted of about 40 scientists from such disciplines as chemistry, biology, materials, food
science, and biophysics who collaborated with process engineers and culinary specialists in
developing and testing improved versions of existing products with better taste, texture, and
aroma and also discovering ways to make new plant-based meat products. New learning about
taste, texture, and aroma for one product was quickly applied to the formulations of other existing
product offerings and tested for use in new products under development. In addition, the
innovation team devoted time and effort to exploring and testing the use of additional plant
protein options, searching for ingredients that could be sourced more easily or more cheaply than
current plant ingredients and that would retain and build upon the quality and appeal of current
product offerings. The company sourced plant ingredients from a variety of vendors, but was
heavily dependent on a single supplier, Roquette America, for the pea protein that was the main
ingredient in all of its products.15
Since opening the new 30,000 square foot Manhattan Beach Project Innovation Center in El
Segundo, California, which was ten times the size of the company’s previous lab space, Beyond
Meat has increased its pipeline of products and product improvements in development and
become more proficient in shortening the time it took to transition its laboratory findings, test
kitchen results, and pilot plant operations into scaled production. As the company’s knowledge
and expertise had deepened, its pace of innovation had accelerated, allowing for reduced time
between new product launches. After taking multiple years to develop the first Beyond Burger, it
took less than a year to develop a second version with improved taste, texture and aroma
attributes and still fewer months to develop an even better third version. Management expected
that this faster pace of product introductions and meaningful enhancements to existing products
would continue as ongoing R&D efforts at the Manhattan Beach Innovation Center strengthened
the company’s innovation capabilities.
Production Strategy
The core of Beyond Meat’s production strategy was to invest in state-of-the art domestic and
international production facilities and expand the capacity of these as needed to supply all of the
company’s requirements for woven protein, the principal ingredient of its plant-based products.
Self-manufacture of woven protein allowed the company to keep the details of its manufacturing
process for woven protein proprietary, thereby making it harder for rival makers of plant-based
protein products to replicate the meat-like texture of Beyond Meat’s products. The remainder of
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the manufacturing process was done by partnering with “co-manufacturers” to complete the
production process in facilities they operated. While the company completed the manufacture of
Beyond Burger patties that it sold to the foodservice channel at its production facilities in
Columbia, it depended on its co-manufacturing partners to complete the production process for
Beyond Burger patties sold through retail grocery channels and for all of its other products at
facilities operated by the co-manufacturers. All third-party co-manufacturers signed non-
disclosure agreements to ensure that Beyond Meat’s proprietary intellectual property and trade
secrets were protected.
In the first quarter of 2019, Beyond Meat’s internal monthly production
capacity was triple what it had been in the second quarter of 2018. Further increases in production
capacity occurred in the remainder of 2019 and in early 2020. The company had ongoing efforts
underway to evaluate and improve the company’s supply chain processes for woven protein and
to collaborate closely with the growing number of its co-manufacturing partners to increase
manufacturing efficiencies and product quality, while reducing overall production costs.
Beyond Meat’s manufacturing process for woven protein is displayed in Exhibit 3. A dry blend
containing pea protein was mixed in the company’s manufacturing facility in Columbia, Missouri.
The dry blend then entered an extruder, where both water and steam were added. A combination
of heating, cooling, and variations of pressure were used to weave together the pea protein into
formed woven protein, which was used as the basis for all of the company’s products.
EXHIBIT 3 Beyond Meat’s Manufacturing Process
Source: Beyond Meat, Form S-1, November 16, 2018, p. 92.
The formed woven protein not used to produce Beyond Meat patties for foodservice customers
in North America was then cut into smaller pieces to expedite the freezing process, and the frozen
woven protein was shipped via third-party logistic providers to cold storage facilities or directly
to production facilities operated by the company’s co-manufacturers. At a co-manufacturer’s
production facility, thawed woven protein was further processed by adding other ingredients and
flavorings, after which the final product was packaged and then shipped frozen to retail grocery
stores and foodservice distributors. To control the quality of its products throughout the
production process, the company utilized a type of Six Sigma quality control process called
DMAIC (short for “define, measure, analyze, improve and control”) that served to “improve,
optimize, and stabilize” its product formulation and production processes. In-process quality
checks were performed throughout the manufacturing process, including temperature, physical
dimension, and weight. Specific instructions were provided to foodservice vendors and
restaurants for storing and cooking the company’s products. Cooking instructions for frozen
Beyond Beef Crumbles, which were intended to be prepared from their frozen state, were on the
packaging.
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Supply Chain Practices
Raw Material Procurement Beyond Meat’s products had about 20 ingredients (the Beyond
Beef burger had 22)—these included pea protein isolate, canola oil, coconut oil, amino acids,
lipids, trace minerals, vitamins, salt, methylcellulose (a binding agent), and assorted flavorings.
The company procured raw materials for woven protein that were readily available from a
number of different suppliers, except for pea protein, which in the United States as of 2018 was
available only from a single supplier. A second supplier in Canada supplied yellow peas for
Beyond Beef Crumbles.
All flavorings in the company’s products were developed at the company’s Innovation Center
in collaboration with the suppliers chosen to produce the flavors, and all these flavorings were
produced exclusively for use by Beyond Meat. Flavoring ingredients considered for use were
qualified through trials at Beyond Meat’s Innovation Center to ensure manufacturability. The
Innovation Center staff, using only ingredients deemed manufacturable, created a
number of alternative formulas for each of the flavors being considered for use in
one or more products. Each formula was extensively tested to identify the specific flavoring
formula and the specific combination of flavorings that best impacted the final product’s taste,
texture, and appearance. While supplies of each ingredient in a flavoring were obtained directly
by the supplier producing a specific flavoring for Beyond Meat, as new ingredient shipments
arrived at a flavoring supplier’s production facilities, the supplier was required to submit a
Certificate of Analysis to Beyond Meat to confirm that the ingredient quality and flavoring
formula used in production runs met the quality control standards previously established at the
Innovation Center.
Shipping Retail products sold in grocery store meat cases as part of Beyond Meat’s “fresh”
platform, such as The Beyond Burger and Beyond Sausage, were shipped to the customer frozen.
Retail grocery stores merchandising burgers and sausage in refrigerated fresh meat cases as part
of Beyond Meat’s “fresh” platform had to apply a “use by date” sticker of seven days for Beyond
Sausage or ten days for The Beyond Burger; at the end of the use-by date, unsold packages in
fresh meat cases had to be discarded. In addition to or as a substitute for their fresh meat displays
of Beyond Meat products, some supermarkets and smaller groceries kept incoming shipments of
frozen Beyond Burger patties and Beyond Sausage products in a frozen state and placed the
packages in their frozen meat cases alongside various branded packages of frozen chicken and
animal meat patties; this was done partly (often mainly) to avoid spoilage losses of fresh products
—the frozen versions required no use-by dates.
Foodservice customers receiving shipments of frozen Beyond Meat products were provided
instructions on ‘slacking,’ which was typically done by moving frozen packages to a refrigerator
to allow them to slowly and safely thaw before cooking.
Supplier Selection Practices Beyond Meat did not have long-term supply agreements with
most of its suppliers; this included raw materials suppliers, suppliers making flavorings, and
comanufacturers. Most all supplies of raw materials, flavorings, and final products produced and
shipped by comanufacturers were obtained on a purchase order basis. Because most of the
ingredients used in its flavorings were readily available in the market from many suppliers, the
company believed it could obtain needed supplies from other vendors in the event of supply
interruptions from the ingredient vendors it typically used. It was the company’s practice to
page C-134
maintain a 20-week supply of flavoring ingredients that would ultimately be shipped to producers
of its flavorings.16
Packaging supplies were sourced in the United States with the exception of the Beyond
Sausage tray which was sourced from China. The company maintained approximately 10 weeks
of inventory of sausage trays to mitigate the risk of supply interruptions. The trays used for
burgers sold through grocery channels were slotted for two 4-ounce patties. Packaging
specifications for all products were clearly defined and provided to all packaging suppliers.
HEALTH AND ENVIRONMENTAL IMPACTS OF ANIMAL-
BASED MEAT CONSUMPTION
Consumer interest in plant-based proteins, particularly among millennials and younger
generations, had been driven in part by growing awareness of the health and environmental
impact of animal-based meat consumption. The Internet and social media channels provided
consumers with easy access to voluminous amounts of information about nutrition, the pros and
cons of eating various food products, climate change, resource scarcity, and the assortment of
health and environmental issues surrounding the consumption of animal meats. Management at
Beyond Meat expected heightened global awareness of and concerns about these issues to have a
positive impact on consumer demand for the company’s products.
Health Impacts
The negative impact on health caused by certain meats has been well publicized in recent years.
In 2004, the World Health Organization highlighted a paper indicating that dietary factors,
including consumption of certain meats, accounted for at least 30 percent of most cancers in
developed countries and up to 20 percent in developing countries. The WHO had since added
processed meats such as hot dogs, ham, bacon, and sausage to its Group 1 category of
carcinogens. A similar conclusion was presented at the American Heart Association,
where researchers conducting a 2017 dietary study of over 15,000 adults between 2003 and 2013
highlighted that people who ate mostly a plant-based diet were associated with a 42 percent
reduced risk of developing heart failure. Additionally, animals and livestock were also susceptible
to various diseases such as Mad Cow (beef), Swine Flu (pork), and Avian Influenza (poultry) that
may cause further health risks from consuming potentially infected animal meats. As an example
of the nutritional benefits of plant-based meats, Beyond Breakfast Sausage patties had 11 grams
of protein per serving with 50 percent less total fat, 35 percent less saturated fat and sodium, and
33 percent fewer calories than a leading brand of pork sausage patties, plus it was made without
any genetically modified ingredients, soy, gluten, or artificially produced ingredients.
Climate Impacts
A number of research studies had indicated that the global livestock industry was responsible for
about one-third of global methane emissions, with animal manure accounting for perhaps 10
percent of global nitrous oxide (carbon dioxide) emissions. According to a series of reports by the
Intergovernmental Panel on Climate Control (an intergovernmental body of the United Nations
which periodically compiles comprehensive “assessment reports” of published studies concerning
climate change, its causes, potential impacts, and response options), there was mounting
consensus among climate scientists that greenhouse gas emissions were likely to cause “severe,
page C-135
widespread, and irreversible impacts” on the natural environment unless carbon emissions were
rapidly and sharply reduced.17 Several studies had concluded that behavioral changes, including
such dietary changes as eating less animal meat, could have a significant role in cutting carbon
emissions.
Environmental Impacts
According to the Food and Agricultural Organization (FAO) of the United Nations, rising global
meat consumption and livestock production had adverse impacts on the world’s land and water
resources.18 According to the FAO, livestock-raising activities occupied 30 percent of the planet’s
land surface and accounted for 78 percent of all agricultural land use.19 A report by the World
Resources Institute (WRI) indicated that 29 percent of agriculture-related water use was directly
or indirectly used for animal production.20 The WRI also concluded that meat consumption was
environmentally burdensome from the standpoint of production inputs. According to the same
WRI report, beef was highly inefficient to produce because only 1 percent of the feed consumed
by cattle was converted to calories that people consumed from eating beef, while pork converted
approximately 10 percent and poultry converted approximately 11 percent of their feed to human-
edible calories. During 2017 and 2018, Beyond Meat engaged the University of Michigan to
conduct a peer-reviewed, third-party-led Life Cycle Assessment comparing the environmental
impacts associated with producing a quarter-pound Beyond Burger versus a quarter-pound,
standard 80 percent lean/20 percent fat beef burger.21 The study showed that compared to the beef
burger, The Beyond Burger generated 90 percent less greenhouse gas emissions, required 46
percent less energy, had 99 percent less impact on water scarcity, and 93 percent less impact on
land use.
Animal Welfare
Worldwide, it was estimated in 2017 that about 60–70 billion farm animals were produced for
food annually; with two out of every three being factory farmed.22 Over the past decade, animal
welfare groups had publicized a range of investigations highlighting the issues related to safety,
welfare, and well-being of animals caused by mass livestock production, which Beyond Meat’s
management believed had prompted a consumer shift toward more plant-based alternatives.
COMPETITORS
Beyond Meat operated in a highly competitive environment that included both animal protein
suppliers and plant-based meat suppliers. In North America, the leading suppliers of fresh meats
(beef, pork, and poultry) and assorted branded meat products included:
The world’s largest meat supplier, JBS, a company headquartered in Brazil whose meat
portfolio consisted of Swift® beef and pork products, 19 brands of fresh beef and
hamburger, Butterball® brand turkey, and Pilgrim’s Pride® chicken.
Tyson Foods, a global supplier of meats with 2019 sales of more than $42 billion and a meat
portfolio that consisted of Tyson® fresh and frozen chicken products, fresh beef and pork, and
such meat brands as Jimmy Dean®, Hillshire Farms®, Ball Park®, Wright®, Aidells®, IBP®,
and State Fair®. Tyson’s plant-based meat brand, Raised & Rooted, was available in 7,000
stores as of November 2019. As of early 2020, Tyson’s Raised & Rooted product line consisted
of (1) frozen Nuggets—a battered chicken-like dish made of pea protein, bamboo fiber, egg
whites, and golden flaxseed and (2) The Blend—burgers patties blended with Angus Beef, pea
protein, dried egg white solids, and assorted flavorings and seasonings that were displayed in
grocery fresh meat cases.
China-based WH Group, whose North American brands included Smithfield pork products,
Eckrich®, Nathan’s®, Farmland®, John Morrell®, Armour®, Gwaltney®, and Cook’s® hams.
Farmland was marketing its plant-based meat under the Pure® brand.
Cargill, one of the world’s biggest global suppliers of fresh beef and poultry products with 2019
sales of over $113 billion. In April 2020, Cargill announced it would begin selling a complete
line of plant-based meat products, including hamburger patties and ground meat. Shortly
thereafter, three KFC restaurants in China conducted a three-day test of a plant-based fried
chicken nugget supplied by Cargill.
Hormel, a well-known company with 2019 sales of $9.5 billion, whose meat brands included
Hormel® bacon and chili, Applegate® (bacon, breakfast and dinner sausage, chicken burgers
and strips, hot dogs, frozen beef and turkey burgers), Jennie-O® turkey, and Columbus® deli
meats.
Maple Leaf Foods, a Canadian consumer packaged meat company with 2019 sales of about
$3.5 billion, whose brands included Maple Leaf, Maple Leaf Prime, Schneiders, Greenfield,
Swift, Field Roast Grain Meat, and Lightlife. Field Roast and Lightlife specialized in plant-
based meat substitutes. Field Roast’s product offerings were largely made of wheat and other
grains; the main ingredients in Lightlife’s plant-based burger patties and ground meat were pea
protein, coconut oil, and beet powder. Lightlife’s other products were plant-based chicken
nuggets (a menu offering at all A&W locations in Canada), chicken tenders, hot dogs, bacon,
sausages, and tempeh.
There were significant variations among the various commonly available types of beef burger
products regarding calorie count, total fat grams, saturated fat grams, protein grams, cholesterol,
milligrams of sodium, carbohydrates, dietary fiber, and other nutritional measures—see Exhibit 4.
EXHIBIT 4 Comparative Nutrition Facts for Selected Brands of Animal Beef
Burger Patties, February 2020
Grain Fed Beef 80% Lean Grain Fed Beef 93% Lean Ground Bison 90% Lean Grass Fed Beef 85% Lean
Amount per 4-oz. serving Amount per 4-oz. serving Amount per 4-oz. serving Amount per 4-oz. serving
Calories 350 Calories 170 Calories 190 Calories 240
Calories from
fat 240
Calories from
fat 70
Calories from
fat 100
Calories from
fat 150
% of
Daily
Value
% of
Daily
Value
% of
Daily
Value
% of
Daily
Value
Total fat 27g 42% Total fat 8% 12% Total fat 11g 17% Total fat 17g 26%
Saturated fat
10g 52%
Saturated fat
3.5g 17%
Saturated fat
4g 20%
Saturated fat
7g 33%
Trans fat 0g 0% Trans fat 0g 0% Trans fat 0g 0% Trans fat 1g —
Cholesterol
95mg 32%
Cholesterol
70mg 24%
Cholesterol
50mg 17%
Cholesterol
75mg 26%
Grain Fed Beef 80% Lean Grain Fed Beef 93% Lean Ground Bison 90% Lean Grass Fed Beef 85% Lean
Amount per 4-oz. serving Amount per 4-oz. serving Amount per 4-oz. serving Amount per 4-oz. serving
Sodium
90mg 4%
Sodium
75mg 3%
Sodium
60mg 3%
Sodium
75mg 3%
Total
Carbohydrate
0g
0%
Total
Carbohydrate
0g
0%
Total
Carbohydrate
0g
0%
Total
Carbohydrate
0g
0%
Dietary fiber
0g 0%
Dietary fiber
0g 0%
Dietary fiber
0g 0%
Dietary fiber
0g 0%
Sugars 0g 0% Sugars Sugars 0g 0% Sugars 0g 0%
Protein 23g 46% Protein 24g 48% Protein 23g 46% Protein 21g 42%
Vitamin A 0% Vitamin A 0% Vitamin A 0% Vitamin A 0%
Vitamin C 0% Vitamin C 0% Vitamin C 0% Vitamin C 0%
Calcium 2% Calcium 2% Calcium 0% Calcium 2%
Iron 15% Iron 15% Iron 10% Iron 15%
Source: Brand labels.
In addition to the above animal-protein companies, Beyond Meat confronted competition from
a number of plant-based protein brands, including Kroger’s Simple Truth brand of plant-based
products, Impossible Foods, Boca Foods, Field Roast Grain Meat Co., Gardein, Lightlife,
Morningstar Farms, and Tofurky. The products of these companies were commonly available
throughout the supermarket and grocery store channel, including most national and regional
supermarket chains, specialty grocer Trader Joe’s, such natural foods and health food chains as
Whole Foods, Natural Grocers, Sprouts Farmer Markets, Fresh Market, and Earth Fare, plus
thousands of mostly local natural/health food stores.
The different brands of plant-based meat products used soy protein or pea protein or potato
protein or wheat protein, or other grains as the main ingredient; lesser ingredients could include
coconut oil, sunflower oil, canola oil, or some other type of vegetable oil, binding agents (food
starch, potato starch, methylcellulose, xanthan gum), yeast extract, maltodextrin, beet juice
extract, salt, water, and a varying assortment of spices, vitamins (C, B6, B12, niacin, thiamin,
riboflavin), minerals (potassium, iron, zinc, calcium, phosphorus), and natural flavorings. There
were sometimes significant variations from brand-to-brand and product-to-product regarding
calorie count, total fat grams, saturated fat grams, protein grams, cholesterol, milligrams of
sodium, carbohydrates, dietary fiber, and other nutritional measures—see Exhibit 5, Most plant-
based meats had protein levels comparable to their animal counterparts, but had lower
cholesterol, less saturated fat, higher dietary fiber, and no antibiotics or hormones. Both 4-ounce
plant burger patties and 4-ounce animal burger patties typically contained about 20 grams of
protein.
EXHIBIT 5 Comparative Nutrition Facts for Selected Brands of Plant-Based
Burger Patties, February 2020
Beyond Meat Impossible Foods Pure Foods Kroger Simple Truth
Amount per 4-oz. serving Amount per 4-oz. serving Amount per 4-oz. serving Amount per 4-oz. serving
Calories 250 Calories 250 Calories 240 Calories 230
page C-136
Beyond Meat Impossible Foods Pure Foods Kroger Simple Truth
Amount per 4-oz. serving Amount per 4-oz. serving Amount per 4-oz. serving Amount per 4-oz. serving
Calories from
fat 160
Calories from
fat 160
Calories from
fat
Calories from
fat 160
% of
Daily
Value
% of
Daily
Value
% of
Daily
Value
% of
Daily
Value
Total fat 18g 28% Total fat 28% Total fat 18g 24% Total fat 14g 16%
Saturated fat
6g 30%
Saturated fat
6g 30%
Saturated fat
12g 60%
Saturated fat
9g 45%
Trans fat 0g 0% Trans fat 0g 0% Trans fat 0g 0% Trans fat 0g 0%
Cholesterol
0mg 0%
Cholesterol
0mg 0%
Cholesterol
0mg 0%
Cholesterol
0mg 0%
Sodium
390mg 16%
Sodium
390mg 16%
Sodium
600mg 26%
Sodium
390mg 17%
Total
Carbohydrate
3g
1%
Total
Carbohydrate
3g
Total
Carbohydrate
8g
2%
Total
Carbohydrate
6g
2%
Dietary fiber
2g 8%
Dietary fiber
2g
Dietary fiber
2g 8
Dietary fiber
0g 0%
Sugars 0g Sugars Sugars 0g 0% Sugars 0g 0%
Protein 20g 40% Protein Protein 14g 26% Protein 20g 26%
Vitamin A 0% Vitamin A Vitamin D0mcg 0% Vitamin A
Vitamin C 0% Vitamin C Potassium374mg 8%
Potassium
136mg 2%
Calcium 8% Calcium Calcium192mg 16%
Calcium
41mg
Iron 25% Iron Iron 2mg 12% Iron6 mg 35%
Source: Brand labels.
Competition revolved around a host of factors:
Taste, meat-like appearance, and texture
Ingredients (being gluten-free and avoiding use of genetically modified ingredients) and
nutritional profile (protein, carbohydrates, sugar, and fiber)
Distribution capabilities (being able to secure a strong presence in both the retail grocery
channel and the restaurant/foodservice channels, including favorable shelf and display locations
in the grocery channel and menu offerings in the restaurant/foodservice channel
Breadth of product offerings
Competitive production costs and product prices
Brand awareness and customer loyalty.
Advertising/media spending
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Ability to secure intellectual property protection on products (to aid in blocking rivals’ efforts
to produce and market copycat products)
While Beyond Meat and other companies offering plant-based meat products were alert to all
of these competitive elements, most all companies in the animal meat sector had substantially
greater financial resources, more comprehensive product lines, broader market presence, longer
standing relationships with distributors and suppliers, longer operating histories, greater
production and distribution capabilities, stronger brand recognition, and greater marketing
resources than any plant-based meat company.
Kroger’s Simple Truth Product Line. In January 2020, Kroger—one of the world’s largest
foot retailers with 2019 sales of about $125 billion—announced the launch of its Simple Truth®
Emerge™: Plant Based Fresh Meats. Kroger’s Simple Truth brand was the best-selling brand in
the natural and organic foods category, and its Emerge-branded entry into plant-based meats was
aimed at offering its 11 million daily customers fresh burger patties and grinds at more affordable
prices.23 Emerge patties and grinds contained 20 grams of pea-based protein per serving, and
packages were located in the refrigerated meat cases alongside other plant-based and animal meat
brands. Going into 2020, Kroger operated almost 2,800 supermarkets in 35 states ’under such
brands as Kroger, City Market, Fred Meyer, Harris Teeter, King Soupers, Ralph’s, Roundy’s,
Pick’n Save, Metro Market, and Mariano’s Fresh Market. Kroger also operated 36 food
manufacturing plants, principally to produce its private-label products.
Kroger anticipated that consumer interest in plant-based products would continue to grow in
2020 and beyond. The entire Simple Truth portfolio already included more than 1,550 natural and
organic products and were located throughout Kroger grocery aisles, with new items launching
monthly. Kroger expected to launch 50 additional Simple Truth plant based products in 2020 to
grow sales of its Simple Truth brand, which exceeded $2.3 billion in sales in 2019.
Analysts expected that Kroger’s entry into the plant-based meat segment would likely stimulate
Whole Foods, Trader Joe’s, and other major supermarket chains to follow Kroger’s lead and
introduce their own private label brands of plant-based meat alternatives.
Impossible Foods. Founded in 2011 by current CEO Pat Brown, Impossible Foods had an
ambitious mission: “To drastically reduce humanity’s destructive impact on the global
environment by completely replacing the use of animals as a food production
technology.”24 The company hoped to accomplish this mission within two decades by creating
the world’s most delicious, nutritious, affordable and sustainable meat, fish, and dairy foods
directly from plants.
Going into 2020, Impossible Foods, whose main product was the Impossible Burger, had
gained brand awareness by convincing some 15,000 restaurants to put its Impossible Burger on
their menus, and by recently securing distribution of its burgers and crumbles in growing numbers
of supermarkets, grocery stores, and natural food stores. In August 2019, after running market
tests in several units, Burger King added the Impossible Whopper to its menu offering at all of its
7,200 Burger King locations in the United States and was featuring the Impossible Whopper in
some of its national TV ads (including ads run during NFL games). The Impossible Whopper
included everything that came on a regular Whopper: a quarter-pound patty, tomatoes, lettuce,
mayonnaise, ketchup, pickles, and white onions on a sesame seed bun. Instead of a flame-grilled
page C-139
beef patty, the Impossible Whopper had a flame-grilled Impossible Burger patty consisting
principally of a unique ingredient called soy leghemoglobin that made Impossible burgers taste so
meat-like. Leghemoglobin was a protein found in many plants and it carried an iron-rich
molecule called heme that during the cooking process caused the Impossible Burger to “bleed”
and take on the product’s signature blood-red color. The patties that Impossible Foods supplied to
Burger King were based on the company’s new 2.0 formulation that was announced in January
2019.25 Among other upgrades, this formulation worked well in restaurant environments because
version 2.0 burgers held up well in hot holding trays and could withstand the 6-inch drop at the
end of Burger King’s conveyor that grilled the patty for exactly 2 minutes , 35 seconds at 630
degrees Fahrenheit. The Impossible Whopper was usually priced $1 more than the regular
Whopper.
In January 2020 Burger King introduced a new Impossible Sausage Croissan’wich to its
breakfast menu offerings at 139 Burger King restaurants in five test locations: Savannah, Georgia;
Lansing, Michigan; Springfield, Illinois; Albuquerque, New Mexico; and Montgomery,
Alabama.26 The croissan’wich featured an egg, cheese, and Impossible Sausage patty sandwiched
in a toasted croissant. A raw two-ounce serving of Impossible Sausage had 7g protein, 1.69mg
iron, 0mg cholesterol, 9g total fat, 4g saturated fat, and 130 calories. It was also gluten-free and
designed to be both halal and kosher. Concurrent with Burger King’s announcement, Impossible
Foods announced its official launch of Impossible Sausage for distribution through retail grocery
and foodservice/restaurants channels. In 2019, Impossible Foods had collaborated with Little
Caesar’s to test its new Impossible Pork product as a pizza topping. Impossible Pork was suitable
for use in a wider assortment of applications and recipes for ground pork as compared to
Impossible Sausage. Pork was especially popular in China, making Impossible Pork an important
product for the company’s global expansion. Like the Impossible Burger, both Impossible Pork
and Impossible Sausage used soy leghemoglobin, a plant-based protein carrying the heme iron
molecule that produced the bleeding effect, as their main ingredient. Both products were gluten
free, had no animal hormones or antibiotics, and were designed for halal and kosher certification.
While burgers were an iconic part of the American diet, the founder and CEO of Impossible
Foods, Pat Brown, believed that within a couple of years his company would conquer the biggest
challenge in the alternative meat marketplace—plant-based steaks and that fast casual steak
chains like Outback or Texas Roadhouse would put them on their menus. He thought the R&D
efforts the company had put into the Impossible Burger had prepared it for the challenge, boldly
stating in 2019 “I can say, with complete confidence, that we’re going to nail it and not only make
a great steak, but we’re going to make a steak that’s as good as anything that ever fell out of a
cow.”27 Many observers and plant-based meat experts, familiar with plant-based proteins and the
speed with which product R&D was accelerating, agreed with Pat Brown. According to Bruce
Friedrich, executive director of the Good Food Institute, which championed plant- and cell-based
meats, “Once we have products that taste the same or better and that cost less, plant-based and
clean meat will simply take over.”28
In early March 2020, Impossible Foods announced a 15 percent price cut on its plant-based
products, and requested that its foodservice distributors pass the price cuts on to their restaurant
customers. Impossible Foods CEO Patrick Brown said:29
Our stated goal since the founding of the company has always been to drive down prices through economies of
scale, reach price parity and then undercut the price of conventional ground beef from cows.
Morningstar Farms Morningstar Farms was a division of Kellogg that produced vegetarian
foods; its product line in 2020 consisted of 49 items that included veggie bacon strips, 5 varieties
of breakfast sausage, 2 varieties of vegan burgers (made with 10 vegetables, grains, and seeds,
with 9 grams of protein), 12 varieties of veggie burgers, 3 varieties of crumbles, vegetarian
buffalo wings and parmesan garlic wings, vegetarian chicken strips, vegetarian hot dogs and corn
dogs, vegetarian chicken nuggets and BBQ chicken nuggets, and 2 varieties of vegetarian chicken
burgers. All products sold to the grocery channel were frozen and displayed in grocery freezer
cases. Morningstar sold 26 of its products in the foodservice channel.
Until 2020, one key difference between Morningstar and the other plant-based meat brands was
that most Morningstar products had egg ingredients and thus did not qualify as vegan. But in
2019 management decided to discontinue production and marketing of Morningstar egg products,
abandon use of egg ingredients, and begin phasing in new vegan versions of the company’s entire
lineup of vegetarian products. By the end of 2020, Morningstar planned to have completed the
process of transitioning all the products it sold through the retail grocery and foodservice
channels to vegan.
Field Roast Grain Meat Co. Since its founding in 1997 as a privately-owned company, Field
Roast had been a pioneer in the plant-based industry by creating flavorful, high-quality products
using fresh whole-food ingredients—grains, vegetables, legumes, and spices—to craft artisanal
plant-based meats and cheeses. Its best-selling products were sausages (three varieties—apple
sage, chipotle, and Italian), frankfurters, corn dogs, and Chao cheese slices, but its product line
also included breakfast sausages, vegetarian deli meats, vegan field burgers, roasts (three
varieties), breaded cutlets, and Fruffalo wings (apple sage sausage cut on the bias, battered and
lightly fried, with buffalo sauce). Its newest product was bratwurst, which, like Field Roast
sausages, came four to a package. All of the meat products were high in protein because wheat
gluten was a principal ingredient. Wheat gluten was wheat flour with all the starches removed—
removing the starches left pure wheat protein. Field Roast meats were soy-free and contained no
GMOs. The company’s products were available in most supermarket chains, medium and large
natural foods stores, and a few online food retailers in both the United States and Canada.
Except for its three varieties of roasts which were displayed in grocery freezer sections, Field
Roast meat products were located in the refrigerated section of grocery stores and had a “use-by”
date. However, their freshness could be extended by freezing them for up to a year; once thawed,
they were good for about 65 days.
Field Roast was acquired by Maple Leaf Foods in 2018.
ENDNOTES
1 John Fingus, “KFC’s plant-based ‘chicken’ sold out in five hours,” posted at https://www.engadget.com/2019/08/27/kfc-beyond-fried-chicken-
popular/ (accessed December 9, 2019).
2 As posted on www.beyondmeat.com (accessed December 9, 2019).
3 Beyond Meat, Form S-1, November 16, 2018, p. 82.
4 Ibid., p. 83.
5 Ibid., p. 81.
6 Ibid., p. 82.
7 Ibid., pp. 81–82.
8 Ibid., p. 82.
9 Ibid., p. 91.
10 Presentation at Barclay’s Global Consumer Staples Conference, September 5, 2019, posted in the Investor Relations section at
www.beyondmeat.com (accessed December 10, 2019) and Company 10-K report for 2019.
https://www.engadget.com/2019/08/27/kfc-beyond-fried-chicken-popular/
http://www.beyondmeat.com/
http://www.beyondmeat.com/
11 Jemima Webber, “McDonald’s and Beyond Meat Launch Vegan ‘P.L.T.’ Burger,” posted at https://www.livekindly.co/mcdonalds-vegan-beyond-
meat-burgers/, September 26, 2019 (accessed December 30, 2019).
12 Food and Agriculture Organization of the United Nations, “Sources of Meat,” http://www.fao.org/ag/againfo/themes/en/meat/backgr_sources.html
(accessed January 9, 2020).
13 Beyond Meat, Form S-1, November 16, 2018, p.84.
14 Tonya Garcia, “Beyond Meat, Tyson’s Raised & Rooted and other plant-based foods are officially mainstream,” www.marketwatch.com, January 10,
2020 (accessed January 11, 2020).
15 Ibid., pp. 15, 71, 92.
16 Ibid., p. 92.
17 Ibid., p. 85.
18 Ibid., pp. 85–86.
19 Ibid., p. 86.
20 Ibid.
21 Ibid.
22 Ibid.
23 Company press release, January 8, 2020.
24 Posted at www.impossiblefoods.com (accessed January 2, 2020).
25 Brian Cooley, “National rollout of Burger King’s Impossible Whopper is here,” posted at www.cnet.com, September 1, 2019 (accessed December 30,
2019).
26 As reported in Nicole Lee, “Impossible Sausage to be in Burger King’s breakfast croissants,” www.engadget.com, January 6, 2020 (accessed
January 9, 2020).
27 Cooley, “National rollout of Burger King’s Impossible Whopper is here.”
28 Ibid.
29 Company press release, March 3, 2020.
https://www.livekindly.co/mcdonalds-vegan-beyond-meat-burgers/
http://www.fao.org/ag/againfo/themes/en/meat/backgr_sources.html
http://www.marketwatch.com/
http://www.impossiblefoods.com/
http://www.cnet.com/
http://www.engadget.com/
H
page C-140
CASE 11
Netflix’s 2020 Strategy for Battling Rivals in the
Global Market for Streamed Video Subscribers
Copyright ©2021 by Arthur A. Thompson. All rights reserved.
Arthur A. Thompson
The University of Alabama
eading into 2020, Netflix was demonstrating significant competitive muscle in attracting millions of
new subscribers across the world to its service for streamed internet content, despite the entry of
formidable new competitors in 2019 and announcements of more to come in 2020. Netflix grew its paid
membership base from 139.3 million at year-end 2018 to 167.1 million worldwide at year-end 2019; it
expected to add another 7 million new paid subscribers in the first quarter of 2020. Netflix was
addressing the growing competition in the global market for streamed entertainment content by
increasing its releases of new original content and strengthening efforts to grow its user base in high-
opportunity country markets.
Over the past nine years, the company had successfully transformed its business model from one
where subscribers paid a monthly fee to receive an unlimited number of DVDs each month (delivered
and returned by mail with one to three titles out at a time) to a model where subscribers paid a monthly
fee to watch an unlimited number of movies and TV episodes streamed over the Internet. During the
same time frame, Netflix had expanded its geographic coverage to over 190 countries, making it the
world’s leading Internet television network. During the past five years, Netflix had made another
adjustment in its business model, shifting from a content library consisting mainly of titles licensed
from the movie studios, broadcast TV networks, and other sources that produced them to a content
library that increasingly consisted of its own self-produced original content (feature films, multi-episode
series, and documentaries). Netflix members, as well as households subscribing to rival content
providers, could not only watch as much streamed content as they wanted—anytime, anywhere, on
nearly any Internet-connected screen—but they could also play, pause, and resume watching, all without
commercials.
In its April 2019 report of Netflix’s financial and operating results for the first quarter of 2019,
management said Netflix subscribers were watching more than 165 million hours of the company’s
content offerings per day. In reporting the company’s quarterly performance during the remainder of
2019, Netflix management did not disclose the total viewership hours per day, saying only that daily
viewership hours worldwide were growing. The company tracked viewership of each title.
In the United States, Netflix still had 2.1 million members as of December 31, 2019 who, because of
limited Internet service or just personal preference, continued to receive DVDs solely by mail (but the
numbers of mail-only subscribers had been declining monthly as members transitioned to streaming).
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(163.9
) 30.8 (591.5)
(378.80
) (542.0)
19.2 73.8 (73.6) 15.2 195.3
Netflix’s swift growth to 61 million paid subscribers in the United States and its promising potential
for rapidly growing its base of international subscribers far past 100 million (some industry analysts
believed Netflix had a clear path to 350 million subscribers worldwide by 2025) pushed the company’s
stock price from $270 at the beginning of 2018 to $380 in the second week of February
2020. (Netflix’s all-time high stock price was $423 in July 2018). Already solidly
entrenched as the global leader in paid memberships for streamed content, the principal questions for
Netflix in 2020 seemed to be:
Whether the company had sufficient competitive and financial strength to combat the efforts of larger,
resource-rich rivals looking to steal subscribers away from Netflix.
Whether the company could grow its subscriber base fast enough to (1) produce the revenues and
internal cash flows needed to finance an ever-larger annual stream of original content that would
please subscribers and also (2) enable the company to be attractively profitable over the long-term.
Financial statement data for Netflix for 2015 through 2019 are shown in Exhibits 1 and 2. Netflix had
never paid a dividend to its shareholders and the company had declared it had no present intention of
paying any cash dividends in the foreseeable future.
EXHIBIT 1 Netflix’s Consolidated Statements of Operations, 2015–2019 (in
millions, except per share data)
[(g) For tables, all underlines should be the length of the longest numerical entry in each column, which may sometimes vary
from column to column; align vertically on $ and ones digits; set end parenthesis to the right of the ones digit and no
underline; underlines should be continuous, no breaks for commas or parentheses]
2015 2016 2017 2018 2019
Revenues $6,779.5 $8,830.7 $11,692.7 $15,794.3 $20,156.4
Cost of revenues (almost all of which relates to
amortization of content assets) 4,591.5 6,257.5 7,659.7 9,967.5 12,440.2
Gross profit 2,188.0 2,800.8 4,033.0 5,826.8 7,716.2
Operating expenses
Technology and development 650.8 780.2 1,052.8 1,221.8 1,545.1
Marketing 824.1 1,097.5 1,278.0 2,369.5 2,652.5
General and administrative 407.3 315.7 863.6 630.3 914.4
Total operating expenses 1,882.2 2,421.0 3,194.4 4,221.6 5,112.0
Operating income 305.8 379.8 838.7 1,605.2 2,604.3
Interest and other income (expense)
Income before income taxes 141.9 260.5 485.3 1,226.5 2,062.2
Provision for (benefit from) income taxes
Net income $ 122.6
$
186.7 $ 558.9
$
1,211.2 1,866.9
Net income per share:
Basic $ 0.29
$
0.44 $ 1.29
$
2.78 $ 4.26
Diluted 0.28 0.43 1.25 2.68 4.13
Weighted average common shares outstanding (in
millions)
Basic 425.9 428.8 431.9 435.4 437.8
page C-142
2015 2016 2017 2018 2019
Diluted 436.5 438.7 446.8 451.2 451.8
Note 1: Some totals may not add due to rounding.
Source: Company 10-K reports for 2010, 2017, and 2019.
EXHIBIT 2 Selected Balance Sheet and Cash Flow Data for Netflix, 2015–2019
(in millions)
2015 2016 2017 2018 2019
Selected Balance Sheet
Data
Cash and cash equivalents $1,809.3 $ 1,467.6 $ 2,822.8 $ 3,794.5 $ 5,018.4
Current assets 5,431.8 5,720.3 7,670.0 9,694.1 6,178.5
Total current and non-current
content assets 7,218.8 14,682.0 20,112.20 20,107.5 $24,504.5
Total assets 10,202.9 13,586.6 19,012.7 25,974.4 33,975.7
Current liabilities 3,529.6 4,586.7 5,466.3 6,487.3 6,855.7
Long-term debt* 2,371.4 3,364.3 6,499.4 10,360.1 14,759.3
Stockholders’ equity 2,223.4 2,679.8 3,582.0 5,238.8 7,582.2
Cash Flow Data
Net cash (used in) provided by
operating activities $ (749.4) $(1,474.0) $ (1,785.9) $(2,680.5)
$
(2,887.3)
Net cash provided by (used in)
investing activities (179.2) 49.8 34.3 (339.1) (387.1)
Net cash provided by (used in)
financing activities 1,640.3 1,091.3 3,077.0 4,048.5 4,505.7
*All of Netflix’s long-term debt consisted of senior unsecured notes that were issued at various points in time and had various
maturity dates and various fixed rates of interest.
Sources: Company 10-K Reports 2011, 2015, 2017, and 2019.
THE FAST-CHANGING MARKET FOR STREAMED
ENTERTAINMENT
In 2020, the world market for streamed entertainment (movies, episodes of TV shows, and live-
streamed events) was undergoing rapid and disruptive change. There were three big change drivers:
1. Increasingly pervasive consumer access to both wired and wireless high-speed Internet connections.
Worldwide rollout of 5G (fifth generation) wired and wireless digital networks promised to increase
data connection speeds by 3 times those of the 3G and 4G digital networks currently serving most
households and individuals across the world. Wired and wireless high-speed data connections greatly
increased the ease with which households and individuals could use a TV, desktop computer, portable
computer, or smartphone, coupled with a growing array of apps, to instantly connect to any Internet-
accessible source/website with streaming capability and content to stream. The upcoming
introduction of 5G mobile phones was widely expected to dramatically increase the time consumers
used their smart phones to watch streamed content, particularly broadcasts of live sporting events,
breaking news, and assorted other programs of interest.
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2. A fast-moving and likely permanent shift in consumer preferences worldwide for watching content
streamed directly to whatever device they wanted to use at whatever times they wanted to watch,
rather than being locked into watching their favorite programs at the time they were broadcast on TV
channels. Cable and satellite firms were losing subscribers annually, partly because these subscribers
were unhappy about having to pay what they considered an outsized price for a multi-channel
package containing more channels than they watched and partly because they could access their
favorite programs from a growing number of streamed sources (and also subscribe to one
or more streamed content sources with sizable content libraries containing ongoing
releases of new original content), thereby giving them an attractively wide variety of content
selections at a lower overall cost that could be watched whenever they wished.
3. The mounting vigor with which well-known, resource-rich companies were launching strategic
initiatives to (a) build bigger and more attractive content libraries—sometimes by merging with or
acquiring the owners of attractive content libraries, sometimes by licensing a bigger assortment of
attractive titles from various content owners, and sometimes by establishing in-house content
development and production capabilities and (b) launching marketing campaigns to publicize and
promote the content libraries they had assembled in an effort to secure a large enough base of paid
streaming subscribers to cover the costs of their content libraries and streaming service and earn
a profit.
During the past decade, the market for in-home entertainment other than broadcast and cable TV
programs had evolved rapidly as households with high-speed Internet service and/or Internet-connected
TVs or DVD players quickly shifted away from subscribing to Netflix’s DVDs-by-mail service or else
renting or buying physical DVDs with the desired content to almost exclusively watching streamed
movies, previously broadcast episodes of TV shows, YouTube videos, and titles in the original content
libraries of paid-subscriber providers, and other types of streamed content. This was because streaming
had the advantage of allowing household members to access and instantly watch the movies, TV
episodes, and other available content they wanted to see, which was much more convenient and often
cheaper than patronizing a nearby rent-or-purchase location getting DVDs by mail from Netflix. This
shift had permanently undercut the once-thriving businesses of selling movie and music DVDs and/or
renting DVDs at local brick-and-mortar locations and standalone rental kiosks (like Redbox in the
United States) or delivering/returning DVDs by mail (as at Netflix).
By 2020, faster internet speeds, the fast-growing and likely permanent shift in consumer preferences
worldwide for watching content streamed directly to whatever device they wanted to use at whatever
times they wanted to watch it, and rapid entry of new streamed content providers like AT&T’s HBO
Max, Disney+, Comcast’s new Peacock offering, ViacomCBS, Apple TV+, and dozens of others in
various geographic regions looking to compete with Netflix and Amazon’s Prime Video had combined
to unleash an increasingly intense competitive global battle among streaming providers to become
serious contenders in the global market for subscriber-based streamed content—a market that was
widely expected to be “the wave of the future,” include billions of individuals and households, and be
highly disruptive to the businesses of traditional cable and satellite providers, whose subscriber counts
had declined annually for several years. College graduates and many millennials typically avoided
subscribing to cable providers because of the “high” monthly prices and the growing availability of
cheaper substitutes for viewing the programs they really wanted to watch or were satisfied
with watching.
In 2019, a study by the Motion Picture Association of America (MPAA) reported that the number of
streamed video subscribers grew to 613 million in 2018 (an increase of 27 percent over 2017), while the
number of cable subscriptions worldwide dropped 2 percent to 551 million.1 However, cable
subscriptions generated the biggest revenues ($118 billion), followed by satellite subscriptions and
streaming video subscriptions. According to the MPAA study, in 2018 80 percent of people in the
page C-144
United States watched cable programs, with 70 percent also watching streamed programs. The MPAA
report further noted that the number of views/transactions of TV and film programs streamed from
subscription-based providers, pay-per-view sources, and ad-supported sources jumped from 76.4 billion
in 2014 to 182.1 billion in 2018, a four-year increase of 238 percent. The increase was partly due to an
increase in the number of scripted original dramas across all sources from 390 in 2014 to 496 in 2018.
Exhibit 3 shows the percentage of Internet users, by country, who watched online video content on
any device as of January 2018.
EXHIBIT 3 The Percentage of Internet Users in Selected Countries Who Watched
Online Video Content on Any Device as of January 2018
Country Percentage of Internet Users Watching Online VideoContent on Any Device
Saudi Arabia 95%
China 92%
New Zealand 91%
Mexico 88%
Australia 88%
Spain 86%
India 85%
Brazil 85%
United States 85%
Canada 83%
France 81%
Germany 76%
South Korea 71%
Japan 69%
Source: Statista, www.statista.com (accessed April 10, 2018).
A SAMPLING OF NETFLIX’S COMPETITORS IN THE GLOBAL
MARKET FOR STREAMED VIDEO SUBSCRIBERS
Going in 2020, Netflix’ principal direct competitors included Amazon’s Prime Video, AT&T (with its
Warner Media and HBO Max subscription options), Disney+, Apple TV+, Comcast’s new Peacock
offering, and A new ViacomCBS streamin option, and AppleTV+, CBS All Access, all of whom had
professed or exhibited a strategic intent to rank among the industry leaders—YouTube was not
considered a direct competitor because its free and paid video content was distinctly different from the
titles offered by Netflix and its direct competitors. Following is a brief description of the media
resources and competitive capabilities of the chief rivals Netflix expected to battle in competing for
streamed entertainment subscribers in countries across the world.
Amazon’s Prime Video
Amazon competed directly with Netflix via its Amazon Prime membership service. In 2020, individuals
and households could become an Amazon Prime member for a fee of $119 per year or $12.99 per month
http://www.statista.com/
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(after a one-month free trial); there was a discounted price for students of $59 per year of $6.49 per
month. Membership in just Prime Video was $8.99 per month. Going into 2020, Amazon announced
that it had over 150 million Amazon Prime members globally.2 While Amazon had originally created its
Amazon Prime membership program as a means of providing unlimited two-day shipping (more
recently, one-day shipping in many locations and two-hour grocery delivery in 2,000 cities) on Prime-
eligible items to customers who ordered merchandise from Amazon and wanted to receive their orders
quickly, in 2012 Amazon began including movie and music streaming as a standard benefit of Prime
membership—Amazon’s video streaming service was called “Prime Video.” Amazon Prime members
were not, however, eligible to view every title in the Prime Video library for free; titles that were not
Prime-eligible could be watched on a pay-per-view basis or else purchased. Going into 2020, many
Amazon Prime members did not utilize their Prime Video membership benefit (Amazon did not disclose
the overall percentage). Another video benefit of Amazon Prime membership was the ability to
subscribe to over 100 premium channels with Prime Video Channels subscriptions.
In 2010, Amazon established Amazon Studios to oversee the development and production of new in-
house original movies and multi-episode series; approximately 200 new original titles were released
during 2015–2018. A 2019 report by Streaming Observer, an independent news site covering streaming
industry news and reviews of movies, said that Amazon’s Prime Video content library contained 17,461
titles versus 3,839 for Netflix and 2,336 for Hulu.3 However, according to the same Streaming Observer
report, Netflix had 592 titles that were “Certified Fresh” by Rotten Tomatoes (the leading online
aggregator of movie and TV show reviews) versus 232 such films on Prime Video and
223 on Hulu. Additionally, the report said almost 16 percent of all movies on Netflix were
“critically acclaimed” compared to just 1.3 percent on Prime Video.
But in 2017 and continuing forward, Amazon began a strategic initiative to upgrade its content
library, with both higher caliber new original content and licensed content. Amazon paid the National
Football League $65 million a year for three seasons starting with 2017 season to live stream Thursday
Night Football games globally to Prime Video members in 200 countries (these broadcasts attracted
more than 18 million total viewers over 11 games in 2017). Amazon Studios spent a reported
$250 million for licensing right to Lord of the Rings, with plans for spending up to $1 billion to produce
5 seasons of episodes. Amazon Studios spent an estimated $5–$6 billion on original content videos in
2019, releasing new titles monthly, including new seasons of Tom Clancy’s Jack Ryan, Emmy-winning
The Marvelous Mrs. Maisel, Bosch, Sneaky Pete, Good Omens, Carnival Row, The Man in the High
Castle, The Boys, Emmy-winning Fleabag, The Romanoffs, Patriot, American Gods, Preacher, and The
Grand Tour. Prime members watched double the hours of original movies and TV shows on Prime
Video in the fourth quarter of 2019 compared to the fourth quarter of 2018, and Amazon Originals
received a record 88 nominations and 26 wins at the Oscar, Emmy, and Golden Globe awards shows.4
The Walt Disney Company, Disney+, Hulu, and ESPN+
The Walt Disney Company in 2020 was a leading diversified international family entertainment and
media enterprise with businesses that included the ABC branded broadcasting network; multiple cable
channels (the ESPN family of five domestic channels and 15 international channels, three domestic
Disney branded channels and approximately 100 Disney branded international channels, three FX
channels, Freeform, National Geographic, and 50 percent ownership of A&E, which offered its own
entertainment programming and operated four other cable channels); ABC Studios, Twentieth Century
Fox Television, and Fox 21 Television which produced many of the company’s TV shows; theme parks
and resorts; Disney Cruise Lines; the sale of Disney-related merchandise at The Disney Stores and
assorted online sites; merchandising licensing covering a wide range of product categories and licensing
of Disney’s wide-ranging intellectual property; motion picture production and distribution under the
Walt Disney Pictures, Twentieth Century Fox, Marvel, Lucasfilm, Pixar, Fox Searchlight Pictures, and
page C-146
Blue Sky Studios banners; and direct-to-consumer streaming services which included Disney+, ESPN+,
Hulu, and Hotstar.
Starting in 2018, Disney made a series of strategic moves to strengthen its capabilities to enter the
video streaming market by acquiring 100 percent control of streaming provider Hulu, which at the time
had about 25 million subscribers in the United States. At the time, Hulu was a joint venture co-owned
by Walt Disney (30 percent), Fox (30 percent), Comcast (30 percent), and Time Warner (10 percent),
but Disney put a deal in place in late 2018 to buy Fox’s 30 percent share of Hulu and then, months later,
AT&T sold its 10 percent of Hulu to the Disney-Comcast owners of the Hulu joint venture for $1.43
billion. In May 2019, Comcast and Disney announced an agreement whereby Disney would have full
100-percent control of Hulu, starting immediately. The Disney-Comcast agreement specified that
Comcast would continue to allow Hulu to carry all NBCUniversal content as well as live-stream
NBCUniversal channels for Hulu’s live TV service until late 2024 (Comcast was the 100-percent owner
of NBCUniversal). The deal called for Comcast’s ownership stake in Hulu to be officially sold to
Disney starting in January 2024.
Hulu’s strategy for attracting subscribers had been to attract subscribers by charging a subscription
fee of $5.99 per month for regular streaming (interspersed with ads) and $11.99 per month for
commercial-free streaming; new subscribers also got a one-month free trial. These two options entitled
subscribers to watch current season episodes of popular TV shows (the day after they aired on ABC,
NBC, Fox, and a few cable channels—no CBS shows were included) plus an estimated 43,000 back-
season episodes of 1,650 TV shows and 2,500 movies. In addition, Hulu offered plans that included not
only its video streaming service, but also packages that included 60+ live TV and cable channels (that
included sports, news, and entertainment) for a monthly fee of $54.99 and options to add on HBO®,
Showtime®, Starz®, and Cinemax®. In March 2020, Disney launched FX on Hulu” that featured every
season of many originals that aired on FX over the past 17 years and that, going forward,
would include new original scripted series by FX Productions shown exclusively to Hulu
subscribers. In recent years, consumers disenchanted with the Further expansions are planned for
Europe and Latin America in late 2020 through 2021, as Disney’s existing international streaming
distribution deals with competing services expire. Reaming prices of cable subscriptions had come to
consider Hulu as their “go-to” choice, and it was widely considered the best streaming provider for
watching TV shows. Nonetheless, Hulu had been a money-losing operation every year since its
streaming service began operations in March 2008.
Disney debuted its new Disney+ streaming service on November 12, 2019, in the United States,
Canada, and The Netherlands at low introductory prices of $69.99 per year or $6.99 per month. A week
later, Disney+ was made available in Australia. New Zealand, and Puerto Rico and then further
expanded to select European countries in March 2020. Additional expansions were planned for Europe
and Latin America in late 2020 through 2021, as Disney’s existing international streaming distribution
licensing agreements with competing services expired.
Disney+ offerings centered on existing film and television content from Walt Disney Studios
(including the Star Wars series), the three Disney TV channels, Pixar, Marvel, National Geographic, and
20th Century Fox, plus forthcoming new original content from these same sources. Disney’s
longstanding reputation for family entertainment attracted an unexpectedly large rush of new
subscribers in the first three months—50 million worldwide as of April 10, 2020. This big subscription
gain was partly due to the fact that, due to a deal between Disney and Verizon, whereby certain Verizon
subscribers could sign up for a free one-year subscription to Disney+ until June 1, 2020, if they agreed
that when the free 12-month subscription expired their Disney+ subscription would auto-renew at $6.99
per month, and they would be charged monthly on their Verizon bill unless the subscription was
cancelled with Verizon. The 50 million number also included 8 million subscribers in India who were
able to access Disney+ through Hotstar, a streaming service owned by Disney.
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Concurrent with the launch of Disney+ in November 2019, Disney began offering a bundle of
Disney+, (ad supported) Hulu, and ESPN+ for $12.99 per month with no free trial included at both the
Disney+ and Hulu websites in the United States. ESPN+ was a conglomeration of live sports programs
(select live MLB, NHL, NBA, MLS, and Canadian Football League games, as well as multiple college
sports games, PGA golf events, Top Rank Boxing matches, Grand Slam tennis matches, United Soccer
League games, cricket and rugby games, English Football League games, and UEFA Nations League
games that were not broadcast live on any of ESPN’s family of channels (ESPN, ESPN2, ESPNU,
ESPN Classic, ESPNews, ESPN Deportes, Longhorn Network, SEC Network, and ACC Network).
ESPN+ was only available to viewers in the United States; the regular subscription fee for ESPN+ was
$49.99 per year or $4.99 per month. ESPN+ had 7.6 million subscribers in the United States as of
February 2020, up from 3.5 million paying subscribers in November 2019—the big increase was mainly
due to the bundling promotion.
Disney management expected to have between 60 and 90 million Disney+ subscribers worldwide by
2024—the same year it believed the service would become profitable. The majority of those subscribers
were forecast to be outside the United States.
AT&T’s Two Video Streaming Subscription Options: Warner Media and HBO Max
In June 2018, AT&T completed its $108.7 billion acquisition of Time Warner, whose businesses
consisted of global media and entertainment leaders Warner Bros. and WarnerMedia Entertainment.
Warner Bros. business assets included the film studios and content libraries of Warner Bros. Pictures,
New Line Cinema, Castle Rock Entertainment, and DC Films; a television production and syndication
company; animation studios and their film libraries; and publishing company DC Comics. The
WarnerMedia Communication Group included such assets as: the studios and film libraries of Home
Box Office (HBO); broadcast and cable channels CNN, TBS, TNN, and TruTV; pay TV channels
Cinemax, Cartoon Network, Boomerang, and Turner Classic Movies; and digital media company Otter
Media. AT&T’s new HBO division had 140 million subscribers who had access to HBO network’s
seven 24-hour multiplex channels through their cable or satellite provider (or as an add-on through
Hulu); the add-on price paid to cable/satellite provider (or to Hulu) was $14.99 per month, cancellable
at any time. All such HBO subscribers could download a free downloadable HBO GO app
that could be used to access the HBO GO website; then, after entering their user name and
password for their account at whatever provider to whom their HBO subscription fee was paid, the
HBO subscriber could click on the desired HBO content and view it on mobile phones, laptops, and
computers. AT&T/HBO had no interest in offering HBO GO access to people who were not already
HBO subscribers because HBO’s principal revenue source was a percentage of the monthly fees that its
140 million subscribers across the world paid their cable/satellite company (or Hulu) for access to HBO
programming as part of their total subscription package.
AT&T executives believed Time Warner’s businesses nicely complemented AT&T’s core businesses
in mobile, broadband, cable and satellite TV, and telephone communications in the United States,
mobile services in Mexico, and pay TV services in 11 countries in South America and the Caribbean.
AT&T’s cable and satellite TV operations lost a combined 4 million subscribers in 2019, bringing the
number of total subscribers for AT&T’s various cable and satellite (DIRECTV) packages down to 19.7
million.
However, it was AT&T’s strategic plan in 2020 to achieve nationwide coverage of 5G by mid-year;
launch its new HBO Max streaming video service in May 2020 with a goal of securing 50 million
subscribers in the United States and another 25 to 40 million international subscribers by 2025; and
curtail the loss of subscribers to AT&T’s cable and satellite services via simplified product packages and
bundling opportunities with such other AT&T communication products as higher-speed broadband
service, home security and monitoring packages, telephone services, and possibly discounted HBO Max
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subscriptions. The announced monthly price for the HBO Max streaming service was $14.99, the same
price currently being paid by HBO Now’s roughly 5 million direct subscribers. Plans were for current
HBO subscribers through cable/satellite providers and direct HBO Now subscribers to be provided
bundled access to HBO Max for free. AT&T expected that HBO Now subscribers would quickly
migrate over to HBO Max, which would help grow total HBO Max subscriptions to 36 million by the
end of 2020.
HBO Max was expected to launch with roughly 10,000 titles from the WarnerMedia film libraries of
its various movie studios, all of HBO’s content, a number of licensed shows, and 20+ fresh Max
originals—the crown jewel of the originals was said to be House of the Dragon, a 10-episode story
about the Targaryens centuries prior to the Game of Thrones.
Comcast’s New Peacock Streaming Service
In January 2020, Comcast and its subsidiary NBCUniversal, jointly announced the launch of a new
Peacock subscription video streaming service that would become available at no additional cost for
Comcast’s more than 20 million Xfinity X1 and Flex cable subscribers on April 15 and then launch July
15 for everyone else. The free tier of Peacock (Peacock Free) contained more than 7,500 hours of ad-
supported programming, including next-day access to first season TV shows broadcast on NBC, a
collection of Universal movies, and access to back seasons of such iconic NBC shows as Saturday Night
Live, Family Movie Night, and Vault. However, Comcast subscribers and Cox cable subscriber could opt
instead to subscribe to Peacock Premium, which included 15,000 hours of content, early access to
NBC’s 2 late night shows, live NBC sports programming, and non-televised Premier League soccer
games. There were two price tiers for Peacock Premium: a $4.99 per month version that included ads
and a $9.99 version with no advertising.
Steven Burke, a Comcast Executive Vice President and Chairman of NBCUniversal believed
NBCUniversal was uniquely positioned to create a streaming platform that would monetize its content
library and enable NBCUniversal to play a leading role in the on-demand video streaming world:5
Comcast management decided to use NBC’s familiar peacock logo as the logo for the company’s new
subscription-based streaming service to remind customers that NBC was a network with great
programming and to drive interest back to NBC’s popular event-type TV programs (The Masked Singer,
The Last Voice, America’s Got Talent) and NBC’s live sports programming, which included the 2020
Summer Olympics. Top management at Comcast and NBCUniversal believed that while streamed video
might indeed be the future of watching TV and movies, the cable business would remain profitable for
years to come (despite the likely permanent declines in the number of cable and satellite subscribers
worldwide) and, further, that free ad-supported viewing was likely to remain far more prevalent and
popular with consumers than subscription-supported viewing. Comcast management believed that
bundling Peacock Free for customers with Comcast cable subscriptions would help reduce
the number of customers dropping the company’s cable service and switching to a rival
streaming provider. Hence, they saw no good business reason to create a streaming platform with
strategy elements that would help undermine the profitability and longevity of company’s cable
business.
During a Peacock Investor Day presentation on January 16, 2020, a NBCUniversal officer cited a
survey where consumers were asked “Which new streaming service are you likely to try—one that is
free with some ads or one that is paid with no ads?” Eighty percent responded “free with some ads,” and
20 percent responded “paid with no ads.” These results were a factor in convincing the Comcast-
NBCUniversal management team to position Peacock as an ad-supported streamer of premium content
in what they viewed as a mostly vacant market niche (among rival video streaming providers, only Hulu
offered consumers a low-priced, ad-supported streaming option). Moreover, the Peacock strategy was to
help secure a competitive edge by having an industry-low average of five minutes of ads per hour,
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which contrasted sharply with TV broadcasting where there were 16–20 minutes of ads per hour and
premium video streaming where there was an average of eight minutes of ads per hour.6 And Peacock
Free’s ad-supported streaming of premium content helped differentiate it from the three competitively
strong subscription-based providers—Netflix, Amazon Prime Video, and HBO Max. Peacock
management believed it would have little difficulty selling ads for Peacock’s content, given that NBC,
ABC, CBS, FOX, and some 250 other channels had advertising-based business models representing 92
percent of total viewership.7
NBCUniversal said it would invest $2 billion in Peacock over 2020 and 2021, with goals of reaching
between 30 and 35 million active users in the United States by 2024, generating $2.5 billion in new
revenues with average revenue per subscriber of $6–$7, and achieving break even on Peacock’s
streaming service on an earnings before interest, taxes, depreciation, and amortization (EBITDA) basis.
ViacomCBS and CBS All Access
Viacom and CBS completed their long-expected and often contentious merger in December 2019,
creating a multinational media conglomerate with assets approaching $50 billion and 2019 revenues of
$27.8 billion. The new company’s main assets included Paramount Pictures film studio and a library of
3,600 movies; the CBS broadcasting network and its library of 140,00 TV episodes, a streaming
platform called CBS All Access that provided approximately 4.5 million subscribers in the United
States, Canada, and Australia with access to current and back season CBS TV shows, CBS Sports (NFL,
college football, and college basketball games), other recently-aired programs on CBS broadcast
properties; a number of CBS-affiliated television stations; CBS Television Studios and CBS Studios
International; cable television networks MTV, Nickelodeon (watched in 600 million households around
the world), BET, Comedy Central, CMT (Country Music Television), Showtime, The Movie Channel,
VH1, Flix, and TEN (a high profile channel in Australia); free ad-supported video-on-demand platform
Pluto TV with 100+ live TV channels and thousands of TV shows and movies; 50 percent co-ownership
with AT&T’s WarnerMedia subsidiary of The CW Television Network (commonly referred to as just
The CW); Nickelodeon Animation Studio; an assortment of international and regional networks and
operations that provided the company with the capability to engage in video streaming in many
countries; and book publisher Simon & Schuster. CBS’s media properties alone made it a global media
titan, with some 4.3 billion watchers of its broadcast and pay TV programs in 180 countries at year-end
2019.
In early 2019, before the merger, Viacom had purchased Pluto TV for $360 million and proceeded to
expand its offering of 100 ad-supported channels by adding 43 channels in the fourth quarter of 2019,
including 22 Spanish and Portuguese ones that were popular in Latin America and Brazil; Pluto’s
subscriber base grew over 70 percent in 2019 to a total of over 20 million going into 2020. On
December 20, 2019, ViacomCBS announced it was buying a 49 percent ownership stake in Miramax
Pictures for an upfront payment of $150 million and an agreement to invest $225 million in Miramax
for movie and television productions over the next five years. The deal also specified that ViacomCBS’s
Paramount Pictures would become the exclusive distributor for the Miramax library of 700+ films and
have a first-look at Miramax’s new content creation.
In February 2020, ViacomCBS executives were in the final stages of readying plans to launch a new
video streaming service built around the CBS All Access streaming service, that would be
expanded to include a broad pay “House of Brands” product offering comprised of a wide
assortment of titles from Viacom’s multiple libraries and selected popular shows on BET, Nickelodeon,
MTV, Comedy Central, Showtime, and perhaps others. Further, the new streaming service would draw
heavily upon the capabilities of Paramount’s and Miramax’s movie and television production studios,
Nickelodeon’s Animation Studio, and perhaps other ViacomCBS operations to develop and produce
new original content. Going into 2020, ViacomCBS had global production studios that were currently
turning out over 750 shows with 43,000 episodes.8
ViacomCBS said the base tier of the new streaming service would be ad-supported, but there would
be two higher-end tiers: an ad-free version and a premium version that included Showtime. It was
speculated that ViacomCBS’s new streaming service could be the final significant streaming offering
that hit the market as traditional media companies repositioned themselves and recast their strategies in
preparing for a post-cable TV future.
AppleTV+
Apple launched its Apple TV+ video streaming service on November 1, 2019, in over 100 countries that
could be accessed on smart TVs connected to an Apple TV box or on new TV models that had the
Apple TV app already installed, or Apple devices with a downloaded Apple TV app. Pitched as Apple’s
strategic means of competing directly with Netflix, Amazon Prime Video and Disney+, the new Apple
TV+ service streamed Apple’s original programming only through Apple TV-capable devices. An
Apple TV+ subscription could be shared with up to six family members. At $4.99 per month (or free for
one year with the purchase of a new Apple device), the cost of Apple’s streaming service was lower
than the monthly subscription service for most of its video streaming rivals.
At launch, there were just nine Apple Originals available to view; the number had increased to a total
of 20 multi-episode shows and five films as of June 2020. However, Apple had committed to adding
new originals every month and 26 new original series and seven films were in development for release
later in 2020 and 2021. Apple was reportedly planning to spend about $4.2 billion on original
programming by 2022.
While Apple had yet to disclose subscriber numbers for its TV+ service, an analyst at Wall Street
firm at Sanford C. Bernstein had estimated that, as of February 2020, fewer than 10 million of the
eligible consumers purchasing a new Apple device had opted to sign up for a free 12-month trial of
Apple TV+.9 It was speculated that Apple TV+’s failure to resonate with consumers was largely due to
its unusually limited content offerings. In December 2019, one of the analysts participating on an expert
panel hosted by UBS (a well-known global financial services firm) said that Apple TV+ “needs a mega-
hit original series to ultimately retain subscribers,” adding that the company “may likely have to
ultimately also acquire an asset with a big backlog of catalog content—most of which will be very
expensive at this point.”10
YouTube TV
In April 2020, Google’s YouTube subsidiary was offering a YouTube TV streamed entertainment
service that included about 70 TV and movie channels for a fee of $50 per month. The service could be
accessed on smart TVs, streaming boxes, computers, and mobile devices. As of early 2020, YouTube
TV had over 2 million subscribers.
NETFLIX’S BUSINESS MODEL AND STRATEGY IN 2020
Since launching the company’s online movie rental service in 1999, Reed Hastings, founder and CEO of
Netflix, had been the chief architect of Netflix’s subscription-based business model and strategy that
had transformed Netflix into the world’s largest online entertainment subscription service. Hastings’s
goals for Netflix were simple—build the world’s best Internet service for entertainment content, keep
improving Netflix’s content offerings and services faster than rivals, attract growing numbers of
subscribers every year, and grow long-term earnings per share. Hastings was a strong believer in
moving early and fast to initiate strategic changes that would help Netflix outcompete rivals, strengthen
its brand image and reputation, and fortify its position as the industry leader.
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A Quick Overview of the Evolutionary Changes in Netflix’s Subscription-Based
Business Model and Strategy, 1999–2019
Netflix had employed a subscription-based business model throughout its history, with members having
the option to choose from a variety of subscription plans whose prices and terms had varied over the
years. Originally, all of the subscription plans were based on obtaining and returning DVDs by mail,
with monthly prices dependent on the number of titles out at a time. But as more and more households
began to have high-speed Internet connections, in 2007 Netflix began bundling unlimited streaming
with each of its DVD-by-mail subscription options, with the long-term intent of encouraging subscribers
to switch to watching instantly streamed content rather than using DVD discs delivered and returned by
mail. As increasing numbers of subscribers gained access high-speed Internet connections, most quickly
switched over to unlimited streaming subscription plans, enabling Netflix to avoid incurring the order
fulfillment costs and postage costs associated with servicing DVD-by-mail subscribers. About two-
thirds of Netflix subscribers in the United States had transitioned to streaming-only plans by year-end
2011, and fewer than four percent of Netflix’s subscribers in the United States were on DVD-by-mail
plans at the end of 2019.
A third major shift in Netflix’s strategy began in 2010 when Netflix started to expand its streaming
service internationally, beginning with Canada. Entry into other countries followed quickly, as shown in
Exhibit 4, and Netflix became a truly global company in 2016. Despite dedicated efforts, going into
2020 Netflix had failed to surmount the barriers erected by the Chinese government that prevented its
entry into the People’s Republic of China, the world’s most massive market for entertainment. For the
past five years, the Chinese government had steadfastly refused to issue Netflix a license to operate in
China, preferring instead to control the content its citizens were allowed to see—for example,
government censors required that an entire series of a multi-episode offering had to be approved before
it could begin to be shown on an online platform. Aside from the censorship issue, most observers
believed the Chinese government was blocking Netflix’s entry in order to protect aspiring local
providers of Internet-streamed content from foreign competition. Recognizing its dim entry prospects,
in 2017 Netflix negotiated a licensing arrangement to exclusively provide some of its original content to
a fast-growing Chinese company named iQiyi (pronounced Q wee), the leading provider of online
entertainment services in China with some 106 million subscribers (as of September 30, 2019) and a
reported 500 million monthly active users watching an average of 12 hours each month on the
company’s platforms.11 Use of a licensing strategy was attractive to Netflix because it provided a means
of gaining content distribution in China and building some awareness of the Netflix brand and Netflix
content, but the licensing arrangement was expected to generate only small revenues for some years to
come. The U.S. government had instituted restrictions precluding all U.S.-based companies from having
operations in North Korea, Syria, and Crimea.
EXHIBIT 4 Netflix’s Rapidly-Executed Entry into New Geographic Areas
Year Entry into New Geographical Areas
September 2010 Canada
September 2011 42 countries in Central America, South America, and theCaribbean
January 2012 United Kingdom, Ireland
October 2012 Denmark, Sweden, Norway, Finland
September 2013 Netherlands
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Year Entry into New Geographical Areas
September 2014 Austria, Belgium, France, Germany, Luxembourg,Switzerland
March 2015 Australia, New Zealand
September 2015 Japan
October 2015 Spain, Portugal, Italy
January 2016
Rest of the world—some 130 countries (but excluding the
People’s Republic of China, North Korea, Syria, and
Crimea)
Source: Company 2017 10-K Report, p. 21.
Netflix estimated that it usually took about two years after the initial launch in a new country or
geographic region to attract sufficient subscribers to generate a positive “contribution profit”—Netflix
defined “contribution profit (loss)” as revenues less cost of revenues (which consisted of amortization of
content assets and expenses directly related to the acquisition, licensing, and
production/delivery of such content) and marketing expenses associated with its domestic
streaming and international streaming business segments (the company ceased all marketing activities
related to its domestic DVD business prior to 2015).
A fourth important shift in Netflix’s business model and strategy began in 2011–2012. CEO Reed
Hastings and other senior Netflix executives realized that there were low barriers to entry into the
subscription-based video streaming business for movie producers and TV broadcasters that had over the
years amassed big libraries of attractive content. Indeed, many of the titles that Netflix was streaming to
subscribers were being licensed from these very same entities, and the license fees for these titles were
rising rapidly, as content owners recognized that their title libraries had significant value to Netflix,
Amazon, and others who were in the streamed entertainment business and that they commanded
significant bargaining power to raise licensing fees as current licenses expired. Netflix executives
further foresaw that the company was likely to be put at a significant competitive disadvantage when
these content owners came to the conclusion they could make bigger profits from their content libraries
by starting up their own video streaming businesses to compete against Netflix for subscribers in many
country markets rather than licensing titles to Netflix. Reed Hastings and his executive team believed
that when content-rich rivals entered the streamed entertainment business (as they were certain to do at
some point) and triggered a head-on competitive battle for subscribers that the winners would be those
companies that potential subscribers viewed as having attractive and fresh content they were willing to
pay monthly or annual fees to watch. Furthermore, they were certain that when these rivals emerged,
they would discontinue renewing their licenses for popular programs (especially TV shows) with
Netflix, preferring to use these titles to attract new subscribers to their own streamed entertainment
services.
These realizations resulted in Netflix undertaking a long-term strategic initiative to change its
portfolio of titles from mainly all licensed to a portfolio of titles that was increasing comprised of
original content created, produced, and owned by Netflix. The company immediately moved to develop
and continually strengthen its in-house content creation and production capabilities, but it also elected to
supplement its internal efforts by entering into multi-year collaborative agreements with outside
developers and producers not owned by its rivals to license portions of their existing titles to Netflix and
to produce new original content that would be owned by Netflix or licensed to Netflix.
Netflix started streaming its first original content title, House of Cards, in February 2012; House of
Cards, a political drama that ran six seasons, was a major hit with subscribers, garnered acclaim from
critics and reviewers, and received 213 awards nominations (Golden Globe, Primetime Emmys, Screen
Actors Guild, and others) and 35 overall wins during 2013–2018. Netflix’s spending for new original
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content mushroomed during the ensuing years, with total spending for new content of $12 billion in
2018 and $15 billion in 2019, of which roughly 85 percent was estimated to be for original content.
Spending for 2020 was projected to be $17.3 billion on a cash basis, with 85 percent or more being
allocated to original content.12 One Wall Street analyst projected that Netflix’s spending for new content
could rise to $26 billion by 2028.13
Netflix’s Strategy in 2020
While over 4.5 billion (57.7 percent) of the world’s population of 7.8 billion people used the Internet as
of January 2020 (an increase of 298 million since January 2019)14, Netflix viewed the size of the near-
term market potential for securing streaming subscribers worldwide (including China) as being the
approximately 1.1 billion people/households currently having high-speed wired and wireless internet
service.15 Surveys conducted during 2019 indicated that the worldwide average amount of time
individuals spent using the internet on any device was 6 hours and 43 minutes, equal to more than 100
days of online time per year.16 The worldwide average fixed internet download speed in December 2019
was 73.6 million bits per second (mbps) and the worldwide average mobile internet download
connection speed was 32.0 mbps.17 These speeds were expected to climb steadily toward 100 mbps (or
more) by 2025, thereby making it feasible for hundreds of millions more households with fixed internet
connections to watch streamed content and paving the way for a rapidly rising percentage of people
worldwide to access streamed content on their smartphones or other mobile devices—going into 2020
there were some 3.5 billion users of smartphones.
Netflix’s strategy going into 2020 was focused squarely on:
Growing the number of global streaming subscribers, particularly in those countries/geographic
regions with the biggest growth opportunities.
Continuing to enhance the appeal of its library of streaming content, with growing emphasis on
exclusive original movies and original series produced in-house and in collaboration with selected
outside movie and TV show producers.
Increasing partnerships with movie and television producers in specific countries to produce original
content for audiences in that country’s language.
Focusing marketing and advertising on the particular countries and geographic regions deemed to
have the biggest subscriber growth potential.
Continuing to introduce mobile-only subscription plans in countries where a big percentage of the
population used mobile devices to watch streaming content.
Subscription Pricing Strategy
Going into 2020, Netflix offered three types of streaming membership plans. Its basic plan, currently
priced at $8.99 per month in the United States, included access to standard definition quality streaming
(640 × 480 pixels) on a single screen at a time. Its standard plan, currently priced at $12.99 per month
and included access to high-definition quality streaming (1080 × 720 pixels) on two screens
concurrently. The company’s premium plan, currently priced at $15.99 per month, included access to
4K ultra-high definition quality (3,840 × 2,160 pixels) content on four screens concurrently. Netflix
recommended three mbps of download speed for standard definition streaming, five mbps for high
definition and 25 mbps for 4K Ultra HD. During 2019, all three plans were attracting healthy numbers
of new subscribers—none of the three clearly stood out as “most popular” worldwide. Netflix
management believed this indicated “we’re providing a range of options at a range of price points that
allow consumers in the markets that we serve to sort of select into the right model.”18 However, over the
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past 5–8 years, there had been a very gradual shift towards the highest-priced premium plan, a trend
likely being driven by more households purchasing big-screen ultra-high definition TVs.
As of September 2019, international pricing for the three plans ranged from approximately $3 for a
mobile-only plan to $22 per month per U.S. dollar equivalent for a premium subscription plan in
Switzerland; in many countries, the monthly prices of standard and premium plans were in the range of
$9–$14 per U.S. dollar equivalent.19 Netflix executives expected that the prices of the various
subscription plans in each country would likely rise over time, thereby helping boost the global monthly
average revenue the company received per paying subscriber above the 2019 average of $10.82.
Netflix began testing a cheaper mobile-only $3 per month plan in 2018 in India, one of its key
developing markets because of the size of India’s population and heavy use of mobile devices for video
streaming. The $3 mobile-only plan test in India was successful in boosting subscriber growth and in
increasing member retention, prompting Netflix to expand its low-priced mobile offering to Malaysia
and Indonesia in 2019; the test in these countries similarly impacted subscriber growth and member
retention. In December 2019, Netflix began testing subscription discounts of up to 50 percent if new
subscribers signed up for three-, six- and 12-month plans; the goal was to gauge the impact of both
lower prices and multi-month plans on new signups and member retention and thereby learn more about
which types of mobile-only subscription plans tended to produce the biggest gains in subscriber
revenues. Netflix indicated that mobile-only plans were likely to be tested in additional countries in
2020, principally in large-population countries where wired high-speed Internet connections were not
widely available and where mobile devices were frequently or exclusively used for video streaming.
In January 2020, Netflix CEO Reed Hastings indicated the company had no interest in adding an ad-
supported subscription plan, largely because of the difficulties in convincing advertisers to shift some of
their advertising dollars to Netflix’s streaming platform. In Reed Hastings view, Google, Facebook, and
Amazon had tremendously powerful capabilities in online advertising because they gathered data about
the browsing and purchasing habits of people while they were online (and their personal data as well)
from many sources and provided it as service to their advertisers. The valuable user-related data
advertisers got from Google, Facebook, and Amazon allowed them to effectively target their ads and
realize a bigger return on their advertising expenditures. The detailed data that Netflix
collected on every subscriber’s viewing history and title preferences was of no value to
advertisers and provided zero competitive benefit in taking advertising dollars away from “the big
three.” So, for Netflix to attract $5 to $10 billion dollars in advertising to support an ad-based
subscription plan posed formidable challenges that Netflix executives firmly believed the company
should not try to surmount.20
Netflix’s Strategy to Develop and Employ Viewership Tracking and
Recommendation Software to Enhance Its Engagement with Subscribers
For some time, Netflix had developed proprietary software technology that allowed members to easily
scan a movie’s length, appropriateness for various types of audiences (G, PG, or R), primary cast
members, genre, and an average of the ratings submitted by other subscribers (based on one to five
stars). With one click, members could watch a trailer previewing a movie or original series or TV show
if they wished. Most importantly, perhaps, were algorithms that created a personalized “percentage
match” for each title that was a composite of a subscribers’ own ratings of previously viewed titles,
titles the member had placed on a “watchlist” for future viewing, and the overall or average rating of all
subscribers (several billion ratings had been provided by subscribers over the years).
Subscribers often began their search for titles by viewing a list of personalized recommendations that
Netflix’s software automatically generated for each member. Each member’s list of recommended titles
was also partly the product of Netflix-created algorithms that organized the company’s entire content
library into clusters of similar movies/TV shows and then sorted the titles in each cluster from most
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liked to least liked based on subscriber ratings. Those subscribers who favorably or unfavorably rated
similar movies/TV shows in similar clusters were categorized as like-minded viewers. When a
subscriber was online and browsing through the selections, the software was programmed to check the
clusters the subscriber had previously viewed, determine which selections in each cluster the customer
had yet to view or place on watchlist, and then display those titles in each cluster in an order that started
with the title that Netflix’s algorithms predicted the subscriber was most likely to enjoy down to the title
the subscriber was predicted to least enjoy. In other words, the subscriber’s ratings of titles viewed, the
titles on the subscriber’s watchlist, and the title ratings of all Netflix subscribers determined the order in
which the available titles in each cluster or genre were displayed to a subscriber—with one click,
subscribers could see a brief profile of each title and Netflix’s predicted rating (from one to five stars)
for the subscriber. When subscribers came upon a title they wanted to view, that title could be watch-
listed for future viewing with a single click. A member’s complete watchlist of titles was immediately
viewable with one click whenever the member visited Netflix’s website. With one additional click, any
title on a member’s watchlist could be activated for immediate viewing. Netflix management saw its
title recommendation software as a quick and personalized means of helping subscribers identify and
then watch titles they were likely to enjoy. Netflix’s subscriber tracking data indicated that 80 percent of
subscribers’ watch choices came from their personal recommendation engine.
Netflix invested in developing new software capabilities and refining existing capabilities every year.
As of 2020, Netflix had data pertaining to:
The titles each subscriber had viewed in the past several days, the past week, the past month, the
current calendar year, the past calendar year, and the entire period the subscriber had been a member.
The subscriber’s ratings of each title.
The titles on the subscriber’s watch list.
The number of times each title had been viewed by all subscribers in both each country and
worldwide the past several days, the past week, the past month, the current calendar year, the past
calendar year, and the entire period that title had been on Netflix.
The total number of hours subscribers spent watching Netflix titles for each month of each year in
each country and worldwide.
Content Strategy
Going into 2020, Netflix had bulked its original content offerings up to a total of 1,197 titles, but its
streaming library still included 3,751 licensed movies and 1,569 television shows.21 New
seasons of five original series and sequels to two original movies had already been
announced for showing in the first quarter of 2020, following an unusually heavy slate of new originals
released in the last two quarters of 2019. Reed Hastings said the company’s fourth quarter 2019 slate of
releases “set a new bar for the variety and high quality of films we produce to appeal to our members’
many diverse tastes.”22
Three high-profile shows —Parks and Recreation (Peacock), Friends (HBO MAX), and The Office
(Peacock)—were all set to leave Netflix and return to rivals during 2020 as current licenses expired.
While the loss of these programs was a setback, Netflix management was not unduly disturbed; its chief
content officer explained:23
We’ve had, over the years, incredibly popular product come on and off the service . . . . . And typically, what happens is our members,
through our incredible personalization, deep library, and broad library, are able to find their next favorite show. And [what will] will
happen with Friends fans, [is that] some of them will find it elsewhere, and some of them will find their next favorite show [on
Netflix].
To help offset the losses of these popular shows, Netflix had reportedly spent $100 million for a
multi-year license to stream Seinfeld episodes to its subscribers.
page C-155
Netflix streamed different sizes and combinations of portfolio titles to different countries. This was
because its title tracking data revealed there were very big differences in the 20 to 30 most-watched
titles from country to country. This was partly because of (1) the different languages spoken in different
countries and the varying percentages of subscribers that understood storylines produced in one
language versus another and (2) varying subscriber preferences from country-to-country for some
types/genres of movies, series, and documentaries versus others. Netflix’s tracking of program
viewership showed clearly that a strategy of streaming much the same number and combination of titles
to all countries was inferior compared to a strategy of customizing the types of titles streamed to each
country to match up well with what its tracking data showed subscribers were watching and to
discontinue streaming of titles not watched or watched very infrequently. As a consequence it had
become standard practice at Netflix to use its title-viewing data for each country to guide decisions of
which titles to stream to which countries and then to make changes in each country’s title mix as shifts
occurred in the viewing hours devoted to particular genres and the popularity of newly released titles.
However, to increase subscriber satisfaction with its streamed offering to each country, Netflix was
continuing a long-term initiative to steam title offerings to more and more countries in their native
languages so that subscribers could enjoy better enjoy Netflix’s programs. In the last quarter of 2019,
Netflix localized the language of its streaming service to Vietnam, Hungary, and the Czech Republic
(Czechia). Furthermore, Netflix was engaged in an ongoing effort to license content from local
producers of movies and TV shows and bundle them with the titles Netflix was streaming to that
country from its own title collection. In late 2019, Netflix added new locally-bundled titles in
partnership with Sky Italia, Canal+ in France, KDDI in Japan, and Izzi in Mexico.
A related shift underway in Netflix’s content strategy in 2020 was the increased emphasis being
placed on growing the number of titles (1) produced in languages other than English, (2) filmed in a
greater number of different locations, and (3) built around local country storylines. This shift was being
driven not only by the positive local subscriber response to new films and series produced in local
languages and containing locally-appealing content but also by Netflix’s tracking data that showed
many of these titles had gained popularity in other countries. A new 2017 Brazilian science-fiction show
produced in Portuguese for Brazil, to the surprise of Netflix executives, had scored well with audiences
around the world—this was Netflix’s first instance of a local-language program working well in
locations where other languages dominated. Local language films produced in India, South Korea,
Japan, Turkey, Thailand, Sweden, and the United Kingdom were among the most popular 2019 titles.
An original Spanish series titled La Casa de Papel, which was retitled Money Heist in English-speaking
countries and was scheduled to begin its fourth season during 2020, had developed a wide audience,
appearing on the top ten most watched titles in more than 70 countries. As of January 2020, Netflix had
globally released 100 seasons of local language, original scripted series from 17 countries and had plans
for over 130 seasons of such programs in 2020.
As a consequence, in 2020 Reed Hastings and Netflix’s other content programming
executives were focused on creating a portfolio of forthcoming titles for every taste, every mood, and
every region of the world. A conscious effort was being made to schedule releases of premium quality
new original films and original series scattered fairly evenly across the year and across all genres so as
to provide subscribers in all parts of the world with an ongoing stream of fresh new titles that looked
interesting to watch and proved very enjoyable after watching them.
Netflix began ramping up its capabilities to create new original animation films in 2017. Its first big
new feature, Klaus, was released in late 2019, and was an instant audience pleaser in countries across
the world and an Oscar nominee for Best Animated Feature. Two new big theatrical-scale animated
features were on tap for release in 2020; Reed Hastings believed both would be competitive with any
page C-156
animated films shown at movie box offices. Animated films traveled more predictably across countries
than other types of titles.
Netflix management also relied heavily on its viewership tracking data for each title to guide
decision-making on how to allocate upcoming expenditures for new original content. For example, if
season one of a new original series was highly popular with subscribers, the series was renewed for a
second season, and if a new series failed to spark widespread viewing and garnered only small
audiences, with declining views of succeeding episodes, the series was canceled. If a new original series
or film was viewed by 40 to 70 million subscribers in the first few weeks or months or if its viewership
built significantly over a 4-to-12 month period, management was likely to invest in the development of
a second season of the series and perhaps a new original series or movie in the same genre (action,
suspense thriller, science fiction, or adult comedy) for release in the following year. Netflix released two
romantic-comedy films in 2019 that proved quite popular with subscribers and quickly decided to
follow-up with sequels to both titles in the first half of 2020. It had several action films scheduled for
2020 as follow-on releases for a much-viewed action film released in the last quarter of 2019.
Going into 2020, Netflix was continuing its efforts to upgrade the content and production quality of
all new originals—the objective was to present subscribers with premium entertainment content
calculated to please subscribers, boost subscriber retention, and help drive subscriber growth. Netflix
had further learned from its viewership tracking data and subscriber growth statistics that media reports
of critically-acclaimed reviews of Netflix titles, coupled with media reports of Netflix titles receiving
numerous nominations and awards, were important positive factors in steering existing subscribers to
watch these titles and stimulating subscriber growth. Netflix’s original content programs in 2019 pulled
in 24 nominations for the 2020 Academy Awards, more than any other studio. From 2013 through
February 2020, Netflix original titles had received 296 nominations and 83 wins24—an indication of the
progress the company had made in creating and producing top notch original series and films. As far as
Netflix top executives were concerned, the more viewer hours spent watching Netflix originals, the
more critically-acclaimed reviews of its original titles, the more award nominations, and the more award
wins, the better. All contributed to improving subscribers’ experiences with Netflix, higher company’s
revenues and operating margins, bigger internal cash flows from operations, and more funds available
for creating more new original content going forward.
Content development projects announced for 2020 included a multiyear pact with Nickelodeon for
animated originals; a multiyear film and TV deal with “Game of Thrones” creators David Benioff and
Dan Weiss; and a three-year deal with a South Korean media conglomerate for originals and licensed
titles and titles from another Korean film producer. Netflix announced in January 2020 that 30
employees in The Netherlands were being transferred to Rome, Italy, for the purpose of opening a new
office to strengthen its local content creation partnerships in Italy and work on growing the number of
new movies and series made in Italy.
Marketing and Advertising Strategy in 2019–2020
Netflix spent $2.65 billion on marketing and advertising in 2019, up from $2.37 billion in 2018. Netflix
used multiple marketing approaches to attract subscribers, but especially online advertising (paid search
listings, banner ads on social media sites, and permission-based e-mails), and ads on regional and
national television. Advertising campaigns of one type or another were underway more or
less continuously, with the lure of one-month free trials and announcements of new and
forthcoming original titles usually being the prominent ad features. Netflix’s expenditures for digital and
television advertising were unreported in 2019 but were $1.8 billion in 2018 and $1.09 billion in 2017.
Other marketing costs in 2019 included:
Costs pertaining to free trial subscriptions.
Payments to mobile operators across the world to create quick and easy-to-use procedures for
smartphone users to access Netflix streamed or downloadable programming. Netflix believed it was
particularly important to make mobile streaming from Netflix instantly accessible to those people who
basically only wanted to have their relationship with Netflix on a mobile device.
Promotional campaigns for new original titles to generate more density of viewing and conversation
around each title. Such campaigns involved sending emails to subscribers at least weekly and often
more frequently calling attention to titles highly matched to a title viewed the previous day, previous
several days, or previous week. E-mails were also sent regularly to announce the availability of new
releases that matched well with the subscriber’s viewing history. When users were browsing various
titles in various genres of interest, there was always a row of titles with the heading “Because you
watched [title] just under rows of titles on the subscriber’s watch list.
On several occasions, Netflix CEO Reed Hastings called attention to the growing importance of
marketing efforts calling a subscriber’s attention to titles closely matched to recently viewed titles or to
help make certain new titles a bigger hit in a particular nation or among a particular demographic
segment. These were deemed valuable contributors to heightening subscriber satisfaction with the
entertainment value Netflix was providing and also aiding subscriber retention and the acquisition of
new subscribers. Further, because Netflix operated in so many countries, Hastings was a big fan of
experimenting with different marketing approaches in different markets and thereby learning more
about what worked well in marketing Netflix’s original content and differentiating Netflix from rival
streaming providers.25 Those approaches that were successful became candidates for use in
other locations.
Business Segment Reporting—New Metrics for 2020
Until the fourth quarter of 2019 Netflix had reported its performance for three business segments:
domestic streaming, international streaming, and domestic DVD. Management used this business
segment classification for purposes of making operating decisions, assessing financial performance, and
allocating resources. The company’s performance in each of these three business segments for 2015
through 2019 is shown in Exhibit 5.
However, beginning with the fourth quarter of 2019 and going forward, management decided the
company’s operations had evolved into a single business—global streaming operations—and revealed
that top management, especially the CEO, had begun making operating decisions, assessing financial
performance, and allocating resources based on the performance of its streaming operations in four
geographic regions: the United States and Canada (UCAN), Europe, the Middle East, and Africa
(EMEA), Latin America (LATAM), and the Asia-Pacific (APAC). The company provided a breakdown
of its performance in each of the four regions for 2019—see Exhibit 6.
Reed Hastings made special mention of the fact that while subscription prices were different in every
country around the world and while management definitely took note of the average monthly revenues
per subscriber in each country and region, Netflix was not managing its business to boost average
revenue per subscriber in each country. Rather, management was managing to maximize revenues
worldwide. Hastings said:26
Obviously, as we have lower-priced mobile offers, that’s going to bring down a blended [average revenue per subscriber] in a country
or in a market. But if we’re doing that in a revenue-accretive way, we think that’s great for our long-term business. We’re growing
subscribers, and we’re growing revenue.
In the first quarter of 2020, as governments in many countries instituted home confinement orders to
stem the spread of coronavirus (COVID-19), Netflix’s global streaming membership surged by a
quarterly record 15.8 million to a total of 182.9 million paid subscribers. School-closings and work-
from-home policies on the part of many organizations caused mushrooming demand for home
page C-157
entertainment and a jump in the average number of daily viewing hours of Netflix members. In
March 2020, Internet usage became so great that a number of governments and internet
service providers asked Netflix to temporarily reduce the network traffic of its members.
According to CEO Reed Hastings,27
EXHIBIT 5 Netflix’s Performance by Business Segment, 2015–2019 (in millions,
except for average monthly revenues per paying member and percentages)
Domestic Streaming Segment 2015 2016 2017 2018 2019
Paid memberships at year-end 43.4 47.9 52.8 58.5 61.0
Paid net membership additions 5.6 4.7 4.9 5.7 2.6
Average monthly revenue per paying
membership $8.50 $9.21 $10.18 $11.40 $12.57*
Revenues $4,180.3 $5,077.3 $6,153.0 $7,646.6 $9,243.0
Cost of Revenues (Note 1) 2,487.2 2,855.8 3,319.2 4,038.4 4,867.3
Marketing costs 313.6 412.9 603.7 1,025.4 1,063.0
Contribution profit (Note 2) $1,375.5 $1,712.4 $2,078.5 $2,582.9 $3,312.6
Contribution margin 33% 34% 34% 34% 36%
International Streaming Segment
Paid memberships at year-end 27.4 41.2 57.8 80.8 106.1
Paid net membership additions 11.7 14.3 18.5 22.9 25.3
Average monthly revenue per paying
membership $ 7.48 $ 7.81 $ 8.66 $ 9.43 Note 3
Revenues $1,953.4 $3,211.1 $ 5,089.2 $ 7,782.1 $ 10,616.2
Cost of Revenues (Note 1) 1,780.4 3,042.7 4,359.6 5,776.0 7,449.7
Marketing costs 506.4 684.6 832.5 1,344.1 1,589.4
Contribution profit (Note 2) $ (333.4)
$
(516.2)
$
(102.9) $ 662.0
$
1,577.1
Contribution margin (17)% (16)% (2)% 9% 15%
Domestic DVD Segment
Paid memberships at year-end 4.8 4.0 3.3 2.7 2.2
Average monthly revenue per paying
membership $ 10.30 $10.22 $10.17 $ 10.19 Note 3
Revenues $ 645.7
$
542.3 $ 450.5 $ 365.6 $ 297.2
Cost of Revenues (Note 1) 323.9 262.7 202.5 153.1 123.2
Marketing costs — — — — —
Contribution profit (Note 2) $ 321.8
$
279.5 $ 248.0 $ 212.5 $ 174.0
Contribution margin 50% 52% 55% 58% 59%
Global Totals
Paid memberships at year end 75.6 93.1 117.2 142.0 169.3
Global average monthly revenue per
paying membership $ 8.15 $ 8.61 $ 9.43 $10.31 $10.82
Revenues $6,779.5 $8,830.7 $11,692.7 $15,794.3 $20,156.4
page C-158
Domestic Streaming Segment 2015 2016 2017 2018 2019
Operating income 305.8 379.8 838.7 1,605.2 2,604.2
Operating margin 5% 4% 7% 10% 13%
Net income $122.6 $186.7 $ 558.9 $1,221.2 $1,867.0
* Includes United States and Canada, due to a Q4 2019 change in Netflix’s reporting of its geographic business segments.
Note 1: Cost of revenues for the domestic and international streaming segments consist mainly of the amortization of
streaming content assets, with the remainder relating to the expenses associated with the acquisition, licensing, and
production of such content. Cost of revenues in the domestic DVD segment consist primarily of delivery expenses such as
packaging and postage costs, content expenses, and other expenses associated with the company’s DVD processing and
customer service centers.
Note 2: The company defined contribution margin as revenues less cost of revenues and marketing expenses incurred by
segment.
Note 3: Netflix discontinued reporting this statistic due to a change in the definitions of its geographic business segments,
effective with the fourth quarter of 2019.
Source: Company 2017 10-K Report, pp. 19–22 and pp. 59–61; Company 2018 10K Report, pp. 20–22 and pp. 60–62; and p.
15 of Reed Hastings’ “Letter to Shareholders,” included as part of the company’s Report of Fourth Quarter 2019 Earnings,
January 21, 2020.
EXHIBIT 6 Netflix’s Performance by Geographic Region, 2019 (in millions, except
for average monthly revenues per paid subscriber)
Three months ended
March 31,
2019 June 30, 2019
Sept. 30,
2019
Dec. 31,
2019
Full Year
2019
UCAN Streaming
Revenue $ 2,257 $ 2,501 $ 2,621
$
2,672
$
10,051.2
Paid Memberships 66.63 66.50 67.11 67.66 67.66
Paid Net Additions 1.88 −0.13 0.61 0.55 2.91
Average Monthly Revenue per Paid
Subscriber $ 11.45 $ 12.52
$
13.08
$
13.22 $ 12.57
EMEA Streaming
Revenue $ 1,233 $ 1,319 $ 1,428
$
1,563
$
5,543.1
Paid Memberships 42.54 44.23 47.36 51.78 51.78
Paid Net Additions 4.72 1.69 3.13 4.42 13.96
Average Monthly Revenue per Paid
Subscriber $ 10.23 $ 10.13
$
10.40
$
10.51 $ 10.33
LATAM Streaming
Revenue $ 630 $ 677 $ 741 $ 746 $ 2,795.4
Paid Memberships 27.55 27.89 29.38 31.42 31.42
Paid Net Additions 1.47 0.34 1.49 2.04 5.34
Average Monthly Revenue per Paid
Subscriber $ 7.84 $ 8.14 $ 8.63 $ 8.18 $ 8.21
APAC Streaming
page C-159
Three months ended
March 31,
2019 June 30, 2019
Sept. 30,
2019
Dec. 31,
2019
Full Year
2019
Revenue $ 320 $ 349 $ 382 $ 418 $ 1,469.5
Paid Memberships 12.14 12.94 14.49 16.23 16.23
Paid Net Additions 1.53 0.80 1.54 1.75 5.63
Average Monthly Revenue per Paid
Subscriber $ 9.37 $ 9.29 $ 9.29 $ 9.07 $ 9.24
Total Streaming
Revenue $4,440.0 $4,846.0 $5,173.0 $5,399.0 $19.859.2
Paid Memberships 148,860 151,510 158,334 167,090 167,090
Paid Net Additions 9.60 3.43 6.77 8.76 27.83
Average Monthly Revenue per Paid
Subscriber Notreported Notreported $11.13 $11.06 $10.82
Source: Company website, Excel spreadsheet regional information for 2019, posted in the Investor Relations section as part
of the company’s report of Fourth Quarter 2019 Financial Results, www.netflix.com, accessed February 15, 2020.
Using our Open Connect technology, our engineering team was able to respond immediately, reducing network use by 25 percent
virtually overnight in those countries, while also substantially maintaining the quality of our service, including in higher definition.
We’re now working with ISPs to help increase capacity so that we can lift these limitations as conditions improve.
Netflix executives expected as progress was made in containing the virus and reducing new infections
that membership growth and viewing hours would decline
The Financial Strain of Netflix’s Growing Expenditures for Original Content and
Other Content Acquisitions
The company’s heightened strategic emphasis on original content produced in-house had resulted in
multi-billion-dollar annual increases in Netflix’s financial obligations to pay for streaming content and
sharply higher negative cash flows from operations (see Exhibit 7). Netflix was covering
these obligations with new issues of common stock and new issues of senior notes; details of
Netflix’s outstanding senior notes are shown in Exhibit 8.
EXHIBIT 7 The Growing Financial Strain of Netflix’s Strategic Emphasis on
Producing Original Content In-House, 2015–2019 (in millions of dollars)
2019 2018 2017 2016 2015
Streaming
content
obligations at
year-
end
$19,490.1 $19,285.9 $17,694.6 $14,479.5 $10,902.2
Additions to
streaming
content
assets
13,916.7 13,043.4 9,805.8 8,653.3 5,771.6
Additions to
DVD content
assets
Note 1 38.6 53.7 77.2 78.0
http://www.netflix.com/
2019 2018 2017 2016 2015
Amortization of
streaming
content
assets
9,216.2 7,532.1 6,197.8 4,788.5 3,405.4
Amortization of
DVD content
assets
2.7 41.2 60.7 79.0 79.4
Net cash used
in operating
activities
(2,887.3) (2,680.5) (1,785.9) (1,474.0) (749.4)
Proceeds from
issuance of
debt
4,469.3 3,921.8 3,020.5 1,000.0 1,500.0
Proceeds from
issuance of
common
stock
72.5 124.5 88.4 37.0 78.0
Outstanding
senior
notes
14,893.0 10,360.0 6,499.4 3,364.3 2,371.4
Note 1: This item was reclassified and merged into a different accounting category on the company’s Cash Flow Statement.
Source: Company 10-K Reports 2019, 2018, 2017, 2016, and 2015.
EXHIBIT 8 Netflix’s Outstanding Long-Term Debt as of December 31, 2019
Debt Issues Principal Amount atPar Issue Date Maturity Date Interest Due Dates
4.875% Senior
Notes $1.00 billion October 2019 June 2030
June 15 and
December 15
3.625% Senior
Notes $1.23 billion October 2019 June 2030
June 15 and
December 15
5.375% Senior
Notes $1.34 billion April 2019 November 2029
June 15 and
December 15
3.875% Senior
Notes $900 million April 2019 November 2029
June 15 and
December 15
6.375% Senior
Notes $800 million October 2018 May 2029
May 15 and
November 15
4.625% Senior
Notes $1,260 million October 2018 May 2029
May 15 and
November 15
5.875% Senior
Notes $1.9 billion April 2018 November 2028
April 15 and
November 15
4.875% Senior
Notes $1.6 billion October 2017 April 2028
April 15 and
October 15
3.625% Senior
Notes $1.561 billion May 2017 May 2027
May 15 and
November 15
4.375% Senior
Notes $1.0 billion October 2016 November 2026
May 15 and
November 15
5.500% Senior
Notes $700 million February 2015 February 2022
April 15 and
October 15
5.875% Senior
Notes $800 million February 2015 February 2025
April 15 and
October 15
page C-160
Debt Issues Principal Amount atPar Issue Date Maturity Date Interest Due Dates
5.750% Senior
Notes $400 million February 2014 March 2024
March 1 and
September 1
5.50% Senior
Notes $700 million February 2015 February 2022
April 1 and October
1
5.375% Senior
Notes $500 million February 2013 February 2021
February 1 and
August 1
Source: Company 2019 10-K Report, p. 55.
Netflix management forecasted that the company would have a negative free cash flow deficit of
about $2.5 billion in 2020 and that the company would continue to experience negative, but
progressively smaller, cash flow deficits, for several more years due to growing expenditures for
original content. However, executive management was confident that the company’s expected growth in
subscribers, subscription revenues, and operating profit margins would in the near future result in
positive and growing cash flows from operations, enabling the company to reduce
borrowing and begin to pay down its long-term debt. In April 2018, CEO Reed Hastings
said:28
We will continue to raise debt as needed to fund our increase in original content. Our debt levels are quite modest as a percentage of
our enterprise value, and we believe [issuing] debt is [a] lower cost of capital compared to equity.
Reed Hasting’s View of the Forthcoming Globally Competitive Battle for Streamed
Entertainment Subscribers
In Reed Hastings’ “Letter to Shareholders” in October 16, 2019, he talked about the upcoming
streaming war with all the various new competitors:29
We compete broadly for entertainment time. There are many competitive activities to Netflix (from watching linear TV to playing
video games, for example). But there is also a very large market opportunity; today we believe we’re less than 10% of TV screen time
in the U.S. (our most mature market) and much less than that in mobile screen time. Many [industry observers] are focused on the
“streaming wars,” but we’ve been competing with streamers (Amazon, YouTube, Hulu) as well as linear TV for over a decade. The
upcoming arrival of services like Disney+, Apple TV+, HBO Max, and Peacock is increased competition, but we are all small
compared to linear TV. While the new competitors have some great titles (especially catalog titles), none have the variety, diversity,
and quality of new original programming that we are producing around the world. The launch of these new services will be noisy.
There may be some modest headwind to our near-term growth. . . In the long-term, though, we expect we’ll continue to grow nicely
given the strength of our service and the large market opportunity. By way of example, our growth in Canada, where Hulu does not
exist, is nearly identical to our growth in the U.S. (where Hulu is very successful at about 30 million paid memberships).
ENDNOTES
1 As reported by Andrew Liptak, “The MPAA says streaming video has surpassed cable viewing worldwide,” posted at www.theverge.com, March 21, 2019
(accessed February 3, 2020).
2 Amazon press release announcing 4th Quarter 2019 financial results, January 30, 2020.
3 Savannah Marie, “Report: Amazon Prime Movie Library almost 5x the Size of Netflix and Nearly 7.5x the Size of Hulu,” Xanjero Media, January 29, 2019, posted
at www.xanjero.com (accessed February 3, 2020).
4 Amazon press release announcing 4th Quarter 2019 financial results, January 30, 2020.
5 Transcript of Peacock’s Investor Day Presentation, January 16, 2020, posted in the Investor Relations section at www.cmcsa.com (accessed February 7,
2020).
6 Peacock Investor Day Presentation Slides, January 16, 2020, posted in the Investor Relations section at www.cmcsa.com (accessed February 7, 2020).
7 Transcript of Peacock’s Investor Day Presentation, January 16, 2020, posted in the Investor Relations section at www.cmcsa.com (accessed February 7,
2020).
8 ViaconCBS Factsheet, posted at www.viacbs.com (accessed February 13, 2020).
9 Ryan Vlastelica and Bloomberg, “Apple’s push in TV is ‘failing to resonate’, says analyst,” posted at www.fortune.com, February 3, 2020 (accessed February 9,
2020).
10 Ibid.
11 Monthly active users and hours watched are based on information about iQiyi posted on Wikipedia (accessed January 27, 2020).
12 Todd Spangler, “Netflix Projected to Spend Over $17 Billion on Content in 2020,” Variety, January 16, 2020, posted at www.Variety.com (accessed February
11, 2020).
http://www.theverge.com/
http://www.xanjero.com/
http://www.cmcsa.com/
http://www.cmcsa.com/
http://www.cmcsa.com/
http://www.viacbs.com/
http://www.fortune.com/
http://www.variety.com/
13 Ibid.
14 Digital 2020 Global Overview Report, posted at www.thenextweb.com on January 30, 2020 (accessed February 10, 2020).
15 Transcript of remarks by David Wells, Netflix’s Chief Financial Officer, at Morgan Stanley, Technology, Media & Telecom Conference, February 27, 2018,
www.netflix.com (accessed April 5, 2018).
16 Digital 2020 Global Overview Report, posted at www.thenextweb.com on January 30, 2020 (accessed February 10, 2020).
17 According to the Speedtest Global Index, posted at www.speedtest.net (accessed February 10, 2020).
18 From p. 7 of Netflix’s 4th Quarter 2019 Earnings Call Transcript, January 21, 2020, posted in the Investor Relations section at www.netflix.com.
19 Rebecca Moody, “Which countries pay the most and least for Netflix?” posted September 3, 2019 at www.comparitech.com (accessed February 12, 2020).
20 For more details, see p.14 of Netflix’s 4th Quarter 2019 Earnings Call Transcript, January 21, 2020, posted in the Investor Relations section at
www.netflix.com.
21 According to data from JustWatch.com, posted on January 17, 2020 and cited in Joe Supan, “Everything You Need to Know About Netflix,” Allconnect, posted
at www.allconnect.com, January 17, 2020 (accessed February 11, 2020).
22 Reed Hastings, “Letter to Shareholders,” p. 3, included as part of Netflix’s announcement of fourth quarter 2019 earnings, January 21, 2020, posted in the
Investor Relations section at www.netflix.com.
23 From p. 11 of Netflix’s 4th Quarter 2019 Earnings Call Transcript, January 21, 2020, posted in the Investor Relations section at www.netflix.com.
24 Wikipedia, https://en.wikipedia.org/wiki/List_of_accolades_received_by_Netflix (accessed February 14, 2020).
25 Based on Reed Hastings’ comments during the company’s conference call announcing the company’s financial results in the first quarter of 2018, April 16,
2018.
26 Netflix’s 4th Quarter 2019 Earnings Call Transcript, January 21, 2020, posted in the Investor Relations section at www.netflix.com.
27 Reed Hastings, “Letter to Shareholders,” p. 2, included as part of Netflix’s announcement of first quarter 2020 earnings, April 21, 2020, posted in the Investor
Relations section at www.netflix.com.
28 Company press release, April 16, 2018.
29 Reed Hastings, “Letter to Shareholders,” p. 5, included as part of Netflix’s announcement of third quarter 2019 earnings, October 16, 2019, posted in the
Investor Relations section at www.netflix.com.
http://www.thenextweb.com/
http://www.netflix.com/
http://www.thenextweb.com/
http://www.speedtest.net/
http://www.netflix.com/
http://www.comparitech.com/
http://www.netflix.com/
http://justwatch.com/
http://www.netflix.com/
http://www.netflix.com/
https://en.wikipedia.org/wiki/List_of_accolades_received_by_Netflix
http://www.netflix.com/
http://www.netflix.com/
http://www.netflix.com/
J
page C-161
CASE 12
Twitter, Inc. in 2020
Copyright ©2021 by David L. Turnipseed All rights reserved.
David L. Turnipseed
University of South Alabama
ack Dorsey, CEO of Twitter, Inc., had breathed a slight sigh of relief when the fourth quarter,
2017 financial results showed the first profitable quarter since the company went public in
2013. One year later, the company’s 2018 annual report showed net income of $1.2 billion, which
was 40 percent of its revenue. Twitter had experienced rapid growth since its founding and by
January 2018, there were more than 330 million active monthly users. Notables with Twitter
accounts included U.S. President Donald Trump, Taylor Swift, Justin Timberlake, Ellen
DeGeneres, Pope Francis, Katy Perry, and Turkish President Recep Erdogan. The first quarter,
2018 was the peak of Twitter’s usage, with 336 million active monthly users: usage fell to
321 million by the year end. The first quarter, 2019 showed a small recovery to 330 million, then
Twitter changed the method of reporting usage to “monetized daily users,” which were
145 million in the third quarter of 2019. Twitter blamed the reduced usage over on a crackdown
on bot accounts and spam (in 2017, it was estimated that 15 percent of Twitter accounts were
bots). The monetized daily usage climbed a bit in 2019, and Twitter reported 152 million average
daily users on December 31 of that year.
However, despite the number of users and the volume of use, Twitter had failed to provide any
financial gains until the fourth quarter of 2017, and this profit had come as a result of cutting
costs, not growing the business. Research and development, and sales and marketing expenses
had been cut by 24 and 25 percent, respectively, and the company’s annual net revenue for fiscal
2017 was down over three percent from 2016. Even more problematic was an accumulated
deficit of over $2.6 billion.
Although Twitter showed its first full year profit in fiscal 2018, it was due largely to
maintaining low costs, and the impact of the Tax Act. Revenue of $3.0 billion in 2018 was an
increase of 24 percent over 2017, but costs for research and development, sales and marketing,
and total costs and expenses were below 2016 levels, as a percent of revenue. Total costs and
expenses were 11 percent lower than 2016, and research and development costs were 20 percent
below 2014 levels. The accumulated deficit, which at the end of fiscal 2017 was over
$2.6 billion, had been reduced to $1.5 billion.
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Fiscal 2019 was another profitable year, with net income of $1.5 billion, however, a look
below the surface suggested that rather than celebrate, Twitter’s management should have
seriously examined the company’s operations. The 2019 net profit was largely due to a
$1.075 billion tax benefit from loss carry forward from prior years. Although revenue increased
by 14 percent from 2018, the cost of revenue increased to 33 percent of revenue, up slightly from
32 percent in 2018. More troubling, total costs and expenses increased from 85 percent of
revenue in 2018 to 89 percent in 2019; consequently, the operating margin fell from 15 percent in
2018 to 11 percent in 2019. Twitter’s market capitalization was $33.5 billion in November of
2019, down from $35 billion in September 2019 and $40 billion in 2014, and again there were
suggestions in the media that Twitter was ripe for a buyout. Twitter, Inc.’s consolidated income
statements for 2015 through 2019 are presented in Exhibit 1. The company’s consolidated
balance sheets for 2015 and 2019 are presented in Exhibit 2.
EXHIBIT 1 Consolidated Statements of Operations: 2015–2019 (in
thousands, except per share data)
Year Ended December 31,
2019 2018 2017 2016 2015
Consolidated Statement of
Operations Data:
Revenue(1) $3,459,329 $3,042,359 $2,443,299 $2,529,619 $2,218,032
Costs and expenses(2)
Cost of revenue 1,137,041 964,997 861,242 932,240 729,256
Research and
development 682,281 553,858 542,010 713,482 806,648
Sales and marketing 913,813 771,361 717,419 957,829 871,491
General and administrative 359,821 298,818 283,888 293,276 260,673
Total costs and
expenses 3,092,956 2,589,034 2,404,559 2,896,827 2,668,068
Income (loss) from
operations 366,373 453,325 38,740 (367,208) (450,036)
Interest expense (138,180) (132,606) (105,237) (99,968) (98,178)
Interest income 157,703 111,221 44,383 24,277 9,073
Other income (expense), net 4,243 (8,396) (73,304) 2,065 5,836
Income (loss) before income
taxes 390,139 423,544 (95,418) (440,834) (533,305)
Provision (benefit) for
income taxes
(1,075,520) (782,052) 12,645 16,039 (12,274)
Net income (loss) $1,465,659 $1,205,596 $ (108,063) $ (456,873) $ (521,031)
Net income (loss) per share
attributable to common
stockholders
Basic $1.90 $1.60 $(0.15) $(0.65) $(0.79)
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Year Ended December 31,
2019 2018 2017 2016 2015
Diluted $1.87 $1.56 $(0.15) $(0.65) $(0.79)
Weighted-average shares
used to compute net income
(loss) per share attributable
to common stockholders
Basic 770,729 754,326 732,702 702,135 662,424
Diluted 785,531 772,686 732,702 702,135 662,424
Cost of revenue $ 22,797 $ 17,289 $ 23,849 $ 29,502 $ 40,705
Research and development 209,063 183,799 240,833 335,498 401,537
Sales and marketing 85,739 71,305 94,135 160,935 156,904
General and administrative 60,426 53,835 74,989 89,298 82,972
Total stock-based
compensation $378,025 $326,228 $433,806 $615,233 $682,118
(1) The company adopted a new revenue standard on January 1, 2018 using the modified retrospective method.
Revenue for the year ended December 31, 2018 was not materially impacted by the application of the new revenue
standard.
(2) Costs and expenses include stock-based compensation expense as follows:
Source: Twitter, Inc. Annual Report 2019.
EXHIBIT 2 Consolidated Balance Sheets, 2015-2019 (in thousands)
As of December 31,
2019 2018 2017 2016 2015
Consolidated Balance
Sheet Data
Cash and cash
equivalents $ 1,799,082 $ 1,894,444 $1,638,413 $ 988,598 $ 911,471
Short-term investments 4,839,970 4,314,957 2,764,689 2,785,981 2,583,877
Property and
equipment, net 1,031,781 885,078 773,715 783,901 735,299
Total assets 12,703,389 10,162,572 7,412,477 6,870,365 6,442,439
Convertible notes 1,816,833 2,628,250 1,627,460 1,538,967 1,455,095
Senior notes 691,967 — — — —
Total liabilities 3,999,003 3,356,978 2,365,259 2,265,430 2,074,392
Total stockholders’
equity 8,704,386 6,805,594 5,047,218 4,604,935 4,368,047
Source: Twitter, Inc. Annual Report 2019.
Twitter was a giant in the industry; however, it faced serious competition from
companies such as Facebook (including Instagram and WhatsApp), Snap, TikTok,
Alphabet (including Google and YouTube), Microsoft (including LinkedIn), and Verizon Media
Group. There were also foreign competitors that were regional social media and messaging
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companies, with strong positions in particular countries, including WeChat, Kakao, and Line,
which posed competitive challenges. Many of these competitors were growing at a multiple of
Twitter’s growth—over the three-year period 2017 to 2020, Facebook had an increase of
450 million monthly active users (+35 percent), WhatsApp increased by 800 million
(+67 percent) and Instagram had increases of 300 million (+43 percent). Over the two-year
period 2017–2019, although there were small variations in the numbers of users, Twitter had no
increase, showing 330 million monthly users in both years (Twitter stopped reporting monthly
active users in the first quarter, 2019). In 2019 Twitter’s share of worldwide digital ad revenue
had climbed to 0.9 percent, up from 0.8 percent in 2018 (compared to Google’s 32.2 percent and
Facebook’s 22.1).
Although Twitter had made a good profit in fiscal 2019, the company’s performance failed to
meet expectations during the First Quarter of 2020. The weak financial performance in early
2020 generated concerns about whether the company continue to grow revenue and operate
without allowing costs and expenses to drift up and erode income. As the company entered the
second quarter of 2020, Twitter’s CEO and its Board were faced with three daunting questions: 1)
how could they spark growth and increase the number of users, 2) what could they do to assure
Twitter’s continued profitability, and 3) were the two profitable years sufficient to prevent the
company from being targeted as a take-over candidate?
HISTORY OF TWITTER
Founded in 2006 by Jack Dorsey, Noah Glass, Biz Stone, and Evan Williams, Twitter was an
online microblogging and social networking service that allowed users to post text-based
messages, known as tweets, and status updates up to 40 characters long. Jack Dorsey, a cofounder
of Twitter, sent the first tweet on March 21, 2006: “just setting up my twttr”—Jack(@jack)
21 March, 2006. By the first of January 2018, Twitter had more 330 million monthly active users.
The history of Twitter began with an entrepreneur named Noah Glass who started a company
named Odeo in 2005. Odeo had a product that would turn a phone message into an MP3 hosted
on the Internet. One of Odeo’s early investors was a former Google employee, Evan Williams,
who got very involved with the company. As Odeo grew, more employees were hired, including
web designer Jack Dorsey and Christopher “Biz” Stone, a friend of Odeo’s new CEO Evan
Williams.
Williams decided that Odeo’s future was not in podcasting and directed the
company’s employees to develop ideas for a new direction. Jack Dorsey, who had been doing
cleanup work on Odeo, proposed a product that was based on people’s present status, or what
they were doing at a given time. In February 2006, Glass, Dorsey, and a German contract
developer proposed Dorsey’s idea to others in Odeo, and over time, a group of employees
gravitated to Twitter while others focused on Odeo. At one point, the entire Twitter service was
run from Glass’ laptop.
Noah Glass presented the Twitter idea to Odeo’s Board in summer of 2006; the Board was not
enthused. Williams proposed to repurchase the Odeo stock held by investors to prevent them
from taking a loss, and they agreed. Five years later, the assets of Odeo that the original investors
sold for about $5 million, were worth $5 billion.
After Williams repurchased Odeo, he changed the name to Obvious Corp. and fired Odeo’s
founder and the biggest supporter of Twitter, Noah Glass. Christopher “Biz” Stone left Twitter in
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2011 and pursued an entrepreneurial venture with Obvious Corp. for six years. In mid-2017, he
returned to Twitter full time. As of the second quarter, 2018, only three of the original Twitter
founders remained active in the company: Biz Stone, Jack Dorsey as the company’s CEO, and
Evan Williams who was on the Board.
Twitter provided an almost-immediate access channel to global celebrities. The majority of the
top 10 most-followed Twitter accounts were entertainers who used the service to communicate
with their fans, spread news, or build a public image. The near-instant gratification through direct
updates from celebrities such as Rihanna, Jimmy Fallon, Lady Gaga, and Taylor Swift and the
feeling of inclusion in a specific group of fans was a major reason for social media users to use
Twitter. The accounts of high-interest people such as entertainers, politicians, or others at risk of
impersonation were verified by Twitter to authenticate their identity. A badge of verification was
placed on confirmed accounts to indicate legitimacy. Major sporting events and industry award
shows such as the Super Bowl or Academy Awards generated significant online action. The
online discussion enabled users to participate in the success of celebrities who often posted
behind-the-scenes photo tweets or commentaries. On-set or in-concert tweets were other methods
utilized by celebrities to enhance their appeal and fan interaction.
Twitter was quite simple: tweets were limited to 140 characters until late 2017 when the limit
was raised to 280. The character constraint made it easy for users to create, distribute, and
discover content that was consistent across the Twitter platform as well as optimized for mobile
devices. Consequently, the large volume of Tweets drove high velocity information exchange.
Twitter’s aim was to become an indispensable daily companion to live human experiences. The
company did not have restrictions on whom a user could follow, which greatly enhanced the
breadth and depth of available content and allowed users to find the content they cared about
most. Also, users could be followed by hundreds of thousands, or millions of other users without
requiring a reciprocal relationship, enhancing the ability of users to reach a broad audience.
Twitter’s public platform allowed both the company and others to extend the reach of Twitter
content: media outlets distributed Tweets to complement their content by making it more timely,
relevant, and comprehensive. Tweets had appeared on over one million third-party websites, and,
in the second quarter of 2013, there were approximately 30 billion online impressions of Tweets.
As of October 2019, there were an average of 6,000 Tweets per second, or 500 million tweets per
day: these number indicate 200 billion tweets per year.
THE TWITTER BRAND IMAGE
Twitter had a powerful brand image. Its mascot bird was not chosen because birds make tweeting
sounds, but rather because “whether soaring high above the earth to take in a broad view, or
flocking with other birds to achieve a common purpose, a bird in flight is the ultimate
representation of freedom, hope and limitless possibility.”1
Twitter was initially named “Jitter” and “Twitch,” because that is what a phone would do when
it received a tweet. However, neither name evoked the image that the founders wanted. Noah
Glass got a dictionary and went to “Twitch,” then to subsequent words starting with “Tw” he
found the word “Twitter,” which in the Oxford English dictionary means a short inconsequential
burst of information, and chirps from birds. Dorsey and Glass thought that “twitter” described
exactly what they were doing, so they decided on that name. The name was already owned, but
not being used, and the company was able to buy it very cheaply.
In 2012, the old Twitter bird was redesigned, slightly resized, changed from red
to blue, and named Larry the Bird (named after NBA star Larry Bird). The lower case “t” icon
and the text “twitter” were removed; the company name was no longer on the logo. The blue bird
alone communicated the Twitter brand. “Twitter achieved in less than six years what Nike,
Apple, and Target took decades to do: To be recognizable without a name, just an icon.”2
According to a Twitter survey conducted to help understand the company’s brand legacy,
90 percent of Twitter users worldwide recognized the Twitter brand. Twitter’s 2018 ad campaign
“What’s happening” used only the Twitter logo and hashtag symbol. The Twitter brand was
called “minimalization at its finest”3—an advertising campaign that did not have one word, yet
delivered a powerful message from the brand.
Twitter’s Global High Profile
Twitter had become very well-known because of several high-profile users and high-profile use.
Several of the world’s leaders had millions of followers, as shown in Exhibit 3. From May 2017
to April 2019, U.S. President Donald Trump’s follow count increased from 30.1 million to
50 million. President Trump regularly used Twitter to break news, praise his friends, campaign
for supporters, and feud with his enemies; consequently, Twitter had been in the daily news
almost constantly since 2016.
EXHIBIT 3 World Leaders with the Most Twitter Followers, May 2017 and
April 2020
Millions of Followers
2017 2020
Pope Francis, Vatican@Pontifex 34 50
Donald Trump, U.S.@RealDonaldTrump 30 77
Narendra Modi, India@NarendraModi 30 55
Prime Minster, India@PMOInd 18 33
President, U.S.@POTUS 18 29
The White House, U.S.@WhiteHouse 14 21
Recep Erdogan, Turkey@RT_Erdogan 10 15
HH Sheikh Mohammed, UAE@Jokowi 8 —
Joko Widodo, Indonesia@jokowi 7 13
Imran Khan, Pakistan@imrankhanpti — 11
Queen Rania, Jordan@QueenRania — 10
Source: Statista, 2018, 2020.
Although the world’s leaders had millions of followers, others have far more. As of June 2020,
Katy Perry had over 109 million followers, Justin Bieber 112 million, former U.S. President
Barack Obama 119 million, Rihanna 97 million, Ellen DeGenerres 80 million, Lady Gaga
82 million, and Justin Timberlake 65 million. Exhibit 3 presents the world leaders with the most
Twitter followers in May 2017 and April 2020.
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The miraculous plane crash on New York’s Hudson River in 2009 was broken on Twitter, and
on May 1, 2011, an IT consultant in Pakistan unknowingly live-tweeted the U.S. Navy Seal raid
that killed Osama Bin Laden over nine hours before the raid was on the news. Prince William
announced his engagement to Catherine Middleton in 2010 on Twitter. Whitney Houston’s death
and the bombing at the Boston marathon were broken on Twitter. President Obama used Twitter
to declare victory in the 2012 U.S. presidential election, with a Tweet that was viewed about
25 million times on the Twitter platform and widely distributed offline in print and broadcast
media. He also tweeted a goodbye message when he left office in January 2017 that garnered
794 million retweets.
TWITTER SERVICES, PRODUCTS AND REVENUE
STREAMS
Twitter’s primary service was the Twitter global platform for real-time public self-expression and
conversation, which allowed people to create, consume, discover, and distribute content. Some of
the most trusted media outlets in the world, such as CNN, Bloomberg, the Associated Press, and
BBC used Twitter to distribute content. Periscope was a mobile app launched by Twitter in 2015
that enabled people to broadcast and watch live video with others. Periscope broadcasts could be
viewed through Twitter and mobile or desktop web browsers.
Twitter, Inc. generated advertising and data licensing revenue as shown in Exhibit 4 by
providing mobile advertising exchange services through the Twitter MoPub exchange, and
offering data products and data licenses that allowed their data partners to search
and analyze historical and real-time data on the Twitter platform, which consisted
of public tweets and their content. Also, Twitter’s data partners usually purchased licenses to
access all or a portion of the company’s data for a fixed period. The company operated a mobile
ad exchange and received service fees from transactions completed on the exchange. The Twitter
mobile ad exchange allowed buyers and sellers to purchase and sell advertising inventory, and it
matched buyers and sellers.
EXHIBIT 4 Twitter, Inc. Advertising and Data Licensing Revenue, 2017–2019
(in thousands)
Year Ended December 31, 2018 to 2019 %
Change
2017 to 2018 %
Change 2019 2018 2017
Advertising services $2,993,392 $2,617,397 $2,109,987 14% 24%
Data licensing and
other 465,937 424,962 333,312 9% 28%
Total revenue $3,459,329 $3,042,359 $2,443,299 14% 25%
Source: Twitter, Inc. 2019 Form 10-K.
TWITTER RESTRUCTURES
On June 29, 2018, Dorsey announced that he was restructuring Twitter to make the company
quicker and more creative, as Ed Ho, VP of product and engineering, stepped down to a part-time
position. Twitter employees would be organized in functional groups such as engineering, as
opposed to the present product teams. Dorsey decided on the structural change to simplify the
way the company worked and to make the organization “more straightforward.” He believed that
a “pure end-to-end functional organization” would help make decision making clearer, allow the
company to build a stronger culture, and prepare the company for increased creativity and
innovation. Dorsey believed that Twitter must enter a creativity phase to be relevant and
important to the world.
Twitter restructured and merged its agency development and applications program interface
departments in April 2019. Prior to the move, the agency development group focused on
Twitter’s relationships with major advertising agencies and the platform solutions team
concentrated on ad-tech companies such as Amobee, 4C Insights, and SocialCode Marketing
which developed automated ad campaigns for digital media platforms including Twitter. There
were no jobs lost due to the restructuring, rather the move showed the value that Twitter placed
on its advertisers.
Twitter’s Stock Performance
Twitter went public on November 7, 2013, with an IPO price of $26.00, and the stock closed up
73 percent ($44.94) on its first trading day. The stock hit its all-time high of $69.00 on January 3,
2014, and began a long down-trend, lasting until mid-April 2017. On August 21, 2015, Twitter
shares dropped below the IPO price to $25.87, rebounded slightly, and then slid to $14.10 on
May 13, 2016. The stock did not get above the IPO price of $26.00 until early February 2018.
After a year’s climb, Twitter stock hit a three year high of $47.79 in early July 2018, and then
began to slide again, trading in the $28.00–$32.00 range until rebounding to $40.80 in early May
2019. Exhibit 5 tracks Twitter’s market performance between May 2014 and April 2019.
EXHIBIT 5 Monthly Performance of Twitter, Inc.’s Stock Price, May 2015–
June 2020
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Source: Bigcharts.com.
Twitter, Inc. joined the S&P 500 index on June 7, 2018, replacing Monsanto. The addition of
Twitter was unusual because the S&P regulations required that the sum of a member company’s
four most recent quarters, as well as the last quarter, were positive. In April of 2018, Twitter
reported its second consecutive profitable quarter, which followed 16 consecutive quarters of
losses. The addition of Twitter to the S&P 500 Index would increase the number of individual
investors who owned the stock through index funds that track the large company stock gauge.
Twitter’s addition to the index fuelled a rally that pushed the company’s stock to
more than $45.00/share by June 2018, which was its highest price since March of
2015.
The S&P 500 bounce was not sustained and Twitter’s stock slid to $27.00 by the end of
December 2018. The stock began an intermittent climb and reached $45.00 again in September
2019, and began another slide down to $23.00 on April 3, 2020. Despite negative first quarter,
2020 earnings, the share price began a choppy uptrend, closing at $34.87 on June 5, 2020.
TWITTER’S MAJOR COMPETITORS
Facebook
Facebook was the world’s largest online social networking and social media company. It was
founded in February 2004 by Mark Zuckerberg, Eduardo Saverin, Dustin Moskivitz, Chris
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Hughes, and Andrew McCollum. As was common among online social networking companies,
Facebook was not immediately profitable; however, after becoming profitable in
2010, it had its IPO in 2012 at $38/share. Although the stock price dropped to under
$20 in August 2012, it rebounded and was selling at $217.50/share in mid-July 2018, and then
began a slide down to $124.95 in December 2018. In late December 2018, Facebook stock began
a recovery and in June 2020, was trading above $230. In April 2020, Facebook had 2.6 billion
users worldwide—India had the largest number of users at 280 million, the United States was
second with 190 million, and Indonesia was third with 130 million.
In the first quarter 2020, Facebook had 2.6 billion average monthly users, and 90 percent of the
total users were from outside the United States. Facebook’s year-over-year revenue growth rate in
the first quarter of 2020 was 18 percent, and net income increased 102 percent over the same
period 2019. A financial summary for Facebook, Inc. for 2015 to 2019 is presented in Exhibit 6.
EXHIBIT 6 Selected Financial Data for Facebook, Inc., 2015–2019
(in millions, except per share data)
Year Ended December 31,
2019 2018 2017 2016 2015
Consolidated
Statements of Income
Data:
Revenue $70,697 $55,838 $40,653 $27,638 $17,928
Total costs and
expenses(1)
46,711 30,925 20,450 15,211 11,703
Income from
operations 23,986 24,913 20,203 12,427 6,225
Income before provision
for income taxes 24,812 25,361 20,594 12,518 6,194
Net income 18,485 22,112 15,934 10,217 3,688
Net income attributable
to Class A and Class B
common stockholders
18,485 22,111 15,920 10,188 3,669
Earnings per share
attributable to Class A
and Class B common
stockholders
Basic $6.48 $7.65 $5.49 $3.56 $1.31
Diluted $6.43 $7.57 $5.39 $3.49 $1.29
(1) Total costs and expenses include $4.84 billion, $4.15 billion, $3.72 billion, $3.22 billion, and $2.97 billion of share-
based compensation for the years ended December 31, 2019, 2018, 2017, 2016, and 2015, respectively.
As of December 31,
2019 2018 2017 2016 2015
Consolidated Balance
Sheets Data:
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As of December 31,
2019 2018 2017 2016 2015
Cash, cash equivalents,
and marketable
securities
$54,855 $41,114 $41,711 $29,449 $18,434
Working capital 51,172 43,463 44,803 31,526 19,727
Property and equipment,
net 35,323 24,683 13,721 8,591 5,687
Total assets 133,376 97,334 84,524 64,961 49,407
Operating lease
liabilities(1)
10,324 — — — —
Total liabilities 32,322 13,207 10,177 5,767 5,189
Additional paid-in
capital 45,851 42,906 40,584 38,227 34,886
Total stockholders’
equity 101,054 84,127 74,347 59,194 44,218
(1) On January 1, 2019, we adopted Accounting Standards Update No. 2016-02, Leases (Topic 842). Prior period
amounts have not been adjusted under the modified retrospective method.
Source: Facebook Annual Report, 2019.
WhatsApp
WhatsApp was a freeware and cross-platform messaging and IP service owned by Facebook. The
company was founded in 2009 by ex-Yahoo employees Jan Koum and Brian Acton. WhatsApp
used the Internet to send messages, audio, video, and images, and was similar to a text messaging
service. However, because WhatsApp sent messages over the Internet, the cost for users was
much less than texting. The company grew quickly and within a few months of startup,
WhatsApp added a service charge to slow down its growth rate. In 2014, WhatsApp was acquired
by Facebook for $21.94 billion.
In early 2018, after a long feud with Facebook founder and CEO Mark Zuckerberg about how
to get additional revenue from WhatsApp, Koum and Acton resigned from Facebook. Zuckerberg
was focused on using targeted ads to WhatsApp’s large user base; Koum and Acton were
believers in privacy and had no interest in the potential commercial applications. When
WhatsApp was sold to Facebook, the founders pledged privacy of WhatsApp. Four years later,
Facebook pushed WhatsApp to change its terms of service and give Facebook access to
WhatsApp users’ phone numbers. Facebook also wanted a unified profile that could be used for
ad targeting and data mining, and a recommendation system that would suggest Facebook friends
based on WhatsApp contacts. WhatsApp was the most popular messaging app in the world in
2020, with 0.2 billion more users than Facebook Messenger. WhatsApp had 1.5 billion users in
180 countries in the first quarter 2020, 68 million in the United States, with 1 billion daily active
WhatsApp users and 65 billion messages, sent each day.
Snapchat
Snap Inc. was a camera company that believed that reinventing the camera was a great
opportunity to improve the way that people communicated and lived. Snap, Inc.’s products
empowered people to express themselves, live in the moment, learn about the world, and have
fun together. The company’s flagship product, Snapchat, was a camera application that helped
people communicate visually with friends and family through short videos and images called
snaps. Snaps were deleted by default, so there was less pressure to look good when creating and
sending images on Snapchat. By reducing the friction typically associated with creating and
sharing content, Snapchat became one of the most-used cameras in the world.
Snapchat had over 398 million active users worldwide, and 101 million users in the United
States in January 2020. On average, 218 million people used Snapchat daily, creating over
3 billion snaps every day; however, its users were declining. A financial summary for Snap Inc.
for 2015 through 2019 is presented in Exhibit 7.
EXHIBIT 7 Selected Financial Data for Snap, Inc., 2015–2019 (in thousands,
except per share amounts)
Year Ended December 31,
2019 2018 2017 2016 2015
Consolidated
Statements of
Operations Data
Revenue $ 1,715,534 $ 1,180,446 $ 824,949 $ 404,482 $ 58,663
Costs and
expenses:
Cost of
revenue 895,838 798,865 717,462 451,660 182,341
Research and
development 883,509 772,185 1,534,863 183,676 82,235
Sales and
marketing 458,598 400,824 522,605 124,371 27,216
General and
administrative 580,917 477,022 1,535,595 165,160 148,600
Total costs
and
expenses
2,818,862 2,448,896 4,310,525 924,867 440,392
Operating loss (1,103,328) (1,268,450) (3,485,576) (520,385) (381,729)
Interest income 36,042 27,228 21,096 4,654 1,399
Interest expense (24,994) (3,894) (3,456) (1,424) —
Other income
(expense), net 59,013 (8,248) 4,528 (4,568) (152)
Loss before
income taxes (1,033,267) (1,253,364) (3,463,408) (521,723) (380,482)
Income tax benefit
(expense) (393) (2,547) 18,342 7,080 7,589
Net loss $(1,033,660) $(1,255,911) $(3,445,066) $(514,643) $(372,893)
Year Ended December 31,
2019 2018 2017 2016 2015
Net loss per share
attributable to
Class A, Class B,
and Class C
common
stockholders
Basic $(0.75) $(0.97) $(2.95) $(0.64) $(0.51)
Diluted $(0.75) $(0.97) $(2.95) $(0.64) $(0.51)
December 31,
2019 2018 2017 2016 2015
Consolidated
Balance Sheet
Data
Cash, cash
equivalents, and
marketable
securities
$2,112,805 $1,279,063 $2,043,039 $987,368 $640,810
Working capital 2,144,311 1,383,237 2,020,538 1,023,241 536,306
Total assets 4,011,924 2,714,106 3,421,566 1,722,792 938,936
Total liabilities 1,752,011 403,107 429,239 203,878 174,791
Additional paid-in
capital 9,205,256 8,220,417 7,634,825 2,728,823 1,467,355
Accumulated
deficit (6,945,930) (5,912,578) (4,656,667) (1,207,862) (693,219)
Total stockholders’
equity 2,259,913 2,310,999 2,992,327 1,518,914 764,145
Source: Snap Inc. Annual Report 2019.
Instagram
Instagram was a video and photo-sharing social network service created by Kevin Systrom and
Mike Krieger in 2010. Facebook acquired the company in 2012: the agreed price was $1 billion
(a mixture of case and Facebook stock), however the final price was $715 million because
Facebook’s share process tumbled before the deal was finalized. If Instagram were a standalone
company, it would be worth more than $100 billion, which would be a 100-fold return for
Facebook.
In March 2019, Instagram reached 1.1 billion monthly active users, but by April 2020, that
number was down slightly to 1 billion. There were 89 percent of which are outside the United
States in October 2019. The company generated $20 billion in advertising revenue in 2019,
which was over 25 percent of Facebook sales, and Instagram attracted new users at a faster rate
than Facebook’s main site in 2018. In the second quarter 2019, at five percent per quarter growth,
Instagram was ahead of Facebook, which was growing at 3.14 percent, and Snapchat, growing at
2.13 percent. The company was forecast to generate $9.5 billion in advertising revenues in 2019
and to grow 47 percent to $13.9 billion in fiscal 2020.
page C-170
page C-171
LinkedIn
LinkedIn was a social media service that operated through websites and mobile apps, and focused
primarily on professional networking, which enabled members to create, manage, and share their
professional identities online, create professional networks, share insights and knowledge, and
find jobs and business opportunities. The company was founded in December 2002 by Allen
Blue, Reid G. Hoffman, Jean-Luc Vaillant, Konstantin Guericke, and Eric Ly. LinkedIn was
named by Forbes as one of America’s Best Employers in 2016. LinkedIn was acquired by
Microsoft for $26.2 billion in June 2016.
In March 2020, LinkedIn had over 660 million members, 70 percent of which were outside the
United States, up from 575 million in March 2019: the company had revenue of
$6.8 billion in 2019. The company was the number one channel that B2B marketers
used to distribute content. LinkedIn had 575 million users in more than 200 countries and
territories worldwide.4
TROUBLING SIGNS IN FIRST QUARTER—2020
Twitter’s first quarter 2020 financial results took a negative turn. Although revenue was up
three percent year over year to $808 million, from $787 million, it was down 20 percent from
$1,007 million in the fourth quarter 2019. Twitter blamed the revenue decline on the impact of
COVID-19. The quarter showed a net loss of $8.4 million, versus the $191 million net income for
the first quarter 2019. The company’s revenues had growth across both service areas—
advertising and data licensing—but surprisingly, despite an increase in overall net revenue,
international revenue was down to 42 percent in the first quarter 2020, from 45 percent in the
same period in the prior year (Exhibit 8 presents Twitters first quarter, 2020 Consolidated
Statements of Operations). Twitter’s first quarter 2020 growth in revenue from the United States,
increased by eight percent, year-over-year, from $432 million to $468 million. International
revenue decreased 2.0 percent, year-over-year, from $318 million to $355 million. Twitter’s first
quarter 2020 Revenue by Geographic Area is provided in Exhibit 9.
EXHIBIT 8 Twitter, Inc. First Quarter, 2020 Consolidated Statement of
Operations, Q1 2019 and Q1 2020
Twitter, Inc.Consolidated Statements of Operations
Three Months Ended March 31,
2020 2019
Revenue $807,637 $786,890
Costs and expenses
Cost of revenue 284,037 264,011
Research and development 200,388 146,246
Sales and marketing 221,287 205,799
General and administrative 109,368 77,176
Total costs and expenses 815,080 693,232
Income (loss) from operations (7,443) 93,658
page C-172
Twitter, Inc.Consolidated Statements of Operations
Three Months Ended March 31,
2020 2019
Interest expense (33,270) (37,260)
Interest income 32,897 40,541
Other expense, net (7,719) (436)
Income (loss) before income taxes (15,535) 96,503
Benefit from income taxes (7,139) (94,301)
Net income (loss) $(8,396) $190,804
Net income (loss) per share attributable to common
stockholders
Basic $(0.01) $0.25
Diluted $(0.01) $0.25
Weighted-average shares used to compute net
income (loss) per share attributable to common
stockholders
Basic 780,688 764,550
Diluted 780,688 777,689
EXHIBIT 9 Twitter, Inc. Revenue by Geographic Area, Q1 2019 and Q2 2020
Three Months Ended March 31,
2020 2019
Revenue by geographic area:
United States $468,430 $432,356
Japan 131,132 135,571
Rest of World 208,075 218,963
Total revenue $807,637 $786,890
Source: Facebook 10-Q, First Quarter, 2020.
Year-over-year advertising revenue increased slightly by 0.4 percent during the first quarter of
2020, from $679 million to $682 million, and data licensing revenue increased from $107 million
to $125 million, year-over-year, a 17 percent increase. Cost of revenue increased to 35 percent of
revenue, up from 34 percent of revenue in the same period, 2019. Increases in
operating expenses proved disastrous in the first quarter 2020: research and
development expenses increased from 19 percent to 25 percent of revenue from the same period
in the prior year, sales and marketing increased from 26 percent to 27 percent, and general and
administrative expenses increased from 10 percent to 14 percent, as a percent of revenue. The
increased expenses resulted in an operating loss of $7.4 million, down from $93.6 million
(12 percent) net income in the same period 2019. The net loss of $8.4 million for the first quarter
2020 was a shocking contrast from net income of $191 million (24 percent of revenue) for the
same period in the prior year.
Citing concerns about the uncertainty due to the COVID-19 pandemic, and rapidly shifting
market conditions in its business environment, Twitter did not provide revenue or income
guidance for the second quarter and suspended full year guidance.
Going into the second quarter of fiscal 2020, Twitter was focused on:
1. Increasing focus on revenue products, particularly performance ads beginning with MAP, with
the goal of accelerating the company’s long-term strategy.
2. Reducing company hiring and non-labor expenses to lower expense growth while continuing
to focus investments on Engineering, Product, and Trust & Safety, ensuring that resources are
allocated against the most important work.
ENDNOTES
1 Armin, “Twitter Gives You the Bird,” June 7, 2012, https://www.underconsideration.com/brandnew/archives/twitter_gives_you_the_bird.php.
2 As quoted in “Is Twitters” logo change the most revolutionary re-branding of the Modern Era?, Gawker, June 6, 2006, http://gawker.com/5916390/is-
twitters-logo-change-the-most-revolutionary-re-branding-of-the-modern-era.
3 Sunil Singh, “How a Logo Personified the Twitter Brand,” February 15, 2018, https://gulfmarketingreview.com/brands/how-a-logo-personified-
the-twitter-brand/.
4 As stated at about.linkedin.com.
http://gawker.com/5916390/is-twitters-logo-change-the-most-revolutionary-re-branding-of-the-modern-era
https://gulfmarketingreview.com/brands/how-a-logo-personified-the-twitter-brand/
http://about.linkedin.com/
I
page C-173
CASE 13
Yeti in 2020: Can Brand Name
and Innovation Keep it Ahead of
the Competition?
Copyright ©2021 by Diana R. Garza and David L. Turnipseed. All rights reserved.
Diana R. Garza
University of the Incarnate Word
David L. Turnipseed
University of South Alabama
n early 2020, Matthew Reintjes, president and CEO of Yeti, contemplated
the company’s fiscal 2019 operations. Although the company had shown a
17 percent increase in revenue over fiscal 2018, with sales of $914 million,
and profit of over $50 million, there were uncertainties ahead for the fast-
moving company. Yeti’s coolers and other products had captured the number
one position in the United States, and awareness in the domestic markets had
risen from two percent in October 2015 to 10 percent in July 2018 according
to the company’s own brand tracking survey. Yeti had become a cult icon for
the hunting, fishing, boating and outdoors sports communities, and was
rapidly expanding beyond those groups. On almost every outing, one would
page C-174
see people wearing Yeti T-shirts and caps, and Yeti stickers on the rear
windows of pickups and SUVs.
Yet despite the meteoric rise increase in revenues, market share, and
profits, there were storm clouds on the horizon. First, the recent tariff
controversy between the United States and China, and the European Union
had the potential to increase prices and thus reduce sales of Yeti products.
Second, the COVID-19 global pandemic that began in early 2020 and its
economic fallout could certainly have a negative impact on the sales of all
Yeti products, both domestically and foreign, for an extended period. Third,
and perhaps most concerning, was the large and increasing number of
competitors across the entire product line, ranging from large well-known
brands such as Otter Box, Tervis, Igloo, and Pelican to numerous small
brands.
Yeti’s management was aware that although the company’s products were
high quality, there were many equally high-quality competitor products
available in the market: the market value of Yeti appeared to be the market
value of its brand. The management team recognized that the path to
continued success for Yeti was to maintain and increase the value of the
brand, and to position the brand to have increased value with larger numbers
of consumers. Mr. Reintjes resolved to craft a strategy that would reestablish
and maintain the upward trajectory of profits for the company.
Two Brothers and a Cooler: From Dream to Icon
After graduation from college, Roy (Texas Tech University) and Ryan
(Texas A & M University) Seiders began searching for business plans in the
outdoor field. Their father had been a successful entrepreneur in the fishing
tackle industry and the boys were determined to follow his lead. Ryan started
a custom fishing-rod business and Roy began building fishing boats. Roy’s
boats included three coolers, one of which was in the bow of the boat and
used as a fishing platform. The coolers were the least satisfactory part of the
boat, and Roy began looking for better options. Brother Ryan identified an
imported Thai cooler at a trade show that impressed him with
ruggedness (but not design or finish). He began importing the
Thai coolers and marketing them to outdoor equipment retailers and fishing
tackle shops, which was the market that he knew best.
The Thai cooler generated sales, but warranty costs and disappointment
with improvements in the design motivated the search for another
manufacturer. The brothers located a manufacturer in the Philippines that
was capable of manufacturing the cooler that Ryan had envisioned. Roy
believed the time had come to start a cooler business and a brand name. The
result of a good cooler is ice retention–even after its usage for food or drink
is complete. This feature, plus the input of family and friends resulted in the
name Yeti–the Ice Monster, and the company was born in 2006. The
company’s mission was simple: “build the cooler you’d use every day if it
existed.”
Roy used the money from his Thai cooler business, and Ryan sold his
fishing-rod business to fund the Yeti prototype. The cooler was designed so
that anything breakable (e.g., the rope handles) could be easily replaced. The
cooler was designed for durability, which came with a cost. The brothers
realized that their cooler would have to be sold for about $300.00, and there
was no market for a cooler in that price range. Their initial marketing and
distribution plan focused on tackle shops which were offered a simple
proposition: rather than compete with Wal-Mart and sell $30.00 coolers with
$5.00 profit, sell $300.00 Yeti coolers with $100.00 profit.
The brothers sold majority owner in Yeti to Cortec Group Management
Services, LLC, a private equity firm, in 2012. Cortec provided management
services for a fee of 1 percent of sales (not to exceed $750,000 annually).
With the advice of an ad agency, Yeti created a tagline ‘Wildly Stronger,
Keep Ice Longer’ and concentrated marketing on fishermen and hunters. The
young company hired influential fishermen and hunting guides as
ambassadors for the brand. Brand awareness was also stoked by the
inclusion of a Yeti hat or t-shirt with each cooler sold.
Over the three-year period of 2015 to 2018, Yeti’s customer base
progressed from nine percent to 34 percent female, and from 64 percent to
70 percent under 45 years of age. Yeti brand awareness in the U.S. cooler
and drinkware markets grew from seven percent in 2015 to 24 percent in
2017. Although Yeti continued to invest in their hunting and fishing
communities, their customer base dropped from 69 to 38 percent hunters
during 2015–2018, as the company’s appeal broadened beyond their original
customer communities.
Yeti’s IPO and Stock
In 2016, Yeti filed an IPO to reduce debt and cash out its private equity
owners, however, a downturn in business caused the company to withdraw
its filing. The young company had considerable success in the early years
and grew too rapidly, with the result of pushing excess product to its retailers
and overbuilding inventory in 2016. Also, a major retailer, Sports Authority,
filed for bankruptcy in 2016 and a large amount of inventory was liquidated
at greatly discounted prices, depressing Yeti’s sales. The excessive inventory
buildup resulted in the company’s margins and revenue suffering a
downturn. Revenue declined by 23 percent in 2017 and after-tax operating
profit declined from 18 percent to seven percent. The business downturn,
plus a general market selloff resulted in Yeti withdrawing its IPO plans in
March 2018.
Seven months later, on October 24, 2018, Yeti went public: the company
priced its public offering at $18.00, a bit less than the $19.00 to $21.00 per
share price that it originally intended, and sold 16 million shares (versus the
20 million projected): the IPO brought in approximately $288 million. Yeti
received only about $42.4 million of the IPO proceeds: the balance of the
proceeds went to the Cortex Group, which retained its majority ownership.
In November 2018, Yeti used the proceeds from the IPO, plus cash on hand
to reduce its debt. The management agreement with Cortex was terminated
with the 2018 IPO.
Yeti’s stock had a generally upward trajectory, reaching $34.92 in April of
2019, which was its high. The stock seesawed from that point through the
beginning of the COVID-19 market sell-off, during which it fell to $16.42
on March 20, 2020. The stock rode the market recovery back up and closed
on May 15, 2020 at $26.93—see Exhibit 1.
EXHIBIT 1 Yeti Holdings, Inc. Stock Price, October 2018–
May 2020
page C-175
Source: nasdaq.com.
Yeti’s Strategy
Yeti product strategy was to expand existing product groups and enter new
product categories by designing new offerings based on its consumers’
visions and product knowledge. The company followed a temporal
progression in expanding their product line: first was introduction of an
anchor product and, second, product expansions such as new colors and
sizes and then offering accessories. To ensure continued success
in bringing products to market, Yeti’s product development and
marketing teams collaborated to identify consumer needs and wants, and
then employed its research and development center to design prototypes and
evaluate performance. Yeti’s development process was designed to provide
reliable quality control while enhancing product speed-to-market. This
strategy appeared to work—a May 2018 Yeti owner study, indicated that 95
percent said they had proactively recommended Yeti products to their
friends, family, and others through social media or by word-of-mouth.
Yeti collaborated with its ‘YETI Ambassadors,’ which was a diverse
group of men and women throughout the United States and select
international markets, comprised of world-class anglers, surfers, hunters,
http://nasdaq.com/
rodeo cowboys, barbecue pitmasters, and various outdoor adventurers who
embodied its brand. Yeti worked hard to cultivate relationships with experts,
serious enthusiasts, and everyday consumers, including a combination of
traditional, digital, social media, and grass-roots initiatives to support the
premium-priced brand, in addition to original short films and high-quality
content for YETI.com.
Yeti learned from the 2016–17 inventory disaster and began increasing its
concentration on direct-to-consumer sales through the company’s direct-to-
consumer strategy including its websites and Amazon Marketplace. This
strategy immediately showed positive results: the direct-to-consumer
channel grew from eight percent of revenue in 2015 to 30 percent in 2017,
26 percent in 2018, and 42 percent in 2019. As comparison, Dick’s Sporting
Goods, Yeti’s largest retail partner, accounted for 14 percent of revenue in
2017 and 15 percent in 2019. The move from brick and mortar retail outlets
to increasingly direct-to-consumer sales provided Yeti with benefits beyond
improved revenue. Customers dealt directly with the company rather than a
retail intermediary, brand loyalty increased, the company had better ability to
manage inventory, there was no retail middleman taking part of the profit,
and thus gross margins were higher. In February 2020, Market Watch ranked
Yeti number one in insulated coolers
Yeti’s Product Line
Yeti’s product portfolio comprised three categories: Coolers & Equipment;
Drinkware; and Other. The company had a history of consistently
broadening its premium-priced product line to meet its expanding customer
base and was quite efficient at identifying customer needs and wants to drive
its product line. As is shown in Exhibit 2, net sales of Coolers & Equipment,
Drinkware, and Other represented 40 and 58 percent of net sales,
respectively, in 2019.
EXHIBIT 2 Yeti Holdings, Inc.’s Net Sales by Category,
2017–2019 (dollars in thousands)
2019 2018 2017
Coolers & Equipment $368,874 $331,224 $312,237
Drinkware 526,241 424,164 310,287
http://yeti.com/
page C-176
2019 2018 2017
Other 18,619 23,445 16,715
Total net sales $913,734 $778,833 $639,239
Source: Yeti Holdings, Inc. Annual Report, 2019.
Coolers. The Coolers & Equipment line included hard and soft coolers,
storage, transport, outdoor living, and accessories. The Yeti hard coolers
were built differently than traditional coolers, and used seamless
rotationally-molded, or rotomolded, construction, making them extremely
strong. To increase ice retention, Yeti pressure-injected up to two inches of
polyurethane foam into the walls and lid and utilized a freezer-quality gasket
to seal the lid. There were five products in Yeti’s core hard cooler category:
YETI Tundra (45 quart, $299.99–210 quart, $799.99), YETI TANK
($199.99–$249.99), YETI Roadie ($199.99), Tundra Haul wheeled cooler
($399.99), and YETI Silo6G ($299.99). The company also offered
accessories such as cooler locks and beverage holders. In 2019, Yeti
introduced a stainless-steel body YETI V Series Hard Cooler ($800.00),
which combined the vacuum insulation technology used in their Tumblers
with the construction of their hard coolers to produce more efficient
insulation.
The Yeti Soft Cooler line was designed to be leakproof and provide
superior durability and ice retention compared to competing soft coolers.
The Hopper soft cooler product line included the Hopper M30 ($299.99),
Hopper BackFlip ($299.99), Hopper Flip ($199.99–$299.99), and Daytrip
Lunch Bag ($79.99). Yeti offered related accessories such as the SideKick
Dry gear case, MOLLE Zinger lanyard, and a mountable MOLLE Bottle
Opener.
Storage, Transport, and Outdoor Living. Yeti’s storage, transport, and
outdoor living product category included: the Panga submersible duffel bag
($299.99–$399.99), LoadOut Bucket ($39.99), Panga Backpack ($299.99),
Crossroads Backpack ($199.99), Crossroads Tote ($179.99), Camino
Carryall ($149.99), SideKick Dry gear case ($49.99), Hondo Base Camp
Chair ($299.99), Lowlands Blanket, Trailhead Dog Bed, and Boomer Dog
Bowls. Yeti also offered several related accessories, including bottle openers,
lids, and storage organizers.
Drinkware. Yeti drinkware was manufactured with 18/8 stainless-steel,
double-wall vacuum insulation, and a No Sweat design. The drinkware
products kept beverages at their preferred temperature, either hot or cold, for
hours at a time without condensation. Yeti’s 2020 drinkware product line
comprised the Rambler Colster ($29.99), Rambler Lowball ($19.99),
Rambler Wine Tumbler ($24.99), Rambler Stackable Pints ($24.99–$49.99),
Rambler Mugs ($24.99–$29.99), Rambler Tumblers ($34.99–$39.99),
Rambler Bottles ($29.99–$49.99), and Rambler Jugs ($99.99–$129.99).
There were also accessories including the Rambler Bottle Straw Cap,
Rambler Tumbler Handles, Rambler Jug Mount, and Rambler Bottle Sling.
Yeti offered a broad line of YETI-branded gear and accessories including
shirts, hats, bottle openers, and ice substitutes. The LoadOut GoBox,
Rambler 12-ounce Bottle with Hotshot Cap, Daytrip Lunch Bag, next-
generation Hopper M30 Soft Cooler, Rambler Jr. Kids Bottle, Rambler 10-
ounce Stackable Mug, the Trailhead Dog Bed, Boomer 4 Dog Bowl,
Crossroads 23 Backpack, Crossroads Tote Bag, Rambler 24-ounce. Mug, V
Series Hard Cooler and new colorways for Drinkware, hard and soft coolers,
and the Camino Carryall were all launched in 2019. Also in 2019, the
company expanded distribution of its Camino Carryall to the wholesale
channel.
Although Yeti products were very high quality, they were not
unquestionably the best. The Strategist ranked Yeti’s insulated tumbler
number three, behind two little-known tumblers, the Beast and Maars Bev in
2019. In July 2019, the Chicago Tribune review also placed Yeti’s Ramble
tumbler number three. In April 2020, Outsidepursuits’ review of camping
coolers had placed the Yeti Tundra at number three behind Pelican and
Engel.
Sales Channels
Yeti’s gross sales to independent retail partners were 22 percent and 18
percent, in 2018 and 2019, respectively. These partners did not provide Yeti
with long-term purchase commitments, and orders placed by these retail
partners could be cancelled. Net channel sales are provided in Exhibit 3.
page C-177
EXHIBIT 3 Yeti Holdings, Inc.’s Net Sales by Channel,
2017–2019(dollars in thousands)
2019 2018 2017
Wholesale $527,634 $491,431 $444,854
Direct-to-consumer 386,100 287,402 194,385
Total net sales 913,734 $778,833 $639,239
Source: Yeti Holdings, Inc. Annual Report, 2019.
Yeti had significant sales concentration among its retail
partners. For example, Dick’s Sporting Goods accounted for 16 percent and
15 percent of gross sales in 2018 and 2019 respectively. Yeti’s wholesale
channels sold to several large, national retailers, including Dick’s Sporting
Goods, Bass Pro Shops, REI, Academy Sports + Outdoors, and Ace
Hardware, other retailers with a significant regional presence, and
independent retail partners throughout the United States, Canada, and
Australia. Yeti’s network of independent retail partners included outdoor
specialty, hardware, sporting goods, and farm and ranch supply stores,
among others. As of the end of 2018, Yeti sold through a diverse base of
nearly 4,800 independent retail partners; however, the company realized that
the loss of key retail partners could be problematic. Part of the company’s
growth strategy was to increase the direct-to-consumer sales; however, the
company had limited experience operating the retail e-commerce part of the
strategy.
The company sold in a direct-to-customer channel to consumers on
YETI.com, au.YETI.com, and YETI Authorized on Amazon Marketplace.
Customized products with licensed brand marks and original artwork were
sold through its corporate sales program and at YETIcustomshop.com. A
full line of Yeti products were also sold in Austin, Texas, at the company’s
first retail store, which opened during fiscal 2017, and in corporate stores in
Dallas, Texas; Charleston, South Carolina; and Chicago, Illinois. Yeti’s
direct to consumer e-commerce channel allowed the company to directly
interact with customers, more effectively control its brand, better understand
consumer behaviors and preferences, and offer exclusive products and
customization. According to Doug Schmidt, Director of Retail Operations,
http://yeti.com/
http://au.yeti.com/
http://yeticustomshop.com/
the goal was to “immerse customers in the Yeti brand. The company
believed its control over its e-commerce channel provided customers the
highest level of brand engagement, and built customer loyalty, while
generating attractive revenues.”
Yeti’s global sales
Part of Yeti’s strategy was international expansion, and in June 2019, the
company launched its Canadian website. Also, in mid-2019, websites were
opened in Europe, the United Kingdom, and New Zealand. The company
showed steady increases in international sales revenue as shown in Exhibit 4.
EXHIBIT 4 Yeti Holdings, Inc.’s Net Sales by Geographic
Region, 2017–2019 (dollars in thousands)
2019 2018 2017
United States $873,867 $761,880 $635,195
International 39,867 16,953 4,044
Total net sales $913,734 $778,833 $639,239
Source: Yeti Holdings, Inc. Annual Report, 2019.
Yeti’s Innovation Center
As the company moved through the developing years, Yeti noticed that its
prototyping services and testing were being outsourced, and the back and
forth communication and sample development was creating long timelines
for new product introductions. The company was also left vulnerable to
leaks and was forced to relinquish a degree of control over product testing.
In order to bring control back to the company, Yeti opened its Innovation
center in August 2016. Operations were streamlined and it began
prototyping, product development, and testing at its own Innovation Center.
This move created greater control over its products, product innovation, and
speed of development, as well as protected its intellectual property. CEO
Matt Reintjes believed that their offensive strategy was to continue to be an
innovation leader and stay ahead of the competition.
The Innovation Center housed 3D printers, which enabled Yeti to speed
up the process of bringing products to reality through prototyping
page C-178
capabilities. The Innovation Center also housed machines used for rigorous
product testing or as Director of Engineering, Scott Barbieri
called it “torture tests.” Prior to Yeti’s products going to
market, they were given to product ambassadors who were professional
outdoor enthusiasts. These ambassadors provided their insights into the
utility of the product, placement of zippers, straps, etc. Having a more
streamlined development process allowed Yeti to involve brand ambassadors
in product development discussions.
According to Category Manager Alex Baires, it was about starting from
the ground up, and making a product as best the company could make it. The
company products were familiar products with renewed utility that could be
employed in a number of ways. The company focused on introducing new
categories of products, and bringing innovation into the market through
performance, durability, quality, and design. Yeti did not target a particular
audience, rather it attracted new audience segments.
Yeti’s Partnerships
Yeti formed several partnerships to help increase and sustain brand
recognition.
Yeti became an official NASCAR partner and a sponsor of the
Professional Bull Riders (PBR) in 2017. In January 2020, Yeti entered into a
partnership with USA Climbing, becoming the Official Cooler and
Drinkware Partner in support of the organization’s sustainability efforts. The
goal was to integrate Yeti in all aspects of the sport and provide support for
the U.S. National team as they compete internationally. Both organizations
had a commitment to sustainability and reducing single-use plastic.
Also in 2020, Yeti entered into a multiyear sponsorship agreement with
Austin FC, the 27th Club Major League Soccer team. This partnership
marked Yeti’s formal entry into professional soccer and eSports. As official
partners, Yeti was featured within Austin’s FC’s visual identity. The
company also sponsored Austin FC’s sustainability efforts to launch green
initiatives that include the development of comprehensive recycling,
compost, and water fill policies and practices at Austin FC’s stadium.
Other Yeti partnerships included a multi-year agreement with the PGA
Tour for product licensing, and the exclusive rights to sell Yeti drinkware
and coolers at TOUR-operated tournament retail outlets and facilities.
Yeti’s Financial Condition
Yeti’s consolidated balance sheets, 2018–2019 are produced in Exhibit 5, the
consolidated statement of operations in Exhibit 6, and a consolidated
statement of operations data in Exhibit 7.
EXHIBIT 5 Yeti Holdings, Inc.’s Consolidated Balance
Sheets, 2018–2019 (in thousands, except per share data)
December 28,2019 December 29, 2018
ASSETS
Current assets
Cash $ 72,515 $ 80,051
Accounts receivable, net 82,688 59,328
Inventory 185,700 145,423
Prepaid expenses and other current
assets 19,644 12,211
Total current assets 360,547 297,013
Property and equipment, net 82,610 74,097
Operating lease right-of-use assets 37,768 —
Goodwill 54,293 54,293
Intangible assets, net 90,850 80,019
Deferred income taxes 1,082 7,777
Deferred charges and other assets 2,389 1,014
Total assets $629,539 $514,213
LIABILITIES AND STOCKHOLDERS’
EQUITY
Current liabilities
Accounts payable $ 83,823 $ 68,737
Accrued expenses and other current
liabilities 42,088 53,022
Taxes payable 3,329 6,390
December 28,2019 December 29, 2018
Accrued payroll and related costs 18,119 15,551
Operating lease liabilities 7,768 —
Current maturities of long-term debt 15,185 43,638
Total current liabilities 170,312 187,338
Long-term debt, net of current portion 281,715 284,376
Operating lease liabilities, non-current 42,200 —
Other liabilities 13,307 13,528
Total liabilities $507,534 $485,242
Source: Yeti Holdings, Inc. Annual Report, 2019.
EXHIBIT 6 Yeti Holdings, Inc.’s Consolidated Statements of
Operations, 2017–2019 (in thousands, except per share data)
Fiscal Year Ended
December 28,
2019
December 29,
2018
December 30,
2017
Net sales $913,734 $778,833 $639,239
Cost of goods sold 438,420 395,705 344,638
Gross profit 475,314 383,128 294,601
Selling, general, and
administrative expenses 385,543 280,972 230,634
Operating income 89,771 102,156 63,967
Interest expense (21,779) (31,280) (32,607)
Other (expense) income 734) (1,261) 699
Income before income taxes 67,258 69,615 32,059
Income tax expense (16,824) (11,852) (16,658)
Net income $ 50,434 $ 57,763 $ 15,401
Net income per share
Basic $0.59 $0.71 $0.19
Diluted $0.58 $0.69 $0.19
Fiscal Year Ended
December 28,
2019
December 29,
2018
December 30,
2017
Weighted-average common
shares outstanding
Basic 85,088 81,777 81,479
Diluted 86,347 83,519 82,972
Source: Yeti Holdings, Inc. Annual Report, 2019.
EXHIBIT 7 Yeti Holdings, Inc.’s Consolidated Statement of
Operations Data, 2015–2019 (in thousands, except per share
data)
Year Ended
December
28, 2019
December
29, 2018
December
30, 2017
December
31, 2016
December
31, 2015
Net sales $913,734 $778,833 $639,239 $818,914 $468,946
Gross profit 475,314 383,128 294,601 413,961 218,701
Net Income 50,434 57,763 15,401 48,788 74,222
Net income per
share–diluted $0.58 $0.69 $0.19 $0.58 $0.92
Source: Yeti Holdings, Inc. Annual Report, 2019.
Yeti’s Rivals in the Outdoor and Recreation Products Market
Yeti competed primarily in the large outdoor and recreation market, but also
competed in other markets. According to Yeti, competition was based on
product quality, performance, durability, styling, price, and brand image and
recognition. In the coolers and equipment category, the company competed
against Igloo and Coleman, as well as many other brands and retailers that
offered similar competing products. Yeti believed that the popularity of their
products, as well as their brand, had attracted numerous new competitors
including Pelican, OtterBox, and others, as well as private label brands. In
the Drinkware category, Yeti competed against well-known brands such as
Tervis and HydroFlask, and many other brands with competing products.
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The outdoor and recreation market was highly fragmented and highly
competitive, with low barriers to entry.
Igloo
Igloo was founded in a metalworking shop in 1947. Igloo had approximately
1200 employees and a 1.8 million square-foot, three building facility in
Katy, Texas in 2019. Igloo sold more than 500 products through hundreds of
retailers worldwide. The company’s products included insulated coolers for
personal and industrial use and insulated tumblers and growlers. In 2014,
Igloo, was acquired by the private-equity firm Acon Investments.
The company’s Legacy stainless steel tumbler line ranged from 12 ounces
($15.99) to 22 ounces ($18.99). Igloo offered stainless steel growlers in 36
ounces ($24.99) and 64 ounces ($34.99) sizes, stainless steel coffee mugs in
16-ounce ($19.99) and 20-ounce ($20.99) sizes, and a full line of tumblers,
and other drinkware in double sided plastic. The company’s hard side cooler
offering was expansive, ranging from seven-quart coolers ($39.99) to 124-
quart ($299.99) and included the very popular Playmate line. There were
numerous Igloo soft side coolers ranging from small lunch bags ($7.99) to
46 can Tactical Duffle Bag coolers ($69.99) to 50 can coolers
($53.99).
Igloo had a very large product offering in all of the cooler and tumbler
categories, which were priced very competitively, plus it had the iconic
Playmate cooler and was a major competitor in the industry. However, its
strategy moving into 2020 appeared to have the potential to significantly
boost Igloo’s sales revenue. In April 2019, Igloo introduced a biodegradable
cooler, the RECOOL, a 16-quart model aimed at the environmentally
conscious consumer. The RECOOL, made of recycled tree pulp and paraffin
wax, won Igloo multiple awards, including Best in Show from Gear Junkie,
at the 2019 Outdoor Retailer and Snow Show. Following the success of the
biodegradable RECOOL cooler, Igloo introduced the REPREVE soft side
cooler made from recycled plastic bottles and announced plans to add 20
new REPREVE bag styles to the recycled plastics line in 2020.
In 2020, Igloo announced development of a bioplastic line of its Playmate
cooler, made from sugarcane plants. The new bioplastic Playmate was
scheduled for the consumer market in early 2021. Also in
2020, Igloo partnered with BASF to engineer a new
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proprietary insulation foam, Thermecool, which was used for all of its hard
side coolers. Igloo claimed that the new environmentally friendly insulation
would have the net effect of removing over 86,000 cars from the American
roads per year.
Igloo sponsored brand ambassadors who were active in outdoor sports
such as fishing, running, and surfing; this group also included graphic
designers whose designs were used on Igloo coolers.
Tervis
Tervis had its beginning in post WWII Detroit, Michigan, when its founders
perfected the double wall cup technology to keep warm things warm and
cool things cool. The name “Tervis” came from the last three
letters of both founders’ names: Frank Cotter and Howlett Davis.
Ten years later, John Winslow bought the rights to the tumbler, moved the
manufacturing to Osprey, Florida, and founded Tervis Tumbler Co. Winslow
sold the cups door-to-door and dock-to-dock, and soon the tumbler became a
Florida favorite. The company produced primarily state novelty cups,
primarily Gulf and Atlantic coast states; however, other decals could be
inserted between the two layers of plastic. Tervis made a shift from primarily
state novelty cups to a national product in 1995 when it began licensing
college sports and, later, major league sports logos. The company’s newest
products include wine glasses, sippy cups for toddlers, and metal insulated
cups.
The Tervis line of drinkware was primarily plastic, however it offered
several stainless-steel products, including tumblers ranging from 20 ounces
($29.99) to 30 ounces ($39.99). Tervis began a partnership with Bed, Bath,
& Beyond, and launched its E-commerce site in 2008. In 2009, despite the
Great Recession, Tervis’s revenues rose 40 percent, from $34 million in
2008, to $47.6 million, and its employees increased from 200 to 275. In
2009, Tervis’s products were sold in more than 6,000 outlets nationwide, and
in company stores in Osprey, Fort Meyers, Palm Beach, and The Villages in
Florida.
Otter Box
Like many start-up companies, OtterBox began with a dream. Curt
Richardson started the company in a garage in 1998, and created the first
OtterBox product, which was a waterproof case. Starting with a simple box,
OtterBox built upon the fundamentals of hard work, taking risks, and being
consumer focused to pursue its mission: “We Grow to Give.” OtterBox was
a seven-time honoree on the Inc. 5000 list of fastest-growing private
companies in the United States. The company was also named one of
‘America’s Most Promising Companies’ by Forbes Magazine, one of the
‘Healthiest Companies to Work For in America’ by Greatist, and ranked as a
‘Great Place to Work’ by Fortune, Forbes, and Entrepreneur Magazine. The
company was headquartered in Fort Collins, Colorado, with offices in San
Diego, Hong Kong, and Cork, Ireland.
Otterbox manufactured a line of coolers, drinkware and accessories that
directly competed with Yeti. Their Venture coolers ranged from 25 to 65
quart capacity with prices from $229.99 to $349.99, and Otterbox Trooper
soft side coolers, in 12 to 30 quart sizes, were priced from $199.99 to
$299.99. The company offered a large line of insulated tumblers, ranging
from small 10-ounce coffee cups (424.99), wine tumblers ($19.99), to 20-
ounce tumblers ($29.99), and growlers in 28-ounce ($34.99) to 64-ounce
($69.99) sizes. There was also an expansive line of hard and soft cooler and
tumbler accessories.
HydroFlask
Hydro Flask was founded in 2009 in Bend, Oregon. The company was a
manufacturer of high-performance insulated products ranging from beverage
and food flasks, to their Unbound Series Soft Coolers. Hydro Flask products
utilized TempShield double-wall vacuum insulation and 18/8 stainless steel
to maintain temperatures in their products. HydroFlask had become popular
among millennials and Gen Zers due to its trendy aesthetics. There were a
variety of sizes, from a 12-ounce kids’ bottle to a 64-ounce jug, standard or
wide mouth bottles and multiple lids to fit each. HydroFlask’s stainless steel
tumblers ranged from 16 ounces ($27.95) to 32 ounces ($39.95). Their large
line of products included 12 ounces to 20 ounces coffee flasks priced from
$29.95 to $34.95; 64-ounce. beer growlers ($64.95); drink bottles in 12-
ounce to 64-ounce sizes ($29.95–$64.95); and insulated totes ($44.95–
$64.95). The company’s line of Unbound soft side coolers and totes ranged
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from 15 liters ($174.95) to 22 liters ($199.85). Tumblers and other
drinkware carried a lifetime warranty, and coolers and totes had a five-year
warranty.
Corkcicle
Corkcicle was founded in 2010 by Ben Hewitt. Hewitt, an avid chardonnay
drinker, who thought there had to be a better idea to keep wine cold that did
not involve a messy ice bucket. His initial idea involved putting the content
of a gel pack into a test tube and covering it with a Kendall-Jackson cork.
During Corkcicle’s first holiday season, the company sold roughly 300,000
corkcicles. This gave way to the creation of other products such as the
Chillsner that kept bottled beer cold, the Artican that would keep canned
beverages chilly, and the crafted canteen that keeps beverages cool for up to
25 hours or warm for up to 12 hours. Corkcicle products included
stainless steel tumblers ($27.95–$37.95), stemless wine cups
($24.95–$29.95), hybrid canteens ($39.95), coffee mugs ($39.95), lunch
boxes ($39.95), and cooler bags ($129.95–$174.95). As of January 2020,
Corkcicle entered into a strategic partnership with Gemline, a promotional
supplier of bags, business accessories, drinkware, gifts, and writing
instruments for product sales and distribution.
Coleman
Coleman had its beginning with a gas-powered lantern designed by W. C.
Coleman. In 1905, the first night football game was lit by Coleman lanterns,
and during WWII, Coleman camping stoves transformed the way soldiers
ate in the field. Coleman designed and manufactured outdoor recreational
products. Coleman’s products included coolers, tents, sleeping bags,
canopies, camping items, and lighting. Coleman products had been sold
domestically and internationally since the 1920s. Their strong market
position was attributable to its well-recognized trademarks, its broad product
line, and product quality. The company did not sell direct, rather through
numerous big box retailers (e.g., Bass Pro Shops, Cabela’s, Home Depot,
Dick’s Sporting Goods, Target, and Walmart), as well as Amazon.
The large Coleman line of hard coolers ranged from small 28-quart
models ($22.61) to 54-quart steel belted coolers ($119.95), and included a
52-quart Xtreme model ($51.00) that would keep drinks cold for a week in
temperatures up to 90 degrees Farenheit, and a 150-quart Marine cooler that
would keep 223 can cold for 6 days in 90 degree Farenheit temperatures.
Coleman’s soft side coolers ranged from small, 4-quart models ($11.25) to
36-quart models ($65.55), and their stainless-steel tumbler line ranged from
a 13oz. Rocks Glass ($12.00) to a 30oz. tumbler ($19.99).
Coleman’s 2019–20 partnerships included Jeep Jamboree USA, an
outdoor family oriented adventure trip; Stagecoach Country Music Festival;
Seven Peaks Music Festival; Great American Beer Festival; and park
districts. Coleman also partnered with Team Rubicon, an organization that
provided relief to those affected by natural disasters, and Convoy of Hope, a
nonprofit community outreach and disaster relief organization.
Pelican
Pelican was founded in 1976 by Dave and Arline Parker in their Torrance,
California garage. Dave, who had been a scuba diver since age 11,
recognized the need for rugged flashlights and cases that wouldn’t leak or
fail and set out to build a better product than any other on the market. After
years of work, Pelican Products became a reality with its first product patent,
the Pelican Float™. The SabreLite™ flashlight and Protector Cases soon
followed. Pelican’s product line and company grew steadily over the years
and, in 2004, the company was acquired by private equity firm, Behrman
Capital. Shortly thereafter, the company experienced a tremendous global
growth trend under its new CEO Lyndon Faulkner. The company added
coolers and drinkware to its product line in 2012.
The Pelican line of Dayventure soft side coolers included nine-quart
($149.95) and 19-quart ($249.95) models, and its hard side cooler line
ranged from 20-quart ($153.95) to 150-quart ($648.95) models. The
company’s hard coolers were 30 percent lighter than roto-molded coolers,
and had two-inch solid wall construction, stainless-steel latches, built-in
cupholders, and were guaranteed for life. Pelican’s stainless steel Dayventure
tumbler line ranged from 10oz. ($19.95) to 22oz. ($29.95), and its insulated
stainless bottles ranged from 18oz. ($24.95) to 64oz. ($49.95).
Numerous Small Brands
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Coolers and especially insulated tumblers and accessories were rather simple
and inexpensive to manufacture and within the abilities of a large number of
manufacturing companies. Consequently, many small specialty retailers
contracted with manufactures for these products and competed with Yeti
(and other large companies). Companies such as ORCA, Monoprice Polar
Bear, RTIC, K2, Domestic, IceMule, Ozark, Titan, Frosted Frog, CaterGater,
Engel, RovR, and Xspec were examples of smaller retailers competing in the
insulated cooler market. The insulated tumbler market was equally crowded,
with companies such as Klean Kanteen, Mira, Sunwill, Beast, Drinco, Maars
Bev, RTIC, Umite Chef, Atlin, Baroon, Ozark Trail, Zojirushi, Sipworksw,
Mukoko, Bugga Keg, Ultra Fyt, MalloMe, and others selling tumblers that
directly competed with Yeti.
Yeti’s Strategic Situation in Mid-2020
Going into mid-2020, Yeti management sought to capitalize on its financial
and market success with continued growth. The company’s products
resonated with consumers, with sales increasing in both in the United States
and internationally. There were opportunities for management to improve the
company’s internal operations and strategy, but external factors were among
the most worrisome issues facing the company. It was imperative that the
company prepare itself for the impact of unfavorable tariffs, prolonged
effects of the COVID-19 pandemic, and the proliferation of rivals seeking to
unseat Yeti as the leading premium brand of coolers, drinkware, and related
products.
G
page C-184
CASE 14
GoPro in 2020: Have its Turnaround
Strategies Failed?
Copyright ©2021 by David L. Turnipseed and John E. Gamble. All rights reserved.
David L. Turnipseed
University of South Alabama
John E. Gamble
Texas A&M University–Corpus Christi
oPro had been among the best examples of how a company could create a new
market based upon product innovations that customers understood and demanded.
However, by late 2015, the action camera product niche appeared saturated. The
company had grown from a humble beginning as a homemade camera tether and plastic
case vendor in 2004 to an action camera vendor with $350,000 in sales in 2005 (its first
full year of operation) to a global seller of consumer electronics with revenue of
$1.6 billion in 2015. The company’s shares had traded as high as $88 in October 2014,
just months after its initial public offering (IPO) in June 2014. In 2014, GoPro was
ranked the number one most popular brand on YouTube with more than 640 million
views, and an average of 845,000 views daily. In 2015, average daily views were up to
1.01 million.
Abruptly, in the third quarter of 2015, GoPro’s magic disappeared, and, by the fourth
quarter of 2015, its revenues dropped by 31 percent from the prior year. In addition, its
net income fell by 128 percent to a net loss of $34.5 million. By the end of December
2015, the stock traded at less than $20. By the end of December 2016, revenues had
dropped another 27 percent to $1.2 billion from $1.6 billion in 2015. In addition, the
company recorded a net loss of $419 million in fiscal 2016, helping drive its share price
to less than $9.00 in December 2016.
page C-185
The company launched a turnaround plan in early 2017 and reduced its workforce in
an effort to reverse its decline: first quarter sales in 2017 increased by 19 percent from
the first quarter 2016, and its operating expenses declined by $50 million. Its adjusted
EBITDA improved from an $87 million loss in the first quarter of 2016 to a $46 million
loss in the first quarter of 2017. The HERO5 Black was the best-selling digital image
camera in the United States in the first quarter of 2017, and GoPro’s drone Karma with
the HERO5 camera was the number-two selling drone priced over $1,000 in the United
States.
After a recall of the Karma drone for flight failure, GoPro abandoned the drone
business in early 2018. The number of camera units shipped in 2018 was flat, compared
to the prior year, and the average selling price decreased which put downward pressure
on the year’s revenue. The company announced another restructuring in 2018, which
resulted in an additional reduction in the global workforce to below 1,000 by the end of
the year, and continuing reductions in operating expenses. These efforts met with mixed
results, and revenue continued to fall, dropping 2.7 percent from the prior year, and
gross margin fell from 32.6 percent in 2017 to 31.5 percent in 2018. Operating expense
decreased from 46 percent of revenue in 2017 to 40 percent in 2018. Yet fiscal 2018
produced a loss of $109 million.
The dismal trend in financial performance continued, albeit with a four percent
uptick in revenue in fiscal 2019. GoPro’s 2019 gross margin increased to 35 percent, up
from 31 percent in 2018, and adjusted EBITDA increased by 230 percent from 2018.
Camera units shipped in 2019 were down two percent from 2018. Although the net loss
in 2019 was the smallest in the past four years, it nonetheless added $14.6 million to
GoPro’s accumulated deficit. The continuing subpar operation took its toll on the share
prices: in the fourth quarter 2019, share prices were slightly over $4.00,
which was 95 percent below its $88.00 high.
In GoPro’s first quarter 2020, results appeared to be the death knell for the struggling
company. In the first quarter, despite GoPro.com recording record revenue, its
subscription service up 69 percent year-over-year, and social followers increasing to
over 44 million, GoPro’s fortunes turned even more negative. The company
experienced a 50 percent decrease in revenue from the same period, 2019, a decline in
gross margin, a 177 percent increase in operating losses, and a 161 percent great net
loss, over the same period in 2019, yet GoPro continued to be the industry leader in
action cameras. The company announced another restructuring aimed at reducing
expenses. Plans included trimming the remaining workforce by 20 percent, reducing
operating expenses by $100 million, and cutting an additional $250 million from
operating expenses in 2021. A summary of the company’s financial performance for
2015 through 2019 is presented in Exhibit 1. The performance of GoPro’s shares from
June 2014 through May 2020 is presented in Exhibit 2.
http://gopro.com/
EXHIBIT 1 Financial Summary for GoPro, Inc., 2015–2019 (in
thousands, except per share amounts)
2019 2018 2017 2016 2015
Revenue $1,194,651 $1,148,337 $1,179,741 $1,185,481 $1,619,971
Gross
Profit 412,789 361,434 384,530 461,920 673,214
Gross
Margin 34.6% 31.5% 32.6% 39.0% 41.6%
Operating
income
(loss)
(2,333) (93,962) (163,460) (372,969) 54,748
Net
Income
(loss)
(14,642) (109,034) (182,873) (419,003) 36,131
Net income
(loss) per
share:
Basic $(0.10) $(0.78) $(1.32) $(3.01) $0.27
Diluted $(0.10) $(0.78) $(1.32) $(3.01) $0.25
Source: GoPro, Inc. 2019 Annual Report.
EXHIBIT 2 GoPro Stock Performance, December 2014–December
2019
Source: GoPro, Inc. 2019 Annual Report.
page C-186
In mid-2020, GoPro was without doubt a dominant force in the global action camera
industry; however, years of net losses had resulted in an accumulated deficit of
$583 million. The first quarter 2020 had produced dismal results, and although the
COVID-19 pandemic could be partially to blame, the continuing losses further
weakened the struggling company. The company’s management was faced with the
critical, time-sensitive mandate: find a way to increase revenue and restore profitability
before the lack of liquidity impeded the ability to make proactive strategic moves.
Company History
GoPro began as the result of business failures. GoPro’s founder, Nick Woodman, grew
up in Silicon Valley, the son of wealthy parents (his father brokered the purchase of
Taco Bell by Pepsi). Woodman started an online electronics store, EmpowerAll.com,
which failed. He subsequently started an online gaming service, Funbug, that failed in
the dot-com crash of 2001, costing investors $3.9 million. Woodman consoled himself
after the failure of Funbug with an extended surfing vacation in Indonesia and
Australia. While on vacation, he fashioned a wrist strap from a broken surfboard leash
and rubber bands to attach a disposable Kodak camera to his wrist while on the water.
Woodman’s friend and current GoPro creative director Brad Schmidt joined the
vacation, worked with the camera strap, and observed that Woodman needed a camera
that could withstand the sea.
After his vacation, Woodman returned home and focused on developing a
comprehensive camera, casing, and strap package for surfers. Originally incorporated
as Woodman Labs, the company began doing business in 2004 as GoPro.
Woodman found a 35-mm camera made in China that cost $3.05 and sent
his homemade plastic case and $5,000 to an unknown company, Hotax. A few months
later, Woodman received his renderings and a 3-D model from the company and sold
his first GoPro camera in September 2004 at an action-sports trade show. Also that
year, GoPro hired its first employee, Neil Dana, who was Woodman’s college
roommate.
The two-man company grossed $350,000 in 2005, the first full year of operation.
Woodman wanted to keep the company private as long as possible: he invested $30,000
personally, his mother contributed $35,000, and his father added $200,000. In a
fortunate coincidence for GoPro, in fall 2006 Google purchased a then-small company,
YouTube, and in spring 2007, the GoPro HERO3 with VGA video was launched.
According to Woodman, the competing name-brand cameras available at the time did
not have good video quality. The combination of GoPro’s HERO3 video quality and the
increasing popularity of YouTube caused GoPro’s sales to triple in 2007.
In 2007, although the company had revenues in the low seven figures, Woodman
began to question his ability to take the firm further. He negotiated a deal to turn the
company over to a group of outside investors, but before the deal was finalized (which
was at the beginning of the 2008 financial crisis), the investors wanted to lower the
http://empowerall.com/
page C-187
valuation of the company. GoPro was profitable, and Woodman did not believe that the
company was having any ill effects from the economy. He refused to negotiate the
company’s value down, and the company’s sales were over $8 million that year. The
company’s growth continued and in 2010, Best Buy began carrying GoPro products,
which was a clear indication that the company was accepted in the market.
In May 2011, GoPro received $88 million in investments from five venture capital
firms (including Steamboat Ventures—Disney’s venture capital company) which
enabled Woodman, his family, and some GoPro executives to take cash from the
company. Also in 2011, GoPro acquired CineForm, a small company that had
developed a proprietary codex that quickly and easily converted digital video files
among different formats. CineForm had used this codex in several movies
including Need for Speed and Slumdog Millionaire. As part of GoPro,
CineForm altered its 3-D footage tool into an editing program that became the
company’s first desktop application, GoPro Studio.
A Taiwanese manufacturing company, Foxconn (trading as Hone Hai Precision
Industry Co.), bought 8.8 percent of GoPro for $200 million, in December 2012, which
brought the value of the privately held company to about $2.25 billion, and Forbes
reported Woodman’s personal net worth to be about $1.73 billion. GoPro sold
2.3 million cameras and grossed $531 million in 2012, and, in December of that year,
GoPro replaced Sony as the highest-selling camera brand at Best Buy.
Sales of GoPro cameras at snow-sports retailers increased by 50 percent for the
2012–2013 ski season. GoPro almost doubled its revenues in each of three consecutive
years, from $234.2 million in 2011 to $525 million in 2012 and $985 million in 2013,
according to the U.S. Securities and Exchange Commission (SEC). Although revenues
increased 87 percent in 2013, in that year the decrease in revenue growth became
obvious. According to its IPO filing, as of December 2013, the company had not
derived any revenue from the distribution of its content on the GoPro Network;
however, it announced plans to pursue new streams of revenue from the distribution of
GoPro content. GoPro formed a new software division in 2013. Also in that year, the
National Academy of Television Arts and Sciences recognized the company with a
Technology and Engineering Emmy Award in the Inexpensive Small Rugged HD
Camera category.
In June 2014, GoPro went public at an IPO price of $24.00 which valued the
company at $2.7 billion. The IPO included a lockup agreement that prevented the
Woodmans from selling any shares of GoPro stock for six months; four months later on
October 2, 2014, the Woodmans made a donation of 5.8 million shares of GoPro stock
into the Jill and Nick Woodman Foundation. A press release about the foundation stated
that details about its mission would be announced at a later date, according to CNN.
Share prices dropped 14 percent after the announcement and angered investors. Also,
GoPro failed to meet investors’ expectations when it released its first earnings report in
August 2014.
page C-188
GoPro increased emphasis on software and video sharing in 2015. In 2015, GoPro
tied with Apple on the Google Brand Leaderboard, which measures the most popular
brands on YouTube. According to Google, more than 4.6 years of content was uploaded
to YouTube in 2015 with GoPro in the title, an increase of 22 percent from 2014. Also
in 2015, the company launched the GoPro Channel on Amazon Fire TV and Fire TV
Stick with a custom-designed streaming channel that was a one-stop destination for
delivering on-demand GoPro videos to Amazon customers.
Another 2015 development was the GoPro Channel on the PlayStation Network
which allowed PlayStation owners to stream GoPro content on-demand and browse
GoPro cameras and accessories. PlayStation joined GoPro’s growing roster of
distribution partners including Amazon Fire TV, Roku, Comcast Watchable, Sky, Vessel
Entertainment, Xbox, LG, and Virgin America. The GoPro Mobile App was
downloaded 2.75 million times in the fourth quarter, totaling almost 24 million
cumulative downloads; fourth quarter installs of GoPro Studio totaled nearly
1.7 million, totaling over 15 million cumulative installs, with average daily video
exports of over 49,000. GoPro’s shareholders were not impressed with the operations,
and from July to the end of December 2015, the company’s stock fell from $63.00 to
$18.00.
GoPro purchased Kolor, a French company with experience making software for
capturing and displaying virtual reality in 2016, and acquired Replay and Splice, two
leading mobile video editing apps. Replay was video editing software that GoPro
rebranded as Quik, and Splice was an app that promised desktop-level performance for
editing video on an iPhone. The Kolor group assisted in the launch of a virtual reality
social media platform that functioned both on the web and as an app. According to The
Verge (June 2, 2016), Woodman understood that “the hardware-first chapter of GoPro”
was coming to the end. He recognized that market saturation had created the problem,
explaining it as “content guilt.” According to Woodman, “Most people don’t even
watch their GoPro footage.” He blamed the company for creating the problem by
solving the capture side but leaving customers hanging in postproduction.
In April 2016, the investment bank Piper Jaffray reported that GoPro was gaining
market share in a declining market, and that action camera ownership declined to
28 percent among teenage consumers, down from 31 percent a year previous, and
40 percent in 2013. This trend clearly indicated the need for GoPro to
transform into something more than an action camera company. The
GoPro brand and reputation had been made as a hardware company, and moving that
reputation to a new market (i.e., software) would be difficult. Although GoPro created
the market for wearable cameras, it found the content-creation software field crowded.
Plus, The Verge (June 2, 2016) pointed out that the company had no clear way to
monetize its software. According to Woodman, building the software team had been the
most time-consuming project the company had undertaken. He believed that the
benefits of success would be large because the amount of video being consumed was
huge, and the market research company NPD Group reported that more than 80 percent
of smartphone users stream video.
GoPro’s third quarter 2016 performance produced large losses, leading to Woodman
firing 15 percent of his workforce. The company’s president, Tony Bates, announced
plans to leave GoPro at year end, after little more than two years with the company.
Woodman also believed in the potential of Karma, GoPro’s camera drone, which was
released in 2016. The Karma drone, which had been postponed several times, was
eventually released in October 2016. Problems quickly became apparent with the drone
— it stopped flying and crashed—that required GoPro to issue a recall on November 8,
2016, and offer full refunds.
In early 2017, GoPro announced a new 360-degree camera, Fusion, but provided few
details. The company planned a pilot release of Fusion in summer 2017, and a launch
with a limited release at the end of 2017. According to Woodman, professional users
would be the main market for Fusion, which was a much smaller market than the
traditional consumers that had bought GoPro’s other cameras. The company announced
another restructuring and cut an additional 270 jobs. Because of the cost reductions,
CEO Woodman said that the company was on track to achieve profitability in 2017.
The Karma drone problems were corrected, and it was back on the market in
February 2017. Shortly after sales resumed, Woodman claimed that the drone was
“exceeding our expectations” (Fortune, April 27, 2017). However, GoPro CFO Brian
McGee said that the bulk of Karma’s sales had come from being bundled with the
HERO5 camera. According to McGee, GoPro made more money from the sale of a
camera than from the sale of a drone. Woodman’s forecast of profitability in 2017 was
inaccurate and the company suffered a $183 million net loss.
Although the Karma’s problem (battery door latch) had been corrected, and the drone
was put back on the market, the damage was done. In January 2018, GoPro announced
that it would exit the drone market after its existing inventory was sold, and laid off
several hundred employees who worked on the drone. Attempting to garner a new
niche of customers, GoPro introduced an entry level HERO, that sold for $199. The
company advertised the HERO as a great first GoPro for people wishing to share
experiences beyond what a phone could capture. The company’s flagship HERO7
Black received numerous awards during 2018, including “Best Specialty Camera” by
Videomaker in its 2018 Best Products of the Year awards. GoPro also received
numerous awards including IEEE’s ICIP “Visual Innovation” award for the HERO
camera line, Newsweek’s “America’s Best Customer Service” award, and IEEE’s
Spectrum Consumer Electronics Hall of Fame. Despite the accolades, GoPro’s sales
continued to shrink in falling to $1,148 million in fiscal 2018, with losses of
$109 million.
The Fusion was discontinued in 2019 and replaced by MAX. In a departure from
prior operations, in 2019, GoPro stopped dropping prices on previous generation
products: rather these products were discontinued. GoPro’s 2019 product line continued
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to excel in the market with the HERO8 Black being the number one selling camera in
the United States in the fourth quarter 2019 and the new 360 degree MAX capturing
54 percent of the spherical camera sales. These accolades were insufficient to rescue
the struggling company. In September 2019, the company downgraded its full-year
guidance for 2019 and blamed production delays for the late introduction of the
HERO8 Black camera. In the later part of 2019, the industry was rife with rumors of
GoPro being an acquisition target.
When GoPro exited the drone market, it pledged to continue to support the Karma
drone software; however, the Karma curse continued and, at the change of the decade
2019–20, the Karma software developed a problem that resulted in grounding the drone
again. According to GoPro, the problem was a GPS clock rollover occurrence. These
rollovers occurred once every 1024 weeks, and most software firms avoided the
problems with updates, but Karma software had not been updated since 2018. By mid
January 2020, an upgrade had been developed to correct the problem.
GoPro ended 2019 with a fourth consecutive year of losses, showing a
$14.6 million net loss.
As GoPro moved into 2020, the first quarter results caused many in the industry to
question whether the company could continue to operate. First quarter revenue dropped
by 51 percent over the same period in the prior year, and the net loss increased by
161 percent. The company’s shares were selling below $3.00. The company announced
another restructuring with a 20 percent employee reduction, reductions in sales and
marketing expenditures, and a move to a direct sales distribution model. According to
GoPro, the distribution change would cost the company between $31 million and
$49 million.
Since its beginning, GoPro had been primarily an action camera and related services
company, with the exception of the Karma venture; however, in May 2020, the
company entered the cutthroat industry of personal lighting and released its first
flashlight, the Zeus Mini, which was priced at $69.99.
The Action Camera Industry from 2014 to 2020
The global action camera market was valued at $3.13 billion in 2018, and was forecast
to reach $10.3 billion by 2026, which would be a six-year CAGR of 16 percent. Much
of the growth in the industry had been driven by the increasing development of the
travel industry and the growing numbers of travel and adventure sports participants.
Entry level pricing and the consumers’ demand for the latest technology were other
major driving forces in the industry. Global demand was spurred by the increased
popularity and use of social networking sites such as Instagram, Twitter, and Facebook,
and the trend of sharing videos and photos with friends and followers. GoPro was the
market leader in the world action camera industry.
Camera unit sales increased by 38 percent in North America in 2014. However, the
largest growth came from the Asia Pacific region, which was up by 114 percent. Sales
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of action cameras worldwide reached 10.5 million in 2017, up from 8.4 million in 2015.
Although the action camera market was expected to enjoy continued sales growth
through at least 2019, several factors, including lengthening replacement cycles, were
expected to slow the growth rate.
Consumer sales, primarily for extreme sports, had accounted for the largest part of
global demand up to mid-2015, but professional sales, primarily driven by TV
production, security, and law enforcement, were expected to increase. In 2014,
consumers were responsible for 86 percent of action camera sales, with the remainder
coming from professional uses. Although GoPro dominated the action camera industry
in mid-2015, there was increased competition from other companies, including Garmin,
TomTom, Canon, JVC, Ion America, Polaroid, and Sony. Other competitors were
focusing on the adjacent market of wearable cameras for security and police officers.
A defining characteristic of the action camera industry in 2019 was the increase in
the number of competitors. In early 2015, the market was experiencing rapid growth
and attracted many new entrants, which had the expected effect on price (lower),
quality (higher), and features (more). A list of action camera brands marketed in 2020
is presented in Exhibit 3.
EXHIBIT 3 Select Action Camera Brands in 2020
GoPro VanTop
Sony TomTom
Yi DJI
Kodak Victure
Garmin Olfi
Activeon Insta360
Akaso DragonTouch
Letscom Vtech
Source: Compiled by case researchers from various internet retailing and product review sites.
Another industry trend was price polarization. Sales of low-end camera models
priced under $200.00 and high-end models (including GoPro’s $299.00 HERO8 Black)
experienced increasing growth. The action camera industry experienced significant
change in early 2015. A Futuresource analyst reported that the 360-degree capture that
had recently become available would drive virtual reality applications over the coming
months, especially for sports broadcasting. The company envisioned the percentage of
360-degree video action cameras growing from one percent in 2015 to 14 percent by
2019.
In 2014, 95 percent of action cameras sold could take high-definition video with at least
720p resolution, and approximately 85 percent of action cameras could take HD video
in 1080p. About half of cameras sold could record video in ultra-high-definition 2160p,
or 4K.
In 2016, the action camera industry experienced adjustments in usage: The demand
for action cameras for professional applications had grown exponentially due to the
focus on better viewing of sports events. Action cameras were increasingly being used
for TV production and to record closer details of sports. The National Hockey League
and Fishing League Worldwide had signed major contracts with iON, GoPro, and other
vendors, and the professional segment of the industry was expected to have a high
growth rate. Also, Global Market Insights pointed out increasing popularity of action
cameras among all age groups and advanced product features as other factors providing
massive growth potential.
The security industry was also finding increasing usage for action cameras in 2016,
which added more fuel to the industry growth. Action cameras and especially drone-
mounted action cameras were expected to be used increasingly in security applications
globally. A leading vendor in the action camera–drones, Lifeline Response, had
developed a smartphone app that could fly a drone to a needed location in emergencies.
According to Technavio Research, professional use of action cameras would exceed
casual usage by 2020.
In addition to increased demand for action cameras for professional applications, the
industry was expanding also due to demand from developing countries, with the largest
growth in the Asia Pacific region. Increasing disposable income, an increase in social
networking, and rapid growth in adventure sport tourism, plus an increasing number of
sports leagues and tournaments were factors increasing sales in emerging countries.
Several action camera vendors sponsored extreme sporting events in various emerging
economies to promote their camera brands. Although European growth was predicted
to be stable from 2016 to 2023, the global action camera market was projected to grow
at an annual rate of 14.6 percent between 2017 and 2021, and reach 10.3 billion in by
2026. These forecasts, however, became questionable in early 2020, when the COVID-
19 crises virtually stopped travel and sports around the world.
The revenue growth rate in the action camera industry was expected to be lower than
the growth rate in unit sales, due to a general price decline. The average action camera
price was expected to decline to $226.00 by 2020, depressed primarily by a global
increase in supply. Also, young consumers were increasingly choosing smartphone
cameras over traditional, which meant they were less likely to purchase an action
camera.
The popularity of social networking sites was a major driver of the action camera
industry, and price polarization continued as a crucial trend moving into 2020. Vendors
were increasingly “bundling” their products (cameras and numerous accessories) to
increase demand for cameras and accessories. Bundle packaging increased demand by
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offering cost-effectiveness to customers because the bundling reduced or eliminated the
need to purchase additional equipment. Other industry trends moving into 2020 were
increasing numbers of new entrants which reduced prices, declining prices, and
increasing significance of the smartphone with enhanced quality and features which
depressed demand. The saturation of the action camera market niche and the declining
prices contributed to the June 2017 bankruptcy filing of iON Worldwide, a major
competitor in the industry.
GoPro’s Business Model and Strategy
The action camera industry was a relatively young and evolving industry, and GoPro
evolved within the industry. Although the company began as an action camera
company, it had rapidly evolved into a diversified lifestyle company. The company’s
business focus, as set out in its 2015 annual report, was to develop product solutions
that enabled consumers to capture, manage, share, and enjoy some of the most
important moments in their lives. In addition to selling action cameras to capture live
events, the company developed GoPro Entertainment, and planned to diversify into a
number of related businesses, including software and drones.
Reflecting awareness of the problems facing the company after the revenue decline
and net loss in 2016, and opportunities on the horizon, GoPro set out its business
strategy in its 2016 Annual Report. The core of the strategy was helping consumers
capture and share experiences, and GoPro was committed to developing solutions that
created an easy experience for consumers to capture, create, and enjoy
personal content. The company believed that when consumers used
GoPro products and services, they enabled authentic content that increased awareness
for the company, and drove a self-reinforcing demand for its products. Revenue growth
was expected to be driven by the introduction of new cameras, drones, accessories, and
software applications. This strategy was not successful, and revenue decreased from
2016–2018, with large net losses in each of those years.
In 2018, GoPro’s general strategy was unchanged from 2016: the key components of
the 2010 strategy were 1) drive profitability through improved efficiency, lower costs
and better execution; 2) strengthen the analytics and understanding of customer
behavior to enable better business planning; 3) launch products that broadened GoPro’s
appeal at all price points, with greater emphasis on new customers; 4) increase the
investment in marketing to grow the brand and attract new customers globally; 5) focus
on the ecosystem of camera, app and cloud experiences; 6) expand the value
proposition of subscription offerings to attract new consumers and engage the global
user base; and 7), attract, engage, and retain top talent. Following this strategy, the
company had a small four percent bounce in revenue in 2019 but continued to
experience net losses.
The essence of GoPro’s strategy for 2020 and beyond was to help customers capture
and share their experiences in exciting ways. GoPro reiterated its belief that its revenue
growth would be driven by the introduction of cameras and accessories, subscriptions,
and monetizing the GoPro app. Basic to this strategy was GoPro’s belief that new or
better camera features would drive a replacement cycle among existing customers and
attract new users.
In 2019, GoPro set out the key components of the company’s 2020 strategy as the
following:
1. Strengthen the core business. Focus on target customer, identify new customer
segments, and deliver high-margin, high-value products which will strengthen the
core business. Continued commitment and investment in consumer research. Extend
GoPro’s brand and products to solve problems for a broader set of customers.
Leverage the GoPro brand strength and product expertise to drive a hardware
upgrade cycle for existing customers and opportunistically enter complementary
device segments and continue to develop cameras.
2. Maximize direct business. Increase gopro.com and direct to retailer sales which were
higher margin sales than the distribution business: gopro.com was a growing percent
of the company’s direct revenue and therefore gross margins should increase. Focus
on the direct business to improve customers’ experience on gopro.com and the retail
channel to improve operating results.
3. Grow the digital and subscription services. GoPro’s strategy included maximizing
the experience for GoPro camera customers and extending software solutions to
smartphone users, thereby expanding the total addressable market. GoPro’s newer
cameras, GoPro Plus, and the company’s apps worked together to allow users to
capture, edit, and share experiences, plus back up content to the cloud. Its 2020
strategy included continuing to increase the functionality of the GoPro app for both
GoPro camera owners and smartphone owners.
4. Improve efficiency and reliability. Focus on strengthening operational excellence to
safeguard reliability and predictability. Operate in 2020 at a similar level of operating
expenses as in 2019, and focus on generating demand, managing better and
improving business predictability. GoPro recognized that future success would be
partially dependent on managing operating expenses.
5. Empower employees, deepen talent development, commitment and culture. GoPro’s
strategy moving into 2020 included the desire to retaining committed employees.
According to GoPro’s strategic plan, the company intended to retain employees by
leveraging its strong brand recognition; unique culture; competitive compensation
and benefits; and a commitment to its diversity, inclusion, and belonging initiative.
GoPro’s 2019/2020 Product Line
GoPro’s 2019/2020 product line comprised the Hero line of cameras, the MAX camera,
the GoPro app, and a subscription service.
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HERO camera line. The HERO8 Black, launched in Fall of 2019, was GoPro’s
flagship camera and sold for $299 in June 2020. The camera had enhanced
HyperSmooth 2.0 image stabilization, TimeWarp Video 2.0, built-in mounting, live
streaming, cloud connectivity, voice control, improved audio and touch display. The
live streaming enabled users to share content in real time to their Facebook,
Twitch, YouTube, Vimeo and other social media platforms. The 2019/2020
product line included three new accessories for the HERO8 Black camera, called Mods,
which enabled users to transform their HERO8 Black camera into a production device.
The Media Mod delivered high-quality, “shotgun”-mic performance with an integrated
directional microphone, the Light Mod illuminated a scene, and the Display Mod
allowed users to frame themselves perfectly during “selfie” self-capture. The company
continued to offer the HERO7 Black ($299.99) and HERO7 Silver ($199.99) cameras
which had been launched in the Fall, 2018.
GoPro MAX. The MAX was GoPro’s newest 360-degree waterproof camera, which
was launched in Fall of 2019. The MAX featured HyperSmooth image stabilization,
360-degree MAX TimeWarp Video, MAX SuperView, PowerPano, built-in mounting,
high-quality audio, live streaming, voice control and a front facing touch display. The
MAX SuperView provided the widest field of view ever available from a GoPro
camera. There were six built-in microphones that enabled users to capture 360-degree
audio, directional audio for vlogging, GoPro’s best stereo sound ever. The MAX sold
for $499.99 in June 2020.
GoPro App. The GoPro app was a mobile app that uploaded GoPro photos and
video clips to a smartphone. The app included video editing capability, that enabled the
app to better identify important moments in users’ footage and suggest story
compilations of photos and videos. The GoPro app cost $4.17/month on a yearly
contract, or $4.99 if purchased monthly.
GoPro Plus. GoPro Plus was a subscription service that provided a camera
protection plan and enabled subscribers to easily access, edit, and share content. GoPro
Plus included unlimited cloud storage; supporting source video and photo quality; and
discounts on accessories, camera replacement, and damage protection. The HERO5
Black and newer cameras could automatically upload photos and videos to a GoPro
Plus member’s account.
Manufacturing, Logistics, and Sales Channels
GoPro products were designed and developed in the United States, France, China, and
Romania. The majority of the company’s manufacturing was outsourced to companies
in China, Mexico, Malaysia, and Japan. In 2019, GoPro moved the majority of
production of its products that were to be sold in the United States from China to
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Mexico, due to concerns over tariffs. The company believed that outsourcing
manufacturing provided greater scale and flexibility. GoPro had a strategic
commodities team that managed the pricing and supply of key components of its
cameras, and utilized their expertise to obtain competitive pricing.
At the end of 2019, GoPro products were sold through direct sales channels in over
100 countries and over 30,000 retail outlets. The company also sold indirectly through
its distribution channel. The direct sales channel lost ground in 2019, providing
46 percent of revenue, compared to 48 percent in 2018. Gopro.com provided a
significant increase in revenue, going from 16 percent in 2018 to 23 percent in 2019,
and distributors increased from 52 percent in to 2018 to 54 percent in 2019.
Direct Sales
GoPro sold directly to large and small retailers in the United States and Europe, and
through e-commerce channels, to consumers worldwide. The company believed that
diverse direct sales channels were a key differentiator for the company, and it
segregated its products among those channels. GoPro used independent specialty
retailers who generally carried higher-end products, and targeted customers who were
believed to be the early adopters of new technology. Big-box retailers with a national
presence such as Amazon, Dixons Carphone, Walmart, Target, and Best Buy were a
second component of the direct sales channel. These retailers carried a variety of GoPro
products and targeted its particular end user. GoPro felt that this allowed the company
to maintain in-store product differentiation between its sales channels and protected its
brand image in the specialty retail markets. Point of purchase displays with video
illustrating the GoPro cameras were widely employed in the direct sales channel, with
about 30,00 displays globally.
Mid-market retailers with a large regional or national presence were also part of
GoPro’s direct sales channel. Retailers focusing on sporting goods, consumer
electronics, hunting, fishing, and motor sports carried a small subset of GoPro products
targeted toward its end users. The full line of GoPro products was sold directly to
consumers through the company’s online store, gopro.com. The company
marketed its e-commerce channel through online and offline advertising.
GoPro felt that its e-commerce sales provided insight into its customers’ shopping
behavior and provided a platform from which the company could inform and educate
its customers on the GoPro brand, products, and services.
Indirect Sales/Distributors
At the end of 2019, GoPro sold to over 55 distributors who resold its products to
retailers in international markets and to retailers in the United States. The company
provided a sales support staff to help the distributors with planning product mix,
marketing, in-store merchandising, development of marketing materials, order
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assistance, and education about the GoPro products. Going into 2020, GoPro, sold
directly to most retailers in the United States, some retailers in Europe, and to
consumers globally through its e-commerce channel.
Marketing and Advertising
GoPro’s merchandising strategy focused on engaging consumers by exposing them to
GoPro content and educating them about new hardware features, the power of the
company’s solutions for both mobile and desktop software editing, and content
management with GoPro Plus. The company’s marketing and advertising efforts were
focused on consumer engagement by exposing them to GoPro content, believing that
this approach enhanced the brand while demonstrating the performance, versatility, and
durability of its products. GoPro’s marketing and advertising programs spanned a wide
range of consumer interests and attempted to leverage traditional consumer and
lifestyle marketing.
Social media were the core of GoPro’s consumer marketing. The company’s
customers captured and shared personal GoPro content on social media platforms such
as Vimeo, YouTube, Twitter, Facebook, TikTok, and Instagram. In 2019, GoPro gained
4.3 million new followers on its social accounts for a lifetime total of 42.8 million
followers. Of the 4.3 million new followers on the company’s social accounts,
2.4 million were on Instagram, resulting in a lifetime total of 19.1 million on Instagram.
As of the end of fiscal 2019, GoPro had reached 1.4 billion views of content tagged
#GoPro on TikTok and more than 2.4 billion views on the company’s YouTube channel.
In the first quarter 2020, viewership of GoPro content across all social channels reached
an all-time high or 243 million views, User-generated content and GoPro originally
produced content were integrated into advertising campaigns across billboards, print,
television commercials, online, and other home advertising, and at consumer and trade
shows. GoPro’s lifestyle marketing emphasized expansion of its brand awareness by
engaging consumers through relationships with influential athletes, entertainers, brands,
and celebrities who used GoPro products to create and share content with their
consumers and fans. The company worked directly with its lifestyle partners to create
content that was leveraged to their mutual benefit across the GoPro Network.
Profiles of Select Rivals in the Action Camera Industry in 2020
Sony Sony competed in the action camera market with a lineup of nine cameras
ranging in price from $199.99 to $549.99. The Sony FDR-X3000 ($549.99) was the
company’s top of the line and was a 4K camera with a 170 wide-angle lens, GPS, and
professional quality output. The camera recorded at a high rate to give better resolution,
produced better low-light pictures, and could be controlled by a remote controller.
PCmag ranked the FDR-X300 best optical video stabilization in 2020. Sony’s HDR-
AS50 was the company’s entry-level camera and produced high-definition video and
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still images, and included SteadyShot stabilization, low-light capabilities, and a
panoramic lens. Other models included built-in stereo microphones, high-speed data
transfer to capture fast action, HDMI output for sharing video on TVs, and wireless
uploading to smartphones or tablets. In July 2019, Sony launched its RXO II which was
the world’s smallest and lightest action camera.
Nikon Camera giant Nikon announced in January 2016, that it was entering the
action camera market. The company’s first in its line of action cameras was the
KeyMission 360, which recorded 360-degree video in 4K ultra-high-definition. The
camera was dust, shock, and temperature resistant, waterproof to 100 feet, and included
electronic vibration reduction to help produce sharp video. Technowize reported that the
KeyMission 360 had the best audio quality of any action camera on the market. The
KeyMission 360 was the “parent” camera in Nikon’s family of action
cameras. The KeyMission 360 was priced at $499.95. Nikon also offered
the KeyMission 80 at $279.95 and the KeyMission 170 at $399.95 in early 2020.
Garmin International Garmin International was far better known as a global leader
in GPS navigation than for its action cameras; however, in 2013 the company released
its first action camera, the VIRB. The VIRB had a color display and was manufactured
in a waterproof housing so an extra protective case was unnecessary. The success of the
VIRB led to two new Garmin action cameras in 2015—the VIRB X and the VIRB XE,
the VIRB Ultra 30 in 2016, the VIRB 360 in 2017, and the DashCAM line in 2018. All
models had GPS, Wi-Fi, and full sensor support. The new models had support for
Bluetooth data streams that allowed the use of a microphone to narrate action in real
time, plus a Garmin app that enabled transfer of video and photos from the camera to a
smartphone and then to social media. Gauges such as altitude and speed could be
applied to the video. In mid-2020, the VIRB Ultra, which sold for $309.00, was
awarded the t3.com Smarter Living “Most Fully Featured” award, and the VIRB XE,
which sold for $399.99 in June 2020 was recognized as number eight in the top 10
action cameras by Digital Camera World. In mid-2020, the VIRB X was priced at
$299.99, the VIRB Ultra 30 at $399.99, the VIRB Elite at $349.00, the Dash Cams at
$149.99 – $249.99, and the VIRB 360 was priced at $799.99.
Kodak Kodak’s PixPro SP1, priced at $170.00 in mid-2020, was rated “Best Bang
for Your Buck” by Consumer Reports in December 2019. The PixPro had a waterproof
case, produced high-quality video, could withstand drops from six feet, had an
integrated display for framing shots, stereo microphones, image stabilization, a zoom
lens, built-in Wi-Fi, and could be paired with iOS and Android smartphones.
Kodak extended its line to include three 360-degree models and waterproof and
shockproof SPZ1. The SPZ1 was Kodak’s lowest priced action camera at $65.99. The
company’s PixPro SP360-degree 1080p action camera was priced at $99.99, the PixPro
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Orbit 360 4K was $199.99, and its 360-degree 4K cameras ranged from $212.99 to
$368.99 in mid-2020.
Polaroid Polaroid entered the action camera market in 2012 by licensing a line of
three low-priced cameras manufactured by C&A Marketing (a Polaroid license), and
sold under the Polaroid name. The first Polaroid action cameras were the XS7, priced at
$69.00; the XS20, priced at $99.00; and the XS100, priced at $199.00. The Polaroid
CUBE was added to the Polaroid action camera line in 2014. The CUBE recorded up to
90 minutes of video in HD 1080p quality and sold for $18.00 in mid-2020. The Cube
Act II sold for $52.99 in June 2020.
In 2015, Polaroid upgraded the CUBE to the CUBE+ which included Wi-Fi, image
stabilization, HD 1440p video, and an 8.0 megapixel still capture feature. The CUBE+
was splash-resistant, shockproof, and included a microphone; numerous mountings
were available for applications ranging from bikes to helmets to dogs. The CUBE+
could stream footage in real time and was compatible with both iOS and Android. A
Wi-Fi enabled CUBE+ could pair with a smartphone for real-time view controls and
shot framing. There was one control on the CUBE+ for on/off and to switch from video
to still. The CUBE+ was priced at $59.99 in mid-2020. The upgraded POLC3BK Cube
HD sold for $78.00 in May 2020.
GoPro’s Financial Performance GoPro’s 2019 revenue of $1.194 billion was an
increase of percent over 2018’s $1.148 billion, largely due to a six percent increase in
average selling price. The number of cameras sold in 2019 decreased by two percent
from 4.33 million in 2018 to 4.26 million. The company reported an improved gross
margin of about 35 percent for 2019, up from 31 percent in 2018. Operating expenses
were down by $40 million to $415 million in 2019 (35 percent of net revenue)
compared to $455 million (40 percent of net revenue) in 2018. The company attributed
the decreased operating expenses to focused management of cost and the financial
benefits recognized from restructuring. Despite an improvement in gross margin and
operating margin, the company posted a net loss of $14.6 million, making 2019 the
fourth consecutive year of losses.
GoPro’s Consolidated Statements of Operations for 2017 to 2019 are presented in
Exhibit 4. Its balance sheets for 2018 and 2019 are shown in Exhibit 5.
EXHIBIT 4 GoPro, Inc.’s Consolidated Statements of Operations,
2017–2019 (in thousands, except per share data)
2019 2018 2017
Revenue $1,194,651 $1,148,337 $1,179,741
Cost of revenue 781,862 786,903 795,211
Gross profit 412,789 361,434 384,530
2019 2018 2017
Operating expenses:
Research and development 142,894 167,296 229,265
Sales and marketing 206,431 222,096 236,581
General and administrative 65,797 66,004 82,144
Total operating expenses 415,122 455,396 547,990
Operating loss (2,333) (93,962) (163,460)
Other income (expense): (19,229) (18,683) (13,660)
Other income, net 2,492 4,970 733
Total other expense, net (16,737) (13,713) (12,927)
Loss before income taxes (19,070) (107,675) (176,387)
Income tax (benefit) expense (4,428) 1,359 6,486
Net income (loss) $(14,642) $(109,034) $(182,873)
Basic and diluted net income (loss)
per share $(0.10) $(0.78) $(1.32)
Weighted-average number of shares
outstanding 144,891 139,495 138,056
Source: GoPro, Inc. 2019 Annual Report.
EXHIBIT 5 GoPro, Inc.’s Consolidated Balance Sheets, 2018–2019
(in thousands, except par values)
December 31, 2019 December 31, 2018
Assets
Current assets:
Cash and cash equivalents $150,301 $152,095
Marketable securities 14,847 45,417
Accounts receivable, net 200,634 129,216
Inventory 144,236 116,458
Prepaid expenses and other current
assets 25,958 30,887
Total current assets 535,976 474,073
Property and equipment, net 36,539 46,567
Operating lease right-of-use assets 53,121 —
Intangible assets, net 5,247 13,065
Goodwill 146,459 146,459
Other long-term assets 15,461 18,195
December 31, 2019 December 31, 2018
Total assets $792,803 $698,359
Liabilities and Stockholders’
Equity
Current liabilities:
Accounts payable $160,695 $148,478
Accrued expenses and other current
liabilities 141,790 135,892
Short-term operating lease
liabilities 9,099 —
Deferred revenue 15,467 15,129
Total current liabilities 327,051 299,499
Long-term taxes payable 13,726 19,553
Long-term debt 148,810 138,992
Long-term operating lease liabilities 62,961 —
Other long-term liabilities 6,726 28,203
Total liabilities 559,274 486,247
Commitments, contingencies, and
guarantees (Note 9)
Stockholders’ equity:
Preferred stock, $0.0001 par value,
5,000 shares authorized; none
issued
— —
Common stock and additional paid-in
capital, $0.0001 par value, 500,000
Class A shares authorized, 117,922
and 105,170 shares issued and
outstanding, respectively;
150,000 Class B shares authorized,
28,897 and 35,897 shares issued and
outstanding, respectively
930,875 894,755
Treasury stock, at cost, 10,710 and
10,710 shares, respectively (113,613) (113,613)
Accumulated deficit (583,733) (569,030)
Total stockholders’ equity 233,529 212,112
Total liabilities and stockholders’
equity $792,803 $698,359
Source: GoPro, Inc. 2019 Annual Report.
GoPro’s sales were predominately from the Americas, with Europe, the Middle East,
and Africa a distance second—see Exhibit 6. Revenue from outside the United States
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311,489 287,102 263,370
was 56 percent, 57 percent, and 51 percent of the company’s revenues for
fiscal 2019, 2018, and 2017, respectively; and GoPro expected this
portion to continue to be a significant part of revenues. Although there
were no clear trends in the composition of sales revenue in the Americas, Europe, the
Middle East, and Africa, there was an upward trend of revenue from outside the United
States and especially from the Asia Pacific region. GoPro’s supply chain partners had
operations in Mexico, Hong Kong, Singapore, China, Czech Republic, the Netherlands,
and other countries in Europe and the Asia Pacific region. The company
intended to expand operations in these, and perhaps other, countries as it
increased its international presence.
EXHIBIT 6 GoPro, Inc. Revenue by Geographic Region, 2017–2019
(in thousands)
Geographic Region 2019 2018 2017
2019 vs
2018 %
Change
2018 vs
2017 %
Change
Americas $523,975 $494,797 $582,917 6% (15)%
Europe, Middle East and
Africa (EMEA) 359,187 366,438 333,454 (2) 10
Asia and Pacific (APAC) 8 9
Total revenue $1,194,651 $1,148,337 $1,179,741 4% (3)%
Source: GoPro, Inc. 2019 Annual Report.
GoPro’s Performance in Early 2020
Despite a small but hopeful revenue uptick in 2019, GoPro’s operations produced
dismal results in early 2020. First quarter 2020 revenue was down by 51 percent year-
over-year, and gross margin dropped to 32.2 percent from 33.1 percent in the same
period in 2019. Operating losses increased by 177 percent to $56 million from
$20 million in 2019, and net losses increased 161 percent to $64 million from
$24 million the same period in 2019. The company’s 2020 first quarter earnings release
did not provide encouragement to investors, and GoPro’s shares drifted down to a low
of $2.00 in mid-March and a closing at $2.29 on April 4. Exhibit 7 presents GoPro’s
quarterly Statements of Operations for the first quarter of 2019 and the first quarter of
2020.
EXHIBIT 7 GoPro, Inc., Statement of Operations, Three Months
Ending March 31, First Quarter 2020 Versus First Quarter 2019 (in
thousands, except per share amounts)
2020 2019 % Change
2020 2019 % Change
Revenue $119,400 $242,708 (50.8)%
Gross margin
GAAP 32.2% 33.1% (90) bps
Non-GAAP 34.2% 34.2% —
Operating loss
GAAP $(56,114) $(20,288) 176.6%
Non-GAAP $(46,654) $(8,118) 474.7%
Net loss
GAAP $(63,528) $(24,365) 160.7%
Non-GAAP $(49,613) $(10,171) 387.8%
Diluted net loss per
share
GAAP $ (0.43) $ (0.17) 152.9%
Non-GAAP $ (0.34) $ (0.07) 385.7%
Adjusted EBITDA $(41,356) $(1,035) 3,895.7%
Source: GoPro, Inc. First Quarter 2020 10-Q.
GoPro withdrew its guidance for the full year 2020, citing uncertainty due to the
COVID-19 pandemic. The company announced another strategic realignment intended
to concentrate on expense reduction, and an increased focus on direct-to-consumer
operations. GoPro reported that it intended to reduce its workforce by more than
20 percent, cut operating expenses by $100 million, and further reduce operating
expenses to $250 million in 2021. The company planned to reduce office space in five
locations, reduce sales and marketing expenditures in 2020 and beyond, and curtail
other expenses. GoPro Inc.’s chief hardware designer Danny Coster left the company in
May 2020 after coming to GoPro from Apple’s design team four years prior. Mr.
Woodman’s announced that he would forego the remained of his salary through the end
of 2929, and the company’s Board of Directors volunteered to forego the remainder of
their salary through the end of 2020. Despite the financial weaknesses, GoPro
remainder the leader in the action camera industry in late 2019. However, the ability of
its top management to craft and execute strategies that could sustain its market
leadership in action cameras while simultaneously regaining profitability would
determine the success of GoPro’s latest turnaround strategy and the continuing viability
of the company.
M
page C-198
CASE 15
Publix Super Markets: Its Strategy in the
U.S. Supermarket and Grocery Store
Industry
Copyright ©2021 by Gregory L. Prescott and David L. Turnipseed. All rights reserved.
Gregory L. Prescott
University of West Florida
David L. Turnipseed
University of South Alabama
oving into the decade of the 2020s, Kevin Murphy reflected back over his two years as
president of Publix Super Markets, Inc. Sales and profits had maintained their positive
trend, established long before Murphy’s presidency, and comparable store sales continued
to increase, despite the chain’s expansion of the number of stores. Publix continued to enjoy
excellent publicity and a great corporate image, both internally and externally: it had been
on Fortune’s 100 Best Companies to Work For, and Publix’s voluntary turnover rate was
5 percent, versus the industry average of 65 percent. The company was the largest
employee-owned company in the United States and had never laid off an employee in its
89-year history.
Although fiscal 2019 had shown net sales of a record $38.1 billion (an increase of
5.6 percent over fiscal 2018), and net earnings of over $3 billion, or 7.9 percent of sales,
Mr. Murphy was concerned about the future. The grocery industry appeared to be moving
rapidly from the traditional in-person shopping experience in which the shopper visited a
favorite grocery and personally chose the week’s grocery items, to e-commerce with home
delivery, or phone app-ordered pickup based shopping. Technology had provided the means
for shoppers to select their grocery items from an app on their phones, and delivery and
logistics improvements enabled quick delivery of the grocery basket to the shoppers’ door.
Mr. Murphy believed that Amazon’s purchase of Whole Foods was a likely catalyst to
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cause faster than normal industry change in ecommerce grocery sales and delivery.
Evolving lifestyles had resulted in a decreasing amount of food cooked at home, and an
increased focus on sustainability, health, and natural organic foods. A new and powerful
force that Murphy thought capable of causing significant and lasting industry effects was
the COVID-19 pandemic sweeping the country. Cost control remained a major key to
success, and private brands had emerged as a practical means of keeping costs low.
Murphy was concerned that the rapid change in the supermarket industry was of
sufficient magnitude to cause a major disruption in Publix’s positive trajectory if the
company did not accurately identify the driving forces in the industry, and forecast and stay
ahead of the industry’s path. He resolved to accurately assess the supermarket industry and
keep Publix at its forefront.
History of Publix Super Markets
The history of Publix began with its founder George Jenkins beginning his retail career in
his father’s general store in Harris, Georgia. In 1925, Jenkins decided that Florida’s real
estate boom offered better opportunities, and he moved to Tampa, Florida. Rather than
working in the real estate industry, Jenkins took a job as a stock clerk in a Piggle Wiggly
store. After two months, he was promoted to store manager, and a short time later, was
transferred to Winter Haven, Florida, to manage the chain’s largest store. Jenkins held the
management position at Winter Haven from 1926 to 1930. In 1930 he resigned from Piggly
Wiggly and opened his own grocery store in Winter Haven and opened a second in 1935.
Jenkins closed his first two stores, and opened his dream store, the first
Publix Super Market, in November 1940. The Publix was a “food palace” of marble, stucco
and glass, and included innovations such as fluorescent lighting, air conditioning, electric
eye doors, and terrazzo floors at a time when these items were considered luxuries not
found in competing grocery stores. He acquired a warehouse and 19 All American stores
from the Lakeland Grocery Company in 1945 and began replacing the small stores with
larger supermarkets. He continued his aggressive expansion and brought the Publix brand
to customers throughout Florida.
The Publix Culture
From the day he opened his first grocery store, Jenkins was focused on excellent customer
treatment. He thought that friendly customer service and royal treatment were crucial
elements in connecting with customers and forming lasting relationships. He believed that
the key to treating his customers like royalty was knowledgeable and friendly employees
who provided a convenient, but lean, shopping environment. At Publix, the foundation of
its first-class customer service was learning all possible about the business, and to make the
shopping experience pleasurable.
Publix employees (called associates) were taught that providing the highest level of
service and treating the customers like royalty, extended beyond the grocery aisles.
Customers should have excellent experiences in every interaction with the company. Publix
believed that its associates, who continued to embrace the philosophies set out by Jenkins,
were what separated Publix from other major grocery retailers. The Company regularly
recognized and rewarded its associates for their hard work, dedication, and service.
Associates were recognized for many reasons, including:
Going “above and beyond.” Associates who had been a role model in embracing the
Publix culture and provided premier service were eligible to receive a free sub coupon
and a personalized note from their manager.
Being dedicated to the Company. Associates received a gift and were invited to a dinner
recognizing each five years of service.
Publix valued its associates and rewarded those who made a difference in the lives of
others. Although Jenkins died in 1996, his beliefs influenced the way Publix operated up to
the present. Each year on September 29, the Company celebrated Jenkins’s birthday. The
celebrations, known as Mr. George Day, honored the man whose passion for “people first”
led to Publix’s beginning in 1930.
Recognition of Publix Super Markets
Fortune’s Best Big Companies to Work For
Fortune’s Best Workplaces for Parents
Indeed’s Top-Rated Workplaces for Veterans
Fortune’s 100 Best Companies to Work for in America for 22 consecutive years
Fortune’s Best Workplaces for Diversity
Fortune’s Best Workplaces for Women
Fortune’s Best Workplaces for Millennials
Fortune’s Best Workplaces for Retail
Fortune’s Most Admired Companies for 23 consecutive years
Indeed’s Top-Rated Workplaces
Publix’s Mission, Commitment, Guarantee, and Key Values
Publix’s mission was “to be the premier quality food retailer in the world.” To achieve that
mission, the company focused on its customers, efficiency, employees, stockholders, and
communities.
Over the years, Publix had an unwavering commitment to being:
Passionately focused on customer value,
Intolerant of waste,
Dedicated to the dignity, value, and employment security of our associates,
Devoted to the highest standards of stewardship for our stockholders, and
Involved as responsible citizens in our communities.
The company gave its customers the guarantee that “We will never knowingly disappoint
you. If for any reason your purchase does not give you complete satisfaction, the full
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purchase price will be cheerfully refunded immediately upon request.” During the early
years, Jenkins reflected on what he had learned in his business life before Publix and
developed a set of values upon which he built the company. These values
were adhered to every day at Publix. These values were:
Invest in Others Give Back
Prepare for Opportunity Respect the Dignity of the Individual
Be There Treat Customers Like Royalty
Jenkins believed in investing in others by building relationship, making connections,
working collaboratively, learning, and mentoring others. Being a good community partner
was requisite for organizational success in Jenkins’ mind and he stressed donating time,
talent and money to the cities in which Publix operated. Publix’s growth required a constant
increase in employees and Jenkins encouraged his people to prepare themselves for the
constantly emerging opportunities in the organization. Having experienced working for a
company where his thoughts and ideas were not valued, Jenkins vowed to make Publix a
place where individuals were respected, communication was open, everyone had a voice,
and opinions were valued. Further, he committed himself to being involved in all aspects of
the company, because he wanted his customers and employees to know that he cared about
them. Until his death in 1996, Jenkins regularly visited stores and other facilities, attended
store openings, serving as a highly visible example of Publix connecting with its
employees, customers, and stakeholders, and this practice was continued by Publix’s
management. Jenkins sought ways to treat customers like royalty and thereby connect with
the customers and form enduring relationships. He used store presentations, personal
service, and quality products to make customers feel valued. Publix attributes its high
customer loyalty to unwavering focus on excellent and unmatched customer service.
Publix Super Markets’ Financial Situation
As of March 2, 2020, Publix operated 1,243 supermarkets in Florida, Georgia, Alabama,
South Carolina, Tennessee, North Carolina, and Virginia. In 2019, Publix ranked as the
eighth largest private company in the United States. Publix’s sales revenue for the five
years 2015–19 increased at a compound average growth rate (CAGR) of 4.2 percent. Over
the same period, gross profit had a CAGR of 3.9 percent, and net profit showed CAGR of
11.2 percent. Publix’s net margin ranged from 6.1 percent in 2015 to 7.9 percent in 2019,
significantly greater than the industry average—see Exhibit 1.
EXHIBIT 1 Selected Financial Data for Publix Super Markets, Inc.,
2015–2019 ($ in thousands)
2019 2018 2017 2016 2015
2019 2018 2017 2016 2015
Sales
Sales $38,116,402 36,093,907 34,558,286 33,999,921 32,362,579
Percent
change 5.6% 4.4% 1.6% 5.1% 5.9%
Comparable
store sales
percent
change
3.6% 2.1% 1.7% 1.9% 4.2%
Earnings
Gross profit 10,375,933 9,782,516 9,428,569 9,265,616 8,902,969
Earnings
before
income tax
expense
3,785,986 2,920,968 3,027,506 2,940,376 2,869,261
Net earnings 3,005,395 2,381,167 2,291,894 2,025,688 1,965,048
Net earnings
as
a percent of
sales
7.9% 6.6% 6.6% 6.0% 6.1%
Source: Publix Super Markets, Inc. 2019 Annual Report.
Publix’s consolidated statement of earnings, 2017–2019, are produced in Exhibit 2, and
consolidated balance sheets, 2018–2019, are provided in Exhibit 3.
EXHIBIT 2 Consolidated Statement of Earnings for Publix Super
Markets, Inc., 2017–2019 (in thousands, except per share amounts)
2019 2018 2017
Revenues
Sales $38,116,402 $36,093,907 $34,558,286
Other operating income 346,351 301,811 278,552
Total revenues 38,462,753 36,395,718 34,836,838
Costs and expenses:
Cost of merchandise sold 27,740,469 26,311,391 25,129,717
Operating and administrative
expenses 7,833,035 7,339,924 6,974,297
Total costs and expenses 35,573,504 33,651,315 32,104,014
Operating profit 2,889,249 2,744,403 2,732,824
Investment income 814,372 56,699 226,626
Other nonoperating income, net 82,365 119,866 68,056
Earnings before income tax expense 3,785,986 2,920,968 3,027,506
2019 2018 2017
Income tax expense 780,591 539,801 735,612
Net earnings $3,005,395 $2,381,167 $2,291,894
Weighted average shares
outstanding 713,535 726,407 753,483
Earnings per share $4.21 $3.28 $3.04
Source: Publix Super Markets, Inc. 2019 Annual Report.
EXHIBIT 3 Consolidated Balance Sheets for Publix Super Markets, Inc.,
2018–2019 ($ in thousands)
2019 2018
ASSETS
Current assets:
Cash and cash equivalents $ 763,382 599,264
Short-term investments 438,105 560,992
Trade receivables 737,093 682,981
Inventories 1,913,310 1,848,735
Prepaid expenses 75,710 122,224
Total current assets 3,927,600 3,814,196
Long-term investments 7,988,280 6,016,438
Other noncurrent assets 441,938 515,265
Operating lease right-of-use assets 2,964,780 —
Property, plant and equipment:
Land 1,984,400 1,850,718
Buildings and improvements 5,948,039 5,535,538
Furniture, fixtures and equipment 5,477,534 5,114,698
Leasehold improvements 1,660,164 1,564,243
Construction in progress 152,272 109,367
15,222,409 14,174,564
Accumulated depreciation (6,037,887) (5,537,947)
Net property, plant and equipment 9,184,522 8,636,617
Total assets $24,507,120 18,982,516
LIABILITIES AND EQUITY
Current liabilities:
Accounts payable $ 1,984,761 1,864,604
Accrued expenses:
Contributions to retirement plans 581,699 540,760
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page C-202
2019 2018
Self-insurance reserves 149,082 145,241
Salaries and wages 148,662 132,916
Other 461,427 321,080
Current portion of long-term debt 39,692 4,954
Current portion of operating lease liabilities 335,391 —
Total current liabilities 3,700,714 3,009,555
Deferred income taxes 682,484 420,757
Self-insurance reserves 226,727 222,419
Accrued postretirement benefit cost 120,015 105,308
Long-term debt 131,997 162,711
Operating lease liabilities 2,603,206 —
Other noncurrent liabilities 140,633 67,102
Total liabilities 7,605,776 3,987,852
Common stock related to Employee Stock Ownership Plan
(ESOP) 3,259,230 3,134,999
Stockholders’ equity:
Common stock of $1 par value. Authorized 1,000,000 shares;
issued and outstanding 706,552 shares in 2019 and 715,445
shares in 2018
706,552 715,445
Additional paid-in capital 3,758,066 3,458,004
Retained earnings 12,317,478 10,840,654
Accumulated other comprehensive earnings (losses) 81,289 (55,762)
Common stock related to ESOP (3,259,230) (3,134,999)
Total stockholders’ equity 13,604,155 11,823,342
Noncontrolling interests 37,959 36,323
Total equity 16,901,344 14,994,664
Total liabilities and shareholders’ equity $24,507,120 $18,982,516
Source: Publix Super Markets, Inc. 2019 Annual Report.
Stock Market Performance
Publix stock was not traded publicly: it was held only by current and former employees.
Because of the lack of active trading, there was no traditional trading- or market-based
daily price available. A group of independent financial analysts determined the Publix stock
price based on comparison of financial performance in a “peer group” of other supermarket
chains. Consequently, stock price swings in other grocers’ stock price could affect Publix’s
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share price. Exhibit 4 produces Publix’s stock, compared to the S&P 500, and its peer group
of supermarkets.
EXHIBIT 4 Comparison of Five-Year Cumulative Return Based on Fiscal
Year End Price for Publix Shares, 2014–2019
Source: Publix Super Markets, Inc. 2019 Annual Report.
Supermarket and Grocery Stores Industry
The U.S. supermarket and grocery stores industry had grown during the five years 2014–19,
primarily due the strong national economy, producing revenue of $655 billion in
2019, a .9 percent increase over 2018. Annual revenue growth, 2015–20 had
been 1.4 percent, and revenue was forecast to top $678 billion in 2020. There were over
66,290 grocery businesses in 2109, with industry employment of 2,772,898.
Industry Margins. The margins vary among departments in a large supermarket. The
main grocery aisles margins, approximately one percent, are the lowest in the economy.
Industry consolidation had resulted from the low margins: in a low margin situation,
economies of scale could provide efficiency and centralization, and economic rewards.
Consequently, for several decades, the grocery industry had been in the process of
consolidation. New store formats pressed margins even lower as competition became more
intense. The present average grocery store was a large supermarket with an average of
about 45,000 square feet and annual revenue of about $14 million a year, or about $500 per
square foot of sales as the industry average. New grocery formats since the 1990s changed
the industry, and specialty chains like Whole Foods were earning margins of about
3.2 percent and higher, far greater than the industry average. The wholesale clubs format
also undercut the larger grocery stores, putting pressure on the struggling industry.
Organic and Private Brands. During the five years 2014–19, many consumers switched
to organic and all-natural food brands, and premium food brands, as per capita disposable
income increased, which boosted industry revenue. However, many consumers continued
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purchasing private-label, or store brands due to rising food costs. Increasing generic food
purchases reduced revenue growth, but increased profit margins, because store brands could
be produced at less cost than national brands. Not only could private- brand foods fill
inventory voids, but they also boosted the bottom line. Profit margins on third-party-
branded foods were about one percent to two percent, while gross margins on private-label
goods could reach between 25 percent and 30 percent. When private brands were first
introduced, retailers’ ideas of private labels were an afterthought. The word “Generic” was
often used interchangeably with private brand, and packaging, usually black and white, was
not highly desirable, and quality was also not a priority.
The Food Marketing Institute’s 2019 poll reports that 46 percent of private-label brands
are “very influential” in their decision of which food retailer to shop, an increase of
35 percent from three years previous. The data reflects a similar result from Coresight
Research posted earlier in 2019, that suggested more than half of U.S.
shoppers visit a particular retailer to purchase a private-label good. Some
grocers turned their private-label brands into lines that are were as well respected as
comparable options from packaged food companies like Kraft Heinz or General Mills, if
not more so. Data from the Food Marketing Institute (FMI) and market research firm IRI
indicated that almost half of all consumers specifically seek out a private-label product.
“Food retailers should be very pleased that their brands are becoming bigger factors in how
consumers shop. This gives retailers the opportunity to further drive loyalty and trips”, the
FMI/IRI study commented.1 The increase in acceptance and importance of private brands
offered the supermarket industry an opportunity that was far more significant than a few
years previous, as the industry moved into an era in which house brands were not just the
cheap alternatives, rather the private brands were increasingly the consumer’s intended
purchase.
Industry Challenges. Despite the industry’s revenue growth, the industry faced
significant challenges. Consumer’s habits had been changing–consumers expected low
prices and the ability to buy almost anything, at anytime, anywhere. The largest U.S.
demographic group, millennials, were the first generation to be less wealthy than their
parents: they wanted deals and discounts, in addition to healthy food, socially and
environmentally responsible companies, knowing where their food came from, and how it
was made. They were also attracted to online shopping. According to BloomReach, a
digital shopping platform, 41 percent of retailers listed improving online sale capabilities as
the number one priority in 2019.2
The greatest challenge facing the Supermarket and Grocery Stores industry appeared to
be the increase in online grocery shopping, which was between three and four percent of
total industry revenue in 2019. According to many leaders in the grocery industry, that
number would rapidly increase to over 20 percent, and the current industry leaders,
Walmart, Kroger, Albertson’s (including Safeway and others), Ahold Delhaize (Stop and
Shop, Giant Food, Peapod and others), and Publix were not prepared to stay on top in
online shopping. A significant problem that faced the industry as online shopping increased,
was the decline in brick and mortar store profitability when 20 percent of customers no
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longer visited the stores, and the consequent decline in the value of supermarket real estate.
In addition to developing high efficiency grocery order fulfillment centers and controlling
costs, grocers must cultivate new skills to motivate consumers. Many supermarket purchase
decisions are made during a visit to the store as customers walk the aisles and make impulse
purchases, motivate in some part by the attractive packaging designed by the product
manufacturers. As the number of traditional grocery consumers visiting the stores
decreases, consumer product companies will face pressure to develop new skills to motivate
the grocery consumers.
The rapid and increasing emergence of new technologies had been quite disruptive for
the retail grocery industry. Amazon and other online competitors had been successful, due
partially to transparent pricing, enabled by their online environment. To compete,
traditional grocers were forced to keep their prices low, even when their costs had risen.
Online grocers pioneered the use of artificial intelligence, advanced analytics, and robotics
far more quickly and aggressively than traditional grocers. Amazon’s website, for example,
has a product-recommendation search engine, over 100,000 robots moving pallets of goods
through its warehouses, and innovations designed to make the online shopping experience
easier and faster. Most traditional grocers were being forced to catch up.
Grocery stores were in a precarious position as they attempted to meet the millennials’
expectations while maintaining low prices. Baby boomers continued to have significant
buying power and remained a vital component of the industry’s customer base. Boomers
valued in-store customer service, they were concerned with health and wellness, were
receptive to new products, and many were comfortable with technology. All demographic
groups presented a huge challenge to the industry with their decreasing inclination to cook.
In the United States, about 50 percent of millennials reported rarely cooking at home, and
food-service revenue exceeded food-at-home sales.
Industry Reaction. Traditional grocers reacted very slowly to the changing consumer
trends, which provided entre for other types of retailers. Convenience stores, discounters,
and club stores began to directly compete with traditional retailers: food service businesses
seized the lunch and dinner demand. Discounters were particularly aggressive, offering a
limited variety, and providing great value on all items, which provided higher earnings, than
supermarkets. The discounters’ low prices reduced the sector’s overall revenue by about
four percent.
The retail grocery industry was generally slow to respond to the changing
competitive conditions, and between 2008 and 2018, sales growth of large grocery chains in
North America had been only two percent, versus 8.4 percent in South America and Eastern
Europe, 6.2 percent in Asia, and 9.8 percent in Africa. As labor costs and commodity prices
increased between 2012 and 2017, traditional grocers had not been able to increase their
prices to compensate, because of intense competition from lower priced formats such as
dollar stores and discount chains. Consequently, their margins dropped dramatically.
Profile of Select Rivals in the U.S. Supermarket Industry
Kroger Co., Costco Wholesale Corporation, Albertsons, H.E. Butt Grocery Co., Meijer,
Inc., and Whole Foods were Publix’s close competitors for top U.S. supermarket—see
Exhibit 5.
EXHIBIT 5 Leading U.S. Supermarket and Grocery Store Chains, 2017
Global Rank Name U.S. Rank 2017 Revenue* 2017 Net Income*
2012–2017
Revenue
CAGR
2 Costco 1 $129,025 $2,714 5.4%
3 Kroger 2 122,622 1,889 4.2%
15 Albertson’s 3 59,925 46 74.4%
31 Publix 4 34,837 2,292 4.7%
37 H.E. Butt 5 24,600e n/a 4.9%
54 Meijer 18,900e n/a 5.3%
58 Whole Foods 16,030 245 6.5%
* In millions US $
e – estimated
Source: Deloitte, “Global Powers of Retailing 2019,
https://www2.deloitte.com/content/dam/Deloitte/global/Documents/Consumer-Business/cons-global-
powers-retailing-2019
A June 2018 study of favorite grocery store chains showed that Publix Supermarkets had
the second highest composite customer loyalty in the grocery/supermarket industry, scoring
76 percent, versus the leader, Wegmans (a small, privately held New England grocery
chain) which was 77 percent. Among Publix’s other close competitors, H-E-B was
69 percent, Costco was 65 percent, and Whole Foods 60 percent, Kroger, Albertsons, and
Meijer did not make the list.3
Publix compared quite favorably to the top supermarket competitors in customer
experience metrics, ranking first among top grocery chains in item availability, store
cleanliness, and finding wanted items. Customers ranked Publix number two in checkout
speed and cashier courtesy: Publix tied for number two with Whole Foods for specialty
department service. Despite these high rankings, Publix placed eighth for good sales and
promotions of the 22 top grocery chains surveyed, and 18th for value for the money.
The Kroger Co.
The world’s largest retail grocery/supermarket chain was Kroger Co. with fiscal 2019 sales
of $121,162 million. Kroger was the third-largest retailer in the world, behind Walmart
Stores, Inc., and Costco Wholesale Corp. Kroger owned 18 chains of supermarkets
including King Soopers’, Ralph’s, Smith’s, City Market, and Pick’n Save, with a total of
2,764 stores, as well as price-impact stores (e.g., Food4Less), multi-department stores (e.g.,
https://www2.deloitte.com/content/dam/Deloitte/global/Documents/Consumer-Business/cons-global-powers-retailing-2019
page C-206
Fred Meyer, Kroger Marketplace), as well as jewelry and specialty retailers. Kroger’s
statement of income is produced in Exhibit 6.
EXHIBIT 6 Consolidated Statements of Operations for The Kroger Co.,
Fiscal 2016–Fiscal 2018 (in millions, except per share amounts)
2018 2017 2016
(52 weeks) (53 weeks) (52 weeks)
Sales $121,162 $122,662 $115,337
Operating expenses
Merchandise costs, including advertising,
warehousing, and transportation, excluding items
shown separately below
94,894 95,662 89,502
Operating, general and administrative 20,305 21,041 19,162
Rent 884 911 881
Depreciation and amortization 2,465
2,436
2,340
Operating profit 2,614 2,612 3,452
Other income (expense)
Interest expense (620) (601) (522)
Non-service component of company-sponsored
pension plan costs (26) (527) (16)
Mark to market gain on Ocado securities 228 — —
Gain on sale of business 1,782
—
—
Net earnings before income tax (benefit)
expense 3,978 1,484 2,914
Income tax (benefit) expense 900
(405)
957
Net earnings including noncontrolling interests 3,078 1,889 1,957
Net loss attributable to noncontrolling interests (32)
(18)
(18)
Net earnings attributable to The Kroger Co. $ 3,110 $ 1,907 $ 1,975
Net earnings attributable to The Kroger Co. per
basic common share $3.80 $2.11 $2.08
Source: Kroger Co. 2018 Annual Report.
Kroger launched a three-year “Restock Kroger” plan, beginning in 2018, that was
intended to create shareholder value by pursing its vision of serving America by food
inspiration and uplift. The company reported that it delivered over $1 billion in savings in
2018 through process improvements and cost controls and invested in the
future. One part of the Restock Kroger plan was an aggressive move toward
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omnichannel retailing: the Company believed that its customers did not distinguish between
online and in-store purchase experiences, but rather sought the easiest and most seamless
solution to their needs or problems. Kroger attempted to expand its capabilities and be
available, relevant and accessible to its customers in both the physical and digital shopping
environments.
The Company had been working on increasing its digital platform for several years and
showed a 58 percent growth in digital sales in 2018, and a 21 percent increase in the third
quarter of 2019. It was integrating its traditional brick and mortar business with its
expanding digital sales platform, with the intention of serving its customers anything,
anytime and anywhere. By December 2018, grocery pickup or delivery was available to
91 percent of Kroger households: in December 2019, the company had 1,915 pickup
locations and 2,326 delivery locations covering 96 percent of Kroger households.
Kroger entered into partnerships with several companies that enhanced the company’s
omnichannel retailing and served the rapidly evolving grocery market. The Company
merged with an online meal kit company, Home Chef, which was ranked first place in
online meal kit companies. Shortly after the merger, Home Chef launched the first in-store
meal kit line, and at the end of 2018, they were in 700 Kroger locations, and expanding. In
February 2019, Kroger announced that Home Chef retail meal kits would be added to an
additional 500 Kroger stores.
Another significant partnership in 2018 was Ocado, one of the world’s largest online
grocery retailers, which used advanced robotics and highly efficient automated warehouses.
This partnership enabled Kroger to provide faster, more organized ecommerce shopping to
its customers. Customers had fresher food, delivered faster from Ocado’s
customer fulfillment centers initially located in central Florida, the Mid-
Atlantic region, and southwest Ohio. A Wisconsin fulfillment was added in 2019.
Kroger invested heavily in private brand foods. Kroger’s private brands, known as Our
Brands (Kroger, Private Selection, Simple Truth, Big K, and Heritage Farms) accounted for
31 percent of Kroger’s sales in 2018. In 2019, Kroger produced about 43 percent of Our
Brand grocery items in Kroger owned food production plants. Kroger also debuted a
Greenwise Market chain of healthy–living stores designed to be a place for customers to
find products that will support their evolving lifestyles. Greenwise locations provided a
beverage bar with coffees, locally crafted beers, wines, and smoothies as well as
handcrafted sandwiches, burritos, acai bowls, gourmet pizzas, bowls, sushi and sausage
made in-house; local and organic produce; body care products; and natural vitamins and
supplements.
Costco Wholesale Corporation
Costco was the second largest retailer in the world, with fiscal 2019 sales of $152.7 billion
—see Exhibit 7. Costco operated as a Cash & Carry/Warehouse Club but was a significant
competitor to grocery stores and supermarkets. The company opened its first
location in 1976 as Price Club, in San Diego. The fledgling company quickly
discovered that it could achieve much greater buying power by serving small businesses
and a select group of non-business members. This was the beginning of the warehouse club
industry. Costco’s operating philosophy is “Keep costs down and pass savings on to our
members.” Costco focused on a best value strategy and provided a 100 percent satisfaction
guarantee on the memberships and merchandise.
EXHIBIT 7 Consolidated Statements of Income for Costco Wholesale
Corporation, Fiscal 2017-Fiscal 2019 (amounts in millions, except per
share data)
52 Weeks Ended 52 Weeks Ended 53 WeeksEnded
September 1, 2019 September 2, 2018 September 3,2017
Revenue
Net sales $149,351 $138,434 $126,172
Membership fees 3,352 3,142 2,853
Total revenue 152,703 141,576 129,025
Operating Expenses
Merchandise costs 132,886 123,152 111,882
Selling, general and administrative 14,994 13,876 12,950
Preopening expenses 86 68 82
Operating income 4,737 4,480 4,111
Other Income (Expense)
Interest expense (150) (159) (134)
Interest income and other, net 178 121 62
Income Before Income Taxes 4,765 4,442 4,039
Provision for income taxes 1,061 1,263 1,325
Net income including noncontrolling
interests 3,704 3,179 2,714
Net income attributable to noncontrolling
interests (45) (45)
(35)
Net Income Attributable to Costco $3,659 $3,134 $2,679
Net Income Per Common Share Attributable
to Costco:
Basic $ 8.32 $ 7.15 $ 6.11
Diluted $ 8.26 $ 7.09 $ 6.08
Shares used in calculation (000s)
Basic 439,755 438,515 438,437
Diluted 442,923 441,834 440,937
Source: Costco Wholesale Corporation 2019 Annual Report.
Costco developed its private brand Kirkland Signature as a way to support its low-cost
strategy by helping to keep prices low. The Kirkland Brand included grocery items, eggs,
honey, sparkling water, razor blades, tissues, wine and vodka, which sold for at least
20 percent less than national brands. Costco’s strategy in private branding had been quite
successful. In 2018, Kirkland Signature’s revenue was $40 billion, an 11 percent increase
over the prior year, and a greater amount than the revenue of Macy’s and JCPenny,
combined. Costco’s private brand had become the powerhouse in private brands by 2019.
The Washington Post ranked Kirkland hot dogs number one of the best-selling brands in
2019. In 2019, Costco’s Kirkland brand revenue of $39 billion, and accounted for about
25 percent of the company’s total sales. Kirkland accounts for about 30 percent of all U.S.
private-brand grocery sales. Kirkland’s numbers starkly contrast with the Private Label
Manufacturers Association’s report that private brands account for only 17 percent of all
grocers’ sales.
Costco was rather late to offer grocery delivery: its online grocery, CostcoGrocery, did
not begin operations until 2017. The company was slow to adopt online shopping because
its members tended to spend more money when they shopped in a physical store. Costco
shoppers had one- and two-day delivery options for online groceries. Costco members in
“qualifying zip codes” could order groceries, including perishable foods, meat, produce,
and seafood online and have it delivered in a selected time window by Instacart, a national
delivery service. The minimum order was $35.00, and prices for same-day delivery items
were higher than Costco warehouse prices. Customers who were not Costco members could
order online from Instacart.com but paid a higher price than Costco members. The two-
day delivery could be used for cleaning supplies, organic non-perishables, tissue, detergent,
and similar items. There was no separate delivery fee for two-day orders, but a minimum
order of $75.00 was required.
Although many groceries and supermarkets were devoting significant resources to
grocery pickup, Costco had no plans to implement pickup services as of mid-2019. Costco’s
CFO Richard Galanti remarked on an earnings call that despite the success that Walmart
and other competitors had with grocery pickup, Costco had no plans to add pickup services.
Galanti said that, “We continue to look at it, we continue to scratch our head about it, we
recognize that they [Walmart] and some others are putting in a lot of financial commitment
to doing this. I think what you’re going to find it is like everything else in life at Costco,
over time we figure out how to do it our way that makes sense for us that still works.
Albertsons
Albertsons Companies, Inc., a Boise, Idaho-based supermarket chain, was the world’s 15th
largest retailer. The Company family of stores includes over 2,200 supermarkets operating
under 22 names in 34 states and the District of Columbia. Albertson’s statement of
operations, 2014–19 are produced in Exhibit 8.
http://instacart.com/
EXHIBIT 8 Consolidated Statements of Operations for Albertsons
Companies, Inc., Fiscal 2014-Fiscal 2018 (in millions)
2018 2017(2) 2016(2) 2015(2) 2014(1)(2)
Results of Operations
Net sales and other
revenue $60,534.5 $59,924.6 $59,678.2 $58,734.0 $27,198.6
Gross Profit 16,894.6 16,361.1 16,640.5 16,061.7 7,502.8
Selling and
administrative
expenses
16,107.3 16,275.4 16,032.9 15,702.6 8,157.0
Goodwill
impairment
—
142.3
—
—
—
Operating income
(loss) 787.3 (56.6) 607.6 359.1 (654.2)
Interest expense,
net 830.8 874.8 1,003.8 950.5 633.2
Loss (gain) on debt
extinguishment 8.7 (4.7) 111.7 — —
Other (income)
expense
(104.4)
(9.2)
(44.3)
(49.6)
91.2
Icome (loss) before
income taxes 52.2 (917.5) (463.6) (541.8) (1,378.6)
Income tax benefit (78.9)
(963.8)
(90.3)
(39.6)
(153.4)
Net income (loss) $131.1 $46.3 $(373.3) $(502.2) $(1,225.2)
(1) Includes results from four weeks for the stores purchased in the Safeway acquisition on January 30, 2015.
(2) These periods have been adjusted for the retrospective adoption of Accounting Standards Update (“ASU”)
2017–07, “Compensation – Retirement Benefits (Topic 715) – Improving the Presentation of Net Periodic
Pension Cost and Net Periodic Postretirement Benefit Cost” in the first quarter of fiscal 201
Source: Albertsons Companies, Inc. 2018 Annual Report.
Albertsons Companies’ in-house brand, Own Brands, launched in 2018, comprised over
1,000 items, and was one of the most diverse private brands in the country. The Company
also owned one of the nation’s largest lines of USDA-certified organic products, with sales
of over $1 billion yearly.
Recognizing that competitive success in the retail grocery industry required a good
online grocery platform, and that omnichannel shoppers were more valuable to the
Company than only traditional brick and mortar customers, Albertsons entered into three
strategic digital partnerships. The partnership with BloomReach, a digital experience
platform, employed artificial intelligence to provide Albertsons’s online customers an
enhanced search experience, quickly showed results in expanding the shopping basket. The
Company partnered with Quotient Technology, which became Albertsons’s exclusive
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digital media platform. Quotient enabled consumer packaged goods companies to work
with Albertsons to direct shoppers to their branded shopping locations that allowed
customers to add products directly to their carts. Although Albertsons had an existing
partnership with Instacart, a grocery delivery service, it launched its own
branded subscription delivery service in 2019, and partnered with Glympse, a
location sharing technology. Glymps enabled customers to get real-time status updates for
delivery and pickup orders. By the fourth quarter 2019, Albertsons’s home delivery services
were available in 11 of the top 15 markets across the United States.
Albertson’s filed for an IPO (Initial Public Offering) in 2015 but abandoned it due to
market volatility of grocery stocks. The company filed again in March of 2020, and if
successful, it would be one of the largest market debuts of the year, estimated at $2 billion.
However, stocks around the world were dropping sharply due to rapid spread of the
coronavirus in March 2020, and the fate of Albertson’s IPO was questionable.
H. E. Butt Grocery
H. E. Butt Grocery, commonly known as H-E-B, was a family-owned, regional supermarket
chain in Texas and Mexico. H-E-B was founded in 1905 by Florence Butt, and had grown
to 400 stores (336 domestic) in 2020. In fiscal 2018, H-E-B had $28 billion in revenue, an
increase of 12 percent from the prior year. The company was the 37th largest retailer in the
world in 2017, and 12th largest private company in the United States. In 2018, the company
had moved up to 11th largest. The company operated as H-E-B, H-E-B Plus, Mi Tienda, Joe
V’s Smart Shop, and Central Market. In 2019, H-E-B was listed by Forbes as number 11 –
America’s largest private companies, number 23 – Best Employers for New Grads, number
32 – Best Employer for Women, and number 32 America’s Best Employers by State. H-E-B
tied for first in customer satisfaction in the 2019–20 survey by the American Consumer
Satisfaction Index ranking.
Financial information was scarce. Annual sales were estimated to be $28 billion in fiscal
2018 (ended October 31, 2018), and $23.12 billion in fiscal 2017. These revenue amounts
exclude results from Mexican operations. In fiscal 2017, Mexican operations generated
sales of $1.48 billion.
H-E-B developed a family of private brands, beginning in 1991, including H-E-B, H-E-B
Select Ingredients, H-E-B Organics, Hill County Products, H-E-B Buddy. Central Market,
H-E-B Kitchen & Table, and ChefStyle. The company promised that the quality of H-E-B
brands would always equal or exceed that of national brands. The company began grocery
delivery in 1916 in a Model T Ford. A century later, in February 2018, H-E-B
acquired Favor Delivery, an innovative, on-demand delivery service. Favor
was the best-rated delivery service in Texas, and in 2017, had become the first U.S. on-
demand company to achieve profitability at scale. According to H-E-B, the Favor and other
acquisition partnerships, plus strategic investments in technology, gives H-E-B the ability to
ship groceries and other merchandise to 48 states and military bases around the world.
Meijer, Inc.
Meijer, Inc. was started in 1935 as a supermarket chain in Grand Rapids, Michigan by
Hendrik Meijer. The company operates over 200 stores in Michigan, Ohio, Indiana, Illinois,
and Kentucky, employs over 80,000, is the 19th largest private company in the United
States, and 54th largest retailer in the world in 2017. Meijer’s estimated 2019 revenue was
$17.8 billion. Meijer is credited for pioneering the modern supercenter concept in 1962,
when it opened “Thrifty Acres,” a food and general merchandise store in which customers
could find everything they needed in only one trip to the store. Each Meijer supercenter has
40 departments, which sell over 120,000 products: the stores are open 24 hours daily, 364
days a year. The company has created about 10,000 private-label brands.
The Meijer corporate values are customers (customers don’t need us, we need them),
family (Meijer is a family business, treating each other with dignity and respect), fresh
food, safety and health, and competition (Meijer is committed to keeping its competitive
spirit strong and staying nimble and flexible to win in the marketplace). The manifestation
of Meijer’s value of competition is evidenced in Grand Rapids, Michigan, where the
company is reacting to the challenge of e-commerce by piloting a micro-fulfillment center,
built in repurposed footage of a supercenter. The center will employ proprietary hardware
and software that will enable Meijer retail stores to pick and assemble on-line orders to
meet their customers’ expectations and make online grocery profitable.
Whole Foods
In 1978, John Mackey and Renee Lawson, with $45,000 borrowed from family and friends,
started a natural foods store named SaferWay in Austin, Texas. Two years later, Mackey
and Lawson partnered with Craig Weller and Mark Skiles, who owned Natural Grocery, and
formed Whole Foods Market in 1980. The company began an expansion and acquisition
strategy in 1984 and expanded into Houston and Dallas. In 1988, Whole Foods Market
acquired Whole Food Company in New Orleans, and, in 1989, expanded into California.
The company continued opening new stores, but the rapid growth was the result of
acquisitions. Throughout the 1990s, Whole Foods Market acquired companies from
California to Boston. In 2002, the company expanded into Canada, and, in 2004, entered
the UK market by acquiring seven Fresh & Wild stores. Whole Foods Market was acquired
by Amazon in August 2017 for $13.4 billion. Whole Foods Market statement of operations
2015–17 (prior to being acquired by Amazon) is produced in Exhibit 9. As of January 2019,
Whole Foods operated 479 stores in the United States.
EXHIBIT 9 Consolidated Statements of Operations for Whole Foods
Market, Inc., 2015–2017 ($ in millions)
2017 2016 2015
Sales $16,030 $15,724 $15,389
Cost of goods sold and occupancy
costs 10,633 10,313 9,973
Gross profit 5,397 5,411 5,416
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2017 2016 2015
Selling, general and administrative
expenses 4,627 4,477 4,472
Merger-related expenses 156 — —
Pre-opening expenses 60 64 67
Relocation, store closure, and lease
termination costs 95 13 16
Operating income 459 857 861
Interest expense (49) (41) —
Investment and other income 7 11 17
Income before income taxes 417 827 878
Provision for income taxes 172 320 342
Net income $ 245 $ 507 $ 536
Source: Whole Foods Market, Inc. 2017 Annual Report.
Amazon immediately began to work toward positioning Whole Foods Market to excel in
the online grocery market. Amazon Prime members received special discount on many
foods and free shipping on online grocery purchases. In many markets, Amazon Prime
customers could receive their online grocery orders in as little as two hours, between 8 a.m.
and 10 p.m. Cost control was a priority: Whole Foods Market centralized its procurement
and operations in Austin, Texas. Amazon imposed merchandizing fees for suppliers of
items that were on sale: the company offered a 10 percent Amazon Prime discount on
selected items, and Whole Foods charged that 10 percent back to the vendor. It was
expected that Whole Foods Market planned to focus on expanding its online grocery
services and the availability of its 365 private label brands to online shoppers under
Amazon managerial control.
Publix Super Markets in Mid-2020. As the industry moved into 2020, the magnitude of
online sales made delivery options almost mandatory. Although delivery was necessary, it
was not always profitable. For example, Walmart, which was considered one of the most
successful online grocery retailers, forecast a loss of over $1 billion in 2019. Obviously,
efficiency and cost control were mandatory areas for grocery retailers’ attention as the
rapidly changing industry moved an increasing amount of sales into ecommerce.
Profitability in the retail grocery industry had been falling due to
decreasing productivity, higher costs and significantly increased price competition.
According to a January 2019 McKinsey & Company report, grocers could experience a
$200 billion to $700 billion in revenue shift to online, discount, and non-grocery channels.
The net result was that the industry was risking more than $1 trillion in earnings (before
interest and taxes), as well as the loss of about half of traditional grocery retailers.
The COVID-19 pandemic in early 2020 injected additional speed into the supermarket
industry change. In 2019, about one-third of a sample of shoppers reported that they bought
“almost none” of their groceries online, while 16 percent bought “some,” and 12 percent
bought “almost all” online. On March 13, 2020, with the COVID-19 pandemic spreading
through the United States, one-third of shoppers reported purchasing groceries online
during the prior week, with 41 percent being first-time online grocery shoppers.
A result of the COVID-19 crisis was that most restaurants were closed, resulting in a
large swing in food sales going to supermarkets. This presented many previously reluctant
online grocery shoppers with the experience of easy, convenient online shopping, which
would likely accelerate the structural change in shopping with an increase in the online
grocery segment. Although the large revenue increase was welcomed by the industry, it
concealed e-commerce deficiencies. A looming challenge for the industry was coping with
the shift from groceries purchased from store shelves to lower-profit ecommerce sales.
ENDNOTES
1 James Brumley, “The Kirkland Brand is Costco’s Secret Weapon When It Matters Most,” Motley Fool,
https://www.fool.com/investing/2019/11/19/the-kirkland-brand-is-costcos-secret-weapon-when-i.aspx.
2 Jenna Coleman, “Three Ways Albertsons is Quitely Upping their Online Grocery Game,” Forbes, November 8, 2019,
https://www.forbes.com/sites/jennacoleman/2019/11/08/3-ways-albertsons-is-quietly-upping-their-online-grocery-
game/#5c2ff0cc3827.
3 “New Market Force Information Study Finds Wegmans is America’s Favorite Grocery Store,” Market Force Information, June 26, 2018,
https://www.marketforce.com/2018-americas-favorite-grocery-stores.
https://www.fool.com/investing/2019/11/19/the-kirkland-brand-is-costcos-secret-weapon-when-i.aspx
https://www.forbes.com/sites/jennacoleman/2019/11/08/3-ways-albertsons-is-quietly-upping-their-online-grocery-game/#5c2ff0cc3827
https://www.marketforce.com/2018-americas-favorite-grocery-stores
T
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CASE 16
Tesla’s Strategy in 2020: Can It Deliver
Sustained Profitability?
Copyright ©2021 by Arthur A. Thompson. All rights reserved.
Arthur A. Thompson
The University of Alabama
esla shocked shareholders and Wall Street by reporting an operating loss of $521.8 million
and a net loss of $702.1 million for the first quarter of 2019. But during the next three
quarters of 2019, the company reported a number of significant improvements and
achievements that signaled a major turning point in its prospects for competitive success and
future profitability:
Tesla delivered a record 112,095 electric vehicles to customers in Q4 of 2019. For full-year
2019, Tesla delivered a record 367,656 electric vehicles to customers, a 50 percent increase
over the 245,530 vehicles delivered in 2018. Buyer demand for Tesla’s models was so strong
that the company spent zero dollars on advertising to achieve its record sales volumes.
The company’s automotive revenues rose from $18.5 billion in 2018 to $20.8 billion in
2019, and its free cash flows from operations (after paying for capital expenditures) jumped
from –$3.35 billion in 2017 to essentially $0 in 2018 to $1.1 billion in 2019.
In January 2020, Tesla began ramping production of a soon-to-be-introduced Model Y at the
company’s Fremont assembly plant in California ahead of schedule; deliveries to customers
were planned to begin in late March or early April. The new Model Y, an SUV version of
Tesla’s best-selling Model 3 sedan, was expected to become Tesla’s most popular vehicle.
Tesla CEO Elon Musk said that within a few years he expected that worldwide annual
demand for Model 3 and Model Y would be on the order of 750,000 and 1.25 million units,
respectively.
The company announced improvements that boosted the single-charge EPA range on the all-
wheel drive Model Y from 280 miles to 315 miles.
Tesla began producing its Model 3 electric vehicle at a new assembly plant in Shanghai less
than 10 months after beginning construction; vehicles produced at the Shanghai plant were
expected to be delivered to buyers in China and other Asian countries. China was by far the
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world’s largest market for motor vehicles, and sales of electric vehicles in China, which
exceeded 1.4 million units in 2019, were the fastest-growing market segment.
Tesla’s engineering team discovered ways to greatly enhance the production and assembly
techniques at the new Shanghai plant compared to those currently in use at the older
Fremont plant; because of the resulting efficiency gains, unit production costs were expected
to be about 25 percent below those at the Fremont plant.
The company finalized plans for constructing a third assembly plant just outside Berlin,
starting in February 2020; this plant was intended to supply vehicles to customers all across
Europe, Scandinavia, and the Middle East.
The company returned to profitability in the last two quarters of 2019, with net income of
$143 million in Q3 and $105 million in Q4.
Due to continuing improvements in operating efficiencies and higher operating leverage, the
company’s operating profit margin went from –11.5 percent in Q1 to –2.6 percent in Q2 to
4.1 percent in Q3 to 4.9 percent in Q4.
Following the January 28, 2020 announcement of Tesla’s 2019 financial
results and its outlook for 2020, Tesla’s stock price, which had already climbed from $480 per
share on January 3 to $567 on January 28, exploded to an intra-day high of $969 on February
19, 2020. Over the next two weeks, Tesla’s stock price lost some of its gains, but still was
trading around $750 per share in the first week of March 2020. However, by June 2020,
Tesla’s stock price had surged again on prospects of a reopening of the global economy
following widespread COVID-19 shutdowns, reaching an all-time high of $1,027 on June 10.
Exhibit 1 shows sales of Tesla’s four models from 2012 when the Models S was first
introduced through the second quarter of 2020.
EXHIBIT 1 Tesla’s Deliveries of the Model S, Model X, Model 3, and Model
Y to Customers, 2012 through the Second Quarter of 2020
Period Model S Deliveries Model S plus ModelX Deliveries Model 3 Deliveries
Model 3 plus Model
Y Deliveries
2012 2,653
2013 22,477
2014 31,655
2015 50,332
2016 76,230
2017 101,420 1,734
2018 99,475 146,055
2019 66,771 300,885
Q1
2020* 12,200 76,200
Q2
2020* 10,600 90,650
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*Deliveries in Q1 and Q2 2020 were negatively impacted by the spread of the Coronavirus, which resulted in a
government-mandated shutdown of the company’s two assembly plants and a sharp falloff in buyer purchases of
new motor vehicles due to stay-at-home restrictions in China, the United States, and many other countries.
Source: Company 10K reports, 2012-2019 and Tesla press releases, April 2, 2020 and July 2, 2020.
Company Background
Tesla Motors was incorporated in July 2003 by Martin Eberhard and Marc Tarpenning, two
Silicon Valley engineers who believed it was feasible to produce an “awesome” electric
vehicle. Tesla’s namesake was the genius Nikola Tesla (1856–1943), an electrical engineer and
scientist known for his impressive inventions (of which more than 700 were patented) and his
contributions to the design of modern alternating-current (AC) power transmission systems
and electric motors. Tesla’s first vehicle, the Tesla Roadster (an all-electric sports car)
introduced in early 2008, was powered by an AC motor that descended directly from Nikola
Tesla’s original 1882 design.
Financing Early Operations. Eberhard and Tarpenning financed the company until Tesla’s
first round of investor funding in February 2004. Elon Musk contributed $6.35 million of the
$6.5 million in initial funding and, as the company’s majority investor, assumed the position of
Chairman of the company’s board of directors. Martin Eberhard put up $75,000 of the initial
$6.5 million, with two private equity investment groups and a number of private investors
contributing the remainder.1 Several rounds of investor funding ensued, with Elon Musk
emerging as the company’s biggest shareholder. Other notable investors included Google co-
founders Sergey Brin and Larry Page, former eBay President Jeff Skoll, and Hyatt heir Nick
Pritzker. In 2009, Germany’s Daimler AG, the maker of Mercedes vehicles, acquired an equity
stake of almost 10 percent in Tesla for a reported $50 million.2 Daimler’s investment was
motivated by a desire to partner with Tesla to accelerate the development of Tesla’s lithium-
ion battery technology and electric drive train technology and to collaborate on electric cars
being developed at Mercedes. Later in 2009, Tesla was awarded a $465 million
low-interest loan by the U.S. Department of Energy to accelerate the production of
affordable, fuel-efficient electric vehicles; Tesla used $365 million for production engineering
and assembly of its forthcoming Model S and $100 million for a powertrain manufacturing
plant employing about 650 people that would supply all-electric powertrain solutions to other
automakers and help accelerate the availability of relatively low-cost, mass-market electric
vehicles.
In June 2010, Tesla Motors became a public company, raising $226 million with an initial
public offering of common stock. It was the first American car company to go public since
Ford Motor Company in 1956.
Management Changes at Tesla. In August 2007, with the company plagued by delays in
getting its first model—the Tesla Roadster—into production, co-founder Martin Eberhard was
ousted as Tesla’s chief executive officer (CEO). While his successor managed to get the Tesla
Roadster into production in March 2008 and begin delivering Roadsters to customers in
October 2008, internal turmoil in the executive ranks prompted Elon Musk to decide it made
more sense for him to take on the role as Tesla’s chief executive officer—while continuing to
serve as chairman of the board—because he was making all the major decisions anyway.
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Elon Musk. Elon Musk was born in South Africa, taught himself computer programming,
and, at age 12, made $500 by selling the computer code for a video game he invented.3 In
1992, after spending two years at Queen’s University in Ontario, Canada, Musk transferred to
the University of Pennsylvania where he earned an undergraduate degree in business and a
second degree in physics. During his college days, Musk spent some time thinking about two
important matters that he thought merited his time and attention later in his career: one was
that the world needed an environmentally clean method of transportation; the other was that it
would be good if humans could colonize another planet.4 After graduating from the University
of Pennsylvania, he decided to move to California and pursue a PhD in applied physics at
Stanford; however, he left the program after two days to pursue his entrepreneurial aspirations
instead.
Musk’s first entrepreneurial venture was to join up with his brother, Kimbal, and establish
Zip2, an Internet software company that developed, hosted, and maintained some 200 websites
involving “city guides” for media companies. In 1999 Zip2 was sold to a wholly-owned
subsidiary of Compaq Computer for $307 million in cash and $34 million in stock options—
Musk received a reported $22 million from the sale.5
In March 1999, Musk co-founded X.com, a Silicon Valley online financial services and e-
mail payment company. One year later, X.com acquired Confinity, which operated a
subsidiary called PayPal. Musk was instrumental in the development of the person-to-person
payment platform and, seeing big market opportunity for such an online payment platform,
decided to rename X.com as PayPal. Musk pocketed about $150 million in eBay shares when
PayPal was acquired by eBay for $1.5 billion in eBay stock in October 2002.
In June 2002, Elon Musk with an investment of $100 million of his own money founded his
third company, Space Exploration Technologies (SpaceX), to develop and manufacture space
launch vehicles, with a goal of revolutionizing the state of rocket technology and ultimately
enabling people to live on other planets. Upon hearing of Musk’s new venture into the space
flight business, David Sacks, one of Musk’s former colleagues at PayPal, said, “Elon thinks
bigger than just about anyone else I’ve ever met. He sets lofty goals and sets out to achieve
them with great speed.”6 In 2011, Musk vowed to put a man on Mars in 10 years.7 In May
2012, a SpaceX Dragon cargo capsule powered by a SpaceX Falcon Rocket completed a near
flawless test flight to and from the International Space Station; since then, under contracts with
NASA, the SpaceX Dragon had delivered cargo to and from the Space Station multiple times.
In early 2020, SpaceX was working toward launching a rocket and spacecraft in May 2029
carrying two American astronauts to the International Space Station, the first visit by
American astronauts on an American rocket and spacecraft since July 2011. But, more
significantly, SpaceX was making rapid progress on Elon Musk’s ambitious Starlink project to
provide high-speed broadband service worldwide via satellite by the end of 2020. Musk
envisioned it might take a network of perhaps 12,000 Starlink satellites roughly the size of an
office desk and weighing about 500 pounds orbiting about 375 miles above the earth to
provide dense enough coverage to provide broadband service to every nook and cranny on
earth. As of April 2020, SpaceX had put up five batches of 60 satellites into
orbit. Musk had tweeted after the launch of the third 60-satellite deployment that
Starlink internet services would become available in the Northern United States and Canada
after the completion of at least seven to nine 60-satellite deployments. After 22 launches, the
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company would be able to offer the service around the globe; Musk believed that if the
Starlink network could capture as little as five percent of the global telecommunications
market with its high-speed broadband service, SpaceX could net annual revenues of $30
billion to $50 billion. SpaceX had developed a fully and rapidly reusable Falcon rocket to
power the Starlink launches (as well as other types of launches). Headquartered in Hawthorne,
California, SpaceX had 7,000 employees and was owned by management, employees, and
private equity firms; Elon Musk was the company’s CEO and largest stockholder.
Another of Elon Musk’s business ventures was SolarCity Inc., a full-service provider of
solar system design, financing, solar panel installation, and ongoing system monitoring for
homeowners, municipalities, businesses (including Intel, Walmart, Walgreens, and eBay),
universities, nonprofit organizations, and military bases. Initially, investors were generally
bullish on SolarCity’s future prospects, and the company’s stock price rose from about $10.50
in late December 2012 to an all-time high of $85 in March 2013. But when the company’s
losses continued to grow, investor sentiment cooled and SolarCity’s stock price dropped to the
$16-$20 range in February 2016. While Solar City had installed many solar energy systems
and managed more solar systems for homes than any other solar company in the United States,
its business model of recovering the capital and operating costs of the installed systems
through leasing fees and power purchase agreements had resulted in negative cash flows and
ever-larger net losses. In November 2016, to rescue SolarCity from probable bankruptcy, Tesla
acquired the company for $2.6 billion (the deal was approved by an 85 percent shareholder
vote); SolarCity’s operations were folded into a new division named Tesla Energy. However,
the business model was changed to one where customers financed their new solar power
installations with cash and loans, thus producing a healthier mix of upfront and recurring
revenue; moreover, the costs of installing solar-powered installations were declining, partly
because of improvements in solar technology, greater efficiencies in manufacturing solar-
generation systems, and cost savings achieved by operating Tesla’s automotive and energy
divisions as sister companies.
During 2008–2015, many business articles had been written about Musk’s brilliant
entrepreneurship in creating companies with revolutionary products that either spawned new
industries or disruptively transformed existing industries. In a 2012 Success magazine article,
Musk indicated that his commitments to his spacecraft, electric car, and solar panel businesses
were long term and deeply felt.8 The author quoted Musk as saying, “I never expect to sort of
sell them off and do something else. I expect to be with those companies as far into the future
as I can imagine.” Musk indicated he was involved in both Tesla’s motor vehicle and energy
businesses “because I’m concerned about the environment,” while “SpaceX is about trying to
help us work toward extending life beyond Earth on a permanent basis and becoming a
multiplanetary species.” The same writer described Musk’s approach to a business as one of
rallying employees and investors without creating false hope.9 The article quoted Musk as
saying:
You’ve got to communicate, particularly within the company, the true state of the company. When people really
understand it’s do or die but if we work hard and pull through, there’s going to be a great outcome, people will give it
everything they’ve got.
Asked if he relied more on information or instinct in making key decisions, Musk said he
made no bright-line distinction between the two.
page C-216
Data informs the instinct. Generally, I wait until the data and my instincts are in alignment. And if either the data or my
instincts are out of alignment, then I sort of keep working the issue until they are in alignment, either positive or
negative.10
Musk was widely regarded as being an inspiring and visionary entrepreneur with
astronomical ambition and willingness to invest his own money in risky and highly
problematic business ventures. He set stretch performance targets and high product quality
standards, and he pushed hard for their achievement. He exhibited perseverance, dedication,
and an exceptionally strong work ethic—he typically worked 85 to 90 hours a week. Most
weeks, Musk split his time between SpaceX and Tesla.
In 2019, Elon Musk’s base salary as Tesla’s CEO was $62,400, an amount required by
California’s minimum wage law; however, he was accepting only $1 in salary.
The company’s Board of Directors in 2017 established an executive
compensation plan for Musk tied to Tesla’s performance on various metrics; compensation
was in the form of stock option awards subject to various vesting conditions. As of January
2020, Musk reportedly owned about 34 million shares of Tesla common stock, equal to about
19 percent of the shares outstanding.11
Musk’s Vision and Strategy for Tesla. Elon Musk’s strategic vision for the automotive
segment of Tesla’s operations featured three major elements:
1. Bring a full-range of affordable electric-powered vehicles to market and become the world’s
foremost manufacturer of premium quality, high-performance electric vehicles.
2. Convince motor vehicle owners worldwide that electric-powered motor vehicles were an
appealing alternative to gasoline-powered vehicles.
3. Accelerate the world’s transition from carbon-producing, gasoline-powered motor vehicles
to zero-emission electric vehicles.
His strategic intent was for Tesla to be the world’s biggest and most highly-regarded
producer of electric-powered motor vehicles, dramatically increasing the share of electric
vehicles on roads across the world and causing global use of gasoline-powered motor vehicles
to fall into permanent long-term decline. At its core, therefore, Tesla’s strategy was aimed
squarely at utilizing the company’s battery and electric drivetrain technology to disrupt the
world automotive industry in ways that were sweeping and transformative. If Tesla’s strategy
proved to be as successful as Elon Musk believed it would be, industry observers expected that
Tesla’s competitive position and market standing vis-à-vis the world’s best-known automotive
manufacturers would be vastly stronger in 2025 than it was in 2020.
Tesla’s Early Sales Successes with the Model S and Model X, 2012–2019.
In 2017 and 2018 production and sales of the company’s trailblazing Model S sedan
(introduced in 2012) and Model X sports utility vehicle (introduced in late 2015) were
proceeding largely on plan. Combined sales of these two models were almost 101,500 units in
2017 and just under 100,000 units in 2018. Combined sales dropped to only 66,800 units in
2019, as many buyers shifted to purchasing the lower-priced Model 3 (see Exhibit 1). Both the
Model S and Model X were being sold in North America, Europe, and Asia in 2017–2020.
The Model S was a fully electric, four-door, five-passenger luxury sedan featuring all-wheel
drive with dual front and rear motors (mounted on the front and rear axles), an all-glass
page C-217
panoramic roof, a top speed of 155 mph, the ability to accelerate from 0 to 60 mph in as little
as 2.4 seconds, an estimated driving range of up to 390 miles on a single charge, a high
definition backup camera, a 17-inch touchscreen that controlled most of the car’s functions,
keyless entry, xenon headlights, certain autopilot and self-driving capabilities, and numerous
other features that were standard in most luxury vehicles.
The Model X was a sport utility vehicle with seating for up to seven adults, a top speed of
155 mph, the ability to accelerate from 0 to 60 mph in 4.4 seconds, an estimated driving range
of 351 miles on a single charge, and a unique falcon wing door system for easy access to the
second and third seating rows. The Model X also had an all-wheel drive dual motor system,
adaptive air suspension, a premium interior and sound system, and autopilot capabilities, along
with assorted other standard and optional features.
The Model S was the most-awarded car of 2013, including Motor Trend’s 2013 Car of the
Year award and Automobile magazine’s 2013 Car of the Year award. The National Highway
Traffic Safety Administration (NTSHA) in 2013, 2014, and 2015 awarded the Tesla Model S a
five-star safety rating, both overall and in every subcategory (a score achieved by
approximately one percent of all cars tested by the NHTSA). Consumer Reports gave the
Model S a score of 99 out of 100 points in 2013, 2014, and 2015, saying it was “better than
anything we’ve ever tested.” However, the Tesla Model S did not make the Consumer Reports
list of the “10 Top Picks” in 2016, 2017, and 2018, but the Model S did earn a perfect 100
score on the 2018 road test drive. In 2020 Consumer Reports gave the Model S a 97 on the
2020 road test drive and a #2 ranking among the top ten ultra-luxury cars; ratings for the
Model X were considerably lower.
The sleek styling and politically correct power source of Tesla’s Model S and Model X were
thought to explain why thousands of wealthy individuals in countries where the two models
were being sold—anxious to be a part of the migration from gasoline-powered vehicles to
electric-powered vehicles and to publicly display support for a cleaner
environment—had become early purchasers and advocates for Tesla’s vehicles.
Indeed, word-of-mouth praise among current owners and glowing articles in the media were
so pervasive that Tesla had not yet spent any money on advertising to boost customer traffic in
its showrooms. In a presentation to investors, a Tesla officer said “Tesla owners are our best
salespeople.”12
Tesla’s Excruciating Struggle to Boost Production Volumes of the Model 3.
Tesla Motors began assembling the first models of its new “affordably-priced” entry-level
Model 3 electric car in May 2017 and delivered the first units the last week of July. The first
production vehicles, delivered to employees who had placed pre-production reservations over
a year earlier, were pre-configured with rear-wheel drive and a long-range battery, had a range
of 310 miles and 0 to 60 mph acceleration time of 5.1 seconds and had a sticker price starting
at $44,000 with premium upgrades available for an additional $5,000 to $10,000.
Tesla unveiled six drivable prototypes of the Model 3 for public viewing and a limited
number of test drives on the evening of March 31, 2016. Buyer reaction was overwhelmingly
positive. Over the next two weeks, some 350,000 individuals paid a $1,000 deposit to reserve
a place in line to obtain a Model 3; reportedly, the number of reservations grew to nearly
400,000 units over the next several months. Because of the tremendous amount of interest in
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the Model 3, Tesla advanced the schedule to begin producing the Model 3 to mid-2017 and
further accelerated its efforts to expand production capacity of the Model 3.
In early August 2017, Musk said: 13
Based on our preparedness at this time, we are confident we can produce just over 1,500 [Model 3] vehicles in Q3 and
achieve a run rate of 5,000 vehicles per week by the end of 2017. We also continue to plan on increasing Model 3
production to 10,000 vehicles per week at some point in 2018.
But in his third quarter 2017 update on November 1, 2017, Musk related a host of
production bottlenecks and challenges that were blocking the ramp-up of Model 3 production
and delaying deliveries, saying, “this makes it difficult to predict exactly how long it will take
for all bottlenecks to be cleared or when new ones will appear.14
Tesla’s “production hell” with the Model 3 continued to haunt the company well into 2018.
Many analysts believed Tesla’s problems stemmed from having taken huge shortcuts in the
parts approval process, production line validation, and full beta testing of the Model 3 in order
to begin early assembly and production ramp-up. There were other reasons, including ongoing
parts bottlenecks and reportedly inconsistent manufacturing quality. Production line
employees interviewed by reporters indicated significant numbers of units coming off the
assembly line had quality problems involving malfunctioning parts/components and/or faulty
installation issues that required reworking. In early 2018, a big parking lot just outside the
assembly plant in Fremont, California, was said to be full of Model 3s awaiting corrective
attention; a few were even being junked because of the high cost of restoring them to a
condition that would pass final pre-delivery inspection. On February 7, 2018, Musk reported:
15
We continue to target weekly Model 3 production rates of 2,500 by the end of Q1 and 5,000 by the end of Q2. It is
important to note that while these are the levels we are focused on hitting and we have plans in place to achieve them, our
prior experience on the Model 3 ramp has demonstrated the difficulty of accurately forecasting specific production rates at
specific points in time. What we can say with confidence is that we are taking many actions to systematically address
bottlenecks and add capacity in places like the battery module line where we have experienced constraints, and these
actions should result in our production rate significantly increasing during the rest of Q1 and through Q2.
A week or so later, Tesla shut down the Model 3 assembly line for four days to address
some of the problems being encountered. Nonetheless, in early March 2018, there were reports
from multiple sources that Tesla had not been able to consistently achieve a production run
rate of 800 units per week. Musk’s target of a weekly production rate of 2,500 Model 3s by the
end of March proved unachievable. During the last week of March, Elon Musk tweeted that he
had taken over the role of supervising Model 3 production for the time being.
The first week of April 2018, Tesla reported that it produced 34,494 vehicles in the first
quarter of 2018 and delivered 29,980 vehicles, of which 11,730 were Model S; 10,070 were
Model X; and 8,180 were Model 3. The company said that after shifting some production
resources away from Model S and Model X production over to production and assembly of the
Model 3 during the last week of March, it was able to produce 2,020 Model 3s
in the last seven days leading up to April 3. In its production and delivery
announcement, the company further said:
Given the progress made thus far and upcoming actions for further capacity improvement, we expect that the Model 3
production rate will climb rapidly through Q2. Tesla continues to target a production rate of approximately 5,000 units per
week in about three months.
Finally, we would like to share two additional points about Model 3:16
The quality of Model 3 coming out of production is at the highest level we have seen
across all our products. This is reflected in the overwhelming delight experienced by our
customers with their Model 3s. Our initial customer satisfaction score for Model 3
quality is above 93 percent, which is the highest score in Tesla’s history.
Net Model 3 reservations remained stable through Q1. The reasons for order cancellation
are almost entirely due to delays in production in general and delays in availability of
certain planned options, particularly dual motor AWD and the smaller battery pack.
While progress was finally being made in boosting Model 3 production volumes, Tesla still
had to prove it could overcome three challenges with the potential to imperil Musk’s vision for
the company:
1. Gasoline prices across much of the world had dropped significantly from 2015 to early 2018
and were expected by many knowledgeable observers to remain permanently “low” because
crude oil prices worldwide were expected to stay below $80 per barrel, in part due to the
growing abundance of shale oil and the sharply-lower costs of extracting oil from shale
deposits. Affordable gasoline prices made the purchase of electric vehicles less attractive,
given that (1) electric vehicles were higher priced than vehicles with gasoline engines, (2)
electric vehicles so far were limited to an upper range of about 300 miles on a single battery
charge, and (3) new vehicles powered by gasoline engines were getting more miles per
gallon (due to government-mandated mileage-efficiency requirements).
2. Tesla was facing the prospect of much more formidable competition from virtually all of the
world’s major motor vehicle manufacturers (BMW, Mercedes-Benz, Jaguar, Volkswagen-
Audi, Toyota, Honda, Nissan, General Motors, and Ford) that were rushing to introduce
affordable and high-end electric vehicles with features and engine configurations that would
enable them to compete head-on with the Model S, Model X, and Model 3. Several vehicle
makers were also pursuing the development of electric-powered semitrucks for commercial
uses.
3. Tesla had yet to prove it could boost operating efficiency and lower costs enough to be both
price competitive and attractively profitable in producing and marketing its vehicle models.
It reported both a loss from operations and a net loss during 2013–2017, despite growing its
automotive sales and leasing revenues from $2.61 billion in 2013 to $9.64 billion in 2017.
In February 2018, the company did say it expected to generate a positive quarterly
operating income before the end of 2018 (but not a positive operating income for the year).
While Tesla’s ongoing operating losses and net losses were partly, or perhaps largely, due to
the sizable new product development costs associated with the Model X and Model 3 and to
the required accounting treatments for both leased vehicles and Tesla’s generous stock
compensation plan, it was nonetheless disconcerting that Tesla’s operating loss of $1.63
billion in 2017 was the largest in the company’s history and its 2017 operating profit per
vehicle sold was a negative $15,855.17
When Tesla announced its financial and operating results for the first quarter of 2018 ending
March 31, Elon Musk said that after numerous adjustments in assembly methods and
correcting problems with faulty and improperly designed parts Tesla was now able to sustain a
production rate of 3,000 Model 3s per week. He also said that continued refinements of the
page C-219
309 762 1,107 883 869
291 468 1,001 1,391 2,226
183 482 708 488 459
287 472 1,229 1,880 2,770
3,123 5,401 9,536 17,419
20,50
9
assembly process and improved operational uptime of the associated machinery should lead to
a production rate of “well over 5,000” vehicles per week by the end of June or beginning of
July. Musk admitted that he had been wrong in mandating use of so many robots along the
assembly line, and that now the assembly line had been and was still being greatly simplified,
with more use being made of semi-automated and manual assembly to perform certain tasks
until the company had enough time to perfect the use of robots and enable full automation to
resume. Musk confidently predicted that the Model 3 would become the best-selling medium-
sized premium sedan in the United States before year end and that, if Tesla
executed according to plan, the company would achieve positive cash flows and
positive net income (excluding non-cash stock-based compensation) in both the third and
fourth quarters of 2018.18 During the May 2, 2018 conference call with analysts to discuss
Tesla’s Q1 2018 financial results, Musk expressed his appreciation to the Chinese government
for its announcement that foreign companies would henceforth be allowed to have 100 percent
ownership of manufacturing facilities in China and said Tesla could have a Gigafactory
capable of vehicle production in China “not later than the fourth quarter” of 2018.19
Exhibit 2 presents selected financial statement data for Tesla for 2015 through 2019.
EXHIBIT 2 Selected Financial Data for Tesla, Inc., Years Ended December
31, 2015–2019 (in millions, except per share data)
Years Ended December 31
2015 2016 2017 2018 2019
Income Statement Data:
Revenues:
Automotive sales $3,432 $5,589 $8,535 17,632 $19,952
Automotive leasing
Total automotive revenues 3,741 6,351 9,642 18,515 20,821
Energy generation and storage 14 181 1,116 1,555 1,531
Services and other
Total revenues 4,046 7,000 11,759 21,461 24,578
Cost of revenues:
Automotive sales 2,640 4,268 6,724.5 13,686 15,939
Automotive leasing
Total automotive cost of revenues 2,823 4,750 7,433 14,174 16,398
Energy generation and storage 12 178 874 1365 1,341
Services and other
Total cost of revenues
Gross profit (loss) 924 1,599 2,223 4,042 4,069
Operating expenses:
Research and development 7,189 834 1,378 1,460 1,343
13 27 32 58 110
Years Ended December 31
2015 2016 2017 2018 2019
Selling, general and administrative 922 1,432. 2,477 2,834.5 2,646
Restructuring and other — — — 135 149
Total operating expenses 1,640 2,267 3,855 4,430 4,138
Loss from operations (717) (667) (1,632) (388) (69)
Interest income 2 9 19 24 44
Interest expense (119) (199) (471) (663) (685)
Other income (expense), net (42) 111 (125) 22 45
Loss before income taxes (876) (746) (2,209) (1,005) (665)
Provision for income taxes
Net loss $(889) $(773) $(2,241) $(1,063) $(775)
Net loss attributable to noncontrolling interests
and subsidiaries — (98) (279) (87) 87
Net loss attributable to common shareholders $(889) $(675) $(1,962) $(976) $(862)
Net loss per share of common
stock, basic and diluted $(6.93) $(4.68) $(11.83) $(5.72) $(4.92)
Weighted average shares used in computing
net loss per share of common stock, basic and
diluted
128 144 166 171 177
Selected Balance Sheet Data:
Cash and cash equivalents $1,197 $3,393 $3,368 $3,686 $6,286
Inventory 1,278 2,067 2,264 3,113 3,552
Total current assets 2,791 6,260 6,571 8,307 12,103
Property, plant, and equipment, net 3,403 5,983 10,028 11,330 10,396
Total assets 8,093 22,664 28,655 29,740 34,309
Total current liabilities 2,816 5,827 7,675 9,992 10,667
Long-term debt and capital leases, net of
current portion 2,040 5,860 9,418. 9,404 11,634
Total stockholders’ equity 1,089 4,753 4,237 4,923 6,618
Selected Cash Flow Data:
Cash flows provided by (used in) operating
activities $(524) $(124) $(61) $2,098 $2,405
Proceeds from issuance of common stock in
public offerings 730 1,702 400 848
Proceeds from issuance of convertible and
other debt 319 2,853 7,138 6,176 10,669
Purchases of property and equipment
excluding capital leases (1,635 (1,281) (3,415) (2,101) (1,327)
Net cash used in investing activities (1,674) (1,081) (4,196) (2,337) (1,436)
Net cash provided by financing activities 1,524 3,744 4,415 574 1,529
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Sources: Company 10-K reports for 2015, 2017, 2018, and 2019.
Tesla in 2020
In 2020 Tesla’s business consisted of designing, developing, manufacturing, and leasing high-
performance fully electric vehicles, and energy generation and storage systems; it also offered
services related to its products.20 The company considered itself to be the world’s first
vertically integrated sustainable energy company, offering end-to-end clean energy products,
including generation, storage and consumption. Tesla products were generally sold directly to
customers at its website and selected retail locations and, in some cases, by an internal
salesforce. To serve customers, Tesla had invested in a global network of vehicle service
centers, Mobile Service technicians, body shops, Supercharger stations, and Destination
Chargers to accelerate the widespread adoption of its battery-powered electric vehicles our
products and help promote the transition from gasoline-powered motor vehicles to zero
emission electric vehicles.
Tesla currently offered or was planning to offer a wide range of technologically advanced,
attractively styled, high-performance consumer and commercial vehicles. To differentiate its
business and vehicles from other vehicle manufacturers, Tesla was aggressively striving to be
the leader, or at worst among the leaders, in introducing full self-driving capability for all of its
models to complement such existing features as leading mileage range on a single charge,
superior acceleration, handling and safety performance, user convenience and infotainment
packages, the ability to have additional features enabled through over-the-air software updates;
and savings in charging, maintenance and other costs of ownership. technology
for improved safety. In addition, Tesla was striving to lower the cost of
ownership for our customers through continuous efforts to reduce manufacturing costs of its
vehicles.
In furtherance of its mission to accelerate the world’s transition to sustainable energy, Tesla
had also developed an expertise in solar energy systems. It sold and leased solar energy
systems for residential and commercial customers, and it offered a Solar Roof product, which
featured attractive and durable glass roof tiles integrated with solar energy generation. Tesla’s
approach to the solar business emphasized simplicity, standardization, and accessibility to
make it easy and cost-effective for customers to adopt clean energy.
Finally, Tesla had leveraged its technological expertise in batteries, energy management,
power electronics, and integrated systems associated with its vehicle powertrain systems to
develop and manufacture energy storage products, including Powerwall, Powerpack and
Megapack. These scalable systems could be used in homes, commercial facilities, and on the
utility grid, and were capable of numerous applications including backup or off-grid power,
peak demand reduction, demand response, reducing intermittency of renewable energy
generation, and facilitating the use of renewable energy generation over fossil fuel generation,
and other grid services and wholesale electric market services. Tesla’s solar business expertise
enabled it to offer integrated systems that combined energy generation and energy storage. As
with Tesla’s vehicles, the company’s energy storage products could be remotely updated over-
the-air with software or firmware improvements.
page C-222
Funding Its Rapidly Expanding Business Operations. During 2014–2017, Tesla raised
billions of dollars via the sale of senior notes convertible into common stock, other types of
long-term debt, and issues of new common stock to provide funding for research and
development (R&D), the development of new models, expanded production capabilities, an
ever-growing network of recharging stations, retail showrooms, vehicle service centers, and its
energy product operations. Tesla’s long-term debt and contractual capital lease obligations
grew from $600 million at year-end 2013 to $11.6 billion at year-end 2019; and the number of
shares of common stock outstanding rose from 119 million to 177 million during the same
period. In recent years, Tesla burned through cash at a torrid pace because of the heavy
expenses it was incurring for design and engineering, gearing up to produce certain parts and
component systems internally, constructing new facilities, equipping vehicle assembly lines
with robotics technology, tools, and other machinery, and boosting its employee count from
almost 6,000 employees at year-end 2013 to just over 48,000 at year-end 2019. The new
Gigafactory in Shanghai, China, was being almost fully funded with local debt.
Tesla’s Strategy to Become the World’s Biggest and Most Highly Regarded
Producer of Electric Vehicles
In 2020, Tesla’s strategy and operating initiatives were focused on:
Continuing to ramp up production of the Model 3 at both the Shanghai plant and the
Fremont plant.
Ramping up the production of the new Model Y SUV at both the Shanghai plant and the
Fremont plant and beginning deliveries to customers in April 2020.
Expanding the production capacity of certain automobile parts (battery packs, electric
motors, motor controllers, cooling pipes) at the Shanghai plant to help localize its supply
chain for vehicles produced in China; it was also building a second stamping line to speed
up car production at the plant.
Adding more production capacity at the Fremont plant so as to enable the production of
90,000 Model S and Model X vehicles and 400,000 Model 3 and Model Y vehicles.
Finishing construction on the second phase of the assembly plant in Shanghai, with a goal of
having 300,000 units of total production capacity (150,000 for Model 3 and 150,000 for
Model Y) in place by year-end 2020 or early 2021.
Moving quickly to construct and equip its third assembly plant in Germany in order to begin
production of Model 3 and Model Y in the first quarter of 2021.
Continuing to refine the designs and development of its next three models.
Continuing to expand the numbers of sales and service locations, mobile service vehicles
and Supercharger stations across the world.
Continuing to develop the technologies, systems, and software to achieve full self-driving
capabilities for all Tesla vehicles.
Selecting sites in the United States for two new manufacturing and assembly plants—one
for producing the Model Y and one for producing a new pickup truck.
Product Line Strategy.
A key element of Tesla’s long-term strategy was to offer vehicle-buyers a full line of electric
vehicle options. So far Tesla had introduced four models—the Tesla Roadster, Model S, Model
X, and Model 3. Aggressive efforts were underway to get the Model Y into the marketplace in
Spring 2020. along with a limited number of Tesla Semi trucks. These were scheduled to be
followed by a Tesla Semi truck, a new pickup-up truck called the Cybertruck, and a fresh
Roadster 2 model.
Tesla’s First Vehicle—The Tesla Roadster. Following Tesla’s initial funding in 2004,
Musk took an active role within the company. Although he was not involved in day-to-day
business operations, he nonetheless exerted strong influence in the design of the Tesla
Roadster, a two-seat convertible that could accelerate from 0 to 60 miles per hour in as little as
3.7 seconds, had a maximum speed of about 120 miles per hour, could travel about 245 miles
on a single charge, and had a base price of $109,000. Musk insisted from the beginning that
the Roadster have a lightweight, high-strength carbon fiber body, and he influenced the design
of components of the Roadster ranging from the power electronics module to the headlamps
and other styling features.21 Prototypes of the Roadster were introduced to the public in July
2006. The first “Signature One Hundred” set of fully equipped Roadsters sold out in less than
three weeks; the second hundred sold out by October 2007. General production began in
March 2008. New models of the Roadster were introduced in July 2009 (including the
Roadster Sport with a base price of $128,500) and in July 2010. Sales of Roadster models to
countries in Europe and Asia began in 2010. From 2008 through 2012, Tesla sold more than
2,450 Roadsters in 31 countries.22 Sales of Roadster models ended in December 2012 so that
the company could concentrate exclusively on producing and marketing the Model S.
However, Tesla announced in early 2015 that Roadster owners would be able to obtain a
Roadster 3.0 package that enabled a 40 to 50 percent improvement in driving range to as much
as 400 miles on a single charge; management indicated additional updates for Roadsters would
be forthcoming. In 2017, Tesla announced it would re-introduce a new version of the Roadster
in 2020 (after it began deliveries of the Tesla Semi truck and Model Y).
Tesla’s Second Vehicle—The Model S. Customer deliveries of Tesla’s second
vehicle—the sleek, eye-catching Model S sedan—began in July 2012. Tesla
introduced several new options for the Model S in 2013, including a sub-zero
weather package, parking sensors, upgraded leather interior, several new wheel
options, and a yacht-style center console. Later, Xenon headlights, a high definition
backup camera, emergency braking, collision warning, blind-spot monitoring, and
various autopilot and self-driving capabilities became standard equipment on all
Model S cars. The Model S powertrain options had been modified several times. In
March 2020, the Model S was being offered with two powertrains options:
Long Range Plus — all-wheel drive with dual front and rear motors (mounted on the front
and rear axles), 390-mile driving range, 0 to 60 mph in 3.7 seconds, with a standard price of
$79,990 (which included adaptive air suspension, premium interior and sound, and free
unlimited supercharging)
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Performance — all-wheel drive with dual front and rear motors (mounted on the front and
rear axles), 348-mile driving range, 0 to 60 mph in 2.4 seconds, with a standard price of
$94,990 (which included adaptive air suspension, enhanced interior styling, premium sound,
and free unlimited supercharging)
Popular options included premium exterior colors (up to $2,000), 21” sonic carbon twin
turbine wheels ($2,500), a full-self-driving computer, with online activation of new self-
driving capabilities as regulatory approval was granted ($7,000); and third-row, rear-facing
seating ($4,000). All Model S vehicles (as well as all other Tesla models) previously delivered
to customers were equipped to receive software updates from Tesla that included new and
updated features. Autopilot software features were updated and upgraded as fast as they were
developed and tested.
To counter the “range anxiety” that Tesla owners sometimes experienced, in 2018 Tesla
introduced a standard software feature called “Range Assurance,” an always-
running application within the car’s navigation system that kept tabs on the
vehicle’s battery charge-level and the locations of Tesla Supercharging stations and parking-
spot chargers in the vicinity. When the vehicle’s battery began running low, an alert appeared
on the navigation screen, along with a list of nearby Tesla Supercharger stations and public
charging facilities; a second warning appeared when the vehicle was about to go beyond the
radius of nearby chargers without enough juice to get to the next facility, at which point
drivers were directed to the nearest charge point. There was also a Trip Planner feature that
enabled drivers to plan long-distance trips based on the best locations for recharging both en
route and at the destination; during travel, the software was programmed to pull in new data
about every 30 seconds, updating to show which charging facilities had vacancies or were full.
In the United States, customers who purchased a Model S (or any other Tesla model) before
2019 were eligible for a federal tax credit of up to $7,500. A number of states also offered
rebates on electric vehicle purchases, with states like California and New York offering rebates
as high as $7,500. Customers who leased a Model S were not entitled to rebates. Legislation
authorizing the federal tax credit called for the tax credits on a manufacturer’s electric vehicles
to expire once the manufacturer’s cumulative sales of electric vehicles reached 200,000 units.
Bills had been introduced in Congress to extend the credits past a cumulative sales volume of
200,000 units, but none of these had passed.
Tesla’s Third Vehicle—The Model X Crossover SUV. To reduce the development costs of
the Model X, Tesla had designed the Model X so that it could share about 60 percent of the
Model S platform. The Model X had seating for up to 7 adults, dual electric motors that
powered an all-wheel drive system, and a driving range of about 351 miles per charge. The
Model X’s distinctive “falcon-wing doors” provided easy access to the second and third
seating rows, resulting in a profile that resembled a sedan more than an SUV. The drive train
options for the Model X in 2020 were the same as for the Model S, but the driving ranges and
acceleration times for the Model X were different from those of the Model S. In 2018, the
standard price for the Long Range Plus Model X was $84,990; the standard price for the
Performance Model X was $104,990. The options were essentially similar to the Model S
except for the seating; five-passenger seating was standard, a six-seat interior cost $6,500, and
a seven-seat interior cost $3,500. Options for the Model X could boost the price to $127,990.
The Model X was the first SUV ever to achieve a five-star safety rating in every category and
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sub-category; it had both the lowest probability of occupant injury and a rollover risk half that
of any SUV on the road.
Tesla’s Fourth Vehicle—The Model 3. The idea behind the Model 3 was to incorporate all
the company had learned from the development and production of the Roadster, Model S, and
Model X to create the world’s first mass market electric vehicle priced on par with its
gasoline-powered equivalents. The Model 3 was attractively styled, with seating for five
adults, a driving range of 250 miles with rear-wheel drive, a driving range of up to 322 miles
with dual motor all-wheel drive, 0 to 60 mph acceleration capability of 3.2 seconds to 5.3
seconds depending on the model and drive train selected, and a five-star safety rating. While
the stated base price was $39,990, the range of available upgrades and options could up the
price to $66,990. The average selling price of the Model 3 in 2018 exceeded $45,000 and, as
of June 2019 Tesla had produced very few of the base-price Model 3 versions (since it was far
more profitable to sell more fully equipped Model 3s).
In the United States, federal legislation provided that buyers of electric vehicles were
eligible for a federal tax credit of up to $7,500 based on the size of the vehicle’s electric
battery. Buyers who leased an electric vehicle were not eligible for the tax credit (the credit
went to the company offering the lease). However, there was a provision in the law stating that
once the cumulative sales volume of a manufacturer’s zero-emission vehicles in the United
States reached 200,000 vehicles, the size of the $7,500 federal tax credit entered a one-year
phase-out period where buyers of qualifying vehicles were “eligible for 50 percent of the
credit if acquired in the first two quarters of the phase-out period and 25 percent of the credit if
acquired in the third or fourth quarter of the phase-out period.”23 Purchasers of that
manufacturer’s vehicles were not eligible for any federal tax credit after the phase-out period.
Tesla’s cumulative sales in the United States exceeded 200,000 vehicles during 2018. Some
states also offered tax credits for the purchases of plug-in electric vehicles. Some states also
offered a variety of tax credits in addition to the federal tax credit. The governments of China,
Japan, Norway, United Kingdom, and several other European countries offered
tax incentives for electric vehicle purchases as well. In 2018, Canada
discontinued the use of incentives for electric vehicles with a manufacturer’s suggested list
price of price greater than C$75,000 (US$58,500) and Norway phased out its tax credits as
well.
Tesla’s Fifth Vehicle—The Model Y Crossover SUV. In 2017, Elon Musk announced that
Tesla had begun developing plans for the development and production of an all-electric
crossover SUV that would be built on the same platform as the Model 3, but like the Model X
would have seating for up to 7 adults. Tesla unveiled a prototype of its Model Y SUV in
March 2019. In early 2020, the Model Y vehicles being offered for sale included dual motor
Long-Range and Performance versions, a driving range of about 315 miles, a top speed of 135
mph and 0 to 60 mph acceleration of 4.8 seconds for the Long Range version and a top speed
of 145 mph and 0-60 mph acceleration of 3.5 seconds for the Performance version. Base prices
were $52,990 and $60,990, respectively for the two versions, while fully equipped versions
had price tags of $67,990 and $73,990, respectively.
In May 2018, while Tesla was struggling with all of its Model 3 production problems, Musk
said he was planning for production of the Model Y to be a “manufacturing revolution,” with a
simplified manufacturing process and greater use of robots.24 Because the Model Y was
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expected to appeal to a large market segment, Elon Musk expected that the Model Y would
ultimately have higher annual sales than Model S, Model X, and Model 3 combined.
The Tesla Semi-Truck. Mention was made of a semi-truck in Tesla’s 2016 master plan. But
behind the scenes Tesla had moved swiftly to come up with not only a design but also
prototypes. The Semi was unveiled with much fanfare at a press conference on November 16,
2017. The company described the Semi as a Class 8 semi-trailer truck prototype that would be
powered by four independent electric motors on rear axles; have a driving range of either 300
miles or 500 miles on a full charge; and have a centered driver’s seat in the cockpit, with touch
screen controls on either side of the steering wheel. Standard equipment on all models would
include Autopilot capabilities, automatic emergency braking, automatic lane keeping, forward
collision warning, and ability to enter an energy-saving “convoy mode” with other semis on
the road. Elon Musk said the 500-mile version, equipped with Tesla’s latest battery design,
would be able to run for 400 miles after an 80 percent charge in 30 minutes using a solar-
powered Tesla Megacharger charging station. He also said the Semi would be able to
accelerate from 0 to 60 mph in seconds unloaded and in 20 seconds fully loaded. Tesla
expected to offer a warranty for a million miles and said maintenance would be simpler than
for a diesel truck.
A week later, Musk said that the regular production versions for the 300-mile range version
of the Semi would be priced at $150,000 and the 500-mile range version would be priced at
$180,000; the company also said it planned to offer a Founder’s Series Semi at $200,000.
Scores of companies, including Walmart, United Parcel Service, Anheuser-Busch, J.B. Hunt
Trucking Co, and PepsiCo, immediately lined up to place pre-orders for 5 to 150 Semis (at an
initial reservation price of $5,000, which was quickly raised to $20,000 per reservation) so
they could conduct tests of how well the Semi would perform in their operations. In March
2018, Tesla began testing the Semi with real cargo, hauling battery packs from Gigafactory 1
in Nevada to the Tesla Factory in Fremont, California. Pictures of the Semi being loaded with
cargo at the Nevada Gigafactory and traveling on the highways were immediately publicized
in the media and posted on the Internet and social media. Production of the Semi was
originally scheduled to begin in 2019, but in early 2020 it appeared that production of the
Semi was on pause until sometime in 2021 at best because mileage tests showed the battery
pack originally planned for use in the truck was not able to achieve the targeted range of 300-
to-500 miles on a single charge. More powerful battery packs capable of achieving the targeted
range were under development. In June 2020, Elon Musk said getting the Tesla Semi into
production was a top priority; however, the company was only in the final stage of choosing a
site to construct a facility to manufacture and assemble the Semi.
The Tesla Pickup Truck. While Elon Musk began talking about Tesla making an all-
electric pickup truck (and an all-electric cargo van on the same chassis) in 2016, the company
had yet to finalize its design and production specifications for what it was calling the
Cybertruck. Elon Musk said in a June 2019 podcast that Tesla wanted to keep the Cybertruck’s
starting price below $50,000 and make sure the truck was highly functional from
a load-carrying standpoint, saying:25
It’s going to be a truck that is more capable than other trucks. The goal is to be a better truck than a [Ford] F-150 in terms
of truck-like functionality and be a better sports car than a standard [Porsche] 911. That’s the aspiration.
Musk went on to say that the truck’s appearance would be pretty sci-fi and not be for
everyone. Further, buyers of the truck would have a range of optional extras that could push
the price up close to $70,000 (on a par with current roomy, luxurious pickups with powerful
engines). The Tesla Cybertruck was unveiled at the company’s Tesla Design Studio in
California in November 2019. Some people loved the futuristic design, others hated it, and
many thought it was too far over the top. Tesla did not respond to questions about whether the
truck’s design would change before it went into production. In March 2020, Elon Musk
announced that Tesla was in the process of evaluating sites in the central United States for a
new plant to manufacture and assemble its new Cybertruck; the current plan was to begin
production in late 2021.
Distribution Strategy: A Company-Owned and Operated Network of Retail Stores and
Service Centers.
Tesla sold its vehicles directly to buyers and also provided them with after-sale service through
a network of company-owned sales galleries and service centers. This contrasted sharply with
the strategy of rival motor vehicle manufacturers, all of whom sold vehicles and replacement
parts at wholesale prices to their networks of franchised dealerships that in turn handled retail
sales, maintenance and service, and warranty repairs. Management believed that integrating
forward into the business of traditional automobile dealers and operating its own retail sales
and service network had three important advantages:
1. The ability to create and control its own version of a compelling buying customer
experience, one that was differentiated from the buying experience consumers had with
sales and service locations of franchised automobile dealers. Having customers deal directly
with Tesla-employed sales and service personnel enabled Tesla to (a) engage and inform
potential customers about electric vehicles in general and the advantages of owning a Tesla
in particular and (b) build a more personal relationship with customers and, hopefully, instill
a lasting and favorable impression of Tesla Motors, its mission, and the caliber and
performance of its vehicles.
2. The ability to achieve greater operating economies in performing sales and service
activities. Management believed that a company-operated sales and service network offered
substantial opportunities to better control inventory costs of both vehicles and replacement
parts, manage warranty service and pricing, maintain and strengthen the Tesla brand, and
obtain rapid customer feedback.
3. The opportunity to capture the sales and service revenues of traditional automobile
dealerships. Rival motor vehicle manufacturers sold vehicles and replacement parts at
wholesale prices to their networks of franchised dealerships that in turn handled retail sales,
maintenance, and service, and warranty repairs. But when Tesla buyers purchased a vehicle
at a Tesla-owned sales gallery, Tesla captured the full retail sales price, roughly 10 percent
greater than the wholesale price realized by vehicle manufacturers selling through
franchised dealers. And, by operating its own service centers, it captured service revenues
not available to vehicle manufacturers who relied upon their franchised dealers to provide
needed maintenance and repairs. Furthermore, Tesla management believed that company-
owned service centers avoided the conflict of interest between vehicle manufacturers and
their franchised dealers where the sale of warranty parts and repairs by a dealer were a key
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source of revenue and profit for the dealer but where warranty-related costs were typically a
substantial expense for the vehicle manufacturer.
Tesla Sales Galleries and Showrooms. Initially, Tesla’s distribution strategy was to
aggressively expand its network of sales galleries and service centers to broaden its
geographical presence and to provide better maintenance and repair service in areas with a
high concentration of Tesla owners. In 2013, Tesla began combining its sales and service
activities at a single location (rather than having separate locations, as earlier had been the
case); experience indicated that combination sales and service locations were more cost-
efficient and facilitated faster expansion of the company’s retail footprint. At the end of 2019,
Tesla had 429 sales and service locations, mostly in or near major metropolitan areas in the
United States, Europe, China, and selected other countries. Some were in
prominent regional shopping malls and others were on highly visible sites along
busy thoroughfares. Most sales locations had only several vehicles in stock that were available
for immediate sale. The vast majority of Tesla buyers, however, preferred to customize their
vehicle by placing an order via the Internet, frequently while in a sales gallery.
In the United States, there was a lurking threat to Tesla’s strategy to bypass distributing
through franchised Tesla dealers and sell directly to consumers. Going back many years,
franchised automobile dealers in the United States had feared that automotive manufacturers
might one day decide to integrate forward into selling and servicing the vehicles they
produced. To foreclose any attempts by manufacturers to compete directly against their
franchised dealers, automobile dealers in every state in the United States had formed statewide
franchised dealer associations to lobby for legislation blocking motor vehicle manufacturers
from becoming retailers of new and used cars and providing maintenance and repair services
to vehicle owners. Legislation either forbidding or severely restricting the ability of
automakers to sell vehicles directly to the public had been passed in 48 states; these laws had
been in effect for many years, and franchised dealer associations were diligent in pushing for
strict enforcement of these laws.
As sales of the Model S rose briskly from 2013 to 2015 and Tesla continued opening more
sales galleries and service centers, both franchised dealers and statewide dealer associations
became increasingly anxious about “the Tesla problem” and what actions to take to block
Tesla’s sell-direct strategy. Dealers and dealer trade associations in a number of states were
openly vocal about their concerns and actively began lobbying state legislatures to consider
either enforcement actions against Tesla or amendments to existing legislation that would
bring a halt to Tesla’s efforts to sell vehicles at company-owned showrooms. A host of
skirmishes ensued in 12 states. In several cases, settlements were reached that allowed Tesla to
open a select few sales locations, but the numbers were capped. In states where manufacturer-
direct sales to consumers were expressly prohibited, Tesla was allowed to have sales galleries,
service centers, and Supercharger locations—but was prevented from using its sales galleries
to take orders, conduct test drives, deliver cars, or discuss pricing with potential buyers.
Buyers in these states could place an order via the Internet, specify when they would like the
car to arrive, and then either have it delivered to a nearby Tesla service center for pickup or
have it delivered directly to their home or business location.
Tesla Announces Sales Gallery Closures and a Shift to Online Sales. In February 2019,
Tesla unexpectedly announced it was closing most of its sales galleries in malls and shopping
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centers and would begin to sell its cars only online. The shift was made partly to reduce
employee headcount and operating expenses and partly to relax lobbying efforts in states that
did not permit manufacturers to own and operate their own dealerships. As part of the shift,
new owners were granted up to a week to return their newly-purchased Tesla vehicle if they
were not satisfied. In the same announcement, Tesla said it would be shifting resources to
improve its repair service systems, with the goal of providing same-day service to Tesla
owners. However, auto dealers in several states, along with the National Automobile Dealers
Association, remained dissatisfied with Tesla’s online sales approach, noting that franchise
laws in some states required dealers to have a physical presence in their state to sell online and
that one of the main purposes of local franchising and licensing laws was promote investment
in an extensive network of independent, neighborhood new-car dealers.
Tesla expected that dealer associations in some states would continue to challenge the
company’s efforts to sell directly to customers and to own and operate its own retail and
service locations, and Tesla management intended to actively fight such efforts. To sell
vehicles to residents of states where the company could not be licensed as a dealer, Tesla made
arrangements to conduct the transfer of title out of the state. In these states it also opened
“galleries” that served the purpose of educating prospective buyers about Tesla products and
how to obtain them (but such galleries did not take any orders for vehicles or perform any title
transfer services).
Tesla Service Centers and Mobile Service Technicians. Tesla Roadster owners could
upload data from their vehicle and send it to a service center on a memory card; all other Tesla
owners had an on-board system that could communicate directly with a service center,
allowing service technicians to diagnose and remedy many problems before ever looking at
the vehicle. When maintenance or service was required, a customer could schedule service by
contacting a Tesla service center or, in a growing number of locations, use the
Tesla mobile app to make arrangements to have service performed at their home,
office, or other remote location by a Tesla Mobile Service technician who had the capability to
perform a variety of services that did not require a vehicle lift. Some service locations offered
valet service, where the owner’s car was picked up, replaced with a well-equipped loaner car,
and then returned when the service was completed—there was no additional charge for valet
service. Mobile service technicians could perform most warranty repairs, but the cost of their
visit was not covered under the New Vehicle Limited Warranty. Mobile service pricing was
based on a per visit, per vehicle basis; there was a $100 minimum charge per visit. Tesla’s
mobile service fleet consisted of 743 vehicles at year-end 2019, with coverage of all of North
America. In early 2018, the company reported its mobile service fleet in North America was
completing 30 percent of all service jobs at a cost below the average fees charged at its service
centers.
Prepaid Maintenance Program. Initially, Tesla recommended that Model S, Model X, and
Model 3 owners have an inspection every 12 months or 12,500 miles, whichever came first.
Owners could purchase plans covering prepaid maintenance for three years or four years; these
involved simply prepaying for service inspections at a discounted rate. All Tesla vehicles were
protected by a 4-year or 50,000-mile (whichever came first) New Vehicle Limited Warranty,
subject to separate limited warranties for the supplemental restraint system, battery and drive
unit, and body rust perforation. For the battery and drive unit on new Model S and Model X
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vehicles, Tesla offered an eight-year, 150,000-mile limited warranty, with minimum 70 percent
retention of battery capacity over the warranty period. For the battery and drive unit on new
Model 3 and Model Y vehicles, Tesla offered an eight-year or 120,000-mile limited warranty
for models with a Long Range or Performance battery, with minimum 70 percent retention of
battery capacity over the warranty period.
In March 2019, after a fleetwide review of maintenance and repair records, Tesla decided to
do away with its recommendations for scheduled annual maintenance for its vehicles because
they were able to withstand longer-than-usual periods of time without regular maintenance
when compared with traditional gasoline-powered vehicles. Effective immediately, Tesla
ceased selling extended three- and four-year prepaid maintenance plans and began
recommending that owners bring their vehicles to a service center only when a specific
component needed service. Owners who had already purchased extended three- and four-year
service plans could request a refund of the remaining length of the plan. However, Tesla
continued to recommend service intervals for certain components of its vehicles:
Tire Rotation, Balance, and Wheel Alignment: 10,000–12,000 miles.
Brake Fluid Test/Flush: 2 years.
Cabin Air Filter: 2 years.
High-Efficiency Particulate Air (HEPA) Filter: 3 years (if equipped).
Air Conditioning Service: 2 years (Model S), 4 years (Model X), 6 years (Model 3).
Winter Care: Annually or every 12,500 miles for cars in cold weather climates.
Tesla’s Supercharger Network: Providing Recharging Services to Owners on
Long-Distance Trips.
A major component of Tesla’s strategy to build rapidly-growing long-term demand for its
vehicles was to make battery recharging while driving long distances convenient and worry-
free for all Tesla vehicle owners. Tesla’s solution to providing owners with ample and
convenient recharging opportunities was to establish an extensive geographic network of
recharging stations. Tesla’s Supercharger stations were strategically placed along major
highways connecting city centers, usually at locations with such nearby amenities as roadside
diners, cafes, and shopping centers that enabled owners to have a brief rest stop or get a quick
meal during the recharging process—about 90 percent of Model S and Model X buyers opted
to have their vehicle equipped with supercharging capability when they ordered their vehicle.
All Model S and Model X owners were entitled to free supercharging service at any of Tesla’s
Supercharging stations; Model 3 owners had to pay a recharging fee. In March 2018, Tesla
announced price increases for its Supercharging stations to about $0.25 per kWh. Tesla owners
charged their vehicles at home more than 90 percent of the time and used Supercharger
stations mainly for trips or when they needed extra range. A 50 percent recharge took 20
minutes, an 80 percent recharge took 40 minutes, and a 100 percent recharge took 75 minutes.
As of year-end 2019, Tesla had a total of 1,821 Supercharger stations globally;
most Tesla stations had between 6 and 30 charging spaces, but newer stations in
high-traffic corridors had as many as 50 spaces, a customer lounge, and a café.
Tesla executives did not expect Supercharger stations to ever become a profit center for the
company; rather, they believed that the benefits of rapidly growing the size of the company’s
Supercharger network came from (1) relieving the “range anxiety” electric vehicle owners
suffered when driving on a long-distance trip and (2) reducing the inconvenience to travelers
of having to deviate from the shortest direct route and detour to the closest Supercharger
station for needed recharging.
Technology and Product Development Strategy.
Heading into 2020, Tesla had spent $6.9 billion on R&D activities to design, develop, test, and
refine the components and systems needed to produce top quality electric vehicles and, further,
to design and develop prototypes of the Tesla Roadster, Model S, Model X, Model 3, Model Y,
Cybertruck, and Tesla Semi vehicles. Tesla executives believed its R&D activities had
produced core competencies in battery and powertrain engineering and manufacturing. The
company’s core intellectual property was contained in its work on developing self-driving
technologies and capabilities and in its electric powertrain technology (the battery pack, power
electronics, induction motor, gearbox, and control software) that enabled these key
components to operate as a system. Tesla personnel had designed each of these major elements
for the Tesla Roadster and Model S; much of this technology had been used in the powertrain
systems that Tesla previously had built for other vehicle manufacturers (mainly Toyota and
Mercedes) and that had been further improved and refined in the powertrain systems being
used in the Model X, Model 3, Model Y, and the prototypes for the Cybertruck and Tesla
Semi.
The powertrain used in Tesla vehicles in 2020 was a compact, modular system with far
fewer moving parts than the powertrains of traditional gasoline-powered vehicles, a feature
that enabled Tesla to implement powertrain enhancements and improvements as fast as they
could be identified, designed, and tested. Tesla had incorporated its latest powertrain
technology into its current models and was planning to use much of this technology in
producing forthcoming electric vehicles. All models included several powertrain variants
along with the latest advances in mobile computing, sensing, displays, and connectivity.
Although Tesla had more than 500 patents and pending patent applications domestically and
internationally in a broad range of areas, in 2014, Tesla announced a patent policy whereby it
irrevocably pledged the company would not initiate a lawsuit against any party for infringing
Tesla’s patents through activity relating to electric vehicles or related equipment so long as the
party was acting in good faith. Elon Musk said the company made this pledge in order to
encourage the advancement of a common, rapidly evolving platform for electric vehicles,
thereby benefiting itself, other companies making electric vehicles, and the world. Investor
reaction to this announcement was largely negative on grounds that it would negate any
technology-based competitive advantage over rival manufacturers of electric vehicles.
Battery Pack. In February 2014, Tesla announced that it and various partners, principally
Panasonic—Tesla’s supplier of lithium-ion batteries since 2010—would invest $4 to 5 billion
through 2020 in a “gigafactory” capable of producing enough lithium-ion batteries to make
battery packs for 500,000 vehicles. Tesla expected the new plant (named the Tesla
Gigafactory, later changed to Gigafactory 1) to reduce the company’s battery pack cost by
more than 30 percent—battery packs were the most expensive component in the company’s
electric vehicles.
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Tesla opted to locate Gigafactory 1 on a site in an industrial park east of Reno, Nevada,
partly because the state of Nevada offered Tesla a lucrative incentive package said to be worth
$1.25 billion over 20 years and partly because the only commercially active lithium mining
operation in the United States was in a nearby Nevada county (this county was reputed to have
the fifth largest deposit of lithium in the world). Construction began immediately. The facility
was built in phases. In 2019, Tesla announced it would continue expanding Gigafactory 1 over
the next few years so that its battery-making capacity would significantly exceed the volume
needed for 500,000 vehicles per year when construction first started. Tesla had already added
space at Gigafactory 1 to enable the manufacture of Tesla Energy’s primary energy storage
products (Powerwall, Powerpack, and Megapack) and the manufacture of Model 3 and Model
Y drive units.
During 2015–2017, Tesla, in close collaboration with Panasonic, discovered
ways to build an improved lithium-ion battery that would be larger, safer, and require fewer
individual batteries per battery pack. The new battery was being used in the Model 3 and
Model Y vehicles produced at the Fremont factory in California. However, in August 2019,
Tesla agreed to purchase lithium-ion batteries from LG Chem, a South Korean firm with a
battery-making plant in China about 200 miles from Shanghai, that would be used to
manufacture the battery packs for the Model 3 and Model Y vehicles produced at the new
Shanghai plant—LG Chem was the world’s second-largest manufacturer of lithium-ion battery
cells. Earlier in 2019 Tesla acquired Maxwell Technologies, a maker of ultracapacitors—
energy storage devices that could charge and discharge rapidly, perform at a wide range of
temperatures, had high power density, and long operational life; Maxwell’s dry electrode
technology could be applied to batteries of varying chemistries and offered the advantages of
higher battery performance at a lower cost.
Going forward, Tesla believed it had the capabilities to quickly incorporate the latest
advancements in battery technology and continue to optimize battery pack system
performance and cost for its current and future vehicles. It already had proprietary technology
and expertise in optimizing the design of the lithium-ion cells used in its battery packs and in
achieving high energy density in its battery packs at progressively lower cost, while also
maintaining safety, reliability, and long life. In addition, its proprietary technological know-
how included capabilities relating to systems for high density energy storage, cooling, charge
balancing, structural durability, and electronics management. Tesla had pioneered and then
continuously refined its advanced manufacturing techniques to produce large quantities of
high-quality battery packs at progressively lower cost per unit. Plus, it had extensive testing
and R&D capabilities for battery cells, packs, and systems, along with an expansive body of
knowledge on lithium-ion cell chemistry types, their performance characteristics, and lithium-
ion cell vendors.
Power Electronics. The power electronics in Tesla’s powertrain system had two primary
functions—the control of torque generation in the electric motor while driving and the control
of energy delivery back into the battery pack while charging. The first function was
accomplished through the drive inverter, which converted direct current from the battery pack
into alternating current to power the electric motors, provide acceleration, and enhance the
overall driving performance of the vehicle. The second function was to capture kinetic energy
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from the wheels being in motion but being slowed down by applying the brakes and reverse
the flow of energy to help recharge the battery pack—a technology called “regenerative
braking.” (When brakes are applied in gasoline-powered vehicles, the brake pads clamp down
on the wheels to slow the vehicle (letting the kinetic energy escape as heat); but in electric
vehicles (and most hybrid vehicles), the regenerative braking systems slow the vehicle by
reversing the flow of electricity to the electric motors powering the wheels, while also
capturing the heat from the kinetic energy to generate electrical energy for partially recharging
the battery pack.) When the electric vehicle was parked, battery recharging was accomplished
by the vehicle’s charger, which converted alternating current (usually from a wall outlet or
other electricity source) into direct current which could be accepted by the battery. The
primary technological advantages to Tesla’s proprietary power electronics designs included the
ability to drive large amounts of electrical current into a small physical package with high
efficiency and low cost, and to recharge on a wide variety of electricity sources at home, at the
office or on the road, including at Tesla’s network of Supercharger stations.
As of March 2020, all of Tesla’s models utilized an all-wheel drive powertrain with two
electric motors: one mounted on the front axle and one on the rear axle. Tesla’s powertrain
design digitally and independently controlled torque to the front and rear wheels, which
resulted in the vehicle having a low center of gravity and enabled near-instantaneous response
of the motors to the driver’s placing more or less pressure on the accelerator. These design
features produced greater traction control and gave drivers more control of the vehicle’s
performance. Tesla engineers were engaged in developing a three-motor powertrain that would
provide further increases in performance.
Control and Infotainment Software. The battery pack and the performance and safety
systems of Tesla vehicles required the use of numerous microprocessors and sophisticated
software. For example, computer-driven software monitored the charge state of each of the
cells of the battery pack and managed all of the safety systems. The flow of
electricity between the battery pack and the motor had to be tightly controlled in
order to deliver the best possible performance and driving experience. There were software
algorithms that enabled the vehicle to mimic the “creep” feeling that drivers expected from an
internal combustion engine vehicle without having to apply pressure on the accelerator. Other
algorithms were used to control traction, vehicle stability, acceleration, regenerative braking,
and the interior climate. Drivers used the vehicle’s information and control systems to
optimize performance, customize vehicle behavior, manage charging modes and times, and
control all infotainment functions. Almost all of the software programs had been developed
and written by Tesla personnel.
Starting in 2014, Tesla began devoting progressively larger fractions of its programming
resources and expertise to developing and enhancing its software for vehicle autopilot
functionality, including such features as auto-steering, traffic-aware cruise control, automated
lane changing, automated parking, driver warning systems, automated braking, object
detection, a Smart Summons feature that enabled vehicles to be remotely summoned over
short distances in parking lots and driveways, and fully-automated self-driving. In October
2016, Tesla began equipping all models with hardware needed for full self-driving capability,
including cameras that provided 360-degree visibility, updated ultrasonic sensors for object
detection, a forward-facing radar with enhanced processing, and a powerful onboard computer.
page C-231
Wireless software updates periodically sent to the microprocessors on board each Tesla
owner’s vehicle, together with field data feedback loops from the onboard camera, radar,
ultrasonic sensors, and GPS, enabled the autopilot system in Tesla vehicles to continually learn
and improve its performance. In 2019, Elon Musk said he expected Tesla’s autopilot software
to be able to handle all modes of driving within two years.
Vehicle Design and Engineering. Tesla had devoted considerable effort to creating
significant in-house capabilities related to designing and engineering portions of its vehicles,
and it had become knowledgeable about the design and engineering of those parts,
components, and systems that it purchased from suppliers. Tesla personnel had designed and
engineered the body, chassis, and interior of its current models. As a matter of necessity, Tesla
was forced to redesign the heating, cooling, and ventilation system for its electric vehicles to
operate without the energy generated from an internal combustion engine and to integrate with
its own battery-powered thermal management system. In addition, the low-voltage electric
system that powered the radio, power windows, and heated seats had to be designed
specifically for use in an electric vehicle. Tesla had developed expertise in integrating these
components with the high-voltage power source in its vehicles and in designing components
that significantly reduced their load on the vehicle’s battery pack, so as to maximize the
available driving range. All Tesla vehicles incorporated the latest advances in mobile
computing, sensing, displays, and connectivity.
Tesla personnel had accumulated considerable expertise in lightweight materials, since an
electric vehicle’s driving range was heavily impacted by the vehicle’s weight and mass. The
Tesla Roadster had been built with an in-house designed carbon fiber body to provide a good
balance of strength and mass. The Model S and Model X had a lightweight aluminum body
and a chassis that incorporated a variety of materials and production methods to help optimize
vehicle weight, strength, safety, and performance. Weight reduction was an important factor in
the design of the Model 3 and Model Y. In addition, top management believed that the
company’s design and engineering team had core competencies in computer-aided design and
crash test simulations; this expertise had reduced the development time of new models. Tesla
was continuing to strengthen its capabilities for on-site crash-testing, durability testing, and
validation of components from suppliers.
Manufacturing Strategy.
Tesla had contracted with Lotus Cars, Ltd. to produce Tesla Roadster “gliders” (a complete
vehicle minus the electric powertrain) at a Lotus factory in Hethel, England. The Tesla gliders
were then shipped to a Tesla facility in Menlo Park, California, where the battery pack,
induction motors, and other powertrain components were installed as part of the final
assembly process. The production of Roadster gliders ceased in January 2012.
In May 2010, Tesla purchased the major portion of a recently closed automobile plant in
Fremont, California, for $42 million; months later, Tesla purchased some of the plant’s
equipment for $17 million.
The facility—formerly a General Motors manufacturing plant (1960–
1982), then operated as a joint venture between General Motors and Toyota (1984–
2010)—was closed in 2010. Tesla executives viewed the facility as one of the
largest, most advanced, and cleanest automotive production plants in the world. The
5.3 million square feet of manufacturing and office space was deemed sufficient for
Tesla to produce about 500,000 vehicles annually (approximately 1 percent of the
total worldwide car production), thus giving Tesla room to grow its output of
electric vehicles to 500,000 or more vehicles annually. The Fremont plant’s location
in the northern section of Silicon Valley facilitated hiring talented engineers already
residing nearby and because the short distance between Fremont and Tesla’s Palo
Alto headquarters ensured “a tight feedback loop between vehicle engineering,
manufacturing, and other divisions within the company.”26 Tesla officially took
possession of the 370-acre site in October 2010, renamed it the Tesla Factory, and
immediately launched efforts to get a portion of the massive facility ready to begin
manufacturing components and assembling the Model S in 2012.
In late 2015, Tesla completed construction of a new high-volume paint shop and a new body
shop line capable of turning out 3,500 Model S and Model X bodies per week (enough for
175,000 vehicles annually). In 2016 and 2017, Tesla made significant additional investments
at the Tesla Factory, including a new body shop with space and equipment for Model 3 final
assembly. Tesla expected the Fremont facility, together with a neighboring 500,000-square-
foot building that Tesla had leased, would be expanded to 10 million square feet in the coming
years.
In December 2012, Tesla opened a new 60,000-square-foot facility in Tilburg, Netherlands,
about 50 miles from the port of Rotterdam, to serve as the final assembly and distribution
point for all Tesla vehicles sold in Europe and Scandinavia. The facility, called the Tilburg
Assembly Plant, received nearly complete vehicles shipped from the Tesla Factory, performed
certain final assembly activities, conducted final vehicle testing, and handled the delivery to
customers across Europe. It also functioned as Tesla’s European service and parts
headquarters. Tilburg’s central location and its excellent rail and highway network to all major
markets on the European continent allowed Tesla to distribute to anywhere across the
continent in about 12 hours. The Tilburg operation had been expanded to over 200,000 square
feet in order to accommodate a parts distribution warehouse for service centers throughout
Europe, a center for remanufacturing work, and a customer service center. A nearby facility in
Amsterdam provided corporate oversight for European sales, service, and administrative
functions.
Tesla’s manufacturing strategy was to source a number of parts and components from
outside suppliers but to design, develop, and manufacture in-house those key components
where it had considerable intellectual property and core competencies (namely lithium-ion
battery packs, electric motors, gearboxes, and other powertrain components) and to perform all
assembly-related activities itself. In 2018–2020, the Tesla Factory contained several
production-related activities, including stamping, machining, casting, plastics molding, drive
unit production for the Model S and Model X, robotics-assisted body assembly, paint
operations, final vehicle assembly, and end-of-line quality testing. In addition, the Tesla
Factory manufactured lithium-ion battery packs, electric motors, gearboxes, and certain other
components for its Model S and Model X vehicles. While some major vehicle component
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systems were purchased from suppliers, there was a high level of vertical integration in the
manufacturing processes at the Tesla Factory in 2018–2019. From 2016 to 2019, efforts to
expand production capacity at the Tesla Factory were ongoing, partly to accommodate
production of the Model S and Model X but mainly to enable high volume production of the
Model 3 and Model Y.
In 2014, Tesla began producing and machining various aluminum components at a 431,000-
square-foot facility in Lathrop, California; an aluminum castings operation was added in 2016.
Aluminum parts and components were used extensively to help reduce the weight of Tesla
vehicles.
Tesla had encountered a number of unexpected quality problems in the first two to three
months of manufacturing the Model X. Getting the complicated hinges on the falcon-wing
doors to function properly proved to be particularly troublesome. Customers who received the
first wave of Model X deliveries also reported problems with the front doors and windows and
with the 17-inch dashboard touchscreen freezing (a major problem because so many functions
were controlled from this screen). Most of these problems were largely resolved by mid-2016,
although Model X owners rated the reliability of their vehicles significantly
lower than Model S owners—the chief culprit was the falcon-wing doors, which
reportedly had generated significant warranty claims and warranty costs. Weekly production
volumes of the Model X rose steadily in the second half of 2016.
Musk believed Tesla had learned valuable manufacturing lessons that could be applied in
ramping up the production volume of the Model 3 at the Fremont plant. These lessons had
driven refinements in the production and assembly lines for the Model S, Model X, and Model
3 at the Fremont plant and had been incorporated into designing and equipping the new
Shanghai Gigafactory that began construction in early 2019 and production in early 2020. The
first-generation production line for the Model 3 in Shanghai was Tesla’s first step in building a
manufacturing platform that could be replicated quickly and cost efficiently across all vehicle
types and in different geographic locations. Design and construction of a second production
line in Shanghai were already underway to add Model Y manufacturing capacity, and
expectations were that the second production line would be at least 50 percent cheaper per unit
of capacity than the current Model 3-related assembly lines in Fremont.27 Major gains in
production efficiency and approximately 50 percent lower unit costs for the Model 3 were
expected when production of the Model 3 ramped up in the new production facility in
Shanghai where Tesla was installing a much-simplified production process and increasing use
of robot-assisted assembly. Production costs for Model Y vehicles at the Shanghai Gigafactory
were expected to be even lower than those for Model 3.
Supply Chain Strategy.
Tesla’s various models used thousands of parts and components sourced from hundreds of
suppliers across the world. Certain components purchased from these suppliers were either
identical or very similar across the company’s growing number of models, which opened
opportunities for volume-based price reductions and related cost-saving efficiencies. Tesla
worked to qualify multiple suppliers for each such component where it was sensible to do so,
in order to reduce the bargaining power of any one supplier and to minimize production risks
associated with being dependent on a single supply source. In many cases, however,
components and systems were sourced from single suppliers. In such cases, the company
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mitigated single-source supply risk by maintaining safety stocks for key parts and assemblies
and die banks for components with lengthy procurement lead times. But in some instances
(like lithium-ion battery cells, battery packs, and drive trains), the company opted to produce
needed parts and components internally.
Tesla’s products also required purchasing such raw materials as steel, aluminum, cobalt,
lithium, nickel, and copper. Pricing for these materials was governed by market supply and
demand conditions, and sometimes by the activities of speculators—factors outside of the
company’s control. Management believed that, while the company was vulnerable to periodic
spikes in the prices of particular raw materials, it nonetheless had sufficiently adequate access
to supplies of raw materials to meet the needs of its operations.
Marketing Strategy.
From 2014 through year-end 2019, Tesla’s principal marketing goals and functions were to:
Work with interested buyers as needed either in sales galleries or online to arrange for a test
drive, view existing inventories at nearby sites, or place an order for a custom-equipped
vehicle.
Build long-term brand awareness and manage the company’s image and reputation.
Develop and nurture brand loyalty among existing owners of Tesla vehicles and help
generate customer referrals.
Obtain feedback from the owners of Tesla vehicles and make sure their experiences and
suggestions for improvement were communicated to Tesla personnel engaged in designing,
developing, and/or improving the company’s current and future vehicles.
As the first company to commercially produce a federally-compliant, fully electric vehicle
that achieved market-leading range on a single charge, Tesla had been able to generate
significant media coverage of the company and its vehicles. Management expected this would
continue for some time to come. So far, the extensive media coverage, largely favorable
reviews in motor vehicle publications and Consumer Reports, praise from owners of Tesla
vehicles and admiring car enthusiasts (which enlarged Tesla’s sales force at zero cost), and the
decisions of many green-minded affluent individuals to help lead the movement away from
gasoline-powered vehicles had all combined to drive good traffic flows at Tesla’s sales
galleries and create a flow of online orders and pre-production reservations. As a
consequence, starting in 2012 and continuing into early 2020, Tesla had
achieved a growing volume of sales without traditional advertising and at relatively low
marketing costs. Nonetheless, Tesla did make use of pay-per-click advertisements on websites
and mobile applications relevant to its target clientele. It also displayed and demonstrated its
vehicles at such widely attended public events as the Detroit, Los Angeles, and Frankfurt auto
shows.
Tesla’s Leasing Activities.
Tesla, in partnership with various financial institutions, began leasing vehicles to customers in
2014; the number and percentage of customers opting to lease Model S vehicles increased
substantially in 2015. By year-end 2015, Tesla was not only offering loans and leases in North
America, Europe, and Asia through its various partner financial institutions, but it was also
offering loans and leases directly through its own captive finance subsidiaries in certain areas
of the United States, Germany, Canada, and Great Britain.
Some of Tesla’s financing programs outside of North America in 2015–2017 provided
customers with a resale value guarantee under which those customers had the option of selling
their vehicle back to Tesla at a preset future date, generally at the end of the term of the
applicable loan or financing program, for a pre-determined resale value. In certain markets,
Tesla also offered vehicle buyback guarantees to financial institutions that could obligate Tesla
to repurchase the vehicles for a predetermined price. These programs, when first introduced in
2015 and 2016 had been widely publicized and attracted numerous buyers, but Tesla
determined in late 2016 and 2017 to back away from these offers in most countries because
they were proving unprofitable, had unattractive accounting requirements, and exposed Tesla
to the risk that the vehicles’ resale value could be lower than its estimates and also to the risk
that the volume of vehicles sold back to Tesla at the guaranteed resale price might be higher
than the company’s estimates—such risks had to be accounted for by establishing a contingent
liability (in the current liabilities section of the balance sheet) deemed sufficient to cover these
risks.
Sales of Regulatory Credits to Other Automotive Manufacturers.
Because Tesla’s electric vehicles had no tailpipe emissions of greenhouse gases or other
pollutants, Tesla earned zero-emission vehicle (ZEV) and greenhouse gas (GHG) credits on
each vehicle sold in the United States. Moreover, it also earned corporate average fuel
economy (CAFE) credits on its sales of vehicles because of their high equivalent miles per
gallon ratings. All three of these types of regulatory credits had significant market value
because the manufacturers of traditional gasoline-powered vehicles were subject to assorted
emission and mileage requirements set by the U.S. Environmental Protection Agency (EPA)
and by certain state agencies charged with protecting the environment within their borders;
automotive manufacturers whose vehicle sales did not meet prevailing emission and mileage
requirements were allowed to achieve compliance by purchasing credits earned by other
automotive manufacturers. Tesla had entered into contracts for the sale of ZEV and GHG
credits with several automotive manufacturers, and it also routinely sold its CAFE credits.
Tesla’s sales of ZEV, GHG, and CAFE credits produced revenues of $594 million in 2019,
$419 million in 2018, $360 million in 2017, $302 million in 2016, and $169 million in 2015.
In Exhibit 2, these amounts were included on Tesla’s income statement in the revenue category
labeled “Automotive sales;” without these revenues, as frequently noted by Wall Street
analysts, Tesla’s losses in 2015 through 2019 would have been significantly higher.
Tesla and the COVID-19 Pandemic.
Tesla’s deliveries of its Model 3 and Model Y vehicles in both Q1 and Q2 of 2020 were below
expectations at the beginning of 2020, partly because of closure of its Gigafactory 2 in
Shanghai for 2 weeks in Q1 (January 30 to February 10) that was mandated by the Chinese
government as part of its campaign to limit the spread of the COVID-19 virus and partly
because of California-mandated closure of the Fremont plant starting March 24 that extended
until May 13, 2020, at which time limited production was allowed, provided California and
Alameda County health and safety measures were strictly observed (Tesla’s observance of
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these measures was periodically checked by Alameda County police). Tesla also experienced
scaled-back battery production at its battery Gigafactory in Nevada for almost 50 percent of
Q1 and then production was suspended entirely for two weeks starting March 26, which was
then extended until May 4, 2020, as part of governmental efforts to contain the spread of the
coronavirus. In June 2020, limited production at the Fremont plant and Nevada Gigafactory
was resuming but the wearing of masks and social distancing were required of
production workers.
Tesla Energy in 2020
In 2015, Tesla formed Tesla Energy, a new subsidiary that would begin producing and selling
two energy storage products in 2016—Powerwall for homeowners and Powerpack for
industrial, commercial, and utility customers. Powerwall was a lithium-ion battery charged
either by electricity generated from a home’s solar panels or from power company sources
when electric rates were low. Powerwall home batteries could also be used as a backup power
source in case of unexpected power outages. Powerpack models were rechargeable lithium-ion
batteries that industrial, commercial, and utility enterprises could use for energy storage or
backup power.
Production and deliveries of second-generation Powerwall 2 and Powerpack 2 began in late
2016. Both products had the capability to receive over-the-air firmware and software updates
that enabled additional features. In 2018–2020, these two energy storage products were being
used for backup power, independence from utility grids, peak demand reduction, generating
power to cover periods when solar and/or wind generating sources were unavailable, and
supplying wholesale electricity to select customers.
When Solar Energy was merged into Tesla, the company arranged to lease a facility, called
Gigafactory 2, in Buffalo, New York, to produce (1) solar energy systems sold to residential
and commercial customers and (2) its freshly-developed Solar Roof, which used aesthetically
pleasing and durable glass roofing tiles designed to complement the architecture of homes and
commercial buildings, to turn sunlight into electricity. A third-generation Solar Roof was
introduced in 2019 that was marketed directly to residential customers and through an
assortment of distribution partners. Installation capabilities had been enhanced by training
both company personnel and the installers of third-party partners. To facilitate the growth of
its solar roof business, Tesla Energy had developed proprietary software to reduce solar energy
system design and installation timelines and costs and had also designed the new generation of
the Solar Roof to work seamlessly with its Powerwall product.
Tesla Energy’s solar energy systems included solar panels that convert sunlight into
electrical current, inverters that convert the electrical output from the panels to a usable current
compatible with the electric grid, racking that attaches the solar panels to the roof or ground,
electrical hardware that connect the solar energy system to the electric grid, and a monitoring
device. The majority of the components were purchased from vendors; the company
maintained multiple sources for each major component to ensure competitive pricing and
adequate supplies.
Tesla Energy had an in-house engineering team that designed its energy storage products
and solar roof systems. Whenever feasible, the engineering team utilized component-level
technologies developed for its electric vehicles (particularly high-density energy storage,
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cooling, safety, charge balancing, structural durability, and electronics management) to
enhance the capabilities and features of its energy storage and solar roof products. While a
majority of the components in the division’s energy storage and solar roof products were
obtained from multiple outside sources, some solar roof components were designed and
manufactured at the Gigafactory in New York.
In the United States, Tesla Energy sold its solar and energy storage products through its
website and sales galleries as well as through its national sales organization, channel partner
network, and customer referral program. Outside the United States, Tesla Energy used its
international sales organization and a network of channel partners to market and sell
Powerwall 2 to residential customers; some Powerwall 2 units were sold directly to utilities,
who then installed the product in customer homes. Powerpack and Megapack systems were
sold to commercial and utility customers through its international sales organization.
In December 2017, Tesla completed installation of a 100-megawatt lithium-ion battery
hooked into the electricity grid in South Australia to relieve power shortages created by a
tornado in 2016. Elon Musk had promised that once the contract was signed, Tesla would
complete the project in 100 days or it would be furnished free of charge—Tesla completed the
installation in 60 days. According to Musk, the battery was three times more powerful than the
world’s next biggest battery. In late 2019 Tesla Energy began selling a Megapack product,
multiple units of which could be grouped together to form energy generating and energy
storage installations big enough to supply the needs of large industrial
customers, utilities, energy generation firms, communities, and large
neighborhoods. In 2019, Tesla Energy deployed more than 1.65 Gigawatt hours of energy
storage systems, an amount greater than in all previous years combined.
Tesla’s revenues from energy generation and storage products were $1.1 billion in 2017,
$1.6 billion in 2018, and $1.5 billion in 2019 (Exhibit 2), resulting in gross profits of $242
million in 2017, $190 million in 2018, and $190 million in 2019. Elon Musk was very
optimistic about the growth opportunities for Tesla Energy, but Tesla’s financial reporting did
not reveal whether Tesla Energy’s operations were generating positive or negative operating
profit margins.
The Electric Vehicle Segment of the Global Automotive Industry
Global sales of passenger cars and SUVs totaled 79.6 million units in 2017, 78.9 million units
in 2018, and 75 million units in 2019. Sales of other types of vehicles (light or pickup trucks,
heavy or cargo-carrying trucks, recreational vehicles, buses, and minibuses) totaled 26.9
million in 2019 versus 26.6 million in 2018. In 2019, global sales of plug-in electric vehicles
totaled 2.2 million units, up from 2.0 million in 2018. million—plug-in vehicles included both
battery-only vehicles and so-called plug-in hybrid electric vehicles equipped with a gasoline or
diesel engine for use when the vehicle’s battery pack (rechargeable only from an external plug-
in source) was depleted, usually after a distance of 20 to 50 miles. Hybrid vehicles were
jointly powered by an internal combustion engine and an electric motor that ran on batteries
charged by regenerative braking and the internal combustion engine; the batteries in a hybrid
vehicle could not be restored to a full charge by connecting a plug to an external power source.
Exhibit 3 shows the best-selling plug-in electric vehicles in the United States from 2013
through 2019. Exhibit 4 shows the world’s 20 largest manufacturers of electric vehicles in
page C-236
12,243 19,532 32,847 41,701 37,783 31,151
2019, along with the 20 best-selling models of electric vehicles in 2019. More electric vehicles
were manufactured in China than in any other country in the world, and China was
the world’s largest market for motor vehicles, with 2019 sales of 25.8 million units,
down from 28.8 million units in 2017 and 28.1 million units in 2018. Europe was the world’s
second largest market for electric vehicles.
EXHIBIT 3 Sales of Best-Selling Plug-in Electric Vehicles in the United
States, 2014–2019
Best-Selling
Models 2014 2015 2016 2017 2018 2019
Tesla Model
3* 1,764 139,782 158,925
Toyota Prius
PHV/Prime 13,264 4,191 2,474 20,963 27,595 23,630
Tesla Model
X* 214 18,223 21,315 26,100 19,225
Chevrolet
Bolt EV* 579 23,297 18,019 16,418
Tesla Model
S* 17,300 25,202 28,896 27,060 25,745 14,100
Nissan
Leaf* 30,200 17,269 14,006 11,230 14,715 12,365
Honda Clarity
PHEV 18,602 10,728
Ford Fusion
Energi 11,550 9,750 15,938 9,632 8,074 7,524
BMW 530e 3,772 8,664 5,862
Chrysler
Pacifica
Hybrid
4,597 7,062 5,723
Audi e-
tron* 5,369
Chevrolet
Volt 18,805 15,393 24,739 20,349 18,306 4,910
Volkswagen
e-Golf* 3,937 3,534 1,354 4,863
BMW i3* 6,092 11,024 7,625 6,276 6,117 4,854
Kia Nero
PHEV 3,389 3,881
All Others
United States
Total 123,049 116,099 158,614 199,826 361,307 329,528
Worldwide 320,713 550,297 777,497 1,227,117 2,018,247 2,209,831
*Battery-operated.
Source: Inside EVs, “Monthly Plug-in Sales Scorecard,” www.insideevs.com (accessed March 5, 2018, June 4,
2019, and March 19, 2020).
EXHIBIT 4 Global Electric Vehicle Sales of Top 20 Manufacturers of
Electric Vehicles and Top 20 Best-Selling Models of Electric Vehicles, 2019
Rank LeadingManufacturers 2019 Unit Sales
Best-Selling Vehicle
Models 2019 Unit Sales
1 Tesla 367,820 Tesla Model 3 300,075
2 BYD (China) 229,506 BAIC EU-Series 111,047
3 BAIC (China) 160,251 Nissan Leaf 69,873
4 SAIC (China) 137,666 BYD Yuan/52 EV 67,839
5 BMW (Germany) 128,883 SAIC Baojun E-Series 60,050
6 Volkswagen(Germany) 84,199 BMW 530e/Le 51,083
7 Nissan (Japan) 80,545 MitsubishiOutlander PHEV 49,649
8 Geely (China) 75,869 Renault Zoe 46,839
9 Hyundai (SouthKorea) 72,959 Hyundai Kona EV 44,386
10 Toyota (Japan) 55,155 BMW i3 41,837
11 Kia (SouthKorea) 53,477 Tesla Model X 39,497
12 Mitsubishi(Japan) 52,145 Chery eQ EV 39,401
13 Renault (France) 50,609 Toyota PriusPHEV 38,201
14 Chery (China) 48,395 Volkswagen e-Golf 36,016
15 GAC (China) 46,695 BYD Tang PHEV 34,084
16 Volvo (Sweden) 45,933 GAC Aion S 32,126
17 Great Wall(China) 41,627
SAIC Roewe EIS
EV 30,550
18 Dongfeng(China) 39,861 BYD e5 29,311
19
Chang’an
Automobile
(China)
38,793 Geely EmgrandEV 28,958
20 JAC (China) 34,494 Tesla Model S 28,248
All others 732,769 All others 1,030,761
Source: Mark Kane, “Global EV Sales for 2019,” www.insideevs.com, February 2, 2020 (accessed March 19,
2020).
http://www.insideevs.com/
http://www.insideevs.com/
page C-237
There was no question in 2020 and beyond that Tesla was faced with intensifying
competition in the global marketplace for electric-powered vehicles. Virtually every motor
vehicle manufacturer in the world was introducing new battery-powered electric vehicles,
most with driving ranges of 200 miles or more. In 2018 and 2019, models with 200+ mile
driving ranges had been introduced by Audi, Jaguar, Mercedes, Kia, Volvo, General Motors,
and Hyundai. Fresh models from Porsche, Aston Martin, Nissan, Audi, Volkswagen, BMW,
General Motors, and Ford came on the market in 2020. Sales of a second-generation Nissan
Leaf with a driving range of up to 150 miles began in January 2018. At year-end 2018, there
were 43 models of electric powered vehicles being sold in the United States, with annual sales
totaling just over 361,000 units. However, in the United States 2019 sales of electric vehicles
dropped nearly 9 percent to 329,500 vehicles as many new vehicle buyers opted for well-
equipped SUVs and pickup trucks.
In 2018 Volkswagen announced plans to equip 16 factories to produce electric vehicles by
the end of 2022, compared with three currently, and to build as many as 3 million electric cars
per year by 2025. In December 2017, Toyota said by around 2025, every Toyota and Lexus
model sold around the world would be available either as a dedicated electrified model or have
an electrified option. Additionally, Toyota expected to have annual sales of more than 5.5
million electrified vehicles by 2030 (including more than 1 million zero-emission vehicles
totally powered by either batteries or fuel cells) and to halt all production of gasoline-powered
vehicles by 2040. In 2018, the government of Germany launched a campaign to
put one million electric cars on its roads by 2020 and to have 40 percent electric
cars on its roads by 2035.
Hydrogen Fuel Cells: An Alternative to Electric Batteries.
Many of the world’s major automotive manufacturers, while actively working on next-
generation battery-powered electric vehicles, were nonetheless hedging their bets by also
pursuing the development of hydrogen fuel cells as an alternative means of powering future
vehicles. Toyota was considered the leader in developing hydrogen fuel cells and was sharing
some of its fuel-cell technology patents for free with other automotive companies in an effort
to spur whether there was merit in installing fuel cells and building out a hydrogen charging
network. Audi, Honda, Toyota, Mercedes-Benz, and Hyundai had recently introduced first-
generation models powered by hydrogen fuel cells.28
Hydrogen fuel cells could be refueled with hydrogen in three to five minutes. California and
several states in the northeastern United States already had a number of hydrogen refueling
stations. Existing gasoline stations could add hydrogen refueling capability at a cost of about
$1.5 million. A full tank of hydrogen provided vehicles with a driving range of about 310
miles. While battery-powered vehicles were currently cheaper than fuel-cell powered vehicles,
experts expected that cheaper materials, more efficient fuel cells, and scale economies would
in upcoming years enable producers of fuel-cell vehicles to match the prices of battery-
powered electric vehicles.
ENDNOTES
1 John Reed, “Elon Musk’s Groundbreaking Electric Car,” FT Magazine, July 24, 2009, www.ft.com (accessed September 26, 2013).
http://www.ft.com/
2 Tesla press release, and Michael Arrington, “Tesla Worth More Than Half a Billion After Daimler Investment,” May 19, 2009,
www.techcrunch.com (accessed September 30, 2013).
3 Josh Friedman, “Entrepreneur Tries His Midas Touch in Space,” Los Angeles Times, April 23, 2003, www.latimes.com (accessed on September
16, 2013).
4 David Kestenbaum, “Making a Mark with Rockets and Roadsters,” National Public Radio, August 9, 2007, www.npr.org (accessed on September
17, 2013).
5 Ibid.
6 Ibid.
7 Video interview with Alan Murray, “Elon Musk: I’ll Put a Man on Mars in 10 Years,” Market Watch (New York: The Wall Street Journal), December
1, 2011 (accessed on September 16, 2013).
8 Mike Seemuth, “From the Corner Office—Elon Musk,” Success, April 10, 2011, www.success.com (accessed September 25, 2013).
9 Ibid.
10 Ibid.
11 Sergei Klebnikov, “As Tesla Stock Skyrockets, Elon Musk Looks Set For $346 Million Payday,” posted at www.forbes.com, January 14, 2020
(accessed May 13, 2020).
12 Jeff Evanson, Tesla Motors Investor Presentation, September 14, 2013, www.teslamotors.com (accessed November 29, 2013).
13 Tesla Second Quarter 2017 Shareholder Letter, August 2, 2017.
14 Tesla Third Quarter 2017 Shareholder Letter, November 1, 2017.
15 Tesla Fourth Quarter 2017 Shareholder Letter, February 7, 2018.
16 Company press release, April 3, 2018.
17 As reported in Autoweek, “Tesla Has to Turn Potential into Real Profits,” May 5, 2017, www.autoweek.com (accessed March 7, 2018).
18 Tesla First Quarter 2018 Shareholder Letter, May 2, 2018.
19 Tesla Q1 2018 Results—Earnings Call Transcript, May 2, 2018, www.seekingalpha.com, (accessed May 9, 2018).
20 Company 2019 10-K Report, p. 1.
21 According to information in Martin Eberhard’s blog titled “Lotus Position,” July 25, 2006, www.teslamotors.com/blog/lotus-position (accessed
September 17, 2013).
22 2013 10-K Report, p. 4.
23 Company documents.
24 Tesla First Quarter 2018 Shareholder Letter, May 2, 2018.
25 Fred Lambert, “Tesla pickup truck to cost less than $50,000, ‘be better than F150’, says Elon Musk,” posted June 2, 2019 at
https://electrek.co/2019/06/02/tesla-pickup-truck-price-f150-elon-musk/ (accessed June 5, 2019).
26 Company press release May 20, 2010.
27 Tesla First Quarter 2019 Shareholder Letter, April 23, 2019.
28 George Ghanem, “Avoid Tesla Because Hydrogen Is the New Electric,” March 6, 2016, www.seekingalpha.com (accessed March 7, 2016).
http://www.techcrunch.com/
http://www.latimes.com/
http://www.npr.org/
http://www.success.com/
http://www.forbes.com/
http://www.teslamotors.com/
http://www.autoweek.com/
http://www.seekingalpha.com/
http://www.teslamotors.com/blog/lotus-position
Tesla Pickup truck to cost less than $50,000, ‘be better than F150’, says Elon Musk
http://www.seekingalpha.com/
page C-238
CASE 17
Unilever’s Purpose-led Brand Strategy: Can Alan
Jope Balance Purpose and Profits?
©2020, IBS Center for Management Research. All rights reserved.
Syeda Maseeha Qumer
ICFAI Business School Hyderabad
Debapratim Purkayastha
ICFAI Business School Hyderabad
In June 2019, six months after taking over as CEO of global FMCG giant Unilever, Alan Jope (Jope) warned that
as part of its sustainability agenda, the company would dispose of brands that lacked a clear social or
environmental purpose within a certain time frame. Unilever was undergoing seismic changes amid an increasing
demand for brands to put purpose ahead of profit, he said, and added that in future, every brand in the company’s
portfolio would be purpose driven. Despite being profitable, Unilever’s popular brands Marmite, Magnum, and Pot
Noodle were left vulnerable to a cull, which potentially hurt the company’s bottom line. “Principles are only
principles if they cost you something,”1 Jope said.
Jope’s predecessor, Paul Polman (Polman), had transformed Unilever into an environmentally conscious and
ethical organization that delivered strong financial growth. Under his leadership, Unilever launched the Unilever
Sustainable Living Plan (USLP) in 2010 that aimed to halve the environmental impact of its products across the
value chain by 2030 and to enhance the livelihood of millions of people by 2020. In 2018, Unilever’s Sustainable
Living Brands, that had a strong social or environmental purpose, grew 69 percent faster than the rest of the
business and delivered 75 percent of the company’s growth. After a decade as Unilever’s CEO, Polman stepped
down from his role in January 2019.
In succeeding Polman, Jope had big shoes to fill. He faced the tough task of building upon Polman’s
sustainability legacy while maintaining profits and boosting growth. Moreover, slowing sales growth, growing
competition, the threat of direct-to-consumer brands, economic and political uncertainties in certain markets, and
investor concerns over sustainability targets were huge challenges that he faced. With the 2020 target dates of the
USLP fast approaching, analysts wondered whether Jope would be able to fulfill the targets or whether he would
succumb to investors’ demand for short-term profits being put ahead of purpose.
As Jope reiterated Unilever’s commitment to a future focused on purpose, analysts wondered whether such an
approach would work in an era of cost-cutting. How could Jope strike a balance between purpose and profits?
What could he do to boost business growth through purpose-led brands while discontinuing certain other brands?
In the words of Melissa Hoffmann, Content Director for PR News, “If Jope follows through on his threat to oust
brands that don’t have a strong purpose and mission beyond selling their products, it will set a new bar for other
brands. But two questions remain: Will other brands follow this example? And in the end, will consumers demand
it?”2
BACKGROUND NOTE
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Unilever was created in 1930 through the merger of British based soapmaker Lever Brothers Ltd. and Margarine
Unie, a Dutch company. In the subsequent decades, Unilever expanded and diversified into various businesses
through innovation and acquisitions, setting up advertising agencies, market research companies, and
packaging businesses. In the early 1980s, Unilever changed its strategy and started focusing on core product areas
in strong markets with a high growth potential. The new business strategy required large acquisitions and equally
large divestments, including the sale of the animal feeds, packaging, transport, and fish farming businesses. The
1990s saw a period of restructuring and consolidation, as the number of categories in which Unilever competed
went down from over 50 to just 13 by the end of the decade. This included the decision to sell or withdraw many
brands and concentrate on those with the biggest potential.
The 2000s were a period of great transformation for Unilever. In February 2000, the company announced a five-
year restructuring plan called the ‘Path to Growth’ Strategy which involved changes with respect to organizational
structure, brand restructuring, operational processes, and supply chain management practices. At its core was the
slimming down of Unilever’s portfolio from about 1,600 brands to just 400. The initiative proved to be beneficial
for the company in terms of the increase in its turnover and improvement in share price. In fiscal 2001, Unilever’s
profits rose 34 percent to €3.7 billion and sales were up 11 percent to €53.5 billion. In 2004, Unilever became a
founding member of the industry-led initiative, Roundtable on Sustainable Palm Oil.
In September 2008, Unilever appointed Polman, who was then executive vice president and zone director for the
Americas at Nestlé, as its CEO. He succeeded Patrick Cescau (Cescau) and was the first outsider to lead the
company since it was founded. Under Polman, Unilever eliminated quarterly reports and invested in early stage
companies. In 2012, Unilever’s turnover exceeded €50 billion.
By 2018, Unilever’s products were being sold in over 190 countries across the globe and used by 2.5 billion
consumers every day. Its business was divided into three segments: Beauty & Personal Care, Home Care, and
Foods & Refreshment. In 2018, Unilever’s revenue was €50.98 billion and the company had 12 brands with a
turnover of over €1 billion (See Exhibit 1 and Exhibit 2). Unilever’s mission was to make sustainable living
commonplace with the focus on three core principles: “Brands with Purpose Grow,” “Companies with Purpose
Last,” and “People with Purpose Thrive.”
EXHIBIT 1 Selected Financial Data for Unilever, 2016–2018
2018 2017 2016
Turnover growth (5.1%) 1.9% (1.0%)
Underlying sales growth* 2.9%^ 3.1%^ 3.7%
Underlying volume
growth* 1.9% 0.8% 0.9%
Operating margin 24.6% 16.5% 14.8%
Underlying operating
margin* 18.4% 17.5% 16.4%
Free cash flow* €5.0 billion €5.4 billion €4.8 billion
Divisions:
Beauty & Personal Care
Turnover €20.6 billion €20.7 billion €20.2 billion
Turnover growth (0.3%) 2.6% 0.5%
Underlying sales growth 3.1%^ 2.9%^ 4.2%
Operating margin 20.0% 19.8% 18.4%
Underlying operating
margin 21.9% 21.1% 20.0%
Foods & Refreshment
Turnover €20.2 billion €22.4 billion €22.5 billion
Turnover growth (9.9%) (0.4%) (2.2%)
Underlying sales growth 2.0%^ 2.7%^ 2.7%
Operating margin 35.8% 16.1% 14.0%
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2018 2017 2016
Underlying operating
margin 17.5% 16.7% 15.6%
Home Care
Turnover €10.1 billion €10.6 billion €10.0 billion
Turnover growth (4.2%) 5.6% (1.5%)
Underlying sales growth 4.2%^ 4.4%^ 4.9%
Operating margin 11.5% 10.8% 9.5%
Underlying operating
margin 13.0% 12.2% 10.9%
*Key Financial Indicators.
^Wherever referenced in this document, 2018 underlying sales growth does not include price growth in Venezuela for the whole of 2018
and in Argentina from July 2018. 2017 underlying sales growth does not include Q4 price growth in Venezuela. See pages 23 and 24 on
non-GAAP measures for more details.
The Group has revised its operating segments to align with the new structure under which the business is managed. Beginning 2018,
operating segment information is provided based on three product areas: Beauty & Personal Care, Foods & Refreshment and Home Care.
Source: www.unilever.com/Images/unilever-annual-report-and-accounts-2018_tcm244-534881_en
While Unilever’s largest international competitors were Nestlé and Procter & Gamble, it faced competition in
local markets or specific product segments from numerous companies.
EMBEDDING SUSTAINABILITY
When Polman was appointed CEO, Unilever’s fiscal growth was at risk due to the global economic recession.
Polman continued with the turnaround process initiated by his predecessor Cescau in 2005, which included
overhauling Unilever’s management structure, cutting costs, and merging its two big divisions, food and consumer
products, to allow them to share marketing expertise and distribution networks. Polman’s vision was to make
Unilever a “truly purpose-driven company.” He made sustainability the core of the company’s corporate strategy,
embedding it in every stage of the value chain. As part of a bold makeover, Polmon scrapped the CSR department,
instructing Unilever’s 169,000 employees to instead embed the company’s extensive social commitments into their
business targets. He began acquiring brands known for their ecological credence such as Seventh Generation and
Tazo tea.
Toward the end of 2009, Polmon announced Unilever’s new vision, “the Compass” strategy, which aimed to
double the size of the business by 2020 while reducing the environmental impact by half. To support this strategy,
he launched USLP in 2010, an initiative with three key goals: to help more than 1 billion people improve their
health and well-being by 2020, to halve the environmental impact of its products across the value chain by 2030,
and to enhance the livelihoods of millions of people across its supply chain by 2020. The plan covered all its
brands and the 180 countries in which it operated, as well as its total supply chain, including the impact on its
consumers. Polman understood that it would take years for the USLP to show concrete results, and that some of its
targets could run counter to growth. So he scrapped the quarterly earnings guidance for investors in favor of a
long-term vision of sustainable growth. In 2010, Unilever generated revenue of €44.2 billion, compared to €39.8
billion in 2010.
At the outset of the plan’s adoption, Unilever assessed its brands and reviewed its factories to reduce waste and
water and energy use. It collaborated with government entities, NGOs, and consumers to achieve its core purpose
of improving the health and well-being of over a billion people. The company focused on sourcing
100 percent of its agricultural raw materials such as palm oil, paper and board, soy, tea, vegetables,
cocoa, and sugar from sustainable sources. By 2012, Unilever was sourcing more than a third of its agricultural
raw materials sustainably and more than 50 percent of its factories had achieved the goal of sending no waste to
landfills.
The USLP created sustainable growth through the development of Sustainable Living Brands–brands which had
a sustainable purpose and contributed to one or more of the USLP goals. Purpose took many forms among the
Unilever brands. For instance, Beauty & Personal Care brand Dove’s3 campaigns focused on driving body
confidence and improving women’s self-esteem. Lifebuoy’s mission was to improve the hygiene behavior of about
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page C-242
1 billion people around the world by 2020. This could prevent 600,000 child deaths annually from respiratory
infections and diarrheal disease. Home Care brand Domestos was working to help 25 million people gain
improved access to toilets by 2020 in partnership with UNICEF and social enterprise, eKutir. While Cif (Home
Care) launched “Cif Cleans” purpose campaigns to encourage local communities to make use of their public
communal areas, restore beauty to public spaces, and improve individual and community well-being. Some of the
Unilever brands even took an activist stance, mobilizing citizens to change policy or create social movements. For
instance, ice cream brand Ben & Jerry’s campaigned for social justice and climate change while Rin’s (Home
Care) Career Academy worked with women across rural India through mentoring and careers fairs. Omo/Persil
(Home Care) supported Outdoor Classroom Day, an initiative championed in more than 50 countries to get
children all over the world, on the same day, to learn and play outdoors for at least one lesson during the school
day.
EXHIBIT 2 Turnover by Product and Geographical Area for Unilever, 2009–2018 (€
amounts in millions)
2009 2010 2011 2012 2013 2014 2015 201
Turnover (€
million) €39,823 €44,262 €46,467 €51,324 €49,797 €48,436 €53,272 €52,713
By product area as
% of total
turnover(a)
Beauty & Personal
Care 30 31 33 35 36 37 38 38
Food &
Refreshment 53 51 49 47 46 44 43 43
Home Care 17 18 18 18 18 19 19 19
Total 100 100 100 100 100 100 100 100
Underlying sales
growth (%) 3.5% 4.1% 6.5% 6.9% 4.3% 2.9% 4.1% 3.7
Underlying volume
growth (%) 2.3% 5.8% 1.6% 3.4% 2.5% 1.0% 2.1% 0.9
Underlying price
growth (%) 1.2% (1.6)% 4.8% 3.3% 1.8% 1.9% 1.9% 2.8
By geographical
area as % of total
turnover
Asia/AMET/RUB(b) 35% 38% 38% 40% 40% 41% 42% 42
The Americas 32% 33% 33% 33% 33% 32% 33% 33
Europe 33% 29% 29% 27% 27% 27% 25% 25
Total 100% 100% 100% 100% 100% 100% 100% 100
Figures are presented on the basis of continuing operations as at 31 December 2018.
(a) The Group has revised its operating segments to align with the new structure under which the business is managed. Beginning 2018,
operating segment information is provided based on three product areas: Beauty & Personal Care, Foods & Refreshment and Home Care.
(b) Refers to Asia, Africa, Middle East, Turkey, Russia, Ukraine and Belarus.
Unilever Turnover (2009–2018).
Source: www.unilever.com/Images/unilever-charts-2018_tcm244-534891_en
Brands such as Wall’s (part of Unilever’s Heartbrand family of ice creams), PG Tips, and Lipton
(tea brands) contributed toward reducing their environmental footprint. To help tackle climate change and reduce
GHG from refrigeration, Wall’s installed freezer cabinets used climate-friendly (hydrocarbon) refrigerants while
PG Tips introduced fully biodegradable tea bags that used a new plant-based material that improved its
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environmental impact without affecting flavor. Lipton committed to sustainably sourcing 100 percent of its tea
from Rainforest Alliance certified tea farms by 2020. Also, Food brand Knorr sourced 100 percent of raw
agricultural materials sustainably and aimed to help more than 1 billion people improve their health and well-being
by teaching them how to cook nutritiously by 2020 while popular mayonnaise brand, Hellmann’s, committed to
sourcing ingredients from sustainable sources by 2020, including 100 percent sustainably sourced oils and 100
percent cage free eggs.
By 2012, Unilever’s initiatives to reduce disease by handwashing with soap, provide safe drinking water,
promote oral health, and improve young people’s self-esteem had reached 224 million people. By 2015, Unilever
had 12 Sustainable Living Brands which contributed to nearly half of its growth and grew 30 percent faster than
the rest of the business. In September 2016, Unilever launched a global sustainability campaign called the ‘Bright
Future’ to highlight the social change achieved by its brands. By 2016, Unilever had helped around 482 million
people to improve their health and hygiene. The company had also reached a new industry-leading achievement of
sending zero non-hazardous waste to landfill across more than 600 sites in 70 countries. In 2016, Unilever’s
purpose-led brands grew 40 percent faster than the rest and delivered more than 60 percent of the company’s
growth, as the company generated a turnover of €52.7 billion. “There is no doubt that the Unilever Sustainable
Living Plan is making us more competitive by helping us to build our brands and spur innovation, strengthen our
supply chain and reduce our risks, lower our costs, and build trust in our business. It is helping Unilever to serve
society and our many consumers, and in doing so, create value for shareholders,”4 said Polman.
Much like Polman, Unilever’s CMO, Keith Weed (Weed), had been integral to company’s focus on purposeful
brands and he played a key role in developing the USLP. Under his guidance, Unilever launched the Unstereotype
Alliance in June 2017 in partnership with UN Women, a UN entity which works for the empowerment of females,
to eliminate stereotypical representations of gender in all advertising and brand-led content.
The strategy adopted by Polman helped bolster Unilever’s reputation globally. In 2018, for the 17th consecutive
year, Unilever was named the leader in the Personal Products industry in the Dow Jones Sustainability Index. As
of 2018, out of 400 Unilever brands, 28 were driving the company’s purpose-driven strategy at a growth rate of 69
percent and adding 75 percent to the total business. These brands accounted for more than half of the group’s €51
billion sales in 2018. The company’s top seven brands with the highest turnover–Dove, Knorr, Persil/Omo,
Rexona, Lipton, Hellmann’s, and Wall’s–were among the Sustainable Living Brands line-up. According to Weed,
“I am most proud that we have grown the sales line and profit every single year in the nine years I’ve been doing
this role. We’ve done this while also building a more sustainable business and one with sustainability at its core.
We have been able to build the business case for sustainability. A lot of people challenge if you can do both and
what we’ve shown at Unilever is yes, you can.”5
During his tenure, Polman delivered a total shareholder return of 290 percent, expanded the company’s presence
in emerging markets, and blocked a £115 billion takeover attempt by rival Kraft Heinz in 2017. However,
Polman’s emphasis on sustainability made him a polarizing figure at times. While some analysts lauded his efforts
to promote responsible business, others were irked by his preachy style on issues such as sustainable living.
Though shareholder returns were impressive during his tenure, some investors were of the view that the purpose-
led approach to running the business was at their expense. “A minority of investors I speak to give
two hoots about Unilever’s Sustainable Living Plan. People indulged Unilever on USLP in the early
years when the reporting numbers were going well. Now they want to hear more muscular language about earnings
and returns,”6 said Martin Deboo, an analyst at financial services company Jefferies.
TAKING OVER THE REINS
Polman stepped down as CEO in December 2018. The move came after he was forced to scrap a plan to move the
company’s headquarters from London to Rotterdam, following an investor revolt. Unilever had been operating
with dual headquarters–one in London (Unilever PLC) and the other in Rotterdam (Unilever NV). In March 2018,
Polman announced a plan to create a single structure for the company in the Netherlands. According to some
industry observers, a failed hostile bid by Kraft Heinz played a key role in Unilever’s decision to have a single
headquarters in the Netherlands, as the country had stronger rules to protect companies against takeovers.
However, most of the shareholders were not supportive of the plan as it could have ended Unilever’s listing on
the London Stock Exchange, forcing them to sell their holdings. Polmon scrapped the plan in October 2018, but
the investor revolt was viewed as a significant blow to him and to Unilever’s chairman Marijn Dekkers.
page C-244
Jope, who was then Unilever’s President of Beauty and Personal Care, succeeded Polman on January 1, 2019.
Jope had joined Unilever in the UK in 1985. Thereafter, he managed the company’s business in North Asia and
served as the President for Russia, Africa, and the Middle East. Jope served as President of Unilever’s Personal
Care business from 2014 and continued as President when the name of the division changed in 2018 to Beauty &
Personal Care.
Following Polman’s exit, Weed too announced his retirement from the company in December 2018 after
spending close to four decades with the group. Weed’s successor was yet to be announced, but according to some
reports Unilever could scrap the CMO role and instead assign responsibility for the marketing functions to
marketing heads within each of its three business categories.
PURPOSE BEYOND PROFIT
Jope continued with his predecessor’s mission to grow the business in a purposeful and sustainable way. Outlining
his vision for the company in June 2019, Jope announced that Unilever would discontinue brands that had failed to
articulate a clear social or environmental purpose despite being profitable. He added that brands without a purpose
would have no long-term future in Unilever and might be sold off and warned that popular brands such as
Marmite, Magnum ice creams, and Pot Noodles, could face the axe. Unilever’s Foods & Refreshment Business
generated a turnover of €20.2 billion, accounting for 40 percent of Unilever’s turnover and 58 percent of the
operating profit in 2018. Magnum itself was one of the top selling ice cream brands in the world with a turnover of
over €1 billion annually. Both Marmite and Pot Noodle had annual global sales in hundreds of millions of euros.
He said, going forward, even the company’s acquisition strategies would target brands with purpose in high-
growth spaces. Jope said, “Brands with purpose grow, companies with purpose last, and people with purpose
thrive. We’re proving that link and it will be our narrative for some time.”7
Jope said that in future, every brand in Unilever’s portfolio would play an active part in social change and put
sustainability at the heart of all its activities. He planned to refocus the company’s marketing strategy to align with
that thought process. Speaking at the Cannes Lions Festival 2019, Jope said that Unilever would scrutinize
marketing efforts for “woke washing” as it was polluting purpose. Besides, some brands were driving fake
purpose, which could lead to consumer distrust in the advertising and marketing industry. According to him,
staying relevant and aligning each brand with a specific purpose would resonate with customers, supercharge
growth, and boost profits. “More and more of our brands will become explicit about the positive social and
environmental impact they have. This is entirely aligned to the instincts of our people and to the expectations of
our consumers. It is not about putting purpose ahead of profits, it is purpose that drives profits,”8 said Jope. In
2018, Unilever’s Sustainable Living Brands grew 69 percent faster than the rest of the business, compared to 46
percent in 2017.
Jope ordered the company’s executives to assign a clear, specific mission to each brand. Unilever in association
with brand consultancy Kantar undertook the service of measuring consumer perceptions around how its brands
were achieving their purpose-driven goals. Those not living up to the company’s expectations were likely to be
disposed of. In order to measure the performance of its purpose-led brands and the impact they had,
Unilever released a checklist which looked at how much investment had to go into communicating
the brands’ purpose and the action to be taken on the ground. Admitting that this was not an easy task, Jope said he
would give brands some time to identify their purpose, should they be lacking one, and how they could take
meaningful action. “There won’t be a set deadline to achieve it; it’ll be a gradual process. But I would imagine in a
few years’ time we will look at our portfolio and the dramatic majority of our brands will be competing with a
clear view on what little good they can do for society or the planet,”9 he added.
While Jope was committed to Unilever’s brands pursuing fairness and social justice, some critics felt that the
idea was risky as it would hurt the bottom line of the company. They were also worried about the future of the
brands that were likely to be culled. According to Graham Hall, Co-Founder/Director of Strategy of ad agency
Saturn, Jope should also make sure that these brands did not end up with an owner that did not care about
sustainability. “Maybe instead he should just kill the ‘bad’ brands in his portfolio and retire them to the great brand
graveyard in the sky? I can’t see that happening as his shareholders will want him to get maximum profit from the
sale of valuable brand assets,”10 he said.
CHALLENGES AHEAD
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As of September 2019, Jope faced a series of challenges including the threat posed by direct-to-consumer brands,
rise of discount chains, increasing costs due to tariffs, growing competition, currency volatility and political
uncertainty in some global markets, and questions over sustainable business. Moreover, regional players with
innovative business models in emerging markets were finding favor with consumers. The growth in the global
FMCG sector remained stagnant as consumers were trading down on their FMCG spends either by buying less or
choosing private labels. The FMCG market globally grew by an anemic 1.9 percent in 2017, and there were little
signs of improvement in the near future.
With the 2020 target dates of the USLP approaching, some analysts were skeptical about Unilever’s ability to
achieve the targets while maintaining profits and boosting growth—see Exhibit 3. One of the most pressing tasks
for Jope would be to get shareholders on his side, especially after Unilever’s botched attempt to move its
headquarters had strained relations with them. Jope was also under pressure from the company’s shareholders over
slowing sales growth. Unilever’s sales had slowed more than expected in the first half of 2019 with an underlying
sales growth of just 2.5 percent, driven almost entirely by volume, as shown in Exhibit 4. For the first half of 2019,
Unilever’s underlying sales grew by a meager 3.3 percent compared to the corresponding period of the previous
year led by its emerging market business, which grew by 6.2 percent. Exhibit 5 indicates turnover decreased by 0.9
percent to €26.1 billion. Some investors blamed Unilever’s heavy focus on sustainability for its growth being
affected. “While [Jope] certainly has the requisite skill set to do the job, the big challenge will be to generate more
growth and rebuild trust with shareholders. Shareholders will want him to focus on being CEO of Unilever rather
than being visible on the world stage as his predecessor was,”11 commented Samuel Johar, Chairman of Buchanan
Harvey & Co., a board advisory firm.
Jope retained the three-year plan laid out by Polman in 2017, which included targets for improving operating
margins to 20 percent by 2020, while delivering three percent to five percent sales growth. Some investors felt that
Jope was treading a fine line as he retained the operating margin target set by Polman that could put Unilever’s
brand investment under pressure while at the same time talking about discontinuing some profitable brands.
Another task for Jope would be the successful activation of purpose-led brands as aligning stakeholder behavior
and decision making around these brands would be more challenging. Also, getting people to engage more on
sustainability and persuading consumers to change to more sustainable behaviors would be a Herculean task as
only a small number of consumers were motivated to make purchase decisions based on that alone. Moreover, with
consumer activism on the rise it was no longer enough for the company’s brands to claim that they were
sustainable. Though Jope was committed to the strategy, there remained the risk of some brands falling short of the
desired sustainable standards. This could damage Unilever’s reputation and business results, opined some analysts.
In the 2018 GlobeScan-Sustainability Leaders Survey12, though Unilever continued to be the global leader on
sustainability for the eighth year in a row, its 2019 ranking was down 10 points compared to 2018, and the gap
with other top companies on the list had narrowed—see Exhibit 6.
EXHIBIT 3 Unilever Sustainable Living Plan Targets, 2016–2018
Target 2018 2017 2016
Improving Health & Well-being
Goal: By 2020 we will help more than a billion people take action to
improve their health and well-being
Health & Hygiene
Target: By 2020 we will help more than a billion people to improve their
health and hygiene. This will help reduce the incidence of life-threatening
diseases like diarrhoea
1 billion 653million
601
million
538
million
Nutrition
Target: By 2020 we will double (i.e., up to 60%) the proportion of our
portfolio that meets the highest nutritional standards, based on globally
recognized dietary guidelines. This will help hundreds of millions of
people to achieve a healthier diet
60% 48% 39% 35%
Reducing Environmental Impact
Goal: By 2030 our goal is to halve the environmental footprint of the
making and use of our products as we grow our business
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246
Target 2018 2017 2016
Greenhouse Gases
Target: Halve the greenhouse gas impact of our products across the
lifecycle (from the sourcing of the raw materials to the greenhouse gas
emissions linked to people using our products) by 2030 (greenhouse gas
impact per consumer use).
(50%) 6% 9% 8%
Target: By 2020 CO2 emissions from energy from our factories will be at
or below 2008 levels despite significantly higher volumes (reduction in
CO2 from energy per tonne of production since 2008).**
≤145.92 70.46 76.77 83.52
Water
Target: Halve the water associated with the consumer use of our products
by 2020 (water impact per consumer use).
(50%) (2%) (2%) (7%)
Target: By 2020 water abstraction by our global factory network will be at
or below 2008 levels despite significantly higher volumes (reduction in
water abstraction per tonne of production since 2008).**
≤2.97 1.67 1.80 1.85
Waste
Target: Halve the waste associated with the disposal of our products by
2020 (waste impact per consumer use)
(50%) (31%) (29%) (28%)
Target: By 2020 total waste sent for disposal will be at or below 2008
levels despite significantly higher volumes (reduction in total waste per
tonne of production since 2008).**
≤7.91 0.20 0.18 0.35
Sustainable Sourcing
Target: By 2020 we will source 100% of our agricultural raw materials
sustainably (% of tonnes purchased).
100% 56% 56% 51%
Enhancing Livelihoods
Goal: By 2020 we will enhance the livelihoods of millions of people as we
grow our business.
Fairness in the Workplace
Target: By 2020 we will advance human rights across our operations and
extended supply chain, by:
100% 61% 55% —
Sourcing 100% of procurement spend from suppliers meeting the
mandatory requirements of the Responsible Sourcing Policy (% of
spend of suppliers meeting the Policy)
Reducing workplace injuries and accidents (Total Recordable
Frequency Rate of workplace accidents per million hours worked)**
0.69 0.89 1.01
Opportunities for Women
Target: By 2020 we will empower 5 million women, by:
Promoting safety for women in communities where we operate.
Enhancing access to training and skills (number of women).
Expanding opportunities in our value chain (number of women)
5 million 1.85million
1.26
million
0.92
million
Building a gender-balanced organization with a focus on management
(% of managers that are women)**
50% 49% 47% 46%
Inclusive Business
Target: By 2020 we will have a positive impact on the lives of 5.5 million
people by:
Enabling small-scale retailers to access initiatives aiming to improve
their income (number of small-scale retailers)
5 million 1.73million
1.60
million
1.53
million
Enabling smallholder farmers to access initiatives aiming to improve
their agricultural practices
0.5
million
0.75
million
0.72
million
0.65
million
Baseline 2010 unless otherwise stated.
**Key Non-Financial Indicators.
() Brackets around numbers indicate a negative trend which, for environmental metrics, represents a reduction in impact.
page C-247
Source: www.unilever.com/Images/unilever-annual-report-and-accounts-2018_tcm244-534881_en
EXHIBIT 4 Unilever Underlying Sales Growth and Volume Growth, 2009–2018
Source: www.unilever.com/Images/unilever-charts-2018_tcm244-534891_en
Besides, Jope had to immediately focus on a major restructuring exercise to fuel growth as building brand
purpose would take time. In March 2019, Unilever announced changes to its leadership and organization as it
continued with its transformation into a faster, leaner, and more agile company. As shown in Exhibit
7, the company reported a net profit of €3.04 billion for the six months up to June 30, 2019, down
from €3.11 billion a year earlier. Jope warned that 2019 could be a tough year for Unilever in terms of sales growth
as market conditions remained challenging due to the overall slowdown in emerging markets such as Asia and
Latin America.
EXHIBIT 5 Operational Review for Unilever, Second Quarter 2019 and First Six Months
2019 (€ amounts in billions)
Second Quarter 2019 First Six Months 2019
Turnover
Underlying
Sales(a)
Growth
(USG)
Underlying
Volume
Growth
(UVG)
Underlying
Price
Growth
(UPG)(a)
Turnover USG (a) UVG UPG (a)
Change in
underlying
operating
margin (b)
Unilever €13.7 3.5% 1.2% 2.3% €26.1 3.3% 1.2% 2.1% 50
Divisions
Beauty & Personal
Care 5.5 3.5% 1.6% 1.9% 10.7 3.3% 1.7% 1.6% 100
Home Care 2.7 8.9% 4.5% 4.3% 5.4 7.4% 2.8% 4.5% 120
Foods &
Refreshment 5.5 1.0% (0.6)% 1.6% 10.0 1.3% (0.1)% 1.4% (40)
Geographical
Area
Asia/AMET/RUB 6.3 6.3% 2.5% 3.7% 12.2 6.2% 2.9% 3.2% 70
The Americas 4.2 3.7% 1.3% 2.3% 8.1 2.1% (0.1)% 2.2% 80
Europe 3.2 (1.6)% (1.1)% (0.5)% 5.8 (0.6)% (0.2)% (0.4)% (40)
(a) Wherever referenced in this announcement, USG and UPG do not include any price growth in Venezuela and Argentina.
(b) 2018 numbers have been restated following adoption of IFRS.
Source: https://www.unilever.com/Images/ir-q2-2019-full-announcement_tcm244-538712_en
http://www.unilever.com/Images/unilever-annual-report-and-accounts-2018_tcm244-534881_en
http://www.unilever.com/Images/unilever-charts-2018_tcm244-534891_en
https://www.unilever.com/Images/ir-q2-2019-full-announcement_tcm244-538712_en
page C-248
EXHIBIT 6 The 2018 GlobeScan/SustainAbility Leaders Survey: Companies Leading on
Integrating Sustainable Development (% of Experts, Total mentions, Unprompted, 2015–
2019)
2015 2016 2017 2018 2019*
Unilever 38 43 45 47 37
Patagonia 11 17 23 23 27
IKEA 5 10 8 9 13
Interface 8 10 11 10 9
Natura 5 6 7 4 8
*Additionally for 2019, Danone (7), Nestle (6), Marks & Spencer (5), Tesla (4) and BASF (3) make up the top 10.
Adapted from https://globescan.com/category/press-release/
With ‘Profit with Purpose’ set to become the new norm for Unilever and with Jope building further on this
commitment, he faced certain questions. Could he uphold Polman’s sustainability legacy and live up to the
expectations of the investors and the customers? What should he do with profitable brands that were not purpose-
led? Should he discontinue them? If so, how? Could a purpose beyond profit drive results and long-term value?
Could Jope’s commitment to purpose go far enough to bring about a fundamental change in the global FMCG
industry?
EXHIBIT 7 Consolidated Income Statements for Unilever, 2016-Fixt Six Months 2019
(In € million except per share data) First Six Months 2019 2018 2017 2016
Turnover €26,126 €50,982 €53,715 €52,713
Operating profit 4,589 12,535 8,857 7,801
After (charging)/crediting non-underlying
items (465) 3,176 (543) (823)
Net finance costs (351) (481) (877) (563)
Finance income 86 135 157 115
Finance costs (420) (591) (556) (584)
Pensions and similar obligations (17) (25) (96) (94)
Net finance cost of non-underlying items — — (382) —
Net Monetary gain arising from
Hyperinflationary economies 29 122 — —
Share of net profit/(loss) of joint ventures
and associates 85 185 155 127
After crediting non-underlying items 3 32 — —
Other income/(loss) from non-current
investments and associates 2 22 18 104
Profit before taxation 4,354 12,383 8,153 7,469
Taxation (1,145) (2,575) (1,667) (1,922)
After (charging)/crediting tax impact of non-
underlying items 89 (288) 655 213
Net profit 3,209 9,808 6,486 5,547
Attributable to:
Non-controlling interests 203 419 433 363
Shareholders’ equity 3,006 9,389 6,053 5,184
Combined earnings per share
Basic earnings per share €1.15 €3.50 €2.16 €1.83
Diluted earnings per share €1.14 €3.48 €2.15 €1.82
https://globescan.com/category/press-release/
Source: www.unilever.com/investor-relations/annual-report-and-accounts/#Download
ENDNOTES
1 Zoe Wood, “Unilever Warns it Will Sell off Brands that Hurt the Planet or Society,” www.theguardian.com, July 25, 2019.
2 Melissa Hoffmann, “Did Unilever’s New CEO Just Irrevocably Change Purpose Marketing?” www.prnewsonline.com, June 21, 2019.
3 The Dove Self-Esteem Project delivered self-esteem education to young people through lessons in schools, workshops for youth groups, and online resources for parents.
4 “Unilever’s Sustainable Living Brands Continue to Drive Higher Rates of Growth,” www.unilever.com, May 18, 2017.
5 Molly Fleming, “Keith Weed on His Biggest Success: We Proved the Business Case for Sustainability,” www.marketingweek.com, December 13, 2018.
6 Vivienne Walt, “Unilever CEO Paul Polman’s Plan to Save the World,” https://fortune.com, February 17, 2017.
7 “New Unilever CEO Jope Banks on Recovery in Sales Growth,” www.ft.com, June 11, 2019.
8 “Profit Through Purpose: Eight Years of Pioneering and Learning,” www.unilever.com, April 12, 2019.
9 Stephen Lepitak, “Unilever CEO Alan Jope: ‘We’ll Dispose of Brands that Don’t Stand for Something’,” www.thedrum.com, June 19, 2019.
10 Graham Hall, “Well Done Unilever, But Hang On. . .,” www.linkedin.com, August 1, 2019.
11 Leila Abboud, Attracta Mooney and Arash Massoudi, “Unilever Veteran Alan Jope Takes Helm at Critical Time,” www.ft.com, November 30, 2018.
12 It tracks opinions of over 800 sustainability experts in 78 countries on sustainable development leadership as well as stakeholders’ views on which companies are leaders in
integrating sustainability into their business strategy.
http://www.unilever.com/investor-relations/annual-report-and-accounts/#Download
http://www.theguardian.com/
http://www.prnewsonline.com/
http://www.unilever.com/
http://www.marketingweek.com/
https://fortune.com/
http://www.ft.com/
http://www.unilever.com/
http://www.thedrum.com/
http://www.linkedin.com/
http://www.ft.com/
O
page C-249
CASE 18
Domino’s Pizza: Business Continuity
Strategy during the Covid-19
Pandemic
©2020, IBS Center for Management Research. All rights reserved.
Debapratim Purkayastha
IBS Hyderabad
Hadiya Faheem
IBS Hyderabad
“I remain highly confident in our strategy and optimistic about the opportunity and potential of our business.
Our solid, resilient business model and strong financial position will continue to serve us well in these
challenging times.”1
—Ritch Allison, CEO, Domino’s Pizza, US, in March 2020
“The restaurant chain is a tech leader within the food services industry and weathering the COVID-19 crisis
well.”2
—Anne Burdakin, The Motley Fool, in March 2020
n March 31, 2020, American multinational pizza giant Domino’s Pizza, Inc.
(Domino’s) released preliminary sales results for the first quarter ended March 22,
2020—see Exhibit 1. It reported same-store sales growth of 1.6 percent for its U.S.
stores and 1.5 percent for its international stores.3 While most dine-in restaurants were
grappling with the impact of the novel COVID-194 pandemic on their sales, Domino’s
was one of the few companies which had not experienced a significant downturn. This
was attributed to its prowess in delivery and a new initiative—“çontactless” delivery at
all its U.S. as well as international stores. Commenting on the results, Ritch Allison
(Allison), CEO of Domino’s, United States, said, “Across the globe, Domino’s will
remain focused on execution, service and value as we continue to navigate through the
headwinds created by COVID-19. We are carefully managing our balance sheet, cash
flow and all areas of the business to ensure we are doing what we believe will help us
best manage through the near-term and, as always, position ourselves for long-term
success.”5
EXHIBIT 1 Domino’s Pizza Preliminary Estimated First Quarter 2020
Sales (Unaudited)
Period 1,
2020 (Dec 30,
2019 to Jan
26, 2020)
Period 2,
2020 (Jan 27,
2020 to Feb
23, 2020
Period 3,
2020 (Feb 24,
2020 to Mar
22, 2020)
First Quarter
of 2020
Same store sales growth: (versus
prior year)
U.S. Company-owned stores +4.0% +2.6% +5.0% +3.9%
U.S. franchise stores +3.6% +0.2% +0.8% +1.5%
U.S. stores +3.6% +0.3% +1.0% +1.6%
International stores (excluding
foreign currency impact) +2.3% +2.4% (0.2%) +1.5%
Global retail sales growth: (versus
prior year period)
U.S. stores +7.1% +3.6% +4.2% +4.9%
International stores +7.2% +5.6% (1.1%) +3.9%
Total +7.2% +4.6% +1.6% +4.4%
Global retail sales growth: (versus
prior year period, excluding foreign
currency impact)
U.S. stores +7.1% +3.6% +4.2% +4.9%
International stores +8.3% +8.0% +4.2% +6.8%
Total +7.7% +5.8% +4.2% +5.9%
Source: “Domino’s Pizza® Announces Business Update,” http://dominos.gcs-web.com, March 30,
2020.
The COVID-19 crisis started in December 2019 in Wuhan, China. With awareness
about the virus increasing, consumers had begun taking precautions to prevent
transmission of the disease. With no cure or established treatment for the infection in
sight, people in many countries were forced to stay indoors. While this affected many
industries, the restaurant industry was badly hit as they were no longer allowed to serve
dine-in customers. Worldwide, governments only allowed the food services industry to
fulfill takeout and delivery orders. Domino’s too was going through disruption with its
14 international markets closed and 23 international markets experiencing partial store
http://dominos.gcs-web.com/
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closures. This represented around 1,400 international stores, with key markets such as
France, Spain, New Zealand, and Panama accounting for nearly 900 of
these temporary store closures.6
Analysts felt that Domino’s was, however, better positioned to tackle the crisis as
delivery was not new to its business. Banking on its strong delivery infrastructure,
Domino’s launched contactless delivery in January 2020 whereby consumers could
choose the contactless delivery option while ordering food online. The delivery boy
would then leave the food outside the consumer’s home and wait at a distance to
ensure that the order was picked up. Analysts appreciated the contactless delivery
model as it was helping the pizza giant survive during the COVID-19 crisis. In fact, to
cater to the increasing demand from consumers, Domino’s was planning to hire 10,000
new workers in the United States.7 However, the company also faced criticism for
putting its employees at risk by expecting them to come to work at a time when most
people were being asked to stay indoors.
With this being early days of the pandemic, some critics opined that it could be a
tough road ahead for Domino’s as the company would have to grapple with the full
impact of the COVID-19 pandemic. Would it be able to come out successful from this
public health crisis? Going forward, how should it balance the need for providing its
service to customers with the need for keeping its employees and customers safe? How
should Allison and the senior management team at Domino’s ensure business
continuity amidst the pandemic?
BACKGROUND NOTE
The history of Domino’s Pizza (Domino’s) dates back to the late 1950s, when
Dominick DeVarti (DeVarti) started a small pizza store called DomiNick’s Pizza on the
Eastern Michigan University campus in Ypsilanti, Michigan. In 1960, two brothers
who were students of the University of Michigan, Thomas S Monaghan (Thomas) and
James S Monaghan (James), bought the store for US$900. In 1961, James sold his
share of the business to Thomas.
The pizza business did well and by 1965, Thomas was able to open
two more stores in the town—Pizza King and Pizza from the Prop. In 1966, DeVarti
opened a pizza store in a neighboring town with the same name, DomiNick’s Pizza.
Thomas therefore decided to change the name of his store to Domino’s Pizza
(Domino’s). The advantage of this name, Thomas felt, was that it would be listed after
DomiNick in the directory. Domino’s philosophy rested on two principles—a limited
menu and the delivery of fresh, hot pizzas within half an hour. In 1967, it opened the
first franchise store in Ypsilanti and, in 1968, a franchise store in Burlington, Vermont.
In 1982, Domino’s established Domino’s Pizza International (DPI) that helped in
opening Domino’s stores internationally. The first store was opened in Winnipeg,
Canada. In 1983, DPI spread to more than 50 countries and in the same year, that is, in
1983, it inaugurated its 1000th store. Around the same time, new pizza chains like
Pizza Hut and Little Caesar had appeared on the scene and begun to establish
themselves in the United States. Domino’s Pizza faced intense competition because its
menu of traditional hand-tossed pizza had remained unchanged over the years. The
other pizza chains, however, offered low-priced breadsticks, salads, and other fast food
apart from pizzas. In the home delivery segment too, Domino’s faced tough
competition from Pizza Hut, while Little Caesar was eating into Domino’s market
share with its innovative marketing strategies.
By 1989, Domino’s sales had fallen significantly, and its cash flows were affected
due to the acquisition of assets. In 1993, Thomas decided to expand the Domino’s
product line in an attempt to revive the company and tackle competition. The company
introduced pan pizza and breadsticks in the United States. In late 1993, it introduced
the Ultimate Deep Dish Pizza and Crunchy Thin Crust Pizza. In 1994, it rolled out
another non-pizza dish—Buffalo Wings. Though Domino’s did not experiment with its
menu for years, it had adopted innovative ways of managing a pizza store. Thomas
gave about 90 percent of the franchisee agreements in the United States to people who
had worked as drivers with Domino’s. The company gave ownership to qualified
people after they had successfully managed a pizza store for a year and had completed
a training course. Domino’s also gave franchises to candidates recommended by
existing franchisees. Outside the United States, most of Domino’s stores were
franchise-owned. Domino’s was also credited for many innovations in the pizza
industry and for setting standards for other pizza companies. It had developed dough
trays, corrugated pizza boxes, insulated bags for delivering pizzas, and conveyor
ovens.
In 1993, Domino’s withdrew the guarantee of delivering pizzas within 30 minutes of
ordering and started emphasizing Total Satisfaction Guarantee (TSG) which read, “If
for any reason, you are dissatisfied with your Domino’s Pizza dining experience, we
will re-make your pizza or refund your money.”
In 1996, Domino’s launched its website. In 1996, it also entered India through a
franchise agreement with Jubilant FoodWorks Ltd.,8 in Delhi. With the overwhelming
success of the first outlet, the company opened another outlet in Delhi. By 2000,
Domino’s had outlets in all the major cities in India.
In 1998, Domino’s introduced a patented pizza delivery bag that was designed to
keep pizzas oven hot until they were delivered to the customer.
In 2001, Domino’s opened its 7000th restaurant in Brooklyn, New York. In 2002, it
acquired 82 franchised restaurants in Phoenix, Arizona. This was the largest restaurant
acquisition in the company’s history.
In 2004, Domino’s was listed on the New York Stock Exchange and became a public
traded company.
page C-252
page C-253
In 2007, it became the first company in the Quick Service Restaurant9 industry to
offer ordering of pizzas through mobile phones. Customers could order from around
2,500 of Domino’s 5,128 stores in the United States on mobile-dominos.com.
Commenting on the launch, Rob Weisberg, Domino’s vice president of precision and
print marketing, said, “With so many people living life on-the-go, Domino’s mobile
ordering delivers even more convenience for our customers’ busy lifestyles. With the
addition of yet another order-taking channel, Domino’s is thrilled to lead the market
with this breakthrough technology that continues to change the way people think about
ordering pizza.”10
In 2008, Domino’s started an online application called Pizza Tracker, which enabled
consumers to track the delivery of their pizzas in real time.
In 2016, Domino’s in cooperation with California-based self-driving robotic delivery
vehicles company Starship Technologies began supplying pizzas through self-driving
robots in some of Dutch and German cities. The same year, Domino’s notched up
another first by delivering a pizza in New Zealand using an unmanned aerial vehicle
using DRU Drone by Reno, Nevada, U.S.-based drone delivery
company, Flirtey. Domino’s used the DRU Drone as a delivery method
and integrated the drone with online ordering and GPS systems. Commenting on the
initiative, Domino’s Group Australia CEO and Managing Director Don Meij said,
“Drones offer the promise of safer, faster deliveries to an expanded delivery area,
meaning more customers can expect to receive a freshly-made order within our
ultimate target of 10 minutes. This is the future.”11
In April 2018, Domino’s announced that it was adding 150,000 HotSpots to its
delivery locations, which would enable pizza to be delivered to customers in a beach,
park, museum, etc., without the need for a physical address.12
In June 2019, Domino’s teamed up with California-based robotics company, Nuro,
to launch a pilot for driverless pizza delivery in Houston, Texas. The pizza giant aimed
to use Nuro’s driverless fleet of custom-built robot cars to deliver pizzas to residents in
Houston who placed online orders.
In 2019, Domino’s recorded total sales of $14.3 billion, with international markets
accounting for $7.3 billion—see Exhibit 2. It had more than 17,000 stores in over 90
markets. Its key international markets included Australia, India, and the
United Kingdom. Independent franchise owners accounted for 98 percent
of its stores as of December 2019 as is shown in Exhibit 3.13 In the
United States, Domino’s had 6,126 stores, of which 5,784 were owned by franchisees.
Analysts felt that Domino’s was a poster boy for globalization and franchising with
104 consecutive quarters of positive same-store sales growth. As of March 2020,
Domino’s and its franchisees employed around 400,000 people worldwide.14
http://mobile-dominos.com/
EXHIBIT 2 Domino’s Pizza Consolidated Statement of Profit or Loss
(Dollars in thousands)
2019 2018 2017 2016 2015
Continuing
Operations:
Revenue $1,435,410 $1,153,952 $790,861 $705,702 $539,138
Other gains
and losses 17,433 19,529 18,566 9,758 6,444
Food,
equipment and
packaging
expenses
(451,768) (385,675) (354,127) (286,069) (213,059)
Employee
benefits
expense
(292,439) (242,340) (239,471) (217,703) (172,112)
Plant and
equipment
costs
(24,560) (20,833) (19,776) (19,225) (18,278)
Depreciation
and
amortisation
expense
(62,785) (53,537) (46,369) (38,129) (27,480)
Occupancy
expenses (49,512) (44,318) (39,943) (36,683) (27,252)
Finance
costs (14,004) (10,276) (5,491) (3,297) (2,451)
Marketing
expenses (150,999) (49,704) (49,220) (48,251) (43,733)
Royalties
expense (68,827) (59,564) (52,282) (46,655) (37,640)
Store related
expenses (24,636) (21,406) (21,799) (19,785) (16,841)
Communication
expenses (20,666) (17,889) (17,760) (15,486) (10,927)
Acquisition,
integration,
conversion and
legal
settlement
costs
(46,216) (20,934) (28,384) (12,735) —
Other
expenses (87,018) (72,529)
(66,389)
(70,139)
(41,268)
Profit before
tax 159,413 174,476 150,680 125,819 97,840
2019 2018 2017 2016 2015
Income tax
expense (45,034) (52,783)
(44,876)
(39,227)
(29,419)
Profit for the
period from
continuing
operations
$ 114,379 $ 121,693 $ 105,804
$
86,592
$
68,421
Profit is
Attributable
to:
Owners of the
parent 115,912 121,466 102,857 82,427 64,048
Non-controlling
interests (1,533) 227 2,947 4,165 4,373
Total profit for
the period 114,379 121,693 105,804 86,952 68,421
Earnings per
Share from
Continuing
Operations:
Basic (per
share) $1.355 $1.394 $1.16 $0.944 $0.742
Diluted (per
share) $1.354 $1.39 $1.147 $0.922 $0.728
Source: “Domino’s Annual Reports, 2019, 2018, 2017, and 2016,” https://investors.dominos.com.au.
EXHIBIT 3 Domino’s Pizza Preliminary Estimated First Quarter 2020
Store Counts (Unaudited)
U.S.
Company-
owned
Stores
U.S.
Franchise
Stores
Total U.S.
Stores
International
Stores Total
Store counts:
Store count at December
29, 2019 342 5,784 6,126 10,894 17,020
Openings 4 31 35 143 178
Closings*† (1) (4) (5) (104) (109)
Store count at March 22,
2020* 345 5,811 6,156 10,933 17,089
First quarter 2020 net
store growth 3 27 30 39 69
https://investors.dominos.com.au/
page C-254
*Temporary store closures due to COVID-19 are not treated as store closures and affected stores are
included in the March 22, 2020. store count.
†Unrelated to COVID-19, the South Africa market, reflecting 71 stores in total, closed in the first quarter.
Source: “Domino’s Pizza® Announces Business Update,” http://dominos.gcs-web.com, March 30,
2020.
THE COVID-19 PANDEMIC
COVID-19 was closely related to the severe acute respiratory syndrome (SARS) which
started in China in 2002. The SARS virus infected around 8,000 people and killed 800.
Another coronavirus was the Middle Eastern Respiratory Syndrome (MERS)
that emerged in Saudi Arabia in 2012. There were around 2,500 infected cases and
900 deaths due to MERS.
COVID-19 was different from SARS and MERS in that 80 percent of the people
affected by it reported only a mild infection. However, many people carried the disease
without displaying any symptoms, which made it difficult to control its spread.
The COVID-19 outbreak started in a wet market in Wuhan, which sold fish, birds,
and both live and dead animals. With live animals being kept and butchered on site, it
was difficult to maintain hygiene in these markets and they posed a huge risk as viruses
from these animals could easily jump onto humans. To add to the problem, the wet
markets were densely packed, which meant the disease spread quickly from species to
species. Though the animal source of the COVID-19 was yet to be identified, scientists
believed that bats could be the original host.
Covid-19 was known to spread via droplets when an infected person coughed or
sneezed. When others touched the surfaces on which the droplets had landed with their
hands, they could spread the virus further. People could catch the virus if they touched
their eyes, nose, or mouth with their infected hands. The single most important thing
that people could do to protect themselves from the virus was to clean their hands by
washing them frequently with soap and water or a hand sanitizer.
On March 11, 2020, the World Health Organization (WHO), the international public
health agency of the United Nations, stated that due to the rapid increase in the number
of cases outside China—over 118,000 COVID-19 cases in more than 110 countries and
territories—COVID-19 could be characterized as a pandemic.15
While 80 percent of the people infected with COVID-19 showed mild symptoms
such as cold and flu, around 14 percent displayed symptoms of pneumonia and
shortness of breath. Around five percent of the patients suffered from septic shock,
respiratory failure, and multiple organ failure, according to data released by the
Chinese authorities.16
Since there was no specific treatment for COVID-19, doctors were
trialling existing drugs that were used in the treatment of Ebola,17 HIV,18 and
http://dominos.gcs-web.com/
malaria.19 Though the early results were promising, doctors could not be certain
whether the drugs were effective until full clinical trials were concluded. A vaccine for
COVID-19 was also not in sight. In mid-April 2020, the WHO said that developing a
vaccine for the COVID-19 pandemic might take 12 months or longer.
According to Johns Hopkins University, as of April 15, 2020, there were more than
2 million confirmed COVID-19 cases with 128,000 deaths.20
With no treatment options in sight, governments across the world were relying
mostly on social distancing to arrest the spread of the disease. Many governments had
imposed lockdowns, only allowing essential businesses to operate. This had led to
massive disruptions in business. Analysts expected the restaurant business to be hit
hard by the pandemic, as states in the United States and elsewhere forced restaurants to
limit service to takeout and delivery in an effort to keep people from clustering
together to prevent transmission of the disease. According to the National Restaurant
Association, out of the 1 million restaurant locations in the United States, about
three percent had already closed permanently, with another 11 percent anticipating
closure by the end of April. They felt that restaurants with delivery would fare
marginally better.21
DOMINO’S LAUNCHES ‘CONTACTLESS’ DELIVERY
Domino’s former CEO Patrick Doyle had famously said that Domino’s was a tech
company that sold pizzas. However, analysts felt that it had remained true to the
company’s core competency: pizza.
Domino’s, which accounted for a 36 percent market share in the United States, had
always been an advocate of the delivery and takeout model rather than offering the
dine-in facility to its consumers. As of January 2020, delivery accounted for 55 percent
of its sales while carry out accounted for the remaining 45 percent of the sales.22 The
pizza chain also had an advantage as most of its consumers had the ability to order
online. In the United States, Domino’s garnered 65 percent of its sales through digital
channels such as Facebook Messenger, Google Home, Apple Watch, Twitter, and
Amazon Echo, in addition to its own ordering platform, Domino’s Hotspots, that
offered service to over 200,000 non-traditional delivery locations. Analysts felt that
Domino’s was well-positioned to tackle the COVID-19 crisis with its dedicated
delivery workforce and a customer base which was accustomed to ordering online.
According to R.J. Hottovy, an analyst with Morningstar, Domino’s “infrastructure is set
up for something like this.”23
With health concerns growing due to the COVID-19 pandemic, Domino’s decided to
bank on its strong delivery infrastructure and in January 2020, it announced its plans to
offer contactless delivery. This meant that the pizza chain delivery person would
deliver the food to a consumer without any contact or interaction between them in a bid
to ensure safety. Explaining the contactless delivery policy to its consumers, Allison
page C-255
said, “We also want to make sure that customers know that we will deliver any way
they choose. Whether they prefer a delivery left at the front door or at a reception desk,
our delivery instruction box is the place to put any special directions. We know many
people would like to choose contactless delivery right now and we want customers to
know we’re here to deliver.”24
Domino’s ensured that all its employees were complying with the hygiene and safety
protocols across all its restaurants which were open for delivery worldwide. The pizzas
were cooked in an oven at 260 degree Celsius and was then packed for delivery and
were not touched by human hands. In addition to this, temperature screening was done
of all its employees and the delivery fleet was asked to use face masks. Domino’s was
constantly sanitizing its restaurants, delivery bikes, delivery bikes’ boxes, and pizza
delivery hot bags to assure consumers that the food delivered by them was safe.
Domino’s launched contactless delivery across the majority of its U.S. as well as
international stores. In India, the company’s licensee, Jubilant FoodWorks Ltd (JFL),
launched zero-contact delivery across all its 1,325 restaurants.25 In addition to this,
Domino’s partnered with India’s fastest growing FMCG company ITC Foods (ITC) to
launch an initiative known as ‘Domino’s Essentials’ wherein consumers could order
groceries and other essentials by downloading the Domino’s app. The service was
launched after the Government of India announced a 21-day lockdown26 in the country
from March 25, 2020, to April 14, 2020, due to the COVID-19 pandemic. On April 14,
the lockdown was extended till May 3, 2020, as the country reported
more than 10,000 COVID-19 cases and 339 deaths, Commenting on the
initiative, Pratik Pota, CEO and whole-time director, JFL, said, “We will use the
Domino’s supply chain and delivery network to deliver essential goods such as
Aashirvaad Atta [flour], spices, etc., at people’s doorstep. Customers can order using
the Domino’s App and their order will be delivered safely and hygienically using Zero
Contact Delivery.”27
After placing the order on the Domino’s delivery app, consumers could make the
payment by digital mode to complete the order. The delivery executives would follow
zero-contact delivery to fulfill the order by leaving the groceries at the consumers’
doorstep and waiting till the order was received. At JFL, the Safe Delivery Experts or
the employees of Domino’s had to undergo mandatory health screening—temperature
screening was done of every employee before they entered the restaurant and the
20second hand wash and sanitation protocol was followed every hour.
Initially, Domino’s Essentials was available in Bengaluru and the company had
plans to offer the service in the Indian cities of Noida, Mumbai, Kolkata, Chennai, and
Hyderabad.
Allison said Domino’s was taking care of its employees during the crisis. According
to him, “As the single largest owner of Domino’s stores in the United States [we] will
be expanding paid leave for full and part time hourly employees of our company-
owned stores and supply chain centers during this outbreak. All employees who are
unwell are asked to stay home. Those with any possible exposure to the virus and in
need of quarantine are also asked to stay home and will be paid.”28 He added, “In our
corporate stores and supply chain centers, we have implemented enhanced sick pay
policies, and we will provide additional compensation for our hourly team members
during this crisis.”29
Major Quick Service Restaurant chains such as McDonald’s, Yum Brands (which
owned Pizza Hut, KFC, and Taco Bell), Wendy’s, and Dunkin’ Brands, had also
switched to drive-thru, takeout, and delivery only.30 While the total restaurant
transactions declined in the United States (QSR transactions down by 34 percent; full-
service restaurant transaction down by 71 percent in March 2020), the average check
sizes increased. This led to restaurants offering family meals/bundles. For instance,
Torchy’s Tacos started offering Family Packs and Black Bear Diner Family Packs and
specially-priced Family Meals. KFC started offering a $30 Fill Up deal (instead of its
$20 Fill Up deal) claiming that it would be enough to feed a family of four for two
meals. Pizza Hut promoted the Big Dipper for $12.99; McDonald’s sold a Double Big
Mac with four patties instead of two, while Taco Bells promoted its massive
“Tripleupa.” 31
OTHER INITIATIVES
Due to the COVID-19 pandemic, many people were working from home and several
others were out of work. Thus, in April 2020, Domino’s announced plans to donate
10 million slices to people most affected by the pandemic in the United States. The
pizza giant aimed to donate the food to hospitals and medical centers, in addition to
helping school children, grocery store workers, health departments, and ‘others in
need.’ According to Russell Weiner, COO and president of the Americas at Domino’s,
“We have a long history of feeding people during times of crisis and uncertainty. When
we were looking at how we could help, we knew we could use the reach of our
national brand to make a difference in thousands of local neighborhoods.”32
The pizza giant launched an initiative called ‘Feeding the Need’ under which all its
6,126 companyowned and franchise-owned stores across the United States aimed to
donate at least 200 pizzas to people in their communities.33 The store managers were
empowered to make the call to hand out the pizzas to any local group in need.
In New Zealand, Domino’s started the “Meals For Seniors” initiative under which
the company distributed one free pizza meal every week during the coronavirus
lockdown to New Zealanders over 70 years of age.
THE RESULTS
Domino’s contactless delivery initiative helped the company thrive despite the
COVID-19 lockdown across many countries worldwide. In April 2020, Domino’s
reported that its first-quarter sales had increased by 4.9 percent in the United States
page C-256
while its international stores recorded an increase in sales of 6.8 percent for the same
period. Despite an increase in sales, analysts pointed out that though overall the results
looked positive during the pandemic, Domino’s sales had been impacted during this
difficult time. The company reported that its U.S. sales growth had fallen
from 3.6 percent in January 2020 to one percent for the period February 24,
2020, to March 22, 2020. According to Allison, “U.S sales were impacted by many
factors, which have varied in magnitude across the cities and towns we serve.”34 He
added, “Shelter in place directives, pantry loading, university and school closures,
event cancellations and the lack of televised sports have all impacted our business in
ways that we cannot yet fully quantify.”35
Domino’s rivals such as Yum Brands predicted U.S. Quarter 1 (Q1) same-store sales
declines in the mid-to-high single digits, while Papa John’s expected an estimated
5.3 percent growth in Q1 compared to 2019.36
As is shown in Exhibit 4, Domino’s share prices shot up 11 percent on March 19,
2020. Analysts had stated that the relative strength of Domino’s shares had risen
sufficiently to allow it to outperform the S&P 500.37
EXHIBIT 4 Domino’s Pizza Stock Chart (October 2019–April 15,
2020)
Source: https://finance.yahoo.com
Domino’s international stores were hit the hardest with China being its first market
to be significantly impacted by COVID-19, according to Allison.38 However, the
company’s sales were recovering and increasing in the last few weeks of the first
quarter, added Allison.
Despite mixed results, several analysts appreciated Domino’s for using its strong
delivery infrastructure to survive amidst the COVID-19 crisis when most businesses
restaurants worldwide were shutting down. “The ones that win, or relative winners, are
https://finance.yahoo.com/
page C-257
restaurants with drive-thrus, restaurants that have big delivery business, restaurants
who do a lot of take-out business—who are known for takeout. If you’re mostly an in-
dining room type restaurant, I think you’re going to struggle,”39 said Peter Saleh
(Saleh), analyst at global financial services company BTIG.
THE CHALLENGES
Though Domino’s was by and large appreciated for its contactless delivery during the
COVID-19 pandemic, it faced a backlash from critics and some of its employees for
keeping its stores open. A campaign started against Domino’s on Change.org40 by
Domino’s employee Issy Anna (Anna) accused the company of putting its employees
at risk at a time when states had entered a lockdown or had urged residents to remain
indoors to curb the spread of COVID-19. According to her, “We are being forced to
work in cramped stores, many that are not equipped to deal with the situation at hand.
Multiple employees are being forced to come in to work sick in fear of their jobs while
corporate refuses to bat an eye at the situation. “Contact-less delivery” has been
anything but successful, as some stores remain open for carryout with people piling
into the lobbies of these establishments even in the midst of shelter-in-place
orders issued by many states, customers continue to give cash which
multiple employees are handling, and hardly anyone actually utilizes the contact-less
system.”41 Anna further claimed that the delivery drivers did not have constant access
to hand sanitizers or sanitizer sprays to properly disinfect the delivery bags. She
wondered how a pizza service could be considered “essential” when there were other
options such as people obtaining food from grocery stores or cooking themselves. She
pointed out that American coffee company Starbucks Corporation had shut its stores
temporarily and was giving each employee an option to take 30 days of paid sick leave.
In early April, Angharad Maddock, a Domino’s employee in Llanelli,
Carmarthenshire, UK, accused the company of dismissing her for raising concerns
about lack of masks, hand sanitizers, and social distancing at the store. Domino’s
refuted these allegations. A spokesperson for Domino’s said that in addition to
introducing contactless delivery, frequent handwashing and increased sanitization, the
company had stopped its collection service and cash handling. It had also put screens
in place and hazard tape on the floor “to help with social distancing for team members
to adhere to.”42
The company started facing more criticism when a store worker at Domino’s in
Eskbank, Midlothian, Scotland, died on April 10, 2020, after contracting the
coronavirus. Nina Arnott, Domino’s spokesperson, offered condolences to the
employee’s family on his demise but stated that the stores remained opened in support
of the UK government’s advice that food delivery services should play an important
role in keeping people at home during the COVID-19 lockdown.
http://change.org/
In another incident on April 12, 2020, a Domino’s store in Crenshaw District in Los
Angeles was closed temporarily for thorough sanitizing after four of its employees
tested positive for COVID-19. A group representing Domino’s workers filed an
emergency complaint with public health services firm Los Angeles County Public
Health Department, demanding that they too shut the Domino’s store. The complaint
filed by delivery driver Angelica Olivares on behalf of herself and 10 co-workers
stated, “Instead of closing the store temporarily and allowing exposed workers to
quarantine for 14 days with pay . . . Domino’s has stayed open without even providing
protective equipment to workers or disinfecting the store.”43
In mid-April, a pizza delivery boy tested positive for COVID-19 in New Delhi,
India, which led to 72 homes being quarantined as a precautionary measure. Domino’s
issued a statement saying that this incident had nothing to do with it. The company
reiterated that 100 percent of its delivery was “zero contact delivery” and that its
employees in its stores were being temperature screened daily and followed hand
washing protocols. Besides, the company was sanitizing restaurants, bikes, pizza
boxes, and hot bags every four hours, it said.44
LOOKING AHEAD
Analysts appreciated Domino’s strategy of gaining a larger portion of the pie during
the COVID-19 lockdown. They opined that Domino’s strong delivery infrastructure in
addition to its having a strong digital consumer base helped it to capitalize on the
contactless delivery trend. They pointed out that smaller independent pizza chains and
restaurants lacking the resources stood to lose their share. According to Saleh,
contactless delivery might not be a gamechanger but the service would become “table
stakes and par for the course” in the pizza industry as the coronavirus was spreading
continuously—see Exhibit 5. Saleh added, “If you don’t have that in this environment,
you are going to lose share.”45
EXHIBIT 5 COVID-19 Statistics—Top 25 Countries (Data as of April
16, 2020, 12:33 GMT)
Country Total Cases Total Deaths Total Recovered Active Cases
World 2,100,149 136,044 523,873 1,440,232
USA 644,417 28,559 48,708 567,150
Spain 182,816 19,130 74,797 88,889
Italy 165,155 21,645 38,092 105,418
France 147,863 17,167 30,955 99,741
Germany 134,753 3,804 77,000 53,949
UK 98,476 12,868 N/A 85,264
page C-258
Country Total Cases Total Deaths Total Recovered Active Cases
China 82,341 3,342 77,892 1,107
Iran 77,995 4,869 52,229 20,897
Turkey 69,392 1,518 5,674 62,200
Belgium 34,809 4,857 7,562 22,390
Netherlands 29,214 3,315 250 25,649
Brazil 29,015 1,760 14,026 13,229
Canada 28,379 1,010 8,979 18,390
Russia 27,938 232 2,304 25,402
Switzerland 26,422 1,269 15,400 9,753
Portugal 18,841 629 493 17,719
Austria 14,412 393 8,098 5,921
Israel 12,591 140 2,624 9,827
Ireland 12,547 444 77 12,026
Sweden 12,540 1,333 381 10,826
India 12,456 423 1,513 10,520
Peru 11,475 254 3,108 8,113
S. Korea 10,613 229 7,757 2,627
Japan 8,626 178 901 7,547
Chile 8,273 94 2,937 5,242
Adapted from www.worldometers.info/coronavirus.
At a time when rivals such as The Cheesecake Factory and Union Square Hospitality
were announcing furloughs and layoffs respectively, Domino’s announced plans to hire
10,000 employees in its U.S. stores in March 2020 as the company was experiencing
an increase in demand for its pizzas with more and more people working from home
amid the pandemic. The company’s UK division was also hiring more store workers
and delivery drivers since more consumers were ordering online. In March 2020, the
pizza giant’s Australian division had already taken on over 2,000 people to serve
consumers in the country.46 “While many local, state, and federal governments [are
issuing orders that close] dine-in restaurants, the opportunity to keep feeding our
neighbors through delivery and carryout means that a small sense of normalcy is still
available to everyone. . . Our corporate and franchise stores want to make sure they’re
not only feeding people but also providing an opportunity to those looking for work at
this time, especially those in the heavily impacted restaurant industry,”47
said Allison. Meanwhile, rivals such as Pizza Hut, Papa John’s, and Jet’s
Pizza were also on a recruitment spree involving thousands of new employees.
http://www.worldometers.info/coronavirus
page C-259
Domino’s was optimistic about cashing in on the trend as it borrowed $158 million
in its outstanding variable funding notes in a bid to improve its strong cash position
and stay operational, though the company had $300 million on hand to increase its
financial flexibility.48 Reflecting the uncertainty of the global economy, Domino’s,
however, withdrew its fiscal 2020 guidance.
James McCann (McCann), CEO of McCann Investments, which invested in early-
stage companies in the grocery tech, food tech, and consumer goods space, opined that
while contactless delivery was booming in the wake of the COVID-19 crisis for
companies such as Domino’s, this service would be prevalent in the future based on
several factors such as how quickly employees and customers accepted the practice
and how long the threat of COVID-19 remained. He added, “If we have nine months of
high virus threat, then physical distancing will be normal. We will have forgotten what
the pre-normal was.”49
ENDNOTES
1 Keith Nunes, “Domino’s Weathering Covid-19 Storm,” www.foodbusinessnews.net, March 31, 2020.
2 Anne Burdakin, “Domino’s Pizza: A Lockdown Winner Any Way You Slice It,” www.fool.com, March 28, 2020.
3 Joanna Fantozzi, “Domino’s Reports Q1 Same-store Sales Growth and withdraws Financial Guidance during COVID-19,”
www.nrn.com, March 31, 2020.
4 COVID-19 or coronavirus is a pandemic caused by severe acute respiratory syndrome coronavirus 2 (SARS-coV-2), which started in
Wuhan, Hubei province in China, in December 2019. As of April 15, 2020, more than 2 million people affected by Covid-19 were
reported with more than 128,000 deaths, according to John Hopkins University.
5 “Domino’s Pizza Announces Business Update,” www.bloomberg.com, March 31, 2020.
6 “Domino’s Pizza® Announces Business Update,” http://dominos.gcs-web.com, March 30, 2020.
7 Amelia Lucas, “Domino’s Expects to Hire 10,000 Workers,” www.cnbc.com, March 19, 2020.
8 In 1995, Jubilant FoodWorks Limited (JFL), part of the Jubilant Bhartia Group, was founded by two brothers Hari Bhartia and Shyam
Bhartia. The Jubilant Bhartia Group has a strong presence in diverse sectors like Pharmaceuticals, Drug Discovery Services and Life
Science Ingredients, Performance Polymers, Food Service (QSR), and Consulting in Aerospace and Oilfield Services.
9 A Quick Service Restaurant is a type of restaurant which serves fast food cuisine.
10 “Domino’s Pizza First in Industry to Offer Mobile Ordering,” www.webrtcworld.com, September 27, 2007.
11 “DRU Drone by Flirtey Delivers Domino’s Pizza in New Zealand,” https://insideunmannedsystems.com, November 29, 2016.
12 “Domino’s Pizza Top 10 Innovations,” https://aaronallen.com, May 18, 2018.
13 “Domino’s Pizza 2019 Annual Report,” http://dominos.gcs-web.com.
14 Anne Burdakin, “Domino’s Pizza: A Lockdown Winner Any Way You Slice It,” www.fool.com, March 28, 2020.
15 Jamie Ducharme, “World Health Organization Declares COVID-19 a ‘Pandemic.’ Here’s what that Means,” https://time.com, March
11, 2020.
16 Sarah Newey and Anne Gulland, “What is Coronavirus, How did it Start and How Big could it Get?” www.telegraph.co.uk, April 10,
2020.
17 Ebola is a virus that can cause bleeding and organ failure, which can eventually lead to death.
18 The HIV or Human Immunodeficiency virus attacks the cells in the human body that help in fighting infections and diseases.
19 Malaria is a disease caused by the plasmodium parasite, which is transmitted by mosquito bites.
20 “Global Coronavirus Cases Top Two Million: Johns Hopkins,” www.cgtn.com, April 15, 2020.
21 Alicia Kelso, “Why Pizza Chains are Weathering the Coronavirus Downturn Better than their Restaurant Counterparts,”
www.forbes.com, April 1, 2020.
22 Alicia Kelso, “Why Domino’s CFO is Confident the Pizza Chain will Gain even More Market Share in 2020,” www.forbes.com,
January 15, 2020.
23 Katie Arcieri, “Pizza Chains Aim for Larger Slice of Contactless Deliveries during Coronavirus,” www.spglobal.com, April 6, 2020.
24 Daniel B Kline, “Domino’s Offers Contact-Free Delivery,” www.fool.com, March 17, 2020.
25 “Coronavirus: McDonald’s, Domino’s Pizza Introduce Contactless Delivery,” www.deccanherald.com, March 16, 2020.
http://www.foodbusinessnews.net/
http://www.fool.com/
http://www.nrn.com/
http://www.bloomberg.com/
http://dominos.gcs-web.com/
http://www.cnbc.com/
http://www.webrtcworld.com/
https://insideunmannedsystems.com/
https://aaronallen.com/
http://dominos.gcs-web.com/
http://www.fool.com/
https://time.com/
http://www.telegraph.co.uk/
http://www.cgtn.com/
http://www.forbes.com/
http://www.forbes.com/
http://www.spglobal.com/
http://www.fool.com/
http://www.deccanherald.com/
26 On March 24, 2020, the Government of India announced a complete lockdown whereby wearing masks in public places was
mandatory. Educational institutions and religious places were closed during the lockdown. International and domestic flights were
suspended till May 3, 2020. Only essentials such as groceries, meat shops, poultry and fish markets, vegetable and fruit shops, and
milk booths were open to the public. Industries in rural areas were allowed to function from April 30, 2020 with social distancing norms.
In addition to this, banks and automated teller machines (ATMs), hospital and medical facilities were also functional.
27 Bhumika Khatri, “Domino’s is now Delivering Essentials in Partnership with ITC Foods,” https://inc42. com, April 11, 2020.
28 “A Letter to Domino’s Customers from Ritch Allison, CEO of Domino’s Pizza, Inc.,” https://biz.dominos.com.
29 Ritch Allison, “Domino’s CEO Pens a Letter Detailing the Impact of Covid-19 on Its Worldwide Business,” www.franchising.com,
April 2, 2020.
30 Bill Peters, “Domino’s Eyes Massive Hiring Spree While Coronavirus Ravages Restaurant Industry,” www.investors.com, March 19,
2020.
31 Alicia Kelso, “Why Pizza Chains are Weathering the Coronavirus Downturn Better than their Restaurant Counterparts,”
www.forbes.com, April 1, 2020.
32 Michael Holan, “Domino’s to Donate 10 Million Slices of Pizza across US,” https://nypost.com, April 7, 2020.
33 “Domino’s 6,126 Stores give Communities 200 Pies each,” www.pizzamarketplace.com, April 6, 2020.
34 John Ballard, “Domino’s Pizza Reports Sales Increase amid COVID-19 Pandemic,” www.nasdaq.com, March 31, 2020.
35 Jonathan Maze, “Not Even Domino’s can Escape the Coronavirus Impact,” www.restaurantbusinessonline.com, March 30, 2020.
36 Alicia Kelso, “Why Pizza Chains are Weathering the Coronavirus Downturn Better than their Restaurant Counterparts,”
www.forbes.com, April 1, 2020.
37 Bill Peters, “Domino’s Eyes Massive Hiring Spree While Coronavirus Ravages Restaurant Industry,” www.investors.com, March 19,
2020.
38 John Ballard, “Domino’s Pizza Reports Sales Increase amid COVID-19 Pandemic,” www.nasdaq.com, March 31, 2020.
39 Kate Taylor, “Dominos-Papa-Johns-and-more-Chains-Thriving-amid-Coronavirus,” www.businessinsider.com, April 2, 2020.
40 Change.org is a petition website started by California-based certified B corporation (corporations that balance profit and purpose)
for-profit Change.org Inc. It aims to facilitate petitions filed by the general public. As of April 17, 2020, the website had 240 million
users.
41 Issy Anna, “Close Domino’s Pizza due to COVID-19 Pandemic,” www.change.org.
42 “Coronavirus: Domino’s Denies Sacking Staff over Safety Concerns,” www.bbc.com, April 4, 2020.
43 “L.A. Domino’s Closed for Sanitizing after Workers say they’re at Risk of Coronavirus,” www.dailynews.com, April 11, 2020.
44 “Pizza Delivery Boy Tests Positive for COVID-19: Zomato and Domino’s Issue Clarification,” www.dqindia.com, April 16, 2020.
45 Katie Arcieri, “Pizza Chains Aim for Larger Slice of Contactless Deliveries during Coronavirus,” www.spglobal.com, April 6, 2020.
46 Harry Wise, “Domino’s Pizza Cancels Dividend despite the Coronavirus Lockdown causing Huge Rise in Demand for Deliveries,”
www.thisismoney.co.uk, March 27, 2020.
47 Anne Burdakin, “Domino’s Pizza: A Lockdown Winner Any Way You Slice It,” www.fool.com, March 28, 2020.
48 Julie Littman, “Domino’s US Same-store Sales Growth Drops by Half in Q1,” www.restaurantdive.com, March 31, 2020.
49 Katie Arcieri, “Pizza Chains Aim for Larger Slice of Contactless Deliveries during Coronavirus,” www.spglobal.com, April 6, 2020.
https://biz.dominos.com/
http://www.franchising.com/
http://www.investors.com/
http://www.forbes.com/
https://nypost.com/
http://www.pizzamarketplace.com/
http://www.nasdaq.com/
http://www.restaurantbusinessonline.com/
http://www.forbes.com/
http://www.investors.com/
http://www.nasdaq.com/
http://www.businessinsider.com/
http://change.org/
http://change.org/
http://www.change.org/
http://www.bbc.com/
http://www.dailynews.com/
http://www.dqindia.com/
http://www.spglobal.com/
http://www.thisismoney.co.uk/
http://www.fool.com/
http://www.restaurantdive.com/
http://www.spglobal.com/
O
page C-260
CASE 19
Burbank Housing: Building from the
Inside Out
Copyright ©2021 by Armand Gilinsky, Jr. All rights reserved.
Christy Anderson,
MBA Student, Sonoma State University
Armand Gilinsky Jr.,
Sonoma State University
n October 8, 2017, Larry Florin awoke to a phone call in the middle of the night.
The call was from an employee at non-profit Burbank Housing’s main office
alerting him that there were massive fires ripping through Northern California, and
Burbank Housing’s properties were at risk. Larry scrambled to leave and drove up from
Marin County to Burbank Housing’s main office in Santa Rosa, California.
Just one year into Larry’s new role as CEO at Burbank Housing, Northern
California’s housing crisis was reaching critical levels. The catastrophic fires put much
more pressure on the region, but came with much needed support from federal and local
government and from the community. Burbank Housing was able to take on more
projects than ever.
By late 2019, two years after the 2017 devastating wildfires, Larry reflected on the
company’s position given the road ahead. His challenge: put Burbank Housing in a
position to take on new development projects to mitigate the housing crisis while
assuring that Burbank Housing could internally manage all new project growth.
For a company like ours, cash flows is everything. And this is actually not different than a for profit company. In
the development world it goes up and down. There are big, big cycles. It’s even worse in the affordable housing
world. Because if you tax a tax credit project, our typical project, the way we make money here is off of developer
fees. Which we are allowed to collect, but we cannot collect a developer fee until a project is done, and it is what
is called stabilized. So, it has to have three months’ worth of full occupancy and people paying rent. So, way
page C-261
down the line we get paid. It’s really about cash flow and how you manage cash in order to keep the operation
going. And that’s a struggle. We do what we can with the money we have.
We currently own about 65 properties. We get a management fee. Most of that goes to our staff that work on the
projects. And the costs associated with running the projects. But we could do that more efficiently. We have never
here established metrics of how much per unit it should cost us. If you are a for profit management company, you
live and die off the cost per unit that you incur. It is somewhere probably between $5,000 and $8,000 per unit is
where our costs are. To systematize that, it would be great. The projects are pretty complex. There are sometimes
four to seven funding sources for each project. The management company could really benefit from being able to
systematize. And we would make money, so say if a unit cost $8,000 we could try to get to $6,000 across the
board.1
—Larry Florin, CEO of Burbank Housing
Burbank Housing, like many affordable housing companies, was comprised of a
development department, a property management department, and a resident services
department as their core organizational structure. The development department was
charged with constructing new projects. Property management managed the rental
properties once they were completed. Resident services provided various types of
support programs for renters. Reviewing these activities, Larry grappled with how to
improve the coordination of these departments, manage the cash flows
associated with new project developments, and systematize processes and
procedures across the organization.
AFFORDABLE HOUSING SEGMENT
Affordable non-profit housing companies acted as developers in that they were able to
compete for tax credits and needed to comply with certain regulations once tax credits
were awarded. However, for-profit developers could also compete for tax credits. The
main difference was that affordable housing companies made it their mission to provide
housing for individuals below the median income levels.
According to IBISWorld, the Construction sector expanded at an annualized rate of
3.4 percent over the five years prior to 2018 and reached $2.0 trillion, including a 3.3
percent jump in 2018 alone.2 Growth in California occurred at a faster rate. The demand
for construction projects was driven by macroeconomic factors such as rising disposable
income, low interest rates, mortgage interest rates, government policy measures which
supported homeownership, and increased access to credit. Construction contractors
additionally benefited from accommodative lending standards by banks over the five
years, providing them with increased financing for operations.2 As a result of the
increased demand for construction services, the average profit margin for operators in
the construction industry reached 5.9 percent of total construction revenue in 2018, up
from 4.5 percent in 2013.3 At the same time, the industry experienced severe shortages
of skilled labor due to tight employment markets.
Across the United States in 2017, floods, hurricanes, wildfires, and earthquakes,
among other natural disasters, acutely decreased the nation’s housing supply and
intensified demand for construction of single-family homes. Housing industry observers
estimated that single-family housing projects had increased by 900,000 units in
page C-262
February 2018, the highest level since September 2007.4 Multifamily, or apartment
complex construction was also a significant driver of residential building construction
from 2012–2018. Multifamily housing starts, which were generally more volatile than
their single-family projects, were expected to rise at an annualized rate of 6.1 percent
over the five years prior to 2018.5 Reports from property management software
solutions firm RealPage reported “apartment completions reached a 30-year high in
2017, with 364,713 units completed in the 150 largest U.S. metro areas.”6 Investors also
took note of the focus on apartment complex projects. Investors had “purchased a
record-setting $19.6 billion in apartment properties in 2015, bolstering revenue for
industry operators in this submarket.”7
TAX CREDITS
Affordable housing was heavily reliant upon tax credits. The low-income housing tax
credit (LIHTC) program had originally been a part of the Tax Reform Act of 1986.
According to the Congressional Research Service group, the LIHTC program acted as
an indirect federal subsidy used to help finance construction and rehabilitation of low-
income affordable rental housing.8 Without this incentive, affordable rental housing
projects were not expected to generate sufficient profits, because housing was provided
at below-market rates.
Tax credits gave investors a dollar-for-dollar decrease on their federal tax liability. At
the same time, investors also accounted for depreciation or losses on housing projects.
Tax credits were paid out annually over ten years. Projects that were awarded tax credits
needed to be available only to low-income tenants and rents needed to be restricted for
at least 30 years. There were two types of tax credits, 4 percent and 9 percent. New
construction projects were generally awarded the highly sought after 9 percent tax
credits, while the 4 percent credit was normally reserved for rehabilitation projects.
The general qualification required that the household made less than 50 percent of the
Area Median Income (AMI). According to the Sonoma County Economic Development
Board, Sonoma County had a median household income of $66,783 in 2017.9
HOUSING CRISIS
According to Larry, and the Congressional Research Service group, tax credits were
almost non-existent during the Great Recession of 2008. The Low-Income Housing Tax
Credit (LIHTC) program existed primarily because of funding from large banks. As a
result, the price of LIHTCs fell, creating funding gaps in projects that had received tax
credit allocations in 2007 and 2008 but had not yet sold.10 This included
thousands of projects and tens of thousands of units that would have
otherwise been bought or rehabilitated. During that time Burbank Housing’s focus
shifted to property management. Without any affordable housing development projects
to support the business during the Great Recession, property management was the only
way Burbank housing could generate funds to stay afloat.
Upon its recovery from the Great Recession, California renewed its focus on trying to
solve the housing crisis. “Housing [was] more expensive in California than just about
anywhere else,” according to the report by California’s Legislative Analyst’s Office
(CLAO), which noted an increasing gap in supply and demand for housing in that state
since the 1970s.11 California was known for its robust economy, creating many job
opportunities, often faster than the housing market could keep pace with. According to
the CLAO, California maintained one of the highest median housing prices and rents in
the United States. In 2015 an average California home cost $440,000, about two-and-a-
half times the average national home price of $180,000, and California’s average
monthly rent was about $1,240, which was 50 percent higher than the rest of the country
at $840 per month.12 According to the CLAO, the main reason that homes were not
built was because local communities made most decisions about housing development.
How residents felt about new housing, particularly affordable housing, was another
important factor. Incumbent residents concerned about new housing had the ability to
bar new construction via the community’s land use authority, which allowed them to
effectively slow or stop housing from being built or require housing to be built in lower
densities. Other important factors that prevented housing projects were the
environmental impacts of new projects and a shortage of land available for
development.
Larry noted how the community and local government were very much in support of
new development of affordable housing projects to help solve the housing crisis,
especially after the fires. The Tubbs Fire began on October 8, 2017, and quickly became
the most destructive fire in California history, resulting in a loss of 4,658 homes.13
Thirteen months later, the Camp Fire obliterated Paradise, California. In 2019,
California’s Governor-elect Gavin Newson called for the construction of 3.5 million
new housing units over the next five years, or an average of 500,000 a year.14 California
had historically built an average of 80,000 new homes per year over the prior decade.
Even to Larry, a goal of 3.5 million housing units seemed very ambitious.
COMPANY HISTORY
Burbank Housing was a 501(c)(3) charitable non-profit with history going back 40
years. When the organization was in its first years, there was not much competition and
the market itself was almost non-existent. During the Great Recession of 2008, Burbank
Housing had to shift their focus to property management because of the economic
factors which affected the construction industry at the time. In 2010, Burbank Housing
developed a strategic plan which focused primarily on taking on tax credit projects,
selling to new partnerships and updating their assets. Around this time other competitors
began entering the market. In 2015, the board of directors brought in a consultant to
page C-263
take a deep dive into the organization and provide recommendations. Some of those
changes focused on leadership, and in 2016 helped the board select Larry Florin as the
new CEO.
In 2017 the Board of Directors, other organizational leaders, and a group of
employees developed a strategic plan focusing on the core values of the organization.
The areas of focus and goals for the strategic plan developed in 2017 can be seen in
Exhibit 1. The dashboard was created (at the time of writing) to highlight in a single
snapshot where the organization was with each goal from the strategic plan. When
asked what his own goal was as CEO, Larry responded:
I want us to run properties that people are going to be proud of in the community. And that’s important. I want us
to be known as a reputable company. So once we build it, we own it, we stay with the project, we take care of the
residents. Ultimately, I think we make our mark by bringing new projects on board given the demand that is
out there.
Focusing on the strategic plan allowed Burbank Housing leaders to decide which
areas were considered priorities, as shown in Exhibit 1. Based on a recent review in
early 2019, the leadership team color-coded where they were currently in attainment of
each identified goal. Green goals were completed. Light-green goals were considered in
completion and ongoing because much of Burbank Housing’s strategic
goals needed to be continuously practiced. Yellow goals were in process.
Orange goals were designated as having been in beginning stages. Red goals were
considered highest priority: the areas that needed more focus were cash flows,
communication, standardizing processes, employee motivation and training—in order to
handle the additional capacity.
EXHIBIT 1 Burbank Housing’s 2017 Strategic Plan, Updated Spring
2019
page C-264
Source: Created by case writer based on Burbank Housing’s 2017 Strategic Plan & interviews with
leadership team.
As of 2019, Burbank Housing managed over 63 properties, almost 3,000 rental units,
and was working on starting projects that would bring over 500 new rental units to
Sonoma County. Based on 2017 financial statements, Burbank Housing reported
459 million in assets of which 385 million were property.
Burbank Housing was divided into three companies according to their Director of
Human Resources. The Development Company had 21 employees, the
Property Management Company had 77, and the Resident Services
Company had 66. Exhibit 2 shows the organization chart of Burbank Housing.
EXHIBIT 2 Burbank Housing Leadership Team Organization Chart in
2019
page C-265
Source: Created by case writer and used with permission.
Development
Burbank Housing existed to develop affordable housing for the North Bay in California.
The Development department was the heart of Burbank
Housing. Development was also Burbank Housing’s most profitable
department. The development department depended on developer fees for cash flow.
EXHIBIT 3 Burbank Housing Development Corporation Statement of
Activities (Change in Unrestricted Net Assets), 2016–2018
2018 2017 2016
Support and revenue:
2018 2017 2016
Support:
Capital grants for sale of single-
family homes $ 46,670 $ 1,276,010 $ 496,000
Donations and other grants 11,347,944 1,881,076 95,388
Total support 11,394,614 3,157,086 591,388
Revenue:
Rental income 29,147,200 26,461,540 26,038,478
Sale proceeds – sale of single-
family homes 24,860 11,271,616 10,884,565
Cost of sales – sale of single-
family homes — (11,917,581) (12,635,326)
Developer fees 1,438,938 2,909,714 2,282,651
Property management and
accounting fees 220,542 207,469 172,017
Partnership, incentive and asset
management fees 52,199 50,678 37,721
Recovery of homeownership
notes 109,112 157,342 119,774
Interest income 160,000 63,116 71,667
Miscellaneous income 1,187,836 775,465 1,230,637
Total revenue 32,340,687 29,979,359 28,202,184
Total support and revenue 43,735,301 33,136,445 28,793,572
Expenses:
Program services:
Rental expenses 15,961,064 16,575,320 18,755,269
Project development 605,627 580,364 148,129
Property management 3,024,112 2,697,760 2,775,140
Management and general 1,852,317 2,526,425 1,550,299
Total expenses 21,443,120 22,379,869 23,228,837
Change in net assets before other
expenses 22,292,181 10,756,576 5,564,735
Other expenses:
Interest expense 9,644,746 8,964,343 5,452,411
Depreciation and amortization 14,443,728 14,223,680 14,412,960
Loss on disposal of fixed assets 837,545
555,412
337,395
Total other expenses 24,926,019 23,743,435 20,202,766
page C-266
2018 2017 2016
Change in net assets (2,633,838) (12,986,859) (14,638,031)
Net assets—beginning of year 109,865,246
113,088,949 95,184,297
Capital contributions—net 220,080
9,763,156 745,026
Net assets—end of year $107,451,488 $109,865,246 $81,291,292
Source: Burbank Housing’s Final Combined Financial Statements, used with permission. Final audited
statements for FY 2019 were not yet available at the time this case was written.
Exhibits 3, 4, and 5 present financial statements for Burbank Housing from 2016 to
2018.15 Burbank Housing had one property under construction, Stoddard
West Apartments, in the city of Napa, which was 50 units of family
affordable rental units. Construction started in April 2018 and was scheduled to be
completed in late summer 2019.
EXHIBIT 4 Burbank Housing Development Corporation Statement of
Cash Flows, 2016–2018
2018 2017 2016
Cash flows from operating activities
Change in net assets $(2,633,838) $(12,986,859) $(15,398,575)
Adjustments to reconcile change in
net assets to net cash provided by
operating activities
Depreciation 14,393,030 14,111,868 14,318,380
Amortization 50,678 111,792 94,580
Interest – amortization of permanent
loan costs 174,587 101,943 88,060
Loss on retirement of fixed assets 837,545 555,412 337,395
Donation of land — (1,715,000) —
(Increase) decrease in partnership
activity 93,096 1,200 (20,059)
(Increase) decrease in assets:
Contributions receivable (858,907) — —
Limited partnership receivable (28,724) 16,163 (110,651)
Property and other
receivables (81,697) 157,133 221,014
Prepaid expenses (139,846) (4,177) 25,151
Deposits and mortgage
impounds (41,943) (42,583) 5,770
2018 2017 2016
Notes and interest receivable
from limited partnerships (52,824) (42,824) (35,067)
Increase (decrease) in
liabilities:
Accounts payable and accrued
expenses (1,189,239) 335,612 1,048,104
Deferred revenue 94,500 1,404,402 (26,904)
Accrued interest on mortgages
and notes payable 4,688,444 4,350,418 3,713,933
Tenant security deposits–net (11,520) (10,546) 32,577
Total adjustments 17,927,180 19,330,813 19,692,283
Net cash provided by
operating activities $15,293,342 $ 6,343,954 $ 4,293,708
Cash flows from investing activities:
Net decrease (increase) in
replacement, operating and other
reserves
(5,487,884) (1,398,248) 698,793
Reduction (purchase) of
development in progress (18,530,439) (16,495,450) 5,767,299
Purchase of property and
equipment (2,469,168) (1,769,167) (15,245,605)
Reduction (purchase) of deferred
costs (41,533) (66,916) 9,755
Net cash used in investing
activities (26,529,024) (19,729,781) (8,769,758)
Cash flows from financing activities:
Net decrease in financing for
development and progress 4,071,860 (3,273,688) (9,477,715)
Net increase in mortgages and
notes payable 9,466,330 6,840,158 8,947,241
Net increase in permanent loan
costs (530,885) (88,912)
Net increase (decrease) in other
long-term payables (76,522) 36,900 22,457
Proceeds from capital contributions,
net of distributions and syndication
costs
220,080 9,763,156 4,810,328
Net cash provided by financing
activities $ 13,150,863 $ 13,277,614 $ 4,302,311
Increase (decrease) in cash and cash
equivalents 1,915,181 (108,213) (173,739)
page C-267
2018 2017 2016
Cash and cash equivalents, beginning
of year 5,532,918 5,641,131 5,814,870
Cash and cash equivalents, end of
year $ 7,448,099 $ 5,532,918 $ 5,641,131
Source: Burbank Housing’s Final Combined Financial Statements, used with permission. Final audited
statements for FY 2019 were not yet available at the time this case was written.
EXHIBIT 5 Map Showing Number of Units Managed by Burbank
Housing in 2019, by City
Source: Created by case writer from interview with Director of Property Management.
Six projects in pre-development included:
Redwood Grove, Napa, 34 units, ownership
Lantana Place, Santa Rosa, 48 units, ownership
page C-268
Caritas Homes, Santa Rosa, 128 units, rental – some of which is homeless-dedicated,
the rest family
Heritage House, Napa, 66 units, rental for homeless households
Valle Verde, Napa, 24 units, family rental
Journey’s End, Santa Rosa, 162 units, senior rental (plus another 300-450 market
rental units)
Costs varied based on a host of factors but often fell into the $450,000–$550,000 per
rental unit. Because ownership units tended to be modest in size, unit costs for those fell
into the same range. Once a property was approved, entitled, and funding sources were
secured, construction could begin. Towards the end of construction an investor or
investors were locked in to take over ownership of the property. Burbank Housing
usually ended up with a small portion of the ownership by entering into a limited
liability partnership with an investor to transfer the management of the property over to
Burbank Housing. Developer fees were not generated by Burbank Housing until, as
Larry said, the project had been “stabilized.” Larry explained it typically took at least
three months after construction for a housing complex to reach full
occupancy with paying renters. These delays in revenue were a big reason
why managing cash flows was so important for Burbank Housing.
Being a company with large development projects made managing debt important.16
Most of the time Burbank Housing had to take on loan financing to fund development
projects. Looking at debt-to-equity allows Burbank Housing insight into the level of risk
they are getting taking on. Debt-to-equity ratios for a company are compared against
industry ratios to see if the level of risk is higher or lower than competitors. Generally,
according to Larry, a ratio of 3 or lower was acceptable in the construction industry.
Table 1 highlights an overview of Burbank Housing’s debt to equity ratios from 2016 to
2018.
TABLE 1 Debt-to-Equity Overview, 2016–2018
FYE 12/31 2016 2017 % Increase 2018 % Increase
Total Liabilities $339,478,199 $349,318,958 2.9% $366,146,306 4.8%
Total Net
Assets
(Shareholders’
equity)
113,088,949 109,865,249 −2.9% 107,451,488 −2.2%
Debt-to-
equity
ratio
3.00 3.18 5.9% 3.41 7.2%
Source: Burbank Housing internal document, used with permission.
Burbank Housing’s debt to equity ratio was higher in 2017 than the industry average.
Larry explained a ratio of 3.2 was not alarming to him, however it is something he was
page C-269
monitoring, and planned to reduce by increasing free cash flow.
Property management
Having developed 63 properties and counting, Burbank Housing supplied Northern
California with almost 3,000 rental units. Property Management generated revenue
based on management fees for running the day-to-day operations of rental properties.
Managing properties with more units brought in greater management fees. Looking at
Table 2, 10 properties consisted of between 80 to 129 rental units. These larger
properties brought in 36% of management fees and at the same time only make up 16%
of the portfolio.
TABLE 2 Summary of Properties Managed by Property Management,
2019
Number of
Projects Unit Count
Annual
Management Fees
Generated
% of Fees
Generated
% of Projects
Represented
19 2 to 29 Units $ 239,188 10% 30%
20 30 to 49 Units $ 663,490 27% 32%
14 50 to 79 Units $ 683,723 28% 22%
10 80 to 129 Units $ 883,881 36% 16%
Total Fees Generated $2,470,282
Source: Burbank Housing internal document, used with permission.
Burbank Housing’s Development Plan called out the goal to “Develop initiatives that
allow employees to work smarter.” Annie McNeany, Director of Property Management,
outlined a plan to help her staff optimize the management of their current portfolio as
well as prepare them to take on more properties. “Optimization of Yardi software has
been a primary focus for my department.” Yardi property management
software was used by many affordable housing and for-profit housing
companies. However, Annie and other managers agreed that Yardi had not yet been
leveraged fully at Burbank Housing.
Burbank Housing implemented Yardi PAYscan paperless invoicing and Yardi
Marketplace, which was to be used by Property Managers to purchase supplies.
Invoicing became noticeably easier and saved costs to the organization because of a
decrease in invoice processing times. Processing one invoice typically cost $35. With
Yardi PAYscan, invoicing costs decreased to $5 or less per invoice. The time it took to
process an invoice also dropped, from 32 to six or fewer days.
Yardi Marketplace was also implemented as a tool to help property managers
purchase supplies needed for properties such as light bulbs, paint, or a refrigerator. This
feature was integrated with the Yardi software used by the Finance and Property
Management departments to streamline tracking costs and paying vendors. Adoption
and usage of the technology remained slow, however. Some of Burbank Housing’s staff
indicated that additional training was needed and that it was difficult to change a
workflow process with which they were already comfortable.
Yardi also had the potential to be used as a performance evaluation tool. Burbank
Housing’s Director of Property Management was excited about the implementation of
Yardi because the performance evaluation feature allowed for greater consistency in
personnel reviews, whereas previously, employee performance evaluation processes and
reports had never been standardized.
For all properties, Property Management created and managed lists of people waiting
to become approved for an affordable rental unit. For larger properties the lists
contained hundreds of applicants. The ideal process would have been automated and/or
systematized in the Yardi software. An example: Burbank Housing purchased Parkwood
Apartments, a 56-unit apartment complex, for $15 million. The City of Santa Rosa
provided a loan of nearly $2.5 million to Burbank to help close the deal.17 Often,
Burbank Housing purchased an existing property to protect the current residents from
having to move out with the threat of a new owner raising rent. Setting up properties
like Parkwood involved a series of steps which required extensive, and often redundant,
communications. When there were already residents in these apartments, they all had to
apply for affordable housing through Burbank Housing. These residents’ information
was captured through the application processes. Then, a new person was recruited and
hired to manage the property. Following that, an assessment of the property’s
rehabilitation needed to be done. These workflows could have been managed far more
efficiently and less costly if the process of information capture and management were
managed in the Yardi software.
“It [was] difficult to automate this process,” said Bonnie Maddox, Assistant Director
of Property Management. For each property they had to update the waiting list by
sending out a letter to each applicant asking certain questions to check the status of the
applicant’s eligibility. Because of the time it took to manage this process, many
properties had already closed waiting lists. A rental application form consisted of
information that was already in the Yardi system. It has been a goal of Property
Management to automate this process however specific Yardi developer experience was
needed to set it up.
Director of Property Management Annie McNeany worked with a consulting
company and Yardi support to try to automate processes in Yardi. Also, specific Yardi
questions and issues that came up day-to-day sometimes proved challenging to solve in
a timely manner. Bonnie connected with the Director of Data Governance at another
large affordable housing company in Northern California to share knowledge and
experience of Yardi issues and utilization. Bonnie learned that the other affordable
housing company had in-house Yardi experts who assisted with issues that came up.
Bonnie also learned this company was able to automate their rental applications,
page C-270
waitlists, and mailing lists in Yardi. Looking at Exhibit 5, we can see the geographical
spread of Burbank Housing’s rental properties. An in-house Yardi expert could have
been added to payroll if Yardi software assistance was needed. Bonnie explained it was
difficult to support all the Property Managers because of how spread out their properties
were throughout Sonoma and Napa Counties, but sometimes Property Managers needed
in person support. Exhibit 6 shows budget space for computer assistance and training,
however this might not be enough for a full-time Yardi administrator salary.
EXHIBIT 6 Burbank Housing’s 2019 Budget (summarized for
technology support and training-related expenses)
Burbank Housing
2019 Budget Consolidated Development
Property
Management
Asset
Management
Resident
Services
Total Revenue $ 8,399,627
$
3,703,729
$
3,073,071
$
732,729 $557,734
Total Rental
Expenses 57,604 — — — —
Total Property
Mgmt Exp. 1,912,476 — 1,648,476 — 264,000
Operating
Expenses
Computer
Consultants 18,583 1,354 11,214 510 510
Computer &
Software Equip. 127,895 5,336 44,182 2,008 2,008
Computer
Maintenance
43,546
3,785
31,338
1,424 1,424
Training 58,500 7,000 $14,000 5,000 —
Other – General &
Admin 2,362,892 1,762,156 (1,463,569) 386,781 252,903
Total Expenses $ 4,581,496
$
1,779,631
$
285,641
$
395,723 $520,845
Source: Burbank Housing’s 2019 Budget, prepared in December 2018, used with permission.
Communication between departments was also extremely important to help Property
Management prepare to take on more properties. Burbank Housing had a
goal to “Foster strong and positive open communication between internal
departments.” Feedback from leadership included that communication had been an
ongoing area Burbank Housing desired to improve. Some front-line staff members, such
as property managers, voiced that they felt they were siloed and didn’t know what was
going on at the main office. Director of Fundraising and Communications, Laurie Lynn
Hogan, implemented a weekly newsletter to be sent out to the entire organization with
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updates of new development projects. This newsletter was well received but proved to
be a significant amount of work to put together. At the time of this writing, leadership
was considering setting up a two-way communication process so front-line staff can
communicate important information.
Employee training was also a focus Annie had in her plan for Property Management.
The training plan consisted of providing employees, and possibly the entire
organization, education on tax credits, affordable housing laws, and software such as
Microsoft Excel. Employees had voiced that they needed more knowledge and training
in those areas to do their jobs more effectively. Exhibit 6 shows the budget for 2019
allocates $58,000 for employee training, of which $14,000 is currently allocated for
Property management alone. Most departments in the organization provided team
development activities throughout the year. Team development activities have improved
employee satisfaction and communication. Annie’s opinion was that employee
education and motivation would help their department efficiently take on more
properties and optimize the way they managed existing properties.
MISSION AND VALUES
Burbank Housing’s mission statement is as follows:
“Burbank Housing is a local nonprofit dedicated to building quality affordable housing in the North Bay. We
create vibrant local communities that are carefully designed, professionally managed, and sustainable both
financially and environmentally, to foster opportunities for people with limited-income of all ages, backgrounds
and special needs.”
Although the purchase of properties like Parkwood helps keep renters in their
apartments, and generated income for Burbank Housing, this was not Burbank
Housing’s main modus operandi. CFO Jeff Moline emphasized the importance of
introducing more affordable housing options into the market as their primary focus.
The organization held four core values: community, integrity, compassion, and
teamwork. As stated in their strategic plan, community was defined by Burbank
Housing as the desire to “actively engage with people and institutions to share
information, ideas and resources in order to help others achieve their
goals.” Burbank Housing is a known name in the community. They have
collaborated with a long list of other organizations focused on housing, homelessness,
wildfire recovery, education, healthcare and politics. CEO Larry Florin and Head of
Community and Government Relations Efren Carrillo, as well as other leaders of
Burbank Housing, have regularly informed the community of various events. Director
of Resident Services Lauren Taylor has built and maintained relationships with other
housing entities in the community to share information, ideas, and resources. From
almost all angles, Burbank Housing has applied their core value of community.
For integrity, Burbank Housing “delivers on our promises. Professional, ethical
behavior is expected by all. We have the courage to acknowledge mistakes and do
whatever is needed to address them.” For compassion, Burbank Housing “values
individual differences, demonstrate empathy and [works] to understand the concerns of
others without judgment.” Integrity and compassion are both paramount values for an
organization like Burbank Housing. Being at their main office, speaking with leadership
and even meeting with Burbank Housing residents, one can feel their organization is
built on integrity and compassion. It is a clear part of the company’s culture.
To emphasize teamwork, Burbank Housing “assumes positive intent, [practices]
effective communication and collaboration to establish mutual understanding to
overcome challenges and inspire others.” This value relates to Goal #1 from the
strategic plan: to “Develop initiatives that allow employees to work smarter.” The idea
is that if employees can be trained in new areas and new initiatives are implemented,
then everyone in the organization can work as a more effective team. As Burbank
Housing accepted new development projects and additional rental properties to manage,
they acknowledged that more focus would be needed on communication, standardized
processes, motivation, and training to create stronger teamwork.
FUTURE OPPORTUNITIES
Burbank Housing’s leadership team concluded there were several opportunities to
optimize the organization internally to handle the additional capacity in the pipeline.
The team considered increasing the estimated cash flows for development projects,
automating processes in Property Management, hiring a Yardi Administrator, improving
internal communication, providing training and education for employees, as well as
motivating employees.
Increasing Cash Flows
Increasing cash flows was not as simple as collecting cash and putting it aside for
development projects. A large amount of cash came from development fees. Burbank
Housing also collected management fees from managing the properties. The challenge
was reaching an understanding of how much cash flows are needed for development
and how much could be generated through the company without having to get funds
through financing.
Yardi Administrator
According to Glassdoor.com, the median salary of a Yardi Administrator in California
in 2019 was $63,174.18 This figure was out of the range budgeted to Property
Management for computer support. However, a Yardi Administrator could possibly pay
for themselves if they automated some of the manual work currently being done by
other employees. That way more of the management fee revenue earned would go to the
company rather than to internal costs.
Optimize Yardi Software & Automate Processes
http://glassdoor.com/
page C-272
Opportunities to optimize processes would come from use of the Yardi software. If all
property managers used Yardi marketplace, billing vendors would be easier and less
costly. Waiting lists and applications processes would be automated. Currently, this is a
very manual and time-consuming process. Employee performance evaluations are
another process that can be optimized through consistency among the organization, if it
was implemented through Yardi.
Increase Internal Communication
An increase of two-way internal communication was requested by many employees
throughout the organization. Property Managers had been specifically vocal about their
desire for communication concerning what was going on at the main office.
Monthly newsletters had been the norm in the past. These monthly
newsletters required a significant amount of time and effort. Encouraging
communication would improve teamwork and provide opportunity for cross-training.
Companywide informational meetings had not been done in over a year. Discussions
about setting up a two-way communication process had already begun; however, the
process was as of late spring 2019 not in place.
Training and Education
Property Management employees voiced a desire for Microsoft Excel training, Yardi
training, as well as classes centered around learning about updated tax credits laws.
Annie decided to make it her priority to create training and team-building activities to
motivate and promote more effective teamwork among her staff.
NEXT STEPS
Much of Larry’s time after the wildfires had been occupied talking about the housing
crisis and recovery efforts. Getting support for affordable housing over the years had its
up and downs, and Larry recalled a time when he was worried to be in the affordable
housing industry because of the lack of funding and support. As California witnessed
the effects of a shortage of supply in the housing market, affordable housing companies
like Burbank Housing were receiving greater support than they had received before.19
Consequently, much of Larry’s time had shifted to focusing on opportunities on how to
navigate this shortage, rather than on the difficulties.
Reviewing Burbank Housing’s Strategic Plan, Larry saw that little focus had been
placed on improving the organization’s internal capacity to handle any future projects.
Larry pondered “what is most important, and where should we start?”
ENDNOTES
1 Case writer’s interview with Larry Florin in January 2019. All subsequent quotes in this case except where noted were based on field
interviews with Burbank Housing staff in 2018 and 2019 and 2020.
2 Anon. (2019). U.S. Construction Industry Reports. (n.d.). Retrieved February 2, 2019, from
http://clients1.ibisworld.com.sonoma.idm.oclc.org/reports/us/industry/currentperformance.aspx?entid=164#KED.
3 Keighley, M. P. (2019). An introduction to the low-income housing tax credit. Congressional Research Service. Retrieved February 16,
2019, from https://crsreports.congress.gov/.
4 Anon., Who qualifies for affordable housing assistance? (n.d.). Retrieved February 15, 2019, from
https://affordablehousingonline.com/housing-help/Who-Qualifies-For-Affordable-Housing.
5 see note 2.
6 see note 2.
7 Ibid.
8 see note 3.
9 Sonoma County Economic Development Board, (2018). City Profile and Projections Report. Retrieved February 15, 2019, from
www.sonomaedb.org.
10 What Works Collaborative. (2009). The disruption of the low-income housing tax credit program: causes, consequences, responses,
and proposed correctives. Joint Center for Housing Studies of Harvard University. Retrieved March 5, 2019, from
http://www.jchs.harvard.edu/sites/default/files/disruption_of_the_lihtc_program_2009_0 .
11 California Legislative Analyst Office. (2015). California’s high housing costs. Retrieved February 21, 2019, from
https://lao.ca.gov/reports/2015/finance/housing-costs/housing-costs .
12 Ibid.
13 Rossmann, R. (November 02, 2017). Cal Fire tally reveals fires’ devastation. Retrieved February 9, 2019, from
https://www.pressdemocrat.com/news/7588914-181/cal-fire-4658-homes-destroyed.
14 Salam, R. (2019, February 15). Gavin Newsom’s Big Idea. Retrieved February 18, 2019, from
https://www.theatlantic.com/ideas/archive/2019/02/governor-newsom-addresses-californias-housing-crisis/582892/
15 Statements for 2019 had not been audited at the time this case was written in spring 2020.
16 Financial Ratios. (2018, February 08). Retrieved May 11, 2019, from
https://www.constructionbusinessowner.com/accounting/accounting-finance/financial-ratios.
17 Minichiello, S. (January 11, 2019). Affordable housing nonprofit buys Rincon Valley apartment complex. Retrieved February 5, 2019,
from https://www.pressdemocrat.com/news/9152733-181/burbank-housing-nonproft-buys-rincon.
18 Yardi Systems’ Administrator Salaries. (n.d.). Retrieved February 20, 2019, from https://www.glassdoor.com/Salary/Yardi-Systems-
Systems-Administrator-Salaries-E31057_D_KO14,35.htm.
19 Minichiello, S. (2019), op. cit.
http://clients1.ibisworld.com.sonoma.idm.oclc.org/reports/us/industry/currentperformance.aspx?entid=164#KED
https://crsreports.congress.gov/
https://affordablehousingonline.com/housing-help/Who-Qualifies-For-Affordable-Housing
http://www.sonomaedb.org/
http://www.jchs.harvard.edu/sites/default/files/disruption_of_the_lihtc_program_2009_0
https://lao.ca.gov/reports/2015/finance/housing-costs/housing-costs
https://www.pressdemocrat.com/news/7588914-181/cal-fire-4658-homes-destroyed
https://www.theatlantic.com/ideas/archive/2019/02/governor-newsom-addresses-californias-housing-crisis/582892/
https://www.constructionbusinessowner.com/accounting/accounting-finance/financial-ratios
https://www.pressdemocrat.com/news/9152733-181/burbank-housing-nonproft-buys-rincon
https://www.glassdoor.com/Salary/Yardi-Systems-Systems-Administrator-Salaries-E31057_D_KO14,35.htm
page C-273
CASE 20
Boeing 737 MAX: What
Response Strategy is Needed to
Ensure Passenger Safety and
Restore the Company’s
Reputation?
Copyright ©2021 by Rochelle R. Brunson and Marlene M. Reed. All rights reserved.
Rochelle R. Brunson
Baylor University
Marlene M. Reed
Baylor University
“All Boeing airplanes are certified and delivered to the highest levels of safety consistent with
industry standards. Airplanes are delivered with baseline configuration, which includes a
standard set of flight deck displays and alerts, crew procedures and training materials that meet
industry safety norms and most customer requirements. Customers may choose additional
options, such as alerts and indications, to customize their airplanes to support their individual
operations or requirements.”1
These were the words of a Boeing spokesman on March 22, 2019, a week
after U.S. President Donald Trump grounded all Boeing 737 MAX planes.
The reason for the grounding was the recent crash of two of these planes
killing 346 people.
Following the grounding of the planes, Boeing management had to
decide how to respond to this action on the part of the government, and the
growing outcry that Boeing had known of certain problems with the MAX
and did nothing. The MAX was scheduled to be returned to service by June
or July of 2020, so the company needed to find a way to repair their
faltering image by then.
History of Boeing
Commercial flight began in the early 20th Century when several engineering
entrepreneurs began to build airplanes. Among those entrepreneurs were
William E. Boeing, Donald Douglas, Sr., James H. “Dutch” Kindelberger,
and James S. McDonnell. The history of Boeing began in July 1916 when
William Boeing incorporated the aircraft manufacturer as the Pacific Aero
Products Company, which became renamed as Boeing Airplane Company
in the same year. Boeing began producing aircraft for the United States
military in 1917 when it produced modified Model Cs for the U.S. Navy.
This began a relationship that the company would have with the military
that continued through 2020.2
After the war ended, the first commercial craft, the B-1, began carrying
mail from Seattle to Canada. In 1927, the Boeing Model 40A was designed
specifically for carrying mail, and it delivered mail from San Francisco to
Chicago. About this time, engineers and pilots were testing the physical
limits and the durability of airplanes. The Army Air Services’ “World
Flyers” completed the first airplane trip around the globe in 1924. Then in
1927, Charles Lindburgh made the first solo nonstop crossing of the
Atlantic. Five years later, Amelia Earhart became the first woman to fly
solo across the Atlantic.
Boeing continued to develop aircraft for the U.S. military after World
War I and launched the B-17 “The Flying Fortress” in 1935. The plane
became a key asset in World War II, as did additional aircraft introduced by
page C-274
Boeing. General Carl Spaatz, who was the U.S. Air Commander in Europe,
said, “Without the B-17, we may have lost the war.”3
Commercial passenger service. Civilian air travel grew rapidly during
the 1950s and Post-War Era. The President of American Airlines, C.R.
Smith, commissioned Douglas Aircraft to come up with an airplane that
would carry passengers overnight. The plane the company designed was the
DC-3. This plane, which was rolled out in 1936, was the first airplane that
turned a profit based on commercial passenger demand. By 1939, the DC-3
and its earlier version, the DC-2, were carrying more than 90 percent of all
U.S. passengers. Other versions of the DC-3 were later produced for
military use during World War II. Even 70 years after its first delivery, this
plane was still in use by smaller and emerging markets.4 Boeing
Commercial Airplanes, which is a unit of the Boeing Company, is
headquartered in Seattle, Washington, and employed more than 60,000
people worldwide by 2020.
The Cold War and Development of Military Jet Aircraft. During the
Berlin Blockade, many countries sent the B-47 Stratojet bomber in to bring
food and supplies to the divided city. Then as Cold War tensions began to
escalate, the United States and the USSR raced to test new advanced jet
aircraft. The U.S. F-86 Sabre Jet helped speed the end of the Korean
Conflict as it dominated the skies over Korea. The F-86 destroyed so many
Russian-built planes that the final air-to-air victory was 10 to 1.
The A-4 Skyhawk Light Attack Bomber gave America’s allies the
flexibility they needed in a light aircraft. In 1964, the first A-4s took flight
in raids on North Vietnam. In addition, the F-4 Phantom II fighter was
deployed in the Vietnam War and in Operation Desert Storm.5
Boeing’s introduction of commercial jet airliners. The delivery of the
four-engine Boeing 707 to Pan Am in August 1958 marked a significant
advancement in commercial aviation. Pan Am made industry news later that
year with its flight from New York to Paris which the 707 completed in 8
hours 41 minutes. The 707 introduced the modern era of passenger jet travel
with longer flights, larger seating capacity, and faster travel times. Boeing’s
industry-leading commercial jet airliners dominated the 1960s through the
early 21st Century with new model introductions such as the 727, 737, 747,
757, 767, 777, and 787.
Boeing 737. The Boeing 737 became the workhorse of the airline
industry soon after its introduction in 1967. Lufthansa first took delivery of
the 737-100, which had six-abreast seating, on December 28, 1967. The
following day, United Airlines was the first U.S. carrier to take delivery of
the plane, a 737-200 model with an increased seating capacity and range.
By 1987, the 737 had become the most ordered plane in history. Boeing
introduced upgraded and lengthened 737-300, −400, and −500 versions of
the plane, with total orders reaching 3,100 by 1993. Boeing continued to
launch advanced versions of the 737 with Next Generation −600, −700,
−800, −900, and −900ER models launched between 1993 and 2005.
The Fourth Generation 737 MAX was launched in 2017 in multiple
model configurations with the MAX 7 having a length of 116 feet and
seating capacity of 172 passengers and the Max 10 having a length of 143
feet and seating capacity of 230. The MAX 8 and MAX 9 models fell
between the two other versions of the aircraft. Key advances of the 737
MAX included improved fuel efficiency that expanded range to up to 3,850
nautical miles, innovative carbon fiber/titanium engine turbine blades,
stylish cabin, improved cockpit displays and updated flight deck. The 737
MAX was Boeing’s fastest-selling passenger plane in history with about
5,000 orders from carriers in more than 100 countries.
Divisions of Boeing
The Boeing Company became the world’s largest producer of commercial
jetliners after its merger with McDonnell Douglas in 1997 and its
acquisition of the defense and space units of Rockwell International in
1996. Boeing was able to provide a selection of 23 different airplane
models to serve markets that required 100 to 600 seats. They also
manufactured a complete line of cargo freighters.
Boeing’s divisions in 2020 were Commercial, Defense, Space,
Innovation, and Services. The Commercial Division had produced such
airplanes as the Next Generation 737, the 737 MAX, the 747-8, the 767, the
page C-275
777, the 777X, the 787, Freighters, Boeing Business Jets, and Boeing
Support and Services. By 2020, there were 10,000 Boeing commercial
jetliners in service. These planes were purported to fly farther on less fuel
and significantly reduce emissions.
The Defense Division produced a large number of aircraft for the
government including Air Force 1, the AH-6 Light Attack Helicopter, the
AH-64 Apache, and various weapons systems. Their produce line also
included fighter jets, rotorcraft, cybersecurity products,
surveillance suites, missile defense, and commercial aircraft
derivatives.
In terms of the Space Division products in 2020, Boeing was attempting
to enable critical research on the International Space Station, deep-space
exploration and life on earth, and the CST-100 Starliner commercial
spacecraft. The company was working on a joint venture with Lockheed
Martin on a United Launch Alliance. They were also building a heavy-lift,
human-rated propulsion to deep space with the Space Launch System
rocket that would launch missions on a path to the Gateway Cislunar
Outpost.6
The Services Division had two parts: The Commercial Service Division
and the Government Services Division. Boeing’s experience in bringing
innovative service solutions to commercial, defense, and space customers
had prepared them to offer customer service to those particular groups.
Finally, Boeing’s organizational divisions in 2020 included an Innovation
Division. This group had more than $3 billion invested annually in research
and development. Some examples of Boeing’s innovations were the first
flights if the 737 MAX 9, the 787-10 and the T-X.
Boeing’s Purpose and Mission
Connect, protect, Explore and Inspire the World through Aerospace
Innovation.
At Boeing, we are committed to a set of core values that not only define
who we are, but also serve as guideposts to help us become the company we
would like to be. And we aspire to live these values every day.
Boeing Behaviors
Lead with courage and passion
Make customer priorities our own
Invest in our team and empower each other
Win with speed, agility and scale
Collaborate with candor and honesty
Reach higher, embrace change and learn from failure
Deliver results with excellence–Live the Enduring Values
Boeing’s Aspiration
Best in Aerospace and Enduring Global Industrial Champion.
Boeing’s Enterprise Strategy
Operate as One Boeing
Build Strength on Strength
Sharpen and Accelerate to Win
Boeing’s 2025 Goals
Market Leadership
Top-quartile Performance and Returns
Growth Fueled by Productivity
Design, Manufacturing, Services Excellence
Accelerated Innovation
Global Scale and Depth
Best Team, Talent and Leaders
Top Corporate Citizen
The Global Aircraft Manufacturing Industry
The Boeing Company was the world’s largest aerospace company in 2020.
The company was also the second-largest defense contractor for the United
States Government behind Lockheed Martin Corporation. Also, in 2020,
Boeing was the largest exporter in the United States.
Boeing and the French company Airbus were the two largest
manufacturers of commercial airplanes in the world. Boeing had developed
a competitive advantage based upon its size and market diversification. The
page C-276
company had the ability to take on multiple projects and clients at the same
time, and it leveraged its economies of scale to buy inputs in bulk.7 Because
Boeing operated in both the commercial and defense sectors, it was able to
offset any decline in one division with an emphasis upon the other sector.
Over the five years leading up to 2019, Boeing’s U.S. manufacturing
sector revenue was expected to decline at an annual rate of 1.0 percent to
$78.1 billion. A strong demand for commercial aircraft has helped soften
the declining defense spending in the United States and the billions of
dollars that have been committed to paying for damages caused by the
recent crashes and the thousands of flight cancellations occasioned by the
grounding of the 737 MAX. (See Exhibit 1 below entitled “The Boeing
Company’s Financial Performance 2014–19.”)
EXHIBIT 1 The Boeing Company’s Financial Performance
2014–2019 ($ amounts in billions)
Year Revenue Growth (%change)
Operating
income
Growth (%
change)
2014 $82.3 N/C $4.9 N/C
2015 85.9 4.4% 4.4 −10.2%
2016 83.7 −2.6% 4.6 4.5%
2017 81.4 −2.7% 7.5 63.0%
2018 85.0 4.4% 8.4 12.0%
2019 78.1 −8.1% 8.6 2.4%
Source: IBISWorld.com
The 737 NG and 737 MAX Crashes
On February 25, 2009, a Boeing 737 NG (Next Generation), a predecessor
of the 737 MAX, crashed near Amsterdam. The plane was Turkish Airlines
Flight 1951, and it was carrying 128 passengers from Istanbul. The first
officer guided the plane toward Runway 18R and called out changes to its
speed and direction. This officer was new to the Boeing jet, so the crew
included a third pilot in addition to the captain who had 13 years of
http://ibisworld.com/
experience flying this aircraft. As the plane dipped to 1,000 feet, the pilots
had not completed their landing checklist. When the plane reached 450 feet,
the pilots’ control sticks began shaking which informed them that there was
an impending stall. One of the pilots pushed the thrust lever forward to gain
speed; but when he let go, the computer commanded it to idle. The captain
intervened and disabled the auto-throttle. This maneuver set the thrust
levers to the maximum. By this time, nine seconds had elapsed since the
stall warning. Now it was too late to do anything else. The jet plunged into
a field close to the airport.8 It was later determined by an investigation of
the crash that Boeing had not included information in the NG operations
manual that could have helped the pilots respond when the sensor failed.
The second crash occurred on October 29, 2018, when a Lion Air Flight
610 fell into the Java Sea just 13 minutes after takeoff from Jakarta,
Indonesia. In that crash, 187 people were killed. The flight crew made a
distress call shortly before losing control. The aircraft had just been
received by Lion Air three months earlier.9
The third crash, which involved a 737 MAX, occurred in March of 2019.
This time Ethiopian Airlines Flight 302 crashed on takeoff from Addis
Ababa killing all 157 people aboard. The plane was bound for Nairobi,
Kenya. Just after takeoff, the pilot radioed a distress call and was given
immediate clearance to return and land. However, before the crew could
make it back to the airfield, the aircraft crashed. This aircraft was only four
months old.10
Investigators determined that Boeing’s design decisions on both the
MAX and the plane involved in the 2009 crash (the 737NG) allowed a
powerful computer command to be triggered by a single faulty sensor, even
though each plane was equipped with two sensors. In the two MAX
accidents, a sensor measuring the plane’s angle to the wind prompted a
flight control computer to push its nose down after takeoff. On the Turkish
Airlines flight, an altitude sensor caused a different computer to cut the
plane’s speed just before landing.11 (See Exhibit 2 below for a recounting of
the times of the crashes entitled “Timeline of First MAX Flights and
Accidents.”)
EXHIBIT 2 Timeline of First MAX Flights and Accidents
page C-277
Feb. 2009 2016
Boeing 737 NG crashes near Amsterdam The first MAX 8 Flight
2016 2017
2 of Boeing’s top pilots indicate problems
with MCAS The first MAX 9 Flight
2018 Oct. 29, 2018
The first MAX 7 Flight Lion Air 737 MAX crashes
March 10, 2019 March 13, 2019
Ethiopian Airlines 737 MAX crashes Pres. Trump grounds MAX planes
October 25, 2019 October 28, 2019
NTSB publishes report on Lion Air crash Boeing’s Pres. Muilenberg admits
Boeing knew of pilots’ concerns
December 23, 2019
Boeing’s President Muilenberg is fired by
the Board of Directors
What Caused the Crashes?
The 737 MAX could fly further and carry more people than any previous
generation of 737s. Because the engines were bigger and because the 737
sat so low to the ground, Boeing moved the engines slightly forward and
raised them higher under the wing. However, the new position of the
engines changed how the aircraft handled in the air. This created a potential
for the nose to pitch up during flight, and a pitched nose is a problem in
flight. If it is raised too high, the aircraft can stall. To keep the nose in trim,
Boeing came up with a software called the Maneuvering Characteristics
Augmentation System (MCAS). With this system, when a sensor on the
fuselage detected the nose was too high, MCAS automatically
pushed the nose down.12
On October 25, 2019, the Indonesian Transportation Safety Committee
published its final report on the Lion Air Crash. The report largely blamed
the MCAS device. Before the crash, the Lion Air pilots were unable to
determine the aircraft’s true airspeed and altitude and struggled to take
control of the plane as it oscillated for about 10 minutes. Whenever they
page C-278
pulled up from a dive, MCAS pushed the nose down again. The report
stated further that the MCAS function was not a fail-safe design and flight
crews had not been adequately trained to use it.13
Boeing’s Knowledge of Problems
On November 12, 2018, The Seattle Times reported that MAX pilots from
Southwest Airlines were “kept in the dark” about the MCAS and how to
respond to warnings from it. Then the Dallas Morning News found similar
complaints from American Airlines pilots just four months later.
In April 29, 2019, shareholders’ meeting, Boeing CEO Muilenberg, in
response to questions about the accidents, suggested that in some cases
pilots didn’t completely follow the procedures that Boeing had outlined to
prevent a crash in case the MCAS should happen to malfunction. On that
same date, the Wall Street Journal reported that, even for airlines that had
ordered it, the warning light was not operating.14
On October 17, 2019, Boeing suggested that it had turned over text
messages between two of the company’s top pilots which were sent in 2016.
The messages revealed that the company knew about the problems with the
MCAS system quite early. In fact, a former chief technical pilot for the
Boeing 737 described the MCAS’ habit of engaging itself “egregious.”15
Then on December 23, 2019, the CEO of Boeing Dennis Muilenberg was
fired by the Board. He was replaced by David Calhoun on January 13,
2020. Calhoun was a Boeing Board member and a former General Electric
executive. In an interview on January 29, 2020, Calhoun criticized the
company’s prior leadership for not immediately disclosing a large amount
of damning internal communications that raised safety questions about the
MAX. Calhoun promised that he would be more transparent.16
In February of 2020, Boeing fired a midlevel executive in charge of
pilots who exchanged internal emails that have embarrassed the company as
it continued to struggle to get the 737 MAX flying again. Those email
messages indicated that Boeing employees were mocking airline officials,
aviation regulators and even their own colleagues. In one of the emails, an
employee said the 7637 MAX had been “designed by clowns, who in turn
are supervised by monkeys.”17
Boeing’s Dilemma
Boeing reported a loss of $1 billion in the fourth quarter of 2019 as revenue
plunged 37 percent due to the grounding of the MAX (see Exhibit 3 entitled
“Summary Financial Results for the Fourth Quarter of 2018 and 2019” and
Exhibit 4 entitled “Commercial Airplane Deliveries in the Fourth Quarter of
2018 and 2019.”) The company suspended deliveries of the plane in the
early spring of 2019 and had speculated that deliveries would have been
restarted by the end of the year. The company lost $636 million for all of
2019. This compared to a profit of nearly $10.5 billion in 2018. This was
the first loss the company had experienced since 1997 when they were hit
by parts shortages, production delays and expenses occasioned by their
merger with McDonnell Douglas.18
EXHIBIT 3 Summary Financial Results for the Boeing,
Fourth Quarter 2018 and Fourth Quarter 2019 (In millions
except for share data)
2019 2018
Revenues $17,911 $28,341
GAAP
(Loss) Earnings from
Operations ($2,204) $4,175
Operating Margin (12.3)% 14.7%
Net (Loss)/Earnings ($1,010) $3,424
(Loss)/Earnings Per Share ($1.79) $5.93
Operating Cash Flow ($2,220) $2,947
Source: Boeing Web Site. https://www.boeing.com
EXHIBIT 4 Commercial Airplane Deliveries in the Fourth
Quarter 2018 and 2019 (Dollars in Millions)
2019 2018
Commercial Airplane
Deliveries 238 79
Revenues $16,531 $7,462
https://www.boeing.com/
2019 2018
(Loss)/Earnings from
Operations $2,600 ($2,844)
Operating Margin 15.7% (38.1)%
Source: Boeing Web Site. https://www.boeing.com
The Board of Directors had to deal with the bad publicity that the
company had received and the loss in revenue for the past year. Some
observers speculated that it might take a rebranding of the MAX to recover
the valued name of the company. Others suggested that an even more
desperate act of dropping the MAX was in order. This was the dilemma the
Boeing Board faced during the first quarter of 2020. There were even some
observers who wondered if the coverup of the difficulties with the MCAS
system might be tantamount to fraud.
ENDNOTES
1 German, K. (January 8, 2020). As Boeing CEO is fired, it’s unclear when the 737 MAX will fly again, CNET.
https://www.cnet.com/news/boeing-737-max-8-all-about-the-aircraft-flight-ban-and-investigations/.
2 Boeing’s website. http://www.boeing.com
3 Boeing website. http://www.boeing.com
4 Boeing website. http://www.boeing.com
5 Boeing website. http://www.boeing.com
6 Boeing website. http://www.boeing.com
7 IBISWorld.Com. https://www.ibisworld.com
8 Hamby, C. (January 21, 2020). How Boeing’s responsibility in a deadly crash “got buried,” The New York Times.
https://www.nytimes.com/2020/01/20/business/boeing-737-accidents.html.
9 German, K. (January 8, 2020). As Boeing CEO is fired, it’s unclear when the 737 Max will fly again.
https://www.cnet.com/news/boeing-737-max-8-all-about-the-aircraft-flight-ban-ande-investigations/.
10 Ibid.
11 Hamby, C. (January 21, 2020). How Boeing’s responsibility in a deadly crash “got buried,” The New York Times.
https://www.nytimes.com/2020/01/20/business/boeing-737-accidents.html.
12 German, K. (January 8, 2020). As Boeing CEO is fired, it’s unclear when the 737 Max will fly again, CNET.
https://www.cnet.com/news/boeing-737-max-8-all-about-the-aircraft-flight-ban-and-investigations/
13 Ibid.
14 Ibid.
15 Ibid.
16 Koenig, D. (January 30, 2020). Boeing posts 1st annual loss in 2 decades, Waco Tribune-Herald.
17 Tangel, A. and Pasztor, A. (February 14, 2020). Boeing fired midlevel executive following embarrassing emails, Wall
Street Journal.
18 Ibid.
https://www.boeing.com/
https://www.cnet.com/news/boeing-737-max-8-all-about-the-aircraft-flight-ban-and-investigations/
http://www.boeing.com/
http://www.boeing.com/
http://www.boeing.com/
http://www.boeing.com/
http://www.boeing.com/
http://ibisworld.com/
https://www.ibisworld.com/
https://www.cnet.com/news/boeing-737-max-8-all-about-the-aircraft-flight-ban-ande-investigations/
https://www.cnet.com/news/boeing-737-max-8-all-about-the-aircraft-flight-ban-and-investigations/
T
page C-279
CASE 21
The Walt Disney Company: Its Diversification
Strategy in 2020
Copyright ©2021 by John E. Gamble. All rights reserved.
John E. Gamble
Texas A&M University-Corpus Christi
he Walt Disney Company was a broadly diversified media and entertainment company with a business
lineup that included theme parks and resorts, motion picture production and distribution, cable television
networks, the ABC broadcast television network, eight local television stations, and a variety of other
businesses that exploited the company’s intellectual property. The company’s revenues had increased from
approximately $52.5 billion in fiscal 2015 to approximately $62.6 billion in fiscal 2019 and its share price
had regularly outperformed the S&P 500. While struggling somewhat in the mid-1980s, the company’s
performance had been commendable in almost every year since Walt Disney created Mickey Mouse in
1928.
Much of the company’s growth in revenues had resulted from acquisitions of leading motion picture
production companies. In 2006, the Walt Disney Company completed the $7.4 billion acquisition of Pixar,
the producer of Toy Story—the highest grossing film of 1995. In 2009, Disney acquired Marvel
Entertainment for $4.2 billion, which had produced highly successful Iron Man, Spider-Man, and Incredible
Hulk films. Walt Disney acquired Lucasfilm in 2012 in a $4 billion cash and stock transaction. Lucasfilm
was founded by George Lucas and was best known for its Star Wars motion picture franchise. However, the
company’s 2019 acquisition of 21st Century Fox for $71.3 billion in cash and stock had the potential to
radically improve its future financial performance.
The acquisition of 21st Century Fox extended Disney’s impressive collection of media franchises to
include 20th Century Fox, FX, National Geographic Channel, and Star India. Twenty-First Century Fox also
held a 30 percent ownership interest in Hulu and a 39.1 percent stake in Sky, Europe’s leading entertainment
company that served nearly 23 million households in five countries. The Fox broadcast network, 29 local
television stations, Fox News, and Fox Sports were not included in the merger and make up a new
independent, public company named Fox Corporation.
Disney CEO Robert Iger commented on the ability of the acquisition to further boost shareholder value.
The acquisition of 21st Century Fox will bring significant financial value to Disney and the shareholders of both companies, and after six
months of integration planning we’re even more enthusiastic and confident in the strategic fit of these complementary assets and the talent
at Fox.
The combination of Disney and 21st Century Fox is an extremely compelling proposition for consumers. It will allow us to create even
more appealing high-quality content, expand our direct-to-consumer offerings and international presence, and deliver more exciting and
personalized entertainment experiences to meet the growing demands of consumers worldwide.1
Just weeks after releasing impressive first quarter fiscal 2020 results for the combined company, Walt
Disney Company announced the retirement of CEO Bob Iger—the architect of the series of acquisitions that
page C-280
had compounded the company’s revenues and drove shareholder value for nearly 15 years. The February 25,
2020 announcement stated that Mr. Iger would remain Executive Chairman and direct the company’s
creative endeavors through 2021, with Mr. Bob Chapek becoming the Walt Disney
Company’s seventh CEO. Mr. Chapek, a 27-year veteran of the company had most recently
held the title of Chairman of Disney Parks, Experiences, and Products and would not only be required to
fully integrate the 21st Century Fox creative assets and operations into the Disney organization, but would
also have to contend with the effects of the novel Coronavirus (COVID-19), which were just becoming
known to the world.
COMPANY HISTORY
Walt Disney’s venture into animation began in 1919 when he returned to the United States from France,
where he had volunteered to be an ambulance driver for the American Red Cross during World War I.
Disney volunteered for the American Red Cross only after being told he was too young to enlist for the
United States Army. Upon returning after the war, Disney settled in Kansas City, Missouri, and found work
as an animator for Pesman Art Studio. Disney, and fellow Pesman animator, Ub Iwerks, soon left the
company to found Iwerks-Disney Commercial Artists in 1920. The company lasted only briefly, but Iwerks
and Disney were both able to find employment with a Kansas City company that produced short animated
advertisements for local movie theaters. Disney left his job again in 1922 to found Laugh-O-Grams, where
he employed Iwerks and three other animators to produce short animated cartoons. Laugh-O-Grams was
able to sell its short cartoons to local Kansas City movie theaters, but its costs far exceeded its revenues—
forcing Disney to declare bankruptcy in 1923. Having exhausted his savings, Disney had only enough cash
to purchase a one-way train ticket to Hollywood, California, where his brother, Roy, had offered a
temporary room. Once in California, Roy began to look for buyers for a finished animated-live action film
he retained from Laugh-O-Grams. The film was never distributed, but New York distributors Margaret
Winkler and Charles Mintz were impressed enough with the short film that they granted Disney a contract in
October 1923 to produce a series of short films that blended cartoon animation with live action motion
picture photography. Disney brought Ub Iwerks from Kansas City to Hollywood to work with Disney
Brothers Studio (later to be named Walt Disney Productions) to produce the Alice Comedies series that
would number 50-plus films by the series end in 1927. Disney followed the Alice Comedies series with a
new animated cartoon for Universal Studios. After Disney’s Oswald the Lucky Rabbit cartoons quickly
became a hit, Universal terminated Disney Brothers Studio and hired most of Disney’s animators to
continue producing the cartoon.
In 1928, Disney and Iwerks created Mickey Mouse to replace Oswald as the feature character in Walt
Disney Studios cartoons. Unlike with Oswald, Disney retained all rights over Mickey Mouse and all
subsequent Disney characters. Mickey Mouse and his girlfriend, Minnie Mouse, made their cartoon debuts
later in 1928 in the cartoons, Plane Crazy, The Gallopin’ Gaucho, and Steamboat Willie. Steamboat Willie
was the first cartoon with synchronized sound and became one of the most famous short films of all time.
The animated film’s historical importance was recognized in 1998 when it was added to the National Film
Registry by the United States Library of Congress. Mickey Mouse’s popularity exploded over the next few
decades with a Mickey Mouse Club being created in 1929, new accompanying characters such as Pluto,
Goofy, Donald Duck, and Daisy Duck being added to Mickey Mouse cartoon storylines, and Mickey Mouse
appearing in Walt Disney’s 1940 feature length film, Fantasia. Mickey Mouse’s universal appeal reversed
Walt Disney’s series of failures in the animated film industry and became known as the mascot of Disney
Studios, Walt Disney Productions, and The Walt Disney Company.
The success of The Walt Disney Company was sparked by Mickey Mouse, but Disney Studios also
produced several other highly successful animated feature films including Snow White and the Seven
Dwarfs in 1937, Pinocchio in 1940, Dumbo in 1941, Bambi in 1942, Song of the South in 1946, Cinderella
in 1950, Treasure Island in 1950, Peter Pan in 1953, Sleeping Beauty in 1959, and One Hundred-One
Dalmatians in 1961. What would prove to be Disney’s greatest achievement began to emerge in 1954 when
construction began on his Disneyland Park in Anaheim, California. Walt Disney’s Disneyland resulted from
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an idea that Disney had many years earlier while sitting on an amusement park bench watching his young
daughters play. Walt Disney thought that there should be a clean and safe park that had attractions that both
parents and children alike would find entertaining. Walt Disney spent years planning the park and
announced the construction of the new park to America on his Disneyland television show that was
launched to promote the new $17 million park. The park was an instant success when it
opened in 1955 and recorded revenues of more than $10 million during its first year of
operation. After the success of Disneyland, Walt Disney began looking for a site in the eastern United States
for a second Disney park. He settled on an area near Orlando, Florida in 1963 and acquired more than
27,000 acres for the new park by 1965.
Walt Disney died of lung cancer in 1966, but upon his death, Roy O. Disney postponed retirement to
become president and CEO of Walt Disney Productions and oversee the development of Walt Disney World
Resort. Walt Disney World Resort opened in October 1971—only two months before Roy O. Disney’s death
in December 1971. The company was led by Donn Tatum from 1971 to 1976. Tatum had been with Walt
Disney Productions since 1956 and led the further development of Walt Disney World Resort and began the
planning of EPCOT in Orlando and Tokyo Disneyland. Those two parks were opened during the tenure of
Esmond Cardon Walker, who had been an executive at the company since 1956 and chief operating officer
since Walt Disney’s death in 1966. Walker also launched The Disney Channel before his retirement in 1983.
Walt Disney Productions was briefly led by Ronald Miller, who was the son-in-law of Walt Disney. Miller
was ineffective as Disney chief executive officer and was replaced by Michael Eisner in 1984.
Eisner formulated and oversaw the implementation of a bold strategy for Walt Disney Studios, which
included the acquisitions of ABC, ESPN, Miramax Films, and the Anaheim Angels, and the Fox Family
Channel; the development of Disneyland Paris, Disney-MGM Studios in Orlando, Disney California
Adventure Park, Walt Disney Studios theme park in France, and Hong Kong Disneyland; and the launch of
the Disney Cruise Line, the Disney Interactive game division, and the Disney Store retail chain. Eisner also
restored the company’s reputation for blockbuster animated feature films with the creation of The Little
Mermaid in 1989, and Beauty and the Beast and The Lion King in 1994. Despite Eisner’s successes, his
tendencies toward micromanagement and skirting board approval for many of his initiatives and his
involvement in a long-running derivatives suit led to his removal as chairman in 2004 and his resignation in
2005.
The Walt Disney Company’s CEO in 2018, Robert (Bob) Iger, became a Disney employee in 1996 when
the company acquired ABC. Iger was president and CEO of ABC at the time of its acquisition by The Walt
Disney Company and remained in that position until made president of Walt Disney International by Alan
Eisner in 1999. Bob Iger was promoted to president and chief operating officer of The Walt Disney
Company in 2000 and was named as Eisner’s replacement as CEO in 2005. Iger’s first strategic moves in
2006 included the $7.4 billion acquisition of Pixar animation studios and the purchase of the rights to
Disney’s first cartoon character, Oswald the Lucky Rabbit, from NBCUniversal. In 2007, Robert Iger
commissioned two new 340-meter ships for the Disney Cruise Lines that would double its fleet size from
two ships to four. The new ships ordered by Iger were 40 percent larger than Disney’s two older vessels and
entered service in 2011 and 2012. Iger also engineered the $4.2 billion acquisition of Marvel Entertainment
in 2009 that would enable the Disney production motion pictures featuring Marvel comic book characters
such as Iron Man, Incredible Hulk, Thor, Spider-Man, and Captain America. In 2012, Walt Disney acquired
Lucasfilm in a $4 billion cash and stock transaction. Lucasfilm was founded by George Lucas and was best
known for its Star Wars motion picture franchise. The $71.3 billion acquisition of 21st Century Fox in 2019
was Iger’s most ambitious merger and would create tremendous market expansion opportunities and
difficult integration challenges.
Bob Chapek became The Walt Disney Company’s seventh CEO on February 25, 2020. Chapek had been
a Disney employee for 27 years and produced strong results in several of the company’s businesses,
including its Theme Parks, Disney Resorts, Consumer Products, and Walt Disney Studios Home
Entertainment. His most recent position prior to being named CEO was serving as Chairman of the Parks,
Experiences and Products since the segment’s creation in 2018 and as Chairman of its predecessor, Parks
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and Resorts, since 2015. Among the most notable accomplishments of Bob Chapek was overseeing the
opening of Shanghai Disney Resort, the creation of Start Wars: Galaxy’s Edge lands at Disneyland and Walt
Disney World, the expansion of Disney Cruise Line with the construction of three new ships, and the
addition of Marvel-themed attractions around the world.
A financial summary for The Walt Disney Company for 2015 through 2019 is provided in Exhibit 1.
Exhibit 2 tracks the performance of The Walt Disney Company’s common shares between March 2013 and
March 29, 2020.
EXHIBIT 1 Financial Summary for The Walt Disney Company, Fiscal Years 2015–
2019 (in millions)
2019(1) 2018(2) 2017(3) 2016(4) 2015(5)
Statements of income
Revenues $ 69,570 $59,434 $55,137 $55,632 $52,465
Net income from continuing operations 10,913 13,066 9,366 9,790 8,852
Net income from continuing operations
attributable to Disney 10,441 12,598 8,980 9,391 8,382
Per common share
Earnings attributable to Disney
Continuing Operations–Diluted $ 6.27 $ 8.36 $ 5.69 $ 5.73 $ 4.90
Continuing Operations–Basic 6.30 8.40 5.73 5.76 4.95
Dividends (6) 1.76 1.68 1.56 1.42 1.81
Balance sheets
Total assets $193,984 $98,598 $95,789 $92,033 $88,182
Long-term obligations 60,852 24,797 26,710 24,189 19,142
Disney shareholders’ equity 88,877 48,773 41,315 43,265 44,525
Statements of cash flows
Cash provided (used) by – continuing operations:
Operating activities $ 5,984 $14,295 $12,343 $13,136 $11,385
Investing activities (15,096) (5,336) (4,111) (5,758) (4,245)
Financing activities (464) (8,843) (8,959) (7,220) (5,801)
(1) On March 20, 2019, the Company acquired TFCF for cash and Disney shares (see Note 4 to the Consolidated Financial
Statements). TFCF and Hulu’s financial results have been consolidated since the date of acquisition and had a number of adverse
impacts on fiscal 2019 results, the most significant of which were amortization expense related to recognition of TFCF and Hulu
intangible assets and fair value step-up on film and television costs ($0.74 per diluted share), an impact from shares issued upon
the TFCF acquisition ($0.74 per diluted share), restructuring and impairment charges ($0.55 per diluted share) and TFCF and Hulu
operating results ($0.27 per diluted share). Additional impacts included a non-cash gain from remeasuring our initial 30% interest in
Hulu to fair value ($2.22 per diluted share), equity investment impairments ($0.25 per diluted share) and a charge for the
extinguishment of a portion of the debt originally assumed in the TFCF acquisition ($0.24 per diluted share). Cash provided by
continuing operating activities reflected payments for tax obligations that arose from the spin-off of Fox Corporation in connection
with the TFCF acquisition and the sale of the RSNs acquired with TFCF and cash used in continuing investing activities reflected a
cash payment of $35.7 billion paid to acquire TFCF, offset by the $25.7 billion in cash and cash equivalents assumed in the TFCF
acquisition.
(2) Fiscal 2018 results include a net benefit from the Tax Act ($1.11 per diluted share) and the benefit from a reduction in the
Company’s fiscal 2018 U.S. federal statutory income tax rate ($0.75 per diluted share) (see Note 10 to the Consolidated Financial
Statements). In addition, fiscal 2018 included gains on the sales of real estate and property rights ($0.28 per diluted share) and an
adverse impact from equity investment impairments ($0.11 per diluted share).
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(3) Fiscal 2017 results include a non-cash net gain in connection with the acquisition of a controlling interest in BAMTech ($0.10
per diluted share) (see Note 4 to the Consolidated Financial Statements).
(4) Fiscal 2016 results include the Company’s share of a net gain recognized by A+E in connection with an acquisition of an
interest in Vice ($0.13 per diluted share).
(5) Fiscal 2015 results include the write-off of a deferred tax asset as a result of a recapitalization at Disneyland Paris ($0.23 per
diluted share).
(6) In fiscal 2015, the Company began paying dividends on a semiannual basis. Accordingly, fiscal 2015 includes dividend
payments related to fiscal 2014 and the first half of fiscal 2015.
Source: The Walt Disney Company 2019 10-K.
EXHIBIT 2 Performance of The Walt Disney Company’s Stock Price, March 2013 to
March 29, 2020
Source: Bigcharts.com
THE WALT DISNEY COMPANY’S CORPORATE STRATEGY AND
BUSINESS OPERATIONS IN 2020
In 2020, The Walt Disney Company was broadly diversified into theme parks, hotels and resorts, cruise
ships, cable networks, broadcast television networks, television production, television station operations,
live action and animated motion picture production and distribution, music publishing, live theatrical
productions, children’s book publishing, interactive media, and consumer products retailing. The company’s
corporate strategy was centered on (1) creating high-quality content, (2) exploiting technological
innovations to make entertainment experiences more memorable, and (3) international expansion. The
company’s 2006 acquisition of Pixar and 2009 acquisition of Marvel were executed to enhance the
resources and capabilities of its core animation business with the addition of new animation skills and
http://bigcharts.com/
page C-284characters. The company’s 2011 acquisition of UTV was engineered to facilitate its international
expansion efforts. The acquisition of Lucasfilm’s Star Wars franchise in 2012 not only allowed
the company to produce new films in the series, but integrate Star Wars into its other business units,
including theme park attractions. The company’s 2019 acquisition of 21st Century Fox was made to further
expand Disney’s portfolio of high-quality branded content with new cable channels such as National
Geographic, FX and accelerate its direct-to-consumer (DTC) strategy by giving the company a 60 percent
controlling interest in Hulu. Hulu was made the official streaming service for FX Networks in 2020.
Disney’s corporate strategy also called for sufficient capital to be allocated to its core theme parks and
resorts business to sustain its advantage in the industry. The company expanded the range of attractions at its
theme parks with billion-dollar plus additions such as its new Toy Story Land attractions opened in 2018 at
Shanghai Disneyland and Disney’s Hollywood Studios and its Star Wars Land opened in Disney’s
Hollywood Studios and Anaheim’s Disneyland in 2019. Expansions were also underway at Tokyo Disney
Resort and Hong Kong Disneyland.
The Walt Disney Company’s corporate strategy also attempted to capture synergies existing between its
business units. Two of the company’s highest grossing films, Pirates of the Caribbean: On Stranger Tides
and Cars 2 were also featured at the company’s Florida and California theme parks. The company had
leveraged ESPN’s reputation in sports by building 230-acre ESPN Wide World of Sports Complex in
Orlando that could host amateur and professional events and boost occupancy in its 18 resort hotels and
vacation clubs located at the Walt Disney World resort.
In 2020, the company’s business units were organized into four divisions: Parks, Experiences and
Products, Media Networks, Direct-to-Consumer & International, and Studio Entertainment.
Parks, Experiences and Products
The Walt Disney Company’s parks and resorts division included the Walt Disney World Resort in Orlando,
the Disneyland Resort in California, Disneyland Paris, the Aulani Disney Resort and Spa in Hawaii, the
Disney Vacation Club, the Disney Cruise Line, and Adventures by Disney. The company also owned a
47 percent interest in Hong Kong Disneyland Resort and a 43 percent interest in Shanghai Disney Resort.
Disney also licensed the operation of Tokyo Disney Resort in Japan. Revenue for the division was primarily
generated through park admission fees, hotel room charges, merchandise sales, food and beverage sales,
sales and rentals of vacation club properties, and fees charged for cruise vacations.
Revenues from hotel lodgings and food and beverage sales were a sizeable portion of the division’s
revenues. For example, at the 25,000-acre Walt Disney World Resort alone, the company operated 18 resort
hotels with approximately 22,000 rooms. Walt Disney World Resort also included the 127-acre Disney
Springs retail, dining, and entertainment complex where visitors could dine and shop during or after park
hours. Walt Disney World Resort in Orlando also included four championship golf courses, full-service
spas, tennis, sailing, water skiing, two water parks, and a 230-acre sports complex that was host to over
200 amateur and professional events each year. In 2019, Disney announced plans to build a Star Wars-
themed hotel at Walt Disney World Resort.
Walt Disney’s 486-acre resort in California included two theme parks—Disneyland and Disney California
Adventure—along with three hotels and its Downtown Disney retail, dining, and entertainment complex.
Disney California Adventure was opened in 2001 adjacent to the Disneyland property and included four
lands—Golden State, Hollywood Pictures Backlot, Paradise Pier, and Bug’s Land. The park was initially
built to alleviate overcrowding at Disneyland and was expanded with the addition of World of Color in 2010
and Cars Land in 2012 to strengthen its appeal with guests.
Aulani was a 21-acre oceanfront family resort located in Oahu, Hawaii. Disneyland Paris included two
theme parks, seven resort hotels, two convention centers, a 27-hole golf course, and a shopping, dining, and
entertainment complex. The company’s Hong Kong Disneyland, Shanghai Disney Resort, and Tokyo
Disney Resort them parks were highly popular with ambitious expansion plans.
The company also offered timeshare sales and rentals in 15 resort facilities through its Disney Vacation
Club. The Disney Cruise Line operated four ships out of North America and Europe. Disney’s cruise
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activities were developed to appeal to the interests of children and families. Its Port Canaveral cruises
included a visit to Disney’s Castaway Cay, a 1,000-acre private island in the Bahamas. The popularity of
Disney’s cruise vacations allowed its fleet to be booked to full capacity year-round.
The company’s consumer products division included the company’s Disney Store retail
chain and businesses specializing in merchandise licensing and children’s book and magazine publishing. In
2020, the company owned and operated approximately 200 Disney Stores in North America, approximately
80 stores in Europe, approximately 50 stores in Japan, and two stores in China. Its publishing business
included comic books, various children’s book magazine titles available in print and eBook format, and
smartphone and tablet computer apps designed for children. The division’s sales were primarily affected by
seasonal shopping trends and changes in consumer disposable income.
The division’s operating results for fiscal years 2018 and 2019 are presented in Exhibit 3.
EXHIBIT 3 Operating Results for Walt Disney’s Parks, Experiences and Products
Business Unit, Fiscal Years 2018–2019 (in millions)
2019 2018
Revenues
Theme park admissions $7,183 $6,504
Parks & Experiences merchandise, food and
beverage 5,674 5,154
Resorts and vacations 5,938 5,378
Merchandise licensing and retail 4,249 4,494
Parks licensing and other 1,657 1,494
Total revenues 24,701 23,024
Operating expenses 13,326 12,455
Selling, general, administrative and other 2,930 2,896
Depreciation and amortization 2,327 2,161
Equity in the loss of investees 23 25
Operating Income $6,095 $5,487
Source: The Walt Disney Company 2019 10-K.
Media Networks
The Walt Disney Company’s media networks business unit included its domestic and international cable
networks, the ABC television network, television production, and U.S. domestic television stations. The
company’s television production was limited to television programming for ABC and its eight local
television stations were all ABC affiliates. Six of Disney’s eight domestic television stations were located in
the 10 largest U.S. television markets. In all, ABC had 240 affiliates in the United States.
When asked about the decline in cable television viewership, Bob Iger suggested that content delivery
method was less important than the quality and appeal of content.
Well, for the most part, we’ve looked at channels less as channels and more as brands. And it’s less important to us how people get those
channels. . .but what’s more important to us is the quality of the brand and intellectual property that fits under that brand umbrella. And our
intention is to. . .migrate those brands and those products in the more modern direction from a distribution and consumption perspective.2
Exhibit 4 provides the market ranking for Disney’s local stations and its number of subscribers and
ownership percentage of its cable networks for 2013, 2017, and 2019. The exhibit also provides a brief
description of its ABC broadcasting and television production operations. The division also included ESPN
Radio, which aired sports-oriented radio programming on 400 terrestrial radio stations (4 of which were
owned by Disney) in the United States. Operating results for Disney’s media networks division for fiscal
2015 through fiscal 2019 are presented in Exhibit 5.
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EXHIBIT 4 The Walt Disney Company’s Media Network Subscribers, 2013, 2017, and
2019 (in millions)
Cable Networks
Estimated
Subscribers
(in millions)(1)
2013
EstimatedSubscribers(in millions)(1)2017 EstimatedSubscribers(in millions)(1)2019
ESPN
ESPN 99 88 83
ESPN–
International n.a. 146 65
ESPN2 99 87 83
ESPNU 72 67 61
ESPNEWS 73 66 58
SEC Network(2) n.a. 60 59
Disney Channels
Worldwide
Disney Channel–
Domestic 99 92 86
Disney Channels–
International(3)
141 221 227
Disney Junior–
Domestic 58 72 66
Disney Junior–
International(3)
n.a. 151 162
Disney XD–
Domestic 78 74 68
Disney XD–
International(3)
91 127 65
Freeform n.a. 90 85
Fox
FX n.a. n.a. 87
FXM n.a. n.a. 56
FXX n.a. n.a. 84
Fox
International n.a. n.a. 220
National
Geographic
National
Geographic–
Domestic
n.a. n.a. 86
National Geographic
Wild n.a. n.a. 59
National Geographic
– International n.a. n.a. 316
Star n.a. n.a. 221
A+E and Vice
A&E 99 91 85
page C-287
Cable Networks
Estimated
Subscribers
(in millions)(1)
2013
EstimatedSubscribers(in millions)(1)2017 EstimatedSubscribers(in millions)(1)2019
Lifetime 99 91 85
HISTORY 99 92 86
Lifetime Movie
Network 82 73 63
FYI n.a. 58 51
Viceland n.a. 70 64
Broadcasting
ABC Television Network (240 local affiliates reaching nearly 100 percent of U.S. television households)
Television Production
ABC Studios, Twentieth Century Fox Television (TCFTV) and Fox 21 Television Studios (Fox21) (Daytime, primetime, late night
and news television programming)
Domestic Television Stations
Market TV Station Television Market Ranking(3)
New York, NY WABC-TV 1
Los Angeles, CA KABC-TV 2
Chicago, IL WLS-TV 3
Philadelphia, PA WPVI-TV 4
Houston, TX KTRK-TV 7
San Francisco, CA KGO-TV 8
Raleigh-Durham, NC WTVD-TV 25
Fresno, CA KFSN-TV 54
(1) Estimated U.S. subscriber counts according to Nielsen Media Research, except as noted below.
(2) Because Nielsen Media Research does not measure this channel, estimated subscribers are according to SNL Kagan.
(3) Based on Nielsen Media Research, U.S. Television Household Estimates, January 1, 2019.
Source: The Walt Disney Company 2019 10-K.
EXHIBIT 5 Operating Results for Walt Disney’s Media Networks Business Unit, Fiscal
Years 2015–2019 (in millions)
Revenues 2019 2018 2017 2016 2015
Affiliate fees $11,907 $11,324 $12,659 $12,259 $12,029
Advertising 6,586 6,938 8,129 8,509 8,361
TV/SVOD distribution and
other 3,429 3,037 2,722 2,921 2,874
Total revenues 21,922 21,299 23,510 23,689 23,264
Operating expenses 13,197 12,754 14,068 13,571 13,150
Selling, general,
administrative and
other
1,899 1,909 2,647 2,705 2,869
Depreciation and
amortization 199 206 237 255 266
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Revenues 2019 2018 2017 2016 2015
Equity in the income of
investees (711) (766) (344) (597) (814)
Operating Income $7,338 $7,196 $6,902 $7,755 $7,793
Source: The Walt Disney Company 2017 and 2019 10-Ks.
Direct-to-Consumer & International
Among the most significant challenges to Disney’s media networks division was the competition for
viewers, which impacted advertising rates and revenues. Not only did the company compete against other
broadcasters and cable networks for viewers, but it also competed against other types of entertainment and
delivery platforms. For example, consumers might prefer to watch videos, movies, or other content on the
Internet or Internet streaming services rather than watch cable or broadcast television. The effect of the
Internet on broadcast news had been significant and the growth of streaming services had the potential to
affect the advertising revenue potential of all of Disney’s media businesses.
The combat competing streaming content providers and capitalize on such opportunities,
Disney launched two direct-to-consumer (DTC) streaming services and Over-the-Top (OTT) services that
delivered content without a distributor. Disney’s ESPN+ DTC video streaming service was launched in 2018
and its Disney+ DTC subscription service that included Disney, Pixar, Marvel, Star Wars, and National
Geographic branded programming was launched in the United States and four other countries in 2019.
Within its first year, ESPN+ had attracted more than 3.5 million paid subscribers. The company expected
Disney+ to also have strong appeal with media consumers and intended to launch Disney+ in additional
countries in 2020 through 2024.
Disney+ users would have immediate access to 500 movies and 7,500 episodes of television content.
Disney+ also launched with 10 original movies, and the company planned to increase Disney+ content to
include 630 movies and 10,000 television episodes by 2024. Disney also planned to add 60 original series,
specials and movies each year to the Disney+ library by 2024. Programming was priced at $6.99 per month
for Disney+ or ESPN+ or at a $12.99 bundle price that included both DTC subscription services and ad-
supported Hulu.
The company’s acquisition of a controlling interest in Hulu was an integral component of its overall DTC
strategy, both domestically and internationally. Hulu was planned as the official streaming service for all FX
Networks programming as well as supporting ESPN+ and Disney+.
The company’s international channels produced local programs or delivered Disney produced content to
cable providers operating in countries throughout the world. Disney branded television channels were
broadcasted in approximately 35 languages in 165 countries. Fox programming was broadcasted in 40
languages in 95 countries. National Geographic was available in 80 countries, while ESPN programming
was available in 15 countries outside the United States. Star operated approximately 80 channels in ten
languages in India, Asia, the United Kingdom, Europe, the Middle East, and parts of Africa. The division
also operated UTC, Bindass and Hungama branded channels in India. Operating results for Disney’s Direct-
to-Consumer & International division for fiscal year 2018 and 2019 are presented in Exhibit 6.
EXHIBIT 6 Operating Results for Walt Disney’s Direct-to-Consumer & International
Business Unit, Fiscal Years 2018–2019 (in millions)
2019 2018
Revenues
Affiliate fees $1,372 $1,335
Advertising 1,311 1,293
Subscription fees and other 731 447
page C-289
2019 2018
Total revenues 3,414 3,075
Operating expenses 2,384 1,983
Selling, general, administrative and other 1,003 861
Depreciation and amortization 185 94
Equity in the income of investees 580 421
Operating Income $(738) $(284)
Source: The Walt Disney Company 2019 10-K.
Studio Entertainment
The Walt Disney Company’s studio entertainment division produced live-action and animated motion
pictures, direct-to-video content, musical recordings, and Disney on Ice and Disney Live! live performances.
The division’s motion pictures were produced and distributed under Walt Disney Pictures, 20th Century
Fox, Pixar, Marvel, Lucasfilm, Fox Searchlight Pictures, and Blue Sky Studios banners. The division
planned to release approximately 25 feature films in 2020 had Disney produced more than 1,000 feature
films and 100 full-length animated films throughout its history. The company’s complete library of Disney-
produced and acquired films stood at 2,300 titles as of September 2019. Disney’s most financially
successful films in 2019 included The Lion King, Toy Story 4, Frozen 2, Star Wars: The Rise of Skywalker,
and Aladdin. The company’s largest grossing films in 2018 were the Incredibles 2 and Ant-Man and the
Wasp. All of the company’s best-grossing films in both years were either remakes or sequels of previous
Disney, Lucasfilm, or Marvel blockbusters.
Most motion pictures typically incurred losses during the theatrical distribution of the film because of
production costs and the cost of extensive advertising campaigns accompanying the launch of
the film. Profits for many films did not occur until the movie became available on DVD or
Blu-Ray disks for home entertainment, which usually began three to six months after the film’s theatrical
release. Revenue was also generated when a movie moved to pay-per-view (PPV)/video-on-demand (VOD)
two months after the release of the DVD and when the motion picture became available on subscription
premium cable channels such as HBO about 16 months after PPV/VOD availability. Broadcast networks
such as ABC could purchase telecast rights to movies later as could basic cable channels such as Lifetime or
the Hallmark Channel. Premium cable channels such as Showtime and Starz might also purchase telecast
rights to movies long after its theatrical release. Similarly, subscription video on demand (SVOD) services
such as Netflix might acquire distribution rights to a film for a 12- to 19-month window. Telecast right fees
decreased as the length of time from initial release increased. Operating results for the Walt Disney
Company’s Studio Entertainment division for fiscal 2015 through fiscal 2019 are produced in Exhibit 7.
EXHIBIT 7 Operating Results for Walt Disney’s Studio Entertainment Business Unit,
Fiscal Years 2015–2019 (in millions)
2019 2018 2017 2016 2015
Revenues
Theatrical distribution 4,726 $4,303 $2,903 $3,672 $2,321
Home entertainment 1,734 1,647 1,798 2,108 1,799
TV/SVOD distribution and
other 4,667 4,115 3,678 3,661 3,246
Total revenues 11,127 10,065 8,379 9,441 7,366
Operating expenses 5,187 4,449 3,667 3,991 3,050
Selling, general, administrative
and other 3,119 2,493 2,242 2,622 2,204
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290
2019 2018 2017 2016 2015
Depreciation and
amortization
135
119
115
125 139
Operating Income $2,686 $3,004 $2,355 $2,703 $1,973
Source: The Walt Disney Company 2017 and 2019 10-Ks.
The company’s consolidated statements of income for fiscal 2017 through fiscal 2019 are presented in
Exhibit 8. The Walt Disney Company’s balance sheets for fiscal 2018 and fiscal 2019 are presented in
Exhibit 9.
EXHIBIT 8 Consolidated Statements of Income for The Walt Disney Company, Fiscal
Years 2017–2019 (in millions, except per share data)
2019 2018 2017
Revenues
Services $60,542 $50,869 $46,843
Products 9,028
8,565
8,294
Total revenues 69,570 59,434 55,137
Costs and expenses:
Cost of services (exclusive of depreciation and
amortization) 36,450 27,528 25,320
Cost of products (exclusive of depreciation and
amortization) 5,568 5,198 4,986
Selling, general, administrative and other 11,541 8,860 8,176
Depreciation and amortization 4,160
3,011
2,782
Total costs and expenses 57,719 (4,597)
41,264
Restructuring and impairment charges 1,183 33 98
Other income, net 4,357 601 78
Interest expense, net 978 574 385
Equity in the income (loss) of investees, net (103)
(102) 320
Income from continuing operations before income taxes 13,944 14,729 13,788
Income taxes from continuing operations 3,031
1,663
4,422
Net income from continuing operations 10,913 13,066 9,366
Income from discontinued operations (includes income tax expense
of $35, $0 and $0, respectively) 671 — —
Net income 11,584 13,066 9,366
Less: Net income from continuing operations attributable to
noncontrolling and redeemable noncontrolling interests 472 468 386
Less: Net income from discontinued operations attributable to
noncontrolling interests 58 — —
Net income attributable to Disney $11,054 $12,598 $8,980
Earnings per share attributable to Disney:
Diluted
page C-291
2019 2018 2017
Continuing operations $ 6.27 $ 8.36 $ 5.69
Discontinued operations 0.37 — —
$ 6.64 $ 8.36 $ 5.69
Basic
Continuing operations $ 6.30 $ 8.40 $ 5.73
Discontinued operations 0.37 — —
$ 6.68 $ 8.40 $ 5.73
Weighted average number of common and common equivalent
shares outstanding:
Diluted 1,666 1,507 1,578
Basic 1,656 1,499 1,568
Source: The Walt Disney Company 2019 10-K.
EXHIBIT 9 Consolidated Balance Sheets for The Walt Disney Company, Fiscal Years
2018 and 2019 (in millions, except per share data)
September 28, 2019 September 29, 2018
ASSETS
Current assets
Cash and cash equivalents $ 5,418 $ 4,150
Receivables 15,481 9,334
Inventories 1,649 1,392
Television costs and advances 4,597 1,314
Other current assets 979 635
Total current assets 28,124 16,825
Film and television costs 22,810 7,888
Investments 3,224
2,899
Parks, resorts and other property
Attractions, buildings and equipment 58,589 55,238
Accumulated depreciation (32,415) (30,764)
26,174 24,474
Projects in progress 4,264 3,942
Land 1,165 1,124
31,603 29,540
Intangible assets, net 23,215 6,812
Goodwill 80,293 31,269
Other assets 4,715 3,365
Total assets $193,984 $98,598
LIABILITIES AND EQUITY
Current liabilities
Accounts payable and other accrued liabilities $ 17,762 $ 9,479
Current portion of borrowings 8,857 3,790
Deferred revenue and other 4,722 4,591
page C-292
September 28, 2019 September 29, 2018
Total current liabilities 31,341 17,860
Borrowings 38,129 17,084
Deferred income taxes 7,902 3,109
Other long-term liabilities 13,760 6,590
Commitments and contingencies
Redeemable noncontrolling interests 8,963 1,123
Equity
Preferred stock — —
Common stock, $.01 par value, Authorized–4.6 billion
shares, Issued–1.8 billion shares at September 28, 2019
and 2.9 billion shares at September 29, 2018
53,907 36,779
Retained earnings 42,494 82,679
Accumulated other comprehensive loss (6,617) (3,097)
Treasury stock, at cost, 19 million shares at September 28,
2019 and 1.4 billion shares at September 29,
2018
(907) (67,588)
Total Disney Shareholders’ equity 88,877 48,773
Noncontrolling interests 5,012 4,059
Total equity 93,889 52,832
Total liabilities and equity $193,984 $98,598
Source: The Walt Disney Company 2019 10-K.
UNCERTAINTY AS THE WALT DISNEY COMPANY ENTERS THE
SECOND HALF OF 2020
The Walt Disney Company reported a revenue increase of 29 percent during its first six months of 2020
compared to the same period in 2019. However, the company’s earnings per share experienced a 73 percent
year-over-year decline during the first six months of 2020. The company’s strong revenue growth was a
result of the inclusion of 21st Century Fox business units into the company’s financial reports, but the steep
73 percent decline in EPS signaled the difficulty of the effective integration of Fox businesses into the
Disney organization.
The dramatic decline in net income from operations from $8.2 billion for the six
months ending March 30, 2019 to $2.6 billion for the six months ending March 28, 2020, also
reflected the early costs of the novel coronavirus pandemic on the company.
The greatest impact of COVID-19 on the company’s divisions occurred in its Parks, Experiences and
Products division, which saw a year-over-year declines in Q1 2020 revenue and operating income of
10 percent and 58 percent, respectively. Disney had closed its domestic parks and resorts, cruise line
business and Disneyland Paris in mid-March 2020. The company’s theme parks and resorts in Asia were
closed earlier in 2020. The company estimated that approximately $1 billion of the company’s operating
profit decline could be attributed to the company’s necessary response to the pandemic. A summary of The
Walt Disney Company’s second quarter revenue and operating income by division for Fiscal 2019 and
Fiscal 2020 is presented in Exhibit 10.
EXHIBIT 10 Revenues and Operating Income by Division for The Walt Disney
Company, First Six Months 2019 and First Six Months 2020 (in millions, except per
share data)
Quarter Ended Six Months Ended
March 28, 2020 March 30, 2019 March 28, 2020 March 30, 2019
Revenues
Media Networks $ 7,257
$
5,683 $14,618 $11,604
Parks, Experiences and
Products(1)
5,543 6,171 12,939 12,995
Studio Entertainment(1) 2,539 2,157 6,303 3,981
Direct-to-Consumer &
International 4,123 1,145 8,110 2,063
Eliminations(2)
(1,453)
(234)
(3,103)
(418)
$18,009 $14,922 $38,867 $30,225
Segment operating income
(loss):
Media Networks $ 2,375
$
2,230
$
4,005
$
3,560
Parks, Experiences and
Products(1)
639 1,506 2,977 3,658
Studio Entertainment(1) 466 506 1,414 815
Direct-to-Consumer &
International (812) (385) (1,505) (521)
Eliminations (252)
(41)
(473)
(41)
$ 2,416
$
3,816
$
6,418
$
7,471
(1) The allocation of Parks, Experiences and Products revenues to Studio Entertainment was $117 million and $126 million for the
quarters ended March 28, 2020 and March 30, 2019, respectively, and $301 million and $280 million for the six months ended
March 28, 2020 and March 30, 2019, respectively.
Source: The Walt Disney Company Form 10-Q, March 28, 2020.
Walt Disney Company CEO Bob Chapek, commented on the Company’s Q2 2020 performance and its
long-term prospects as it entered the second half of Fiscal 2020.
While the COVID-19 pandemic has had an appreciable financial impact on a number of our businesses, we are confident in our ability to
withstand this disruption and emerge from it in a strong position. Disney has repeatedly shown that it is exceptionally resilient, bolstered by
the quality of our storytelling and the strong affinity consumers have for our brands.3
ENDNOTES
1 As quoted by Bob Iger, Chairman and Chief Executive Officer of The Walt Disney Company, during Investor Conference Call, June 20, 2018.
2 As quoted by Bob Iger, Chairman and Chief Executive Officer of The Walt Disney Company, during the Morgan Stanley Technology, Media and Telcom Conference,
February 26, 2018.
3 As quoted by Bob Chapek, Chief Executive Officer of The Walt Disney Company, “The Walt Disney Company Reports Secon Quarter and Six Months Earnings for
Fiscal 2020,” May 5, 2020.
I
page C-293
CASE 22
Robin Hood
Copyright ©1991 by Joseph Lampel.
Joseph Lampel
Alliance Manchester Business School
t was in the spring of the second year of his insurrection against the High
Sheriff of Nottingham that Robin Hood took a walk in Sherwood Forest.
As he walked, he pondered the progress of the campaign, the disposition of
his forces, the Sheriff’s recent moves, and the options that confronted him.
The revolt against the Sheriff had begun as a personal crusade. It erupted
out of Robin’s conflict with the Sheriff and his administration. However,
alone Robin Hood could do little. He therefore sought allies, men with
grievances and a deep sense of justice. Later he welcomed all who came,
asking few questions and demanding only a willingness to serve. Strength,
he believed, lay in numbers.
He spent the first year forging the group into a disciplined band, united in
enmity against the Sheriff and willing to live outside the law. The band’s
organization was simple. Robin ruled supreme, making all important
decisions. He delegated specific tasks to his lieutenants. Will Scarlett was in
charge of intelligence and scouting. His main job was to shadow the Sheriff
and his men, always alert to their next move. He also collected information
on the travel plans of rich merchants and tax collectors. Little John kept
discipline among the men and saw to it that their archery was at the high
page C-294
peak that their profession demanded. Scarlett took care of the finances,
converting loot to cash, paying shares of the take, and finding suitable
hiding places for the surplus. Finally, Much the Miller’s son had the
difficult task of provisioning the ever-increasing band of Merry Men.
The increasing size of the band was a source of satisfaction for Robin,
but also a source of concern. The fame of his Merry Men was spreading,
and new recruits were pouring in from every corner of England. As the
band grew larger, their small bivouac became a major encampment.
Between raids the men milled about, talking and playing games. Vigilance
was in decline, and discipline was becoming harder to enforce. “Why,”
Robin reflected, “I don’t know half the men I run into these days.”
The growing band was also beginning to exceed the food capacity of the
forest. Game was becoming scarce, and supplies had to be obtained from
outlying villages. The cost of buying food was beginning to drain the band’s
financial reserves at the very moment when revenues were in decline.
Travelers, especially those with the most to lose, were now giving the forest
a wide berth. This was costly and inconvenient to them, but it was
preferable to having all their goods confiscated.
Robin believed that the time had come for the Merry Men to change their
policy of outright confiscation of goods to one of a fixed transit tax. His
lieutenants strongly resisted this idea. They were proud of the Merry Men’s
famous motto: “Rob the rich and give to the poor.” “The farmers and the
townspeople,” they argued, “are our most important allies. How can we tax
them, and still hope for their help in our fight against the Sheriff?”
Robin wondered how long the Merry Men could keep to the ways and
methods of their early days. The Sheriff was growing stronger and
becoming better organized. He now had the money and the men and was
beginning to harass the band, probing for its weaknesses. The tide of events
was beginning to turn against the Merry Men. Robin felt that the campaign
must be decisively concluded before the Sheriff had a chance
to deliver a mortal blow. “But how,” he wondered, “could this
be done?”
Robin had often entertained the possibility of killing the Sheriff, but the
chances for this seemed increasingly remote. Besides, killing the Sheriff
might satisfy his personal thirst for revenge, but it would not improve the
situation. Robin had hoped that the perpetual state of unrest and the
Sheriff’s failure to collect taxes would lead to his removal from office.
Instead, the Sheriff used his political connections to obtain reinforcement.
He had powerful friends at court and was well regarded by the regent,
Prince John.
Prince John was vicious and volatile. He was consumed by his
unpopularity among the people, who wanted the imprisoned King Richard
back. He also lived in constant fear of the barons, who had first given him
the regency but were now beginning to dispute his claim to the throne.
Several of these barons had set out to collect the ransom that would release
King Richard the Lionheart from his jail in Austria. Robin was invited to
join the conspiracy in return for future amnesty. It was a dangerous
proposition. Provincial banditry was one thing, court intrigue another.
Prince John had spies everywhere, and he was known for his vindictiveness.
If the conspirators’ plan failed, the pursuit would be relentless and
retributions swift.
The sound of the supper horn startled Robin from his thoughts. There
was the smell of roasting venison in the air. Nothing was resolved or settled.
Robin headed for camp promising himself that he would give these
problems his utmost attention after tomorrow’s raid.
I
page C-295
CASE 23
Southwest Airlines in 2020: Culture,
Values, and Operating Practices
Copyright ©2021 by Arthur A. Thompson and John E. Gamble. All rights reserved.
Arthur A. Thompson
The University of Alabama
John E. Gamble
Texas A&M University—Corpus Christi
n 2020, Southwest Airlines was the largest U.S. domestic airline with 162.7 million
passengers boarded in 2019. The company had held the title of largest U.S. air carrier
since 2003, despite offering few international flights relative to major airlines, such as
American Airlines, Delta Air Lines, and United Air Lines—see Exhibit 1. Southwest
also had the enviable distinction of being the only major air carrier in the world that had
been profitable for 46 consecutive years (1973–2019). In 2020, Southwest was named
to Fortune’s list of the World’s Most Admired Companies for the 27th consecutive year,
coming in at number 11.
EXHIBIT 1 Total Number of Domestic and International Passengers
Traveling on Selected U.S. Airlines, 2015, 2017, 2019 (in thousands)
Carrier Total Number of Enplaned Passengers (including both passengerspaying for tickets and passengers traveling on frequent flyer awards)
American Airlines 2015 2017 2019
Domestic 93,280 116,528 126,067
International 25,010 28,391 29,752
Total 118,290 144,919 155,819
page C-296
Carrier Total Number of Enplaned Passengers (including both passengerspaying for tickets and passengers traveling on frequent flyer awards)
Delta Air Lines
Domestic 114,904 120,929 136,407
International 22,828 24,508 26,066
Total 137,732 145,437 162,473
Southwest Airlines
Domestic 142,408 153,859 158,446
International 2,167 3,868 4,262
Total 144,575 157,727 162,708
United Air Lines
Domestic 69,179 80,554 87,586
International 25,713 26,607 28,743
Total 94,892 107,161 116,329
Source: U.S. Department of Transportation, Bureau of Transportation Statistics, Air Carrier Statistics,
Form T-100.
From humble beginnings in 1971 as a scrappy underdog with quirky practices that
once flew mainly to “secondary” airports (rather than high traffic airports like Chicago
O’Hare, Los Angeles International, Dallas-Fort Worth International, and Hartsfield-
Jackson International Airport in Atlanta), Southwest had climbed up through the
industry ranks to become a major competitive force in the domestic segment of the U.S.
airline industry. It had weathered industry downturns, dramatic increases in the price of
jet fuel, cataclysmic falloffs in airline traffic due to terrorist attacks and economy-wide
recessions, and fare wars and other attempts by rivals to undercut its business, all the
while adding more and more flights to more and more airports.
In 2019, Southwest earned after-tax profits of $2.3 billion on revenues of
$22.4 billion, as airline passenger travel in the United States set a fifth consecutive
record high with enplaned passengers increasing by 4.2 percent since 2018, 9.1 percent
since 2017, and 12.5 percent from 2016. The grounding of the Boeing 737-MAX by
President Trump on March 13, 2019 impacted Southwest Airlines’ profitability for the
year as its fleet included 34 737-MAX aircraft. The reliability of the 737
MAX had been brought into question after the crash of Lion Air Flight
610 in Jakarta, Indonesia, on October 29, 2018, which was followed by the crash of
Ethiopian Airlines Flight 302 on March 10, 2019. As of mid-2020, all 737-MAX
aircraft remained grounded until Boeing could develop design changes necessary to
meet the Federal Aviation Administration’s airworthiness directive.
More challenges to the airline industry arose in 2020 as novel Coronavirus brought
about stay-at-home orders, social distancing requirements, and remote working
protocols. U.S. passenger airlines experienced a combined loss of $5.2 billion for the
first quarter of 2020 as a result of the impact of the COVID-19 pandemic on global air
travel. The number of passengers flying on U.S. airlines had declined by 96 percent
between April 2019 and April 2020 as the world focused on limiting potential exposure
to the virus. Only three million passengers flew on U.S. airlines in April 2020, which
was the smallest number of monthly air travelers in the United States since 1974.
Between March 2020 and April 2020, airline employment had decreased by 31,000
workers to approximately 428,000—the lowest total number of full-time employees in
the industry since August 2017. Southwest Airlines’ strategy, commitment to
excellence in operations, and strategy-supportive culture would help the company
recover from the devastating effects of the pandemic on the airline industry, but few
were predicting when air travel would return to pre-COVID-19 levels.
COMPANY BACKGROUND
In late 1966, Rollin King, a San Antonio entrepreneur who owned a small commuter air
service, marched into Herb Kelleher’s law office with a plan to start a low-cost/low-fare
airline that would shuttle passengers between San Antonio, Dallas, and Houston.1 Over
the years, King had heard many Texas businessmen complain about the length of time
that it took to drive between the three cities and the expense of flying the airlines
currently serving these cities. His business concept for the airline was simple: Attract
passengers by flying convenient schedules, get passengers to their destination on time,
make sure they have a good experience, and charge fares competitive with travel by
automobile. Kelleher, skeptical that King’s business idea was viable, dug into the
possibilities during the next few weeks and concluded a new airline was feasible; he
agreed to handle the necessary legal work and also to invest $10,000 of his own funds
in the venture.
In 1967, Kelleher filed papers to incorporate the new airline and submitted an
application to the Texas Aeronautics Commission for the new company to begin
serving Dallas, Houston, and San Antonio.2 But rival airlines in Texas pulled every
string they could to block the new airline from commencing operations, precipitating a
contentious four-year parade of legal and regulatory proceedings. Herb Kelleher led the
fight on the company’s behalf, eventually prevailing in June 1971 after winning two
appeals to the Texas Supreme Court and a favorable ruling from U.S. Supreme Court.
Kelleher recalled, “The constant proceedings had gradually come to enrage me. There
was no merit to our competitors’ legal assertions. They were simply trying to use their
superior economic power to squeeze us dry so we would collapse before we ever got
into business. I was bound and determined to show that Southwest Airlines was going
to survive and was going into operation.”3
In January 1971, Lamar Muse was brought in as the CEO to get operations
underway. Muse was an aggressive and self-confident airline veteran who knew the
page C-297
business well and who had the entrepreneurial skills to tackle the challenges of building
the airline from scratch and then competing head-on with the major carriers. Through
private investors and an initial public offering of stock in June 1971, Muse raised
$7 million in new capital to purchase planes and equipment and provide cash for start-
up. Boeing agreed to supply three new 737s from its inventory, discounting its price
from $5 million to $4 million and financing 90 percent of the $12 million deal. Muse
was able to recruit a talented senior staff that included a number of veteran executives
from other carriers. He particularly sought out people who were innovative, would not
shirk doing things differently or unconventionally, and were motivated by the challenge
of building an airline from scratch. Muse wanted his executive team to be willing to
think like mavericks and not be lulled into instituting practices at Southwest that
imitated what was done at other airlines.
Southwest’s Struggle to Gain a Market Foothold
In June 1971, Southwest initiated its first flights with a schedule that soon included six
roundtrips between Dallas and San Antonio and 12 roundtrips between
Houston and Dallas. But the introductory $20 one-way fares to fly the
Golden Triangle, well below the $27 and $28 fares charged by rivals, attracted
disappointingly small numbers of passengers. To try to gain market visibility and drum
up more passengers, Southwest undertook some creative actions to supplement its ad
campaigns publicizing its low fares:
Taking a cue from being based at Dallas Love Field, Southwest began using the tag
line “Now There’s Somebody Else Up There Who Loves You.” The routes between
Houston, Dallas, and San Antonio became known as the Love Triangle. Southwest’s
planes were referred to as Love Birds, drinks became Love Potions, peanuts were
called Love Bites, drink coupons were Love Stamps, and tickets were printed on
Love Machines. The “love” campaign set the tone for Southwest’s approach to its
customers and company efforts to make flying Southwest Airlines an enjoyable, fun,
and differentiating experience. (Later, when the company went public, it chose LUV
as its stock-trading symbol.)
In order to add more flights without buying more planes, the head of Southwest’s
ground operations came up with a plan for ground crews to off-load passengers and
baggage, refuel the plane, clean the cabin and restock the galley, on-load passengers
and baggage, do the necessary preflight checks and paperwork, and push away from
the gate in ten minutes. The 10-minute turn became one of Southwest’s signatures
during the 1970s and 1980s. (In later years, as passenger volume grew and many
flights were filled to capacity, the turnaround time gradually expanded to 25 minutes.
Even so, the 25-minute average turnaround times at Southwest were shorter than the
30-to-50-minute turnarounds typical at other major airlines.)
page C-298
In late November 1971, Lamar Muse came up with the idea of offering a $10 fare to
passengers on the Friday night Houston-Dallas flight. With no advertising, the 112-
seat flight sold out. This led Muse to realize that Southwest was serving two quite
distinct types of travelers in the Golden Triangle market: (1) business travelers who
were more time sensitive than price sensitive and wanted weekday flights at times
suitable for conducting business and (2) price-sensitive leisure travelers who wanted
lower fares and had more flexibility about when to fly.4 He came up with a two-tier
on-peak and off-peak pricing structure in which all seats on weekday flights departing
before 7 p.m. were priced at $26 and all seats on other flights were priced at $13.
Passenger traffic increased significantly—and system-wide on-peak and off-peak
pricing soon became standard across the whole airline industry.
In 1972, the company decided to move its flights in Houston from the newly-opened
Houston Intercontinental Airport (where it was losing money and where it took 45
minutes to get to downtown) to the abandoned Houston Hobby Airport located much
closer to downtown Houston. Despite being the only carrier to fly into Houston
Hobby, the results were spectacular—business travelers that flew to Houston
frequently from Dallas and San Antonio found the Houston Hobby location far more
convenient and passenger traffic doubled almost immediately.
All these moves paid off. The resulting gains in passenger traffic enabled allowed
Southwest to report its first-ever annual profit in 1973.
More Legal and Regulatory Hurdles
During the rest of the 1970s, Southwest found itself embroiled in another round of legal
and regulatory battles. One battle involved Southwest’s refusal to move its flights from
Dallas Love Field, located 10 minutes from downtown, out to the newly-opened Dallas-
Fort Worth Regional Airport, which was 30 minutes from downtown Dallas. Local
officials were furious because they were counting on fees from Southwest’s flights in
and out of DFW to help service the debt on the bonds issued to finance the construction
of DFW. Southwest’s position was that it was not required to move because it had not
agreed to do so or been ordered to do so by the Texas Aeronautics Commission—
moreover, the company’s headquarters were located at Love Field. The courts
eventually ruled Southwest’s operations could remain at Love Field.
A second battle ensued when rival airlines protested Southwest’s application to begin
serving several smaller cities in Texas; their protest was based on arguments that these
markets were already well-served and that Southwest’s entry would result in costly
overcapacity. Southwest countered that its low fares would allow more
people to fly and grow the market. Again, Southwest prevailed and its
views about low fares expanding the market proved accurate. In the year before
Southwest initiated service, 123,000 passengers flew from Harlingen Airport in the Rio
Grande Valley to Houston, Dallas, or San Antonio; in the 11 months following
Southwest’s initial flights, 325,000 passengers flew to the same three cities.
Believing that Braniff and Texas International were deliberately engaging in tactics
to harass Southwest’s operations, Southwest convinced the U.S. government to
investigate what it considered predatory tactics by its chief rivals. In February 1975,
Braniff and Texas International were indicted by a federal grand jury for conspiring to
put Southwest out of business—a violation of the Sherman Antitrust Act. The two
airlines pleaded “no contest” to the charges, signed cease-and-desist agreements, and
were fined a modest $100,000 each.
When Congress passed the Airline Deregulation Act in 1978, Southwest applied to
the Civil Aeronautics Board (now the Federal Aviation Agency) to fly between Houston
and New Orleans. The application was vehemently opposed by local government
officials and airlines operating out of DFW because of the potential for passenger traffic
to be siphoned away from DFW. The opponents solicited the aid of Fort Worth
congressman Jim Wright, then the majority leader of the U.S. House of Representatives,
who took the matter to the floor of the House of Representatives; a rash of lobbying and
maneuvering ensued. What emerged came to be known as the Wright Amendment of
1979: no airline may provide non-stop or through-plane service from Dallas Love Field
to any city in any state except for locations in Texas, Louisiana, Arkansas, Oklahoma,
and New Mexico. Southwest was prohibited from advertising, publishing schedules or
fares, or checking baggage for travel from Dallas Love Field to any city it served
outside the five-state “Wright Zone.” The Wright Amendment continued in effect until
1997 when Alabama, Mississippi, and Kansas were added to the five-state “Wright
Zone”; in 2005, Missouri was added to the Wright Zone. In 2006, after a heated battle
in Congress, legislation was passed and signed into law that repealed the Wright
Amendment beginning in October 2014. With the repeal of the Wright Amendment,
Southwest Airlines increased flight activity from Dallas Love Field by 50 percent to
add 20 new nonstop destinations with 180 daily departures to a total of 50 nonstop
destinations.
The Emergence of a Combative Can-Do Culture at Southwest
The legal, regulatory, and competitive battles that Southwest fought in these early years
produced a strong esprit de corps among Southwest personnel and a drive to survive
and prosper despite the odds. With newspaper and TV stories reporting Southwest’s
difficulties regularly, employees were fully aware that the airline’s existence was
constantly on the line. Had the company been forced to move from Love Field, it would
most likely have gone under, an outcome which employees, Southwest’s rivals, and
local government officials understood well. According to Southwest’s former president,
Colleen Barrett, the obstacles thrown in Southwest’s path by competitors and local
officials were instrumental in building Herb Kelleher’s passion for Southwest Airlines
and ingraining a combative, can-do spirit into the corporate culture:5
page C-299
They would put twelve to fifteen lawyers on a case and on our side there was Herb. They almost wore him to the
ground. But the more arrogant they were, the more determined Herb got that this airline was going to go into the
air—and stay there.
The warrior mentality, the very fight to survive, is truly what created our culture.
When Lamar Muse resigned in 1978, Southwest’s board wanted Herb Kelleher to take
over as chairman and CEO. But Kelleher enjoyed practicing law and, while he agreed
to become chairman of the board, he insisted that someone else be CEO. Southwest’s
board appointed Howard Putnam, a group vice president of marketing services at
United Airlines, as Southwest’s president and CEO in July 1978. Putnam asked
Kelleher to become more involved in Southwest’s day-to-day operations, and over the
next three years, Kelleher got to know many of the company’s personnel and observe
them in action. Putnam announced his resignation in Fall 1981 to become president and
COO at Braniff International. This time, Southwest’s board succeeded in persuading
Kelleher to take on the additional duties of CEO and president.
Sustained Growth Transforms Southwest into the Domestic Market
Share Leader, 1981–2019
When Herb Kelleher took over in 1981, Southwest was flying 27 planes to 14
destination cities and had $270 million in revenues and 2,100 employees. Over the next
20 years, Southwest Airlines prospered under Kelleher’s leadership. When Kelleher
stepped down as CEO in mid-2001, the company had 350 planes flying to 58 U.S.
airports, annual revenues of $5.6 billion, over 30,000 employees, and 64 million fare-
paying passengers annually.
Under the two CEOs who succeeded Kelleher, Southwest continued its march to
becoming the market share leader in domestic air travel. In the process, the company
won more industry Triple Crown awards for best on-time record, best baggage
handling, and fewest customer complaints than any other U.S. airline. While Southwest
fell short of its on-time performance and baggage handling goals in some years, it still
led the domestic airline industry in Customer Satisfaction and received other awards
and recognitions, including #1 U.S. Low-Cost Carrier for Customer Satisfaction by J.D.
Power, Best Airline Rewards Program by U.S. News & World Report, 2019 Airline of
the Year by Airlines Reporting Corp., #1 for Customer Satisfaction with Airline Travel
Websites by J.D. Power, and the top ranking by the Freddie Awards for Best Customer
Service and Best Loyalty Credit Card.
Exhibit 2 provides a five-year summary of Southwest’s financial and operating
performance.
HERB KELLEHER: THE CEO WHO TRANSFORMED
SOUTHWEST INTO A MAJOR AIRLINE
Herb Kelleher majored in philosophy at Wesleyan University in Middletown,
Connecticut, graduating with honors. He earned his law degree at New York University,
again graduating with honors and also serving as a member of the law review. After
graduation, he clerked for a New Jersey Supreme Court justice for two years and then
joined a law firm in Newark. Upon marrying a woman from Texas and becoming
enamored with Texas, he moved to San Antonio where he became a successful lawyer
and came to represent Rollin King’s small aviation company.
EXHIBIT 2 Summary of Southwest Airlines’ Financial and Operating
Performance, 2015–2019
Year ended December 31,
2019 2018 2017 2016 2015
Financial Data
(in millions, except per
share amounts):
Operating revenues $ 22,428
$
21,965
$
21,146 $ 20,289 $ 19,820
Operating expenses 19,471 18,759 17,739 16,767 15,821
Operating income 2,957 3,206 3,407 3,522 3,999
Other expenses (income)
net – 42 142 72 520
Income before taxes 2,957 3,164 3,265 3,450 3,479
Provision (benefit) for
income taxes 657 699 (92) 1,267 1,298
Net income $ 2,300 $ 2,465 $ 3,357 $ 2,183 $ 2,181
Net income per share,
basic $4.28 $4.30 $5.58 $3.48 $3.30
Net income per share,
diluted $4.27 $4.29 $5.57 $3.45 $3.27
Cash dividends per
common share $0.70 $0.61 $0.48 $0.38 $0.29
Total assets at period-end 25,895 26,243 25,110 23,286 21,312
Long-term obligations at
period-end 1,846 2,771 3,320 2,821 2,541
Stockholders’ equity at
period-end 9,832 9,853 9,641 7,784 7,358
Operating Data:
page
C-300
Year ended December 31,
2019 2018 2017 2016 2015
Revenue passengers
carried (000s) 134,056 134,890 130,256 124,720
118,171
Enplaned passengers
(000s) 162,681 163,606 157,677 151,740 144,575
Revenue passenger miles
(RPMs) (in millions) (a) 131,345 133,322 129,041 124,798 117,500
Available seat miles
(ASMs) (in millions) (b) 157,254 159,795 153,811 148,522 140,501
Load factor (c) 83.50% 83.40% 83.90% 84.00% 83.60%
Average length of
passenger haul (miles) 980 988 991 1,001 994
Average aircraft stage
length (miles) 748 757 754 760 750
Trips flown 1,367,727 1,375,030 1,347,893 1,311,149 1,267,358
Seats flown (000s) (d) 206,390 207,223 200,879 193,168 184,955
Seats per trip (e) 150.90 150.70 149.00 147.30 145.90
Average passenger fare $154.98 $151.64 $151.73 $152.89 $154.85
Passenger revenue yield
per RPM (cents) (f) 15.82 15.34 15.32 15.28 15.57
Operating revenues per
ASM (cents) (g) (j) 14.26 13.75 13.75 13.66 13.98
Passenger revenue per
ASM (cents) (h) 13.21 12.80 12.85 12.84 13.02
Operating expenses per
ASM (cents) (i) 12.38 11.74 11.53 11.29 11.26
Operating expenses per
ASM, excluding fuel
(cents)
9.62 8.85 8.88 8.73 8.60
Operating expenses per
ASM, excluding fuel and
profitsharing (cents)
9.19 8.51 8.53 8.34 8.16
Fuel costs per gallon,
including fuel tax $2.09 $2.20 $1.99 $1.90 $1.96
Fuel consumed, in gallons
(millions) 2,077 2,094 2,045 1,996 1,901
Active fulltime equivalent
employees 60,767 58,803 56,110 53,536 49,583
page C-301
Year ended December 31,
2019 2018 2017 2016 2015
Aircraft at end of period 747 750 706 723 704
(a) A revenue passenger mile is one paying passenger flown one mile. Also referred to as ”traffic,” which
is a measure of demand for a given period.
(b) An available seat mile is one seat (empty or full) flown one mile. Also referred to as ”capacity,” which is
a measure of the space available to carry passengers in a given period.
(c) Revenue passenger miles divided by available seat miles.
(d) Seats flown is calculated using total number of seats available by aircraft type multiplied by the total
trips flown by the same aircraft type during a particular period.
(e) Seats per trip is calculated by dividing seats flown by trips flown.
(f) Calculated as passenger revenue divided by revenue passenger miles. Also referred to as ”yield,” this
is the average cost paid by a paying passenger to fly one mile, which is a measure of revenue production
and fares.
(g) Calculated as operating revenues divided by available seat miles. Also referred to as ”operating unit
revenues” or ”RASM,” this is a measure of operating revenue production based on the total available seat
miles flown during a particular period.
(h) Calculated as passenger revenue divided by available seat miles. Also referred to as ”passenger unit
revenues,” this is a measure of passenger revenue production based on the total available seat miles
flown during a particular period.
(i) Calculated as operating expenses divided by available seat miles. Also referred to as ”unit costs” or
”cost per available seat mile,” this is the average cost to fly an aircraft seat (empty or full) one mile, which
is a measure of cost efficiencies.
(j) Year ended 2015 RASM excludes a $172 million one-time special revenue adjustment in July 2015 as a
result of the Company’s amendment of its co-branded credit card agreement with Chase Bank USA, N.A.
and the resulting required change in accounting methodology. Including the special revenue adjustment,
RASM would have been 14.11 cents for the year ended 2015.
Source: Southwest Airlines 10-K Report, 2019.
When Herb Kelleher took on the role of Southwest’s CEO in 1981, he
made a point of visiting with maintenance personnel to check on how well the planes
were running and talking with the flight attendants. Kelleher did not do much managing
from his office, preferring instead to be out among the troops as much as he could. His
style was to listen and observe and to offer encouragement. Kelleher attended most
graduation ceremonies of flight attendant classes, and he often appeared to help load
bags on “Black Wednesday,” the busy travel day before Thanksgiving. He knew the
names of thousands of Southwest employees and was held in the highest regard by
Southwest employees. When he attended a Southwest employee function, he was
swarmed like a celebrity.
Kelleher was a strong believer in the principle that employees—not customers—
came first:6
You have to treat your employees like your customers. When you treat them right, then they will treat your
outside customers right. That has been a very powerful competitive weapon for us. You’ve got to take the time to
listen to people’s ideas. If you just tell somebody no, that’s an act of power and, in my opinion, an abuse of
power. You don’t want to constrain people in their thinking.
Another indication of the importance that Kelleher placed on employees was the
message he had penned in 1990 that was prominently displayed in the lobby of
Southwest’s headquarters in Dallas:
The people of Southwest Airlines are “the creators” of what we have become—and of what we will be.
Our people transformed an idea into a legend. That legend will continue to grow only so long as it is nourished
—by our people’s indomitable spirit, boundless energy, immense goodwill, and burning desire to excel.
Our thanks—and our love—to the people of Southwest Airlines for creating a marvelous family and a
wondrous airline.
In June 2001, Herb Kelleher stepped down as CEO but continued on in his role as
chairman of Southwest’s Board of Directors and the head of the board’s executive
committee; as chairman, he played a lead role in Southwest’s strategy, expansion to
new cities and aircraft scheduling, and governmental and industry affairs. In May 2008,
after more than 40 years of leadership at Southwest, Kelleher retired as chairman (but
he remained a full-time Southwest employee until July 2013 and carried the title of
Chairman Emeritus in 2016). Herb Kelleher died in Dallas, Texas at age 87 on January
3, 2019.
EXECUTIVE LEADERSHIP AT SOUTHWEST: 2001–
2020
In June 2001, Southwest Airlines, responding to anxious investor concerns about the
company’s leadership succession plans, began an orderly transfer of power and
responsibilities from Herb Kelleher, age 70, to two of his most trusted protégés. James
F. Parker, 54, Southwest’s general counsel and one of Kelleher’s most trusted protégés,
succeeded Kelleher as Southwest’s CEO. Another of Kelleher’s trusted protégés,
Colleen Barrett, 56, Southwest’s executive vice-president-customers and self-described
keeper of Southwest’s pep rally corporate culture, became president and chief operating
officer.
James Parker, CEO from 2001–2004
James Parker’s association with Herb Kelleher went back 23 years to the time when
they were colleagues at Kelleher’s old law firm. Parker moved over to Southwest from
the law firm in February 1986. Parker’s profile inside the company as Southwest’s vice
president and general counsel had been relatively low, but he was Southwest’s chief
labor negotiator and much of the credit for Southwest’s good relations with employee
unions belonged to Parker. Parker and Kelleher were said to think much alike, and
Parker was regarded as having a good sense of humor, although he did not have as
colorful and flamboyant a personality as Kelleher. Parker was seen as an honest,
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straight-arrow kind of person who had a strong grasp of Southwest’s culture and market
niche and who could be nice or tough, depending on the situation.
Parker retired unexpectedly, for personal reasons, in July 2004, stepping down as
CEO and Vice Chairman of the Board and also resigning from the
company’s board of directors. He was succeeded by Gary C. Kelly.
Colleen Barrett, Southwest’s President, 2001–2008
Barrett began working with Kelleher as his legal secretary in 1967 and had been with
Southwest since 1978. As executive vice president—customers, Barrett had a high
profile among Southwest employees and spent most of her time on culture-building,
morale-building, and customer service; her goal was to ensure that employees felt good
about what they were doing and felt empowered to serve the cause of Southwest
Airlines.7 She and Kelleher were regarded as Southwest’s guiding lights, and some
analysts said she was essentially functioning as the company’s chief operating officer
prior to her formal appointment as president. Much of the credit for the company’s
strong record of customer service and its strong-culture work climate belonged to
Barrett.
Barrett had been the driving force behind lining the hallways at Southwest’s
headquarters with photos of company events and trying to create a family atmosphere at
the company. Believing it was important to make employees feel cared about and
important, Barrett had put together a network of contacts across the company to help
her stay in touch with what was happening with employees and their families. When
network members learned about events that were worthy of acknowledgment, the word
quickly got to Barrett—the information went into a database and an appropriate
greeting card or gift was sent. Barrett had a remarkable ability to give gifts that were
individualized and connected her to the recipient.8
Barrett was the first woman appointed as president and COO of a major U.S. airline.
In October 2001, Fortune included Colleen Barrett on its list of the 50 most powerful
women in American business (she was ranked number 20). Barrett retired as president
in July 2008.
Gary C. Kelly, Southwest’s CEO, 2004-Present
Gary Kelly was appointed Vice Chairman of the Board of Directors and Chief
Executive Officer of Southwest effective July 15, 2004. Prior to that time, Mr. Kelly
was Executive Vice President and Chief Financial Officer from 2001 to 2004, and Vice
President-Finance and Chief Financial Officer from 1989 to 2001. He joined Southwest
in 1986 as its Controller. In 2008, effective with the retirement of Kelleher and Barrett,
Kelly assumed the titles of Chairman of the Board, CEO, and President.
As CEO, Kelly and other top-level Southwest executives sharpened and fine-tuned
Southwest’s strategy in a number of areas, continued to expand operations (adding both
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more flights and initiating service to new airports), and worked to maintain the
company’s low-cost advantage over its domestic rivals.
Kelly saw four factors as keys to Southwest’s recipe for success:9
Hire great people, treat ‘em like family.
Care for our Customers warmly and personally, like they’re guests in our home.
Keep fares and operating costs lower than anybody else by being safe, efficient, and
operationally excellent.
Stay prepared for bad times with a strong balance sheet, lots of cash, and a stout fuel
hedge.
To guide Southwest’s efforts to be a standout performer on these four key success
factors, Kelly had established five strategic objectives for the company:10
Be the best place to work.
Be the safest, most efficient, and most reliable airline in the world.
Offer customers a convenient flight schedule with lots of flights to lots of places they
want to go.
Offer customers the best overall travel experience.
Do all of these things in a way that maintains a low-cost structure and the ability to
offer low fares.
SOUTHWEST AIRLINES’ STRATEGY IN 2020
From day one, Southwest had pursued a low-cost/low-price/no-frills strategy to make
air travel affordable to a wide segment of the population. While specific aspects of the
strategy had evolved over the years, three strategic themes had characterized the
company’s strategy throughout its existence and still had high profiles in 2020:
Offering air travelers a robust route network
Creating compelling brand appeal through customer service, low fares, and its
frequent flyer program
Ensuring a superior financial position through a low-cost operating position
Southwest’s Development of a Robust Route Network
Southwest’s route network was based upon a point-to-point flight model that was more
cost-efficient than the hub-and-spoke systems used by most rival airlines. Hub-and-
spoke systems involved passengers on many different flights coming in from spoke
locations (and sometimes another hub) to a central airport or hub within a short span of
time and then connecting to an outgoing flight to their destination—a spoke location or
another hub). Most flights arrived and departed a hub across a two-hour window,
creating big peak-valley swings in airport personnel workloads and gate utilization—
airport personnel and gate areas were very busy when hub operations were in full swing
and then were underutilized in the interval awaiting the next round of
inbound/outbound flights. In contrast, Southwest’s point-to-point routes permitted
scheduling aircraft so as to minimize the time aircraft were at the gate, currently
approximately 25 minutes, thereby reducing the number of aircraft and gate facilities
that would otherwise be required. Furthermore, with a relatively even flow of
incoming/outgoing flights and gate traffic, Southwest could staff its terminal operations
to handle a fairly steady workload across a day whereas hub-and-spoke operators had to
staff their operations to serve 3-4 daily peak periods.
Expanding Daily Departure and Route Options for Passengers. Southwest’s
strategy to grow its business consisted of (1) adding more daily flights to the
cities/airports it currently served and (2) adding new cities/airports to its route schedule.
It was normal for customer traffic to grow at the airports Southwest served. Hence,
opportunities were always emerging for Southwest to capture additional revenues by
adding more flights at the airports already being served. Sometimes these opportunities
entailed adding more flights to one or more of the same destinations and sometimes the
opportunities entailed adding flights to a broader selection of Southwest destinations,
depending on the mix of final destinations the customers departing from a particular
airport were flying to.
To spur growth beyond that afforded by adding more daily flights to cities/airports
currently being served, it had long been Southwest’s practice to add one or more new
cities/airports to its route schedule annually. In selecting new cities, Southwest looked
for city pairs that could generate substantial amounts of both business and leisure
traffic. Management believed that having numerous flights flying the same routes
appealed to business travelers looking for convenient flight times and the ability to
catch a later flight if they unexpectedly ran late.
As a general rule, Southwest did not initiate service to a city/airport unless it
envisioned the potential for originating at least eight flights a day there and saw
opportunities to add more flights over time—in Denver, for example, Southwest had
boosted the number of daily departures from 13 in January 2006 (the month in which
service to and from Denver was initiated) to 79 daily departures in 2008, 129 daily
departures in 2010, and 214 daily departures in December 2019.
Creating a Compelling Brand: Southwest’s Strategy to Provide a
Topnotch Travel Experience
Southwest’s approach to delivering good customer service and building a loyal
customer clientele was predicated on presenting a happy face to passengers, displaying
a fun-loving attitude, and doing things in a manner calculated to provide passengers
with a positive flying experience. The company made a special effort to employ gate
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personnel who enjoyed interacting with customers, had good interpersonal skills, and
displayed cheery, outgoing personalities. A number of Southwest’s gate personnel let
their wit and sense of humor show by sometimes entertaining those in the gate area
with trivia questions or contests such as “who has the biggest hole in their sock.” Apart
from greeting passengers coming onto planes and assisting them in finding open seats
and stowing baggage, flight attendants were encouraged to be engaging, converse and
joke with passengers, and go about their tasks in ways that made passengers smile. On
some flights, attendants sang announcements to passengers on takeoff and landing. The
repertoires to amuse passengers varied from flight crew to flight crew.
Fare Structure Strategy
Southwest employed a relatively simple fare structure, displayed in ways that made it
easy for customers to choose the fare they preferred. In 2020, Southwest’s
fares were bundled into three major categories: “Wanna Get Away,”
“Anytime,” and “Business Select”:
1. “Wanna Get Away” fares were always the lowest fares and were subject to advance
purchase requirements. No fee was charged for changing a previously purchased
ticket to a different time or day of travel (rival airlines charged a change fee of $75 to
$550), but applicable fare differences were applied. The purchase price was non-
refundable but the funds could be applied to future travel on Southwest, provided the
tickets were not canceled or changed within ten minutes of a flight’s scheduled
departure.
2. “Anytime” fares were refundable and changeable, and funds could also be applied
toward future travel on Southwest. Anytime fares also included a higher frequent
flyer point multiplier under Southwest’s Rapid Rewards frequent flyer program than
do Wanna Get Away fares.
3. “Business Select” fares were refundable and changeable, and funds could be applied
toward future travel on Southwest. Business Select fares also included additional
perks such as priority boarding, a higher frequent flyer point multiplier than other
Southwest fares (including twice as many points per dollar spent as compared to
Wanna Get Away fares), priority security and ticket counter access in select airports,
and one complimentary adult beverage coupon for the day of travel (for customers of
legal drinking age). The Business Select fare had been introduced in 2007 to help
attract economy-minded business travelers; Business Select customers had early
boarding privileges, received extra Rapid Rewards (frequent flyer) credit, and a free
cocktail.
4. No fee was charged for changing a previously-purchased ticket to a different time or
day of travel, but applicable fare differences were applied. The purchase price was
nonrefundable, but funds could be applied to future travel on Southwest, provided the
tickets were not canceled or changed within ten minutes of a flight’s scheduled
page C-305
departure. Also, the company’s “Bags Fly Free” program that allowed passengers to
check two bags at no additional charge was unmatched by all major airlines in 2020.
Southwest’s Rapid Rewards Frequent Flyer Program
Southwest’s Rapid Rewards frequent flyer program, launched in March 2011, linked
free travel awards to the number of points members earned purchasing tickets to fly
Southwest. The amount of points earned was based on the fare and fare class purchased,
with higher fare products (like Business Select) earning more points than lower fare
products (like Wanna Get Away). Likewise, the amount of points required to be
redeemed for a flight was based on the fare and fare class purchased. Rapid Rewards
members could also earn points through qualifying purchases with Southwest’s Rapid
Rewards Partners (which included car rental agencies, hotels, restaurants, and retail
locations), and they could purchase points. Members who opted to obtain a Southwest
co-branded Chase Visa credit card earned two points for every dollar spent on
purchases of Southwest tickets and on purchases with Southwest’s car rental and hotel
partners, and they earned one point on every dollar spent everywhere else. Holders of
Southwest’s co-branded Chase Visa credit card could redeem credit card points for
items other than travel on Southwest, including international flights on other airlines,
cruises, hotel stays, rental cars, gift cards, event tickets, and more.
The most active members of Southwest’s Rapid Rewards program qualified for
priority check-in and security lane access (where available), standby priority, free
inflight WiFi, and—provided they flew 100 qualifying flights or earned 125,000
qualifying points in a calendar year—automatically received a Companion Pass, which
provided for unlimited free roundtrip travel for one year to any destination available on
Southwest for a designated companion of the qualifying Rapid Rewards Member.
Rapid Rewards members could redeem their points for every available seat, every
day, on every flight, with no blackout dates. Points did not expire so long as the Rapid
Rewards Member had points-earning activity during the most recent 24 months.
Ensuring a Superior Financial Position: Southwest’s Strategy to Create
and Sustain Low-Cost Operations
Southwest management fully understood that earning attractive profits by charging low
fares necessitated the use of strategy elements that would enable the company to
become a low-cost provider of commercial air service. There were three main
components of Southwest’s strategic actions to achieve a low-cost operating structure:
using a single aircraft type for all flights, creating an operationally-efficient
point-to-point route structure, and striving to perform all value chain
activities in a cost-efficient manner.
Use of a Single Aircraft Type For many years, Southwest’s aircraft fleets had
consisted only of Boeing 737 aircraft. Operating only one type of aircraft produced
many cost-saving benefits: minimizing the size of spare parts inventories, simplifying
the training of maintenance and repair personnel, improving the proficiency and speed
with which maintenance routines could be done, and simplifying the task of scheduling
planes for particular flights. In 2019, Southwest operated the biggest fleet of Boeing
737 aircraft in the world. Exhibit 3 provides information about Southwest’s aircraft
fleet.
EXHIBIT 3 Southwest’s Aircraft Fleet as of December 31, 2019
Type of Aircraft Number Seats Comments
Boeing 737-700 506 143
Southwest was Boeing’s launch customer for this
model in 1997. All were equipped with satellite-
delivered broadband internet reception capability
Boeing 737-800 207 175 All were equipped with satellite-delivered broadbandinternet reception capability
Boeing 737 MAX 8 34 175
Southwest was Boeing’s launch customer for this
model in 2011. All were equipped with satellite-
delivered broadband internet reception capability
TOTAL number of
aircraft 747
Other Fleet-Related Facts
Average age of aircraft fleet—approximately 11 years
Average aircraft trip length—749 miles, with an average duration of 2 hours and 4 minutes
Average aircraft utilization—more than 5 flights per day and approximately 11 hours of flight time
Fleet size—1990: 106 1995: 224 2000: 344 2009: 537
Firm orders for new aircraft—2020–2026: 380
Source: Company 10-K Report, 2019 and Southwest Corporate Fact Sheet
(https://www.swamedia.com/pages/corporate-fact-sheet).
Incorporating Larger Boeing Aircraft into Southwest’s Fleet Starting in 2012,
Southwest began a long-term initiative to replace older Southwest aircraft with a new
generation of Boeing aircraft that had greater seating capacity, a quieter interior, LED
reading and ceiling lighting, improved security features, reduced maintenance
requirements, increased fuel efficiency, and the capability to fly longer distances
without refueling. Southwest had consistently removed older and smaller versions of
the 737, such as the Boeing 737-300 aircraft (with 143 seats and an average age of 20
years), and 15 Boeing 737-500 aircraft (with 122 seats and an average age of 22 years)
from its fleet and replaced them with new Boeing 737-700s (143 seats), 737-800s (175
seats), and 737-MAX aircraft (up to 189 seats). The company had firm orders for 30
new Boeing 737-MAX 7 and 219 MAX 8 aircraft were scheduled to be delivered in
https://www.swamedia.com/pages/corporate-fact-sheet
page C-306
2020–2026 (with options to take delivery on an additional 131 planes)—Southwest was
Boeing’s launch customer for the 737-MAX. Plans called for some of the new aircraft
to be leased from third parties rather than being purchased—of the company’s current
fleet of 747 aircraft, 625 were owned and 122 were leased.
Southwest expected that the new Boeing 737-800 and 737-MAX aircraft would
significantly enhance the company’s capabilities to (1) more economically fly long-haul
routes (the number of short-haul flights throughout the domestic airline industry had
been declining since 2000), (2) improve scheduling flexibility and more economically
serve high-demand, gate-restricted, slot-controlled airports by adding seats to such
destinations without increasing the number of flights, and (3) boost overall fuel
efficiency to reduce overall costs. Additionally, the aircraft would enable Southwest to
profitably expand its operations to new, more distant destinations (including extended
routes over water), such as Hawaii, Alaska, Canada, Mexico, and the Caribbean.
Southwest management expected that the new Boeing 737-MAX planes would have the
lowest operating costs of any single-aisle commercial airplane on the market.
Grounding of the Boeing 737-MAX With 189 crew and passengers lost in the Lion
Air Flight 610 crash in October 29, 2018 and another 157 people killed in the March
10, 2019 crash of Ethiopian Airlines Flight 302, President Trump ordered the plane
grounded on October 13, 2019 until the mechanical problems with the plane could be
identified and corrected. As of mid-2020, Boeing had yet to satisfy the Federal Aviation
Administration that the 737-MAX was airworthy. Southwest Airlines and other airlines
who had purchased the planes were unable to utilize the equipment in their fleets until
the FAA had concurred that Boeing has identified the mechanical failures of the aircraft
and all planes were made safe to fly. The 737-MAX grounding resulted in $828 million
in additional costs for Southwest Airlines in 2019 and continued into 2020 as planes
remained grounded.
Striving to Perform All Value Chain Activities Cost Effectively Southwest made a
point of scrutinizing every aspect of its operations to find ways to trim costs. The
company’s strategic actions to reduce or at least contain costs were extensive and
ongoing.
Southwest was the first major airline to introduce ticketless travel.
Southwest was also the first airline to allow customers to make reservations and
purchase tickets at the company’s website (thus bypassing the need to pay
commissions to travel agents for handling the ticketing process and reducing staffing
requirements at Southwest’s reservation centers).
For most of its history, Southwest stressed flights into and out of airports in medium-
sized cities and less congested airports in major metropolitan areas (Chicago Midway,
Detroit Metro, Houston Hobby, Dallas Love Field, Baltimore-Washington
International, Burbank, Manchester, Oakland, San Jose, Providence, and Ft.
Lauderdale-Hollywood). This strategy helped produce better-than-average on-time
performance and reduce the fuel costs associated with planes sitting in line on
crowded taxiways or circling airports waiting for clearance to land.
To economize on the amount of time it took terminal personnel to check passengers
in and to simplify the whole task of making reservations, Southwest dispensed with
the practice of assigning each passenger a reserved seat. All passengers could check
in online up to 24 hours before departure time and print out a boarding pass, thus
bypassing counter check-in (unless they wished to check baggage).
Southwest flight attendants were responsible for cleaning up trash left by deplaning
passengers and otherwise getting the plane presentable for passengers to board for the
next flight.
Southwest did not have a first-class section in any of its planes and had no fancy
clubs for its frequent flyers to relax in at terminals.
Southwest did not provide passengers with baggage transfer services to other carriers
—passengers with checked baggage who were connecting to other carriers to reach
their destination were responsible for picking up their luggage at Southwest’s
baggage claim and then getting it to the check-in facilities of the connecting carrier.
Southwest was a first-mover among major U.S. airlines in employing fuel hedging
and derivative contracts to counteract rising prices for crude oil and jet fuel.
Southwest regularly upgraded and enhanced its management information systems to
speed data flows, improve operating efficiency, lower costs, and upgrade its customer
service capabilities.
For many decades, Southwest’s operating costs had been lower than those of rival U.S.
airline carriers—see Exhibit 4 for comparative costs per revenue passenger mile among
the five major U.S. airlines during the 2005–2019 period.
EXHIBIT 4 Comparative Operating Cost Statistics per Revenue
Passenger Mile, Major U.S. Airlines, 2005, 2010, 2015, 2019 (in cents)
Costs incurred per revenue passenger mile (in cents)
Total
Salaries
and
Fringe
Benefits
Fuel
and Oil Rentals
Landing
Fees Advertising
General and
Administrative
Other
Operating
Expenses
Total
Operating
Expenses
American
Airlines
2005 4.65 3.67 0.41 0.32 0.10 0.95 3.66 15.18
2010 5.18 4.57 0.47 0.35 0.13 1.23 3.68 17.53
2015 5.01 3.08 0.67 0.30 0.07 2.26 3.93 17.09
Costs incurred per revenue passenger mile (in cents)
Total
Salaries
and
Fringe
Benefits
Fuel
and Oil Rentals
Landing
Fees Advertising
General and
Administrative
Other
Operating
Expenses
Total
Operating
Expenses
2019 6.31 3.54 1.27 0.31 0.06 2.55 6.03 20.07
Delta Air
Lines
2005 4.31 3.68 0.38 0.22 0.16 0.84 6.01 16.69
2010 4.15 4.51 0.14 0.28 0.10 0.64 6.26 17.41
2015 5.55 3.45 0.18 0.27 0.12 1.38 5.08 17.50
2019 6.18 3.36 0.68 0.29 0.13 1.29 6.77 18.69
Southwest
Airlines
2005 4.70 2.44 0.31 0.34 0.29 0.73 1.23 11.21
2010 4.97 4.63 0.28 0.46 0.26 0.83 1.32 14.23
2015 5.69 3.07 0.25 0.42 0.18 1.02 1.28 13.35
2019 6.60 3.29 0.79 0.42 0.16 1.22 2.23 14.72
United Air
Lines
2005 3.72 3.53 0.35 0.30 0.16 0.60 5.09 15.35
2010 4.34 4.46 0.32 0.38 0.06 1.31 5.24 17.96
2015 5.45 3.44 0.32 0.36 0.11 1.58 5.04 17.81
2019 6.03 3.45 0.65 0.38 0.10 1.50 6.18 18.29
Note 1: Cost per revenue passenger mile for each of the cost categories in this exhibit is calculated by
dividing the total costs for each cost category by the total number of revenue passenger miles flown,
where a revenue passenger mile is equal to one paying passenger flown one mile. Costs incurred per
revenue passenger mile thus represent the costs incurred per ticketed passenger per mile flown.
Note 2: US Airways and America West started merging operations in September 2005, and joint reporting
of their operating costs began in late 2007. Effective January 2010, data for Delta Airlines includes the
combined operating costs of Delta and Northwest Airlines; the merger of these two companies became
official in October 2008. United Airlines acquired Continental Airlines in 2010, and the two companies
began joint reporting of operating expenses in 2012.
Note 3: Southwest Airlines acquired AirTran in late 2010; starting in 2013 and continuing into 2014,
AirTran flights were rebranded as Southwest Airlines flights. Southwest’s first international flights began
when some of AirTran’s international flights were rebranded as Southwest flights in 2013.
Note 4: United Airlines acquired Continental Airlines in 2010, and the two companies began joint reporting
of passenger traffic in 2012. Prior to 2012, traffic count data is only for United flights.
Source: United States Department of Transportation, Bureau of Transportation Statistics, Form 41.
page C-308
page C-307
SOUTHWEST’S PEOPLE MANAGEMENT
PRACTICES AND CULTURE
Whereas the litany at many companies was that customers come first, at Southwest the
operative principle was that “employees come first and customers come second.” The
high strategic priority placed on employees reflected management’s belief that
delivering superior service required employees who not only were passionate about
their jobs but who also knew the company was genuinely concerned for their well-
being and committed to providing them with job security. Southwest’s thesis was
simple: Keep employees happy—then they will keep customers happy.
Since becoming the company’s CEO, Gary Kelly had continuously
echoed the views of his predecessors: “Our People are our single greatest strength and
our most enduring long-term competitive advantage.”11
The company changed the personnel department’s name to the People Department in
1989. Later, it was renamed the People and Leadership Development Department.
Recruiting, Screening, and Hiring
Southwest hired employees for attitude and trained for skills. Herb Kelleher
explained:12
We can train people to do things where skills are concerned. But there is one capability we do not have and that
is to change a person’s attitude. So we prefer an unskilled person with a good attitude. . . .[to] a highly skilled
person with a bad attitude.
Management believed that delivering superior service came from having employees
who genuinely believed that customers were important and that treating them warmly
and courteously was the right thing to do, not from training employees to act like
customers are important. The belief at Southwest was that superior, hospitable service
and a fun-loving spirit flowed from the heart and soul of employees who themselves
were fun-loving and spirited, who liked their jobs and the company they worked for,
and who were also confident and empowered to do their jobs as they saw fit (rather than
being governed by strict rules and procedures).
Screening Candidates. In hiring for jobs that involved personal contact with
passengers, the company looked for people-oriented applicants that were extroverted
and had a good sense of humor. It tried to identify candidates with a knack for reading
peoples’ emotions and responding in a genuinely caring, empathetic manner. Southwest
wanted employees to deliver the kind of service that showed they truly enjoyed meeting
people, being around passengers, and doing their job, as opposed to delivering the kind
of service that came across as being forced or taught. Kelleher elaborated: “We are
interested in people who externalize, who focus on other people, who are motivated to
help other people. We are not interested in navel gazers.”13 In addition to a “whistle
while you work” attitude, Southwest was drawn to candidates who it thought would be
likely to exercise initiative, work harmoniously with fellow employees, and be
community-spirited.
Southwest did not use personality tests to screen job applicants nor did it ask them
what they would or should do in certain hypothetical situations. Rather, the hiring staff
at Southwest analyzed each job category to determine the specific behaviors,
knowledge, and motivations that job holders needed and then tried to find candidates
with the desired traits—a process called targeted selection. A trait common to all job
categories was teamwork; a trait deemed critical for pilots and flight attendants was
judgment. In exploring an applicant’s aptitude for teamwork, interviewers often asked
applicants to tell them about a time in a prior job when they went out of their way to
help a co-worker or to explain how they had handled conflict with a co-worker. Another
frequent question was “What was your most embarrassing moment?” The thesis here
was that having applicants talk about their past behaviors provided good clues about
their future behaviors.
To test for unselfishness, Southwest interviewing teams typically gave a group of
potential employees ample time to prepare five-minute presentations about themselves;
during the presentations in an informal conversational setting, interviewers watched the
audience to see who was absorbed in polishing their presentations and who was
listening attentively, enjoying the stories being told, and applauding the efforts of the
presenters. Those who were emotionally engaged in hearing the presenters and giving
encouragement were deemed more apt to be team players than those who were focused
on looking good themselves. All applicants for flight attendant positions were put
through such a presentation exercise before an interview panel consisting of customers,
experienced flight attendants, and members of the People and Leadership Department.
Flight attendant candidates that got through the group presentation interviews then had
to complete a three-on-one interview conducted by a recruiter, a supervisor from the
hiring section of the People and Leadership Department, and a Southwest flight
attendant; following this interview, the three-person panel tried to reach a consensus on
whether to recommend or drop the candidate.
Training
Apart from the FAA-mandated training for certain employees, training activities at
Southwest were designed and conducted by Southwest Airlines University. The
curriculum included courses for new recruits, employees, and managers. Learning was
viewed as a never-ending process for all company personnel; the expectation was that
each employee should be an “intentional learner,” looking to grow and develop not just
from occasional classes taken at Southwest Airlines University but also from their
everyday on-the-job experiences.
page C-309
Southwest Airlines University conducted a variety of courses offered to maintenance
personnel and other employees to meet the safety and security training requirements of
the Federal Aviation Administration, the U.S. Department of
Transportation, the Occupational Safety and Health Administration, and other
government agencies. And there were courses on written communications, public
speaking, stress management, career development, performance appraisal, decision-
making, leadership, customer service, corporate culture, environmental stewardship and
sustainability, and employee relations to help employees advance their careers.
Leadership development courses that focused on developing people, team-building,
strategic thinking, and being a change leader were keystone offerings. New supervisors
attended a four-week course “Leadership Southwest Style” that emphasized coaching,
empowering, and encouraging, rather than supervising or enforcing rules and
regulations. New managers attended a two-and-a-half-day course on “Next-Level
leadership.” There were courses for employees wanting to explore whether a
management career was for them and courses for high-potential employees wanting to
pursue a long-term career at Southwest. From time to time supervisors and executives
attended courses on corporate culture, intended to help instill, ingrain, and nurture such
cultural themes as teamwork, trust, harmony, and diversity. All employees who came
into contact with customers, including pilots, received customer-care training.
The OnBoarding Program for Newly-Hired Employees. Southwest had a program
called OnBoarding “to welcome New Hires into the Southwest Family” and provide
information and assistance from the time they were selected until the end of their first
year. All new hires attended a full-day orientation course that covered the company’s
history, an overview of the airline industry and the competitive challenges that
Southwest faced, an introduction to Southwest’s culture and management practices, the
expectations of employees, and demonstrations on “Living the Southwest Way.” All
new hires also received safety training. Anytime during their first 30 days, new
employees were expected to access an interactive online tool—OnBoarding Online
Orientation—to learn more about the company. During their first year of employment,
new hires were invited to attend a “LUV@First Bite Luncheon” in the city where they
worked; these luncheons were held on the same day as Leadership’s Messages to the
Field; at these luncheons, there were opportunities to network with other new hires and
talk with senior leaders.
An additional element of the Onboarding Program involved assigning each new
employee to an existing Southwest employee who had volunteered to sponsor a new
hire and be of assistance in acclimating the new employee to their job and Living the
Southwest Way; each volunteer sponsor received training from Southwest’s Onboarding
Team in what was expected of a sponsor. Much of the indoctrination of new employees
into the company’s culture was done by the volunteer sponsor, co-workers, and the new
employee’s supervisor. Southwest made active use of a one-year probationary
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employment period to help ensure that new employees fit in with its culture and
adequately embraced the company’s cultural values.
Promotion
Approximately 80 to 90 percent of Southwest’s supervisory positions were filled
internally, reflecting management’s belief that people who had “been there and done
that” would be more likely to appreciate and understand the demands that people under
them were experiencing and also more likely to enjoy the respect of their peers and
higher-level managers. Employees could either apply for supervisory positions or be
recommended by their present supervisor.
Employees being considered for managerial positions of large operations (Up and
Coming Leaders) received training in every department of the company over a six-
month period in which they continued to perform their current job. At the end of the
six-month period, candidates were provided with 360-degree feedback from department
heads, peers, and subordinates; personnel in the People and Leadership Department
analyzed the feedback in deciding on the specific assignment of each candidate.14
Compensation and Benefits
Southwest’s pay scales and fringe benefits were quite attractive compared to other
major U.S. airlines (see Exhibit 4). In 2020, in addition to vacation, paid holidays, and
sick leave, Southwest offered full-time and part-time Southwest employees a benefits
package that included:
A 401(k) retirement savings plan
A profit-sharing plan
Medical and prescription coverage
Mental health chemical dependency coverage
Vision coverage
Dental coverage
Adoption assistance
Mental health assistance
Life insurance
Accidental death and dismemberment insurance
Long-term disability insurance
Dependent life insurance
Dependent care flexible spending account
Health care flexible spending account
Employee stock purchase plan
Wellness program
Flight privileges
Health care for committed partners
Early retiree health care
Employee Relations
About 83 percent of Southwest’s 60,800 employees belonged to a union. An in-house
union—the Southwest Airline Pilots Association (SWAPA)—represented the
company’s pilots. The Teamsters Union represented Southwest’s material specialists
and flight simulator technicians; a local of the Transportation Workers of America
represented flight attendants; another local of the Transportation Workers of America
represented baggage handlers, ground crews, and provisioning employees; the
International Association of Machinists and Aerospace Workers represented customer
service and reservation employees, and the Aircraft Mechanics Fraternal Association
represented the company’s mechanics.
Management encouraged union members and negotiators to research their pressing
issues and to conduct employee surveys before each contract negotiation. Southwest’s
contracts with the unions representing its employees were relatively free of restrictive
work rules and narrow job classifications that might impede worker productivity. All of
the contracts allowed any qualified employee to perform any function—thus pilots,
ticket agents, and gate personnel could help load and unload baggage when needed and
flight attendants could pick up trash and make flight cabins more presentable for
passengers boarding the next flight.
Except for one brief strike by machinists in the early 1980s and some unusually
difficult negotiations in 2000–2001, Southwest’s relationships with the unions
representing its employee groups had been harmonious and non-adversarial for the
most part. However, the company was engaged in difficult contract negotiations with its
pilots in 2016 and had been at odds with mechanics in 2019 over maintenance and
safety concerns that had resulted in 40 planes being taken out of service and the
company declaring an operational emergency.
The No-Layoff Policy
Southwest Airlines had never laid off or furloughed any of its employees since the
company began operations in 1971. The company’s no-layoff policy was seen as
integral to how the company treated its employees and management efforts to sustain
and nurture the culture. According to Kelleher,15
Nothing kills your company’s culture like layoffs. Nobody has ever been furloughed here, and that is
unprecedented in the airline industry. It’s been a huge strength of ours. It’s certainly helped negotiate our union
contracts. . .. . .We could have furloughed at various times and been more profitable, but I always thought that
was shortsighted. You want to show your people you value them and you’re not going to hurt them just to get a
page C-311
little more money in the short term. Not furloughing people breeds loyalty. It breeds a sense of security. It breeds
a sense of trust.
Southwest had built up considerable goodwill with its employees and unions over the
years by avoiding layoffs. Despite the impact of the Coronavirus pandemic, CEO Gary
Kelly reiterated to employees in March 2020 that the company remained committed to
its no-layoff policy even though small pay cuts might be necessary to protect the
company’s solvency. Kelly even pledged to employees that he would work for no salary
if the company was forced to ask employees for large pay cuts as a result of the
COVID-19 pandemic.16
Management Style
At Southwest, management strived to do things in a manner that would make Southwest
employees proud of the company they worked for and its work force practices.
Managers were expected to spend at least one-third of their time out of the office,
walking around the facilities under their supervision, observing firsthand
what was going on, listening to employees and being responsive to their
concerns.
Company executives were very approachable, insisting on being called by their first
names. At new employee orientations, people were told, “We do not call the company
chairman and CEO Mr. Kelly, we call him Gary.” Managers and executives had an
open-door policy, actively listening to employee concerns, opinions, and suggestions
for reducing costs and improving efficiency.
Employee-led initiatives were common. Southwest’s pilots had been instrumental in
developing new protocols for takeoffs and landings that conserved fuel. Another
frontline employee had suggested not putting the company logos on trash bags, saving
an estimated $250,000 annually. It was Southwest clerks that came up with the idea of
doing away with paper tickets and shifting to e-tickets.
There were only four layers of management between a front-line supervisor and the
CEO. Southwest’s employees enjoyed substantial authority and decision-making power.
From time to time, there were candid meetings of frontline employees and managers
where operating problems and issues between/among workers and departments were
acknowledged, openly discussed, and resolved.17 Informal problem avoidance and
rapid problem resolution were seen as managerial virtues.
Southwest’s Two Big Core Values—LUV and Fun
Two core values—LUV and fun—permeated the work environment at Southwest. LUV
was much more than the company’s ticker symbol and a recurring theme in Southwest’s
advertising campaigns. Over the years, LUV grew into Southwest’s codeword for
treating individuals—fellow employees and customers—with dignity and respect and
demonstrating a caring, loving attitude. LUV and red hearts commonly appeared on
page C-312
banners and posters at company facilities, as reminders of the compassion that was
expected toward customers and other employees. Practicing the Golden Rule, internally
and externally, was expected of all employees. Employees who struggled to live up to
these expectations were subjected to considerable peer pressure and usually were asked
to seek employment elsewhere if they did not soon leave on their own volition.
Fun at Southwest was exactly what the word implies and it occurred throughout the
company in the form of the generally entertaining behavior of employees in performing
their jobs, the ongoing pranks and jokes, and frequent company-sponsored parties and
celebrations (which typically included the Southwest Shuffle). On holidays, employees
were encouraged to dress in costumes. There were charity benefit games, chili cook-
offs, Halloween parties, new Ronald McDonald House dedications, and other special
events of one kind or another at one location or another almost every week. According
to one manager, “We’re kind of a big family here, and family members have fun
together.”
Culture-Building Efforts
Southwest executives believed that the company’s growth was primarily a function of
the rate at which it could hire and train people to fit into its culture and consistently
display the traits and behaviors set forth in Living the Southwest Way. Kelly said.
“. . ..some things at Southwest won’t change. We will continue to expect our people to
live what we describe as the ‘Southwest Way,’ which is to have a Warrior Spirit,
Servant’s Heart, and Fun-Loving Attitude. Those three things have defined our culture
for 36 years.”18
The Corporate Culture Committee. Southwest formed a Corporate Culture
Committee in 1990 to promote “Positively Outrageous Service” and devise tributes,
contests, and celebrations intended to nurture and perpetuate the Southwest Spirit and
Living the Southwest Way. The Committee was composed of 100 employees that had
demonstrated their commitment to Southwest’s mission and values and zeal in
exhibiting the Southwest Spirit and Living the Southwest Way. Members came from a
cross-section of departments and locations and functioned as cultural ambassadors,
missionaries, and storytellers during their two-year term.
Over the years, the Committee had sponsored and supported hundreds of ways to
promote and ingrain the traits and behaviors embedded in Living the Southwest Way—
examples included promoting the use of red hearts and LUV to embody the spirit of
Southwest employees caring about each other and Southwest’s customers, showing up
at a facility to serve pizza or ice cream to employees or to remodel and decorate an
employee break room. Kelleher indicated, “We’re not big on Committees at Southwest,
but of the committees we do have, the Culture Committee is the most important.”19
Each major department and geographic operating unit had a Local Culture
Committee charged with organizing culture-building activities and nurturing the
Southwest Spirit within their unit. The company had created a new position in each of
its major operating departments and largest geographic locations called Culture
Ambassador; the primary function of cultural ambassadors was to nurture the
Southwest Spirit by helping ensure that the Local Culture Committee had the resources
needed to foster the culture at each of their locations, planning and coordinating
departmental celebrations and employee appreciation events, and acting as a liaison
between the local office and the corporate office on culture-related matters.
Efforts to Nurture and Sustain the Southwest Culture. Apart from the efforts of
the Corporate Culture Committee, the Local Culture Committees, and the cultural
ambassadors, Southwest management sought to reinforce the company’s core values
and culture via a series of employee recognition programs to single out and praise
employees for their outstanding contributions to customer service, operational
excellence, cost efficiency, and display of the Southwest Spirit. In addition to Kick Tail
awards, there were “Heroes of the Heart” awards, Spirit magazine Star of the Month
awards, President’s Awards, and LUV Reports whereby one or more employees could
recognize other employees for an outstanding performance or contribution.
Other culture-supportive activities included a CoHearts mentoring program, a Day in
the Field program where employees spent time working in another area of the
company’s operations, a Helping Hands program where volunteers from around the
system traveled to work two weekend shifts at other Southwest facilities that were
temporarily shorthanded or experiencing heavy workloads, and periodic Culture
Exchange meetings to celebrate the Southwest Spirit and company milestones. Almost
every event at Southwest was videotaped, which provided footage for creating such
multipurpose videos as Keepin’ the Spirit Alive that could be shown at company events
all over the system and used in training courses. The concepts of LUV and fun were
spotlighted in all of the company’s training manuals and videos.
Southwest’s monthly employee newsletter often spotlighted the experiences and
deeds of particular employees, reprinted letters of praise from customers, and reported
company celebrations of milestones. A quarterly news video was sent to all facilities to
keep employees up to date on company happenings, provide clips of special events, and
share messages from customers, employees, and executives. The company had
published a book for employees describing “outrageous” acts of service.
Employee Productivity and Effectiveness
Management was convinced the company’s strategy, culture, esprit de corps, and people
management practices fostered high labor productivity and contributed to Southwest
having low costs in comparison to the costs at its principal domestic rivals (Exhibit 4).
Southwest’s current CEO, Gary Kelly, had followed Kelleher’s lead in pushing for
operating excellence. One of Kelly’s strategic objectives for Southwest was “to be the
safest, most efficient, and most reliable airline in the world.” Southwest managers and
employees in all positions and ranks were proactive in offering suggestions for
improving Southwest’s practices and procedures; those with merit were quickly
implemented.
Much time and effort over the years had gone into finding the most effective ways to
do aircraft maintenance, to operate safely, to make baggage handling more efficient and
baggage transfers more accurate, and to improve the percentage of on-time arrivals and
departures. Believing that air travelers were more likely to fly Southwest if its flights
were reliable and on-time, Southwest’s managers constantly monitored on-time arrivals
and departures, making inquiries when many flights ran behind and searching for ways
to improve on-time performance. Exhibit 5 presents data comparing Southwest against
its four domestic rivals on four measures of operating performance.
EXHIBIT 5 Comparative Statistics on On-Time Flights, Mishandled
Baggage, Boarding Denials Due to Oversold Flights, and Passenger
Complaints for Major U.S. Airlines, 2016–2020
Percentage of Scheduled Flights Arriving within 15 Minutes of the Scheduled Time (during the
first quarter of each year)
Airline 2016 2017 2018 2019 2020
American
Airlines 81.7% 79.2% 78.6% 77.4% 78.4%
Delta Air Lines 87.2% 80.7% 82.1% 82.3% 83.3%
Southwest
Airlines 81.1% 78.7% 79.3% 78.7% 84.8%
United Air Lines 80.9% 80.3% 79.7% 73.6% 78.7%
Mishandled Baggage Reports per 1,000 Passengers (in March of each year)
Airline 2016 2017 2018 2019 2020
American
Airlines 3.08 2.63 3.33 7.44 5.91
Delta Air Lines 1.56 1.63 1.81 4.39 4.09
Southwest
Airlines 2.77 2.36 2.65 4.23 3.04
United Air Lines 2.29 2.42 2.42 6.82 4.70
Involuntary Denied Boardings per 10,000 Passengers Due to Oversold Flights (January through
March of each year)
Airline 2016 2017 2018 2019 2020
American
Airlines 0.84 0.75 0.16 0.77 0.39
Delta Air Lines 0.10 0.12 0.01 0.00 0.00
page C-313
page C-314
Percentage of Scheduled Flights Arriving within 15 Minutes of the Scheduled Time (during the
first quarter of each year)
Airline 2016 2017 2018 2019 2020
Southwest
Airlines 0.91 0.72 0.18 0.43 0.04
United Air Lines 0.49 0.44 0.02 0.01 0.00
Complaints per 100,000 Passengers Boarded (in March of each year)
Airline 2016 2017 2018 2019 2020
American
Airlines 1.99 1.45 1.05 1.46 5.15
Delta Air Lines 0.45 0.45 0.56 0.31 2.24
Southwest
Airlines 0.29 0.34 0.27 0.38 2.62
United Air Lines 1.99 1.35 2.25 0.96 17.89
Source: Office of Aviation Enforcement and Proceedings, Air Travel Consumer Report, various years.
SOUTHWEST AIRLINES STANDING IN MID-2020
The 737-MAX grounding had affected Southwest Airlines’ financial performance in the
second half of 2019, but the effect of the novel coronavirus on the airline industry was a
far more financially severe event and was expected to have longer term implications for
the industry than even the September 11, 2001 terrorist attacks. Southwest
Airlines recorded a first quarter net loss of $94 million, with operating
revenues down 17.8 percent year over year. The company had obtained financial
support in the amount $3.3 billion provided by the CARES Act, which protected the
salaries of Southwest’s 60,000+ employees and bolstered cash on hand.
CEO Gary Kelly commented in a weekly YouTube broadcast to employees that the
company was in “intensive care” and the future airline competitive environment would
be “a brutal, low-fare environment as there are fore more airline seats, and there will be
for some time, than there are customers.”20 The company’s historic focus on
operational excellence, low-costs, and strategy-supportive organizational culture would
likely become even more important and would be heavily relied upon during a recovery
of the industry.
ENDNOTES
1 Kevin and Jackie Freiberg, NUTS! Southwest Airlines’ Crazy Recipe for Business and Personal Success (New York: Broadway Books,
1998), p. 15.
2 Freiberg and Freiberg, NUTS!, pp. 16–18.
3 Katrina Brooker, “The Chairman of the Board Looks Back,” Fortune, May 28, 2001, p. 66.
4 Feiberg and Freiberg, NUTS, p. 31.
5 Freiberg and Freiberg, NUTS!, pp. 26–27.
6 Ibid., p. 72.
7 Speech at Texas Christian University, September 13, 2007; accessed at www.southwest.com on September 8, 2008.
8 Freiberg and Freiberg, NUTS!, p. 163.
9 Speech to Greater Boston Chamber of Commerce, April 23, 2008; accessed at www.southwest.com on September 5, 2008.
10 Speech to Business Today International Conference, November 20, 2007; accessed at www.southwest.com on September 8, 2008.
11 Statement posted in the Careers section at www.southwest.com, accessed August 18, 2010 and re-accessed on May 16, 2016.
Kelly’s statement had been continuously posted on www.southwest.com since 2009.
12 As quoted in James Campbell Quick, “Crafting an Organizational Structure: Herb’s Hand at Southwest Airlines,” Organizational
Dynamics 21, no. 2 (Autumn 1992), p. 51.
13 Quick, “Crafting an Organizational Structure,” p. 52.
14 Sunoo, “How Fun Flies at Southwest Airlines,” p. 72.
15 Brooks, “The Chairman of the Board Looks Back,” p. 72.
16 Mary Schlangenstein, “With ‘Virtually Zero’ Air Travel, Southwest Warns of Pay Risk,” Bloomberg, April 23, 2020, accessed at
https://www.bloomberg.com/news/articles/2020-04-23/.southwest-ceo-urges-pay-cuts-with-air-travel-at-virtually-zero.
17 Hallowell, “Southwest Airlines: A Case Study Linking Employee Needs Satisfaction and Organizational Capabilities to Competitive
Advantage,” p. 524.
18 Speech to Business Today International Conference, November 20, 2007; accessed at www.southwest.com on September 8, 2008.
19 Freiberg and Freiberg, NUTS!, p. 165.
20 As quoted in Kyle Arnold, “Southwest Airlines CEO Gary Kelly: ‘It will be a brutal, low-fare environment’,” The Dallas Morning News,
May 29, 2020, accessed at https://www.dallasnews.com/business/airlines/2020/05/29/southwest-airlines-ceo-gary-kelly-it-will-be-
a-brutal-low-fare-environment/.
http://www.southwest.com/
http://www.southwest.com/
http://www.southwest.com/
http://www.southwest.com/
http://www.southwest.com/
https://www.bloomberg.com/news/articles/2020-04-23/.southwest-ceo-urges-pay-cuts-with-air-travel-at-virtually-zero
http://www.southwest.com/
https://www.dallasnews.com/business/airlines/2020/05/29/southwest-airlines-ceo-gary-kelly-it-will-be-a-brutal-low-fare-environment/
I
page C-315
CASE 24
Uber Technologies in 2020: Is the
Gig Economy Labor Force Working
for Uber?
Emily Farrell
MBA Candidate, Sonoma State University
Armand Gilinsky, Jr.
Sonoma State University
n the words of Travis Kalanick, founder and former CEO of Uber
Technologies, “In a lot of ways, it’s not the money that allows you to do new
things. It’s the growth and the ability to find things that people want and to
use your creativity to target those.”1 When Kalanick and Garrett Camp
generated the idea that became Uber in 2009, they saw an existing taxi
industry that was not meeting their needs and sought to create a service that
was more efficient and worked better for everyone involved. They sought out
to create a service that people would want. The business model that Kalanick
and Camp created saw success as the company spread internationally, but
there were also many challenges. Uber had always considered as central to its
business model the gig economy drivers as “customers of its mobile
technology.” Nonetheless, recent legislation in the State of California
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threatened that model as it was intended to reclassify all gig economy workers
as hired and paid employees.
As of January 1, 2020, California’s state legislature began to implement
legislation known as Assembly Bill 5 (AB5), reclassifying many independent
contractors as employees, intended to include Uber’s drivers. At the time,
Uber’s CEO Dara Khosrowshahi faced the challenge of deciding the best
course of action to handle the legal situation in California, by either agreeing
to convert all California Uber drivers to payroll employees; fighting the
legislation to prove that it did not apply to Uber’s independent drivers; or
assuming that Uber would not be impacted by the legislation and carrying on
with business as usual. Each option potentially placed the company at risk.
While Khosrowshahi’s immediate focus was on the impact on Uber’s
California business model, he also needed to prepare for the possibility that
other states and countries where Uber operated could follow California’s
example and enact similar laws challenging the labor status of gig economy
workers.
THE SOFTWARE INDUSTRY
Uber Technologies often made the claim that it was not in the transportation
industry as it did not own the vehicles and did not consider drivers to be its
employees. Uber instead asserted itself as a technology company that supplied
a software platform that allowed independent users to connect to facilitate ride
sharing. The assertion that Uber was a technology company supplying
software grouped it into a large and diverse industry of software developers
and suppliers. The software industry was comprised of companies that design,
develop, and publish software for computers, smartphones, and video games.
Major industry products and services included system and application
software publishing, custom application design and development, technology
consulting and training, and re-sale of computer hardware and software. Total
industry revenue in 2019 was $269.9 billion, but profit margins declined 28.6
percent. Annual growth from 2014 to 2019 was five percent and was projected
to be 2.1 percent from 2019 to 2024. The number of businesses in the
software publishing industry rose 10.8 percent from 2014 to
2019.2
Major Challenges
High competition was one of the major challenges of the software industry,
although it had varied greatly from company to company. Because the
industry was so large and broad, there has often been more external
competition than competition with other companies within the industry.
Competition has depended largely on the target market, with companies that
produce software experiencing the highest competition.3 Uber’s direct
competition within its industry sector was Lyft, another ridesharing
application that had a similar business model to Uber’s, while the majority of
Uber’s indirect competition existed within the transportation industry.
Rapid technological change was a consistent challenge for the software
industry, not only in terms of changing industry standards, but also the
increasing rates of adoption by and sophistication of customers. This required
companies to invest significant capital in research and development for a new
product. Companies had to constantly improve their performance levels while
keeping prices as low as possible in order to stay competitive. Once a product
was released successfully, in order to stay competitive, updates needed to be
programmed and released regularly. One development that eased this stress
for the industry was the trend to release software as a digital subscription
rather than a physical product that must be installed on a computer. It thus
became much easier for developers to provide updates that did not require the
customer to return to a physical store.4 Uber’s business model allowed users
to use its application free of charge, paying only for the individual ride and
related charges. Its smartphone application enabled Uber to constantly
improve the app performance to better support drivers and riders via periodic
releases of updates to its users.
Data security was also a challenge for the software publishing industry.
Many software companies retain their customers’ personal and sensitive
information, making them targets of cyber-attacks. With an increase in cyber
hacking in the last decade, the way companies collect, store, and transmit
customer data has been under scrutiny. The possibility of becoming a cyber-
attack victim has been a concern for the companies’ integrity and trust among
consumers, not to mention the litigation and liability that comes with an
attack. But it has also been a financial liability to prevent hacking, as
companies must dedicate significant resources to ensure data security keeps
them protected.5 Uber’s business model has allowed users to store credit card
information in the application so that Uber can charge riders directly to the
page C-317
card on file and pay the drivers through the app as well. This has placed great
responsibility on Uber to protect user financial data, as a security breach could
threaten user confidence in Uber and potentially result in users no longer
using Uber’s technology.
Market Size and Forecasted Growth
Software is a large and diverse industry, which brought in $269.9 billion in
2019 from domestic and international sources. The United States controlled
roughly 45 percent of the international software market as of 2019. Beginning
in the late 1990s, the industry experienced an explosive level of growth before
the recession stalled growth of sales and employment.6 Although growth has
slowed in the last decade compared to the boom of the 1990s, the software
industry has forecasted to continue growing from 2020 to 2025. There has
been a growing demand from businesses, individuals, and government for
various types of software. Businesses have accounted for approximately 63.9
percent of industry software, while individual households have accounted for
28.6 percent and government has accounted for 7.5 percent.7 In the
ridesharing niche of the market, Uber and Lyft have been able to take control
and accounted for 98 percent of market spending, which has made it a
challenge for new competitors to enter the market.8 In 2019, Uber had a total
of 110 million users worldwide, and more than 200,000 in California.9
Industry annual growth rates were expected to slow from now through
2024, compared to the five percent annual growth from 2014 to 2019, but
revenues were expected to consistently grow through 2024 as seen in Exhibit
1. In 2019, the software industry was well into the growth phase of the
industry life cycle. Increases in the number of households with at least one
computer, as well as increases in smartphone ownership, mobile internet
connections, and government spending were expected to support continual
growth in the software industry. Businesses were expected to continue to use
software to improve productivity and add value to other areas of their
companies. Software-as-a-service was also expected to gain a
more consistent revenue stream in the future, as it charges
customers a monthly subscription fee to access software, as compared to a
one-time purchase of the software.10 As an individual company, Uber was
well into the growth phase of its life cycle as well in 2019. From its early days
starting in San Francisco, offering free rides in order to create buzz through
word of mouth, Uber was now a wellestablished service provider throughout
the United States, as well as worldwide. As Uber established itself in the
rideshare segment, it started working on expanding its services. Uber Eats has
been launched as a food delivery service, as Uber has also expanded into the
trucking industry and was expected to expand into the aviation industry.11
EXHIBIT 1 Performance Data Outlook for the Software
Industry
Revenue ($m) Enterprises(units)
Employment
(units) Wages ($m)
Number of
Mobile
Internet
Connections
(Millions)
2019 $269,874 10,606 660,932 $117,156 366
2020 $275,864 11,257 692,231 $122,115 398
2021 $281,773 11,936 723,439 $127,042 431
2022 $287,490 12,671 756,229 $132,164 464
2023 $293,161 13,457 789,600 $137,352 497
2024 $299,084 14,290 819,270 $142,035 530
2025 $305,435 15,067 848,673 $146,717 565
Recreated from source: Cook, D. (July 2019). IBISWorld Industry Report 51121: Software
Publishing in the US.
Key Industry Players
The software publishing industry is very diverse, with a large number of
smaller companies competing more with companies in other industries more
so than with internal competition. The largest well-known companies in the
industry are Apple, Microsoft, Oracle, and IBM, which only made up 37.5
percent of the market in 2019. A large number of minor players that have a
narrower concentration focused only on one or two market segments, such as
Uber Technologies, Square Inc., and Xcel Mobility Inc., make up the
remaining 62.5 percent of the market.12 Many companies like Uber have been
considered part of the software and technology industry, but have not directly
competed with many other software companies. They have instead disrupted
page C-318
competition in other industries, such as Uber has done in the transportation
industry.
THE HISTORY OF UBER TECHNOLOGIES
In December 2008, founders Travis Kalanick and Garrett Camp could not find
a ride during a snowstorm in Paris, France, which led them to create the
concept of Uber. Kalanick and Camp sought out to develop a better service
than the common taxi, and chose the name Uber because it is derived from the
German word which means “above all the rest.”13 In March 2009, Kalanick
and Camp, along with Oscar Salazar Gaitan, developed a smartphone app that
allowed users to tap a button on their phone and get a car ride. UberCab
officially launched in San Francisco, California, with their first ride request on
July 5, 2010. Uber began hiring immediately, finding their first employee and
eventual chief executive officer Ryan Graves through a Twitter post. Shortly
after Graves was promoted to chief executive officer, Uber introduced UberX,
the company’s most well-known service, which sought to match drivers using
their own vehicles to users in need of a ride. Uber’s rideshare service was
immediately popular with San Francisco’s tech-savvy residents, many of
whom did not own their own cars. They could now quickly hail a ride from
the convenience of their smartphone. The founders decided in October 2010
to drop “Cab” from the company name, as they determined that their service
was not a taxicab so there was no need to include it, so they opted to maintain
the Uber name alone.14
In order to edge out competition that offers a similar service, a company
must strategize a way to differentiate itself.15 Uber has done this
by continuously expanding its reach and expanding the services
it offers. In May 2011, Uber launched in New York, which was met by much
opposition from the city’s taxi industry. Seven months later in December
2011, Uber launched internationally in Paris, the same city where the idea was
first born. In August 2014, UberPool was launched, allowing rides to be
coordinated so that a driver had multiple riders travelling in the same general
direction. This concept allowed riders to share the cost and also aimed to
decrease traffic congestion and related pollution. Uber first began to venture
out of the rideshare service in April 2015 with Uber Eats, an on-demand food
delivery service, which debuted in New York, Los Angeles, and Chicago. In
September 2016, Uber launched a self-driving vehicle pilot program in
Pittsburgh, where riders could choose to request a self-driving car to pick
them up. Uber again looked to expand the services it offers in May 2017,
when Uber Freight launched, offering a hassle-free platform to allow trucking
companies and independent drivers to connect with shippers. Uber started as
an idea that eased the way people connect through ridesharing, and over the
course of time has evolved to become a multi-use platform for people in need
of a variety of services to easily find someone willing to provide such a
service. In August 2017, Uber’s board voted to hire Dara Khosrowshahi,
former CEO of Expedia, as the new CEO. He replaced Travis Kalanick after
he resigned following a series of controversies regarding Kalanick and the
cultural environment of Uber.16 As of December 2018, Uber had 91 million
monthly active platform consumers and 3.9 million drivers. At this time,
10 billion trips were completed worldwide in 63 countries, with an average of
14 million trips completed each day. In May 2019, Uber went public on the
New York Stock Exchange, with a share price of $45 and a market
capitalization of $75.5 billion.17 A graph depicting Uber’s stock price
performance since its May 10, 2019, conception date through December 30,
2019 is presented in Exhibit 2.
EXHIBIT 2 Uber’s Stock Price Since Going Public on May 10,
2019 through December 30, 2019
page C-319
Recreated from source: Uber Technologies, Inc. (UBER) Stock Historical Prices & Data. (2020,
April 15). Retrieved April 15, 2020, from https://finance.yahoo.com/quote/UBER/history?
p=UBER.
UBER’S BUSINESS MODEL
Target Market
As of January 2020, Uber was now a worldwide brand, but from its early days
Uber sought out to serve those with busy lives in large urban cities. Many
people living in large cities like San Francisco and New York often did not
own cars due to the lack of parking and the high cost of available parking.
Often these people relied on public transportation or taxis, and
Uber sought to provide a more efficient, lower cost means of
transportation for when a ride was needed at a moment’s notice. As Uber
expanded, it began to offer a wide array of levels of service, aimed to serve
basically every segment of society. Exhibit 3 shows a breakdown of Uber
segmentation, targeting and positioning based on several demographic
categories of users served worldwide in January 2020.
Uber for Business targeted the business traveler by allowing employees to
use Uber and have the trip billed directly to their company’s account. The aim
of launching Uber for Business was to create a centralized billing system for
company administrators to track and schedule rides for all members of the
organization.18
EXHIBIT 3 Uber Segmentation, Target and Positioning
Type of Segmentation SegmentationCriteria
Uber Target
Customer
Segment
Uber Target
Customer
Segment
Uber Target
Customer
Segment
Uber X, Uber
XI, Uber
pool, Uber-
MOTO, Uber
Auto
Uber
Premium,
Uber Go,
UberEATS,
UberBOAT,
UberRUSH
Uber Access
https://finance.yahoo.com/quote/UBER/history?p=UBER
Type of Segmentation SegmentationCriteria
Uber Target
Customer
Segment
Uber Target
Customer
Segment
Uber Target
Customer
Segment
GEOGRAPHIC Region
North & South
America,
Asia, New
Zealand,
Australia,
Europe, Africa
Uber AUTO –
Bangalore
and Pune only
North &
South
America,
Asia, New
Zealand,
Australia,
Europe,
Africa
North &
South
America,
Asia, New
Zealand,
Australia,
Europe,
Africa
Density Urban/rural Urban/rural Urban/rural
DEMOGRAPHIC Age 18+ 25–65 45–65
Gender Males &Females
Males &
Females
Males &
Females
Life-cycle
stage
Bachelor,
Newly
Married, Full
Nest I, II, III,
Empty Nest I,
II, Solitary
Survivor I, II
Full Nest I, II,
III,
Empty Nest I,
II Full Nest
III, Empty
Nest I, II
Occupation
Students,
employees,
professionals
Employees,
professionals
Retired,
handicapped
BEHAVIORAL Degree ofloyalty
‘Hard core
loyals’
‘Soft core
loyals’
‘Switchers’
‘Hard core
loyals’
‘Soft core
loyals’
‘Switchers’
‘Soft core
loyals’
Benefits
sought
Cost-
efficiency
Sense of
achievement Convenience
Personality
Easygoing,
determined,
ambitious
Determined,
ambitious Easygoing
User status
Non-users,
potential
users, first-
time users,
regular users
Potential
users, first-
time users,
regular users
Non-users,
potential
users
page C-320
Type of Segmentation SegmentationCriteria
Uber Target
Customer
Segment
Uber Target
Customer
Segment
Uber Target
Customer
Segment
PSYCHOGRAPHIC Socialclass
Lower class,
working class,
middle class
Middle class,
upper class
Working
class, middle
class, upper
class
Lifestyle
Struggler,
mainstreamer,
explorer,
reformer
Aspirer,
succeeder,
explorer,
reformer
Resigned,
struggler,
mainstreamer
Recreated from source: Dudovskiy, J. (2018, March 25). Uber Segmentation, Targeting and
Positioning – Research-Methodology. Retrieved March 15, 2020, from https://research-
methodology.net/uber-segmentation-targeting-and-positioning/.
Competition
Uber’s main competition in the software industry were other gig economy
companies like Lyft and DoorDash. Lyft has a seemingly similar business plan
that facilitates ridesharing. Both companies have recently gone
public, and currently are trading for similar prices as of January
2020, although Lyft has had a higher peak in the last year at $74.99 per share
and Uber’s 52 week peak is only $47.08 per share.19 Both companies’
ridesharing apps offer relatively similar levels of ridesharing services that both
advertise as hailing a ride with the touch of a button. Uber’s meal delivery
service UberEATS has competed with other similar companies like DoorDash,
which offer a platform for drivers to pick up prepared food from local
restaurants and deliver to the customer. Uber, Lyft, and DoorDash were facing
the same controversy over how they classify their drivers, with all three gig
economy companies maintaining that they do not hire employees, they have
only provided the technology to facilitate the service. Uber has differentiated
itself from other gig economy companies by offering a wide array of services.
It has competed with Lyft in ridesharing, and its Uber Eats segment has
competed with DoorDash, but as of January 2020, there are no other
companies that offer the array of technology services that Uber does in every
segment in which it competes.
Outside of the gig economy, the majority of Uber’s competition has come
from the taxi and limousine industry. From the very beginning, the taxi
industry has viewed Uber as a threat and has worked to push regulations
regarding how and where Uber operates. For example, in Colorado regulators
working to protect the taxi industry enacted laws prohibiting Uber from
operating within 100 feet of local restaurants and hotels. Limo services have
also attacked Uber over its business methods. Uber has refused to back down
from competition. While Travis Kalanick led Uber as CEO, the company
continued to operate in mass despite many cease-and-desist letters from
numerous officials in markets Uber was operating in. Kalanick was a
controversial leader, but his tenaciousness earned him a reputation among
Silicon Valley’s elite, and earned the company high profile investors,
including Jeff Bezos and Bill Gurley.20
Operations
As a software company, Uber has asserted that it does not employ the drivers,
but rather it provides the network that connects available drivers with
passengers in need of a ride. Uber has been attractive to riders as an upgraded
alternative to hailing a taxi or using public transportation, while it has
appealed to drivers as a flexible way to achieve a high earning potential.
Uber’s network orchestrator model has given it the ability to respond to
market changes quickly and effectively in comparison to its competitors in the
transportation industry that use a service provider network. Uber’s operational
strategy paid drivers based on fares rather than an hourly wage like a
traditional taxi company. This has allowed revenues to be more accurately
reflective of the local market share and has been useful in analyzing the
markets in which Uber operates. It has also helped Uber to reduce costs, as
drivers have only been paid for rides provided to passengers, rather than by
the hour, regardless of the number, or lack thereof, of rides provided. Uber has
offered financing options to obtain a car for people looking to drive that do
not currently own their own car, but Uber’s business model has depended on
drivers driving their own cars. This also helped Uber to reduce costs, as Uber
has not been responsible for the expense of the vehicle, insurance, gas, or
maintenance cost.21
Controversies over the Years
Uber has not survived as a company for this long without controversy. Uber
has faced much opposition in large cities, such as San Francisco and New
York, from the taxi industry. In 2010, Uber received a cease and desist letter
page C-321
from San Francisco’s Metro Transit Authority, which claimed that Uber was
running a taxi service without proper licensing. After three years of regulatory
litigation, a deal was reached that allowed Uber to continue to operate in San
Francisco.
In February 2017, Uber faced the first of several sexual harassment charges.
After news of a sexist workplace culture was exposed, Uber responded by
hiring former United States Attorney General Eric Holder to investigate the
claims and workplace culture issues. Founder Travis Kalanick was forced to
resign as chief executive officer by strong pressure from the board of
directors, and he was replaced by Dara Khosrowshahi.22
Uber was first met with opposition on how it classifies its drivers in
December 2013, when 35,000 Uber drivers joined together to file a lawsuit
against Uber. The drivers argued that they should be categorized as employees
with benefits and paid time off, rather than contract workers as Uber had
designated them. Uber was able to settle with the drivers outside
of court, and their drivers are still considered independent
contractors in most states as of January 2020.23 Uber and other gig economy
companies have faced much opposition on classifying their labor forces as
independent contractors who are able to set their own flexible schedules but
are not eligible for employee benefits such as paid time off, overtime, and
medical coverage.
California’s AB5
On January 1, 2020, a new law, AB5, took effect in California reclassifying
many independent contractors as employees. The law aimed to force gig
economy companies like Uber to offer their workers rights like minimum
wage, overtime, and paid leave, which labor unions have been advocating for
years. Uber had previously stated that it would follow AB5, but rather has so
far only attempted to prove that the law’s legal framework does not apply to
its drivers.24 In 2019, before the California law came into effect, Uber joined
with Lyft and DoorDash to file paperwork for the Protect App-Based Drivers
and Services Act, as an attempt to block the upcoming law. This initiative
sought to define an app-based driver as an independent contractor based on
multiple criteria. It argued that if the entity, such as Uber, did not require the
driver to work or be on call for specific hours, did not require the driver to
accept any specific rideshare or delivery request to remain active, and did not
restrict the driver from working on other apps, that said driver should not be
considered an employee. The initiative also aimed to amend certain issues that
led to AB5 being passed, including requiring employers of independent
contractors to provide a healthcare subsidy and a guaranteed minimum
earning equal to 120 percent of the current minimum wage. The initiative also
addressed a per-mile compensation to be adjusted for inflation, workers’
compensation for on-the-job injuries, discrimination protections, criminal
background checks for drivers, zero-tolerance drug and alcohol policies, and
driver safety training. As of this time, the status of the Protect App-Based
Drivers and Services Act is still pending.25
KHOSROWSHAHI’S DECISION
Uber had many areas to keep an eye on regarding their future operations, but
as of late spring 2020, the immediate challenges were the classification and
safety of its workers. Many gig economy companies were facing the similar
issues, and some had already joined with Uber to fight the pending
implementation of the California legislation. Going forward, Uber’s CEO
Dara Khosrowshahi needed to decide how Uber should continue to operate in
California, and do so safely, given the unknown ramifications and duration of
the COVID-19 pandemic.
One option under consideration was to interpret AB5 as legislation that
would include all Uber drivers and reclassify all California drivers as
employees on their payroll. This option could be very costly to Uber, which
had posted a net profit in only one fiscal year since 2016, as seen in Exhibit 4.
Under this option, Uber would be required to pay for employee benefits such
as paid time off and medical insurance and workers’ compensation, all of
which would add to the current liabilities on its balance sheet. Uber’s current
liabilities had already increased since 2017, as shown in Exhibit 5. This option
was also not ideal for most drivers, especially those that already had another
job with a set schedule and were driving to supplement their incomes. As an
employer, if Uber saw it to be fit, it would have the authority to set the hours
and locations that drivers were required to drive.
EXHIBIT 4 Uber Technologies, Inc.’s Income Statements,
2016–2019 (in thousands)
2019 2018 2017 20162019 2018 2017 2016
Total Revenue $14,147,000 $11,270,000 $7,932,000 $3,845,000
Cost of Revenue 7,208,000 5,623,000 4,160,000 2,228,000
Gross Profit 6,939,000 5,647,000 3,772,000 1,617,000
Operating
Expenses
Research &
Development 4,836,000 1,505,000 1,201,000 864,000
SG&A Expenses 7,925,000 5,233,000 4,787,000 2,575,000
Total Operating
Expenses
15,525,000 8,680,000 7,852,000
4,640,000
Operating
Income/Loss (8,596,000) (3,033,000) (4,080,000) (3,023,000)
Interest Expense 559,000 648,000 479,000 334,000
Total Other
Income/Expenses
Net
488,000 4,889,000 (87,000) 117,000
Income Before Tax (8,433,000) 1,312,000 (4,575,000) (3,218,000)
Income Tax
Expense
45,000
283,000 (542,000)
28,000
Income from Cont.
Operations after
income taxes and
before loss from
equity method
investment
(8,512,000) 987,000 (4,033,000) (3,246,000)
Income (loss) from
discontinued
operations, net of
income taxes
— — — 2,876,000
Net Income $ (8,506,000) $ 997,000 $(4,033,000) $ (370,000)
Net Income
available to common
shareholders
(8,506,000) 1,938,000 (4,033,000) (370,000)
Basic and diluted
EPS $(6.81) — $(9.46) $(0.90)
2019 2018 2017 2016
Basic Average
Shares 1,248,353 443,360 426,360 411,501
Diluted Average
Shares 1,248,353 478,999 426,360 411,501
Source: Uber Technologies, Inc. 2019 Annual Report.
EXHIBIT 5 Uber Technologies, Inc.’s Balance Sheets, 2017–
2019 (in thousands)
At December 31 2019 2018 2017
Assets
Current Assets
Cash and Cash Equivalents $10,873,000 $ 6,406,000 $ 4,393,000
Other Short-Term Investments 440,000 – –
Total Cash 11,313,000 6,406,000 4,393,000
Net Receivables 1,214,000 919,000 739,000
Other Current Assets 300,000 179,000 21,000
Total Current Assets 13,925,000 8,658,000 6,837,000
Non-Current Assets
Property, Plant and Equipment
Gross Property, Plant and
Equipment 4,699,000 2,587,000 1,723,000
Accumulated Depreciation (1,374,000) (946,000) (531,000)
Net Property, Plant and
Equipment 3,325,000 1,641,000 1,192,000
Equity and Other Investments 11,891,000 11,667,000 5,969,000
Goodwill 167,000 153,000 39,000
Intangible Assets 71,000 82,000 54,000
Other Long-Term Assets 2,382,000 1,787,000 1,335,000
Total Non-Current Assets 17,836,000 15,330,000 8,589,000
Total Assets $31,761,000 $23,988,000 $15,426,000
Liabilities and Stockholders’
Equity
At December 31 2019 2018 2017
Liabilities
Current Liabilities
Current Debt $ 0 $ 0 $ 87,000
Accounts Payable 272,000 150,000 213,000
Taxes Payable 194,000 – 244,000
Accrued Liabilities 1,289,000 4,211,000 942,000
Deferred Revenues 76,000 – 38,000
Other Current Liabilities 222,000 11,000 517,000
Total Current Liabilities 5,639,000 5,313,000 3,847,000
Non-Current Liabilities
Long Term Debt 5,707,000 4,535,000 3,048,000
Deferred Tax Liabilities 1,027,000 – 1,041,000
Other Long-Term Liabilities 315,000 1,811,000 741,000
Total Non-Current Liabilities 11,250,000 8,342,000 20,136,000
Total Liabilities 16,889,000 13,655,000 23,983,000
Stockholders’ Equity
Common Stock – – –
Retained Earnings (16,362,000) (10,334,000) (8,874,000)
Accumulated Other
Comprehensive Income (187,000) (188,000) (3,000)
Total Stockholders’ Equity 14,190,000 10,333,000 (8,557,000)
Total Liabilities and
Stockholders’ Equity $31,761,000 $23,988,000 $15,426,000
Source: Uber Technologies, Inc. 2019 Annual Report.
Khosrowshahi’s second option was to ignore AB5 and continue business as
usual in California. This option could be detrimental to Uber, as labor unions
were adamant that the gig economy workers should be reclassified as
employees with all of the benefits that would accrue to being paid workers.
Ignoring AB5 could possibly result in a future court ruling that Uber drivers
must be included in the umbrella of workers that California’s AB5 covers.
Failure to comply could also ultimately result in the termination of Uber’s
services in the State of California.
page C-323
page C-322
page C-324
Khosrowshahi’s third option was to hire lawyers to advocate on its behalf
that Uber drivers “are independent contractors and do not fit the definition of
an employee,” therefore AB5 does not apply to Uber. Mindful that Uber had
experienced more than a few legal and ethical controversies surrounding its
operations, navigating the legal route to classifying their drivers was expected
to play a major role in determining whether or not Uber would be allowed to
operate in California, not to mention in other states considering similar
legislation down the road.
After ridership plummeted 80 percent in April 2020 due to
the due to the COVID-19 pandemic, on May 4, 2020, Uber
announced that it was cutting 3,700 jobs. On May 18, 2020, Uber
Technologies Inc. announced in an e-mail to its staff that it was cutting
thousands of additional jobs, closing more than three dozen offices, and re-
evaluating big bets in areas ranging from freight to self-driving technology as
Khosrowshahi attempted to steer the ride-hailing giant through the
coronavirus pandemic. Through these moves, Uber planned to save more than
$1 billion in fixed costs. Uber has rebuilt its app to make sure drivers and
riders adhere to safety guidelines around the novel coronavirus. Before each
trip, drivers and passengers will now have to agree to a “Go Online Checklist”
of items, including wearing a face mask, keeping windows rolled down when
possible and have no one sitting in the front seat. “Many countries around the
world are moving to a new phase of recovery,” Khosrowshahi was quoted in
the popular business press as saying. “We’ve built a new product experience
for a new normal.” On its website, the company pledged 10 million free rides
and deliveries of food for frontline healthcare workers, seniors, and people in
need around the world.
As Khosrowshahi contemplated Uber’s next move, he remained mindful
that, while only his California drivers were currently under scrutiny,
developing a California-only approach would help or hinder the company’s
ability to handle future legislation in the remaining 49 states and the District
of Columbia.
ENDNOTES
1 Wohlsen, M. (2018, October 5). What Uber Will Do With All That Money From Google. Retrieved April 4, 2020, from
https://www.wired.com/2014/01/uber-travis-kalanick/.
2 Cook, D. (July 2019). IBISWorld Industry Report 51121: Software Publishing in the US.
3 Ibid.
4 Ibid.
5 Ibid.
6 Multimedia, graphics & publishing software – quarterly update 6/10/2019. (2019, June 10). Fort Mill, South Carolina:
Mergent. Retreived February 20, 2020 from https://search-proquest-
com.sonoma.idm.oclc.org/abicomplete/docview/2299432057/BD153144CA5F4431PQ/1?accountid=13949.
7 Industry Profiles: Prepackaged Software. (2020, February 15). Retrieved February 22, 2020, from
https://www.encyclopedia.com/economics/economics-magazines/industry-profiles-prepackaged-software-0.
8 Cai, K. (2019, October 16). To Beat Uber And Lyft, This Startup Vows To Give Its Drivers The Full Fare. Retrieved
February 15, 2020, from https://www.forbes.com/sites/kenrickcai/2019/08/22/nomad-rides-commission-free-ride-
hailing/.
9 Herrera, S. (2019, September 21). Uber, Lyft Drivers Torn as California Law Could Reclassify Them. Retrieved April 20,
2020, from https://www.wsj.com/articles/uber-lyft-drivers-torn-as-california-law-could-reclassify-them-
11569063601.
10 Cook, D. (July 2019). IBISWorld Industry Report 51121: Software Publishing in the US.
11 Brown, M. (n.d.). Uber—What’s Fueling Uber’s Growth Engine? Retrieved February 15, 2020, from
12 Cook, D. (July 2019). IBISWorld Industry Report 51121: Software Publishing in the US.
13 O’Connell, B. (2019, July 23). History of Uber: Timeline and Facts. Retrieved February 15, 2020, from
https://www.thestreet.com/technology/history-of-uber-15028611.
14 The History of Uber—Uber’s Timeline: Uber Newsroom US. (n.d.). Retrieved February 22, 2020, from
https://www.uber.com/newsroom/history/.
15 Porter, M. E. (1996). What Is Strategy? Harvard Business Review, 74(6), pp. 61–78.
16 Carson, B. (2017, August 30). It’s Official: Dara Khosrowshahi Is Uber’s New CEO. Retrieved April 15, 2020, from
https://www.forbes.com/sites/bizcarson/2017/08/29/its-official-dara-khosrowshahi-is-ubers-new-ceo/.
17 O’Connell, B. (2019, July 23). History of Uber: Timeline and Facts. Retrieved February 15, 2020, from
https://www.thestreet.com/technology/history-of-uber-15028611.
18 Donovan, F. (2014). Uber competitor Lyft targets corporate market with Lyft for work. FierceMobileIT, Retrieved from
http://sonoma.idm.oclc.org/login?url=https://search-proquest-com.sonoma.idm.oclc.org/docview/1625154452?
accountid=13949.
19 Uber Technologies, Inc. (UBER) Stock Price, Quote, History & News. (2020, April 4). Retrieved April 4, 2020, from
https://finance.yahoo.com/quote/UBER?p=UBER.
20 Hempel, J., & Mangalindan, J. (2013). Hey, Taxi Company, You Talkin’ to Me? Fortune, 168(6), p. 96.
21 O’Connell, B. (2019, July 23). History of Uber: Timeline and Facts. Retrieved February 15, 2020, from
https://www.thestreet.com/technology/history-of-uber-15028611.
22 Ibid.
23 Tamberino, R. (n.d.). Uber: A Winning Strategy. Retrieved February 29, 2020, from https://digital.hbs.edu/platform-
rctom/submission/uber-a-winning-strategy/.
24 Absher, S. (2020). California’s AB5 & gig work: What now? BenefitsPRO, Retrieved
from http://sonoma.idm.oclc.org/login?url=https://search-proquest-
com.sonoma.idm.oclc.org/docview/2348119608?accountid=13949.
25 Uber, lyft, DoorDash try end run of California’s AB5 with new bill. (2019, October 30). Benzinga Newswires Retrieved
from http://sonoma.idm.oclc.org/login?url=https://search-proquest-
com.sonoma.idm.oclc.org/docview/2310418054?accountid=13949.
https://www.wired.com/2014/01/uber-travis-kalanick/
https://search-proquest-com.sonoma.idm.oclc.org/abicomplete/docview/2299432057/BD153144CA5F4431PQ/1?accountid=13949
https://www.encyclopedia.com/economics/economics-magazines/industry-profiles-prepackaged-software-0
https://www.forbes.com/sites/kenrickcai/2019/08/22/nomad-rides-commission-free-ride-hailing/
https://www.wsj.com/articles/uber-lyft-drivers-torn-as-california-law-could-reclassify-them-11569063601
https://www.thestreet.com/technology/history-of-uber-15028611
https://www.uber.com/newsroom/history/
https://www.forbes.com/sites/bizcarson/2017/08/29/its-official-dara-khosrowshahi-is-ubers-new-ceo/
https://www.thestreet.com/technology/history-of-uber-15028611
http://sonoma.idm.oclc.org/login?url=https://search-proquest-com.sonoma.idm.oclc.org/docview/1625154452?accountid=13949
https://finance.yahoo.com/quote/UBER?p=UBER
https://www.thestreet.com/technology/history-of-uber-15028611
https://digital.hbs.edu/platform-rctom/submission/uber-a-winning-strategy/
http://sonoma.idm.oclc.org/login?url=https://search-proquest-com.sonoma.idm.oclc.org/docview/2348119608?accountid=13949
http://sonoma.idm.oclc.org/login?url=https://search-proquest-com.sonoma.idm.oclc.org/docview/2310418054?accountid=13949
S
page C-325
CASE 25
Starbucks in 2020: Is the Company on
Track to Achieve Attractive Growth and
Operational Excellence?
Copyright ©2021 by Arthur A. Thompson. All rights reserved.
Arthur A. Thompson
The University of Alabama
ince its founding in 1987 as a modest nine-store operation in Seattle, Washington,
Starbucks had become the premier roaster, marketer, and retailer of specialty
coffees in the world, with just over 32,000 store locations in 78 countries as of April
2020 and annual sales of $26.5 billion in fiscal year 2019, ending September 30, 2019.
In addition to its flagship Starbucks brand coffees and coffee beverages, Starbucks’
other brands and products included Starbucks Reserve blends of coffee, Teavana teas,
Seattle’s Best Coffee, Evolution Fresh juices and smoothies, Ethos bottled waters,
Torrefazione Italia Coffee, and Princi bakery products. Starbucks stores also sold baked
pastries, cold and hot sandwiches, salads, salad and grain bowls, oatmeal, yogurt
parfaits and fruit cups purchased from a variety of local, regional, and national
suppliers. In January 2017, then CEO and company founder Howard Starbucks
launched a somewhat grandiose strategic initiative to inject more innovation and fresh
approaches into the company’s operations and to spur growth:
Open 20-30 Starbucks Reserve™ Roasteries and Tasting Rooms, which would
showcase the theater of coffee roasting and brewing in a big, multi-level stores with
amazing decorations, seating for upwards of a thousand patrons, multiple types of
coffee bars with elaborate menus of innovative coffee beverages and interesting food
selections, areas where friends could gather at community tables or in lounge areas
with fireplaces, a mixology bar serving traditional Italian cocktails, multiple dining
page C-326
venues, and an upscale Princi bakery where patrons could watch chefs preparing
fresh-baked artisanal Italian breads, sandwiches, and pastries being served to diners.
Going into 2020, Roasteries had been opened in Seattle, Shanghai, Milan, New York,
Chicago, and Tokyo—all attracted local coffee enthusiasts, partiers, nearby shoppers
curious to see what the Brewery offered, and visiting sightseers looking to enjoy a
very different kind of Starbucks experience.
Open 1,000 Starbucks Reserve stores worldwide to bring premium experiences to
customers and promote the company’s recently-introduced Starbucks Reserve™
coffees; these locations were to offer a more intimate small-lot coffee experience and
gave customers a chance to chat with a barista about all things coffee. The menu at
Starbucks Reserve stores was to consist of handcrafted hot and cold Starbucks
Reserve™ coffee beverages, hot and cold teas, ice cream/coffee beverages, and an
assortment of small plates, sandwiches and wraps, desserts, wines, and beer. Packages
of Starbucks Reserve™ whole bean coffees were to be available for purchase. Plans
called for four types of brewing methods for the coffees and teas. Starbucks had 43
Starbucks Reserve locations in February 2020.
Transform about 20 percent of the company’s existing portfolio of Starbucks stores
into upgraded Starbucks Reserve coffee bars.
However, shortly after announcing the initiative, Howard Schultz
stepped down as Starbucks CEO, turning the role over to Kevin Johnson, Starbucks
chief operating officer with whom Schultz had worked closely for the past two years—
they had adjoining offices connected by a door and usually visited together multiple
times a day. Shultz stayed on as chairman of the company’s board of directors and
focused his time on social initiatives and plans for the upscale Roastery locations and
Starbucks Reserve brand. Schultz exuded confidence that Johnson was the right person
to lead Starbucks in the future and that he was well prepared to meet the challenges of
continuing to build the Starbucks brand, enhance the consumer experience, and manage
its global operations.
Johnson fairly quickly scaled back the sizes of all three of the somewhat
transformational strategic moves announced by Schultz, chiefly due to their cost and
questionable profitability, and proceeded to steer Starbucks back to the strategic path
the company had steadfastly pursued for most of the past decade; these included the
following strategy elements:
Maintain Starbucks standing as one of the most recognized and respected brands in
the world and stay strongly focused on providing customers with a pleasing Starbucks
experience that prompted them to patronize Starbucks stores frequently.
Continue disciplined expansion of the company’s store base, adding stores in both
existing, developed markets and in newer, higher growth markets like China, which
for several years had been singled out as Starbucks best opportunity for opening
hundreds of new stores annually. During fiscal 2018 and fiscal 2019, Starbucks
opened new stores in China at the rate of 1 every 15 hours; as of March 31, 2020, the
company had 4,351 company-operated stores in China. Shanghai alone had over 600
Starbucks stores, more than any other city in the world. Starbucks goal was to have
5,000 stores in China by 2021.
Optimize the mix of company-operated and licensed stores by determining which
type of store was best suited to ongoing changes in business and political
circumstances in various countries around the world and by recognizing that to the
special situations of stores operating in big hotels, resorts, airports, hospitals, major
office buildings, and on university campuses sometimes called for licensed stores and
sometimes for stores owned and operated by Starbucks.
Continue to offer consumers new coffee and other products in a variety of forms,
across new categories, diverse channels, and alternative store formats.
Continue to enhance the company’s social responsibility strategy and increase the
company’s efforts to be a good corporate citizen, ethically source high-quality coffee,
contribute positively to the communities in which it does business, be an employer of
choice, and exert ever-stronger efforts to protect the planet.
Exhibit 1 provides an overview of Starbucks performance during fiscal years 2010–
2019.
EXHIBIT 1 Financial and Operating Summary for Starbucks
Corporation, Fiscal Years 2010–2019 ($ in millions, except for per-
share amounts)
Fiscal Years Ending
Sept. 29, 2019 Sept. 30, 2018 Oct. 1,2017 Oct. 2,2016 Oct. 3,2010
INCOME
STATEMENT
DATA
Net revenues:
Company-
operated stores $21,544.4 $19,690.3 $17,650.7 $16,844.1 $ 8,963.5
Licensed
stores 2,875.0 2,652.2 2,355.0 2,154.2 875.2
Consumer
packaged goods,
foodservice, and
other
2,089.2
2,377.0 2,381.1
2,317.6
868.7
Total net
revenues $26,508.6 $24,719.5 $22,386.8 $21,315.9 $10,707.4
Cost of sales 8,526.9 $ 7,930.7 $ 8,486.8 $ 8,511.1 $ 4,458.6
Fiscal Years Ending
Sept. 29, 2019 Sept. 30, 2018 Oct. 1,2017 Oct. 2,2016 Oct. 3,2010
Store operating
expenses 10,493.6 9,472.2 7,065.8 6,064.3 3,551.4
Other operating
expenses 371.0 554.9 518.0 545.4 293.2
Depreciation and
amortization
expenses
1,377.3 1,247.0 1,011.4 980.8 510.4
General and
administrative
expenses
1,824.1 1,708.2 1,408.2 1,360.6 569.5
Restructuring and
impairments
135.8
224.4 153.5
—
-
53.0
Total operating
expenses 22,728.7 21,137.4 18,643.5 17,462.2 9,436.1
Income from
equity investees
and other
298.0
301.2 391.4
318.2
148.1
Operating
income 4,077.9 3,883.3 4,134.7 4,171.9 1,419.4
Gain resulting
from acquisition
of joint venture
—- 1,376.4 —- —- —-
Net gain resulting
from divestiture of
certain
operations
622.8 499.2 93.5 5.4 —
Net earnings
attributable to
Starbucks
$ 3,594.6 $ 4,518.0 $ 2,884.97 $ 2,817.7
$
945.6
Net earnings per
common share—
diluted
$ 2.92 $ 3.24 $ 1.97 $ 1.90
$
0.62
BALANCE
SHEET DATA
Current assets $ 5,653.9 $12,494.2 $ 5,283.4 $ 4,757.9 $ 2,756.5
Current
liabilities 6,168.7 5,684.2 4,220.7 4,546.8 2,703.6
Total assets 19,219.6 24,156.4 14,365.6 14,312.5 6,385.9
Long-term debt
(including current
portion)
11,167.0 9,090.2 3,932.6 3,585.2 549.4
Fiscal Years Ending
Sept. 29, 2019 Sept. 30, 2018 Oct. 1,2017 Oct. 2,2016 Oct. 3,2010
Shareholders’
equity (6,232.0) 1,175.8 5,457.0 5,890.7 3,674.7
OTHER
FINANCIAL
DATA
Net cash
provided by
operating
activities
$ 5,047.0 $11,937.8 $ 4,251.8 $ 4,697.9 $ 1,704.9
Capital
expenditures
(additions to
property, plant,
and equipment)
1,806.6 1,976.4 1,519.4 1,440.3 440.7
STORE
INFORMATION
Stores open at
year-end
United States
Company-
operated
stores
8,799 9,684 8,222 7,880 6,707
Licensed
stores 6,250 7,770 5,708 6,588 4,424
International
Company-
operated
stores
7,035 5,657 5,053 4,831 2,182
Licensed
stores 9,172 8,356 8,356 7,082 3,545
Worldwide 31,256 29,324 27,339 25,085 16,858
Worldwide
percentage
change in sales
at company-
operated stores
open 13 months
or longer
5% 2% 3% 5% 7%
*Starbucks1 fiscal year ends on the Sunday closest to September 30.
Note 1: In fiscal years 2016 and 2010, cost of sales included occupancy expenses for Starbucks company-operated
stores. In fiscal years 2017, 2018 and 2019, occupancy expenses for Starbucks company-operated stores were
reclassified and included in store operating expenses. This change accounts for much of the discontinuity between
page C-327
page C-328
cost of sales for 2016 and costs of sales in 2017, 2018, and 2019, and similarly for the big jump between store
operating expenses for 2017 versus store operating expenses for 2018 and 2019.
Sources: Company 10-K reports for 2011, 2017, 2018, and 2019 and data reporting Starbucks store
counts by market posted in the investor relation section at www.starbucks.com (accessed November 1,
2019).
COMPANY BACKGROUND
Starbucks Coffee, Tea, and Spice
Starbucks got its start in 1971 when three academics (English teacher Jerry Baldwin,
history teacher Zev Siegel, and writer Gordon Bowker—all coffee aficionados) opened
Starbucks Coffee, Tea, and Spice in touristy Pike Place Market in Seattle. The three
partners shared a love for fine coffees and exotic teas and believed they could build a
clientele in Seattle that would appreciate the best coffees and teas. By the early 1980s,
the company had four Starbucks stores in the Seattle area and had been profitable every
year since opening its doors.
Howard Schultz Enters the Picture
In 1981, Howard Schultz, vice president and general manager of U.S. operations for a
Swedish maker of stylish kitchen equipment and coffeemakers based in New York City,
decided to pay Starbucks a visit. He was curious why Starbucks was selling so many of
his company’s products. When he arrived at the Pike Place store, a solo violinist was
playing Mozart at the door (his violin case open for donations). Schultz was
immediately taken by the coffee aroma, store décor and ambiance, and the freshly
brewed cup of coffee he bought. He began asking questions about the company, the
coffees from different parts of the world, and the different ways of roasting coffee.
Later, when he met with two of the owners, Schultz was struck by their knowledge
about coffee, their commitment to providing customers with quality coffees, their
passion for educating customers about the merits and quality of dark-roasted coffees,
and their business philosophy. Top quality, fresh-roasted, whole-bean coffee was the
company’s differentiating feature and a bedrock value. The company depended mainly
on word-of-mouth to get more people into its stores, then built customer loyalty cup by
cup as buyers gained a sense of discovery and excitement about the taste of fine coffee.
By the time he landed on his return trip to New York, Howard Schultz knew in his heart
he wanted to go to work for Starbucks. But it took over a year and multiple meetings
and discussions to convince the owners to bring in a high-powered New Yorker who
had not grown up with the values of the company. In Spring 1982, Schultz was offered
http://www.starbucks.com/
page C-329
the job of heading marketing and overseeing Starbucks’ retail stores; he assumed his
new responsibilities at Starbucks in September 1982.
Starbucks and Howard Schultz: The 1982–1985 Period
In his first few months at Starbucks, Schultz spent most of his time in the four Seattle
stores—working behind the counters, tasting different kinds of coffee, talking with
customers, getting to know store personnel, and learning the retail aspects of the coffee
business. In December, he began the final part of his training, that of actually roasting
the coffee. Schultz spent a week getting an education about the colors of different coffee
beans, listening for the telltale second pop of the beans during the roasting process,
learning to taste the subtle differences among the various roasts, and familiarizing
himself with the roasting techniques for different beans.
Schultz overflowed with ideas for the company. However, his biggest inspiration and
vision for Starbucks future came during the spring of 1983 when the company sent him
to Milan, Italy, to attend an international housewares show. While walking from his
hotel to the convention center, he spotted an espresso bar and went inside to look
around. The cashier beside the door nodded and smiled. The “barista” behind the
counter greeted Schultz cheerfully and began pulling a shot of espresso for one
customer and handcrafting a foamy cappuccino for another, all the while conversing
merrily with patrons standing at the counter. Schultz thought the barista’s performance
was “great theater.” Just down the way, he went to an even more crowded espresso bar
where the barista was greeting customers by name, and people were laughing and
talking in an atmosphere that plainly was comfortable and familiar. In the next few
blocks, he saw two more espresso bars. That afternoon, Schultz walked the streets of
Milan to explore more espresso bars. Some were stylish and upscale; others attracted a
blue-collar clientele. Most had few chairs and it was common for Italian opera to be
playing in the background. What struck Schultz was how popular and vibrant the Italian
coffee bars were. Energy levels were typically high and they seemed to function as an
integral community gathering place. Each one had its own unique character, but they all
had a barista that performed with flair and there was camaraderie between the barista
and the customers. Schultz liked it immediately, concluding that lattes
should be a feature item on any coffee bar menu even though none of the
coffee experts he had talked to had ever mentioned coffee lattes. Schultz was also struck
by the fact that there were 1,500 coffee bars in Milan, a city about the size of
Philadelphia, and a total of 200,000 in all of Italy.
Schultz’s 1983 trip to Milan produced a revelation: the Starbucks stores in Seattle
completely missed the point. There was much more to the coffee business than just
selling beans and getting people to appreciate grinding their own beans and brewing
fine coffee in their homes. What Starbucks needed to do was serve fresh-brewed coffee,
espressos, and cappuccinos in its stores (in addition to beans and coffee equipment) and
try to create an American version of the Italian coffee bar culture. Going to Starbucks
should be an experience, a special treat, a place to meet friends and visit. Re-creating
the authentic Italian coffee bar culture in the United States could be Starbucks
differentiating factor.
Schultz Becomes Frustrated
On Schultz’s return from Italy, he shared his revelation and ideas for modifying the
format of Starbucks’ stores, but the owners strongly resisted, contending that Starbucks
was a retailer, not a restaurant or coffee bar. They feared serving drinks would put them
in the beverage business and diminish the integrity of Starbucks’ mission as a purveyor
of fine coffees. They pointed out that Starbucks had been profitable every year and there
was no reason to rock the boat in a small, private company like Starbucks. It took
Howard Schultz nearly a year to convince them to let him test an espresso bar when
Starbucks opened its sixth store in April 1984. It was the first store designed to sell
beverages and it was the first store located in downtown Seattle. Schultz asked for a
1,500-square-foot space to set up a full-scale Italian-style espresso bar, but he was
allocated only 300 square feet in a corner of the new store. The store opened with no
fanfare as a deliberate experiment to see what happened. By closing time on the first
day, some 400 customers had been served, well above the 250-customer average of
Starbucks best performing stores. Within two months the store was serving 800
customers per day. The two baristas could not keep up with orders during the early
morning hours, resulting in lines outside the door onto the sidewalk. Most of the
business was at the espresso counter, while sales at the regular retail counter were only
adequate.
Schultz was elated at the test results, expecting that the owners’ doubts about entering
the beverage side of the business would be dispelled and that he would gain approval to
pursue the opportunity to take Starbucks to a new level. Every day he shared the sales
figures and customer counts at the new downtown store. But the lead owner was not
comfortable with the success of the new store, believing that it felt wrong and that
espresso drinks were a distraction from the core business of marketing fine Arabica
coffees at retail.1 While he didn’t deny that the experiment was succeeding, he would
not agree to go forward with introducing beverages in other Starbucks stores.
Over the next several months, Schultz made up his mind to leave Starbucks and start
his own company. The two owners, knowing how frustrated Schultz had become,
supported his efforts to go out on his own and agreed to let him stay in his current job
and office until definitive plans were in place. Schultz left Starbucks in late 1985.
Schultz’s Il Giornale Venture
Schultz spent several months raising money from investors to fund his new venture. An
investor suggested naming the new company Il Giornale Coffee Company (pronounced
il-jor-nahl’-ee), a suggestion that Howard accepted. The first Il Giornale store opened in
page C-330
April 1986. It measured 700 square feet and was located near the entrance of Seattle’s
tallest building. The décor was Italian and there were Italian words on the menu. Italian
opera music played in the background. The baristas wore white shirts and bow ties. All
service was stand up—there were no chairs. National and international papers were
hung on rods on the wall. By closing time on the first day, 300 customers had been
served—mostly in the morning hours. But while the core idea worked well, it soon
became apparent that several aspects of the format were not appropriate for Seattle.
Some customers objected to the incessant opera music, others wanted a place to sit
down; many people did not understand the Italian words on the menu. These “mistakes”
were quickly fixed, but an effort was made not to compromise the style and elegance of
the store. Within six months, the store was serving more than 1,000 customers a day.
Regular customers had learned how to pronounce the company’s name.
Because most customers were in a hurry, it became apparent that speedy
service was essential.
Six months after opening the first store, a second store was opened in another
downtown building. In April 1987, a third store was opened in Vancouver, British
Columbia, to test the transferability of the company’s business concept outside Seattle.
By mid-1987, sales at each of the three stores were running at a rate equal to $1.5
million annually.
II Giornale Acquires Starbucks
In March 1987, the Starbucks owners decided to sell the whole Starbucks operation in
Seattle—the stores, the roasting plant, and the Starbucks name. Schultz knew
immediately that he had to buy Starbucks; his board of directors agreed. Within weeks,
Schultz had raised the $3.8 million needed to buy Starbucks. The acquisition was
completed in August 1987. The new name of the combined companies was Starbucks
Corporation. Howard Schultz, at the age of 34, became Starbucks president and CEO.
Starbucks as a Private Company: 1987–1992
The Monday morning after the deal closed, Howard Schultz returned to the Starbucks
offices at the roasting plant, greeted all the familiar faces, and accepted their
congratulations. Then, he called the staff together for a meeting on the roasting plant
floor:2
All my life I have wanted to be part of a company and a group of people who share a common vision. . . . I’m
here today because I love this company. I love what it represents. . . . I know you’re concerned. . . . I promise you
I will not let you down. I promise you I will not leave anyone behind. . . . In five years, I want you to look back
at this day and say “I was there when it started. I helped build this company into something great.
Schultz told the group that his vision was for Starbucks to become a national company
with values and guiding principles that employees could be proud of. He aspired for
Starbucks to become the most respected brand name in coffee and for the company to
page C-331
be admired for its corporate responsibility. He indicated that he wanted to include
people in the decision-making process and that he would be open and honest with them.
For Schultz, building a company that valued and respected its people, that inspired
them, and that shared the fruits of success with those who contributed to the company’s
long-term value was essential, not just an intriguing option. He made the establishment
of mutual respect between employees and management a priority.
The business plan Schultz had presented investors called for the new 9-store
company to open 125 stores in the next five years—15 the first year, 20 the second, 25
the third, 30 the fourth, and 35 the fifth. Revenues were projected to reach $60 million
in 1992. But the company lacked experienced management. Schultz had never led a
growth effort of such magnitude and was just learning what the job of CEO was all
about, having been the president of a small company for barely two years. Dave Olsen,
a Seattle coffee bar owner who Schultz had recruited to direct store operations at II
Giornale, was still learning the ropes in managing a multistore operation. Ron
Lawrence, the company’s controller, had worked as a controller for several
organizations. Other Starbucks employees had only the experience of managing or
being a part of a six-store organization.
Schultz instituted a number of changes in the first several months. To symbolize the
merging of the two companies and the two cultures, a new logo was created that melded
the designs of the Starbucks logo and the Il Giornale logo. The Starbucks stores were
equipped with espresso machines and remodeled to look more Italian than old-world
nautical. Il Giornale green replaced the traditional Starbucks brown. The result was a
new type of store—a cross between a retail coffee bean store and an espresso bar/café—
that quickly evolved into Starbucks’ signature.
By December 1987, the mood at Starbucks was distinctly upbeat, with most
employees buying into the changes that Schultz was making, and trust was beginning to
build between management and employees. New stores were on the verge of opening in
Vancouver and Chicago. One Starbucks store employee, Daryl Moore, who had started
working at Starbucks in 1981 and voted against unionization in 1985, began to question
the need for a union with his fellow employees. Over the next few weeks, Moore began
a move to decertify the union. He got a majority of store employees to sign a de-
certification letter and presented it to the National Labor Relations Board. The union
representing store employees was decertified. Later, in 1992, the union
representing Starbucks roasting plant and warehouse employees was also
decertified.
Market Expansion Outside the Pacific Northwest
The first Chicago store opened in October 1987 and three more stores were opened over
the next six months. Initially, customer counts at the stores were substantially below
expectations because Chicagoans did not take to dark-roasted coffee as fast as Schultz
had anticipated. While it was more expensive to supply fresh coffee to the Chicago
stores out of the Seattle warehouse, the company solved the problem of freshness and
quality assurance by putting freshly roasted beans in special FlavorLock bags with a
one-way valve to allow carbon dioxide to escape without allowing air and moisture in.
Moreover, rents, and wage rates were higher in Chicago. The result was a squeeze on
store profit margins. Gradually, customer counts improved, but Starbucks lost money on
its Chicago stores until, in 1990, prices were raised to reflect higher rents and labor
costs, more experienced store managers were hired, and a critical mass of customers
caught on to the taste of Starbucks products.
Portland, Oregon, was the next market entered, and Portland coffee drinkers took to
Starbucks products quickly. Store openings in Los Angeles and San Francisco soon
followed. L.A. consumers embraced Starbucks quickly, and the Los Angeles Times
named Starbucks the best coffee in America before the first store opened.
Starbucks’s store expansion targets proved easier to meet than Schultz had originally
anticipated and he upped the numbers to keep challenging the organization. Starbucks
opened 15 new stores in fiscal 1988, 20 in 1989, 30 in 1990, 32 in 1991, and 53 in 1992
—producing a total of 161 stores, significantly above his original 1992 target of 125
stores.
From the outset, the strategy was to open only company-owned stores; franchising
was avoided so as to keep the company in full control of the quality of its products and
the character and location of its stores. But company-ownership of all stores required
Starbucks to raise new venture capital to cover the cost of new store expansion. In 1988,
the company raised $3.9 million; in 1990, venture capitalists provided an additional
$13.5 million; and in 1991, another round of venture capital financing generated $15
million. Starbucks was able to raise the needed funds despite posting losses of $330,000
in 1987, $764,000 in 1988, and $1.2 million in 1989. While the losses were troubling to
Starbucks’ board of directors and investors, Schultz’s business plan had forecast losses
during the early years of expansion. At a particularly tense board meeting where
directors sharply questioned Schultz about the lack of profitability, Schultz said:3
Look, we’re going to keep losing money until we can do three things. We have to attract a management team
well beyond our expansion needs. We have to build a world-class roasting facility. And we need a computer
information system sophisticated enough to keep track of sales in hundreds and hundreds of stores.
Schultz argued for patience as the company invested in the infrastructure to support
continued growth well into the 1990s. He contended that hiring experienced executives
ahead of the growth curve, building facilities far beyond current needs, and installing
support systems laid a strong foundation for rapid profitable growth later on down the
road. His arguments carried the day with the board and with investors, especially since
revenues were growing approximately 80 percent annually and customer traffic at the
stores was meeting or exceeding expectations.
Starbucks became profitable in 1990. After-tax profits had increased every year since
1990 except for fiscal year 2000 (because of $58.8 million in investment write-offs in
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four dot.com enterprises) and for fiscal year 2008 (when the sharp global economic
downturn hit the company’s bottom line very hard).
RAPID EXPANSION OF STARBUCKS LOCATIONS
In 1992 and 1993, Starbucks began concentrating its store expansion efforts in the
United States on locations with favorable demographic profiles that also could be
serviced and supported by the company’s operations infrastructure. For each targeted
region, Starbucks selected a large city to serve as a “hub;” teams of professionals were
located in hub cities to support the goal of opening 20 or more stores in the hub within
two years. Once a number of stores were opened in a hub, then additional stores were
opened in smaller surrounding “spoke” areas in the region. To oversee the expansion
process, Starbucks had zone vice presidents that oversaw the store expansion process in
a geographic region and that were also responsible for instilling the
Starbucks culture in the newly opened stores. For a time, Starbucks went to
extremes to blanket major cities with stores, even if some stores cannibalized a nearby
store’s business. While a new store might draw 30 percent of the business of an existing
store two or so blocks away, management believed a “Starbucks everywhere” strategy
cut down on delivery and management costs, shortened customer lines at individual
stores, and increased foot traffic for all the stores in an area. In 2002, new stores
generated an average of $1.2 million in first-year revenues, compared to $700,000 in
1995 and only $427,000 in 1990; the increases in new-store revenues were partly due to
growing popularity of premium coffee drinks, partly to Starbucks growing reputation,
and partly to expanded product offerings. But by 2008-09 the strategy of saturating big
metropolitan areas with stores began cannibalizing sales of existing stores to such an
extent that average annual sales per store in the United States dropped to less than
$1,000,000 and pushed store operating margins down from double-digit levels to mid-
single-digit levels. As a consequence, Starbucks’ management cut the number of
metropolitan locations, closing 900 underperforming Starbucks stores in 2008–09, some
75 percent of which were within three miles of another Starbucks store.
Despite the mistake of over-saturating portions of some large metropolitan areas with
stores, Starbucks was regarded as having the best real estate team in the coffee bar
industry and a core competence in identifying good retailing sites for its new stores. The
company’s sophisticated methodology enabled it to identify not only the most attractive
individual city blocks but also the exact store location that was best. It also worked hard
at building good relationships with local real estate representatives in areas where it was
opening multiple store locations.
Licensed Starbucks Stores. In 1995, Starbucks began entering into licensing
agreements for store locations in areas in the United States where it did not have the
ability to locate company-owned outlets. Two early licensing agreements were with
Marriott Host International to operate Starbucks retail stores in airport locations and
with Aramark Food and Services to put Starbucks stores on university campuses and
other locations operated by Aramark. Very quickly, Starbucks began to make increased
use of licensing, both domestically and internationally. Starbucks preferred licensing to
franchising because it permitted tighter controls over the operations of licensees, and in
the case of many foreign locations licensing was much less risky.
Starbucks received a license fee and a royalty on sales at all licensed locations and
supplied the coffee for resale at these locations. All licensed stores had to follow
Starbucks’ detailed operating procedures and all managers and employees who worked
in these stores received the same training given to managers and employees in
company-operated Starbucks stores.
International Expansion. In markets outside the continental United States,
Starbucks had a two-pronged store expansion strategy: either open company-owned-
and-operated stores or else license a reputable and capable local company with retailing
know-how in the target host country to develop and operate new Starbucks stores. In
most countries, Starbucks utilized a local partner/licensee to help it locate suitable store
sites, set up supplier relationships, recruit talented individuals for positions as store
managers, and adapt to local market conditions. Starbucks looked for partners/licensees
that had strong retail/restaurant experience, had values and a corporate culture
compatible with Starbucks, were committed to good customer service, possessed
talented management and strong financial resources, and had demonstrated brand-
building skills. In those foreign countries where business risks were deemed relatively
high, most if not all Starbucks stores were licensed rather than being company-owned
and operated.
Exhibit 2 shows the speed with which Starbucks grew its network of company-
operated and licensed retail stores.
EXHIBIT 2 Company-Operated and Licensed Starbucks Stores
A. Number of Starbucks Store Locations Worldwide, Fiscal Years 1987–2019 and March 31, 2020
Company-operated StoreLocations Licensed Store Locations
End of Fiscal
Year* United States International United States International
Worldwide
Total
1987 17 0 0 0 17
1990 84 0 0 0 84
1995 627 0 49 0 676
2000 2,446 530 173 352 3,501
2005 4,918 1,263 2,435 1,625 10,241
2010 6,707 2,182 4,424 3,545 16,858
2015 6,764 2,198 4,364 3,309 23,043
2017 8,224 4,763 5,745 6,043 27,339
Company-operated StoreLocations Licensed Store Locations
End of Fiscal
Year* United States International United States International
Worldwide
Total
2018 8,581 6,758 6,043 7,940 29,324
2019 8,799 7,035 6,250 9,172 31,256
March 29,
2020 16,188 worldwide 15,862 worldwide 32,050
B. International Starbucks Store Locations, September 29, 2019
International Locations of
Company-operated Starbucks
Stores
International Locations of Licensed Starbucks Stores
Americas Europe/Africa/Middle East
Canada 1,175 Canada 432 Turkey 494
United Kingdom 288 Mexico 748 United Kingdom 707
China 4,123 17 Others 663 United ArabEmirates 211
Japan 1,379 Spain 149
All Others 70 Asia-Pacific Saudi Arabia 201
Taiwan 480 Kuwait 160
South Korea 1,334 Germany 161
Philippines 397 36 Others 1,135
Malaysia 303
Indonesia 421
Thailand 392
International
Company-
Operated Total
7,035 8 Others 784 InternationalLicensed Total 9,172
*In the first quarter of fiscal 2018, Starbucks acquired its Chinese licensing partner’s share of their joint
venture in China, resulting in the transfer of all 1,477 licensed stores in China to company-operated retail
stores.
Sources: Company records of store counts by market, posted in the investor relations section at
www.starbucks.com (accessed May 4, 2012 and November 6, 2019); company 10-K Reports 2016,
2018, 2019; and company press release, April 28, 2020.
STORE DESIGN AND AMBIENCE: KEY ELEMENTS
OF THE “STARBUCKS EXPERIENCE”
Store Design
http://www.starbucks.com/
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Starting in 1991, Starbucks created its own in-house team of architects and designers to
ensure that each store would convey the right image and character. Stores had to be
custom-designed because the company didn’t buy real estate and build its own
freestanding structures. Instead, each space was leased in an existing
structure, which resulted in stores differing in size and shape. Most stores
ranged in size from 1,000 to 1,500 square feet and were located in office buildings,
downtown and suburban retail centers, airport terminals, university campus areas, and
busy neighborhood shopping areas convenient for pedestrian foot traffic and/or drivers.
A few were in suburban malls. Four store templates—each with its own color
combinations, lighting scheme, and component materials—were introduced in 1996; all
four were adaptable to different store sizes and settings.
But as the number of stores increased rapidly over the next 20-plus years, greater
store diversity and layouts quickly became necessary. Some stores were
equipped with special seating areas to help make Starbucks a desirable
gathering place where customers could meet and chat or simply enjoy a peaceful
interlude in their day. Flagship stores in high-traffic, high-visibility locations had
fireplaces, leather chairs, newspapers, couches, and lots of ambience. Increasingly, the
company began installing drive-through windows at locations where speed and
convenience were important to customers and locating kiosks in high-traffic
supermarkets, building lobbies, the halls of shopping malls, and other public places
where passers-by could quickly and conveniently pick up a Starbucks beverage and/or
something to eat.
A new global store design strategy was introduced in 2009. Core design
characteristics included the celebration of local materials and craftsmanship, a focus on
reused and recycled elements, the exposure of structural integrity and authentic roots,
the absence of features that distracted from an emphasis on coffee, seating layouts that
facilitated customer gatherings, an atmosphere that sought to engage all five customer
senses (sight, smell, sound, hearing, and feel), and flexibility to meet the needs of many
customer types.4 Each new store was to be a reflection of the environment in which it
operated and be environmentally friendly. In 2010, Starbucks began an effort to achieve
LEED (Leadership in Energy and Environmental Design) Certification for all new
company-owned stores (a LEED-certified building had to incorporate green building
design, construction, operations, and maintenance solutions).5
To better control average store opening costs, the company centralized buying,
developed standard contracts and fixed fees for certain items, and consolidated work
under those contractors who displayed good cost control practices. The retail operations
group outlined exactly the minimum amount of equipment each core store needed, so
that standard items could be ordered in volume from vendors at 20 to 30 percent
discounts, then delivered just in time to the store site either from company warehouses
or the vendor. Modular designs for display cases were developed. The layouts for new
and remodeled stores were developed on a computer, with software that allowed the
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costs to be estimated as the design evolved. All this cut store opening and remodeling
costs significantly and shortened the process to about 18 weeks.
Store Ambience
Starbucks management viewed each store as a billboard for the company and as a
contributor to building the company’s brand and image. The company went to great
lengths to make sure the store fixtures, the merchandise displays, the colors, the
artwork, the banners, the music, and the aromas all blended to create a consistent,
inviting, stimulating environment that evoked the romance of coffee and signaled the
company’s passion for coffee. To try to keep the coffee aromas in the stores pure,
smoking was banned, and employees were asked to refrain from wearing perfumes or
colognes. Prepared foods were kept covered so customers would smell coffee only.
Colorful banners and posters were used to keep the look of the Starbucks stores fresh
and in keeping with seasons and holidays. All these practices reflected a conviction that
every detail mattered in making Starbucks stores a welcoming and pleasant “third
place” (apart from home and work) where people could meet friends and family, enjoy a
quiet moment alone with a newspaper or book, or simply spend quality time relaxing—
and most importantly, have a satisfying experience.
Starting in 2002, Starbucks began providing Internet access capability and enhanced
digital entertainment to patrons. The objective was to heighten the “third place”
Starbucks experience, entice customers into perhaps buying a second latte or espresso
while they caught up on e-mail, listened to digital music, put the finishing touches on a
presentation, or surfed the Internet. Wireless Internet service and faster Internet speeds
were added as fast as they became available.
STARBUCKS’ STRATEGY TO EXPAND ITS PRODUCT
OFFERINGS AND ENTER NEW MARKET SEGMENTS
Starting in the mid-1990s, Howard Schultz began a long-term strategic campaign to
expand Starbucks product offerings beyond its retail stores and to pursue sales of
Starbucks products in a wider variety of distribution channels and market segments. The
strategic objectives were to capitalize on Starbucks growing brand awareness and
brand-name strength and create a broader foundation for sustained long-term growth in
revenues and profits.
The Strategic Initiative to Sell Starbucks Packaged Coffees
Outside Its Retail Stores. Starbucks first step to expand its product offering beyond
its stores involved the establishment of an in-house specialty sales group to begin
marketing Starbucks coffee to restaurants, airlines, hotels, universities, hospitals,
business offices, country clubs, and other select retailers. The sales group’s first big
success was convincing two airlines to begin serving Starbucks coffee on flights.
Shortly thereafter accounts were won at five leading hotel chains, resulting in packets of
Starbucks coffee being in each room with coffee-making equipment. Later, the specialty
sales group began working with two leading institutional food service distributors,
SYSCO Corporation and US Foodservice, to handle the distribution of Starbucks
products to hotels, restaurants, office coffee distributors, educational and healthcare
institutions, and other such enterprises. Sales of Starbucks packaged coffees continued
to grow, with Starbucks generating revenues of $372.2 million from providing whole
bean and ground coffees and assorted other Starbucks products to some 21,000
foodservice accounts in fiscal 2009.
Starbucks Partnership with PepsiCo The second initiative came in 1994 when
PepsiCo and Starbucks entered into a joint venture arrangement to create new coffee-
related products in bottles or cans for mass distribution through Pepsi channels. The
joint venture soon introduced a bottled version of Frappuccino, a new cold coffee drink
Starbucks began serving at its retail stores in the summer of 1995 that quickly became a
big hot weather seller. Sales of Frappuccino ready-to-drink beverages reached
$125 million in 1997 and achieved a national supermarket penetration of 80 percent.
Sales of ready-to-drink Frappuccino products soon began in Japan, Taiwan, South
Korea, and China chiefly through agreements with leading local distributors. In 2010,
sales of Frappuccino products worldwide reached $2 billion annually.6 Sales of
Frappuccino products worldwide were continuing in 2020.
Starbucks Entry into Ice Cream In 1995, Starbucks partnered with Dreyer’s
Grand Ice Cream to supply coffee extracts for a new line of coffee ice cream made and
distributed by Dreyer’s under the Starbucks brand. Starbucks coffee-flavored ice cream
became the number-one-selling superpremium brand in the coffee segment in mid-1996.
In 2008, Starbucks discontinued its arrangement with Dreyer’s and entered into an
exclusive agreement with Unilever to manufacture, market, and distribute Starbucks-
branded ice creams in the United States and Canada. Unilever was the global leader in
ice cream with annual sales of about $6 billion; its ice cream brands included Ben &
Jerry’s, Breyers, and Good Humor. There were seven flavors of Starbucks ice cream and
two flavors of novelty bars being marketed in 2010, but buyer demand eroded after
several years and Starbucks-branded ice cream was discontinued in 2013. But in 2017,
new premium ice cream drinks (a scoop of ice cream drowned in espresso called an
“affogato,” several other affogato concoctions, and tall cold brew floats and malts)
became top-10 menu items at the new Starbucks Roastery and Starbucks Reserve store
locations in Seattle and were rolled out to other Starbucks Roasteries and Reserve
locations in 2018 and 2019.
The Licensing Agreement with Kraft Foods In 1998, Starbucks licensed Kraft
Foods to market and distribute Starbucks whole bean and ground coffees in grocery and
mass merchandise channels across the United States. Kraft managed all distribution,
marketing, advertising, and promotions and paid a royalty to Starbucks based on a
percentage of net sales. Product freshness was guaranteed by Starbucks’s FlavorLock
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packaging, and initially the price per pound paralleled the prices in Starbucks’s retail
stores. Flavor selections in supermarkets were more limited than the varieties at
Starbucks stores. The licensing relationship with Kraft was later expanded to include
the marketing and distribution of Starbucks coffees in Canada, the United Kingdom,
and other European countries. Going into 2010, Starbucks coffees were available in
some 33,500 grocery and warehouse clubs in the United States and 5,500 retail outlets
outside the United States; Starbucks revenues from these sales were approximately
$370 million in fiscal 2009.7 During fiscal 2011, Starbucks discontinued its distribution
arrangement with Kraft and instituted its own in-house organization to handle direct
sales of packaged coffees to supermarkets and to warehouse club stores (chiefly Costco,
Sam’s Club, and BJ’s Warehouse). During 2012–2019, sales of Starbucks packaged
coffees continued to grow throughout the retail grocery channel, with supermarkets
stocking a wider selection of flavor selections and frequently offering promotional price
discounts on Starbucks and other coffee brands to boost shopper traffic.
The Acquisition of Tazo Tea In 1999, Starbucks purchased Tazo
Tea for $8.1 million. Tazo Tea, a tea manufacturer and distributor based in Portland,
Oregon, was founded in 1994 and marketed its teas to restaurants, food stores, and tea
houses. Starbucks proceeded to introduce hot and iced Tazo Tea drinks in its retail
stores. As part of a long-term campaign to expand the distribution of its lineup of super-
premium Tazo teas, Starbucks expanded its agreement with Kraft to market and
distribute Tazo teas worldwide. In 2008, Starbucks entered into a licensing agreement
with a partnership formed by PepsiCo and Unilever (Lipton Tea was one of Unilever’s
leading brands) to manufacture, market, and distribute Starbucks’ super-premium Tazo
Tea ready-to-drink beverages (including iced teas, juiced teas, and herbal-infused teas)
in the United States and Canada—in 2012, the Pepsi/Lipton Tea partnership was the
leading North American distributor of ready-to-drink teas. In fiscal 2011, when
Starbucks broke off its packaged coffee distribution arrangement with Kraft, it also
broke off its arrangement with Kraft for distribution of Tazo tea and began selling Tazo
teas directly to supermarkets (except for Tazo Tea ready-to-drink beverages).
Introduction of the Starbucks Rewards™ Card In 2001, Starbucks introduced
the Starbucks Card, a reloadable card that allowed customers to pay for their purchases
with a quick swipe of their card at the cash register and also to earn “stars” and redeem
rewards. Since then, Starbucks Rewards™ had evolved into one of the best retail
loyalty programs in existence, aided by the introduction of Starbucks Gift Cards, the
Starbucks mobile app, rewards for in-store purchases and purchases of Starbucks
products in grocery stores and other retail locations where Starbucks products were
sold. Rewards members earned two stars for every one dollar spent on in-store
purchases; cardmembers also had the opportunity to take advantage of monthly
“Double-Star Day” promotions. In April 2019, Starbucks shifted from a two-tier reward
structure (green star and gold star status) to a single tier rewards structure where the
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various benefits/perks were linked to having earned 25, 50, 150, 250, and 400 stars.
Users of the Starbucks app could easily see how many stars they currently had, place
orders and make payments right from their smartphones, and find the nearest Starbucks
location. Members with a Starbucks Rewards™ Visa® Card also earned one star for
every four dollar purchased with the Starbucks Visa card. When members reloaded a
registered Starbucks Card using their Starbucks Rewards™ Visa® Card on the mobile
app or Starbucks.com, they received one star for every dollar loaded in addition to the
two stars earned for every dollar spent when using a registered Starbucks Card or the
Starbucks mobile app for purchases in participating Starbucks stores. As of year-end
2019, there were 18.9 million active Starbuck Rewards™ members globally. Use of
Starbucks Reward cards accounted for 40 percent of transactions in company-operated
stores in the United States, and about 75 percent of Starbucks customers in North
America either used a Starbucks Card or the Starbucks mobile app to pay for in-store
purchases.
The Seattle’s Best Coffee Acquisition In 2003, Starbucks spent $70 million to
acquire Seattle’s Best Coffee, an operator of 540 Seattle’s Best coffee shops, 86
Seattle’s Best Coffee Express espresso bars, and marketer of some 30 varieties of
Seattle’s Best whole bean and ground coffees. The decision was made to operate
Seattle’s Best as a separate subsidiary. Very quickly, Starbucks expanded its licensing
arrangement with Kraft Foods to include marketing, distributing, and promoting the
sales of Seattle’s Best coffees and by 2009, Seattle’s Best coffees were available
nationwide in supermarkets and at more than 15,000 food service locations (college
campuses, restaurants, hotels, airlines, and cruise lines). A new Seattle’s Best line of
ready-to-drink iced lattes was introduced in April 2010, with manufacture, marketing,
and distribution managed by PepsiCo as part of the long-standing Starbucks–PepsiCo
joint venture for ready-to-drink Frappuccino products. In 2010, Starbucks introduced
new distinctive red packaging and a red logo for Seattle’s Best Coffee, boosted efforts
to open more franchised Seattle’s Best cafés, and expanded the availability of Seattle
Best coffees to 30,000 distribution points. When Starbucks licensing agreement with
Kraft to handle sales and distribution of Seattle’s Best coffee products was terminated in
2011, responsibility for the sales and distribution of Seattle’s Best products was
transitioned to the same in-house sales force that handled direct sales and distribution of
Starbucks-branded coffees and Tazo tea products to supermarkets and warehouse clubs.
The Ethos™ Water Acquisition. In 2005, Starbucks Corporation acquired
Ethos™ Water, a privately held bottled water company based in Santa
Monica, California, whose mission was to help children get clean water
by supporting water projects in such developing countries as Bangladesh, the
Democratic Republic of Congo, Ethiopia, Honduras, India, and Kenya. One of the terms
of the acquisition called for Starbucks to donate $1.25 million in 2005–2006 to support
these projects. In the years since the acquisition, a key element of Starbucks corporate
social responsibility effort has been to donate $0.05US ($0.10CN in Canada) for every
bottle of Ethos Water sold in Starbucks stores to the Ethos® Water Fund, part of the
Starbucks Foundation, to fund ongoing efforts to provide clean water to children in
developing countries and to support water, sanitation, and hygiene education programs
in water-stressed countries.
The Introduction of New Coffee Blends In 2008, Starbucks introduced a new
coffee blend called Pike Place™ Roast that would be brewed every day, all day, in
every Starbucks store.8 Before then, Starbucks rotated various coffee blends through its
brewed lineup, sometimes switching them weekly, sometimes daily. While some
customers liked the ever-changing variety, the feedback from a majority of customers
indicated a preference for a consistent brew that customers could count on when they
came into a Starbucks store. The Pike Place blend was brewed in small batches at 30-
minute intervals so as to provide customers with a freshly-brewed coffee. In January
2012, after eight months of testing over 80 different recipe and roast iterations,
Starbucks introduced three blends of lighter-bodied and milder-tasting Starbucks
Blonde Roast® coffees to better appeal to an estimated 54 million coffee drinkers in the
United States who said they liked flavorful, lighter coffees with a gentle finish. The
Blonde Roast blends were available as a brewed option in Starbucks stores in the United
States and in packaged form in Starbucks stores and supermarkets. Because the majority
of coffee sales in supermarkets were in the light and medium roast categories, Starbucks
management saw its new Blonde Roast coffees blends as being a $1 billion market
opportunity in the United States alone. From time to time, Starbucks introduced new
blends of its packaged whole bean and ground coffees—some of these were seasonal,
but those that proved popular with buyers became standard offerings.
The Introduction of Starbucks Via® Instant Coffee In Fall 2009, Starbucks
introduced Starbucks VIA® Ready Brew, packets of roasted coffee in an instant form,
in an effort to attract a bigger fraction of on-the-go and at-home coffee drinkers. VIA
was made with a proprietary micro-ground technology that produced an instant coffee
with a rich, full-bodied taste that closely replicated the taste, quality, and flavor of
traditional freshly brewed coffee. Encouraged by favorable customer response,
Starbucks expanded the distribution of VIA to some 25,000 grocery, mass merchandise,
and drugstore accounts, including Kroger, Safeway, Walmart, Target, Costco, and CVS.
Instant coffee made up a significant fraction of coffee purchases in the United Kingdom
(80 percent), Japan (53 percent), Russia (85 percent), and several other countries where
Starbucks stores were located; globally, the instant and single-serve coffee category was
a $23 billion market. By the end of fiscal year 2011, VIA products were available at
70,000 locations and generating annual sales of $250 million.9
The Introduction of Starbucks K-Cup Packs for Keurig Single-Cup Brewing
Systems In fall 2011, Starbucks began selling Starbucks-branded coffee K-Cup®
Portion Packs for the Keurig® Single-Cup Brewing system in its retail stores; the
Keurig Brewer was produced and sold by Green Mountain Coffee Roasters. Starbucks
entered into a strategic partnership with Green Mountain to manufacture the Starbucks-
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branded portion packs and also to be responsible for marketing, distributing, and selling
them to major supermarket chains, drugstore chains, mass merchandisers and wholesale
clubs, department stores, and specialty retailers throughout the United States and
Canada. The partnership made good economic sense for both companies. Green
Mountain could manufacture the single-cup portion packs in the same plants where it
was producing its own brands of single-cup packs and then use its own internal
resources and capabilities to market, distribute, and sell Starbuck-branded single-cup
packs alongside its own brands of single-cup packs. It was far cheaper for Starbucks to
pay Green Mountain to handle these functions than to build its own manufacturing
plants and put its own in-house resources in place to market, distribute, and sell
Starbucks single-cup coffee packs. Just two months after launch, shipments of
Starbucks-branded single-cup portion packs had exceeded 100 million units and the
packs were available in about 70 percent of the targeted retailers; company officials
estimated that Starbucks had achieved an 11 percent dollar share of the market for
single-cup coffee packs in the United States.10
Starbucks Move into Coffee-Making Equipment In March 2012,
Starbucks announced that it would begin selling its first at-home premium single cup
espresso and brewed coffee machine, the Verismo™ system by Starbucks, at select
Starbucks store locations, online, and in upscale specialty stores. The Verismo brewer
was a high-pressure system with the capability to brew both coffee and Starbucks-
quality espresso beverages, from lattes to americanos, consistently and conveniently one
cup at a time; sales of the Verismo single-cup machine put Starbucks into head-to-head
competition with Nestlé’s Nespresso machine and, to a lesser extent, Green Mountain’s
popular lineup of low-pressure Keurig brewers. At the time, the global market for
premium at-home espresso/coffee machines was estimated at $8 billion.11 The Verismo
introduction was the last phase of Starbucks’ strategic initiative to offer coffee products
covering all aspects of the single-cup coffee segment—instant coffees (with its VIA
offerings), single portion coffee packs for single-cup brewers, and single-cup brewing
machines.
Bigger Menu Selections at Starbucks Stores In response to customer requests for
more wholesome food and beverage options and also to bring in business from non-
coffee drinkers, Starbucks in 2008 altered its menu offerings in stores to include fruit
cups, yogurt parfaits, skinny lattes, banana walnut bread, a 300-calorie farmer’s market
salad with all-natural dressing, and a line of 250-calorie “better-for-you” smoothies.12
In 2009–11, the company continued to experiment with healthier, lowercalorie
selections and by May 2012, retail store menus included a bigger assortment of hot and
cold coffee and tea beverages, pastries and bakery selections, prepared breakfast and
lunch sandwiches and wraps, salads, parfaits, smoothies, juices, and bottled water—at
most stores in North America, food items could be warmed. A bit later, beer, wine, and
other complementary food offerings were added to the menus at some stores to help
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them become an attractive and relaxing after-work destination. Since 2013, it has
become standard practice for Starbucks to continually tweak its menu offerings,
switching out whimsical and limitededition offerings and adding/dropping certain
beverages, flavorings, breakfast items, sandwiches, pastries, and snacks, both to
broaden buyer appeal and respond to ongoing shifts in customer preferences. In 2018–
2019, Starbucks began introducing new stores menus at the beginning of each season
(spring, summer, fall, and winter), along with special Holiday menu offerings in
November-December. Menu offerings at Starbucks stores were typically adapted to
local cultures—for instance, the menu offerings at stores in North America included a
selection of muffins, but stores in France had no muffins and instead featured locally
made pastries.
The Acquisition of Evolution Fresh Starbucks purchased cold-pressed juice
maker Evolution Fresh for $30 million in 2011 to use Starbucks sales and marketing
resources to grow the sales of Evolution Fresh and capture a bigger share of the $3.4
billion super-premium juice segment and begin a long-term campaign to pursue growth
opportunities in the $50 billion health and wellness sector of the U.S. economy. A $70
million juice making facility in California was opened in 2013 to make Evolution Fresh
products. Starbucks opened four Evolution Fresh juice bars after the acquisition, but
soon decided to ditch the stand-alone juice bar concept, opting to sell Evolution Fresh
beverages in Starbucks stores and supermarkets. Evolution Fresh competed with
PepsiCo’s category leader Naked juice brand, as well as scores of other large and small
bottled juice brands. As of 2017, Starbucks had secured 20,000 points of distribution for
Evolution Fresh products and the brand was said to be “thriving.”
The Acquisition of Teavana Tea In 2012, Starbucks paid $620 million to acquire
Atlanta-based specialty tea retailer Teavana, which sold more than 100 varieties of
premium loose-leaf teas and tea-related merchandise through 300 company-owned
stores (usually located in upscale shopping malls) and on its website; Teavana teas were
used mostly for home consumption. Howard Schultz believed Starbucks could
capitalize on Teavana’s world-class tea knowledge and its global sourcing and
merchandising capabilities (a) to expand Teavana’s domestic and global footprint, (b) to
bring an elevated tea experience to the patrons of Starbucks domestic and international
locations, and (c) to increase Starbucks penetration of the $40 billion world market for
tea, especially in the world’s highconsumption tea markets where Starbucks had stores.
These strategic outcomes failed to materialize. By 2016 and 2017, sales at Teavana
stores had eroded to the point where the stores were unprofitable, prompting Starbucks
to begin the process of closing all 379 Teavana stores (the majority by Spring 2018).
However, Starbucks continued to sell Teavana teas and beverages in
Starbucks stores because they were popular and contributed to store
profitability, accounting for sales of more than $1 billion annually and growing fast
enough to double over the next five years. In late 2017, Starbucks sold its Tazo Tea
business to Unilever for $384 million, opting to focus its sales of tea products on the
Teavana brand. In May 2019, Starbucks began selling 3 flavors of Teavana™ Sparkling
Craft Iced Teas in all of its stores in the United States to complement its other Teavana
bottled tea offerings.
The La Boulange Acquisition Also in 2012, Starbucks bought Bay Bread Group’s
La Boulange sandwich and coffee shops for $100 million. When Starbucks acquired the
San Francisco chain, plans called not only for bringing La Boulange products into its
stores to bolster its lineup of pastries and sandwiches but also to open new La Boulange
cafes and expand the chain’s geographic footprint. Three years later, however,
Starbucks concluded that sales at the La Boulange cafes were growing too slowly to
support its growth and profitability targets; it closed the 23 existing La Boulange cafes
but retained the manufacturing facilities to stock Starbucks stores with La Boulange
bakery products. Starbucks later discovered that other bakers could supply Starbucks
with comparable quality products at a lower cost. In 2018, the La Boulange brand name
was typically not very visible in Starbucks stores and disappeared altogether at most all
locations in 2019.
THE SALES MIX AT STARBUCKS STORES IN 2019
Starbucks overall sales mix in its company-owned retail stores in fiscal 2019 was 74
percent beverages, 20 percent food, 1 percent packaged and single-serve coffees and
teas, and 5 percent ready-to-drink beverages, coffee mugs, and other merchandise.13
However, the product mix in each Starbucks store varied, depending on the size and
location of each outlet. Larger stores carried a greater variety of whole coffee beans,
gourmet food items, teas, coffee mugs, coffee grinders, filters, storage containers, and
other accessories. Smaller stores and kiosks typically sold a full-line of coffee and tea
beverages, a very limited selection of whole bean and ground coffees and Teavana teas,
and a few coffee-drinking accessories.
STARBUCKS’ NEW INTERNAL ORGANIZATION
ARRANGEMENTS FOR OUTSIDE SALES OF
STARBUCKS PRODUCTS
In 2010, Starbucks formed a new Consumer Products Group (CPG) to be responsible
for sales of Starbuck products sold in all channels outside of Starbucks company-
operated and licensed retail stores and to manage all of the company’s distribution
partnerships and joint ventures. A few years later, CPG was renamed and slightly
reorganized into what was called the Channel Development segment. In 2018,
management of the Channel Development segment was responsible for sales and
distribution of roasted whole bean and ground coffees, Starbucks-branded single-serve
products, a variety of ready-to-drink beverages (such as Frappuccino®, Starbucks
Doubleshot®, Starbucks Refreshers® and Teavana™ iced tea, and Evolution juices)
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and other branded products sold worldwide through grocery stores, warehouse clubs,
specialty retailers, convenience stores, and food service accounts. This segment
accounted for sales of $2.3 billion and operating income of $927.1 million in fiscal year
2018, up from revenues of $707.4 million and operating income of $261.4 million in
fiscal year 2010.
However, the Starbucks Channel Development segment, as part of a companywide
effort to streamline some of Starbucks wide-ranging operations, decided to enter into a
global coffee alliance with Nestlé S.A. (“Nestlé”) in 2018 whereby Starbucks would
agree to a licensing and distribution agreement with Nestlé that gave Nestlé the rights to
market, sell, and distribute Starbucks®, Seattle’s Best Coffee®, Starbucks Reserve®,
Teavana™, Starbucks VIA®, and Torrefazione Italia® packaged coffees and tea in all
global channels outside of Starbucks stores. In return, Nestlé was to pay Starbucks an
upfront royalty payment of $7.15 billion, and Starbucks would remain as the supplier of
these same branded coffee and tea products to Nestlé. The alliance agreement meant
that henceforth the Channel Development segment would shift to a licensed distribution
model with revenues consisting of product sales to Nestlé, royalty revenues from
Nestlé, and revenues from the sales of ready-to-drink products through its
distribution partnerships with PepsiCo, Anheuser-Busch InBev, and others
(which sold them directly to retail grocers, warehouse clubs, specialty retail stores, and
institutional food service companies). Starbucks global coffee alliance with Nestlé
resulted in the Channel Development segment reporting a fiscal 2019 drop of $305
million in revenues and a drop of nearly $230 million in operating income as compared
to fiscal 2018 levels. While the move resulted in weaker fiscal 2019 performance versus
fiscal 2018, Starbucks expected that performance of the Channel Development segment
would improve in the years to come because of Nestle’s ability to significantly increase
overall global sales of the packaged coffee and tea products it licensed from Starbucks.
Starbucks Advertising Strategy
Starbucks spent sparingly on advertising, preferring instead to build the brand cup by
cup with customers and depend on word of mouth, the ambience of its stores, the and
quality of its menu offerings, and the pleasing experience store employees delivered to
customers to drive store traffic. However, from time to time Starbucks did call public
attention to new Starbucks products or new things happening at Starbucks stores. The
company’s advertising expenses totaled $245.7 million in fiscal 2019, $260.3 million in
fiscal 2018, $282.6 million in 2017, and $248.6 million in fiscal 2016.
TWO NEW DEVELOPMENTS AT STARBUCKS GOING
INTO 2020
The Availability of Order Delivery
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Starbucks began experimenting with a pilot program in Miami to deliver orders to
customers in late 2018 via a partnership with Uber Eats, a global delivery service that
partnered with over 200,000 restaurants in more than 500 cities across 36 countries.
Starbucks envisioned order delivery as a means of extending its engagement with
customers who currently included a Starbucks beverage as part of their morning or
afternoon routines and also as a new way of extending potential engagement to new
customers—delivering orders provided the ultimate Starbucks convenience.
The pilot order delivery program was enthusiastically received and repeatedly used
by Starbucks customers in Miami. Starbucks management believed the pilot program
suggested the existence of a strong pent-up demand for order delivery and quickly
proceeded with a rollout of Starbucks® Delivers to 11 metropolitan markets in the
United States and abroad in 2019 to further refine and integrate Starbucks digital
ordering technology with the Uber Eats app and platform. About 95 percent of the items
on Starbucks store menus were available for delivery. Customers used a downloaded
Uber Eats app to place and pay for orders, which included the Uber Eats delivery fee;
they also could use the Uber Eats app to track progress of their order and the location of
their Uber courier. Delivery orders had splash-proof lids, delivery containers designed
to keep drinks hot or cold, and tamper-proof packaging seals. In late 2019, Starbucks
introduced Starbucks Delivers in five more cities in the United States, along with
expanded coverage in the New York metro area. Expansion into 33 more cities in the
United States. began in January 2020, and top executives expected to have Starbucks
Delivers in operation in cities nationwide within four to six months.
Going into 2020, Starbucks had launched Starbucks Delivers in more than 15 global
markets, including Canada, Chile, China, Colombia, Hong Kong, India, Indonesia,
Japan, Mexico, Singapore, the U.K., and Vietnam. In China, where Uber did not
operate, Starbucks opted to partner with Alibaba and use its Ele.me delivery platform to
deliver customer orders; Alibaba’s delivery drivers in China had promised to deliver
orders in 30 minutes or less.
As of March 2020, Starbucks customers who placed delivery orders via the Uber Eats
app were unable to receive Rewards credit for their orders and could not use the current
Starbucks Mobile Order & Pay app to place delivery orders.
Starbucks indicated it had invested in voice ordering capability to enhance its
delivery service, but, as of February 2020, this feature was not available in the United
States.14
A New “Airport Strategy”
In early February, HMSHost announced it was terminating its exclusive licensing
agreement to operate all Starbucks stores in airports in the United States, an agreement
which had been in place since 1991; HMSHost’s plan was to replace the agreement with
Starbucks with new agreements to partner with local coffee companies in
providing coffee service in airports. A week later, Starbucks announced that
it was expanding its airport locations in partnership with airport retailer and restaurateur
Paradies Lagardère and airport hospitality group OTG Management.
Starbucks and its new partners immediately announced they would be implementing
a reimagined Starbucks experience for airport travelers that included (1) using mobile
kiosks with digital and mobile ordering capabilities moving throughout airport terminals
to provide Starbucks coffee service to travelers before boarding or upon arrival (2)
widespread use of mobile ordering and payment at the counters of traditional Starbucks
stores in airports where it had long been common for travelers to encounter 15- to 20-
minute wait lines during peak periods to get their order. For example, OTG-operated
airport locations were noted for using iPads that allowed customers to order and pay for
items at their own pace without having to wait in a line. OTG had more than 5,000
iPads deployed at its retail locations in New Jersey’s Newark Liberty International
airport.
In November 2019, Starbucks announced the opening of its first Starbucks Pickup
store in New York City’s Penn Plaza. The Pickup store along with the Starbucks Dewata
Coffee Sanctuary in Bali and the various Starbucks Roasters signaled that Starbucks
was endeavoring to create a diverse store portfolio offering customers a variety of
Starbucks experiences.
HOWARD SCHULTZ’S EFFORTS TO MAKE
STARBUCKS A GREAT PLACE TO WORK, 1988–2018
Howard Schultz deeply believed that Starbucks’s success was heavily dependent on
customers having a very positive experience in its stores. This meant having store
employees who were knowledgeable about the company’s products, who paid attention
to detail in preparing the company’s espresso drinks, who eagerly communicated the
company’s passion for coffee, and who possessed the skills and personality to deliver
consistent, pleasing customer service. Many of the baristas were in their 20s and
worked part-time, going to college on the side or pursuing other career activities.
Schultz viewed the company’s challenge as one of attracting, motivating, and rewarding
store employees in a manner that would make Starbucks a company that people would
want to work for and that would generate enthusiastic commitment and higher levels of
customer service. Moreover, Schultz wanted to send all Starbucks employees a message
that would cement the trust that had been building between management and the
company’s workforce.
Instituting Health Care Coverage for All Employees
One of the requests that employees had made to the prior owners of Starbucks back in
the 1980s was to extend health care benefits to part-time workers. Their request had
been turned down, but Schultz believed that expanding health care coverage to include
part-timers was something the company needed to do. He knew from having grown up
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in a family that struggled to make ends meet how difficult it was to cope with rising
medical costs. In 1988, Schultz went to the board of directors with his plan to expand
the company’s health care coverage to include part-timers who worked at least 20 hours
per week. He saw the proposal not as a generous gesture but as a core strategy to win
employee loyalty and commitment to the company’s mission. Board members resisted
because the company was then unprofitable and the added costs of the extended
coverage would only worsen the company’s bottom line. But Schultz argued
passionately that it was the right thing to do and wouldn’t be as expensive as it seemed.
He observed that if the new benefit reduced turnover, which he believed was likely, then
it would reduce the costs of hiring and training—which equaled about $3,000 per new
hire. He further pointed out that it cost $1,500 a year to provide an employee with full
benefits. Part-timers, he argued, were vital to Starbucks, constituting two-thirds of the
company’s workforce. Many were baristas who knew the favorite drinks of regular
customers; if the barista left, that connection with the customer was broken. Moreover,
many part-time employees were called upon to open the stores early, sometimes at 5:30
or 6 am; others had to work until closing, usually 9 pm or later. Providing these
employees with health care benefits, he argued, would signal that the company honored
their value and contribution.
The board approved Schultz’s plan and parttimers working 20 or more hours were
offered the same health coverage as full-time employees starting in late 1988. Starbucks
paid 75 percent of an employee’s health care premium; the employee paid
25 percent. Over the years, Starbucks extended its health coverage to
include preventive care, prescription drugs, dental care, eye care, mental health, and
chemical dependency—see Exhibit 3 below). Coverage was also offered for unmarried
partners in a committed relationship.
EXHIBIT 3 Starbucks’ Fringe Benefit Program, 2019
Medical, dental, and vision coverage
Sick pay, up to 40 hours per year
Paid vacations (up to 120 hours annually for hourly workers with five or more years of service at
retail stores and up to 200 hours annually for salaried and non-retail hourly employees with 10 or
more years of service)
Seven paid holidays
One paid personal day every six months for salaried and non-retail hourly partners only
Mental health and chemical dependency coverage
401(k) retirement savings plan—Partners age 18 or older with 90 days of service were eligible to
contribute from 1 to 75 percent of their pay each pay period (up to the annual IRS dollar limit).
Partners age 50 and older had a higher IRS annual limit than younger employees. Starbucks
matched 100 percent of the first 5 percent of eligible pay contributed each pay period. Starbucks
matching contributions to the 401(k) plans worldwide totaled $122 million in fiscal 2019, $111.7
million in fiscal 2018, and $101.4 million in fiscal 2017.
Short- and long-term disability
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Stock purchase plan—eligible employees could buy shares at a 5 percent discount through regular
payroll deductions of between 1 and 10 percent of base pay.
Life insurance coverage equal to annual base pay for salaried and non-retail employees; coverage
equal to $5,000 for store employees. Supplemental coverage could be purchased in flat dollar
amounts of $10,000, $25,000, and $45,000.
Short term disability coverage (partial replacement of lost wages/income for 26 weeks, after a short
waiting period); hourly employees can purchase long-term disability coverage
Company-paid long-term disability coverage for salaried and nonretail employees
Accidental death and dismemberment insurance
Adoption assistance—Reimbursement of up to $10,000 to help pay for qualified expenses related
to the adoption of an eligible child
Financial assistance program for employees that experience a financial crisis
Stock option plan (Bean stock)—Shares were granted to eligible partners, subject to the
company’s achievement of specified performance targets and the employee’s continued
employment through the vesting period. Vesting occurred in two equal annual installments
beginning two years from the grant date. The company’s board of directors determined how many
shares were to be granted each year and also established the specified performance targets. Pre-
tax payroll deductions for work-related commuter expenses
A free coffee or tea product each week
An in-store discount of 30 percent on purchases of beverages, food, and merchandise
A college achievement plan featuring full tuition reimbursement every semester for employees
enrolled in Arizona State University’s top ranked online degree programs. As of March 2018, some
1,282 Starbucks employees had graduated and over 10,000 were currently working toward their
degrees.
Gift-matching benefits—Starbucks matched up to $1,500 per fiscal year for individual contributions
of money or volunteer time to eligible non-profit organizations
Source: Information in the Careers section at www.starbucks.com (accessed May 28, 2019); Starbucks
2018 10-K Report, pp. 80–82 and 2019 10-K Report, pp. 75–77.
A Stock Option Plan for Employees
By 1991, the company’s profitability had improved to the point where Schultz could
pursue a stock option plan for all employees, a program he believed would have a
positive, long-term effect on the success of Starbucks.15 Schultz wanted to turn every
Starbucks employee into a partner, give them a chance to share in the success of the
company, and make clear the connection between their contributions and the company’s
market value. Even though Starbucks was still a private company, the plan that emerged
called for granting stock options to every full-time and part-time employee in
proportion to their base pay. In May 1991, the plan, dubbed Bean Stock, was presented
to the board. Though board members were concerned that increasing the number of
shares might unduly dilute the value of the shares of investors who had put
up hard cash, the plan received unanimous approval. The first grant was
made in October 1991, just after the end of the company’s fiscal year in September;
each partner was granted stock options worth 12 percent of base pay. When the Bean
http://www.starbucks.com/
Stock program was initiated, Starbucks dropped the term employee and began referring
to all of its people as “partners” because every member of the Starbucks workforce
became eligible for stock option awards after six months of employment and 500 paid
work hours.
After Starbucks went public in June 1992, starting in October 1992 and continuing
through October 2004, Starbucks granted each eligible employee a stock option award
with a value equal to 14 percent of base pay. Beginning in 2005, the plan was modified
to tie the size of each employee’s stock option awards to three factors: (1) Starbucks’
success and profitability for the fiscal year, (2) the size of an employee’s base wages,
and (3) the price at which the stock option could be exercised. Since becoming a public
company, Starbucks stock had split two-for-one on six occasions. The total intrinsic
value of options exercised was $466 million, $236 million, and $181 million during
fiscal 2019, 2018, and 2017, respectively. The total fair value of options vested was $31
million, $53 million, and $40 million during fiscal 2019, 2018, and 2017, respectively.
Starbucks’ Stock Purchase and 401(k) Plans for Employees
In 1995, Starbucks implemented an employee stock purchase plan that gave partners
who had been employed for at least 90 days an opportunity to purchase company stock
through regular payroll deductions of 1 to 10 percent of their base earnings (up to an
annual maximum of $25,000). At the end of each calendar quarter, each participant’s
contributions were used to buy Starbucks shares at a discounted price. In fiscal 2018,
about 600,000 shares were purchased under this plan, and about 400,000 shares were
purchased in fiscal 2019.
Later, a 401(k) plan was initiated for employees that included matching company
contributions. Details of the current stock purchase plan and 401(k) plans are included
in Exhibit 3.
The Workplace Environment
Starbucks management believed its competitive pay scales and comprehensive benefits
for both full-time and part-time partners (employees) allowed it to attract motivated
people with above-average skills and good work habits. An employee’s base pay was
determined by the pay scales prevailing in the geographic region where an employee
worked and by the person’s job, skills, experience, and job performance. About 90
percent of Starbucks’ partners were full-time or part-time baristas, paid on an hourly
basis. In 2020, after six months of employment, baristas at company-owned stores in the
United States earned an average of -$12 per hour or about $24,240 annually, according
to ZipRecruiter; the majority earned between $20,500 and $26,500 annually, but annual
barista pay at some locations ranged on up to $33,500.16 In February 2020, pay scales
for shift supervisors were in the range of $11 to $16 per hour; store managers earned
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about $55,000, and salaries for district store managers were in the $88,000 to $134,000
range.17
Starbucks was named to Fortune’s list of the “100 Best Companies to Work For” 14
times during the 1988–2020 period.
Schultz’s approach to offering employees good compensation and a comprehensive
benefits package was driven by his belief that sharing the company’s success with the
people who made it happen helped everyone think and act like an owner, build positive
long-term relationships with customers, and do things in an efficient way. Schultz’s
rationale, based on his father’s experience of going from one low-wage, no-benefits job
to another, was that if you treat your employees well, that is how they will treat
customers.
Employee Training and Recognition
To accommodate its strategy of rapid store expansion, Starbucks put in systems to
recruit, hire, and train baristas and store managers. Every partner/barista hired for a
retail job in a Starbucks store received at least 24 hours training in their first two to four
weeks. Training topics included coffee history, drink preparation, coffee knowledge,
customer service, and retail skills, plus a four-hour workshop on “Brewing the Perfect
Cup.” Baristas spent considerable time learning about beverage preparation—grinding
the beans, steaming milk, learning to pull perfect (18- to 23-second) shots of espresso,
memorizing the recipes of all the different drinks, practicing making the different
drinks, and learning how to customize drinks to customer specifications. There were
sessions on cash register operations, how to clean the milk wand on the espresso
machine, explaining the Italian drink names to unknowing customers,
making eye contact with customers and interacting with them, and taking
personal responsibility for the cleanliness of the store. And there were rules to be
memorized: milk must be steamed to at least 150 degrees Fahrenheit but never more
than 170 degrees; every espresso shot not pulled within 23 seconds must be tossed;
always compensate dissatisfied customers with a Starbucks coupon that entitles them to
a free drink.
There were also training programs for shift supervisors, assistant store managers,
store managers, and district managers that went much deeper, covering not only coffee
knowledge and information imparted to baristas but also the details of store operations,
practices and procedures as set forth in the company’s operating manual, information
systems, and the basics of managing people. In addition, there were special career
development programs, such as a coffee masters program for store employees and more
advanced leadership skills training for shift supervisors and store management
personnel. When Starbucks opened stores in a new market, it sent a star team of
experienced managers and baristas to the area to lead the store opening effort and to
conduct one-on-one training following the basic orientation and training sessions.
To recognize and reward partner contributions, Starbucks had created a partner
recognition program consisting of 18 different awards and programs.18 Examples
included Partner of the Quarter Awards (for one partner per store per quarter) for
significant contributions to their store and demonstrating behaviors consistent with the
company’s mission and values; Spirit of Starbucks awards for making exceptional
contributions to partners, customers, and community while embracing the company’s
mission and values; a Manager of the Quarter for store manager leadership; Green
Apron Awards where partners could recognize fellow partners for how they bring to life
the company’s mission, values, and customer commitment; and Bravo and Team Bravo!
awards for above and beyond the call of duty performance and achieving exceptional
results.
STARBUCKS’ MISSION, BUSINESS PRINCIPLES,
AND VALUES
During the early building years, Howard Schultz and other Starbucks senior executives
worked to instill some values and guiding principles into the Starbucks culture. The
cornerstone value in their effort “to build a company with soul” was that the company
would never stop pursuing the perfect cup of coffee by buying the best beans and
roasting them to perfection. Schultz was adamant about controlling the quality of
Starbucks products and building a culture common to all stores. He was rigidly opposed
to selling artificially flavored coffee beans—“we will not pollute our high-quality beans
with chemicals;” if a customer wanted hazelnut-flavored coffee, Starbucks added
hazelnut syrup to the drink.
Starbucks’ management was also emphatic about the importance of employees
paying attention to what pleased customers. Employees were trained to go out of their
way, and to take heroic measures if necessary, to make sure customers were fully
satisfied. The theme was “just say yes” to customer requests. Further, employees were
encouraged to speak their minds without fear of retribution from upper management—
senior executives wanted employees to be vocal about what Starbucks was doing right,
what it was doing wrong, and what changes were needed. The intent was for employees
to be involved in and contribute to the process of making Starbucks a better company.
Starbucks’ Mission Statement
In early 1990, the senior executive team at Starbucks went to an offsite retreat to debate
the company’s values and beliefs and draft a mission statement. Schultz wanted the
mission statement to convey a strong sense of organizational purpose and to articulate
the company’s fundamental beliefs and guiding principles. The draft was submitted to
all employees for review and several changes were made based on employee comments.
The resulting mission statement was: “Establish Starbucks as the premier purveyor of
the finest coffee in the world while maintaining our uncompromising principles as we
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grow.” It was accompanied by six guiding principles intended to help company
personnel measure the appropriateness of the company’s decisions:19
Provide a great work environment and treat each other with respect and dignity.
Embrace diversity as an essential component in the way we do business.
Apply the highest standards of excellence to the purchasing, roasting, and fresh
delivery of our coffee.
Develop enthusiastically satisfied customers all of the time.
Contribute positively to our communities and our environment.
Recognize that profitability is essential to our future success.
In 2008, Starbucks partners from all across the company met for several months to
refresh the mission statement; the revised mission statement was “To inspire and nurture
the human spirit—one person, one cup, and one neighborhood at a time.” That mission
had endured going into 2020. But, over time, the original six guiding principles were
recast into five core values that in 2020 were phrased as follows:20
Creating a culture of warmth and belonging, where everyone is welcome.
Delivering our very best in all we do, holding ourselves accountable for results.
Acting with courage, challenging the status quo and finding new ways to grow our
company and each other.
Being present, connecting with transparency, dignity, and respect.
We are performance-driven, through the lens of humanity.
STARBUCKS’ COFFEE PURCHASING STRATEGY
Coffee beans were grown in 70 tropical countries and were the second most traded
commodity in the world after petroleum. Most of the world’s coffee was grown by some
25 million small farmers, most of whom lived on the edge of poverty. Starbucks
personnel traveled regularly to coffee-producing countries, building relationships with
growers and exporters, checking on agricultural conditions and crop yields, and
searching out varieties and sources that would meet Starbucks’ exacting standards of
quality and flavor. The coffee-purchasing group, working with Starbucks personnel in
roasting operations, tested new varieties and blends of green coffee beans from different
sources. The company’s supplies of green coffee beans were chiefly grown on about 1
million small family farms (less than 30 acres) located in the coffee-growing
communities of countries across the world. Sourcing from multiple geographic areas not
only allowed Starbucks to offer a greater range of coffee varieties to customers but also
spread its risks regarding weather, price volatility, and changing economic and political
conditions in coffee-growing countries.
Starbucks’ coffee sourcing strategy had three key elements:
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Make sure that the prices Starbucks paid for green (unroasted) coffee beans were high
enough to ensure that small farmers were able to cover their production costs and
provide for their families. The company was firmly committed to a goal of “100
percent ethically-sourced coffees”—in 2016 management believed it had reached a
milestone of 99 percent ethically sourced coffee.21 Because the company also
purchased tea and cocoa for its stores and ready-to-drink beverages, it was similarly
committed to 100 percent ethically sourced tea and cocoa.
Utilize purchasing arrangements that limited Starbucks exposure to sudden spikes in
green coffee prices.
Work directly with small coffee growers, local coffeegrowing cooperatives, and other
types of coffee suppliers to promote coffee cultivation methods that were
environmentally sustainable. Starbucks’ objective was to “make coffee the world’s
first sustainable agricultural product.”22
Pricing and Purchasing Arrangements
Commodity-grade coffee was traded in a highly competitive market as an
undifferentiated product. However, high-altitude Arabica coffees of the quality
purchased by Starbucks were bought on a negotiated basis at a premium above the “C”
coffee commodity price. Both the commodity price and the prices of the top-quality
coffees sourced by Starbucks depended on supply and demand conditions at the time of
the purchase and were subject to considerable volatility due to weather, natural
disasters, crop disease, changes in input prices and the costs of production, inventory
levels, and economic and political conditions in the growing countries. Prices were also
impacted by trading activities in the arabica coffee futures market, including the trading
activities of hedge funds and commodity index funds. In addition, green coffee prices,
on occasion, were influenced by the actions of certain organizations and associations to
establish export quotas or restrict coffee supplies.
Starbucks bought coffee using fixed-price and price-to-be-fixed
purchase commitments, depending on market conditions, to secure an adequate supply
of quality green coffee. Price-to-be-fixed contracts were purchase commitments
whereby the quality, quantity, delivery period, and other negotiated terms were agreed
upon, but the date at which the base price component of commodity grade coffee was to
be fixed was as yet unspecified. In the case of price-to-be-fixed contracts, either
Starbucks or the seller had the option to select a date on which to “fix” the base price of
commodity grade coffee prior to the delivery date. Starbucks also utilized forward
contracts, futures contracts, and collars to hedge “C” price exposure under its price-to-
be-fixed green coffee contracts and its forecasted green coffee needs for the upcoming
12 months. It was the goal of the company’s coffee purchasing personnel to have
sufficient purchasing and hedging agreements in place, together with its existing
inventory, to provide an adequate supply of green coffee for the upcoming 11–12
months.
Purchasing of Other Needed Supplies
Products other than whole bean coffees and coffee beverages sold in Starbucks stores
included tea and a number of ready-to-drink beverages that were purchased from
several specialty suppliers, usually under long-term supply contracts. Food products,
such as pastries, breakfast sandwiches, and lunch items, were purchased from national,
regional and local sources. Starbucks purchased a broad range of paper and plastic
products, such as cups and cutlery, from several manufacturers and distributors to
support the needs of its retail stores and its manufacturing and distribution operations.
Management believed, based on relationships established with these suppliers and
manufacturers, that the risk of non-delivery of sufficient amounts of these items to its
many store locations and various other operations was remote.
Starbucks’ Supplier Code of Conduct
Starbucks made an effort to work with suppliers that were committed to its own
principles of conducting business in a responsible and ethical manner, respecting the
rights of individuals, and helping to protect the environment. All Starbucks suppliers
worldwide were expected to sign an agreement pledging compliance with Starbucks
Supplier Code of Conduct, which included the following:23
Demonstrating commitment to the welfare, economic improvement and sustainability
of the people and places that produce products and services for Starbucks.
Adherence to local laws and international standards regarding human rights,
workplace safety, and worker compensation and treatment.
Meeting or exceeding national laws and international standards for environmental
protection and minimizing negative environmental impacts of the supplier’s
operations.
Commitment to measuring, monitoring, reporting and verification of compliance to
this code.
Pursuing continuous improvement of these social and environmental principles.
There were further specified standards for manufacturers, food suppliers, and non-
food suppliers pertaining to such things as anti-bribery practices, workplace
harassment, quality control, hazardous materials, packing and shipping of refrigerated
products, transportation and shipping modes, and customs clearance.
Verification of compliance was subject to audits by Starbucks personnel or acceptable
third parties. From time to time, Starbucks had temporarily or permanently discontinued
its business relationship with suppliers who failed to comply or failed to work with
Starbucks to correct a non-complying situation.
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COFFEE ROASTING OPERATIONS
Starbucks considered the roasting of its coffee beans to be something of an art form,
entailing trial-and-error testing of different combinations of time and temperature to get
the most out of each type of bean and blend. Recipes were put together by the coffee
department, once all the components had been tested. Computerized roasters guaranteed
consistency. Highly trained and experienced roasting personnel monitored the process,
using both smell and hearing, to help check when the beans were perfectly done—
coffee beans make a popping sound when ready. Roasting standards were exacting.
After roasting and cooling, the coffee was immediately vacuum-sealed in
bags that preserved freshness for up to 26 weeks. As a matter of policy,
however, Starbucks packaged coffees were removed from retailer shelves well before
the 26-week expiration date (frequently because of discounted price promotions). In the
case of coffee used to prepare beverages in stores, the shelf life was limited to seven
days after the bag was opened.
In 2020, Starbucks had multiple roasting plants in numerous locations, having
expanded its roasting operations as its store base expanded to more geographic regions
and countries. Roasting plants also had additional space for warehousing and shipping
coffees. In keeping with Starbucks’ corporate commitment to reduce its environmental
footprint, since 2009 all newly-built roasting plants and all other newly-built company
facilities had conformed to LEED (Leadership in Energy and Environment Design)
standards devised by the United States Green Building Council; LEED standards were
the most widely used green building rating system in the world for evaluating the
environmental performance of a building and encouraging market transformation
towards sustainable design. Starbucks had launched and achieved an initiative to
achieve LEED Certification for all company-operated facilities built after 2010;
facilities constructed prior to 2010 had been remodeled and/or retrofitted accordingly.
Currently, Starbucks goal was designing, building and operating 10,000 “Greener
Stores” globally by 2025.
STARBUCKS’ CORPORATE SOCIAL
RESPONSIBILITY STRATEGY
Howard Schultz’s effort to “build a company with soul” included a long history of
doing business in ways that were socially and environmentally responsible. A
commitment to do the right thing and strike a balance between profitability and a social
conscience was central to how Starbucks operated from the time Howard Schultz first
became Starbucks CEO in 1987. The specific actions comprising Starbucks’ corporate
social responsibility (CSR) strategy had varied over the years but the intent of the
strategy was consistently one of contributing positively to the communities in which
Starbucks had stores, being a good environmental steward, and conducting the
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company’s business in ways that earned the trust and respect of customers,
partners/employees, suppliers, and the general public. Some of main elements
comprising Starbucks CSR strategy over the past 30 years and some of the resulting
accomplishments and beneficial outcomes include the following:
1. Employing coffee-sourcing practices that resulted in paying fair and ethical prices to
the small family farmers in low-income countries where the high-quality green
coffees Starbucks purchased were being grown. This CSR initiative, which Starbucks
referred to as “ethical-sourcing, had two principal objectives. One was to ensure that
small coffee growers received prices for their green coffee beans sufficiently high
enough to allow them to pay fair wages to their workers, earn enough to reinvest in
their farms and communities, develop the business skills needed to compete in the
global market for coffee, and afford basic health care, education, and home
improvements. The second was to educate these small farmers about the benefits of
using sustainable agricultural practices to grow coffee and then to fund support their
efforts to implement these practices—with the long-term environmentally-beneficial
goal of making coffee one of the world’s first products to be widely grown with
sustainable agricultural practices.
To achieve “the fair and ethical prices” objective, in 1998, Starbucks began
partnering with Conservation International’s Center for Environmental Leadership to
develop specific guidelines (called Coffee and Farmer Equity [C.A.F.E.] Practices)
covering four areas: product quality, the price received by farmers/growers, safe and
humane working conditions (including compliance with minimum wage requirements
and child labor provisions), and environmentally responsible cultivation practices.
Top management at Starbucks set a goal that by 2015 all of the green coffee beans
purchased from growers would be C.A.F.E. Practice certified, Fair Trade certified,
organically certified, or certified by some other equally acceptable third party. By
2011, 86 percent of Starbucks purchases of green coffee beans were C.A.F.E.
Practices–verified sources and 8 percent were from Fair Trade–certified sources,
making Starbucks among the world’s largest purchasers and marketers of Fair Trade–
certified coffee beans. Since 2015, Starbucks coffee had been verified as 99 percent
ethically sourced, and the company was committed to reaching its goal
of 100 percent. It was similarly committed to 100 percent ethically
sourced supplies of tea and cocoa (for its cocoa-based beverages) by 2020 and was
pursuing efforts to do so.
To promote achievement of the second outcome, Starbucks created and operated
farmer support centers staffed with agronomists and sustainability experts who
worked with coffee farming communities to promote best practices in coffee
production, implement advanced soilmanagement techniques, improve both coffee
quality and yields, and address climate and other impacts. To complement the
activities of farmer support centers, Starbucks instituted a Small Farmer Loan
Program to provide funding for loans to small coffee growers since many of the small
family farms lacked the money to make farming improvements and/or cover all
expenses until they sold their crops. In 2010, $14.6 million was loaned to nearly
56,000 farmers who grew green coffee beans for Starbucks in 10 countries; in 2011,
an additional $14.7 million was loaned to over 45,000 farmers who grew green coffee
beans for Starbucks in another seven countries. Later, the company established a
$50 million Starbucks Global Farmer Fund to provide loans to coffee farmers for
coffee tree renovation and infrastructure improvements. Moreover, the Starbucks
Foundation began partnering with organizations with local expertise to award grants
to support smallholder-farming families in coffee-growing and tea-growing
communities, reaching approximately 47,000 direct and indirect beneficiaries. By
2020 the Foundation planned to reach 200,000 people.
A still further ethical-sourcing initiative called the One Tree for Every Bag
Commitment was launched in 2015 for the purpose of planting 20 million coffee tree
seedlings to replace trees declining in productivity due to age and disease such as
coffee leaf rust. The goal was exceeded in just over a year, at which time Starbucks
committed to providing a total of 100 million coffee tree seedlings to farmers by
2025, particularly in coffee-growing communities being impacted by climate change.
2. Environmental stewardship—This CSR strategy element had taken on an ever bigger
role in Starbucks overall CSR strategy over the years and was arguably the
centerpiece of the company’s CSR strategy in 2020. Starbucks had invested in
renewable energy since 2005, and it achieved a milestone in 2015 by purchasing the
equivalent of 100 percent of the electricity consumption of all company-operated
stores worldwide from renewable energy sources. In North Carolina and Washington
state, Starbucks had invested in a solar farm and a wind farm that delivered enough
energy to power more than 700 Starbucks stores.
Beginning in 2008 and continuing thereafter, Starbucks undertook an energy-
saving commitment to make all company facilities as green as possible by using
environmentally friendly building materials and energy-efficient designs.
Management determined that henceforth all of its new operating facilities (roasting
plants, offices, manufacturing and distribution facilities) and all new company-owned
retail stores globally would be constructed to achieve LEED certification (LEED
stood for Leadership in Energy and Environmental Design and was a green building
certification program used worldwide). LEED-certification standards were also
employed in remodeling or retrofitting existing facilities and retail stores. As of 2019,
Starbucks had built more than 1,600 LEED-certified retail stores in 20 countries.
Starting in 2005 and continuing until the present, Starbuck pursued actions to
reduce water consumption, reduce food waste, use recycled cardboard boxes and
other back-of-store items, place recycling bins in place in all company-owned
locations where there were municipal recycling capabilities, use more
environmentally-friendly coffee cups, and substitute paper straws for single-use
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plastic straws across all stores worldwide. Since 1985, Starbucks had given a $0.10
discount to customers who brought reusable cups and tumblers to stores for use in
serving the beverages they ordered. An initiative was launched to empower 10,000
Starbucks employees to be “sustainability champions.” Stores participated in Earth
Day activities each year with in-store promotions and volunteer efforts to educate
employees and customers about the impacts their actions had on the environment.
3. Creating opportunities to help people achieve their dreams. The chief initiatives here
included partnering with some 50other employers to hire, train, and advance the
careers of 100,000 youth aged 16–24 by 2020, hiring at least 25,000
veterans and military spouses by 2025, welcoming and employing 10,000
refugees across the 75 countries in which Starbucks stores were located by 2022, and
expanding partner participation in the company’s college achievement plan that
covered full-tuition reimbursement for admission to one of Arizona State University’s
online degree programs.
4. Charitable contributions—The Starbucks Foundation, set up in 1997, oversaw a
major portion of the company’s philanthropic activities; it received the majority of its
funding from Starbucks Coffee Company and private donations. Over the years, the
Starbucks Foundation had made to nonprofit organizations such as the American Red
Cross for relief efforts to communities experiencing severe damage from earthquakes,
hurricanes, tornadoes, floods, and other natural disasters, Save the Children for
efforts to improve education, health, and nutrition, the Global Fund and Product
(RED)™ to provide medicine to people in Africa with AIDS, and a wide assortment
of community-building efforts, including youth literacy programs and jobs training
programs. Donations were made in cash and in-kind contributions. In 2017-19, the
foundation made “Opportunity for All” grants ranging from $10,000 to $100,000 to
more than 40 nonprofits in 27 U.S. cities, plus others to various communities across
the world and it donated $10 million to four Community Development Financial
Institutions in Chicago to help fund loans to cash-short small business and
entrepreneurs and provide borrowers with mentoring and technical assistance to help
ensure the success of their projects—and thereby provide more neighborhood jobs to
local area residents.24 Water, sanitation, and hygiene education programs in water-
stressed countries were supported through the Starbucks Foundation’s Ethos Water
Fund. For each bottle of Ethos water purchased at Starbucks stores, Starbucks
donated $0.05 ($0.10 in Canada) to the Ethos© Water Fund. Since 2005, the Fund
had made over $15 million in grants, benefitting more than 500,000 people around
the world.
In early 2020, Starbucks CEO Kevin Johnson announced three new environmental
goals for the company’s CSR strategy and five strategic initiatives to pursue them.
Johnson’s vision was for Starbucks over a multi-decade period to become a “resource-
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positive” company that gave more than it took from the planet. To begin this multi-
decade journey, Johnson set forth three objectives for Starbucks to achieve by 2030:
1. A 50 percent reduction in carbon emissions in Starbucks direct operations and supply
chain.
2. Conserving or replenishing 50 percent of water currently being used in company
operations and coffee production, with a focus on communities and basins with high
water risk.
3. A 50 percent reduction in waste sent to landfill from stores and manufacturing, driven
by a broader shift toward a circular plastics economy where plastics never became
waste or pollution because they were 100 percent recycled.
He indicated that a comprehensive, data-driven environmental footprint of carbon
emissions, water use, and waste in Starbucks global operations and supply chain had
produced five strategies to prioritize the work needed to be done to reach the 2030
objectives:
1. Expanding plant-based options on Starbucks menus, thereby migrating toward a more
environmentally friendly menu.
2. Shifting from single-use to reusable packaging.
3. Investing in innovative and regenerative agricultural practices, reforestation, forest
conservation, and water replenishment in Starbucks supply chain.
4. Investing in better ways to manage waste, both in Starbucks stores and in its
communities, to ensure more reuse, recycling, and elimination of food waste.
5. Innovating to develop more eco-friendly stores, operations, manufacturing, and
delivery.
Starbucks had been named to Corporate Responsibility Magazine’s list of the 100
Best Corporate Citizens on numerous occasions; this list was based on more than 360
data points of publicly available information in seven categories: Environment, Climate
Change, Human Rights, Philanthropy, Employee Relations, Financial Performance, and
Governance. Over the years, Starbucks had received over 25 awards from a diverse
group of organizations for its philanthropic, community service, and environmental
activities.
LUCKIN COFFEE’S SUDDEN EMERGENCE TO
CHALLENGE STARBUCKS COFFEE MARKET
LEADERSHIP IN CHINA
China-based Luckin Coffee began operations in October 2017, and by March 31, 2019,
had opened an astonishing 2,370 wholly-owned locations in 28 cities—a blitz rarely
seen in the retail or restaurant industries. Six months later, Luckin had 3,680 store
locations, of which 3,433 were pickup stores with seating for no more than 10
customers, 138 were “relax” stores with enough seating space for 25 to 50 customers,
and 109 were delivery kitchens. The company’s strategic intent was to become the
largest network of coffee stores in China—on November 13, 2019, Luckin executives
said they fully expected that Luckin Coffee would have more store locations than
Starbucks by the end of 2019. Starbucks had approximately 4,292 stores in China at the
end of December 2019 and was planning to add about 600 more stores in China by the
end of September 2020.
In 2018, its first full year of operation, Luckin Coffee used aggressive promotions
and coupons offering price discounts to achieve revenues of $125.3 million on which it
reported a loss of $241.3 million. For the three months ending March 31, 2019, Luckin
reported revenues of $71.3 million and a net loss of $82.2 million. Revenues during the
first three months of 2019 were derived from the sale of freshly brewed drinks (75.4
percent), other products (17.6 percent), and “other” (7.0 percent). The company
reported in April 2019 that it had achieved a total of 16.8 million customer transactions
since inception and sold some 90 million items in 2018. Its customer repurchase rate in
2018 was just over 54 percent.
In the next six months, customer traffic at Luckin Coffee store picked up
significantly. Store revenues were $208.9 million in the third quarter of 2019, up 67
percent over first quarter revenues.25 Average monthly total items sold were 44.2
million in Q3 versus 16.3 million in Q1. The average number of customer transactions
storewide in Q3 was 9.34 million versus 4.4 million in Q1. In Q3 Luckin reported its
first store-level operating profit of $26.1 million, equal to 12.5 percent of store revenues
in Q3. This 12.5 percent margin represented a significant improvement over the
negative store profit margins of 6.4 percent in Q2 and 44.3 percent in Q1. The $26
million store-level operating profit in Q3 was far short of covering corporate-level sales
and marketing expenses, general administrative expenses, store pre-opening expenses,
and depreciation charges, resulting in a quarterly operating loss of $82.7 million and net
loss of $74.4 million. But these losses were smaller than those incurred in Q2 of 2019.
Some 2,163 of Luckin Coffee’s stores (91 percent) were “pickup stores” with limited
seating and were typically located in areas with high demand for coffee (office
buildings, commercial areas, and university campuses); the company also had 109
“relax stores” and 98 delivery kitchens. Luckin had created mobile apps covering the
entire customer purchase process, enabling it to offer app users a 100 percent cashier-
free option. Luckin Coffee sourced premium Arabica coffee beans from prominent
suppliers and engaged World Barista Champion teams to design its coffee recipes. Its
coffee won the Gold Medal in the 2018 IIAC International Coffee Tasting
Championship. The company purchased coffee machines, coffee condiments, juices,
and assorted food products that were sold in its stores from reputable outside vendors at
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what Luckin management believed were favorable prices. Luckin had 16,645
employees as of March 31, 2019.
On April 17, 2019, Luckin Coffee filed documents with the Securities and Exchange
Commission stating its desire to undertake an initial public offering (IPO) of common
stock and become a public company, with its stock trading on the NASDAQ under the
symbol LK. In its IPO filing, Luckin Coffee management cited four company strengths
as contributing to its initial success:
Being the leading and fastest growing player driving coffee consumption in China.
Being the pioneer of a disruptive new retail model.
Having strong technology capabilities.
Offering a superior customer proposition underpinned by high quality, high
affordability, and high convenience.
In May 2019, the company’s IPO application received SEC approval, and Luckin
quickly moved forward with its IPO. Luckin priced its IPO issue at $17 per share and
raised $561 million on an upsized offering of 33 million shares, making it one of the
fastest companies ever to reach a $6 billion valuation (based on all the
preferred and common shares outstanding). Its common stock began
trading May 17, 2019, with initial trades around $25 per share; however, the share price
began a downward trend in the latter stages of the first day’s trading session that
continued for the next five trading days. The stock price slowly climbed back to trade in
the low 20s, but then quickly jumped to over $28 per share following release of the Q3
financial results in November. Management announced it expected the company to be
profitable in 2020.
On January 7, 2020, Luckin Coffee Inc. announced the launch of Luckin Pop, a smart
vending machine, and Luckin Coffee Express, a smart coffee machine. Both types of
vending machines were to be installed in office buildings, gas stations, bus terminals,
airports, and on college campuses and various locations in residential communities. The
Luckin Pop vending machines would sell bottled and canned beverages and snacks from
brands like Pepsi and Nestlé that also supplied products to Luckin’s retail shops. The
Luckin Coffee Express vending machine enabled customers to order hot coffee drinks
like those at the company’s retail stores; customers used the LK App to place orders on
a specific Express machine and picked up the chosen brewed coffee drink by scanning
the QR code from the app after paying for it. This new strategy initiative was aimed at
building a low-cost unmanned retail distribution network that would make Luckin
Coffee products readily available to more customers in more locations, thereby growing
the company’s sales revenues while bypassing the payroll, rental costs, and other
expenses associated with operating Luckin Coffee retail stores. However, some of the
operating cost savings associated with vending machine sales would be offset by higher
depreciation costs on the vending machines.
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According to the company’s January 7, 2020 announcement, the Luckin Coffee
Express vending machines would contain a coffee-making machine supplied by
Schaerer, a Swiss-based manufacturer of premium automated coffee machines; the cost
of each installed Express vending machine was expected to be in the range of $15,000
to $20,000. Local observers believed that Luckin would employ a low-introductory
pricing strategy for all the products sold in its Luckin Pop and Luckin Coffee Express
vending machines. Currently, Luckin’s retail stores were continuing to sell coffee
products at half the posted price and were also running a special “Buy 2, get one free”
promotion on top of the 50 percent discount.
To help finance its new vending machine initiative and fund capital requirements for
ongoing store network expansion, sales and marketing, and other corporate activities,
Luckin issued 11 million shares of common stock (realizing net proceeds of
$418.3 million) and sold $460 million in convertible senior notes due 2025 (realizing
net proceeds of $446.7 million) for a total capital raise of $865 million. At the end of
2019, Luckin Coffee had 4,507 self-operated stores, higher than Starbucks year-end
store count of 4,292.
On April 2, 2020, Luckin Coffee disclosed that an investigation by a special
committee of the Board of Directors revealed the company’s chief operating officer, and
several employees reporting to him, had fraudulently inflated the company’s sales by
approximately $310 million from the second quarter to the fourth quarter of 2019. The
misconduct involved “fabricating certain transactions” and substantially inflating
certain costs and expenses, thus rendering the company’s financial statements
unreliable; the company’s auditor was Ernst & Young. The individuals involved were
suspended, and the company said it intended to pursue legal actions against them. The
China Securities Regulatory Commission announced it would investigate the alleged
fraud; Morgan Stanley, Credit Suisse, and several other investment banks involved in
preparing documents for the company’s $645 million IPO and subsequent debt issues
began reviewing the due diligence work they had done. Earlier in 2020, Muddy Waters
Capital, a well-known short-seller located in the United States, announced it had
reviewed an anonymous 69-page report alleging fraud that was circulating, found the
content credible, and had initiated a short position in Luckin’s common stock. When
news of the fraud was publicly reported on April 2, Luckin Coffee’s stock price quickly
plummeted 80 percent to about $6 per share, after trading as high as $50 in the weeks
following the May 2019 IPO. Trading in the company’s stock on the Nasdaq was
suspended on April 8, 2020; the last trade was at $4.39. On May 12, 2020, the company
announced that Luckin’s chief executive officer and chief operating officer had been
terminated and that the company’s Board of Directors had demanded and received their
resignations from the Board. In addition, it was announced that six other employees,
who were involved in or had knowledge of the fabricated transactions,
had been placed on suspension or leave and that a Senior Vice President
of the company had been appointed as the new interim CEO. In June 2020, authorities
in China announced that emails had been discovered in which the company’s board
chairman and largest shareholder, Lu Zhengyao, instructed Luckin executives to commit
fraud; Lu was expected to face criminal charges for fraud.
Back in June 2019, Jeffrey Towson, a private equity investor, author, and business
professor at Peking University in Beijing, observed in a two-part article that, in China,
Starbucks’s most interesting competitor was not Luckin Coffee (whose coffee products
were not something that many Chinese consumers drank) but rather HeyTea, an upscale
Starbucks-type business focused on tea (something Chinese consumers really, really
like).26 Towson noted that HeyTea appeared to be focused on product development and
continually thrilling its customers with their product offerings. He believed Hey Tea’s
high-priced creative tea drinks were becoming a consumer phenomenon in China
because of its 220 stores operating at capacity, with people holding places in line for
other people and with the average order being three drinks costing about $11.
STARBUCKS’ FIRST MOVES TO COUNTER THE
COMPETITIVE CHALLENGE FROM LUCKIN COFFEE
In July 2019, Starbucks opened its first Starbucks Now™ store in the central financial
district of Beijing that combined the signature Starbucks café environment with Mobile
Order & Pay and Starbucks Delivers™ to offer customers new levels of convenience
and speed.27 Customers entering the store were greeted by a Starbucks barista at an
elevated concierge counter to assist with ordering or order pickup. They could choose
from a menu of handcrafted beverage options tailored for on-the-go customers along
with an assortment of popular food items. Limited seating was available for customers
who chose to stay in the store and relax with their orders.
There was a dedicated area for Starbucks Delivers orders to facilitate barista-assisted
quick and easy pickup by delivery drivers. Online orders that were ready for pickup
were placed in an exterior wall system with designated portals for each order, which
speeded drive-by pickup by delivery couriers. The Starbuck Now store also had a
central kitchen where baristas could prepare handcrafted beverage orders for delivery
within a certain radius. Enabling the kitchen to function as a central dispatch center at
peak periods had the advantage of permitting baristas at neighboring cafes to focus on
serving their in-store customers.
Starbucks had plans to open about 300 new Starbucks Now stores in high-traffic
areas and business and transportation hubs in 10 cities in China.
Voice Ordering in Conjunction with Starbucks Delivery Begins in China
Two months after opening the first Starbucks Now store in Beijing, Starbucks and
Alibaba, its delivery partner in China, jointly announced the launch of voice ordering
within Alibaba’s smart speaker, Tmall Genie, coupled with order delivery capabilities
within a 30-minute timeframe.28 Tmall Genie used cutting-edge Artificial Intelligence
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(AI) technology, along with voiceprint payment technology, to enable customers to
place an order and pay for it using their voice and then track their order in real time
during the 30-minute delivery timeframe. Starbucks®Rewards members could also earn
Stars and receive Rewards membership updates, including benefits, via the Tmall
Genie. Further, members were able to receive personalized recommendations when
using voice commands to place orders that were tailored to previous order preferences
and popular items from Starbucks seasonal menus. As yet another added benefit,
Starbucks customers in China could listen to the latest Starbucks in-store playlists
through Alibaba’s music streaming app, Xiami Music.
An exclusive Starbucks-themed Tmall Genie was available through the Starbucks
virtual store in China. This particular version of the Tmall Genie unified Starbucks
offerings within Alibaba’s mobile apps, including Taobao, Alipay, and Tmall.
ENDNOTES
1 Howard Schultz and Dori Jones Yang, Pour Your Heart Into It (New York: Hyperion, 1997), p. 34.
2 Ibid., pp. 101–102.
3 Ibid., p. 142.
4 “Starbucks Plans New Global Store Design,” Restaurants and Institutions, June 25, 2009, accessed at www.rimag.com on
December 29, 2009.
5 Starbucks Global Responsibility Report for 2009, p. 13.
6 As stated by Howard Schultz in an interview with Harvard Business Review editor-in-chief Adi Ignatius; the interview was published in
the July–August 2010 issue of the Harvard Business Review, pp. 108–115.
7 2009 Annual Report, p. 5.
8 Company press release, April 7, 2008.
9 Company press release, April 13, 2010.
10 Company press release, January 26, 2012.
11 Starbucks management presentation at UBS Global Consumer Conference, March 14, 2012; accessed at www.starbucks.com on
May 18, 2012.
12 Company press release, July 14, 2008.
13 2018 10-K Report, p. 4.
14 Company press release, October 22, 2019.
15 As related in Schultz and Yang, Pour Your Heart Into It, pp. 131–136.
16 Information posted at www.ziprecruiter.com, February 19, 2020.
17 Data posted at www.indeed.com, www.pyscale.com, and www.salary.com (accessed February 19, 2020).
18 Information posted at www.sbuxrecognition.com (accessed June 1, 2018).
19 Company documents and postings at www.starbucks.com (accessed May 15, 2012).
20 Posted at https://livingourvalues.starbucks.com (accessed January 31, 2020).
21 Starbucks 2016 Global Social Impact Performance Report, p. 4.
22 Ibid.
23 Information on “Doing Business with Starbucks,” posted at www.starbucks.com/business/suppliers (accessed February 20, 2020).
24 Information posted at www.starbucks.com/responsibility/community/starbucksfoundation (accessed June 5, 2018 and February
20, 2020) and company press release, October 29, 2019.
25 Company press release announcing Q3 financial results, November 3, 2019.
26 Jeffrey Towson, “While Luckin Fights Starbucks, HeyTea has Lines Out the Door,” posted at www.jefftowson.com (accessed April 3,
2020).
27 Company press release, July 19, 2019.
28 Company press release, September 18, 2019.
http://www.rimag.com/
http://www.starbucks.com/
http://www.ziprecruiter.com/
http://www.indeed.com/
http://www.pyscale.com/
http://www.salary.com/
http://www.sbuxrecognition.com/
http://www.starbucks.com/
https://livingourvalues.starbucks.com/
http://www.starbucks.com/business/suppliers
http://www.starbucks.com/responsibility/community/starbucksfoundation
F
page C-354
CASE 26
Nucor Corporation in 2020: Pursuing Efforts
to Grow Sales and Market Share Despite
Tough Market Conditions
Arthur A. Thompson
The University of Alabama
alling steel prices, coupled with widespread customer actions to reduce their steel inventories,
caused Nucor’s sales to drop from a record high of $25.1 billion in 2018 down to $22.6 billion
in 2019, a 10 percent decline. Net earnings suffered an even bigger 46 percent decline, from a
record high of $2.36 billion in 2018 to $1.27 billion in 2019. Nucor shipped five percent fewer
tons of steel, steel products, and scrap metal to outside customers in 2019 compared to 2018 and
received an average percent lower price on the tons shipped. Nonetheless, during 2018–2019,
Nucor Corp., already the largest manufacturer of steel and steel products in North America and the
12th largest steel company in the world based on tons shipped in 2018, continued its long-term
strategy of aggressively investing in new facilities and capabilities to produce an ever-wider range
of high-quality steel products, improve its cost competitiveness against rival steel producers, and
serve a bigger number of the needs of steel buyers. Not only was Nucor Corp. regarded as a low-
cost producer, but it also had a sterling reputation for being a global first-mover in investing in the
latest steel-making technologies and production facilities and implementing the best practices to
operate them very cost effectively, while at the same time developing the capabilities needed to
produce more types of high-quality steel products and further diversify its already diversified
product portfolio.
Heading into 2020, Nucor had 25 steel mills with the capability to produce a diverse assortment
of steel shapes (steel bars, sheet steel, steel plate, and structural steel) and additional finished steel
manufacturing facilities that made steel joists, steel decking, cold finish bars, steel tubing, steel
buildings, steel mesh, steel grating, steel fasteners, and fabricated steel reinforcing products. The
company’s lineup of product offerings was the broadest of any steel producer serving steel users in
North America, and top management was focused on executing strategic initiatives to further
expand the range of the company’s product offerings and enter even more market segments.
COMPANY BACKGROUND
page C-355
Nucor began its journey from obscurity to a steel industry leader in the 1960s. Operating under the
name of Nuclear Corporation of America in the 1950s and early 1960s, the company was a maker
of nuclear instruments and electronics products. After suffering through several money-losing
years and facing bankruptcy in 1964, Nuclear Corporation of America’s board of directors opted
for new leadership and appointed F. Kenneth Iverson as president and CEO. Shortly thereafter,
Iverson concluded that the best way to put the company on sound footing was to exit the nuclear
instrument and electronics business and rebuild the company around its profitable South Carolina-
based Vulcraft subsidiary that was in the steel joist business—Iverson had been the head of
Vulcraft prior to being named president. Iverson moved the company’s headquarters from
Phoenix, Arizona, to Charlotte, North Carolina, in 1966 and proceeded to expand the
joist business with new operations in Texas and Alabama. Then, in 1968, top
management decided to integrate backward into steelmaking, partly because of the benefits of
supplying its own steel requirements for producing steel joists and partly because Iverson saw
opportunities to capitalize on newly-emerging technologies to produce steel more cheaply. In 1972
the company adopted the name Nucor Corporation, and Iverson initiated a long-term strategy to
grow Nucor into a major player in the U.S. steel industry.
By 1985 Nucor had become the seventh largest steel company in North America, with revenues
of $758 million, six joist plants, and four state-of-the-art steel mills that used electric arc furnaces
to produce new steel products from recycled scrap steel. Moreover, Nucor had gained a reputation
as an excellently managed company, an accomplished low-cost producer, and one of the most
competitively successful manufacturing companies in the country.1 A series of articles in The New
Yorker related how Nucor, a relatively small American steel company, had built an enterprise that
led the whole world into a new era of making steel with recycled scrap steel. Network broadcaster
NBC did a business documentary that used Nucor to make the point that American manufacturers
could be successful in competing against low-cost foreign manufacturers.
Under Iverson’s leadership, Nucor came to be known for its aggressive pursuit of innovation
and technical excellence in producing steel, rigorous quality systems, strong emphasis on
workforce productivity and job security for employees, cost-conscious corporate culture, and skills
in achieving low costs per ton produced. The company had a very streamlined organizational
structure, incentive-based compensation systems, and steel mills that were among the most
modern and efficient in the United States. Iverson proved himself as a master in crafting and
executing a low-cost provider strategy, and he made a point of practicing what he preached when it
came to holding down costs throughout the company. The offices of executives and division
general managers were simply furnished. There were no company planes and no company cars,
and executives were not provided with company-paid country club memberships, reserved parking
spaces, executive dining facilities, or other perks. To save money on his own business expenses
and set an example for other Nucor managers, Iverson flew coach class and took the subway when
he was in New York City.
When Iverson left the company in 1998 following disagreements with the board of directors, he
was succeeded briefly by John Correnti and then Dave Aycock, both of whom had worked in
various roles under Iverson for a number of years. In 2000, Daniel R. DiMicco, who had joined
Nucor in 1982 and risen up through the ranks to executive vice president, was named president
and CEO. DiMicco was Nucor’s Chairman and CEO through 2012. Like his predecessors,
DiMicco continued to pursue Nucor’s longstanding strategy to aggressively grow the company’s
production capacity and product offerings via both acquisition and new plant construction; tons
sold rose from 11.2 million in 2000 to 25.2 million in 2008. Then the unexpected financial crisis in
page C-356
the fourth quarter of 2008 and the subsequent economic fallout caused tons sold in 2009 to plunge
to 17.6 million tons and revenues to nosedive from $23.7 billion in 2008 to $11.2 billion in 2009.
Even though the steel industry remained in the doldrums until he retired in 2012, DiMicco was
undeterred by the depressed market demand for steel and proceeded to expand Nucor’s production
capabilities and range of product offerings. It was his strong belief that Nucor should be
opportunistic in initiating actions to strengthen its competitive position despite slack market
demand for steel because doing so put the company in even better position to significantly boost
its financial performance when market demand for steel products grew stronger. DiMicco
expressed his thinking thusly:2
Nucor uses each economic downturn as an opportunity to grow stronger. We use the good times
to prepare for the bad, and we use the bad times to prepare for the good. Emerging from
downturns stronger than we enter them is how we build long-term value for our stockholders. We
get stronger because our team is focused on continual improvement and because our financial
strength allows us to invest in attractive growth opportunities throughout the economic cycle.
During DiMicco’s 12-year tenure, Nucor completed more than 50 acquisitions, expanding
Nucor’s operations from 18 locations to more than 200, boosting revenues from $4.8 billion in
2000 to $19.4 billion at the end of 2012, and transforming Nucor into the undisputed leader in
providing steel products to North American buyers. When DiMicco retired at the end of 2012, he
was succeeded by John J. Ferriola, who had served as Nucor’s President and COO
since 2011. Ferriola immediately embraced Nucor’s strategy of investing in down
markets to better position Nucor for success when the economy strengthened and market demand
for steel products became more robust. Ferriola retired at year-end 2019 and was succeeded as
President and CEO by Leon J. Topalian, effective January 2020. Topalian previously served as
President and Chief Operating Officer beginning in September 2019, Executive Vice President of
Beam and Plate Products from 2017 to 2019, General Manager of Nucor-Yamato from 2014 to
2017, General Manager of Nucor Steel Kankakee, Inc. from 2011 to 2014, and in several other
positions after beginning his career as a project engineer and then as cold mill production
supervisor at Nucor Steel-Berkeley.
Going into 2020, Nucor was the biggest, most cost-efficient, and most diversified steel producer
in North America. It had the capacity to produce 29 million tons of steel annually at its 25 steel
mills. All of its steel mills were among the most modern and efficient mills in the United States.
The breadth of Nucor’s product line in steel mill products and finished steel products was
unmatched; it competed in 12 distinct product categories. No other producer of steel products in
North America competed in more than six of the 12 product categories in which Nucor competed.3
Moreover, Nucor was the North American market leader in seven of the 12 product categories in
which it had a market presence—merchant bar steel, structural steel, steel joists and steel decking,
cold-finished bar steel, metal buildings, steel electrical conduit pipe, and steel pilings distribution.
4 It was the number two market leader in steel plate, special quality bar steel, rebar steel and
fabrication, and hollow structural steel tubing. And it was the number three market leader in sheet
steel (hot rolled, cold rolled, and galvanized).
With the exception of three quarters in 2009, one quarter in 2010, and the fourth quarter of
2015, Nucor earned a profit in every quarter of every year from 1966 through 2019—a truly
remarkable accomplishment in a mature and cyclical business where it was common for industry
members to post losses when demand for steel sagged. As of June 2020, Nucor had paid a
dividend for 188 consecutive quarters and had raised the base dividend it paid to stockholders for
47 consecutive years (every year since 1973 when the company first began paying cash
dividends). In years when earnings and cash flows permitted, Nucor had paid a supplemental year-
end dividend in addition to the base quarterly dividend. Exhibit 1 provides highlights of Nucor’s
growth and performance from 1970 through 2019. Exhibit 2 shows Nucor’s sales by product
category for 1990–2019. Exhibit 3 contains a summary of Nucor’s financial and operating
performance during 2015–2019.
EXHIBIT 1 Nucor’s Growing Presence in the Market for Steel, 1970–2019
Year
Total Tons Sold
to Outside
Customers
Average
Price per
Ton
Net Sales (in
millions)
Earnings
before Income
Taxes (in
millions)
Pretax
Earnings per
Ton
Net Earnings (in
millions)
Attributable to
Nucor
Shareholders
1970 207,000 $ 245 $ 50.8
$
2.2
$
10
$
1.1
1975 387,000 314 121.5 11.7 30 7.6
1980 1,159,000 416 482.4 76.1 66 45.1
1985 1,902,000 399 758.5 106.2 56 58.5
1990 3,648,000 406 1,481.6 111.2 35 75.1
1995 7,943,000 436 3,462.0 432.3 62 274.5
2000 11,189,000 425 4,756.5 478.3 48 310.9
2001 12,237,000 354 4,333.7 179.4 16 113.0
2002 13,442,000 357 4,801.7 227.0 19 162.1
2003 17,473,000 359 6,265.8 70.0 4 62.8
2004 19,109,000 595 11,376.8 1,725.9 96 1,121.5
2005 20,465,000 621 12,701.0 2,027.1 104 1,310.3
2006 22,118,000 667 14,751.3 2,692.4 129 1,757.7
2007 22,940,000 723 16,593.0 2,253.3 104 1,471.9
2008 25,187,000 940 23,663.3 2,790.5 116 1,831.0
2009 17,576,000 637 11,190.3 (470.4) (28) (293.6)
2010 22,019,000 720 15,844.6 194.9 9 134.1
2011 23,044,000 869 20,023.6 1,169.9 53 778.2
2012 23,092,000 841 19,429.3 613.8 27 409.5
2013 23,730,000 803 19,052.0 714.2 31 499.4
2014 25,413,000 830 21,105.1 1,048.1 42 679.3
2015 22,680,000 725 16,439.3 129.6 6 80.7
2016 24,309,000 667 16,208.1 1,298.6 50 796.3
2017 26,492,000 764 20,252.4 1,688.1 65 1,318.7
2018 27,899,000 899 25,067.3 3,109.1 114 2,360.8
2019 26,532,000 851 22,588.9 1,683.0 65 1,271.1
Note: In 2016, Nucor changed its method of accounting for valuing certain inventories from the last-in, first-out (LIFO)
method to the first-in, first out (FIFO) method. The information in this table for the years 2012–2019 reflects this change
in accounting principle.
Source: Company records posted at www.nucor.com (accessed February 1, 2018 and March 23, 2020); Company 10-
K Report, 2019, p. 47.
EXHIBIT 2 Nucor’s Sales of Steel Mill and Finished Steel Products to Outside
Customers, By Product Category, 1990–2019
Tons Sold to Outside Customers (in thousands)
Steel Mill Products Finished Steel Products
Year
Sheet
Steel
(2019
capacity
of ~12.1
million
tons)
Steel
Bars
(2019
capacity
of ~8.8
million
tons)
Structural
Steel
(2019
capacity
of ~3.25
million
tons)
Steel
Plate
(2019
capacity
of ~2.9
million
tons)
Total (2019
capacity of
~27 million
tons)
Steel
Joists
(2019
capacity
of
~745,000
tons)
Steel
Deck
(2019
capacity
of
~560,000
tons)
Cold
Finished
Steel
(2019
capacity
of ~1.1
million
tons)
Rebar
Fabrication
and Other
Steel
Products*
(2019
capacity of
~5.71
million
tons)
Total
Tons
Sold**
2019 9,008 5,761 1,816 2,000 18,585 499 495 498 4,814 26,532
2018 9,153 6,389 2,064 2,284 19,890 490 479 569 4,846 27,889
2017 9,311 5,838 2,303 2,249 19,137 472 457 487 4,454 26,492
2016 9,119 5,304 2,319 2,023 18,160 445 442 426 3,524 24,309
2015 8,080 4,790 2,231 1,905 16,369 427 401 449 3,518 22,680
2014 8,153 5,526 2,560 2,442 17,9341 421 396 504 3,618 25,413
2013 7,491 5,184 2,695 2,363 16,976 342 334 474 3,658 23,730
2012 7,622 5,078 2,120 2,268 17,088 291 308 492 3,365 23,092
2011 7,500 4,680 2,338 2,278 17,460 288 312 494 3,073 23,044
2010 7,434 4,019 2,139 2,229 16,370 276 306 462 5,154 22,019
2009 5,212 3,629 1,626 1,608 12,571 264 310 330 2,564 17,576
2008 7,505 5,266 2,934 2,480 18,696 485 498 485 2,395 25,187
2007 8,266 6,287 3,154 2,528 20,580 542 478 449 2,136 22,940
2006 8,495 6,513 3,209 2,432 20,649 570 398 327 2,883 22,118
2005 8,026 5,983 2,866 2,145 19,020 554 380 342 2,360 20,465
2000 4,456 2,209 3,094 20 9,779 613 353 250 1,351 11,189
1995 2,994 1,799 1,952 — 6,745 552 234 234 1,198 7,943
1990 420 1,382 1,002 — 2,804 443 134 163 884 3,648
*Other products include steel piling, tubular steel products, and steel fasteners (steel screws, nuts, bolts, washers, and
bolt assemblies), steel mesh, steel grates, metal building systems, and light gauge steel framing.
**Includes sale of raw materials, principally scrap metal, beginning in 2008 when Nucor acquired David J. Joseph Co.,
a leading supplier of scrap metal.
Source: Company records posted at www.nucor.com (accessed March 23, 2020).
EXHIBIT 3 Five-Year Financial and Operating Summary, Nucor Corporation,
2015–2019 ($ in millions, except per share data and sales per employee)
2019 2018 2017 2016 2015
http://www.nucor.com/
http://www.nucor.com/
2019 2018 2017 2016 2015
FOR THE YEAR
Net sales $22,588.9 $25,067.3 $20,252.4 $16,208.1 $16,439.3
Costs, expenses and
other:
Cost of products sold 19,909.8 20,771.9 17,683.0 14,182.2 15,325.4
Marketing, administrative
and other expenses 711.2 860.7 687.5 596.8 459.0
Equity in (earnings) losses
of minority-owned
enterprises
(3.3) (40.2) (41.7) (38.8) (5.3)
Impairment and losses on
assets 66.9 110.0 — — 244.8
Interest expense, net 121.4 135.5 173.6 169.2 173.5
Total 20,806.0 21,837.9 18,502.4 14,909.5 16,197.4
Earnings before income
taxes and non-controlling
interests
1,782.8 3,229.4 1,750.0 1,298.7 241.9
Provision for income taxes 411.9 748.3 369.4 398.2 48.8
Net earnings (loss) 1,370.9 2,481.1 1,380.6 900.4 193.0
Less earnings attributable to
the minority interest partners
of Nucor’s joint ventures*
99.8 120.2 61.9 104.1 112.3
Net earnings (loss)
attributable to Nucor
stockholders
$1,271.1 $2,360.8 $ 1,318.7 $ 796.3 $ 80.7
Basic $4.14 $7.44 $4.11 $2.48 $0.25
Diluted 4.14 7.42 4.10 2.48 0.25
Dividends declared per
share $1.6025 $1.5400 $1.5125 $1.5025 $1.4925
Percentage of net earnings
to net sales 5.6% 9.4% 6.5% 4.9% 0.5%
Return on average
stockholders’ equity 12.6% 25.5% 17.2% 10.4% 1.0%
Capital expenditures $1,512 $997.3 $448.6 $617.7 $364.8
Acquisitions (net of cash
acquired) 83.1 33.1 544.0 474.8 19.1
Depreciation 648.9 630.9 635.8 613.2 625.8
Sales per employee (000s) 849 986 820 690 690
AT YEAR END
Cash, cash equivalents, and
short-term investments $1,834.6 $1,399.0 $ 999.1 $2,046.0 $2,039.5
Current assets 8,226.4 8,636.3 6,824.4 6,506.4 5,854.4
Current liabilities 2,463.8 2,806.3 2,824.8 2,390.0 1,385.2
Working capital 5,762.6 5,830.0 3,999.6 4,116.4 4,469.2
page C-360
page C-357
page C-358
page C-359
2019 2018 2017 2016 2015
Cash provided by operating
activities 2,809.4 2,394.0 1,051.3 1,737.5 2,157.0
Current ratio 3.3 3.1 2.4 2.7 4.2
Property, plant and
equipment $6,178.6 $5,334.7 $ 5,093.2 $5.078.7 $ 4,891.2
Total assets 18,344.7 17,920.6 15,841.3 15,223.5 14,327.0
Long-term debt (including
current maturities) 4,320.6 4,233.3 3,742.2 4,339.1 4,337.1
Percentage of long-term debt
to total capital** 28.6% 29.3% 29.2% 34.5% 35.6%
Stockholders’ equity 10,357.9 9,792.1 8,739.0 7,879.9 7,416.9
Shares outstanding (000s) 301,812 305,592 317,962 318,737 317,962
Employees 26,800 26,300 25,100 23,900 23,700
*The principal joint venture responsible for these earnings is the Nucor-Yamato Steel Company, of which Nucor owns
51 percent. This joint venture operates a structural steel mill in Blytheville Arkansas, and it is the largest producer of
structural steel beams in the Western Hemisphere.
**Total capital is defined as stockholders’ equity plus long-term debt.
Note: In 2016, Nucor changed its method of accounting for valuing certain inventories from the last-in, first-out (LIFO)
method to the first-in, first-out (FIFO) method. The information in this table for 2015 has been backward adjusted to
reflect this change in accounting principle.
Source: Nucor’s 2019 10-K, p. 23.
NUCOR’S STRATEGY TO BECOME THE BIGGEST
AND MOST DIVERSIFIED STEEL PRODUCER IN NORTH
AMERICA, 1967–2020
In its nearly 52-year march to become North America’s biggest and most diversified steel
producer, Nucor relentlessly expanded its production capabilities to include a wider range of steel
shapes and more categories of finished steel products. However, most every steel product that
Nucor produced was viewed by buyers as a “commodity.” Indeed, the most competitively relevant
feature of the various steel shapes and finished steel products made by the world’s different
producers was that, for any given steel item, there were very few, if any, differences in the
products of rival steel producers. While some steel-makers had plants where production quality
was sometimes inconsistent or on occasions failed to meet customer-specified
metallurgical characteristics, most steel plants turned out products of comparable
metallurgical quality—one producer’s reinforcing bar was essentially the same as another
producer’s reinforcing bar, a particular type and grade of sheet steel made at one plant was
essentially identical to the same type and grade of sheet steel made at another plant.
The commodity nature of steel products meant that steel buyers typically shopped the market
for the best price, awarding their business to whichever seller offered the best deal. The ease with
which buyers could switch their orders from one supplier to another forced steel producers to be
very price competitive. In virtually all instances, the going market price of each particular steel
product was in constant flux, rising or falling in response to shifting market circumstances (or
shifts in the terms that particular buyers or sellers were willing to accept). As a consequence, spot
market prices for commodity steel products bounced around on a weekly or even daily basis.
Because competition among rival steel producers was so strongly focused on price, it was
incumbent on all industry participants to be cost-competitive and operate their production facilities
as efficiently as they could.
Nucor’s success over the years stemmed largely from its across-the-board prowess in cost-
efficient operations for all the product categories in which it elected to compete. Nucor’s top
executives were very disciplined in executing Nucor’s strategy to broaden the company’s product
offerings; no moves to enter new steel product categories were made unless management was
confident that the company had the resources and capabilities needed to operate the accompanying
production facilities efficiently enough to be cost competitive.
Finished Steel Products
Nucor’s first venture into steel in the late 1960s, via its Vulcraft division, was principally one of
fabricating steel joists and joist girders from steel that was purchased from various steel-makers.
Vulcraft expanded into the fabrication of steel decking in 1977. The division expanded its
operations over the years and, as of 2018, Nucor’s Vulcraft division was the largest producer and
leading innovator of open-web steel joists, joist girders, and steel deck in the United States. It had
seven plants with annual capacity of 745,000 tons that made steel joists and joist girders and ten
plants with 545,000 tons of capacity that made steel deck; typically, about 85 percent of the steel
needed to make these products was supplied by various Nucor steel-making plants. Vulcraft’s joist,
girder, and decking products were used mainly for roof and floor support systems in retail stores,
shopping centers, warehouses, manufacturing facilities, schools, churches, hospitals, and, to a
lesser extent, multi-story buildings and apartments. Customers for these products were principally
nonresidential construction contractors.
In 1979, Nucor began fabricating cold finished steel products. These consisted mainly of cold
drawn and turned, ground, and polished steel bars or rods of various shapes—rounds, hexagons,
flats, channels, and squares—made from carbon, alloy, and leaded steels based on customer
specifications or end-use requirements. Cold finished steel products were used in tens of thousands
of products, including anchor bolts, hydraulic cylinders, farm machinery, air conditioner
compressors, electric motors, motor vehicles, appliances, and lawn mowers. Nucor sold cold finish
steel directly to large-quantity users in the automotive, farm machinery, hydraulic, appliance, and
electric motor industries and to steel service centers that in turn supplied manufacturers needing
only relatively small quantities. In 2017, Nucor Cold Finish was the largest producer of cold
finished bar products in North America and had facilities in Missouri, Nebraska, South Carolina,
Utah, Wisconsin, Ohio, Georgia, and Ontario, Canada with a capacity of about 1.1 million tons per
year. It obtained most of its steel from Nucor’s mills that made steel bar. This factor, along with
the fact that all of Nucor’s cold finished facilities employed the latest technology and were among
the most modern in the world, resulted in Nucor Cold Finish having a highly competitive cost
structure. It maintained sufficient inventories of cold finish products to fulfill anticipated orders.
Nucor produced metal buildings and components throughout the United States under several
brands: Nucor Building Systems, American Buildings Company, Kirby Building Systems, and
CBC Steel Buildings. In 2019, the Nucor Buildings Group had 9 metal buildings plants with an
page C-361annual capacity of approximately 360,000 tons. Nucor’s Buildings Group began
operations in 1987 and currently had the capability to supply customers with
buildings ranging from fewer than 1,000 square feet to more than 1 million square feet. Complete
metal building packages could be customized and combined with other materials such as glass,
wood, and masonry to produce a cost-effective, aesthetically pleasing building built to a
customer’s particular requirements. The buildings were sold primarily through an independent
builder distribution network. The primary markets served were commercial, industrial, and
institutional buildings including distribution centers, automobile dealerships, retail centers,
schools, warehouses, and manufacturing facilities. Nucor’s Buildings Group obtained a significant
portion of its steel requirements from the company’s bar and sheet mills.
Another Nucor division produced steel mesh, grates, and fasteners. Various steel mesh products
were made at two facilities in the United States and one in Canada that had combined annual
production capacity of about 128,000 tons. Steel and aluminum bar grating, safety grating, and
expanded metal products were produced at several North American locations that had combined
annual production capacity of 120,000 tons. Nucor Fastener, located in Indiana, began operations
in 1986 with the construction of a $25 million plant. At the time, imported steel fasteners
accounted for 90 percent of the U.S. market because U.S. manufacturers were not competitive on
cost and price. Iverson said “We’re going to bring that business back; we can make bolts as
cheaply as foreign producers.” Nucor built a second fastener plant in 1995, giving it the capacity
to supply about 20 percent of the U.S. market for steel fasteners. Currently, these two facilities had
annual capacity of about 75,000 tons and produced carbon and alloy steel hex head cap screws,
hex bolts, structural bolts, nuts and washers, finished hex nuts, and custom-engineered fasteners
that were used for automotive, machine tool, farm implement, construction, military, and various
other applications. Nucor Fastener obtained much of the steel it needed from Nucor’s mills that
made steel bar.
Beginning in 2007, Nucor—through its newly-acquired Harris Steel subsidiary—began
fabricating, installing, and distributing steel reinforcing bars (rebar) for highways, bridges,
schools, hospitals, airports, stadiums, office buildings, high rise residential complexes, and other
structures where steel reinforcing was essential to concrete construction. Harris Steel had over 70
fabrication facilities in the United States and Canada, with each facility serving the surrounding
local market. Since acquiring Harris Steel, Nucor had more than doubled its rebar fabrication
capacity to over 1,650,000 tons annually. Total fabricated rebar sales in 2019 were 1,223,000 tons,
up from 1,190,000 tons in 2015. Much of the steel used in making fabricated rebar products was
obtained from Nucor steel plants that made steel bar. Fabricated reinforcing products were sold
only on a contract bid basis.
Steel Mill Products
Nucor entered the market for steel mill products in 1968, when the decision was made to build a
facility in Darlington, South Carolina, to manufacture steel bars. The Darlington mill was one of
the first steel-making plants of major size in the United States to use electric arc furnace
technology to melt scrap steel and cast molten metal into various shapes. Electric arc furnace
technology was particularly appealing to Nucor because the labor and capital requirements to melt
steel scrap and produce crude steel were far lower than those at conventional integrated steel mills
where raw steel was produced using coke ovens, basic oxygen blast furnaces, ingot casters, and
multiple types of finishing facilities to make crude steel from iron ore, coke, limestone, oxygen,
scrap steel, and other ingredients. By 1981, Nucor had four steel mills making carbon and alloy
page C-362
steels in bars, angles, and light structural shapes; since then, Nucor had undertaken extensive
capital projects to keep these facilities modernized and globally competitive. During 2000–2011,
Nucor aggressively expanded its market presence in steel bars and by 2012 had 13 bar mills
located across the United States that produced concrete reinforcing bars, hot-rolled bars, rods, light
shapes, structural angles, channels, and guard rail in carbon and alloy steels; in 2019, these 13
plants had total annual capacity of approximately 8.5 million tons. Four of the 13 mills made hot-
rolled special quality bar manufactured to exacting specifications. Two new bar mills, one in
Florida and one in Missouri, with combined capacity of 330,000 tons per year were
expected to begin production in 2020. The products of the Nucor’s bar mills had wide
usage and were sold primarily to customers in the agricultural, automotive, construction, energy,
furniture, machinery, metal building, railroad, recreational equipment, shipbuilding, heavy truck,
and trailer industries.
Expansion into Sheet Steel In the late 1980’s, Nucor entered into the production of sheet steel
at a newly-constructed plant in Crawfordsville, Indiana. Flat-rolled sheet steel was used in the
production of motor vehicles, appliances, steel pipe and tubes, and other durable goods. The
Crawfordsville plant was the first in the world to employ a revolutionary thin slab casting process
that substantially reduced the capital investment and costs to produce flat-rolled sheet steel. Thin-
slab casting machines had a funnel-shaped mold to squeeze molten steel down to a thickness of
1.5–2.0 inches, compared to the typically 8 to 10-inch thick slabs produced by conventional
casters. It was much cheaper to then build and operate facilities to roll thin-gauge sheet steel from
1.5 to 2-inch thick slabs than from 8 to 10-inch thick slabs. When the Crawfordsville plant first
opened in 1989, it was said to have cost $50 to $75 per ton below the costs of traditional sheet
steel plants, a highly significant cost advantage in a commodity market where the going price at
the time was $400 per ton. Forbes magazine described Nucor’s pioneering use of thin slab casting
as the most substantial, technological, industrial innovation in the past 50 years.5 By 1996, two
additional sheet steel mills that employed thin slab casting technology were constructed and a
fourth mill was acquired in 2002. Nucor also operated two Castrip sheet production facilities, one
built in 2002 at the Crawfordsville plant and a second built in Arkansas in 2009; these facilities
used the breakthrough strip casting technology that involved the direct casting of molten steel into
final shape and thickness without further hot or cold rolling. The process allowed for lower capital
investment, reduced energy consumption, smaller scale plants, and improved environmental
impact (because of significantly lower emissions). A fifth sheet mill with annual capacity of 1.8
million tons, strategically located on the Ohio River in Kentucky, was acquired in 2014, giving
Nucor a total flat-rolled capacity of 12.1 million tons.
In May 2017, Nucor announced that it would invest approximately $176 million to build a 72-
inch hot band galvanizing and pickling line at its sheet mill in Ghent, Kentucky. The new
galvanizing line, which began operations in 2019, would be the widest hot-rolled galvanizing line
in North America and enable Nucor to enter additional segments of the automotive market. Going
into 2020, all five of Nucor’s sheet mills had galvanizing lines and four of them were equipped
with cold-rolling mills for the further processing of hot-rolled sheet steel.
Entry into Structural Steel Products Also in the late 1980s, Nucor added wide-flange steel
beams, pilings, and heavy structural steel products to its lineup of product offerings. Structural
steel products were used in buildings, bridges, overpasses, and similar such projects where strong
weight-bearing support was needed. Customers included construction companies, steel fabricators,
manufacturers, and steel service centers. To gain entry to the structural steel segment, in 1988
Nucor entered into a joint venture with Yamato-Kogyo, one of Japan’s major producers of wide-
page C-363
flange beams, to build a new structural steel mill in Arkansas; a second mill was built on the same
site in the 1990s that made the Nucor-Yamato venture in Arkansas the largest structural beam
facility in the Western Hemisphere. In 1999, Nucor started operations at a third structural steel mill
in South Carolina. The mills in Arkansas and South Carolina had combined capacity to make 3.25
million tons of structural steel products annually, and both used a special continuous casting
method that was quite cost-effective.
Entry into the Market for Steel Plate Starting in 2000, Nucor began producing steel plate of
various thicknesses and lengths that was sold to manufacturers of heavy equipment, ships, barges,
bridges, rail cars, refinery tanks, pressure vessels, pipe and tube, wind towers, and similar
products. Steel plate was made at three mills in Alabama, North Carolina, and Texas that had
combined capacity of about 2.9 million tons. In 2011–2013, Nucor greatly expanded its plate
product capabilities by constructing a 125,000-ton heat treating facility and a 120,000-ton
normalizing line at its North Carolina plate mill. These investments yielded two big strategic
benefits: (1) enabling the North Carolina mill to produce higher-margin plate products sold to
companies making pressure vessels, tank cars, tubular structures for offshore oil rigs,
and naval and commercial ships and (2) reducing the mill’s exposure to competition
from foreign producers of steel plate who lacked the capability to match the features of the steel
plate Nucor produced for these end-use customers.
The Cost Efficiency of Nucor’s Steel Mills All of Nucor’s steel mills used electric arc furnaces
to melt scrap steel and other metals which was then poured into continuous casting systems.
Sophisticated rolling mills converted the billets, blooms, and slabs produced by various casting
equipment into rebar, angles, rounds, channels, flats, sheet, beams, plate, and other finished steel
products. Nucor’s steel mill operations were highly automated, typically requiring fewer operating
employees per ton produced than the mills of rival companies. High worker productivity at all
Nucor steel mills resulted in labor costs roughly 50 percent lower than the labor costs at the
integrated mills of companies using union labor and conventional blast furnace technology.
Nucor’s value chain (anchored in using electric arc furnace technology to recycle scrap steel)
involved far fewer production steps, far less capital investment, and considerably less labor than
the value chains of companies with integrated steel mills that made crude steel from iron ore.
Pricing and Sales
During 2012–2019, 14 to 20 percent of the steel shipped from Nucor’s steel mills went to supply
the steel needs of the company’s finished steel operations that produced tubular products, steel
joists, steel deck, rebar, fasteners, metal buildings, and cold finish products, plus the needs of its
steel products distribution business. But three of Nucor’s acquisitions in 2016–2017, all makers of
finished steel products and tubing, began sourcing their sheet steel requirements from Nucor’s
steel mills, driving the percentage of steel mill shipments to internal customers to 20 percent in
2018 and 2019. The other 80 percent of the company’s steel mill shipments were to external
customers who placed orders monthly based on their immediate upcoming needs. It was Nucor’s
practice to maintain inventory levels at its steel mills that were deemed adequate to fill the
expected incoming orders from customers.
Nucor marketed the output of its steel mills and steel products facilities mainly through an in-
house sales force; there were salespeople located at most every Nucor production facility. Going
into 2020, approximately 75 percent of Nucor’s sheet steel sales were to contract customers
(versus 30 percent in 2009); these contracts for sheet steel were usually for periods of 6 to 12
months, were non-cancellable, and permitted price adjustments to reflect changes in the market
pricing for steel and/or raw material costs at the time of shipment. The other 25 percent of Nucor’s
sheet steel shipments and virtually all of the company’s shipments of plate, structural, and bar steel
were at the prevailing spot market price—customers not purchasing sheet steel rarely ever wanted
to enter into a contract sales agreement. Nucor’s spot pricing strategy was to charge external
customers the going spot price on the day an order was placed. Shifting market demand-supply
conditions and daily variations in spot market prices caused Nucor’s average sales prices per ton to
fluctuate from quarter to quarter, sometimes by considerable amounts—see Exhibit 4. It was
Nucor’s practice to quote the same payment terms to all external customers and for these
customers to pay all shipping charges.
Nucor sold steel joists, joist girders, and steel deck on the basis of firm, fixed-price contracts
that in most cases were won in competitive bidding against rival suppliers. Longer-term supply
contracts for these items that were sometimes negotiated with customers contained clauses
permitting price adjustments to reflect changes in prevailing raw materials costs. Steel joists,
girders, and deck were manufactured to customers’ specifications and shipped immediately;
Nucor’s plants did not maintain inventories of steel joists, girders, or steel deck. Nucor also sold
fabricated reinforcing products only on a construction contract bid basis. However, cold finished
steel, steel fasteners, steel grating, wire, and wire mesh were all manufactured in standard sizes,
with each facility maintaining sufficient inventories of its products to fill anticipated orders; most
all sales of these items were made at the prevailing spot price. The average prices Nucor received
for its various finished steel products are shown in the last column of Exhibit 4.
EXHIBIT 4 Nucor’s Average Quarterly Sales Prices for Steel Products, By
Product Category, 2016 through Q2 2020
Average Sales Prices per Net Ton
Period Sheet
Steel Steel Bars Structural Steel Steel Plate
All Steel Mill
Products
All Finished
Steel Products*
2016
Qtr 1 $471 $505 $870 $545 $538 $1,271
Qtr 2 550 561 845 604 593 1,285
Qtr 3 666 567 865 661 664 1,299
Qtr 4 603 544 837 584 614 1,337
2017
Qtr 1 661 600 738 703 657 1,201
Qtr 2 709 605 766 746 688 1,245
Qtr 3 695 624 769 749 685 1,263
Qtr 4 691 607 764 727 674 1,294
2018
Qtr 1 723 660 798 785 717 1,270
Qtr 2 838 742 876 931 819 1,357
Qtr 3 897 781 939 988 876 1,459
Qtr 4 858 771 928 1,018 860 1,525
2019
Qtr 1 797 762 921 1,022 826 1,480
page C-365
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Average Sales Prices per Net Ton
Period Sheet
Steel Steel Bars Structural Steel Steel Plate
All Steel Mill
Products
All Finished
Steel Products*
Qtr 2 758 742 900 969 788 1,462
Qtr 3 668 695 847 839 711 1,442
Qtr 4 623 651 796 748 663 1,427
2020
Qtr 1 650 662 787 740 680 1,372
Qtr 2 640 651 817 705 672 1,372
*An average of the steel prices for steel deck, steel joists and girders, steel buildings, cold finished steel products, steel
mesh, fasteners, fabricated rebar, and other finished steel products.
Source: Company records posted in the investors section at www.nucor.com (accessed June 5, 2018, March 24,
2020, and June 12, 2020).
NUCOR’S STRATEGY TO GROW AND STRENGTHEN
ITS BUSINESS AND COMPETITIVE CAPABILITIES
Starting in 2000, Nucor embarked on a five-part growth strategy that involved new acquisitions,
new plant construction, continued plant upgrades and cost reduction efforts, international growth
through joint ventures, and greater control over raw materials costs. Going into 2020, this same
five-part strategy was still in place.
Strategic Acquisitions
Beginning in the late 1990s, Nucor management concluded that growth-minded companies like
Nucor might well be better off purchasing existing plant capacity rather than building new
capacity, provided the acquired plants could be bought at bargain prices, economically retrofitted
with new equipment if need be, and then operated at costs comparable to (or even below) those of
newly-constructed state-of-the-art plants. At the time, the steel industry worldwide had far more
production capacity than was needed to meet market demand, forcing many companies to operate
in the red. Nucor had not made any acquisitions since about 1990, and a team of five
people was assembled in 1998 to explore acquisition possibilities that would strengthen
Nucor’s customer base, geographic coverage, and lineup of product offerings.
For almost three years, no acquisitions were made. But then in 2001, despite tough conditions,
Nucor management concluded that oversupplied steel industry conditions and the number of
beleaguered U.S. companies made it attractive to expand Nucor’s production capacity via
acquisition. During 2001 and continuing through 2017, the company proceeded to make a series of
strategic acquisitions to strengthen Nucor’s competitiveness, selectively expand its product
offerings improve its ability to serve customers in particular geographic locations, and boost the
company’s financial performance in times when market demand for steel was strong enough to
boost prices to more profitable levels:
In 2001, Nucor paid $115 million to acquire substantially all of the assets of Auburn Steel
Company’s 400,000-ton steel bar facility in Auburn, New York. This acquisition gave Nucor
http://www.nucor.com/
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expanded market presence in the Northeast and was seen as a good source of supply for a new
Vulcraft joist plant being constructed in Chemung, New York.
In November 2001, Nucor acquired ITEC Steel Inc. for a purchase price of $9 million. ITEC
Steel had annual revenues of $10 million and produced load bearing light gauge steel framing
for the residential and commercial market at facilities in Texas and Georgia. Nucor was
impressed with ITEC’s dedication to continuous improvement and intended to grow ITEC’s
business via geographic and product line expansion.
In July 2002, Nucor paid $120 million to purchase Trico Steel Company, which had a 2.2
million ton sheet steel mill in Decatur, Alabama. Trico Steel was a joint venture of LTV (which
owned a 50 percent interest), and two leading international steel companies—Sumitomo Metal
Industries and British Steel. The joint venture partners had built the mill in 1997 at a cost of
$465 million, but Trico was in Chapter 11 bankruptcy proceedings at the time of the acquisition
and the mill was shut down. The Trico mill’s capability to make thin sheet steel with a superior
surface quality added competitive strength to Nucor’s strategy to gain sales and market share in
the flat-rolled sheet segment. In October 2002, Nucor restarted operations at the Decatur mill
and began shipping products to customers.
In December 2002, Nucor paid $615 million to purchase substantially all of the assets of
Birmingham Steel Corporation, which included four bar mills in Alabama, Illinois, Washington,
and Mississippi. The four plants had capacity of approximately 2 million tons annually. Top
executives believed the Birmingham Steel acquisition would broaden Nucor’s customer base
and build profitable market share in bar steel products.
In August 2004, Nucor acquired a cold rolling mill in Decatur, Alabama, from Worthington
Industries for $80 million. This 1 million-ton mill, which opened in 1998, was located adjacent
to the previously-acquired Trico mill and gave Nucor added ability to service the needs of sheet
steel buyers located in the southeastern United States.
In June 2004, Nucor paid a cash price of $80 million to acquire a plate mill owned by Britain-
based Corus Steel that was located in Tuscaloosa, Alabama. The Tuscaloosa mill, which
currently had capacity of 700,000 tons that Nucor management believed was expandable to 1
million tons, was the first U.S. mill to employ a special technology that enabled high-quality,
wide steel plate to be produced from coiled steel plate. The mill produced coiled steel plate and
plate products that were cut to customer-specified lengths. Nucor intended to offer these niche
products to its commodity plate and coiled sheet customers.
In February 2005, Nucor completed the purchase of Fort Howard Steel’s operations in Oak
Creek, Wisconsin, that produced cold finished bars in size ranges up to six-inch rounds and had
approximately 140,000 tons of annual capacity.
In June 2005, Nucor purchased Marion Steel Company located in Marion, Ohio, for a cash price
of $110 million. Marion operated a bar mill with annual capacity of about 400,000 tons; the
Marion location was within close proximity to 60 percent of the steel consumption in the United
States.
In May 2006, Nucor acquired Connecticut Steel Corporation for $43 million in cash.
Connecticut Steel’s bar products mill in Wallingford had annual capacity to make 300,000 tons
of wire rod and rebar and approximately 85,000 tons of wire mesh fabrication and
structural mesh fabrication, products that complemented Nucor’s present line-up of
steel bar products provided to construction customers.
In late 2006, Nucor purchased Verco Manufacturing Co for approximately $180 million; Verco
produced steel floor and roof decking at one location in Arizona and two locations in California.
The Verco acquisition further solidified Vulcraft’s market leading position in steel decking,
giving it a total annual capacity of over 500,000 tons.
In January 2007, Nucor acquired Canada-based Harris Steel for about $1.07 billion. Harris Steel
had 2005 sales of Cdn$1.0 billion and earnings of Cdn$64 million. The company’s operations
consisted of (1) Harris Rebar which was involved in the fabrication and placing of concrete
reinforcing steel and the design and installation of concrete post-tensioning systems; (2) Laurel
Steel which manufactured and distributed wire and wire products, welded wire mesh, and cold
finished bar; and (3) Fisher & Ludlow which manufactured and distributed of heavy industrial
steel grating, aluminum grating, and expanded metal. In Canada, Harris Steel had 24 reinforcing
steel fabricating plants, two steel grating distribution centers, and one cold finished bar and wire
processing plant; in the United States, it had 10 reinforcing steel fabricating plants, two steel
grating manufacturing plants, and three steel grating manufacturing plants. Harris had customers
throughout Canada and the United States and employed about 3,000 people. For the past three
years, Harris had purchased a big percentage of its steel requirements from Nucor. Nucor
management opted to operate Harris Steel as an independent subsidiary.
Over several months in 2007 following the Harris Steel acquisition, Nucor through its new
Harris Steel subsidiary acquired rebar fabricator South Pacific Steel Corporation, Consolidated
Rebar, Inc., a 90 percent equity interest in rebar fabricator Barker Steel Company, and several
smaller transactions—all aimed at growing its presence in the rebar fabrication marketplace.
In August 2007, Nucor acquired LMP Steel & Wire Company for a cash purchase price of
approximately $27.2 million, adding 100,000 tons of cold drawn steel capacity.
In October 2007, Nucor completed the acquisition of Nelson Steel, Inc. for a cash purchase price
of approximately $53.2 million, adding 120,000 tons of steel mesh capacity.
In the third quarter of 2007, Nucor completed the acquisition of Magnatrax Corporation, a
leading provider of custom-engineered metal buildings, for a cash purchase price of
approximately $275.2 million. The Magnatrax acquisition enabled Nucor’s Building System
Group to become the second largest metal building producer in the United States.
In August 2008, Nucor’s Harris Steel subsidiary acquired Ambassador Steel Corporation for a
cash purchase price of about $185.1 million. Ambassador Steel was one of the largest
independent fabricators and distributors of concrete reinforcing steel—in 2007, Ambassador
shipped 422,000 tons of fabricated rebar and distributed another 228,000 tons of reinforcing
steel. Its business complemented that of Harris Steel and represented another in a series of
moves to greatly strengthen Nucor’s competitive position in the rebar fabrication marketplace.
Another small rebar fabrication company, Free State Steel, was acquired in late 2009, adding to
Nucor’s footprint in rebar fabrication.
In June 2012, Nucor acquired Skyline Steel, LLC and its subsidiaries for a cash price of
approximately $675.4 million. Skyline was a market-leading distributor of steel pilings, and it
also processed and fabricated spiral weld pipe piling, rolled and welded pipe piling, cold-formed
sheet piling, and threaded bar. The Skyline acquisition paired Skyline’s leadership position in
the steel piling distribution market with Nucor’s own Nucor-Yamato plant in Arkansas that was
the market leader in steel piling manufacturing. To capitalize upon the strategic fits between
Skyline’s business and Nucor’s business, Nucor launched a $155 million capital project at the
Nucor-Yamato mill to (a) add several new sheet piling sections, (b) increase the production of
page C-367
single sheet widths by 22 percent, and (c) produce a lighter, stronger sheet covering more area at
a lower installed cost—outcomes that would broaden the range of hot-rolled steel piling
products Nucor could market through Skyline’s distribution network in the United States,
Canada, Mexico, and the Caribbean. Nucor opted to operate Skyline as a subsidiary.
In 2014, Nucor acquired Gallatin Steel Company for approximately $779 million. Gallatin
produced a range of flat-rolled steel products (principally steel pipe and tube) at a mill with
annual production capacity of 1.8 million tons that was located on the Ohio River in Kentucky.
The Gallatin mill strengthened Nucor’s position as the North American market leader in hot-
rolled steel products by boosting its capacity to supply customers in the Midwest region, the
largest flat-rolled consuming market region in the United States.
In 2015, Nucor acquired Gerdau Long Steel’s two facilities in Ohio and Georgia that produced
cold-drawn steel bars and had combined capacity of 75,000 tons per year. These facilities,
purchased for about $75 million, strengthened Nucor’s already strong competitive position in
cold-finished steel bars by expanding Nucor’s geographic coverage and range of cold-finished
product offerings.
In October 2016, Nucor used cash on hand to acquire Independence Tube Corporation (ITC) for
a purchase price of $430.1 million. ITC was a leading manufacturer of hollow structural section
(HSS) tubing used primarily in nonresidential construction. ITC had the ability to produce
approximately 650,000 tons of HSS tubing annually at its four facilities, two in Illinois and two
in Alabama. This acquisition not only further expanded Nucor’s product offerings to include a
variety of tubular products but also provided a new channel for marketing Nucor’s hot-rolled
sheet steel, as ITC’s plants (which used hot-rolled sheet steel to make tubular steel products)
were located in close proximity to Nucor’s sheet mills in Alabama, Indiana, and Kentucky.
On January 9, 2017, Nucor used cash on hand to acquire Southland Tube for a purchase price of
approximately $130 million. Southland Tube was also a manufacturer of HSS tubing and had
one manufacturing facility in Birmingham, Alabama which shipped approximately 240,000 tons
in 2016.
Nucor further expanded its value-added product offerings to buyers of pipe and tubular products
in January 2017 by purchasing Republic Conduit for a purchase price of approximately $335
million. Republic Conduit produced steel electrical conduit primarily used to protect and route
electrical wiring in various nonresidential structures such as hospitals, office buildings, and
stadiums. Republic had two facilities located in Kentucky and Georgia with annual shipment
volume in 2015–2016 of 146,000 tons.
In December 2019, Nucor announced the acquisition of TrueCore, LLC, a manufacturer of
insulated metal panels for cold storage and other applications. TrueCore’s plant in Laurens,
South Carolina, was to become part of the Nucor Buildings Group, which utilized a high volume
of insulated panels for buildings it designed and manufactured.
In January 2020, Nucor and its 50–50 joint venture partner JFE Steel Corp. of Japan began
operations at a newly-constructed 400,000 ton-per-year sheet steel production facility in central
Mexico to produce hot-dip galvanized sheet steel for motor vehicle manufacturers who had built
plants in central Mexico. Automotive production in Mexico was expected to continue to grow
and the new United States-Mexico-Canada Agreement (USMCA) increased the amount of North
American content required in cars and trucks to avoid tariffs imposed by the United States.
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Aggressively Investing to Expand the Company’s Internal Production
Capabilities
Complementing Nucor’s ongoing strategic efforts to grow its business via acquisitions was a
strategy element to invest aggressively in (1) the construction of new plant capacity and (2)
enhanced production capabilities at existing plants whenever management spotted opportunities to
boost sales with an expanded range of product offerings and/or strengthen its competitive position
vis-à-vis rivals by lowering costs per ton or expanding its geographic coverage. The purpose of
making ongoing capital investments was to improve efficiency and lower production costs at each
and every facility it operated.
This strategy element had been in place since Nucor’s earliest days in the steel business. Nucor
always built state-of-the-art facilities in the most economical fashion possible and then made it
standard company practice to invest in plant modernization and efficiency improvements
whenever cost-saving opportunities emerged.
Examples of Nucor’s efforts included the following:
In 2006, Nucor announced that it would construct a new $27 million facility to produce metal
buildings systems in Brigham City, Utah. The new plant, Nucor’s fourth building systems plant,
had capacity of 45,000 tons and gave Nucor national market reach in building systems products.
In 2006, Nucor initiated construction of a $230 million state-of-the-art steel mill in Memphis,
Tennessee, with annual capacity to produce 850,000 tons of special quality steel bars.
Management believed this mill, together with the company’s other special bar quality mills in
Nebraska and South Carolina, would give Nucor the broadest, highest quality, and lowest cost
offering of special quality steel bar in North America.
In 2009, Nucor opened an idle and newly-renovated $50 million wire rod and bar mill in
Kingman, Arizona, that had been acquired in 2003. Production of straight-length rebar, coiled
rebar, and wire rod began in mid-2010; the plant had an initial capacity of 100,000 tons, with the
ability to increase annual production to 500,000 tons.
The construction of a $150 million galvanizing facility located at the company’s sheet steel mill
in Decatur, Alabama, gave Nucor the ability to make 500,000 tons of 72-inch wide galvanized
sheet steel, a product used by motor vehicle and appliance producers and in various steel frame
and steel stud buildings. The galvanizing process entailed dipping steel in melted zinc at
extremely high temperatures; the zinc coating protected the steel surface from corrosion.
In 2013 Nucor installed caster and hot mill upgrades at its Berkeley, South Carolina, sheet mill
that enabled it to roll light-gauge sheet steel to a finished width of 74 inches. This new capability
(which most foreign competitors did not have) opened opportunities to sell large quantities of
wide-width, flat-rolled products to customers in a variety of industries while, at the same time,
providing the mill with less exposure to competition from imports of less wide, flat-rolled
products.
In 2016, Nucor initiated a project to install a $75 million cooling process at the Nucor-Yamato
mill in Arkansas that was expected to generate savings on alloy costs of $12 million annually.
In 2017, Nucor began construction of a $230 million specialty cold mill complex in Hickman,
Arkansas, to produce advanced high-strength and motor lamination steel products for
automotive customers. The mill began operations in October 2019.
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In 2017, Nucor initiated an $85 million project to modernize the rolling mill at Nucor’s 400,000-
ton steel bar mill in Marion, Ohio, that produced rebar and signposts.
In November 2017, Nucor announced that it would construct a $250 million rebar micro mill in
Sedalia, Missouri, about 90 miles from Kansas City, to give Nucor a sustained shipping cost
advantage over other domestic producers in supplying rebar to customers in the Kansas City
area and the upper Midwestern and Plains region. Rebar supply to customers in this geographic
area currently traveled long distances, giving Nucor’s micro mill a sustained shipping cost
advantage. This location also allowed Nucor to take advantage of the abundant scrap supply in
the immediate area provided by Nucor’s scrap metal subsidiary, The David J. Joseph Co. The
Sedalia mill was expected to begin production in the second quarter of 2020.
In early 2018, Nucor initiated construction of a $185 million full-range merchant bar quality
(MBQ) mill at its existing bar steel mill near Kankakee, Illinois. The MBQ mill would have an
annual capacity of 500,000 tons, take approximately two years to complete, and begin
production in the second quarter of 2020. Nucor executives believed the new mill’s strategic
location mill would enable Nucor to capture costs savings by (1) optimizing the melt capacity
and infrastructure that was already in place at the existing Kankakee mill (which would continue
to be a supplier of quality reinforcing bar products) and (2) taking advantage of an abundant
scrap supply in the region. These cost-savings would enhance Nucor’s cost-competitiveness and,
in top management’s opinion, position Nucor to capture a big fraction of the bar products
tonnage currently being supplied by competitors outside the region and, also, fortify Nucor’s
market leadership in steel bars by enhancing the appeal of its product offerings of merchant bar,
light shapes, structural angle bars, and channel bars used by customers in the central Midwest
region of the United States—one of the largest markets for MBQ products.
In March 2018, Nucor announced it would construct a $240 million rebar micro mill
in Frostproof, Florida, with annual capacity of 350,000 tons, to complement the rebar
micro mill project in Sedalia, Missouri, announced in November 2017. This second mill was in a
market region with strong and growing demand, along with an abundant supply of scrap metal
that could mostly be supplied by Nucor’s David J. Joseph scrap metal subsidiary. Nucor
management believed the Frostproof mill would have a cost advantage over competitors
shipping rebar into the region from longer distances. The mill was expected to begin production
in the latter part of 2020.
In May 2018, Nucor announced it would construct a $240 million galvanizing line with annual
capacity of 500,000 tons at the company’s sheet mill in Arkansas to support Nucor’s growth into
a wider and more diverse set of advanced high-strength steel products for automotive customers.
Nucor’s CEO, John Ferriola, said, “This new galvanizing line, coupled with our new specialty
cold mill complex, will allow us to efficiently produce products beyond the capability of any
North American sheet mill.”6 The new galvanizing line was expected to be operational in the
first half of 2021.
In January 2019, Nucor announced that it would build a $1.35 billion state-of-the-art plate mill
in Brandenburg, Kentucky, on the Ohio River that would be well placed to serve customers in
the midwestern United States, the largest plate-consuming area in the country. The new plate
mill had an annual capacity of approximately 1,200,000 tons and was expected to begin
production in 2022.
In May 2019, Nucor announced it would add vacuum degassing to its engineered bar
capabilities at its bar mill in Darlington, South Carolina. Adding this capability would enable the
page C-370
mill to produce engineered bar products meeting some of the most stringent quality
specifications in the industry and thereby growing demand in the region for higher quality
automotive and other specialty steel applications. The vacuum degassing system was expected
to begin operations in late 2020.
In December 2019 Nucor announced an expansion project to add a coil paint line at the
company’s sheet mill in Hickman, Arkansas. The new coil paint line would have a capacity of
250,000 tons per year and was expected to start up in the first half of 2022. The new paint line
further diversified the sheet mill’s product and market mix by opening new sales opportunities to
the makers of roofing and siding, light fixtures, and appliances, while also strengthening its
product offerings to steel service centers and the makers of HVAC equipment and garage doors.
Nucor’s Strategy to Be a First-Mover in Adopting the Best, Most Cost-Efficient
Production Methods
The third element of Nucor’s competitive strategy was to be a technology leader and first-rate
operator of all its production facilities—outcomes that senior executives had pursued since the
company’s earliest days. Two approaches to improving and expanding Nucor’s steel-making
capabilities and achieving low costs per ton were utilized:
Being quick to implement disruptive technological innovations that would give Nucor a
sustainable competitive advantage because of the formidable barriers rivals would have to
hurdle to match Nucor’s cost competitiveness and/or product quality and/or range of products
offered.
Being quick to implement ongoing advances in production methods and install the latest and
best steel-making equipment, thus providing Nucor with a path to driving down costs per ton
and/or leapfrogging competitors in terms of product quality, range of product offerings, and/or
market share.
Nucor’s biggest success in pioneering trailblazing technology had been at its Crawfordsville,
Indiana, facilities where Nucor installed the world’s first facility for direct strip casting of carbon
sheet steel—a process called Castrip®. The Castrip process, which Nucor tested and refined for
several years before implementing it in 2005, was a major technological breakthrough for
producing flat-rolled, carbon, and stainless steels in very thin gauges because (1) it involved far
fewer process steps to cast metal at or very near customer-desired thicknesses and shapes and (2)
the process drastically reduced capital outlays for equipment and produced sizable savings on
operating expenses (by enabling the use of cheaper grades of scrap metal and requiring 90 percent
less energy to process liquid metal into hot-rolled steel sheets). An important
environmental benefit of the Castrip process was cutting greenhouse gas emissions
by up to 80 percent. Seeing these advantages earlier than rivals, Nucor management had the
foresight to acquire exclusive rights to Castrip technology in the United States and Brazil. Once it
was clear that the expected benefits of the Castrip facility at Crawfordsville were indeed going to
become a reality, Nucor in 2006 launched construction of a second Castrip facility on the site of its
structural steel mill in Arkansas.
Since technological breakthroughs (like the Castrip process) were relatively rare, Nucor
management made a point of scouring locations across the world for reports of possible cost-
effective technologies, ways to improve production methods and efficiency, and new and better
equipment that could be used to improve operations and/or lower costs in Nucor’s facilities. All
such reports were checked out thoroughly, including making trips to inspect promising new
developments firsthand if circumstances warranted. Projects to improve production methods or
install more efficient equipment were promptly undertaken when the investment payback was
attractive.
The Drive for Improved Efficiency and Lower Production Costs When Nucor acquired
plants, it drew upon its ample financial strength and cash flows from operations to immediately
fund efforts to get them up to Nucor standards—a process that employees called “Nucorizing.”
This included not only revising production methods and installing better equipment but also
striving to increase operational efficiency by reducing the amount of time, space, energy, and
manpower it took to produce steel products and paying close attention to worker safety and
environmental protection practices.
Simultaneously, Nucor’s top-level executives insisted upon continual improvement in product
quality and cost at every company facility. Most all of Nucor’s production locations were ISO
9000 and ISO 14000 certified. The company had a “BESTmarking” program aimed at being the
industry-wide best performer on a variety of production and efficiency measures. Managers at all
Nucor plants were accountable for demonstrating that their operations were competitive on both
product quality and cost vis-à-vis the plants of rival companies. A deeply embedded trait of
Nucor’s corporate culture was the expectation that plant-level managers would be persistent in
initiating actions to improve product quality and keep costs per ton low relative to rival plants.
Nucor management viewed the task of pursuing operating excellence in its manufacturing
operations as a continuous process. According to former CEO Dan DiMicco:7
We talk about “climbing a mountain without a peak” to describe our constant improvements. We can take pride in what we
have accomplished, but we are never satisfied.
The strength of top management’s commitment to funding projects to improve plant efficiency,
keep costs as low as possible, and achieve overall operating excellence was reflected in the
company’s capital expenditures for new technology, plant improvements, and equipment upgrades
(see Exhibit 5). The beneficial outcomes of these expenditures, coupled with companywide
vigilance and dedication to discovering and implementing ways to operate most cost-efficiently,
were major contributors to Nucor’s standing as North America’s lowest-cost, most diversified
provider of steel products.
EXHIBIT 5 Nucor’s Capital Expenditures for New Plants, Plant Expansions,
New Technology, Equipment Upgrades, and Other Operating Improvements,
2000–2019
Year Capital Expenditures (inmillions) Year
Capital Expenditures (in
millions)
2000 $415.0 2010 $345.2
2001 261.0 2011 450.6
2002 244.0 2012 1,019.3
2003 215.4 2013 1,230.4
2004 285.9 2014 568.9
2005 331.5 2015 364.8
2006 338.4 2016 617.7
2007 520.4 2017 507.1
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Year Capital Expenditures (inmillions) Year
Capital Expenditures (in
millions)
2008 1,019.0 2018 997.3
2009 390.5 2019 1,512.1
Sources: Company records, accessed at www.nucor.com, various dates; data for 2009–2019 is from the 2013 10-K
report, p. 43 and the 2019 10-K report, p. 23.
Shifting Production from Lower-End Steel Products to Value-Added Products
During 2010–2019, Nucor undertook a number of actions to shift more of the production tonnage
at its steel mills and steel products facilities to “value-added products” that could command higher
prices and yield better profit margins than could be had by producing lower-end or commodity
steel products. Examples included:
Adding new galvanizing capability at the Decatur, Alabama, mill that enabled Nucor to sell
500,000 tons of corrosion-resistant, galvanized sheet steel for high-end applications.
Expanding the cut-to-length capabilities at the Tuscaloosa, Alabama mill that put the mill in
position to sell as many as 200,000 additional tons per year of cut-to-length and tempered steel
plate.
Shipping 250,000 tons of new steel plate and structural steel products in 2010 that were not
offered in 2009, and further increasing shipments of these same new products to 500,000 tons in
2011.
Completing installation of a heat treating facility at the Hertford County plate mill in 2011 that
gave Nucor the capability to produce as much as 125,000 tons annually of heat-treated steel
plate ranging from 3/16 of an inch through 2 inches thick.
Installing new vacuum degassers at the Hickman, Arkansas sheet mill and Hertford County,
North Carolina mill to enable production of increased volumes of higher-value sheet steel, steel
plate, steel piping, and tubular products.
Investing $290 million at its three steel bar mills to enable the production of steel bars and wire
rod for the most demanding engineered bar applications and also put in place state-of-the-art
quality inspection capabilities. The project enabled Nucor to offer higher-value steel bars and
wire rod to customers in the energy, automotive, and heavy truck and equipment markets (where
the demand for steel products had been relatively strong in recent years).
Completing installation of a new 120,000-ton “normalizing” process for making steel plate at
the Hertford County mill in June 2013; the new normalizing process allowed the mill to produce
a higher grade of steel plate that was less brittle and had a more uniform fine-grained structure
(which permitted the plate to be machined to more precise dimensions). Steel plate with these
qualities was more suitable for armor plate applications and for certain uses in the energy,
transportation, and shipbuilding industries. Going into 2014, the normalizing process, coupled
with the company’s recent investments in a vacuum tank degasser and a heat-treating facility at
this same plant, doubled the Hertford mill’s capacity to produce higher-quality steel plate
products that commanded a higher market price.
Modernizing the casting, hot rolling, and downstream operations at the Berkeley, South Carolina
mill in 2013 to enable the production of 72-inch wide sheet steel and lighter gauge hot-rolled
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and cold-rolled steel products with a finished width of 74-inches, thereby opening opportunities
for Nucor to sell higher-value sheet steel products to customers in the agricultural, pipe and tube,
industrial equipment, automotive, and heavy-equipment industries. In 2015, the Berkeley mill
shipped 150,000 tons of wider-width products and was pursuing a goal of increasing shipments
to 400,000 tons.
Instituting a $155 million project at the Nucor-Yamato mill in 2014 to produce lighter, wider,
and stronger steel pilings and a second $75 million project in 2016 to produce structural steel
sections with high-strength, low-alloy grade chemistry; both projects helped Nucor grow sales
of value-added structural steel products that had above-average profitability.
Acquiring two Gerdau Long Steel facilities in 2015 that produced higher-margin, value-added
cold-finished bars sold to steel service centers and other customers across the United States.
Acquiring a specialty steel plate mill in Longview, Texas, in 2016 that was capable of producing
steel plate ranging that was thicker and wider than the company’s existing steel plate offerings,
thereby opening opportunities for Nucor to compete for a growing share of the value-added plate
market. Less than 12 months after the acquisition, production and shipments at the Longview
plant had doubled.
Investing in a $230 million specialty cold mill complex at Nucor Steel Arkansas to expand the
company’s capability to produce advanced high-strength, high-strength low-alloy,
and motor lamination steel products for automotive customers. The project, expected
to begin operations in late 2018, was expected to bring value to all of Nucor’s sheet mills,
mainly by broadening the automotive capability of Nucor’s galvanized lines at mills in Alabama
and South Carolina to include products that Nucor was currently unable to manufacture. The
specialty cold mill complex in Arkansas takes Nucor into the future by enabling us to produce
the high strength steel grades original equipment manufacturers are designing into future
vehicles to reduce weight and improve performance and safety. The mill differentiates Nucor
Steel Arkansas from its competitors; there are no other carbon mills like this in North America.
Investing $176 million to build a 72-inch hot band galvanizing and pickling line with annual
capacity of 500,000 tons at its sheet mill in Ghent, Kentucky. The 72-inch galvanizing line
would be the widest hot-rolled galvanizing line in North America and would enable Nucor to
enter the marketplace for such heavy-gauge, high-quality, hot-rolled galvanized steel products as
frames, control arms, supports, and brackets for automotive customers, a market segment it
previously was unable to serve. The new galvanizing line began operations in late 2019.
Acquiring two plants in St. Louis, Missouri, and Monterrey, Mexico, in 2017 that produced
higher-margin, value-added cold drawn rounds, hexagons, squares, and related products sold
mainly to automotive and certain industrial customers in the United States and Mexico. The two
facilities, with combined annual capacity of 200,000 tons, strengthened Nucor’s position as the
market leader in cold bar finished products by increasing the total capacity of Nucor’s cold
finished bar and wire facilities to more than 1.1 million tons annually, advancing Nucor’s goal of
growing its sales to automotive customers, and creating another channel for Nucor’s existing
special quality bars mills to market their products.
Constructing a $240 million galvanizing line with annual capacity of 500,000 tons at the
company’s sheet mill in Arkansas in 2018 to support Nucor’s growth into a wider and more
diverse set of advanced high-strength steel products for automotive customers. The specialty
cold mill complex in Arkansas takes Nucor into the future by enabling us to produce the high
strength steel grades original equipment manufacturers are designing into future vehicles to
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reduce weight and improve performance and safety. The mill differentiates Nucor Steel
Arkansas from its competitors; there are no other carbon mills like this in North America. With
its new galvanizing line, Nucor Steel Gallatin is now positioned to supply the under-served
Midwest heavy-gauge, hot-band galvanized market. The new line will enable us to grow our
automotive applications to include frames, control arms, supports, and brackets. Customer
feedback on the new products coming out of these two sheet mills has been excellent and now
that these projects are operating, we see even more opportunities than we had anticipated.
Adding vacuum degassing to its engineered bar capabilities at its bar mill in Darlington, South
Carolina, in 2019. Adding this capability enabled the mill to produce engineered bar products
meeting some of the most stringent quality specifications in the steel industry
Product upgrades had also been undertaken at several Nucor facilities making cold-finished and
fastener products. Senior management believed that all of these upgrades to higher-value product
offerings would boost revenues and earnings in the years ahead.
Global Growth via Joint Ventures
In 2007, Nucor management decided it was time to begin building an international growth
platform. The company’s strategy to grow its international revenues had two elements:
Establishing foreign sales offices and exporting U.S.-made steel products to foreign markets.
Because about 60 percent of Nucor’s steel-making capacity was located on rivers with deep
water transportation access, management believed that the company could be competitive in
shipping U.S.-made steel products to customers in a number of foreign locations.
Entering into joint ventures with foreign partners to invest in steel-making projects outside
North America. Nucor executives believed that the success of this strategy element was finding
the right partners to grow with internationally.
Nucor opened a Trading Office in Switzerland and proceeded to establish
international sales offices in Mexico, Brazil, Colombia, the Middle East, and Asia. The company’s
Trading Office bought and sold steel and steel products that Nucor and other steel producers had
manufactured. In 2010, approximately 11 percent of the shipments from Nucor’s steel mills were
exported. Customers in South and Central America presented the most consistent opportunities for
export sales, but there was growing interest from customers in Europe and other locations.
In January 2008, Nucor entered in a 50/50 joint venture with the European-based Duferco
Group to establish the production of beams and other long products in Italy, with distribution in
Europe and North Africa. A few months later, Nucor acquired 50 percent of the stock of
Duferdofin-Nucor S.r.l. for approximately $667 million (Duferdofin was Duferco’s Italy-based
steel-making subsidiary). In 2019, Duferdofin-Nucor operated a steel melt shop and bloom/billet
caster with an annual capacity of 1.1 million tons and a 495,000-ton special quality merchant bar
mill, and a 60,000-ton trackshoes/cutting edges mill. In May 2019, the joint venture announced it
would begin construction of a new rolling mill in northern Italy to produce 1 million tons of steel
beams and other rolled products using the latest technologies, with operations to begin in 2022.
The new mill would be supplied by the venture’s 1.1 million-ton melt shop and was expected to be
a low-cost producer. The customers for the products produced by Duferdofin-Nucor were
primarily steel service centers and distributors located both in Italy and throughout Europe. So far,
the joint venture project had not lived up to the partners’ financial expectations because all of the
plants made construction-related products. The European construction industry had been hard hit
by the economic events of 2008–2009 and the construction-related demand for steel products in
Europe was very slowly creeping back toward pre-crisis levels. Ongoing losses at Nucor
Duferdofin and revaluation of the joint venture’s assets had resulted in Nucor’s investment in
Duferdofin Nucor being valued at $412.9 million at December 31, 2017.
In early 2010, Nucor invested $221.3 million to become a 50/50 joint venture partner with
Mitsui USA to form NuMit LLC—Mitsui USA was the largest wholly-owned subsidiary of Mitsui
& Co., Ltd., a diversified global trading, investment, and service enterprise headquartered in
Tokyo, Japan. NuMit LLC owned 100 percent of the equity interest in Steel Technologies LLC, an
operator of 26 sheet steel processing facilities throughout the United States, Canada, and Mexico.
Nucor received distributions from NuMit of $6.7 million in 2013, $52.7 million in 2014, $13.1
million in 2015, $38.6 million in 2016, $48.3 million in 2017, $29.2 million in 2018, and $3.3
million in 2019 (the 2019 decrease in earnings was due to profit margin compression and lower
sales volumes).
In 2016 Nucor announced a 50/50 joint venture with JFE Steel Corporation of Japan to build a
$270 million galvanized sheet steel mill with a capacity of 400,000 tons in central Mexico to serve
the motor vehicle manufacturers who had built or were building plants in central Mexico
Automotive production in Mexico is predicted to increase from 3.4 million to 5.3 million vehicles
by 2020. In January 2020, operations began at the new plant to produce hot-dip galvanized sheet
steel. The recently-signed United States-Mexico-Canada Agreement (USMCA) increased the
amount of North American content required in cars and trucks to avoid tariffs imposed by the
United States, which enhanced the plant’s competitiveness.
Nucor’s Raw Materials Strategy
Scrap metal and scrap substitutes were Nucor’s single biggest cost—all of Nucor’s steel mills used
electric arc furnaces to make steel products from recycled scrap steel, scrap iron, pig iron, hot
briquetted iron (HBI), and direct reduced iron (DRI). On average, it took approximately 1.1 tons of
scrap and scrap substitutes to produce a ton of steel—the proportions averaged about 70 percent
scrap steel and 30 percent scrap substitutes. Nucor was the biggest user of scrap metal in North
America, and it also purchased millions of tons of pig iron, HBI, DRI, and other iron products
annually—top-quality scrap substitutes were especially critical in making premium grades of sheet
steel, steel plate, and special bar quality steel at various Nucor mills. Scrap prices were driven by
market demand-supply conditions and could fluctuate significantly—see Exhibit 6. Rising scrap
prices adversely impacted the company’s costs and ability to compete against steel-makers that
made steel from scratch using iron ore, coke, and traditional blast furnace technology.
EXHIBIT 6 Nucor’s Costs for Scrap Steel and Scrap Substitute, 2000–Q2
2020
Period
Average Cost of Scrap and
Scrap Substitute per Ton
Used
Period
Average Cost of Scrap and
Scrap Substitute per Ton
Used
2000 $120 2018 Quarter 1 $337
2005 244 Quarter 2 373
2006 246 Quarter 3 374
2007 278 Quarter 4 359
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Period
Average Cost of Scrap and
Scrap Substitute per Ton
Used
Period
Average Cost of Scrap and
Scrap Substitute per Ton
Used
2008 438 Full-Year Average 361
2009 303
2010 351 2019 Quarter 1 $352
2011 439 Quarter 2 330
2012 407 Quarter 3 299
2013 376 Quarter 4 275
2014 381 Full-Year Average 314
2015 270
2016 228 2020 Quarter 1 $293
2017 307 Quarter 2 284
Source: Nucor’s Annual Reports for 2007, 2009, 2011 and information posted in the investor relations section at
www.nucor.com (accessed April 12, 2012, April 15, 2014, February 11, 2016, February18, 2018, and March 24, 2020).
Nucor’s raw materials strategy was aimed at achieving greater control over the
costs of all types of metallic inputs (both scrap metal and iron-related substitutes) used at its steel
plants. A key element of this strategy was to backward integrate into the production of 6 million to
7 million tons per year of high quality scrap substitutes (chiefly pig iron and direct reduced iron) at
either its own wholly-owned and operated plants or at plants jointly-owned by Nucor and other
partners—integrating backward into supplying a big fraction of its own iron requirements held
promise of raw material savings and less reliance on outside iron suppliers. The costs of producing
pig iron and direct reduced iron (DRI) were not as subject to steep swings as was the price of scrap
steel.
Nucor’s first move to execute its long-term raw materials strategy came in 2002 when it
partnered with The Rio Tinto Group, Mitsubishi Corporation, and Chinese steel maker Shougang
Corporation to pioneer Rio Tinto’s HIsmelt® technology at a new plant to be constructed in
Kwinana, Western Australia. The HIsmelt technology entailed converting iron ore to liquid metal
or pig iron and was both a replacement for traditional blast furnace technology and a hot metal
source for electric arc furnaces. Rio Tinto had been developing the HIsmelt technology for 10
years and believed the technology had the potential to revolutionize iron-making and provide low-
cost, high quality iron for making steel. Nucor had a 25 percent ownership in the venture and had a
joint global marketing agreement with Rio Tinto to license the technology to other interested steel
companies. The Australian plant represented the world’s first commercial application of the
HIsmelt technology; it had a capacity of over 880,000 tons and was expandable to 1.65 million
tons at an attractive capital cost per incremental ton. Production started in January 2006. However,
the joint venture partners opted to permanently close the HIsmelt plant in December 2010 because
the project, while technologically acclaimed, proved to be financially unviable. Nucor’s loss in the
joint venture partnership amounted to $94.8 million.
In April 2003, Nucor entered a joint venture with Companhia Vale do Rio Doce (CVRD) to
construct and operate an environmentally friendly $80 million pig iron project in northern Brazil.
The project, named Ferro Gusa Carajás, utilized two conventional mini-blast furnaces to produce
about 418,000 tons of pig iron per year, using iron ore from CVRD’s Carajás mine in northern
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page C-375Brazil. The charcoal fuel for the plant came exclusively from fast-growing
eucalyptus trees in a cultivated forest in northern Brazil owned by a CVRD
subsidiary. The cultivated forest removed more carbon dioxide from the atmosphere than the blast
furnace emitted, thus counteracting global warming—an outcome that appealed to Nucor
management. Nucor invested $10 million in the project and was a 22 percent owner. Production of
pig iron began in the fourth quarter of 2005; the joint venture agreement called for Nucor to
purchase all of the plant’s production. However, Nucor sold its interest in the project to CVRD in
April 2007.
Nucor’s third raw-material sourcing initiative came in 2004 when it acquired an idled direct
reduced iron (DRI) plant in Louisiana, relocated all of the plant assets to Trinidad (an island off
the coast of South America near Venezuela), and expanded the project (named Nu-Iron Unlimited)
to a capacity of 2 million tons. The plant used a proven technology that converted iron ore pellets
into direct reduced iron. The Trinidad site was chosen because it had long-term and very cost-
attractive supply of natural gas (large volumes of natural gas were consumed in the plant’s
production process), along with favorable logistics for receiving iron ore and shipping DRI to
Nucor’s steel mills in the United States. Nucor entered into contracts with natural gas suppliers to
purchase natural gas in amounts needed to operate the Trinidad site through 2028. Production
began in January 2007. Nu-Iron personnel at the Trinidad plant had recently achieved world class
product quality levels in making DRI; this achievement allowed Nucor to use an even larger
percentage of DRI in producing the most demanding steel products.
In September 2010, Nucor announced plans to build a $750 million DRI facility with annual
capacity of 2.5 million tons on a 4,000-acre site in St. James Parish, Louisiana. This investment
was expected to move Nucor two-thirds of the way to its long-term objective of being able to
supply 6 to 7 million tons of its requirements for high-quality scrap substitutes. However, the new
DRI facility was the first phase of a multi-phase plan that included a second 2.5 million-ton DRI
facility, a coke plant, a blast furnace, an iron ore pellet plant, and a steel mill. Construction of the
first DRI unit at the St. James site began in 2011, and production began in late 2013. However, the
plant experienced significant operating losses in the first three quarters of 2014 and then
experienced an equipment failure that shut operations down. Due to adverse market conditions that
forced Nucor’s steel mills to operate well below capacity in 2015, the Louisiana DRI plant did not
resume operation until early 2016. While Nucor had anticipated that its use of DRI in its steel
mills would give the company an approximate $75 per ton cost advantage in producing a ton of
steel over traditional integrated steel mills using conventional blast furnace technology, little if any
cost-saving benefits from the $750 million investment in the Louisiana plant had seemingly been
realized as of 2019, and all activities relating to a second 2.5 million ton DRI facility, a coke plant,
a blast furnace, an iron ore pellet plant, and a steel mill at the St. James Parish site in Louisiana
had been put on hold.8 Nonetheless, Nucor management believed that the recent investments in its
two DRI plants (in Trinidad and Tobago and Louisiana) had put the company in better position
going forward to manage its overall costs of metallic materials and the associated supply-related
risks.
Because producing DRI was a natural gas intensive process, Nucor pursued a number of
strategic initiatives during 2011–2017 with drillers and operators of natural gas wells in Louisiana
to help offset the company’s exposure to future increases in the price of natural gas consumed by
the DRI facility in St. James Parish. In 2020, chiefly because of highly successful exploration
efforts of companies employing fracking technology in areas close to Louisiana where there were
big shale deposits containing both oil and natural gas, Nucor management believed that the
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company’s investment in the Louisiana DRI plant had little exposure to competitively-damaging
increases in natural gas prices.
The Acquisition of the David J. Joseph Company In February 2008, Nucor acquired The
David J. Joseph Company (DJJ) and related affiliates for a cash purchase price of approximately
$1.44 billion, the largest acquisition in Nucor’s history. DJJ was one of the leading scrap metal
companies in the United States, with 2007 revenues of $6.4 billion. It processed about 3.5 million
tons of scrap iron and steel annually at some 35 scrap yards and brokered over 20 million tons of
iron and steel scrap and over 500 million pounds of non-ferrous materials in 2007. DJJ obtained
scrap from industrial plants, the manufacturers of products that contained steel, independent scrap
dealers, peddlers, auto junkyards, demolition firms, and other sources. The DJJ Mill and Industrial
Services business provided logistics and metallurgical blending operations and offered on-site
handling and trading of industrial scrap. The DJJ Rail Services business owned over
2,000 railcars dedicated to the movement of scrap metals and offered complete
railcar fleet management and leasing services. Nucor was familiar with DJJ and its various
operations because it had obtained scrap from DJJ since 1969. Most importantly, though, all of
DJJ’s businesses had strategic value to Nucor in helping gain control over its scrap metal costs.
Within months of completing the DJJ acquisition (which was operated as a separate subsidiary),
the DJJ management team acquired four other scrap processing companies. Additional scrap
processors were acquired during 2010–2019, and several new scrap yards were opened. As of
year-end 2019, DJJ had 80 operating facilities in 18 states (along with 11 domestic and 1 foreign
brokerage offices), 57 scrap yards and recycling facilities, and total annual scrap processing
capacity of 5.2 million tons. And, because of DJJ’s fleet of 2,500 open top railcars, Nucor could
quickly and cost-efficiently deliver scrap to its steel mills.
Nucor’s Commitment to Being a Global Leader in Environmental Performance
Every Nucor facility was evaluated for actions that could be taken to promote greater
environmental sustainability. Measurable objectives and targets relating to such outcomes as
reduced use of oil and grease, more efficient use of electricity, and site-wide recycling were in
place at each plant. Computerized controls on large electric motors and pumps and energy-
recovery equipment to capture and reuse energy that otherwise would be wasted had been installed
throughout Nucor’s facilities to lower energy usage—Nucor considered itself to be among the
most energy-efficient steel companies in the world. All of Nucor’s facilities had water-recycling
systems. Nucor even recycled the dust from its electric arc furnaces because scrap metal contained
enough zinc, lead, chrome, and other valuable metals to recycle into usable products; the dust was
captured in each plant’s state-of-the-art bag house air pollution control devices and then sent to a
recycler that converted the dust into zinc oxide, steel slag, and pig iron. The first Nucor mill
received ISO 14001 Environmental Management System certification in 2001; by year-end 2015,
all of Nucor’s facilities were ISO 14001 certified.
Nucor’s sheet mill in Decatur, Alabama, used a measuring device called an opacity monitor,
which gave precise, minute-by-minute readings of the air quality that passed through the bag
house and out of the mill’s exhaust system. While rival steel producers had resisted using opacity
monitors (because they documented any time a mill’s exhaust was out of compliance with its
environmental permits, even momentarily), Nucor’s personnel at the Decatur mill viewed the
opacity monitor as a tool for improving environmental performance. They developed the expertise
to read the monitor so well that they could pinpoint in just a few minutes the first signs of a
problem in any of the nearly 7,000 bags in the bag house—before those problems resulted in
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increased emissions. Their early-warning system worked so well that the division applied for a
patent on the process, with an eye toward licensing it to other companies.
Organization and Management Philosophy
Nucor had a simple, streamlined organizational structure to allow employees to innovate and make
quick decisions. The company was highly decentralized, with most day-to-day operating decisions
made by group or plant-level general managers and their staff. Each group or plant operated
independently as a profit center and was headed by a general manager, who in most cases also had
the title of vice president. The group manager or plant general manager had control of the day-to-
day decisions that affected the group or plant’s profitability.
The organizational structure at a typical plant had four layers:
General Manager
Department Manager
Supervisor/Professional
Hourly Employee
Group managers and plant managers reported to one of 5 executive vice presidents at corporate
headquarters. Nucor’s corporate staff was exceptionally small, consisting of about 100 people in
2019, the philosophy being that corporate headquarters should consist of a small cadre of
executives who would guide a decentralized operation where liberal authority was delegated to
managers in the field. Each plant had a sales manager who was responsible for selling the products
made at that particular plant; such staff functions as engineering, accounting, and
personnel management were performed at the group/plant level. There was a minimum
of paperwork and bureaucratic systems. Each group/plant was expected to earn about a 25 percent
return on total assets before corporate expenses, taxes, interest, or profit-sharing. As long as plant
managers met their profit targets, they were allowed to operate with minimal restrictions and
interference from corporate headquarters. There was a very friendly spirit of competition from one
plant to the next to see which facility could be the best performer, but, since all of the vice
presidents and general managers shared the same bonus systems, they functioned pretty much as a
team despite operating their facilities individually. Top executives did not hesitate to replace group
or plant managers who consistently struggled to achieve profitability and operating targets.
Workforce Compensation Practices
Nucor was a largely nonunion “pay for performance” company with an incentive compensation
system that rewarded goal-oriented individuals and did not put a maximum on what they could
earn. All employees, except those in the recently-acquired Harris Steel and DJJ subsidiaries that
operated independently from the rest of Nucor, worked under one of four basic compensation
plans, each featuring incentives related to meeting specific goals and targets:
1. Production Incentive Plan—Production line jobs were rated on degree of responsibility required
and assigned a base wage comparable to the wages paid by other manufacturing plants in the
area where a Nucor plant was located. But in addition to their base wage, operating and
maintenance employees were paid weekly bonuses based on the number of tons by which the
output of their production team or work group exceeded the “standard” number of tons. All
operating and maintenance employees were members of a production team that included the
team’s production supervisor, and the tonnage produced by each work team was measured for
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each work shift and then totaled for all shifts during a given week. If a production team’s
weekly output beat the weekly standard, team members (including the team’s production
supervisor) earned a specified percentage bonus for each ton produced above the standard—
production bonuses were paid weekly (rather than quarterly or annually) so that workers and
supervisors would be rewarded immediately for their efforts. The standard rate was calculated
based on the capabilities of the equipment employed (typically at the time plant operations
began), and no bonus was paid if the equipment was not operating (which gave maintenance
workers a big incentive to keep a plant’s equipment in good working condition)—Nucor’s
philosophy was that when equipment was not operating everybody suffered and the bonus for
downtime ought to be zero. Production standards at Nucor plants were seldom raised unless a
plant underwent significant modernization or important new pieces of equipment were installed
that greatly boosted labor productivity. It was common for production incentive bonuses to run
from 50 to 150 percent of an employee’s base pay, thereby pushing compensation levels up well
above those at other nearby manufacturing plants. Worker efforts to exceed the standard and get
a bonus did not so much involve working harder as it involved good teamwork and close
collaboration in resolving problems and figuring out how best to exceed the production
standards.
2. Department Manager Incentive Plan—Department managers earned annual incentive bonuses
based primarily on the percentage of net income to dollars of assets employed for their division.
These bonuses could be as much as 80 percent of a department manager’s base pay.
3. Professional and Clerical Bonus Plan—A bonus based on a division’s net income return on
assets was paid to employees that were not on the production worker or department manager
plan.
4. Senior Officers Annual Incentive Plan—Nucor’s senior officers did not have employment
contracts and did not participate in any pension or retirement plans. Their base salaries were set
at approximately 90 percent of the median base salary for comparable positions in other
manufacturing companies with comparable assets, sales, and capital. The remainder of their
compensation was based on Nucor’s annual overall percentage of net income to stockholder’s
equity (ROE) and was paid out in cash and stock. Once Nucor’s ROE reached a threshold of
greater than three percent, senior officers earned a bonus equal to 20 percent of their base salary.
If Nucor’s annual ROE was 20 percent or higher, senior officers earned a bonus
equal to 225 percent of their base salary. Officers could earn an additional bonus of
up to 75 percent of their base salary based on a comparison of Nucor’s net sales growth with the
net sales growth of members of a steel industry peer group. There was also a long-term
incentive plan that provided for stock awards and stock options. The structure of these officer
incentives was such that bonus compensation for Nucor officers fluctuated widely—from close
to zero (in years when industry conditions were bad and Nucor’s performance was sub-par) to
four hundred percent (or more) of base salary (when Nucor’s performance was excellent).
5. Senior Officers Long-Term Incentive Plan—The long-term incentive was intended to balance
the short-term focus of the annual incentive plan by rewarding performance over multi-year
periods. These incentives were received in the form of cash (50 percent) and restricted stock (50
percent) and covered a performance period of three years; 50 percent of the long-term award
was based on how Nucor’s three-year ROAIC (return on average invested capital) compared
against the three-year ROAIC of the steel industry peer group and 50 percent was based on how
Nucor’s three-year ROAIC compared against a multi-industry group of well-respected
companies in capital-intensive businesses similar to that of steel.
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Nucor management had designed the company’s incentive plans for employees so that bonus
calculations involved no discretion on the part of a plant/division manager or top executives. This
was done to eliminate any concerns on the part of workers that managers or executives might
show favoritism or otherwise be unfair in calculating or awarding incentive awards.
There were two other types of extra compensation:
Profit Sharing—Each year, Nucor allocated at least 10 percent of its operating profits to profit-
sharing bonuses for all employees (except senior officers). Depending on company performance,
the bonuses could run anywhere from 1 percent to over 20 percent of pay. Twenty percent of the
bonus amount was paid to employees in the following March as a cash bonus and the remaining
80 percent was put into a trust for each employee, with each employee’s share being
proportional to their earnings as a percent of total earnings by all workers covered by the plan.
An employee’s share of profit-sharing became vested after one full year of employment.
Employees received a quarterly statement of their balance in profit sharing.
401(k) Plan—Both officers and employees participated in a 401(k) plan where the company
matched from 5 percent to 25 percent of each employee’s first 7 percent of contributions; the
amount of the match was based on how well the company was doing.
In 2020, entry-level, hourly workers at a Nucor plant could expect to earn $40,000 to $50,000
annually (including bonuses). Earnings for more experienced production, engineering, and
technical personnel were normally in the $70,000 to $95,000 range. Total compensation for
salaried workers ranged from $60,000 to $200,000, depending on type of job (accounting,
engineering, sales, information technology), years of experience, level of management, and
geographic location. It was common for worker compensation at Nucor plants to be double or
more the average earned by workers at other manufacturing companies in the states where Nucor’s
plants were located. As a rule of thumb, production workers in Nucor’s steel mills earned three
times the local average manufacturing wage. Nucor management philosophy was that these
workers ought to be excellently compensated because the production jobs were strenuous and the
work environment in a steel mill was relatively dangerous.
Employee turnover in Nucor mills was extremely low; absenteeism and tardiness were minimal.
Each employee was allowed four days of absences and could also miss work for jury duty, military
leave, or the death of close relatives. After this, a day’s absence cost a worker the entire
performance bonus pay for that week and being more than a half-hour late to work on a given day
resulted in no bonus payment for the day. When job vacancies did occur, Nucor was flooded with
applications from people wanting to get a job at Nucor; plant personnel screened job candidates
very carefully, seeking people with initiative and a strong work ethic.
Employee Relations and Human Resources
Employee relations at Nucor were based on four clear-cut principles:
1. Management is obligated to manage Nucor in such a way that employees will have the
opportunity to earn according to their productivity.
2. Employees should feel confident that if they do their jobs properly, they will have a
job tomorrow.
3. Employees have the right to be treated fairly and must believe that they will be.
4. Employees must have an avenue of appeal when they believe they are being treated unfairly.
The hallmarks of Nucor’s human resources strategy were its incentive pay plan for production
exceeding the standard and the job security provided to production workers—despite being in an
industry with strong down-cycles, Nucor had made it a practice not to lay off workers. Instead,
when market conditions were tough and production had to be cut back, workers were assigned to
plant maintenance projects, cross-training programs, and other activities calculated to boost the
plant’s performance when market conditions improved. No Nucor employee had ever been laid
off.
Nucor took an egalitarian approach to providing fringe benefits to its employees; employees had
the same insurance programs, vacation schedules, and holidays as upper level management.
However, certain benefits were not available to Nucor’s officers. The fringe benefit package at
Nucor included:
1. Medical and Dental Plans—The company had a flexible and comprehensive health benefit
program for officers and employees that featured low premiums, no deductible, an out-of-pocket
expense limit based on a percentage of the employee’s earnings, a dental plan, a vision plan,
healthcare spending accounts.
2. Tuition Reimbursement—Nucor reimbursed up to $3,500 of an employee’s approved educational
expenses each year and up to $1,750 of a spouse’s educational expenses for two years.
3. Service Awards—After each five years of service with the company, Nucor employees received
a service award consisting of five shares of Nucor stock.
4. Scholarships and Educational Disbursements— Nucor provided the children of every employee
(except senior officers) with college funding of $3,500 per year for four years to be used at
accredited academic institutions.
5. Company Contributions to Profit-Sharing and Retirement Savings—These contributions were
made annually for qualified employees and were based on the company’s profitability.
Employees could contribute up to 4 percent of their salary to a 401(K) with Nucor matching 50
percent of the employee’s contribution. The profit-sharing plan set aside at least 10 cents out of
every dollar that Nucor earned before taxes. Nucor’s expense for these benefits totaled $181.4
million in 2019, $307.9 million in 2018, and $169.4 million in 2017. At year-end 2018, the plan
had over 20,000 active participants and net assets of $4.0 billion.9
6. Other benefits—Long-term disability, life insurance, paid vacation, paid volunteer time off, and
parental leave.
Most of the changes Nucor made in work procedures came from employees. The prevailing view
at Nucor was that the employees knew the problems of their jobs better than anyone else and were
thus in the best position to identify ways to improve how things were done. Most plant-level
managers spent considerable time in the plant, talking and meeting with frontline employees and
listening carefully to suggestions. Promising ideas and suggestions were typically acted upon
quickly and implemented—management was willing to take risks to try worker suggestions for
doing things better and to accept the occasional failure when the results were disappointing.
Teamwork, a vibrant team spirit, and a close worker-management partnership were much in
evidence at Nucor plants.
Nucor plants did not utilize job descriptions. Management believed job descriptions caused
more problems than they solved, given the teamwork atmosphere and the close collaboration
among work group members. The company saw formal performance appraisal systems as a waste
of time and added paperwork. If a Nucor employee was not performing well, the problem was
page C-380
dealt with directly by supervisory personnel and the peer pressure of work group members (whose
bonuses were adversely affected).
Employees were kept informed about company and division performance. Charts showing the
division’s results in return on assets and bonus payoff were posted in prominent places in the plant.
Most all employees were quite aware of the level of profits in their plant or division. Nucor had a
formal grievance procedure, but grievances were few and far between. The corporate office sent
all news releases to each division where they were posted on bulletin boards. Each employee
received a copy of Nucor’s annual report; it was company practice for the cover of the annual
report to consist of the names of all Nucor employees.
All of these practices had created an egalitarian culture and a highly motivated
workforce that grew out of former CEO Ken Iverson’s radical insight: employees, even hourly
clock punchers, would put forth extraordinary effort and be exceptionally productive if they were
richly rewarded, treated with respect, and given real power to do their jobs as best they saw fit.10
There were countless stories of occasions when managers and workers had gone beyond the call of
duty to expedite equipment repairs (in many instances even using their weekends to go help
personnel at other Nucor plants solve a crisis); the company’s workforce was known for displaying
unusual passion and company loyalty even when no personal financial stake was involved. As one
Nucor worker put it, “At Nucor, we’re not ‘you guys’ and ‘us guys.’ It’s all of us guys. Wherever
the bottleneck is, we go there, and everyone works on it.”11
It was standard procedure for a team of Nucor veterans, including people who worked on the
plant floor, to visit with their counterparts as part of the process of screening candidates for
acquisition.12 One of the purposes of such visits was to explain the Nucor compensation system
and culture face-to-face, gauge reactions, and judge whether the plant would fit into “the Nucor
way of doing things” if it was acquired. Shortly after making an acquisition, Nucor management
moved swiftly to institute its pay-for-performance incentive system and to begin instilling the
egalitarian Nucor culture and idea-sharing. Top priority was given to looking for ways to boost
plant production using fewer people and without making substantial capital investments; the take-
home pay of workers at newly-acquired plants typically went up rather dramatically. At the
Auburn Steel plant, acquired in 2001, it took Nucor about six months to convince workers that
they would be better off under Nucor’s pay system; during that time Nucor paid people under the
old Auburn Steel system but posted what they would have earned under Nucor’s system. Pretty
soon, workers were convinced to make the changeover—one worker’s pay climbed from $53,000
in the year prior to the acquisition to $67,000 in 2001 and to $92,000 in 2005.13
New Employees. Each plant/division had a “consul” responsible for providing new employees
with general advice about becoming a Nucor teammate and serving as a resource for inquiries
about how things were done at Nucor, how to navigate the division and company, and how to
resolve issues that might come up. Nucor provided new employees with a personalized plan that
set forth who would give them feedback about how well they were doing and when and how this
feedback would be given; from time to time, new employees met with the plant manager for
feedback and coaching. In addition, there was a new employee orientation session that provided a
hands-on look at the plant/division operations; new employees also participated in product group
meetings to provide exposure to broader business and technical issues. Each year, Nucor brought
all recent college hires to the Charlotte headquarters for a forum intended to give the new hires a
chance to network and provide senior management with guidance on how best to leverage their
talent.
THE WORLD STEEL INDUSTRY
Global production of crude steel hit a record high of 1,870 million tons in 2019—see Exhibit 7.
Steel-making capacity worldwide was approximately 2,460 million tons in 2019, resulting in
global excess capacity of just over 640 million tons and a 2019 capacity utilization rate of 76.0
percent (up from a historically unprecedented low of 52 percent in 2009). Overcapacity was
especially pronounced in China. Nonetheless, construction of new capacity additions were
underway during 2019, with more capacity additions in the planning stages; indications were that
worldwide capacity would grow to about 2,570 million tons in 2021.14 Although global demand
for steel mill products had grown an average of about 3.6 percent annually during 2015–2019,
going forward global demand for steel products was forecast to grow at an annual rate of 1–
2 percent through 2025. The six biggest steel-producing countries in 2019 were:15
Country Total Production of Crude Steel Percent of WorldwideProduction
China 996 million tons 53.3%
India 111 million tons 5.9%
Japan 99 million tons 5.3%
United States 88 million tons 4.7%
Russia 72 million tons 3.8%
South Korea 71 million tons 3.8%
EXHIBIT 7 Worldwide Production of Crude Steel, with Compound Average
Growth Rates, 1975–2019
Compound Average Growth Rates in World Crude
Steel Production
Year
World Crude Steel
Production (millions of
tons)
Period Compound AverageGrowth Rate
1975 644 1975–1980 2.17%
1980 717 1980–1985 0.06%
1985 719 1985–1990 1.38%
1990 770 1990–1995 −0.45%
1995 753 1995–2000 2.45%
2000 850 2000–2005 6.20%
2005 1,148 2005–2010 4.53%
2010 1,433 2010–2015 2.51%
2011 1,538 2015–2019 3.62%
2012 1,560
2013 1,650
2014 1,671
2015 1,622
2016 1,629
2017 1,732
page C-381
Compound Average Growth Rates in World Crude
Steel Production
Year
World Crude Steel
Production (millions of
tons)
Period Compound AverageGrowth Rate
2018 1,817
2019 1,870
Source: Worldsteel Association, Steel Statistical Yearbook, 2019 (Concise Version) and Worldsteel Association press
release, January 27, 2020, posted at www.worldsteel.org, accessed on March 26, 2020.
Exhibit 8 shows the world’s 15 largest producers of crude steel in 2018.
EXHIBIT 8 Top 15 Producers of Crude Steel Worldwide, 2018
Global Rank Company (Headquarters Country) Crude Steel Production(millions of metric tons)
1. ArcelorMittal (Luxembourg) 96.4
2. China Baowu Group (China) 67.4
3. Nippon Steel Corp. (Japan) 49.2
4. HBIS Group (China) 46.8
5. POSCO (South Korea) 42.9
6. Shagang Group (China) 40.7
7. Ansteel (China) 37.4
8. JFE Steel (Japan) 29.2
9. Jianlong Group (China) 27.9
10. Shougang Group (China) 27.3
11. Tata Steel (India) 27.3
12. Nucor (USA) 25.5
13. Shandong Steel Group (China) 23.2
14. Valin Group (China) 23.0
15. Hyundai Steel (South Korea) 21.9
Source: Worldsteel Association, World Steel in Figures, 2019, posted at www.worldsteel.org, accessed on March 26,
2020.
Steel-Making Technologies
Steel was produced either by integrated steel facilities or by mills that employed electric arc
furnace (EAF) technology. Integrated mills used metallurgical coal fired in coke ovens to produce
coke, a fuel with low impurities and high carbon content; the coke was then used to fire blast
furnaces and provide needed carbon to react with iron ore, air, and other additives at high
temperatures and produce a hot metal mixture (often called molten pig iron). The hot metal was
then poured into a converter where the hot metal was pretreated with magnesium and subjected to
a 20-minute bath of high-purity oxygen which created a lot of heat. To cool down the reaction heat
created by the oxygen bath, charges of scrap metal and lime were added. Following completion of
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the oxygen bath, the converter was titled and the resulting liquid crude steel was drained off. To
make flat rolled steel products, liquid steel was either fed into a continuous caster machine and
cast into slabs or else cooled in slab form for later processing. Slabs were further shaped or rolled
at a plate mill or hot strip mill. In making certain sheet steel products, the hot strip mill process
was followed by various finishing processes, including pickling, cold-rolling, annealing,
tempering, galvanizing, or other coating procedures. These various processes for converting raw
steel into finished steel products were often distinct steps undertaken at different times and in
different on-site or off-site facilities rather than being done in a continuous process in a single
plant facility—an integrated mill was thus one which had multiple facilities at a single plant site
and could therefore not only produce crude (or raw) steel but also run the crude steel through
various facilities and finishing processes to make hot-rolled and cold-rolled sheet steel products,
steel bars and beams, stainless steel, steel wire and nails, steel pipes and tubes, and
other finished steel products. But such facilities entailed high capital and energy costs
and required a sizable work force to operate. The work forces at many integrated mills in Europe,
the United States, and several other countries were often unionized.
Steel-making at mills using electric arc furnace technology was far simpler and quicker. High-
powered electric arcs were thrust down into a vessel to melt scrap metal, scrap substitutes, and
perhaps directly reduced iron pellets into molten metal which was then cast into crude steel slabs,
billets, or blooms in a continuous casting process. As was the case at integrated mills, the crude
steel at EAF mills was then run through various facilities and finishing processes to make hot-
rolled and cold-rolled sheet steel products, steel bars and beams, stainless steel, steel wire and
nails, steel pipes and tubes, and other finished steel products. EAF steel mills could accommodate
short production runs and had relatively fast product change-over time. The electric arc technology
employed by these mills offered two primary competitive advantages: capital investment
requirements that were 75 percent lower than those of integrated mills and smaller workforce
requirements (which translated into lower labor costs per ton shipped).
Initially, companies with EAF mills were able to only make low-end steel products (such as
reinforcing rods and steel bars). But when thin-slab casting technology came on the scene in the
1980s, EAF mills that invested in thin-slab casting facilities were able to compete in the market for
flat-rolled carbon sheet and strip products; these products sold at substantially higher prices per
ton and thus were attractive and profitable market segments to enter—as Nucor proved at its plants
in Indiana and elsewhere. Other EAF steel mills in the United States and across the world were
quick to follow Nucor’s lead in adopting thin-slab casting technology because the low capital costs
of thin-slab casting facilities, often coupled with lower labor costs per ton, gave EAF-mills a cost
and pricing advantage over integrated steel producers, enabling them to grab a growing share of
the global market for flat-rolled sheet steel and other carbon steel products. Many integrated
producers also switched to thin-slab casting as a defensive measure to protect their profit margins
and market shares. But the advent of thin-slab casting was by no means the only technological
development that allowed EAF mills to enter market segments dominated by integrated mills.
Since 1990, numerous production refinements and technological improvements had been
introduced at various EAF mills (like those at Nucor) that permitted them to gradually invade
other steel product segments and to produce higher quality steels capable of meeting the strict
specifications of steel users in more and more industry categories. However, EAF mills were from
time-to-time competitively challenged by rising prices for scrap metal.
In 2018, 70.8 percent of the world’s steel mill production was made at large integrated mills and
about 28.8 percent was made at EAF mills.16 In China 88.4 percent of the crude steel was
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produced at integrated mills using the basic oxygen process; this compared with 75 percent in
Japan, 67 percent in Russia, 67 percent in South Korea, and 78 percent in Brazil. In the United
States, however, 68.0 percent of the crude steel was produced at EAF mills and 32.0 percent at
mills using blast furnaces and basic oxygen processes.17 Large integrated steel mills using blast
furnaces, basic oxygen furnaces, and assorted casting and rolling equipment typically had the
ability to manufacture a wide variety of steel mill products but faced significantly higher capital
costs and higher operating costs for labor and energy. While mills using electric-arc furnaces were
sometimes challenged by high prices for scrap metal, they tended to have far lower capital and
operating costs compared with the integrated steel producers. However, the quality of the steel
produced using basic oxygen furnace technologies tended to be superior to that of electric arc
furnaces unless, like at most of Nucor’s facilities, the user of electric arc furnaces invested in
additional facilities and processing equipment to enable the production of upgraded steel products.
Market Conditions in the Global Steel Market, 2015–2019
The global marketplace for steel was intensely price competitive and expected to remain so unless
and until the estimated 700 million tons of excess steel-making capacity across the world shrunk
substantially and global demand for steel products rose sufficiently to more closely match global
supplies. Approximately 150 million tons of the world’s excess steel-making capacity was in
China, but there were sizable pockets of excess capacity in many other countries.
Companies with excess production capacity were typically active in seeking to increase
their exports of steel to foreign markets. Steel producers in some countries, particularly those in
the European Union, Turkey, South Korea, and Canada, were both big exporters and big importers
because domestic steel makers had more capacity to make certain types and grades of steel than
was needed locally (and thus strived to export such products to other countries) but lacked
sufficient domestic capability to produce certain types and grades of semi-finished and finished
steel products needed by domestic customers (which consequently had to be imported). In most
countries of the world, the difference between steel exports and steel imports was a matter of a few
million tons. But there were six countries that stood out as big net exporters of semi-finished and
finished steel products, of which China was by far the largest (Exhibit 9).
EXHIBIT 9 Major Net Exporters (Exports – Imports) of Semi-Finished and
Finished Steel Products, By Country, 2015–2018 (in millions of metric tons)
Country 2015 2016 2017 2018
China 98.4 94.5 60.9 54.4
Japan 34.9 34.5 31.2 29.8
Russia 25.4 26.7 24.9 27.0
South Korea 9.5 7.3 12.1 15.1
Ukraine 16.9 17.1 13.8 13.5
Brazil 10.5 11.5 13.0 11.6
Source: Worldsteel Association, Steel Statistical Yearbook, 2017 and World Steel in Figures, 2018 and 2019. Accessed
May 31, 2018 and March 30, 2020 at www.worldsteel.org.
The major Chinese steelmakers, most of which were wholly or partly government-owned, had
responded to the burden of having large amounts of unused capacity by aggressively seeking out
page C-384
buyers for their products in other countries and securing orders by offering prices that significantly
undercut the prices of local steel makers and enabled the Chinese sellers to steal away sales and
market share. The low prices offered by Chinese steelmakers were partly enabled by Chinese
currency devaluations initiated by the Chinese government and partly enabled by subsidies and
other financial assistance the Chinese government provided to domestic steel makers. The success
of Chinese steelmakers in capturing the business of foreign buyers resulted in total Chinese
exports of semi-finished and finished steel products of 102.4 million tons in 2014, 123.0 million
tons in 2015, 119.2 million tons in 2016, 86.4 million tons in 2017, and 75.8 million tons in
2018.18
A flood of steel imports from China and certain other countries into the United States and many
other countries across the world in 2015–2018, powered by price discounting on the part of the
sellers, resulted in governments imposing more than 130 anti-dumping tariffs and duties on
Chinese steel producers (and Chinese manufacturers of aluminum and certain other metals as well)
to protect their domestic steel companies from what they termed the unfair trade practices of
Chinese producers to take sales away from domestic producers by selling at ultralow prices
(typically enabled by subsidies from the Chinese government).19 The average price of Chinese
steel exports fell by about 50 percent between 2011 and 2016.
In 2016, the Chinese government agreed to pursue actions to reduce its domestic steel-making
capacity by 150 million tons by 2020. But, while some capacity reductions had occurred, Chinese
producers began pursuing ways to escape the tariffs being imposed. One method was to sell steel
to buyers in a country which had not been singled out for tariffs imposed by the United States and
other countries; these buyers, participants in a Chinese-engineered scheme to disguise the origin of
the Chinese-made steel products, in turn shipped the steel products tariff-free to buyers in the
United States and other countries. China Zhongwang Holdings, China’s largest producer of
aluminum flat-rolled and extrusion products, used a different tariff-evading scheme. In 2016,
China Zhongwang was discovered to have stockpiled more than 500,000 metric tons of aluminum
products hidden under hay and tarpaulins in a Mexican desert just below the U.S.
border, with alleged intentions of shipping them to the United States to avoid trade
restrictions on Chinese exports of aluminum to the United States—provisions in the North
American Free Trade Agreement allowed for aluminum products to be moved tariff-free from
Mexico into the United States (reports and pictures of the stockpile in the media blew up the
scheme).20 In recent years, aluminum smelters in China had come to dominate the global
aluminum market, reportedly supplying about half of the world’s need for aluminum products in
2016–2017. Of the 23 aluminum smelters in operation in the United States in 2000, only 5 were
still in operation in 2016, largely due to the fact that the Chinese manufacturers of aluminum
products could use the subsidies they received from the Chinese government to undercut the prices
of U.S. producers.
In 2018, the Trump Administration announced 25 percent tariffs on certain steel and aluminum
imports from China, the European Union, Canada, and Mexico. Within weeks, there were multiple
media reports that, in an effort to escape these tariffs, various Chinese steel-makers had sold steel
to Chinese brokers who then shipped the steel to buyers in various countries that were not
confronted tariffs on their steel exports to the United States and elsewhere; these buyers in turn
promptly shipped the steel products to buyers in the United States. In 2017–2018, however,
Chinese steel producers devised another way to skirt tariffs on steel. While they were shutting
down some of their production in China, they had started aggressively expanding overseas, using
tens of billions of dollars supplied by Chinese lenders owned by the Chinese government, to buy
and build steel plants at locations around the world.21 Already operational were plants with 3.5
million metric tons of capacity in Malaysia, 3.0 million metric tons in Indonesia, and 2.2 million
metric tons in Serbia. Under construction were plants with capacity of 6.0 million metric tons in
Indonesia, 2.0 million metric tons in India, and 0.5 million metric tons in Texas. And there were
plants on the verge of starting construction in 2018 with capacity of 10 million metric tons in
Brazil (where the Brazilian steel industry was currently operating at 70 percent of capacity), 7.5
million metric tons in Indonesia, and 2.0 million metric tons in Bangladesh.22
The steel plant in Serbia, owned and operated by a recently-renamed Chinese company called
the Hesteel Group, had begun selling wide hot-rolled steel coil to U.S. buyers through Duferco, a
Swiss trading company that was 51 percent owned by Hesteel.23 This same plant was also
reportedly exporting tariff-free steel products into the 28-nation European Union. A new 2 million
metric ton steel plant built on the Indonesian island of Sulawesi by Tsingshan Group Holdings
(that was funded by a $570 million loan from the government-backed China Development Bank)
accounted for 4 percent of the world’s stainless-steel production and had exported 300,000 metric
tons to the United States through a joint venture with Pittsburgh-based stainless-steel producer
Allegheny Technologies.24
Exhibit 10 shows the volumes of U.S. imports and exports of semi-finished and finished steel
products for 2005–2018. The column showing “apparent domestic use of finished steel products”
is obtained by adding up deliveries (defined as what comes out of the facility gates of domestic
steel producers) minus exports of steel products plus imports of steel products; as such, it is a good
approximation of total domestic consumption of steel products and is a commonly used metric in
the steel industry. The last column shows the percentage of domestic steel use supplied by foreign
steel producers.
EXHIBIT 10 U.S. Exports and Imports of Semi-Finished and Finished Steel
Products, 2005–2018 (in millions of metric tons)
Year U.S. Exports U.S. Imports
Net Imports
(Exports—
Imports)
Apparent Domestic Use of
Finished Steel Products
U.S. Imports as a Percent
of Domestic Apparent Use
2005 9.4 30.2 20.8 110.3 27.4%
2006 9.6 42.2 32.6 122.4 34.5%
2007 9.8 27.7 17.9 111.2 24.9%
2008 12.0 24.6 12.6 101.1 24.3%
2009 9.2 15.3 6.1 59.3 25.8%
2010 11.8 22.5 10.7 115.8 19.4%
2011 13.3 26.6 13.3 89.2 29.8%
2012 13.6 30.9 17.3 96.2 32.1%
2013 12.5 29.8 17.3 95.7 31.1%
2014 12.0 41.4 29.4 107.0 38.7%
2015 10.0 36.5 26.5 96.1 38.0%
2016 9.2 30.9 21.7 91.9 33.6%
2017 10.2 35.4 25.2 97.7 36.2%
2018 8.6 31.7 23.1 100.2 31.6%
page C-385
page C-386
Source: Worldsteel Association, Steel Statistical Yearbook, 2017 and World Steel in Figures, 2018 and 2019, accessed
at www.worldsteel.org, May 31, 2018 and March 30, 2020; and Worldsteel Association, Steel Statistical Yearbook,
2010, accessed at www.steel-on-the-net.com, May 31, 2018.
NUCOR AND COMPETITION IN THE U.S. MARKET
FOR STEEL
Nucor’s broad product line-up meant that it was an active participant in the U.S. markets for a
wide variety of unfinished and finished steel products, plus the markets for scrap steel and scrap
substitutes. Nucor executives considered all the market segments and product categories in which
it competed to be intensely competitive, many of which were populated with both domestic and
foreign rivals. For the most part, competition for steel mill products and finished steel products
was centered on price and the ability to meet customer delivery requirements. And, due to global
overcapacity, many of the world’s steelmakers were actively seeking new business in whatever
geographic markets they could find willing buyers.
Finished steel imports into North America (the United States, Canada, and Mexico peaked in
2014 at almost 30 million tons and declined to approximately 25.7 million tons in 2017. In 2019,
with section 232 (implemented in 2018) adding a 25 percent tariff on most imports
outside NAFTA, finished steel imports in the United States decreased by
approximately 6 million tons from the levels of 2017. As a result, import penetration in the United
States fell from 23 percent in 2018 to 19 percent in 2019. Relative to other regions, imports from
Canada and Mexico decreased by only about 15 percent in 2019, as section 232 tariffs were not
applied after May 2019. Other countries such as Brazil, Ukraine, Australia and South Korea,
though not subject to 25 percent tariffs, were subject to quotas. Imports decreased further from
Turkey (down approximately 70 percent year-on-year), where its share of imports declined from 5
percent in 2018 to approximately 1 percent in 2019; the sharp Turkish decline had to do with
tariffs—beginning May 16, 2019, Turkish imports were subject to a 25 percent tariff after having
been subject to 50 percent tariffs since August 2018.
Many foreign steel producers had costs on a par with or sometimes below those of Nucor,
although their competitiveness in the U.S. market varied significantly according to the prevailing
strength of their local currencies versus the U.S. dollar, the extent to which they received
government subsidies, and prevailing tariffs and trade restrictions.
In Nucor’s 2017 Annual Report, CEO Ferriola reported to shareholders on the impacts that
global excess capacity and unfair trade practices were having on the company:25
Our industry remains greatly constrained by the impact of global overcapacity . . . . the extraordinary increase in China’s steel
production in the last decade, together with the excess capacity from other countries that have state-owned
enterprises . . . . have exacerbated this overcapacity issue. We believe Chinese producers . . . benefit from . . . the receipt of
government subsidies, which allow them to sell steel into our markets at artificially low prices.
China is not only selling steel at artificially low prices into our domestic market but also across the globe. . . . Nucor has
joined three other domestic steelmakers in filing a petition alleging China is circumventing previously levied duties by shipping
products through third-party countries.
But conditions improved in 2019. Nucor CEO Topalian said:26
As the year ended, there were a number of positive developments that led to more optimism about the outlook
for the U.S. economy in 2020. The U.S. and China signed a phase one agreement on trade issues, and the U.S.
House and Senate both passed the United States-Mexico-Canada trade agreement with strong bipartisan support. The new trade
deal will benefit the U.S. steel industry, especially given the revamped country of origin rules that will greatly incentivize the
use of North American steel in autos, auto parts, and other products containing steel. The Section 232 steel tariffs also
continued to be effective in keeping unfairly traded imports out of the U.S. market, with imports down approximately six
million tons from the previous year.
http://www.steel-on-the-net.com/
Nucor’s Two Largest Domestic Competitors
Consolidation of both the global and domestic steel industry into a smaller number of larger and
more efficient steel producers had heightened competitive pressures for Nucor and most other
steelmakers. Nucor had two major rivals in the United States—the NAFTA division of
ArcelorMittal (the United States, Canada, and Mexico) and United States Steel.
ArcelorMittal NAFTA In 2020, ArcelorMittal NAFTA operated two coke-making facilities,
five integrated mills, 10 EAFs at three sites, rolling and finishing facilities at about 14 sites. It had
the capability to produce hot-rolled and cold-rolled coils of sheet steel, steel plate, steel bars,
coated steels, high-quality wire rods, rebar, structural steel, tubular steel, and tin mill products.
Much of its production was sold to customers in the automotive, trucking, off-highway,
agricultural-equipment, and railway industries, with the balance being sold to steel service centers
and companies in the appliance, office furniture, electrical motor, packaging, and industrial
machinery sectors. The division’s performance for the most recent three years is shown below: 27
Year Shipments (tons) Average Price perton Sales Revenues
Operating Profit
(Loss)
2019 20.9 million $810 $18.6 billion ($1.3 billion)
2018 22.0 million 850 $20.3 billion $1.9 billion
2017 23.5 million 740 $18.0 billion $1.2 billion
Globally, ArcelorMittal was the world’s largest steel producer, with steelmaking operations in
20 countries on four continents, annual production capacity of about 112 million tons of crude
steel. ArcelorMittal’s performance companywide for the past three years is summarized below: 28
Year Shipments (tons) Average Price perton Sales Revenues Net Profit (Loss)
2019 83.9 million $754 $70.6 billion ($2.4 billion)
2018 84.5 million 826 $76.0 billion $5.3 billion
2017 85.2 million 736 $68.7 billion $4.6 billion
One important cause of ArcelorMittal’s spotty financial performance was the industry’s massive
amount of excess capacity, which had spurred steel producers in China, Japan, India, Russia, and
other locations to dump steel products at artificially low prices in many of the geographic markets
where ArcelorMittal had operations (and thereby push down the market prices of many steel
products to unprofitable levels).
U.S. Steel U.S. Steel was an integrated steel producer of flat-rolled and tubular steel products
with major production operations in the United States and Europe. Going into 2020, U.S. Steel
was the third largest producer of crude steel in the United States and in 2018 the twenty-sixth
largest in the world. It was widely considered to have a labor cost disadvantage versus Nucor and
ArcelorMittal NAFTA, partly due to the lower productivity of its unionized workforce and partly
due to its retiree pension costs.
U.S. Steel’s operations were organized into three business segments: North American flat-rolled
products, tubular products, and U.S. Steel Europe. The Flat-Rolled segment included four
integrated steel mills in the United States, with combined crude steel capacity of 17 million tons
annually, that produced slabs, strip mill plates, sheets and tin mill products, as well as iron ore and
coke production facilities in the United States. These operations primarily served North American
page C-387
customers in the service center, conversion, transportation (including automotive), construction,
container, and appliance and electrical markets.
The Tubular segment had annual production capacity of 1.9 million tons that produced seamless
and electric resistance welded steel casing and tubing, standard and line pipe, and mechanical
tubing primarily for customers in the oil, gas, and petrochemical markets. The European segment
included coke production facilities and an integrated steel mill with annual capacity of 4.5 million
tons in Slovakia that produced steel slabs, strip mill plate, sheet, tin mill products and spiral
welded pipe, as well as refractory ceramic materials to customers in Central and
Western Europe in the transportation (including automotive), construction, container,
appliance, electrical, service center, conversion and oil, gas and petrochemical markets.
The performance of these three business segments for the most recent three years is shown in
Exhibit 11.
EXHIBIT 11 Performance of U.S. Steel’s Business Segments, 2017–2019
Year Shipments(tons)
Average Price
per ton
Sales
Revenues Operating Profit (Loss)
Flat Rolled Products
2019 11.4million $753
$ 9.3
billion $196 million
2018 11.9million 811 9.7 billion 883 million
2017 10.8million 726 1.2 billion 375 million
Tubular Products
2019 11.4million $1,450
$ 1.2
billion $(67 million)
2018 11.9million 1,483 1.2 billion (58 million)
2017 10.8million 1,253 0.94 billion (99 million)
U.S. Steel Europe
2019 3.6 million $652 $ 2.4billion $(57 million)
2018 4.5 million 693 3.2 billion 359 million
2017 4.6 million 622 2.9 billion 327 million
Source: Company 10-K Report, 2019.
NUCOR CEO LEON J. TOPALIAN’S PRIORITIES GOING
FORWARD
Shortly after becoming CEO on January 1, 2020, Leon Topalian in his first annual report letter to
Nucor’s stockholders announced what his immediate priorities were for the company:29
There is no value within our culture that tells us more about ourselves than Safety. It is our cultural measuring stick. . . . Our
goal is to make 2020 the safest year in our history and eventually to make Nucor the Safest steel company in the world. That
means zero injuries across Nucor.
The second priority is the execution of our strategic investments. . . . These investments are focused on ensuring that Nucor is
the supplier of choice in all the product areas where we compete.
page C-388
The third priority is looking at how to effectively manage our portfolio of businesses to grow our earnings potential. We
remain committed to, and focused on, our long-term growth strategy. We must harness Nucor’s culture of continuous
improvement to achieve the full return potential across our entire asset base.
Continuing to attract, hire, develop and retain future leaders of tomorrow is another priority. . . . Our focus on talent will
continue to enable us to achieve the results our investors, customers and team have grown to rely on. . . . Having the right
people has always driven Nucor’s success.
Finally, as one of the most efficient and cleanest steel producers in the world, we will continue to focus on sustainability. We
are always looking for opportunities to become even more efficient, use less energy and reduce our environmental footprint.
ENDNOTES
1 Tom Peters and Nancy Austin, A Passion for Excellence: The Leadership Difference, (New York: Random House, 1985) and “Other Low-Cost
Champions,” Fortune, June 24, 1985.
2 Nucor’s 2011 Annual Report, p. 4.
3 February 2016 Investor Presentation, posted at www.nucor.com (accessed March 21, 2016).
4 BMO Conference Presentation, February 25, 2020, posted at www.nucor.com (accessed March 24, 2020).
5 According to information posted at www.nucor.com (accessed October 11, 2006).
6 Company press release, May 11, 2018.
7 Nucor’s 2008 Annual Report, p. 5.
8 March 2014 Investor Presentation, posted at www.nucor.com, (accessed April 21, 2014).
9 According to Form 5500 information posted at www.brightscope.com (accessed March 25, 2020).
10 Nanette Byrnes, “The Art of Motivation,” Business Week, May 1, 2006, p. 57.
11 Ibid., p. 60.
12 Ibid.
13 Ibid.
14 Organization for Economic Co-operation and Development, “Capacity Developments in the World Steel Industry,” July 2019, posted at www.oecd.org
(accessed March 27, 2020).
15 Worldsteel Association press release, January 27, 2020, posted at www.worldsteel.org (accessed on March 26, 2020).
16 Worldsteel Association, World Steel in Figures, 2019, p. 10, posted at www.worldsteel.org (accessed March 30, 2020).
17 Ibid.
18 Worldsteel Association, World Steel in Figures, 2019, posted at www.worldsteel.org (accessed March 30, 2020).
19 Matthew Dalton and Lingling Wei, “China’s Blueprint for Skirting U.S. Tariffs on Steel,” Wall Street Journal, June 5, 2018, p. A1 and A8.
20 Scott Patterson, Biman Mukherji, and Vu Trong Khanh, “Giant Aluminum Stockpile Was Shipped from Mexico to Vietnam,” Wall Street Journal,
December 1, 2016, posted at www.wsj.com (accessed June 8, 2018).
21 Ibid., p. A8.
22 Ibid.
23 Ibid.
24 Ibid.
25 Nucor Annual Report, 2017, p. 24.
26 Nucor Annual Report, 2019, p. 4.
27 ArcelorMittal Annual Report, 2017 and 2019.
28 Ibid.
29 Nucor Annual Report, 2019, p. 5.
Copyright ©2021 by Arthur A. Thompson. All rights reserved.
http://www.nucor.com/
http://www.nucor.com/
http://www.nucor.com/
http://www.nucor.com/
http://www.brightscope.com/
http://www.oecd.org/
http://www.wsj.com/
I
page C-389
CASE 27
Eliminating Modern Slavery from Supply Chains:
Can Nestlé Lead the Way?
©2020, IBS Center for Management Research.
Syeda Maseeha Qumer
ICFAI Business School, Hyderabad
Debapratim Purkayastha
ICFAI Business School, Hyderabad
n April 2019, a federal court in California filed a class action lawsuit against Nestlé SA (Nestlé) over claims the
global chocolate manufacturer facilitated the use of forced child labor in West Africa even though it labeled its
products as “sustainably sourced.” Nestlé, one of the world’s largest food processing companies, had been
grappling with accusations of aiding and abetting child slavery on cocoa plantations in Ivory Coast1 for more than
a decade.
Earlier in 2015, Nestlé surprised many by admitting that it had found forced labor in its seafood supply chain in
Thailand. Magdi Batato (Batato), Executive Vice President and Head of Operations at Nestlé, self-reported that
Nestlé had uncovered child labor exploitation on fishing boats in Thailand that supplied its factories. He reported
details of the investigation and also initiated a detailed action plan on how it intended to tackle the issue. The news
generated a mixed response from industry observers. Hailing Nestlé’s honesty, Brian Griffin, CEO of digital
marketing agency Vero PR, said, “First of all, what Nestlé did was brave, and from a moral perspective, they did
the right thing to let stakeholders know about this issue. They will feel some pain from this initially, particularly
from a consumer standpoint, and it’s not hard to imagine that sales of seafood products may decline. There is no
question that the issue must be cleaned up, and that it must happen now. We should appreciate what Nestlé has
done to bring even more attention to the issue.”2
However, Nestlé’s critics contended that the company had done this only to fend off growing criticism against it.
It had admitted to slavery in seafood, a low-profit area of the company’s business, while not doing enough to
tackle this problem in its lucrative chocolate business. Critics accused Nestlé of turning a blind eye to human rights
abuses by cocoa suppliers in West Africa while falsely portraying itself as a socially and ethically responsible
company. Nestlé said it was committed to tackling child labor in its cocoa supply chain and had been taking action
to address the issue which included increasing access to education, stepping up systems of age verification at
cocoa farms, and increasing awareness about the company’s own code of conduct. Despite Nestlé’s assurances, the
use of child labor continued and became even more prevalent in its cocoa supply chains. Though Nestlé’s
commitment to eliminating slavery seemed promising, lawsuits related to slavery in its core business operations
questioned such promises, critics said.
The existence of modern slavery within its cocoa supply chain posed ethical and reputational risks for Nestlé.
Analysts said addressing slavery would be a critical issue for the company going forward due to the complexity
and limited visibility of its supply chain, its reputation for reliability among stakeholders (customers, investors,
NGOs), transparency dilemmas, as well as cost and pricing pressures. However, some analysts said Nestlé being a
financially sound company, it could do more to stop slave labor and take more control over its supply chain
management. According to Marianne Smallwood, a diplomat for the U.S. Agency for International Development,
page C-390
“In initiating the public examination of its flaws, and in working with an organization like Verite, Nestlé has
already gone a more honorable and transparent route than other companies have done. But while it has taken the
first step toward being a more responsible company, Nestlé’s commitment to funding a long-term
strategy — and how it pushes beyond the inevitable roadblocks ahead — will determine its ultimate
footprint and legacy.”3
According to Batato, “Every reasonable person who has gone to Africa, gone to Asia, who has seen the farmers
and factories, can tell you that [child labor] does exist. It is part of their life. Do we accept it? No. Are we going to
stay quiet and do nothing? No. But making a big declaration that tomorrow morning we are going to see it
disappear, sometimes the problem is bigger than us, bigger than a company even the size of Nestlé.”4 Nevertheless,
the critical questions before him were: How to eliminate forced labor from Nestlé’s supply chains worldover?
Could he address the problem and bring real and sustained change in how the company’s cocoa supply chains were
managed?
BACKGROUND NOTE
Nestlé, headquartered in Vevey, Switzerland, was founded in 1866. One of the leading players in the food and
beverage categories, the company had a global presence and employed more than 328,000 people as of 2017. Its
sales and profits for the year 2016 were CHF 89.5 billion and CHF 8.53 billion respectively.5
Though Nestlé was among the world’s largest food processing companies and had great consumer brands well
known for their quality, critics pointed out that there seemed to be an element of arrogance in its actions.6 The
company had a history of confrontations over a range of issues.7 There were instances of Nestlé being accused of
disregarding its corporate responsibility in many countries in which it operated. The Swiss conglomerate had had
its fair share of controversies and ethical dilemmas during its nearly 150-year-long history.8 Experts pointed out
that the history of Nestlé’s public relations troubles began in the 1970s with allegations of unethical marketing of
baby formula9 in less developed countries.10 Since then, Nestlé had continued to get into trouble. For instance, in
2008, it was blacklisted by the Chinese government.11 Later, it was targeted for the misleading promotion of its
bottled water brands as well as for interfering in policies that protected natural water resources.12
In the United Kingdom, the Ethical Consumer Research Association (ECRA)13 gave Nestlé an ethical rating,
Ethiscore14 of 0.5 out of 20. ECRA had found the company to be linked to social ills such as child labor, slavery,
rainforest destruction, water extraction, and debt perpetuation. Critics pointed out that in 2005, when it launched
the ‘Partners Blend’ fair trade 15 coffee, Nestlé was termed as the UK’s most boycotted and irresponsible
corporation.16
MODERN SLAVERY IN GLOBAL SUPPLY CHAINS
Modern slavery could be described as control by people or organizations over vulnerable individuals in order to
obtain personal gain or profit. Modern slavery included forced labor, debt-bondage, child labor, wage exploitation,
human trafficking, forced marriage, involuntary domestic servitude, or any other practice wherein victims were
engaged in unreasonable work through physical or mental threat. According to the 2017 Global Slavery Index,
about 40.3 million people were victims of some form of modern slavery globally. Of these people, about 24.9
million were in forced labor. The rate of modern slavery was reported to be the highest in Africa, with 7.6 victims
for every 1,000 people in the region—see Exhibits 1 and 2.
EXHIBIT 1 2017 Global Estimates of Modern Slavery: Prevalence of Modern Slavery (per
1,000 population), by Region and Category
Source: https://www.alliance87.org/global_estimates_of_modern_slavery-forced_labour_and_forced_marriage
EXHIBIT 2 2017 Global Estimates of Modern Slavery: Number and Prevalence of Persons
in Modern Slavery, by Category, Sex, and Age (Number in thousands and prevalence in per
thousand)
Forced labor sub-categories
Forced labor
slavery
Exploitation
Forced sexual
exploitation of
adults and
commercial
sexual
exploitation of
children
State-imposed
forced labor
Total forced
labor
For
mar
World Number 15,975 4,816 4,060 24,850 15,442
Prevalence 2.2 0.7 0.5 3.4 2.1
Sex Male Number 6,766 29 2,411 9,206 2,442
Prevalence 1.8 0 0.6 2.4 0.6
Female Number 9,209 4,787 1,650 15,646 13,000
Prevalence 2.5 1.3 0.4 4.2 3.5
Age Adults Number 12,995 3,791 3,778 20,564 9,762
Prevalence 2.5 0.7 0.7 3.9 1.9
Children Number 2980 1024 282 4286 5679
Prevalence 1.3 0.4 0.1 1.9 2.5
Source: https://www.alliance87.org/global_estimates_of_modern_slavery-forced_labour_and_forced_marriage
Modern slavery had broader social and economic costs, in terms of impeding economic development and
perpetuating poverty, said experts. According to them, globalization had led companies to turn to lower-cost
suppliers who sourced cheaper raw materials and used low wage labor in order to maximize profits. According to
an ILO report, forced labor generated about $ 150 billion in illegal profits annually.
Analysts pointed out that slavery was an abuse of human rights in the pursuit of profits and that corporations had
a moral duty not to indulge in or tolerate it. Addressing human rights and labor issues in the supply chain had
become a necessity for businesses in the consumer goods industry, they said. This was partly due to rising
consumer demand for ethical products. Several governments had enacted legislations which mandated that
companies ensure respect for human rights in their supply chains. As shown in Exhibit 3, a number of anti-modern
slavery regulations had also come into existence. The California Transparency in Supply Chains Act, signed in
https://www.alliance87.org/global_estimates_of_modern_slavery-forced_labour_and_forced_marriage
https://www.alliance87.org/global_estimates_of_modern_slavery-forced_labour_and_forced_marriage
page C-391
page C-392
2010 and enacted on January 1, 2012, was one of the first anti-modern slavery regulations. This Act aimed to
ensure that “large retailers and manufacturers provide consumers with information regarding their
efforts to eradicate slavery and human trafficking from their supply chains.” The United Nations
Guiding Principles on Business and Human Rights (UNGPs) were endorsed by the UN Human
Rights Council in June 2011. These were a set of guidelines for States and companies to prevent, address, and
remedy human rights abuses committed in business operations. The UNGPs based on the three pillars “Protect,
Respect, and Remedy” had since become the trusted global framework for business and human rights.
EXHIBIT 3 Anti-Modern Slavery Regulations
Year Regulation
2000
The United Nations passes the Protocol to Prevent, Suppress,
and Punish Trafficking in Persons as part of the Convention
against Transnational Organized Crime. It is the first global
legally binding treaty with an internationally agreed definition of
trafficking in persons.
2002
The International Cocoa Initiative is established as a joint effort
of anti-slavery groups and major chocolate companies to protect
children and contribute to the elimination of child labor.
2004 The United Nations appoints a Special Rapporteur on HumanTrafficking.
2008 The Council of Europe Convention on Action against Traffickingin Human Beings comes into force.
2010 California enacts the California Transparency in Supply ChainsAct.
2014
The ILO adopts a protocol on forced labor, bringing its 1930
Convention on Forced Labor into the modern era to address
practices such as human trafficking.
2015 Britain’s Modern Slavery Act comes into force.
2015
The United Nations adopts 17 Sustainable Development Goals,
including a target of ending slavery and eradicating forced labor
and human trafficking.
Compiled from various sources.
The most prominent of anti-slavery regulations was the UK Modern Slavery Act, passed on March 26, 2015. It
required businesses with a turnover of more than £36 million annually to produce a ‘slavery and human trafficking
statement’ once a year disclosing what action they had taken to ensure their supply chains were free of slave labor.
Experts felt that though the legislation did not impose financial penalties on companies that failed to comply, the
adverse effects of being prosecuted for failing to do so could lead to reputational risks and could be more
damaging than any fine.
CHILD SLAVERY IN Nestlé’S COCOA SUPPLY CHAIN
Nestlé was a leader in the chocolate confectionery industry and used 10 percent of the world’s cocoa production. It
worked directly with almost 165,000 direct suppliers and 695,000 individual farmers worldwide for procuring raw
materials such as cocoa, dairy, sugar, coffee, etc. Nestlé primarily sourced cocoa from co-ops and farms in Ivory
Coast and Ghana. Nestlé purchased around 414,000 tons of cocoa annually for chocolate and confectionery as well
as beverages. The cocoa supply chain includes many intermediaries between the farmer and consumer. Small
farmers typically sell their cocoa harvest to local middlemen for cash. The middlemen work under contract for
local exporters, who, in turn, sell cocoa to international traders and the major international cocoa brands.
Allegations of child labor and human rights abuses in its cocoa and agricultural supply chains had dogged Nestlé
for years. Since the late 1990s, Nestlé and its competitors had received negative publicity and media coverage over
their use of child slave labor and the lack of transparency within their cocoa supply chain. Though Nestlé’s
Corporate Business Principles and Supplier Code prohibited both child and forced labor, Nestlé was aware that
cocoa beans from Ivory Coast were produced using child labor. While Nestlé and its competitors vied for market
share and profits, cocoa farmers suffered due to low income attributed to the fall in the price of cocoa beans. Cocoa
bean futures on the Intercontinental Exchange in New York hit $2,052 per metric ton on February 3, 2017,
page C-393
compared to $3,422 per metric ton in December 2015. Many farmers felt that child labor was a viable option in
order to cut production and work costs. As a result, child slavery had become extremely prevalent throughout the
cocoa supply chain, and there had been minimal action taken by the chocolate manufacturing companies to stop
the exploitation of these children.
The practice of child labor was rampant in the cocoa industry wherein harvesting and processing
of the cocoa plant was left to children, often unpaid and living in slavery—see Exhibit 4. Some children were sold
by their parents to traffickers, while many were kidnapped. Reportedly, they worked from dawn to dusk each day,
were denied sufficient food, and locked in a shed at night where they were given a tiny cup in which to urinate. 17
Some children were forced to do unsafe tasks, including carrying heavy loads, using machetes and sharp tools, and
applying pesticides and fertilizers. “The rules and regulations are so lax there that there is no government to step in
and stop the atrocities. This horrific state of child slavery is also the perfect cheap labor for candy companies that
want to sell you chocolate for dirt cheap prices. Why do you think it only costs $1 for a chocolate bar? 18 wrote
journalist LJ Vanier.
EXHIBIT 4 Children’s Involvement in Child Labor and Hazardous Work, 2000–16
Children in Child Labor World (5–17 Years) Children in Hazardous Work World (5–17Years)
Number
(000s)
Prevalence
(%)
Number
(000s)
Prevalence
(%)
2000 245,500 16.0% 170,500 11.1%
2004 222,294 14.2% 128,381 8.2%
2008 215,209 13.6% 115,314 7.3%
2012 167,956 10.6% 85,344 5.4%
2016 151,622 9.6% 72,525 4.6%
Source: Adapted from https://www.ilo.org/wcmsp5/groups/public/@documents/publication/wcms_575541
The growing awareness about child slaves working in the production of cocoa led to consumers questioning
where exactly their chocolate was coming from and who was making it. In 2001, following pressure and outrage
from civil society groups, media, and the general public, eight chocolate manufacturing companies in the United
States including Nestlé, signed the Harkin-Engel protocol 19 to investigate the labor practices and eliminate the
worst forms of child labor in the processing of cocoa in Ivory Coast and Ghana by 2005. However, when the 2005
deadline arrived, the companies had yet to eradicate child labor from their supply chains. The target was then
extended to 2008. Unable to meet the new self-imposed deadline again, in 2010, the signatories of the protocol
started afresh with a treaty called The Declaration of Joint Action to implement the Harkin-Engel Protocol and to
reduce the worst forms of child labor by 70 percent across the cocoa plantations of Ivory Coast by 2020.
In 2005, a lawsuit was filed against Nestlé, Archer Daniels Midland Co20, and Cargill Inc21 by three former
child slavery victims originally from Mali in West Africa who alleged that these companies aided and abetted
human rights violations through their active involvement in purchasing cocoa in Ivory Coast. The lawsuit claimed
that the companies were aware of the child slavery problem and offered financial and technical assistance to local
farmers to procure the cheapest source of cocoa. In court documents, the three plaintiffs claimed that they had been
trafficked from their homes and put to work on plantations in Ivory Coast. They described how they had been
whipped, beaten, and forced to work for 14 to 16 hours a day before being allowed to retire to their dark rooms.
One plaintiff recounted how guards would slice open the feet of any child worker who tried to escape. The lawsuit
accused Nestlé of making false assertions to consumers and not disclosing that its suppliers relied on child laborers
to procure cocoa at the point of purchase.
Nestlé said that the claims against it should be dismissed as it was committed to the goal of eliminating child
labor from its cocoa supply chain. Claiming that the lawsuit was without merit, Nestlé said that “proactive and
multi-stakeholder efforts” were required to eradicate child labor, not lawsuits. “Forced child labor is a complex,
global social issue in foreign countries that is not going to be solved by lawsuits in U.S. courts against the very
companies that are leading the fight to help eradicate it,”22 said Paul Bakus, President of Corporate Affairs, Nestlé
USA. After a first dismissal in 2008, the case was examined again and the lawsuit was reinstated by the U.S. Court
https://www.ilo.org/wcmsp5/groups/public/@documents/publication/wcms_575541
page C-394
page C-395
of Appeals in San Francisco in 2014 on the grounds that the plaintiffs had valid reasons to accuse
Nestlé of pursuing profits more than human well-being.
In October 2009, Nestlé launched a companywide initiative called The Nestlé Cocoa Plan (TNCP) in
collaboration with International Cocoa Initiative23(ICI) in order to ensure a sustainable future for the cocoa
industry worldwide and the communities depending on it. The goal of TNCP was “to help cocoa farmers run
profitable farms, respect the environment, have a good quality of life and for their children to benefit from
education and see cocoa farming as a respectable profession.”24 To achieve this, Nestlé committed CHF 110
million to the plan for 10 years and pledged to source 230,000 MT of cocoa through TNCP by 2020. Despite the
industry’s assurances, critics contended that the worst forms of child labor continued in Ivory Coast.
Amid accusations of failing to carry out checks on child labor in its cocoa supply chain, in November 2011,
Nestlé commissioned Fair Labor Association (FLA)25 to assess its cocoa supply chain in Ivory Coast. The goals of
the assessment were to map stakeholders involved in Nestlé’s cocoa supply chain and to analyze the associated
labor risks in its cocoa supply chain. The assessment team mapped the cocoa supply chain in depth including
Nestlé’s headquarters in Switzerland; R&D in Abidjan; local operations in the Ivory Coast; Tier 1 suppliers of
Nestlé and their subsidiaries in West Africa; processing facilities and buying centers in the Ivory Coast; third-party
service providers; pisteurs26 cooperatives; traitants27 farmers; Métayers28 Coxers 29 and workers—see Exhibit 5. A
team of 20 local and international experts visited a total of seven suppliers, 20 co-operatives, and two co-operative
unions, and 87 farms. In all, over 500 interviews were conducted with farmers and other stakeholders in the supply
chain, including local community members, local governments, NGOs, suppliers, and Nestlé staff. The FLA
released the results of its audit in 2012, finding continued evidence of child labor in the Ivory Coast farms
supplying Nestlé. The researchers found 56 workers under the age of 18, of whom 27 were under 15. According to
Steve Berman (Berman), managing partner at law firm Hagens Berman Sobol Shapiro LLP, “They
claim they’ve been taking steps. They partner with the Fair Labor Association to investigate, and
they claim they’re committed to eradicating it, but the fact is the recent reports show the number of children in the
cocoa industry has increased. We doubt that Nestlé is taking this very seriously.”30
EXHIBIT 5 Nestle’s Cocoa Supply Chain Map in the Ivory Coast
Source: http://www.fairlabor.org/sites/default/files/documents/reports/cocoa-report-final_0
Moreover, Nestlé’s claims that it had made progress toward meeting the Harkin-Engel Protocol fell flat when a
2015 report from the Payson Center for International Development of Tulane University, sponsored by the U.S.
Department of Labor, found that the number of children engaged in cocoa production in Ivory Coast had increased
51 percent to 1.4 million in 2013-14, compared to 791,181 children engaged in such work in 2008-09. However,
Nestlé defended itself stating, “cocoa supply chain is long and complex – making it difficult for food companies to
establish exactly where their cocoa comes from and under what conditions it was harvested.”31
Nestlé’s failure to bring transparency into its supply chain again came under the public spotlight in September
when consumers filed three class-action lawsuits against Nestlé, The Hershey Co., and Mars Inc. for allegedly
http://www.fairlabor.org/sites/default/files/documents/reports/cocoa-report-final_0
page C-396
using child labor in chocolate production. The lawsuit stated that in violation of California law, the companies did
not disclose that their suppliers in Ivory Coast relied on child laborers and instead continued to profit by tricking
consumers into indirectly supporting the use of such labor. According to the complaint, “Nestlé, as one of the
largest companies in the world, can dictate the terms by which cocoa beans are produced and supplied to it,
including the labor conditions in the supply chain. But through its own inadequate efforts over the course of
decades Nestlé is presently not able to trace all of the cocoa beans that make up its Chocolate Products back to the
cocoa plantations on which they are grown, much less ensure that the cocoa beans are not the product of child or
slave labor. And meanwhile Nestlé continues to profit from the child and forced labor that is used to make its
Chocolate Products. This is shameful.”32
Nestlé’S INITIATIVES TO ADDRESS THE ISSUE
Following the findings of the FLA report, Nestlé set out to address child labor by undertaking the 11
recommendations the FLA had made to it which included strengthening the Nestlé Supplier Code, increasing
accountability from the various tiers of suppliers, and developing a robust and comprehensive internal monitoring
and remediation system. Reiterating the promise made in 2001, Nestlé said it was taking action to progressively
eliminate child labor in cocoa-growing areas by assessing individual cases and tackling the root causes. “The use
of child labor is unacceptable and goes against everything Nestlé stands for. Nestlé is committed to following and
respecting all international laws and is dedicated to the goal of eradicating child labor from our cocoa supply
chain,”33 the company said in a statement.
In 2012, Nestlé was the first cocoa purchaser to set up a Child Labor Monitoring and Remediation System
(CLMRS) in Ivory Coast in association with ICI—see Exhibit 6. The system locally recruited ‘community liaison
people’ and ‘child labor agents’ who worked to raise awareness about child labor in communities, identified
children at risk, and reported their findings to Nestlé and its suppliers. By the end of 2015, the system covered 40
cooperatives and 26,000 cocoa farmers. In 2016, the CLMRS was extended to a further 29 cooperatives, taking the
total to 69. As of August 2019, CLMRS covered 1,751 communities in Côte d’Ivoire compared to 1,553 in 201734
As shown in Exhibit 7, the number of children monitored increased from 40,728 in 2017 to 78,580 in 2019. Half of
the identified children were included in CLMRS and sent to school while income generating activities were
developed for their families. Nestlé built 49 schools in Ivory Coast to help end unlawful child labor. Despite this,
allegations that the company was not doing enough continued. According to a spokesperson from Nestlé,
“Unfortunately, the scale and complexity of the issue is such that no company sourcing cocoa from Ivory Coast
can guarantee that it has completely removed the risk of child labor from its supply chain.”35
EXHIBIT 6 Child Labor Monitoring and Remediation System
page C-397
Source: Adapted from www.nestle.com.
EXHIBIT 7 Growth of Child Labor Monitoring and Remediation Systems, 2017, 2019
2017 2019
Number of co-ops in CLMRS 75 87
Number of farmers monitored by CLMRS 48,496 73,248
Communities covered by CLMRS 1,553 1,751
Community members educated about child labor 163,407 (attendees)5,877(sessions)
593,925 (attendees) 56,183
(sessions)
Number of children aged 5–17 being monitored 40,728 78,580
Child labor rate 17% 23%
Number of children identified in child labor and existing in the
system 7,002 18,283
Number of children who received atleast one form of remediation Not measured 15,740
Source: Nestle CSV Full Report 2019.
Earlier in 2010, Nestlé entered into a partnership with the Danish Institute for Human Rights 36 (DIHR) to
support its commitment to respecting human rights as stated in the company’s Corporate Business Principles. As
part of this commitment, Nestlé developed and implemented an 8-pillar Human Rights Due Diligence Program
(HRDD) shown in Exhibit 8 with the aim of making Nestlé’s approach to human rights strategic, comprehensive,
and coordinated. As part of the program, Nestlé continued to tackle child labor in its cocoa supply
chain in Ivory Coast by focusing on vulnerable groups, especially girls and children of migrant
http://www.nestle.com/
page C-398
workers. In 2015, Nestlé was one of the early adopters of the UNGP Reporting Framework to effectively manage
human rights in its operations. This Framework was based on the global standard of the UNGPs.
EXHIBIT 8 Nestlé Human Rights Due Diligence Program
HRDD pillar Components
1 Policy commitments
Revised 17 different corporate policies, standards, and
commitments to incorporate the relevant human rights elements.
These include Nestlé’s Corporate Business Principles,
Responsible Sourcing Standard, Employee Relations Policy,
Consumers’ Communication Policy and Privacy Policy.
2 Stakeholder engagement
Partnered with expert organizations such as the Danish Institute
for Human Rights (DIHR), the Fair Labor Association (cocoa and
hazelnuts) and Verité (fish and seafood, and coffee) to develop
policies and procedures, and improve performance on the
ground.
3 Training and awareness
Rolled out human rights training programs to raise awareness of
human rights issues among employees and develop their skills
in dealing with them. As of 2018, Nestlé trained about 96,599
employees.
4 Risk evaluation Integrated human rights risks within its Enterprise RiskManagement Framework and market compliance committees.
5 Salient issues
Carried out business risk and impact assessments at the
corporate level and on the ground and identified 11 most salient
human rights issues and developed dedicated action plans to
address them.
6 Governance
Established clear roles and responsibilities at different levels of
the company and set up boards and committees to assess work
and lead the strategic implementation of human rights work.
7 Grievance mechanisms Identified and enabled effective remediation across countriesand industries.
8 Monitoring and reporting Reviewed progress and performance regularly as the companywas publicly accountable for its promises.
Source: http://www.nestle.com/csv/communities/respecting-human-rights
In October 2015, Batato37 was appointed as Executive Vice President and Head of Operations at Nestlé. Batato
controlled all 500 of Nestle’s manufacturing facilities around the world He was also responsible for Nestlé’s rural
development activities and procurement. Nestlé operated a Child Labor and Women’s Empowerment Steering
Group, chaired by Batato, to identify measures, take decisions, and monitor progress.
In 2016, Nestlé increased the amount of cocoa purchased through TNCP to 140,933 tonnes at a cost of about
CHF 30 million. By 2017, the company planned to source 150,000 tonnes of cocoa through TNCP and 230,000
tonnes by 2020. The company claimed that its KitKat brand had become the first global confectionery brand to be
sourced from 100 percent certified cocoa. In order to strengthen its cocoa bean supply in a responsible way, Nestlé
encouraged its supplying farms to be UTZ38 certified. The process included farm selection and farmer training in
good agricultural practices, health and safety, and care for the environment. Farmer compliance was checked by
both Nestlé agronomists and an external auditor.
NESTLÉ ADMITS TO FORCED LABOR
Following allegations that it was using slave labor to catch and process fish for its popular Fancy Feast cat food, in
early 2015, Nestlé commissioned Verité39, a human rights watchdog, to conduct an investigation into six of its
production sites in Thailand. Verité conducted a three-month assessment into the possibility of forced labor and
human trafficking in Nestlé’s Thai supply chain. The investigation was targeted specifically at the vessel-to-market
place shrimp and fishmeal supply chain. Verité interviewed more than 100 people, including about 80 workers
from Myanmar and Cambodia, as well as boat owners, shrimp farm owners, site supervisors, and representatives
of Nestlé’s suppliers. It visited fishing ports, fishmeal packing plants, shrimp farms, and docked fishing
boats in Thailand. Verite found indicators of forced labor, human trafficking, and child labor present in
land and sea-based workers at the sites assessed. These indicators included deceptive recruitment practices, little or
http://www.nestle.com/csv/communities/respecting-human-rights
page C-399
no employment protections for workers, restriction on the freedom of movement of workers, and instances of both
verbal and physical abuse.
According to the Verité study, workers were either sold as slaves to seafood suppliers in Thailand, or trapped in
the fishing industry through false promises and debt bondage. Often trafficked from Thailand’s neighboring
countries such as Cambodia and Myanmar, the laborers were sold to fishing boat captains needing crews to man
their fishing boats, according to the report. The work was strenuous with shifts lasting up to 20 hours a day with
little or no pay and refusal to work to a supervisor’s satisfaction led to beatings or sometimes even death.
“Sometimes, the net is too heavy and workers get pulled into the water and just disappear. When someone dies, he
gets thrown into the water. Some have fallen overboard,”40 said a Burmese worker to Verité.
While Nestlé had publicly accepted the findings of the report, Verité said this problem was not unique to
Nestlé’s supply chain but rather “systemic in nature” within the vulnerable migrant worker communities in
Thailand.
Meanwhile, in August 2015, pet-food buyers filed a class-action lawsuit against Nestlé for importing fish-based
pet food 41 from suppliers in Thailand who used slave labor. According to the lawsuit, Nestlé supported a system
of slave labor and human trafficking to distribute and market its Purina brand Fancy Feast cat food while hiding its
involvement in human rights violations from the public. Nestlé had partnered with Thai Union Frozen Products
PCL to import seafood-based pet food for its Purina pet food brand. Melanie Barber, the plaintiff, alleged that
Nestlé had violated consumer protection statutes by failing to disclose that some ingredients in its cat food
products contained seafood which was sourced from forced labor. She argued that Nestlé was obliged to make
additional disclosures at the point of sale regarding the probability that the product contained seafood sourced from
forced labor.
According to Berman, “By hiding this from public view, Nestlé has effectively tricked millions of consumers
into supporting and encouraging slave labor on floating prisons. It’s a fact that the thousands of purchasers of its
top-selling pet food products would not have bought this brand had they known the truth – that hundreds of
individuals are enslaved, beaten or even murdered in the production of its pet food.”42
The alleged violations were brought under the California Unfair Competition Law (UCL), the California Legal
Remedies Act, and the California False Advertising law. Nestlé applied for the lawsuit to be dismissed, arguing
that it could rely on so-called ‘safe harbor’ provisions, as the company had made specific disclosures on forced
labor issues as required by the California Transparency in Supply Chain Acts of 2010.
After fending off allegations, in November 2015, Nestlé took observers by surprise when it publicly admitted
that its seafood supply chain was tainted by modern slavery. The company emphasized that “no other company
sourcing seafood from Thailand, the world’s third-largest seafood exporter, could have avoided being exposed to
the same risks.”43 In 2015, Batato in a brave move self-reported that Nestlé had uncovered child labor exploitation
on fishing boats in Thailand that supplied its factories. According to industry observers, the disclosure came as a
surprise as international companies rarely acknowledged abuses in their supply chains. Some analysts felt that
Nestlé’s voluntary disclosure could boost its ethical image and possibly shift the parameters of what could be
expected of businesses when it came to supply chain accountability. “Nestlé’s decision to conduct this
investigation is to be applauded. If you’ve got one of the biggest brands in the world proactively coming out and
admitting that they have found slavery in their business operations, then it’s potentially a huge game-changer and
could lead to real and sustained change in how supply chains are managed,”44 said Nick Grono, CEO of NGO the
Freedom Fund.
In December 2015, the Central District of California dismissed the lawsuit on the grounds that the California
Act had created a ‘safe harbor’ under which companies were sheltered from liability when they accurately
complied with the limited disclosure obligations that the law mandated.
Following Verité’s investigation and its own admission, Nestlé launched an action plan on seafood sourced from
Thailand which included a series of actions to protect workers from abuses and improve working conditions—see
Exhibit 9. The plan included commitments to establish an emergency response team with various partners to
remediate risks and take short-term action to protect workers, a grievance mechanism allowing
anonymous reporting, a fishing vessel verification program involving regular third-party verification
of randomly selected boats to assess working conditions, and a training program for boat owners and captains
based on best practices. Batato, said, “As we’ve said consistently, forced labor and human rights abuses have no
place in our supply chain. Nestlé believes that by working with suppliers we can make a positive difference to the
sourcing of ingredients.”45 Batato further added that it would be neither a quick nor an easy endeavour, but the
company planned to achieve significant progress going forward.
EXHIBIT 9 Responsible Sourcing of Seafood – Thailand Action Plan 2015-2016
Objective Action
Incorporate new business
requirements into commercial
relationship, based on the
current signature of the Nestlé
Supplier Code.
Work closely with suppliers to ensure development and implementation of capacity building
programs and business requirements that address human rights and labor standards and
demonstrate compliance on an ongoing basis.
At a minimum the supplier shall run a traceability system enabling the identification of all
potential origins (farms, mills, back to fishing vessels) linked with seafood and other
ingredients used as part of product recipes.
Additionally the supplier shall operate a seafood responsible sourcing program to ensure that
origins identified are continuously assessed and assisted in meeting business requirements
detailed in the Nestlé Responsible Sourcing Guidelines.
Enforce traceable supply chains
identifying all potential sources
of origins as part of a
comprehensive supply chain
risk assessment.
Ensure a verifiable supply chain traceability system as part of a comprehensive supply chain
risk assessment that is aligned with industry partners and stakeholders within the Thailand
Seafood Industry enabling traceability of seafood ingredients from fishing vessels through the
complete supply chain to the receiving manufacturing sites and finished products.
Define and communicate
requirements to boat owners
and/or captains, including
recruitment practices and
living/working conditions for
boat workers.
Building on the Marine Catch Purchasing Document, or any other industry recognized best
practice, create a set of requirements for boat owners and captains.
Requirements will cover traceability, recruitment practices, fish catching system, living and
working conditions for boat workers.
A toolkit composed of Employment Contract Template and rules, Worker ID cards, template to
monitor worker’s names, working time, salary, and associated deductions if any.
Implement a training program
for boat owners and/or captains.
In association with industry partners and stakeholders within the Thailand Seafood Industry,
create a training hub to generate awareness and provide education to ensure effective worker
protections in priority areas as determined by Verite.
The training hub may take the form of a “demonstration boat” or “university” where a training
program will be given to electable boat owners/captains.
As reward and enabler for continuous improvement, the program will include a mechanism to
apply for financial support to speed up the implementation of best practices learned.
Award financial support in the form of sponsoring or micro credit, for instance, for boat lodging
and cooking facilities.
Implement an awareness raising
campaign on human rights and
labor conditions, targeting
primarily boat workers.
In collaboration with local authority and industry partners and stakeholders in the Thailand
Seafood Industry, create an awareness raising campaign addressing the areas of labor
standards & health and safety at the workplace.
Campaign to be deployed in locations identified as impactful for migrant workforce & linked
with regular boat’s docking, including the introduction of a grievance mechanism & providing
some immediate tangible personal benefits to workers.
Campaign will incorporate an anonymous reporting system to identify the worst form of labor
conditions to be addressed by the Emergency Response Team.
Enable the work of a Migrant
Workforce Emergency
Response team.
Identify a third party partner (e.g., project Issara, to be considered) experienced in protecting
individuals from the worst form of labor conditions.
Deploy and empower this partner organization as the Migrant Workforce Emergency
Response Team in charge to deploy the necessary assessments to identify individuals in need
of immediate assistance.
Create and implement a fishing
vessels verification program.
Implement, at first, an internal audit program verifying working (labor and health and safety at
workplace) conditions in fishing vessels for 100 percent of the fleet used.
Along with monitoring of compliance through Key Performance Indicators, randomly select
boats on a monthly basis to undergo a third-party verification audit by an independent
organization, executed every quarter.
Third party verification audit should include interview of boat workers and establish the history
of their working career in the region and country.
Dedicate resources.
Appoint an executive from Nestlé to implement the action plan. His profile will include
coordination with relevant parties, management of implementation activities, establishment of
KPIs and dashboard, effective use of internal and financial resources, representation to
relevant industry parties and stakeholders.
page C-400
page C-401
Objective Action
Collaborate and scale up
Leverage opportunities for collaboration with industry partners and stakeholders with the
Thailand Seafood Industry and seek to become a member of the Shrimp Sustainable Supply
Chain Taskforce, share progress on implementation of action plan and learning, contribute to
testing of innovative solutions and continuously seek to expand implementation to other
supply schemes and locations in South East Asia.
Achieve similar aims as part of the Good Labor Practices Working Group, convened by
Government of Thailand and supported by the International Labor Organization.
Publicly Report
Report publicly on progress, including challenges and failures identified with how to best
resolve and solutions to address. This should include ongoing monitoring of business
partners’ supply chain management systems by independent third party assessments and
identification of risks and issues to be addressed.
Source: https://www.nestle.com/asset-library/documents/library/documents/corporate_social_responsibility/nestle-seafood-
action-plan-thailand-2015-2016
By the end of 2016, over 99 percent of the seafood ingredients that Nestlé sourced from its
seafood supply chain in Thailand were traceable back to fishing vessels and farms due to actions taken as part of
the plan. Nestlé worked with Verité, its supplier Thai Union, the Royal Thai Government, and the Southeast Asian
Fisheries Development Center (SEAFDEC) to develop a training program to educate fishing vessel owners,
captains, and crew members on living and working conditions onboard the boats, and on workers’ rights. In March
2016, Nestlé partnered with the Issara Institute, a not-for-profit body focusing on worker voice and grievance
mechanisms, to help workers voice their concerns.
Experts said Nestlé’s disclosures and commitment to change served as an example to other companies in
industries in which labor trafficking and slavery were rampant. Praising Nestlé for self-policing and public
reporting, Mark Lagon, president of nonprofit anti-trafficking organization Freedom House, said, “It’s unusual and
exemplary. The propensity of the PR and legal departments of companies is not to ‘fess up, not to even say they
are carefully looking into a problem for fear that they will get hit with lawsuits.”46
CRITICISM
Though Nestlé was applauded for its admission of forced labor within its seafood supply chain and its move
toward transparency, some analysts felt that this was just an attempt by the company to cover up bigger allegations
of child labor in its profitable chocolate making business. They felt that in order to escape the charges of being an
unethical company, Nestlé had admitted to slavery in seafood suppliers, a low-profit area of the company’s
business, in Thailand. Some critics saw Nestlé’s actions as a public relations stunt to alleviate the criticism it had
received for abetting child slavery in Ivory Coast. “For me there is a big issue with one part of Nestlé saying, ‘OK
we have been dragged along with everyone else to face the issue of slavery in Thailand and so let’s take the
initiative and do something about it’, and at the same time fighting tooth and nail through the courts to
avoid charges of child slavery in its core operations in the Ivory Coast,”47 remarked Andrew Wallis,
CEO of anti-human trafficking charity Unseen UK. Analysts said that this apparent double standard had raised
doubts among civil society activists and customers regarding Nestlé’s true motives. Critics said by its admission,
Nestlé had left consumers falsely confident in the ‘goodness’ of its products.
Some anti-trafficking advocates remained highly skeptical of Nestlé’s actions and saw the move toward
transparency as a tactic to deflate other pending civil litigation suits in its cocoa supply chains. They said Nestlé
had been falsely assuring customers that it would eliminate child and forced labor in its Ivory Coast supply chain
since 2001 and in the meantime an entire generation of children in West Africa had been suffering due to Nestlé’s
false promises.
Nestlé’s admission that it had found slavery in its supply chain in Thailand was greeted with a negative reaction
from both traditional and social media. According to the LexisNexis Newsdesk48 analysis, mentions of Nestlé in
relation to slavery rose steeply with 20 to 90 articles per week, discussing slavery in the company’s supply chain.
According to the sentiment chart presented in Exhibit 10, more than a third of the coverage was entirely negative,
while only 2.5 percent was positive.
EXHIBIT 10 Nestle’s Media Coverage Related to Slavery
https://www.nestle.com/asset-library/documents/library/documents/corporate_social_responsibility/nestle-seafood-action-plan-thailand-2015-2016
page C-402
Source: https://bis.lexisnexis.co.uk/blog/posts/human-trafficking-awareness/reputational-risks-are-greater-than-ever-for-brands-
associated-with-slavery
Some analysts contended that Nestlé’s efforts to eliminate child labor from its global cocoa supply chain were
not credible because of its inadequately transparent self-monitoring system. For instance, they
pointed out that the company provided incomplete and insufficient information regarding the details
of TNCP and its certification schemes and had omitted material information related to TNCP’s distribution and
progress in the rest of its global cocoa supply chain. Some analysts pointed out that the FLA investigation was not
an accurate representation of the conditions on Nestlé’s cocoa farms because a majority of Nestlé’s cocoa farms
(about 75 percent) were not part of TNCP. They also said that there was significant discrepancy between Nestlé’s
grand official policies and statements to combat slavery and the nominal actions it took. Nestlé had yet to develop
a concrete plan outlining when it would source entirely sustainable cocoa. They said that TNCP was only a
greenwashing ploy aimed at making Nestlé appear to be ethically responsible.
Nestlé received some respite in March 2017, when U.S. District Judge Stephen V. Wilson dismissed the case on
child slavery in Africa on the ground that the complaint “seeks an impermissible extraterritorial application of the
Alien Tort Statute which means companies can be sued in the United States for actions outside the country but only
when some conduct touches and concerns the United States with sufficient force.”49 He said that the former child
slaves could not sue in the United States over wrongdoing that had occurred in Africa. The judge said that the
plaintiffs’ attempt to single out CSR initiatives as evidence that Nestlé was knowingly aiding and abetting child
slavery was counter-productive because it would freeze companies’ speech and prevent them from taking up such
initiatives in the future. He said, “Even worse, relying on corporate social responsibility programs as ’relevant
conduct’ would also chill corporations from creating these programs. Corporations would be incentivized to allow
human rights abuses to occur without shedding light on the issue or trying to combat it out of fear they will
displace the presumption and be held responsible.”50
https://bis.lexisnexis.co.uk/blog/posts/human-trafficking-awareness/reputational-risks-are-greater-than-ever-for-brands-associated-with-slavery
page C-403
THE WAY FORWARD
In April 2019, a federal court in California filed a fresh class action lawsuit against Nestlé over claims the
company mislabelled its products as sustainable when, in fact, it sourced its cocoa from farms that caused
environmental devastation and used child slave labor. However, Nestlé said that it had prevailed in similar law
suits earlier as it was committed to eliminate forced labor from its supply chain. “Forced child labor is
unacceptable and has no place in our supply chain. We have explicit policies against it and are working with other
stakeholders to combat this global social problem. Regrettably, in bringing such lawsuits, the plaintiffs’ class
action lawyers are targeting the very organizations trying to fight forced labor,”51 said a Nestlé spokesperson.
Going forward, analysts said that identifying and tackling the menace of modern slavery in its cocoa supply
chain would not be an easy task for Nestlé. Nestlé’s cocoa supply chain was complex, and regulating the co-
operatives and farms could be tough for the senior management, they said. It would be challenging to continually
follow up on the work of co-operatives given their remote locations, they added. Though Nestlé had monitoring
systems in place to communicate supplier policies and conduct audits, they often covered only tier one suppliers at
the top of the value chain, while forced labor was mostly found in the bottom tiers. Moreover, cost and pricing
pressures, supplier engagement, and transparency dilemmas were some of the issues Nestlé had to deal with while
addressing slavery. “The problem is, we can’t just stop using a supplier. People ask why we don’t boycott them.
We did that in the case of palm oil. We delisted suppliers. We delisted coffee suppliers in South America who were
using child labor. But it doesn’t always solve the bigger problem. There is no one-size fits all solution. If we took
the view to delist every single supplier who is doing the wrong thing today, it will not improve the situation. It will
cut the income of those who rely on this income. It is lose-lose. But, with our size, we believe we can change
things over time,”52 said Batato.
Modern slavery was considered as a criminal activity often actively hidden by perpetrators, making it difficult to
detect. Third party auditors appointed by Nestlé might struggle to get full access to facilities and victims would be
unwilling to speak up fearing retribution.
Another challenge would be driving workers toward community awareness-raising sessions. Some families were
often resistant to change as they had few livelihood alternatives. Moreover, the isolation of some of the farms and
villages was a challenge in itself. Supplying school kits and providing literacy classes to women were all the more
difficult as a result. Some researchers found that though Nestlé’s code of conduct prohibited the use of child labor
in its supply chain, awareness of the code was low among farmers. Moreover, the farmers did not
attend training sessions either due to lack of interest or lack of time. “Being a leader in our industry
. . . we do understand we can influence the supply chains we work with, and that’s what we do. We recognize it is a
difficult issue to deal with,”53 said Marco Goncalves, Nestlé’s chief procurement officer.
Analysts said that given its global scale and financial prowess, Nestlé could play a crucial role in driving
significant changes and abolishing slavery from the global cocoa supply chain. Going forward, the question before
Nestlé was what more the company could do to ensure its cocoa supply chain was free from slavery. How could it
assure consumers that its products did not come at the expense of innocent people who went through untold
suffering. Could Nestlé have a positive impact on the chocolate industry through its honest revelations and by
raising the bar on labor protection? Should the company take a clear leadership position on this issue given its
influence? If so, how should Nestlé go about doing this?
ENDNOTES
1 Ivory Coast, also known as Cote d’Ivoire, is a tropical country in southern West Africa. It is the world’s largest producer of cocoa, the raw ingredient used in making chocolates.
2 Faaez Samedi, “Nestlé Admits Forced Labor is Part of its Seafood Supply Chain,” www.campaignlive.co.uk, November 27, 2015.
3 Marianne Smallwood “Slavery Found within Nestle’s Seafood Supply Chain . . . Now What?” www.triplepundit.com, December 14, 2015.
4 Mark Hawthorne, “One Step at a Time, Nestle Slowly Changes its Ways,” www.smh.com.au, February 24, 2017.
5 “Annual Results 2016,” www.nestle.com.
6 “Nestle’s 12 Dark Secrets Worldwide!” www.theequalizerpost.wordpress.com, November 18, 2010.
7 Jon Entine, “Greenpeace and Social Media Mob Nestlé,” www.blog.american.com, March 31, 2010.
8 “Nestlé’s 12 Dark Secrets Worldwide!” www.theequalizerpost.wordpress.com, November 18, 2010.
9 Baby formula is food manufactured for supporting the adequate growth of infants.
10 “Starbucks as Fairtrade-lite and Nestlé on the Blacklist,” www.faircompanies.com, October 8, 2008.
11 “Pepsi and Nestlé Backlisted for Water Pollution in China,” www.polarisinstitute.org/pepsi_and_nestle_backlisted_for_water_pollution_in_china.
12 “Nestlé’s Sinking Division,” www.polarisinstitute.org/nestl%C3%A9%E2%80%99s_sinking_division.
13 The ECRA is a not-for-profit, multi-stakeholder co-operative, dedicated to the promotion of universal human rights, environmental sustainability, and animal welfare.
14 The Ethiscore is a numerical rating that differentiates companies based on the level of criticism that they have attracted. Generally, an Ethiscore of 15 would be the best, while 0
would be the worst.
http://www.campaignlive.co.uk/
http://www.triplepundit.com/
http://www.smh.com.au/
http://www.nestle.com/
http://www.theequalizerpost.wordpress.com/
http://www.blog.american.com/
http://www.theequalizerpost.wordpress.com/
http://www.faircompanies.com/
http://www.polarisinstitute.org/pepsi_and_nestle_backlisted_for_water_pollution_in_china
http://www.polarisinstitute.org/nestl%C3%A9%E2%80%99s_sinking_division
page C-404
15 Fair trade coffee is one that is obtained directly from the growers. It usually retails at a higher price than standard coffee.
16 “Starbucks as Fairtrade-lite and Nestlé on the Blacklist,” www.faircompanies.com, October 8, 2008.
17 Abby Haglage, “Lawsuit: Your Candy Bar Was Made by Child Slaves,” www.thedailybeast.com, September 30, 2015.
18 LJ Vanier, “Hershey, Nestle and Mars Use Child Slaves to Make Your Chocolate,” http://thespiritscience.net, October 18, 2015.
19 In 2001, the Chocolate Manufacturers Association of the US signed the protocol for the growing and processing of cocoa beans and their derivative products in a manner that
complied with ILO Convention 182 concerning the prohibition and immediate action for the elimination of the worst forms of child labor.
20 The Archer Daniels Midland Co is a US-based global food processing and commodities trading corporation.
21 Based in Minnesota, US, Cargill Inc is a provider of food, agriculture, financial, and industrial products and services worldwide.
22 Daniel Fisher, “Cue The Documentary: Nestlé Still Fighting Slavery Lawsuit by Foreign Plaintiffs,” www.forbes.com, October 7, 2016.
23 Established in 2012, The International Cocoa Initiative (ICI) is a multi-stakeholder partnership between cocoa companies, labor unions, and NGOs in order to eliminate the worst
forms of child labor and forced labor in the growing and processing of cocoa beans.
24 https://www.nestle.com.au/creating-shared-value/social-impact/the-nestl%C3%A9-cocoa-plan
25 Fair Labor Association is a non-profit multi-stakeholder initiative that works with major companies to improve working conditions in their supply chains.
26 Pisteurs are individuals commissioned to buy cocoa beans from farmers.
27 Traitants are middlemen, licensed by the government, who trades cocoa beans. Traitants may source beans either from cooperatives or from pisteurs.
28 Métayers are sharecroppers who manage a cocoa farm on behalf of its owner.
29 Coxers are individuals who live in the villages and inform pisteurs when there is a harvest ready to be collected.
30 Abby Haglage, “Lawsuit: Your Candy Bar Was Made by Child Slaves,” www.thedailybeast.com, September 30, 2015.
31 “Nestle ‘to Act over Child Labour in Cocoa Industry’,” www.bbc.com, November 28, 2011.
32 “Nestle – Truth in Advertising,” www.truthinadvertising.org, September 28, 2015.
33 Ellen Wulfhorst, “U.S. Supreme Court Gives Boost to Child Slave Labor Case Against Nestle,”www.reuters.com, January 14, 2016.
34 Nestle CSV Full Report 2019.
35 Joe Sandler Clarke, “Child Labour on Nestlé Farms: Chocolate Giant’s Problems Continue,” www.theguardian.com, September 2, 2015.
36 The Danish Institute for Human Rights is Denmark’s independent state-funded human rights institution.
37 Previously, Batato served as the CEO and Managing Director of Nestle Pakistan Limited from June 6, 2012 to September 1, 2015 and May 25, 2012 to September 1, 2015,
respectively. He has extensive experience in the manufacturing and technical area, combined with business experience in both developed and emerging markets.
38 UTZ Certified is a program and a label for sustainable farming.
39 Verité is a Massachusetts-based non-profit organization that advocates workers’ rights worldwide.
40 James Tennent, “Nestlé Admits Forced Labour, Trafficking, and Child Labour in its Thai Seafood Supply,” www.ibtimes.co.uk, November 24, 2015.
41 The fishmeal used to feed farmed shrimp and a prawn is made from fish caught by migrant workers. The US is the biggest customer of Thai fish, and pet food is among the
fastest growing exports from Thailand. In 2014, Thai Union shipped more than 28 million pounds of seafood-based cat and dog food for some of the top brands sold in America
including Iams, Meow Mix, and Fancy Feast.
42 “Nestle Accused of Using Slave-Caught Fish in Cat Food,” www.nationmultimedia.com, August 28, 2015.
43 Annie Kelly, “Nestlé Admits Slavery in Thailand While Fighting Child Labour Lawsuit in Ivory Coast,” www.theguardian.com, February 1, 2016.
44 “Control Over Supply Chain a Must,” www.pressreader.com, November 5, 2016.
45 Annie Kelly, “Nestlé Admits Slavery in Thailand While Fighting Child Labour Lawsuit in Ivory Coast,” www.theguardian.com, February 1, 2016.
46 Marthe Mendoza, “Nestle Confirms Labor Abuse among its Thai Seafood Suppliers,” www.ap.org, November 23, 2015.
47 Claire Bernish, “Why is Nestle Finally Admitting to Using Slave Labor?” www.mintpressnews.com, February 2, 2016.
48 LexisNexis is a global provider of legal, regulatory and business information and analytics.
49 “Nestlé, Cargill and ADM Cocoa Child Slavery Lawsuit Dismissed,” www.confectionerynews.com, March 15, 2017.
50 Daniel Fisher, “Judge Tosses Nestlé Suit Over Child Slavery in Africa,” www.forbes.com, March 13, 2017.
51 “USA: Class Action Lawsuit Filed Against Nestle for Child Slavery on Cocoa Harvest in West African Farms, ” https://www.business-humanrights.org, April 24, 2019.
52 Mark Hawthorne, “One Step at a Time, Nestle Slowly Changes its Ways,” www.smh.com.au, February 24, 2017.
53 Katie Nguyen, “All Companies Have Slave Labour in Supply Chains but it Can be Stopped-Tesco,” www.reuters.com, November 18, 2015.
http://www.faircompanies.com/
http://www.thedailybeast.com/
http://www.forbes.com/
https://www.nestle.com.au/creating-shared-value/social-impact/the-nestl%C3%A9-cocoa-plan
http://www.thedailybeast.com/
http://www.bbc.com/
http://www.truthinadvertising.org/
http://www.reuters.com/
http://www.theguardian.com/
http://www.ibtimes.co.uk/
http://www.nationmultimedia.com/
http://www.theguardian.com/
http://www.pressreader.com/
http://www.theguardian.com/
http://www.mintpressnews.com/
http://www.confectionerynews.com/
http://www.forbes.com/
https://www.business-humanrights.org/
http://www.smh.com.au/
http://www.reuters.com/
page CA-1
Guide to Case
Analysis
I keep six honest serving
men
(They taught me all I
knew);
Their names are What and
Why and When;
And How and Where and
Who.
Rudyard Kipling
I
page CA-2
n most courses in strategic management, students use cases about actual
companies to practice strategic analysis and to gain some experience in
the tasks of crafting and implementing strategy. A case sets forth, in a
factual manner, the events and organizational circumstances surrounding a
particular managerial situation. It puts readers at the scene of the action and
familiarizes them with all the relevant circumstances. A case on strategic
management can concern a whole industry, a single organization, or some
part of an organization; the organization involved can be either profit
seeking or not-for-profit. The essence of the student’s role in case analysis
is to diagnose and size up the situation described in the case and then to
recommend appropriate action steps.
Why Use Cases to Practice Strategic
Management?
A student of business with tact
Absorbed many answers he lacked.
But acquiring a job,
He said with a sob,
“How does one fit answer to fact?”
The foregoing limerick was used some years ago by Professor
Charles Gragg to characterize the plight of business students who
had no exposure to cases.1 The facts are that the mere act of
listening to lectures and sound advice about managing does little
for anyone’s management skills and that the accumulated
managerial wisdom cannot effectively be passed on by lectures and
assigned readings alone. If anything had been learned about the
practice of management, it is that a storehouse of ready-made
textbook answers does not exist. Each managerial situation has
unique aspects, requiring its own diagnosis, judgment, and tailor-
made actions. Cases provide would-be managers with a valuable
way to practice wrestling with the actual problems of actual
managers in actual companies.
The case approach to strategic analysis is, first and foremost, an exercise
in learning by doing. Because cases provide you with detailed information
about conditions and problems of different industries and companies, your
task of analyzing company after company and situation after situation has
the twin benefit of boosting your analytical skills and exposing you to the
ways companies and managers actually do things. Most college students
have limited managerial backgrounds and only fragmented knowledge
about companies and real-life strategic situations. Cases help substitute for
on-the-job experience by (1) giving you broader exposure to a variety of
industries, organizations, and strategic problems; (2) forcing you to assume
a managerial role (as opposed to that of just an onlooker); (3) providing a
test of how to apply the tools and techniques of strategic management; and
(4) asking you to come up with pragmatic managerial action plans to deal
with the issues at hand.
Objectives of Case Analysis
Using cases to learn about the practice of strategic management is a
powerful way for you to accomplish five things:2
1. Increase your understanding of what managers should and should not do
in guiding a business to success.
2. Build your skills in sizing up company resource strengths and
weaknesses and in conducting strategic analysis in a variety of industries
and competitive situations.
3. Get valuable practice in identifying strategic issues that need to be
addressed, evaluating strategic alternatives, and formulating workable
plans of action.
4. Enhance your sense of business judgment, as opposed to uncritically
accepting the authoritative crutch of the professor or “back-of-the-book”
answers.
5. Gain in-depth exposure to different industries and companies, thereby
acquiring something close to actual business experience.
If you understand that these are the objectives of case analysis, you are
less likely to be consumed with curiosity about “the answer to the case.”
Students who have grown comfortable with and accustomed to textbook
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statements of fact and definitive lecture notes are often frustrated when
discussions about a case do not produce concrete answers. Usually, case
discussions produce good arguments for more than one course of action.
Differences of opinion nearly always exist. Thus, should a class discussion
conclude without a strong, unambiguous consensus on what to do, don’t
grumble too much when you are not told what the answer is or what the
company actually did. Just remember that in the business world answers
don’t come in conclusive black-and-white terms. There are
nearly always several feasible courses of action and
approaches, each of which may work out satisfactorily. Moreover, in the
business world, when one elects a particular course of action, there is no
peeking at the back of a book to see if you have chosen the best thing to do
and no one to turn to for a provably correct answer. The best test of whether
management action is “right” or “wrong” is results. If the results of an
action turn out to be “good,” the decision to take it may be presumed
“right.” If not, then the action chosen was “wrong” in the sense that it didn’t
work out.
Hence, the important thing for you to understand about analyzing cases is
that the managerial exercise of identifying, diagnosing, and recommending
is aimed at building your skills of business judgment. Discovering what the
company actually did is no more than frosting on the cake—the actions that
company managers actually took may or may not be “right” or best (unless
there is accompanying evidence that the results of their actions were highly
positive).
The point is this: The purpose of giving you a case assignment is not to
cause you to run to the library or surf the Internet to discover what the
company actually did but, rather, to enhance your skills in sizing up
situations and developing your managerial judgment about what needs to be
done and how to do it. The aim of case analysis is for you to become
actively engaged in diagnosing the business issues and managerial problems
posed in the case, to propose workable solutions, and to explain and defend
your assessments—this is how cases provide you with meaningful practice
at being a manager.
Preparing a Case for Class Discussion
If this is your first experience with the case method, you may have
to reorient your study habits. Unlike lecture courses where you can
get by without preparing intensively for each class and where you
have latitude to work assigned readings and reviews of lecture
notes into your schedule, a case assignment requires conscientious
preparation before class. You will not get much out of hearing the
class discuss a case you haven’t read, and you certainly won’t be
able to contribute anything yourself to the discussion. What you
have got to do to get ready for class discussion of a case is to study
the case, reflect carefully on the situation presented, and develop
some reasoned thoughts. Your goal in preparing the case should be
to end up with what you think is a sound, well-supported analysis
of the situation and a sound, defensible set of recommendations
about which managerial actions need to be taken.
To prepare a case for class discussion, we suggest the following
approach:
1. Skim the case rather quickly to get an overview of the situation it
presents. This quick overview should give you the general flavor of the
situation and indicate the kinds of issues and problems that you will need
to wrestle with. If your instructor has provided you with study questions
for the case, now is the time to read them carefully.
2. Read the case thoroughly to digest the facts and circumstances. On this
reading, try to gain full command of the situation presented in the case.
Begin to develop some tentative answers to the study questions your
instructor has provided. If your instructor has elected not to give you
assignment questions, then start forming your own picture of the overall
situation being described.
3. Carefully review all the information presented in the exhibits. Often,
there is an important story in the numbers contained in the exhibits.
Expect the information in the case exhibits to be crucial enough to
materially affect your diagnosis of the situation.
4. Decide what the strategic issues are. Until you have identified the
strategic issues and problems in the case, you don’t know what to
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analyze, which tools and analytical techniques are called for, or otherwise
how to proceed. At times the strategic issues are clear—either being
stated in the case or else obvious from reading the case. At other times
you will have to dig them out from all the information given; if so, the
study questions will guide you.
5. Start your analysis of the issues with some number crunching. A big
majority of strategy cases call for some kind of number crunching—
calculating assorted financial ratios to check out the company’s financial
condition and recent performance, calculating growth rates of sales or
profits or unit volume, checking out profit margins and the makeup of the
cost structure, and understanding whatever revenue-cost-profit
relationships are present. See Table 1 for a summary of key financial
ratios, how they are calculated, and what they show.
6. Apply the concepts and techniques of strategic analysis you have been
studying. Strategic analysis is not just a collection of opinions; rather, it
entails applying the concepts and analytical tools described in Chapters 1
through 12 to cut beneath the surface and produce sharp insight and
understanding. Every case assigned is strategy related and presents you
with an opportunity to usefully apply what you have learned. Your
instructor is looking for you to demonstrate that you know how and when
to use the material presented in the text chapters.
7. Check out conflicting opinions and make some judgments about the
validity of all the data and information provided. Many times cases
report views and contradictory opinions (after all, people don’t always
agree on things, and different people see the same things in different
ways). Forcing you to evaluate the data and information presented in the
case helps you develop your powers of inference and judgment. Asking
you to resolve conflicting information “comes with the territory” because
a great many managerial situations entail opposing points of view,
conflicting trends, and sketchy information.
8. Support your diagnosis and opinions with reasons and evidence. The
most important things to prepare for are your answers to the question
“Why?” For instance, if after studying the case you are of the opinion
that the company’s managers are doing a poor job, then it is your answer
to “Why?” that establishes just how good your analysis of the situation is.
If your instructor has provided you with specific study questions for the
case, by all means prepare answers that include all the reasons and
number-crunching evidence you can muster to support your diagnosis. If
you are using study questions provided by the instructor, generate at least
two pages of notes!
9. Develop an appropriate action plan and set of recommendations.
Diagnosis divorced from corrective action is sterile. The test of a
manager is always to convert sound analysis into sound actions—actions
that will produce the desired results. Hence, the final and most telling
step in preparing a case is to develop an action agenda for management
that lays out a set of specific recommendations on what to do. Bear in
mind that proposing realistic, workable solutions is far preferable to
casually tossing out off-the-top-of-your-head suggestions. Be prepared to
argue why your recommendations are more attractive than other courses
of action that are open.
As long as you are conscientious in preparing your analysis and
recommendations, and have ample reasons, evidence, and arguments to
support your views, you shouldn’t fret unduly about whether what you’ve
prepared is “the right answer” to the case. In case analysis, there is rarely
just one right approach or set of recommendations. Managing companies
and crafting and executing strategies are not such exact sciences that there
exists a single provably correct analysis and action plan for each strategic
situation. Of course, some analyses and action plans are better than others;
but, in truth, there’s nearly always more than one good way to analyze a
situation and more than one good plan of action.
Participating in Class Discussion of a Case
Classroom discussions of cases are sharply different from attending
a lecture class. In a case class, students do most of the talking. The
instructor’s role is to solicit student participation, keep the
discussion on track, ask “Why?” often, offer alternative views, play
the devil’s advocate (if no students jump in to offer opposing
views), and otherwise lead the discussion. The students in the class
carry the burden for analyzing the situation and for being prepared
page CA-5
to present and defend their diagnoses and recommendations.
Expect a classroom environment, therefore, that calls for your size-
up of the situation, your analysis, what actions you would take, and
why you would take them. Do not be dismayed if, as the class
discussion unfolds, some insightful things are said by your fellow
classmates that you did not think of. It is normal for views and
analyses to differ and for the comments of others in the class to
expand your own thinking about the case. As the old adage goes,
“Two heads are better than one.” So it is to be expected that the
class as a whole will do a more penetrating and searching job of
case analysis than will any one person working alone. This is the
power of group effort, and its virtues are that it will help you see
more analytical applications, let you test your analyses and
judgments against those of your peers, and force you to wrestle
with differences of opinion and approaches.
Table 1 Key Financial Ratios: How to Calculate Them and
What They Mean
Ratio How Calculated What It Shows
Profitability
ratios
1. Gross profit
margin
Shows the percentage
of revenues available
to cover operating
expenses and yield a
profit. Higher is better
and the trend should
be upward.
2. Operating profit
margin (or
return on sales)
or
Shows the profitability
of current operations
without regard to
interest charges and
income taxes. Higher
is better and the trend
should be upward.
Ratio How Calculated What It Shows
3. Net profit
margin (or net
return on sales)
Shows after-tax profits
per dollar of sales.
Higher is better and
the trend should be
upward.
4. Total return on
assets
A measure of the
return on total
monetary investment
in the enterprise.
Interest is added to
after-tax profits to form
the numerator since
total assets are
financed by creditors
as well as by
stockholders. Higher is
better and the trend
should be upward.
5. Net return on
total assets
(ROA)
A measure of the
return earned by
stockholders on the
firm’s total assets.
Higher is better, and
the trend should be
upward.
6. Return on
stockholder’s
equity (ROE)
Shows the return
stockholders are
earning on their capital
investment in the
enterprise. A return in
the 12–15% range is
“average,” and the
trend should be
upward.
Ratio How Calculated What It Shows
7. Return on
invested capital
(ROIC)—
sometimes
referred to as
return on
capital
employed
(ROCE)
A measure of the
return shareholders
are earning on the
long-term monetary
capital invested in the
enterprise. A higher
return reflects greater
bottom-line
effectiveness in the
use of long-term
capital, and the trend
should be upward.
8. Earnings per
share (EPS)
Shows the earnings for
each share of common
stock outstanding. The
trend should be
upward, and the bigger
the annual percentage
gains, the better.
Liquidity ratios
1. Current ratio
Shows a firm’s ability
to pay current liabilities
using assets that can
be converted into cash
in the near term. Ratio
should definitely be
higher than 1.0; ratios
of 2 or higher are
better still.
Ratio How Calculated What It Shows
2. Working capital Current assets – Current liabilities
Bigger amounts are
better because the
company has more
internal funds available
to (1) pay its current
liabilities on a timely
basis and (2) finance
inventory expansion,
additional accounts
receivable, and a
larger base of
operations without
resorting to borrowing
or raising more equity
capital.
Leverage ratios
1. Total debt-to-
assets ratio
Measures the extent to
which borrowed funds
have been used to
finance the firm’s
operations. Low
fractions or ratios are
better—high fractions
indicate overuse of
debt and greater risk
of bankruptcy.
page CA-6
Ratio How Calculated What It Shows
2. Long-term
debt-to-capital
ratio
An important measure
of creditworthiness
and balance sheet
strength. Indicates the
percentage of capital
investment that has
been financed by
creditors and
bondholders. Fractions
or ratios below .25 or
25% are usually quite
satisfactory since
monies invested by
stockholders account
for 75% or more of the
company’s total
capital. The lower the
ratio, the greater the
capacity to borrow
additional funds. Debt-
to-capital ratios above
50% and certainly
above 75% indicate a
heavy and perhaps
excessive reliance on
debt, lower
creditworthiness, and
weak balance sheet
strength.
Leverage ratios
(Continued)
3. Debt-to-equity
ratio
Should usually be less
than 1.0. High ratios
(especially above 1.0)
signal excessive debt,
lower creditworthiness,
and weaker balance
sheet strength.
Ratio How Calculated What It Shows
4. Long-term
debt-to-equity
ratio
Shows the balance
between debt and
equity in the firm’s
long-term capital
structure. Low ratios
indicate greater
capacity to borrow
additional funds if
needed.
5. Times-interest-
earned (or
coverage) ratio
Measures the ability to
pay annual interest
charges. Lenders
usually insist on a
minimum ratio of 2.0,
but ratios above 3.0
signal better
creditworthiness.
Activity ratios
1. Days of
inventory
Measures inventory
management
efficiency. Fewer days
of inventory are
usually better.
2. Inventory
turnover
Measures the number
of inventory turns per
year. Higher is better.
3. Average
collection
period
or
Indicates the average
length of time the firm
must wait after making
a sale to receive cash
payment. A shorter
collection time is
better.
Other important measures of financial performance
Ratio How Calculated What It Shows
1. Dividend yield
on common
stock
A measure of the
return that
shareholders receive
in the form of
dividends. A “typical”
dividend yield is 2–3%.
The dividend yield for
fast-growth companies
is often below 1%
(maybe even 0); the
dividend yield for slow-
growth companies can
run 4–5%.
2. Price-earnings
ratio
P-E ratios above 20
indicate strong
investor confidence in
a firm’s outlook and
earnings growth; firms
whose future earnings
are at risk or likely to
grow slowly typically
have ratios below 12.
3. Dividend
payout ratio
Indicates the
percentage of after-tax
profits paid out as
dividends.
4. Internal cash
flow
After-tax profits + Depreciation
A quick and rough
estimate of the cash
the business is
generating after
payment of operating
expenses, interest,
and taxes. Such
amounts can be used
for dividend payments
or funding capital
expenditures.
page CA-7
Ratio How Calculated What It Shows
5. Free cash flow
After-tax profits + Depreciation –
Capital expenditures – Dividends
A quick and rough
estimate of the cash a
company’s business is
generating after
payment of operating
expenses, interest,
taxes, dividends, and
desirable
reinvestments in the
business. The larger a
company’s free cash
flow, the greater is its
ability to internally fund
new strategic
initiatives, repay debt,
make new
acquisitions,
repurchase shares of
stock, or increase
dividend payments.
To orient you to the classroom environment on the days a
case discussion is scheduled, we compiled the following list of things to
expect:
1. Expect the instructor to assume the role of extensive questioner and
listener.
2. Expect students to do most of the talking. The case method enlists a
maximum of individual participation in class discussion. It is not enough
to be present as a silent observer; if every student took this approach,
there would be no discussion. (Thus, expect a portion of your grade to be
based on your participation in case discussions.)
3. Be prepared for the instructor to probe for reasons and supporting
analysis.
4. Expect and tolerate challenges to the views expressed. All students have
to be willing to submit their conclusions for scrutiny and rebuttal. Each
student needs to learn to state his or her views without fear of disapproval
and to overcome the hesitation of speaking out. Learning respect for the
________
________
________
views and approaches of others is an integral part of case analysis
exercises. But there are times when it is OK to swim against the tide of
majority opinion. In the practice of management, there is always room
for originality and unorthodox approaches. So while discussion of a case
is a group process, there is no compulsion for you or anyone else to cave
in and conform to group opinions and group consensus.
5. Don’t be surprised if you change your mind about some things as the
discussion unfolds. Be alert to how these changes affect your analysis
and recommendations (in the event you get called on).
6. Expect to learn a lot in class as the discussion of a case progresses;
furthermore, you will find that the cases build on one another—what you
learn in one case helps prepare you for the next case discussion.
There are several things you can do on your own to be good and look
good as a participant in class discussions:
Although you should do your own independent work and independent
thinking, don’t hesitate before (and after) class to discuss the case with
other students. In real life, managers often discuss the company’s
problems and situation with other people to refine their own thinking.
In participating in the discussion, make a conscious effort to contribute,
rather than just talk. There is a big difference between saying something
that builds the discussion and offering a long-winded, off-the-cuff remark
that leaves the class wondering what the point was.
Avoid the use of “I think,” “I believe,” and “I feel”; instead, say, “My
analysis shows ” and “The company should do because .” Always give
supporting
reasons and
evidence for
your views;
then your instructor won’t have to ask you “Why?” every time you make
a comment.
In making your points, assume that everyone has read the case and knows
what it says. Avoid reciting and rehashing information in the case—
instead, use the data and information to explain your assessment of the
situation and to support your position.
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Bring the printouts of the work you’ve done on Case-TUTOR or the notes
you’ve prepared (usually two or three pages’ worth) to class and rely on
them extensively when you speak. There’s no way you can remember
everything off the top of your head—especially the results of your
number crunching. To reel off the numbers or to present all five reasons
why, instead of one, you will need good notes. When you have prepared
thoughtful answers to the study questions and use them as the basis for
your comments, everybody in the room will know you are well prepared,
and your contribution to the case discussion will stand out.
Preparing a Written Case Analysis
Preparing a written case analysis is much like preparing a case for class
discussion, except that your analysis must be more complete and put in
report form. Unfortunately, though, there is no ironclad procedure for doing
a written case analysis. All we can offer are some general guidelines and
words of wisdom—this is because company situations and management
problems are so diverse that no one mechanical way to approach a written
case assignment always works.
Your instructor may assign you a specific topic around which to prepare
your written report. Or, alternatively, you may be asked to do a
comprehensive written case analysis, where the expectation is that you will
(1) identify all the pertinent issues that management needs to address, (2)
perform whatever analysis and evaluation is appropriate, and (3) propose an
action plan and set of recommendations addressing the issues you have
identified. In going through the exercise of identify, evaluate,
and recommend, keep the following pointers in mind.3
Identification It is essential early on in your written report that you provide
a sharply focused diagnosis of strategic issues and key problems and that
you demonstrate a good grasp of the company’s present situation. Make
sure you can identify the firm’s strategy (use the concepts and tools in
Chapters 1–8 as diagnostic aids) and that you can pinpoint whatever
strategy implementation issues may exist (again, consult the material in
Chapters 10–12 for diagnostic help). Consult the key points we have
provided at the end of each chapter for further diagnostic suggestions.
Consider beginning your report with an overview of the company’s
situation, its strategy, and the significant problems and issues that confront
management. State problems/issues as clearly and precisely as you can.
Unless it is necessary to do so for emphasis, avoid recounting facts and
history about the company (assume your professor has read the case and is
familiar with the organization).
Analysis and Evaluation This is usually the hardest part of the report.
Analysis is hard work! Check out the firm’s financial ratios, its profit
margins and rates of return, and its capital structure, and decide how strong
the firm is financially. Table 1 contains a summary of various financial
ratios and how they are calculated. Use it to assist in your financial
diagnosis. Similarly, look at marketing, production, managerial
competence, and other factors underlying the organization’s strategic
successes and failures. Decide whether the firm has valuable resource
strengths and competencies and, if so, whether it is capitalizing on them.
Check to see if the firm’s strategy is producing satisfactory results and
determine the reasons why or why not. Probe the nature and strength of the
competitive forces confronting the company. Decide whether and why the
firm’s competitive position is getting stronger or weaker. Use the tools and
concepts you have learned about to perform whatever analysis and
evaluation is appropriate. Work through the case preparation exercise on
Case-TUTOR if one is available for the case you’ve been assigned.
In writing your analysis and evaluation, bear in mind four things:
1. You are obliged to offer analysis and evidence to back up your
conclusions. Do not rely on unsupported opinions, over-generalizations,
and platitudes as a substitute for tight, logical argument backed up with
facts and figures.
2. If your analysis involves some important quantitative calculations, use
tables and charts to pre-sent the calculations clearly and efficiently. Don’t
just tack the exhibits on at the end of your report and let the reader figure
out what they mean and why they were included. Instead, in the body of
your report cite some of the key numbers, highlight the conclusions to be
drawn from the exhibits, and refer the reader to your charts and exhibits
for more details.
3. Demonstrate that you have command of the strategic concepts and
analytical tools to which you have been exposed. Use them in your
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report.
4. Your interpretation of the evidence should be reasonable and objective.
Be wary of preparing a one-sided argument that omits all aspects not
favorable to your conclusions. Likewise, try not to exaggerate or
overdramatize. Endeavor to inject balance into your analysis and to avoid
emotional rhetoric. Strike phrases such as “I think,” “I feel,” and “I
believe” when you edit your first draft and write in “My analysis shows”
instead.
Recommendations The final section of the written case analysis should
consist of a set of definite recommendations and a plan of action. Your set
of recommendations should address all of the problems/issues you
identified and analyzed. If the recommendations come as a surprise or do
not follow logically from the analysis, the effect is to weaken greatly your
suggestions of what to do. Obviously, your recommendations for actions
should offer a reasonable prospect of success. High-risk, bet-the-company
recommendations should be made with caution. State how your
recommendations will solve the problems you identified. Be sure the
company is financially able to carry out what you recommend; also check
to see if your recommendations are workable in terms of acceptance by the
persons involved, the organization’s competence to implement them, and
prevailing market and environmental constraints. Try not to hedge or
weasel on the actions you believe should be taken.
By all means state your recommendations in sufficient detail to be
meaningful—get down to some definite nitty-gritty specifics. Avoid such
unhelpful statements as “the organization should do more planning” or “the
company should be more aggressive in marketing its product.” For instance,
if you determine that “the firm should improve its market
position,” then you need to set forth exactly how you think
this should be done. Offer a definite agenda for action, stipulating a
timetable and sequence for initiating actions, indicating priorities, and
suggesting who should be responsible for doing what.
In proposing an action plan, remember there is a great deal of difference
between, on the one hand, being responsible for a decision that may be
costly if it proves in error and, on the other hand, casually suggesting
courses of action that might be taken when you do not have to bear the
responsibility for any of the consequences.
A good rule to follow in making your recommendations is: Avoid
recommending anything you would not yourself be willing to do if you
were in management’s shoes. The importance of learning to develop good
managerial judgment is indicated by the fact that, even though the same
information and operating data may be available to every manager or
executive in an organization, the quality of the judgments about what the
information means and which actions need to be taken does vary from
person to person.4
It goes without saying that your report should be well organized and well
written. Great ideas amount to little unless others can be convinced of their
merit—this takes tight logic, the presentation of convincing evidence, and
persuasively written arguments.
Preparing an Oral Presentation
During the course of your business career it is very likely that you will be
called upon to prepare and give a number of oral presentations. For this
reason, it is common in courses of this nature to assign cases for oral
presentation to the whole class. Such assignments give you an opportunity
to hone your presentation skills.
The preparation of an oral presentation has much in common with that of
a written case analysis. Both require identification of the strategic issues
and problems confronting the company, analysis of industry conditions and
the company’s situation, and the development of a thorough, well-thought-
out action plan. The substance of your analysis and quality of your
recommendations in an oral presentation should be no different than in a
written report. As with a written assignment, you’ll need to demonstrate
command of the relevant strategic concepts and tools of analysis and your
recommendations should contain sufficient detail to provide clear direction
for management. The main difference between an oral presentation and a
written case is in the delivery format. Oral presentations rely principally on
verbalizing your diagnosis, analysis, and recommendations and visually
enhancing and supporting your oral discussion with colorful, snappy slides
(usually created on Microsoft’s PowerPoint software).
page CA-10
Typically, oral presentations involve group assignments. Your instructor
will provide the details of the assignment—how work should be delegated
among the group members and how the presentation should be conducted.
Some instructors prefer that presentations begin with issue identification,
followed by analysis of the industry and company situation analysis, and
conclude with a recommended action plan to improve company
performance. Other instructors prefer that the presenters assume that the
class has a good understanding of the external industry environment and the
company’s competitive position and expect the presentation to be strongly
focused on the group’s recommended action plan and supporting analysis
and arguments. The latter approach requires cutting straight to the heart of
the case and supporting each recommendation with detailed analysis and
persuasive reasoning. Still other instructors may give you the latitude to
structure your presentation however you and your group members see fit.
Regardless of the style preferred by your instructor, you should take great
care in preparing for the presentation. A good set of slides with good
content and good visual appeal is essential to a first-rate presentation. Take
some care to choose a nice slide design, font size and style, and color
scheme. We suggest including slides covering each of the following areas:
An opening slide covering the “title” of the presentation and names of the
presenters.
A slide showing an outline of the presentation (perhaps with presenters’
names by each topic).
One or more slides showing the key problems and strategic issues that
management needs to address.
A series of slides covering your analysis of the company’s situation.
A series of slides containing your recommendations and the supporting
arguments and reasoning for each recommendation—one slide for each
recommendation and the associated reasoning will give it a lot of merit.
You and your team members should carefully plan and
rehearse your slide show to maximize impact and minimize distractions.
The slide show should include all of the pizzazz necessary to garner the
attention of the audience, but not so much that it distracts from the content
of what group members are saying to the class. You should remember that
the role of slides is to help you communicate your points to the audience.
Too many graphics, images, colors, and transitions may divert the
audience’s attention from what is being said or disrupt the flow of the
presentation. Keep in mind that visually dazzling slides rarely hide a
shallow or superficial or otherwise flawed case analysis from a perceptive
audience. Most instructors will tell you that first-rate slides will definitely
enhance a well-delivered presentation, but that impressive visual aids, if
accompanied by weak analysis and poor oral delivery, still add up to a
substandard presentation.
Researching Companies and Industries via the Internet and
Online Data Services
Very likely, there will be occasions when you need to get additional
information about some of the assignee cases, perhaps because your
instructor has asked you to do further research on the industry or company
or because you are simply curious about what has happened to the company
since the case was written. These days, it is relatively easy to run down
recent industry developments and to find out whether a company’s strategic
and financial situation has improved, deteriorated, or changed little since
the conclusion of the case. The amount of information about companies and
industries available on the Internet and through online data services is
formidable and expanding rapidly.
It is a fairly simple matter to go to company websites, click on the
investor information offerings and press release files, and get quickly to
useful information. Most company websites allow you to view or print the
company’s quarterly and annual reports, its 10-K and 10-Q filings with the
Securities and Exchange Commission, and various company press releases
of interest. Frequently, a company’s website will also provide information
about its mission and vision statements, values statements, codes of ethics,
and strategy information, as well as charts of the company’s stock price.
The company’s recent press releases typically contain reliable information
about what of interest has been going on—new product introductions,
recent alliances and partnership agreements, recent acquisitions, summaries
of the latest financial results, tidbits about the company’s strategy, guidance
page CA-11
about future revenues and earnings, and other late-breaking company
developments. Some company web pages also include links to the home
pages of industry trade associations where you can find information about
industry size, growth, recent industry news, statistical trends, and future
outlook. Thus, an early step in researching a company on the Internet is
always to go to its website and see what’s available.
Online Data Services LexisNexis, Bloomberg Financial News Services,
and other online subscription services available in many university libraries
provide access to a wide array of business reference material. For example,
the web-based LexisNexis Academic Universe contains business news
articles from general news sources, business publications, and industry
trade publications. Broadcast transcripts from financial news programs are
also available through LexisNexis, as are full-text 10-Ks, 10-Qs, annual
reports, and company profiles for more than 11,000 U.S. and international
companies. Your business librarian should be able to direct you to the
resources available through your library that will aid you in your research.
Public and Subscription Websites with Good Information Plainly, you
can use a search engine such as Google or Yahoo! or MSN to find the latest
news on a company or articles written by reporters that have appeared in the
business media. These can be very valuable in running down information
about recent company developments. However, keep in mind that the
information retrieved by a search engine is “unfiltered” and may include
sources that are not reliable or that contain inaccurate or misleading
information. Be wary of information provided by authors who are
unaffiliated with reputable organizations or publications and articles that
were published in off-beat sources or on websites with an agenda. Be
especially careful in relying on the accuracy of information you find posted
on various bulletin boards. Articles covering a company or issue should be
copyrighted or published by a reputable source. If you are turning in a paper
containing information gathered from the Internet, you should cite your
sources (providing the Internet address and date visited); it is
also wise to print web pages for your research file (some web
pages are updated frequently).
The Wall Street Journal, Bloomberg Businessweek, Forbes, Barron’s, and
Fortune are all good sources of articles on companies. The online edition of
The Wall Street Journal contains the same information that is available
daily in its print version of the paper, but the WSJ website also maintains a
searchable database of all The Wall Street Journal articles published during
the past few years. Fortune and Bloomberg Businessweek also make the
content of the most current issue available online to subscribers as well as
provide archives sections that allow you to search for articles published
during the past few years that may be related to a particular keyword.
The following publications and websites are particularly good sources of
company and industry information:
Securities and Exchange Commission EDGAR database (contains company 10-Ks, 10-
Qs, etc.)
http://www.sec.gov/edgar/searchedgar/companysearch
Google Finance
http://finance.google.com
CNN Money
http://money.cnn.com
Hoover’s Online
http://hoovers.com
The Wall Street Journal Interactive Edition
www.wsj.com
Bloomberg Businessweek
www.businessweek.com and www.bloomberg.com
Fortune
www.fortune.com
MSN Money Central
http://moneycentral.msn.com
Yahoo! Finance
http://finance.yahoo.com/
Some of these Internet sources require subscriptions in order to access
their entire databases.
You should always explore the investor relations section of every public
company’s website. In today’s world, these websites typically have a wealth
of information concerning a company’s mission, core values, performance
http://www.sec.gov/edgar/searchedgar/companysearch
http://finance.google.com/
http://money.cnn.com/
http://hoovers.com/
http://www.wsj.com/
http://www.businessweek.com/
http://www.bloomberg.com/
http://www.fortune.com/
http://moneycentral.msn.com/
http://finance.yahoo.com/
page CA-12
targets, strategy, recent financial performance, and latest developments (as
described in company press releases).
Learning Comes Quickly With a modest investment of time, you will
learn how to use Internet sources and search engines to run down
information on companies and industries quickly and efficiently. And it is a
skill that will serve you well into the future. Once you become familiar with
the data available at different websites mentioned above and learn how to
use a search engine, you will know where to go to look for the particular
information that you want. Search engines nearly always turn up too many
information sources that match your request rather than too few. The trick is
to learn to zero in on those most relevant to what you are looking for. Like
most things, once you get a little experience under your belt on how to do
company and industry research on the Internet, you will be able to readily
find the information you need.
The Ten Commandments of Case Analysis
As a way of summarizing our suggestions about how to approach the task
of case analysis, we have put together what we like to call “The Ten
Commandments of Case Analysis.” They are shown in Table 2. If you
observe all or even most of these commandments faithfully as you prepare a
case either for class discussion or for a written report, your chances of
doing a good job on the assigned cases will be much improved. Hang in
there, give it your best shot, and have some fun exploring what the real
world of strategic management is all about.
Table 2 The Ten Commandments of Case Analysis
To be observed in written reports and oral presentations, and while participating in
class discussions:
1. Go through the case twice, once for a quick overview and once to gain full
command of the facts. Then take care to explore the information in every one of the
case exhibits.
2. Make a complete list of the problems and issues that the company’s management
needs to address.
3. Be thorough in your analysis of the company’s situation (make a minimum of one to
two pages of notes detailing your diagnosis).
4. Look for opportunities to apply the concepts and analytical tools in the text chapters
—all of the cases in the book have very definite ties to the material in one or more of
the text chapters!!!!
5. Do enough number crunching to discover the story told by the data presented in the
case. (To help you comply with this commandment, consult Table 1 in this section to
guide your probing of a company’s financial condition and financial performance.)
6. Support any and all off-the-cuff opinions with well-reasoned arguments and
numerical evidence. Don’t stop until you can purge “I think” and “I feel” from your
assessment and, instead, are able to rely completely on “My analysis shows.”
7. Prioritize your recommendations and make sure they can be carried out in an
acceptable time frame with the available resources.
8. Support each recommendation with persuasive argument and reasons as to why it
makes sense and should result in improved company performance.
9. Review your recommended action plan to see if it addresses all of the problems and
issues you identified. Any set of recommendations that does not address all of the
issues and problems you identified is incomplete and insufficient.
10. Avoid recommending any course of action that could have disastrous consequences
if it doesn’t work out as planned. Therefore, be as alert to the downside risks of your
recommendations as you are to their upside potential and appeal.
Endnotes
1 Charles I. Gragg, “Because Wisdom Can’t Be Told,” in The Case Method at the Harvard Business School, ed. M. P.
McNair (New York: McGraw-Hill, 1954), p. 11.
2 Ibid., pp. 12–14; and D. R. Schoen and Philip A. Sprague, “What Is the Case Method?” in The Case Method at the
Harvard Business School, ed. M. P. McNair, pp. 78–79.
3 For some additional ideas and viewpoints, you may wish to consult Thomas J. Raymond, “Written Analysis of
Cases,” in The Case Method at the Harvard Business School, ed. M. P. McNair, pp. 139–63. Raymond’s article
includes an actual case, a sample analysis of the case, and a sample of a student’s written report on the case.
4 Gragg, “Because Wisdom Can’t Be Told,” p. 10.
page I-1
Company Index
A
AAFA (American Apparel and Footwear Association), C-64
ABC 20/20, C-32
ABC News, C-19
ABC television network, C-279, C-281
Abercrombie & Fitch, C-69, C-70
Aber Diamond, 171
Accenture, 111, 215
Adams Golf, C-109
Adaptive Biotechnologies, 179
Adidas, 206
adidas Group, C-60, C-61, C-82, C-83, C-85, C-87, C-97, C-103, C-108–C-110
Adobe, Inc., 363
Advent International Corporation, C-69
AES energy, 358
Ahold Delhaize, C-129, C-204
AIG, Inc., 365
Airbnb, 142, 267
Airbnb, case, C-2–C-6
accommodation market, C-2–C-3
consumer experience, C-4–C-5
COVID-19 pandemic, C-5–C-6
overview, C-2–C-3
regulating, C-5
sharing economy business model, C-3–C-4
Airbus, 206
Air France, 159
Albert, C-129
Albertsons, 70, C-129, C-204, C-208–C-209
Alcohol and Tobacco Tax and Trade Bureau (TTB), C-10
Alcon, 336
Aldi, 70
ALDO Group, C-91
Alibaba.com, 35, 136, 216, 312
Alitalia airlines, 159
All-America Games, C-96
Allegheny Technologies, C-384
Allegro Manufacturing, 234
Alliance Boots (UK), 199–200
Alliance Manchester Business School, C-293
Allianz Italy, 34
Allied Signal, 335
Allstate insurance, 173
Ally Financial, 275
Alphabet (Google parent), 3, 303, 336
Amazon.com, 3, 35, 102, 158, 170, 172, 304, 312, 339–341, 363, 369–370, C-4, C-35, C-74, C-99, C-151, C-204
Amazon Prime, 67
Amazon Prime Music, C-118, C-144–C-145
Ambassador Steel Corporation, C-366
American Airlines, 168, 339, C-274
American Apparel and Footwear Association (AAFA), C-64
American Express, 46
American Red Cross, C-280, C-349
AMR Corporation, 168
Anchor, C-114
http://alibaba.com/
http://amazon.com/
Anheuser-Busch InBev SA/NV, 70, 127, C-7, C-13–C14, C-224
Animal Compassion Foundation, 288
Ann Taylor Stores, 34, 173
Aon Hewitt, 176
Apple, Inc., 3–4, 6–8, 17, 158, 165, 172, 177, 312–313, 354, 363, 368, C-113, C-118, C-165, C-187
AppleTV+, C-149
Aramark Food and Services, C-332
ArcelorMittal USA, C-386
Arc’teryx, 314
Arizona State University, C-109, C-349
Armani, 81, C-29
Army and Air Force Exchange Service, C-98
Asahi Group Holdings, C-12
Ashworth sport apparel, C-109
Associated Press, C-165
Aston Martin, C-236
AstraZeneca, 271
Atitalia, 159
A. T. Kearney, 111
AT&T, Inc., 225, 330, C-116, C-144–C-147
Auburn Steel Company, C-365
Auburn University, C-96
Audi Motor Co., 147, C-236–C-237
Austin FC, C-178
Automobile magazine, C-216
Avago Technologies, 311
Avon Products, 84
A&W Canada, C-126, C-129
B
Bain Capital, 30
Ballast Point Brewing & Spirits, C-13
Bank of America, 228, 275, 336
Bareburger, C-129
Barker Steel Company, C-366
Barnes & Noble, C-35
Barron magazine, 279
BASF, 46, C-180
Bass Pro Shops, C-98
Bath & Body Works, 173, C-84
Bay Bread Group, C-339
Baylor University, C-43, C-273
BBC (UK), C-165
Beaird-Poulan, 234
Beam, Inc., 240
Bebe Stores, Inc., C-71
Belk, Inc., C-98
Benchnet–The Benchmarking Exchange, 111
Ben & Jerry’s, 289
Bentley, 139
Berkshire Hathaway, 3, 35, 239
Berlin Marathons, C-110
Best Buy, 70, 153, 345, C-35, C-40
Best Practices, LLC, 111
Beyond Meat, Inc., case, C-124–C-139
background of, C-124–C-128
competitors, C-134–C-139
distribution strategy of, C-130–C-131
growth strategy of, C-129–C-130
health and environmental impacts of, C-133–C-134
production strategy of, C-131–C-132
R&D strategy of, C-131
supply chain practices of, C-132–C-133
page I-2
Bharti Enterprises, 242
Bic pens, 134
Bing.com, 325
Birmingham Steel Corporation, C-365
BJ’s Wholesale Club, 144, C-38–C-41
Black & Decker, 234
Bloomberg News, C-165
Bloomin’ Brands, 263
Bloomingdale’s, C-52, C-59
Blue Apron, 108
Blue Nile jewelry, 142
Blue Point, C-12
Blumercury, Inc., C-52
BMW, 6, 105, 136, 147, 188, C-236
Boca Foods, C-135
Boeing aircraft, 313
Boeing Company, case, C-273–C-278
aspiration, C-275
behaviors, C-275
dilemma, C-278
divisions of, C-274–C-275
enterprise strategy, C-275
global aircraft manufacturing industry, C-275
history of, C-273–C-274
knowledge of problems, C-277
737 NG and 737 MAX crashes, C-276, C-277
purpose and mission, C-275
2025 goals, C-275
Bombardier, 234
Bonobos men’s fashion, 170
Bosch, 136
Bose, 102
Boston Beer Company, C-12
Boston College, C-96
Boston Consulting Group, 28, 303
Boston Marathon, C-110
Bouygues Telecom Broadband company, C-117
BP, Ltd., 202, 365
Braun, 115
Brewers Association, C-8
Bridgestone Tires, 70
Briggs & Stratton, 134
British Air, 159
British Steel, C-365
British Telecommunications, 225
Broadcom, 311
BTR (UK), 255
Budweiser, 70
Bugatti, 144
Build-A-Bear Workshop, 29
Burbank Housing Development Corporation, case, C-260–C-272
affordable housing segment, C-261
company history, C-262–C-270
housing crisis, C-261–C-262
mission and values, C-270–C-271
opportunities, C-271–C-272
tax credits, C-261
Burberry, 81, 139
Bureau of International Labor Affairs, C-63
BurgerFi, C-129
Burger King restaurants, 313, C-138
Burghy (Italy), 228
Burt’s Bees, 282
Business Roundtable, 280
http://bing.com/
BuyVia app, 71
C
Cabela’s, C-98
Cadbury Limited/Mondelez International, 271
Caesars Entertainment, 340–341
California’s Legislative Analyst’s Office (CLAO), C-262
Calvin Klein, C-25
Campbell’s soups, 136
CampusBookRentals, 159
Canada Goose, 144–145
Canon, 12
Cargill, Inc., C-135, C-393
Carl’s Jr., C-129
Carrefour (France), 115
Cartier, 139, 208
Casella Wines (Australia), 161
CBS, C-148–C-149
CCR Hockey, C-109
Centers for Medicare and Medicaid Services (CMS), 337
CFRA Research, C-130
Charles Schwab Corporation, 27, 136, 314
Charleston Area Medical Center (WV), 336–337, 349
Charlotte Bobcats, C-96
The Cheesecake Factory, C-257
Chicago Bulls, C-117
Chief Executives magazine, 304
China Development Bank, C-384
China Zhongwang Holdings, C-383
Chronic Tacos, C-129
Chrysler Motor Company, 123
Ciba Vision, 336
CineForm, C-186–C-187
Cinemark Theaters, C-129
Cinnabon, Inc., 123
Cirque du Soleil, 161
Cisco Systems, 169, 177–178, 280, 304, 372
Citigroup, 28, 255, 275
Citizen Watch Company, 231
Clarks shoes, C-60, C-61
Cleveland Clinic, 140
Clinton Global Initiative, 143
Clorox Company Foundation, 289
CMS (Centers for Medicare and Medicaid Services), 337
CNN television network, 140, C-165, C-187
Coach, Inc., 139, 171, 173
Coca-Cola Co., 28, 100, 114, 138, 282, 286, 290, 336
Coleman, C-182
Coles, C-129
Colgate-Palmolive, 131, 176
Colo-Colo soccer club (Chile), C-96
Comcast, 234, C-145, C-147–C-148
Community Coffee, 142
Companhia Vale do Rio Doce (CVRD, Brazil), C-374
Compaq Computer, C-214
Congressional Research Service group, C-261
Connecticut Steel Corporation, C-365
Conservation International’s Center for Environmental Leadership, C-347
Consolidated Rebar, Inc., C-366
Constellations Brands, C-13
Consumer Reports magazine, C-194, C-216, C-232
Continental Tires, 70
Cord Project, C-114
Corkcicle, C-181–C-182
Corning, 231
Corporate Knights magazine, 282
Corporate Responsibility magazine, 282, C-349
Cortec Group Management Services, LLC, C-174
Corus Steel (UK), C-365
Costco Connection, The, C-27, C-29
Costco Wholesale Corporation, 105, 144, 153, C-15, C-129, C-207–C-208, C-337
Costco Wholesale Corporation, case
background of, C-18–C19
compensation and workforce practices, C-30–C-33
competition: BJ’s Wholesale Club, C-38–C-41
competition: Merchandise Offerings, C-37–C-38
competition: Sam’s Club, C-36
environmental sustainability of, C-34–C-35
financial and operating data, C-20–C-21
founder’s leadership style, C-19–C-20
marketing and advertising of, C-27
membership demographics, C-29–C-30
mission of, C-22
responsible sourcing of meat and dairy products, C-34–C-35
strategy of, C-22–C-27
supply chain and distribution of, C-28–C-29
values and codes of ethics, C-33–C-34
warehouse management, C-30
website sales of, C-27
Countrywide Financial, 365
Coursera, 76
Craft Brew Alliance, C-14–C-15
Craftsman, 64
Craigslist.com, C-60
Crowd Album, C-114
Cruz Azul soccer team (Mexico), C-96
CVRD (Companhia Vale do Rio Doce, Brazil), C-374
CVS, Inc., 144, C-337
D
Daimler AG, 179, C-213
Daimler-Chrysler, 177–178
Dallas Morning News, C-277
Daniels Midland Co., C-393
Dartmouth College, C-59
David J. Joseph Co., C-368, C-369, C-375–C-376
Dean Foods, 28
De Beers Group, 171, 228
Dell, 131, 138, 215, 234, 293, 303, 313
Deloitte Touche Tohmatsu Limited, 303–304
Delta Airlines, 339
Del Taco, C-129
Denny’s Corp., C-129, C-130
Devil’s Backbone Brewing, C-12
DHL Express, 132, 339
Dick’s Sporting Goods, C-88, C-98, C-175
Dillard’s, Inc., C-98
Discord, C-116
DISH Network, 234
Disney, C-112
Disney+, C-145–C-146
Disneyland Park, C-280
Disney World, C-129
Dolce & Gabbana, 176
Dollar General, 115, 315
Dome Corporation (Japan), C-99
http://craigslist.com/
page I-3
Domino’s Pizza, Inc., 108, 145
Domino’s Pizza, Inc., case, C-249–C-259
background of, C-250–C-253
contactless delivery, C-254–C-258
COVID-19 pandemic, C-253–C-254
DoorDash, C-320, C-321
Dow Jones Global Index, 291
Dow Jones Sustainability World Index, 284–286
DreamWorks Animation, 28
Dreyer’s Grand Ice Cream, C-335
Dr Pepper Snapple Group, 169
Drybar, 161
Ducati Motorcycles, 138, 173, 191, 322
Duferco Group (Europe), C-373, C-383, C-384
Dunkin Brands, C-129
Dunkin Donuts, 108
DuPont Co., Inc., 34
E
EA (Electronic Arts), 205
Earth Fare, C-135
Eastern Michigan University, C-250
Eastman Kodak, 364
EasyJet airlines (UK), 134, 158–159
eBay.com, 17, 161, 164–165, 259, C-4, C-214
EBSCO, 375
Echoing Green, 143
The Echo Nest, C-113
Economist, The, 3
Edeka, C-129
EDS, 215
Edward Jones, 28, 75, 173, 303, 371
edX, 76
Eero, 159
Electronic Arts (EA), 205
Embraer aircraft, 271
Emerson Electric, 234
Emirates Airlines (Dubai), 3
Endeavor, 143
Enron, Inc., 276
Environmental Protection Agency’s Energy Star and Climate Protection Partnerships, C-35
EPCOT, C-281
Epic Systems Corporation, 354
Epson, 12
Equifax, 273
ESPN, C-117, C-281, C-284
Essex Equity Management, 297
Ethical Consumer Research Association (ECRA), C-390
Ethicsphere, 279
Ethos Water, C-336–C-337, C-349
E*TRADE, 75
Etsy’s Blue Ocean Strategy, 162
Everlane apparel, 173
Everlane Inc., 108, 109
Evolution Fresh juice, C-338
Expedia.com, 168, C-318
ExxonMobil, 34
EY global accounting, 287
http://ebay.com/
http://expedia.com/
F
Facebook.com, 35, 76, 108, 158, 303, 307, 325, 343, 363, 369, C-76, C-152, C-163, C-167–C-168
FaceTime, 164
Fair Labor Association (FLA), C-394
Family Dollar, 315
Fast Company magazine, 283
Federal Aviation Agency, C-298
FedEx Corporation, 28, 115, 339
Fed-Mart, C-18
Ferrari, 191
Field Roast Grain Meat Co., C-135, C-139
FIFA World Cup, C-109
Financial Times, C-113
Fishing League Worldwide, C-190
Flirtey, C-252
FMC Corp., 259
Focus Media (China), 214–215
Food and Agricultural Organization (FAO) of the United Nations, C-134
Food Lion, C-129
Food Marketing Institute (FMI), C-204
Footlocker, Inc., C-98
Forbes magazine, C-169, C-362
Ford Credit Company, C-48
Ford Motor Company, 34, 123, 230, 287, 335, C-214, C-218, C-236
Ford Motor Company, case, C-43–C-50
challenges, C-48
coronavirus pandemic, C-48–C-49
future strategy, C-49
global automobile status, C-49
history of, C-43–C-44
new product strategy, C-45–C-48
strategic situation in 2020, C-44
Fort Howard Steel, C-365
Fortune 500, 111
Fortune Brands, 240
Fortune magazine, 7, 154, 157, 279, 287, 344, C-302, C-343
Four Seasons Hotels, 144, 205–206
Foxconn contract manufacturer (China), 177, 312
Fox, Inc., C-145
Fox News, 140, 142
Freakonomics, C-116
Fred Meyer, C-137
Free State Steel Corporation, C-366
Fresh Direct, 164
The Fresh Market, C-129, C-135
Froedtert Hospital (WI), 336
G
Gallatin Steel Company, C-367
Galyan’s Sporting Goods, C-88
The Gap, Inc., 28, 108, 310, C-70, C-73
Gardein, C-135
Garmin International, C-194
GEICO insurance, 336
Genentech, 280, 303
General Electric (GE), 3, 31, 36, 42, 223, 240, 242–243, 254, 309, 334–336, 343–344, C-48–C-49
General Mills, 33, 231, 282
General Motors (GM), 106, 123, 139, 215, 219, 307, 315, C-218, C-230, C-231, C-236
Gerdau Long Steel Company, C-367
Gett.com, 274
Giant, C-129
http://facebook.com/
http://gett.com/
Gillette, Inc., 12
Gilt Groupe, 161
Gimlet, C-114, C-119
Giving Partners nonprofits, C-62–C-63
GlaxoSmithKline, 271
Global Fund and Product (RED), C-349
Global Reporting Initiative, 284, 288
Golden State Warriors, C-97
Goldman Sachs, 108, 303, 368–369, C-4
Goodyear Tires, 70, 173
Google.com, 24, 76, 104, 158, 169, 171, 230, 363, 369, 372, 375, C-118, C-187
Goose Island, C-12
GoPro, Inc., case, C-184–C-197
action camera industry from 2014 to 2020, C-189–C-190
business model and strategy, C-190–C-191
company history, C-185–C-189
direct sales, C-192–C-193
financial performance, C-197
indirect sales/distributors, C-193
manufacturing, logistics, and sales channels, C-192
marketing and advertising, C-193
product line 2019/2020, C-191–C-192
profiles, C-193–C-197
Goya Foods, 8
Graniterock, 371
Green Mountain Coffee Roasters, C-337
Greylock Partners, C-123
Groupon, 363
Grupo Modelo, C-7
Gucci, 81, 136
Guinness beer, C-10
H
Häagen-Dazs, 33, 281
Habitat for Humanity, 27
Halliburton, 271
Hallmark cable channel, 334, C-289
Hand of Hope, C-64
Handy Dan Home Improvement, 159
Hannaford, 70, C-129
Hanson Trust, 241
Harley-Davidson, 114, 173
Harris Steel (Canada), C-366, C-377
Harris Teeter, C-129, C-137
HauteLook, 161
HBO Max, C-146–C-147
HBO Now, C-147
H. E. Butt Grocery Co., C-209–C-210
Heineken NV, 70, C-13
Hello Fresh, C-129
The Hershey Co., C-395
Hesteel Group (China), C-384
Hewlett-Packard (HP), 12, 31, 177, 215, 259, 312
HGTV, 142
Hibbett Sporting Goods, C-98
Highland Capital Partners, C-69
Hilton Hotels Corporation, 24, 46, 146, 197, C-4
Hindalco (India), 215
Hitachi, 187
H. J. Heinz Holding Corporation, 237
H&M Group, 188
Hockey Canada, C-96
Hoffman-La Roche healthcare, 179
http://google.com/
page I-4
Hold Everything, 307
HomeAway, Inc., 142, 168
Home Depot, 42, 70, 131, 136, 159, 213, C-35
Honda Motor Company, 28, 64, 123, 188, 209
Hone Hai Precision Industry Co., C-187
Honeywell, 213, 335
Hong Kong Disneyland, C-284
Hormel Foods, C-127, C-135
House of Blues, 184
Houston Rockets, C-97
HP (Hewlett-Packard), 12, 31, 177, 215, 259, 312
HSBC, Ltd. (UK), 3, 255
Huawei (China), 134
Hudson’s Bay, 161
Hulu streaming service, 76, C-116, C-144–C-148, C-279
HydroFlask, C-181
Hyundai Motor Co., 8, C-236, C-237
I
IBISWorld, C-35, C-261
IBM, Inc., 176–177, 215, 280, 353
IBS Hyderabad, C-249
ICFAI Business School (Hyderabad, India), C-238, C-389
Igloo, C-178–C-180
IKEA, 8, 270
Il Giornale Coffee Company, C-329–C-330
IMA World Health, C-63
Impossible Foods, C-135, C-137–C-139
Independence Tube Corporation (ITC), C-367
Indiana University, C-96
Inditex Group (Spain), 172, 233, 310
Indochino menswear, 173
Industry Week, 346
Infosys Technologies (India), 215
Insperity, 176
Instagram.com, 27, C-163, C-169
Insys Therapeutics, 271
Intel, Inc., 67, 187, 363
International Labor Organization, 270
International Paper Company, 172
International Standards Organization (ISO), 282
Intuit, Inc., 28, 303
iQiyi (China), C-150
iSixSigma.org, 335–336
ISO (International Standards Organization), 282
ITC (Independence Tube Corporation), C-367
ITEC Steel, Inc., C-365
ITT, 242, 264
J
Jacksonville Jaguars, C-96
Jaguar Motor Co., 147, C-236
J.B. Hunt Trucking Co., C-224
JBS, C-134–C-135
J.C. Penny Company, Inc., C-58, C-84
J.D. Power awards, 213, C-299
Jet Blue Airlines, 28, 33
Jet.com, 170
http://instagram.com/
http://isixsigma.org/
http://jet.com/
Jewel-Osco, C-129
JFE Steel Corporation (Japan), C-373
Jimmy Choo, 226
John Deere, 64, 136
Johns Hopkins University, C-254
Johnson & Johnson, 6, 258, 264, 290, 325
Johnson & Wales University, C-2, C-7
JPMorgan Chase, 271, 275, 365
Jubilant FoodWorks Ltd., C-251, C-254, C-255
K
Kellogg, Inc., 97, 212
KendraScott.com, 154
Kesko, C-129
Keurig Green Mountain, 169, 287, 289, C-337
KFC, Inc., 204, C-124, C-127
Kia Motor Co., C-236
Kimberly-Clark Corporation, 223
Kimpton Hotels and Restaurants, 372
King Soupers, C-137
Kmart Holding Corporation, C-57
Kobe Steel, 273
Kodak, C-194
Kohl’s Stores, Inc., 74, C-35, C-98
Kolor, C-187
Kona Brewing Company, C-15
Kontoor Brands, Inc., 261
KP Sports’, C-88
Kraft Foods, 104, 237, C-335, C-336
Kraft Heinz, 237, C-242, C-243
Kroger/City Market, C-129, C-135, C-137
Kroger Co., Inc., 70, 114, 148, C-35, C-204–C-207, C-337
L
La Boulange Cafe & Bakery, C-339
Lagunitas Brewing Company, C-13
Las Vegas Sands, 271
LEGO Group (Denmark), 3
Lenovo (China), 215
LensCrafters, 371
LexisNexis, 375
LG Corporation, 106, 136
Lidl, C-129
Lifetime cable channel, C-289
Lightlife, C-135
LimeWire, C-112
Limited Brands, C-69
Lincoln Electric Company, 105
LinkedIn.com, 8, 280, C-123, C-163, C-169–C-170
Linksys, 159
Listerine, 136
Little Caesar pizza, 145, C-138, C-251
L. L. Bean, 115
LMP Steel & Wire Company, C-366
Loblaws, C-129
Lockheed Martin Corporation, C-275
L’Oréal, 218, 231, 263
Los Angeles Times, 30, C-331
Lot18, 161
Lotus Cars, Ltd., C-230
http://kendrascott.com/
http://linkedin.com/
Loudr, C-114
Louis Vuitton, 139
Lowe’s Home Improvement Stores, C-35
LTV Steel Corp., C-365
Lucasfilm, C-279, C-281, C-284
Luckin Coffee, Inc., C-350–C-352
Lufthansa Airlines, 339
Lululemon Athletica, Inc., 8, 33
Lululemon Athletica, Inc., Case, C-68–C-85
background of, C-68–C-74
competition, C-82–C-84
COVID-19 pandemic, C-84–C-85
strategy, C-74–C-82
Luxttica eyewear, 176
LVMH, 228
Lyft, 134, 161, 274, C-316, C-319, C-320
M
Macy’s, Inc., C-98
Macy’s, Inc., case, C-51–C-58
background of, C-52
overview, C-52–C-56
profiles of, C-56–C-58
strategic, C-58
Magnatrax Corporation, C-366
Major League Baseball (MLB), C-90, C-96, C-110
Maple Leaf Foods, 171, C-127, C-135
MapMyFitness.com, C-91–C-92, C-94, C-95
Mariano’s Fresh Market, C-129, C-137
Marine Stewardship Council, C-35
Marion Steel Company, C-365
Marriott and Hilton hotels, C-129
Marriott Hotels and Resorts International, C-3, C-332
Marriott International, 146, 371
Marshall’s, 81
Mars, Inc., C-395
Marvel Comics, 230
Marvel Entertainment, C-279, C-281, C-283
Mary Kay Cosmetics (MKC), 84, 368, 372
Maserati, 191
MasterCard International, 46
Match.com, 108
Mayo Clinic, 140, 334
McCann Investments, C-258
McDonald’s, Inc., 12, 188, 197–198, 204, 212, 228, 280, 309, 332–333, 371–372, C-129
McDonnell Douglas, C-274
McKinsey & Company, 303, 344
M. D. Anderson, 140
MediaChain Labs, C-114
Meijer, Inc., C-210
Mercedes-Benz, 136, 147, 303, C-218, C-237
Merrill Lynch, 75, 228, 336
Metro Market, C-137
Michael Kors, 226
Michelin Tires, 70, 136, 188
Microsoft Corp., 64, 67, 100, 136, 179, 330, 353, 369, C-116, C-169
MightyTV, C-114
MillerCoors, C-13
Milwaukee Bucks, C-96
Mitsubishi Corporation, 242, C-374
Mitsui USA, C-373
MKC (Mary Kay Cosmetics), 84, 368, 372
MLB (Major League Baseball), C-90, C-96, C-110
http://mapmyfitness.com/
http://match.com/
page I-5
Modcloth vintage clothing, 170
Modell’s Sporting Goods, C-98
Molson Coors, 70, C-12
Molton Brown, 144
Moncler, 145
Money magazine, 133
Monitor Consulting, 127
Morgan Motors, 136
Morningstar Farms, C-135, C-139
Motel, 6, 143
Motion Picture Association of America (MPAA), C-143
Motorola Mobility, 169, 171, 204, 214, 312, 335
Motor Trend magazine, C-216
MyHabit.com, 161
N
Napster, C-112
NASDAQ, C-34, C-69
National Academy of Television Arts and Sciences, C-187
National Basketball Association (NBA), C-95, C-96, C-104
National Collegiate Athletic Association (NCAA), C-90
National Football League (NFL), C-90, C-95, C-96, C-110
National Highway Traffic Safety Administration (NTSHA), C-216
National Hockey League (NHL), C-90, C-190
National Labor Relations Board (NLRB), C-330
National Relief Charities (NRC), C-63
National Renewable Energy Laboratory (NREL), 112
National Restaurant Association, 87, C-254
Natural Grocers, C-129, C-135
NBA (National Basketball Association), C-95, C-96, C-104
NBC television network, C-355
NBCUniversal, C-147, C-281
NCAA (National Collegiate Athletic Association), C-90. see also Concussions in college and pro football, case
Neiman Marcus, 80, C-62
Nelson Steel, Inc., C-366
Nestlé, 100–101, 188, C-127, C-338
Nestlé, case, C-389–C-404
admits to forced labor, C-397–C-403
background of, C-390
child slavery, C-392–C-395
initiatives to address the issue, C-395–C-397
modern slavery, C-390–C-392
overview, C-389–C-390
Netflix, 67, 76, 172, 349, C-117, C-289
Netflix, case, C-140–C-160
business model, C-149–C-160
business segment reporting, C-156–C-158
content strategy, C-153–C-155
develop and employ viewership tracking, C-153
financing original content and acquisitions, C-158–C-160
overview, C-140–C-141, C-150–C151
strategy of, C-149–C-160
streamed entertainment market and, C-142–C-144
subscription pricing strategy, C-152–C-153
Netgear, 159
NetJets, 161
Newell-Rubbermaid, 74, 188, 241, 243
New Jersey Supreme Court, C-301
News Corp, 223
New Yorker magazine, 106, C-355
New York Federal Reserve Bank, C-48
http://myhabit.com/
NFL (National Football League), C-90, C-95, C-96, C-110
NHL (National Hockey League), C-90, C-190
Nike, Inc., 10, 26, 64, 97, 103, 173, 284, 290, C-60, C-61, C-69, C-70, C-83–C-85, C-99, C-100, C-104–C-108, C-
165
Under Armour versus, C-103–C-104
manufacturing, C-108
marketing, promotions, and endorsements, C-105–C-107
overview, C-104–C-108
products, C-105
resources and capabilities, C-107–C-108
Nikon, C-193–C-194
Niland, C-114
Nissan Motor Co., 106, 290, C-236
NLRB (National Labor Relations Board), C-330
Nokia telecommunications, 204, 214
Nordstrom, Inc., 136, 354, C-57, C-59, C-62, C-83, C-98
Northwestern University, C-71, C-96
Notre Dame University, C-96
Novartis, 271
NPD Group, C-188
NRC (National Relief Charities), C-63
NREL (National Renewable Energy Laboratory), 112
NTSHA (National Highway Traffic Safety Administration), C-216
NTT (Japan), 225
Nucor Corporation, 115, 132–134, 345–346, 368
Nucor Corporation, case, C-354–C-388
acquisitions of, C-364–C-367
background of, C-354–C-359
competition of, C-384–C-387
cost-efficiency of, C-360
cost-efficient production adoption, C-369–C-370
employee relations of, C-378–C-380
as environmental performance leader, C-376
finished steel products of, C-360–C-361
global growth versus joint ventures, C-372–C-373
organization and management philosophy of, C-376–C-377
overview, C-354
pricing and sales of, C-363–C-364
production investments of, C-367–C-369
raw materials strategy of, C-373–C-376
steel as commodity, C-360
steel industry worldwide, C-380–C-384
steel mill products of, C-361–C-363
value-added products strategy of, C-371–C-372
workforce compensation of, C-377–C-378
O
Obvious Corp., C-164
Ocean Spray, 336
Oculus VR, 307
Odeo, C-163–C-164
OECD (Organization for Economic Cooperation and Development), 270
Office Depot, C-36
Old El Paso, 33
Olympic Games, C-96, C-97
Omission Brewing Co., C-15
Open Table, 164
Organic Report magazine, 87
Organic Trade Association, 87
Organization for Economic Cooperation and Development (OECD), 270
Oriental Brewery, C-13
Oriental Land Company (Japan), 197
Oshkosh Corporation, 343
Otis Elevator, 204, 340
OtterBox, C-181
P
Pabst beers, 80
Pacific Gas and Electric, 286
Panasonic, C-228, C-229
Pandora broadcast radio, 13–14, C-118
Papa John’s pizza, 145
Páramo outdoor clothing (UK), 293
Parcast, C-114
PAREXEL research, 179
Paris Disneyland, C-284
Partners in Health, C-63
Patagonia, 106, 289
Paychex, 176
PayPal, 259, C-214
Pelican, C-182
Pemex (Mexico), 177
People magazine, 145
Pepperidge Farm, 173
PepsiCo, 114, 138, 259, 278–279, 286, 290, C-224, C-335, C-336, C-338, C-340
Perdue Farms, C-127
Periscope mobile app, C-165
Perrigo Company Plc, 144
Pesman Art Studio, C-280
PetCo, 103
PetSmart, 103, C-35
Pfizer, Inc., 34, 47, 336
PGA (Professional Golf Association), C-94, C-96, C-178
Philips Electronics, 42
Philips Lighting, 76
Pick’n Save, C-137
Pirate Bay, C-112
Pirelli Tires, 70
Pixar animation studios, C-281, C-283
Pizza Hut, C-251
Plank Industries, C-90–C-91
Polaroid, C-194
Porsche Motors, C-236
Pottery Barn, 307
Poulan, 134
Prada, 81, 136, 310
Preact, C-114
Premier League Football clubs (EU), C-99
Price Club, C-18–C-19
Private Label Manufacturers Association, C-208
Procter & Gamble (P&G), 74, 96, 234–235, 258, 283
Professional Golf Association (PGA), C-94, C-96, C-178
Publix Co., Inc., 114, 371, C-129
Publix Super Markets, Inc., case, C-198–C-211
culture, C-199
financial situation, C-201–C-202
history of, C-198–C-199
mission, commitment, guarantee, and key values, C-199–C-201
profile of, C-205
recognition, C-199
stock market performance, C-202
supermarket and grocery stores industry, C-202–C-205
PUMA’s high-performance culture, 362
page I-6
Q
QualServe Benchmarking Clearinghouse, 111
Queen’s University (Canada), C-214
Quicken Loans, 303
R
Radiolab, C-116
Rainforest Alliance Certified farms, 287
Ralph Lauren Corporation, 139, 167
Ralph’s, C-129, C-137
Rambler’s Way, 167
Recording Industry Association of America (RIAA), C-112
Red Bull, 136
Redhook Brewery, C-15
Reebok, Inc., C-69, C-82, C-108–C-110
Renault-Nissan-Mitsubishi Alliance, 178
Repsol oil production (Spain), 193
Republic Conduit Corporation, C-367
RIAA (Recording Industry Association of America), C-112
The Ringer, C-114
Rio Tinto Group, C-374
Rite Aid, Inc., 144
Ritz Carlton Hotels, 136, 206, 357
Robert Bosch GmbH, 179
Roche Partnering, 179
Rockport shoes, C-109
Rodarte, 8
Rolex, 6, 115, 208
Rolex China Mobile (Switzerland), 3
Rolls-Royce, 12
Ronald McDonald House, 280
Room and Board, 115
Roto-Rooter, 197
Roundy’s, C-137
Royal Bank of Scotland, 255
Royal Canadian Mounted Police, 34
Royal Dutch/Shell, 289
RueLaLa, 161
Rugby Canada, C-96
Ryanair Airlines (Ireland), 115, 134, 339
S
SABMiller, C-7, C-12
Safeway Co., Inc., 114, 144, 148, C-129, C-337
Saint Archer Brewing Company, C-12–C-13
Saks Fifth Avenue, 80, 161
Salesforce.com, 47, 115, 303, 375
Sam’s Club, 144, 153, C-19, C-36
Samsung Group, 64, 179, 214, 259, 273, 312, C-112, C-116
São Paulo soccer team (Brazil), C-96
SAP, 334
SAS, 303
Satyam Computer Services (India), 215
Savage River, Inc., C-124
Save the Children, C-63, C-349
Scotland Yard, 27
http://salesforce.com/
Sears Holdings Corporation, C-57
Sears, Inc., 364, C-23
Seattle’s Best Coffee, C-336
The Seattle Times, C-277
Securities and Exchange Commission (SEC), 271–272, C-38, C-73, C-127, C-187
7-Eleven, 34, 197
Shanda video games (China) Home Depot, 214
Shanghai Disneyland, C-284
Shell Oil Company, 177
ShoeBuy.com, 170
ShopSavvy app, 71
Shougang Corporation (China), C-374
SHOWTIME, C-116
Showtime cable channel, C-148, C-289
Siemens, 336
Siemens Healthcare, 340
SiriusXM broadcast radio, 13–14, 17
Sisley, 177
Six Sigma Academy, 335
Sky entertainment (Europe), C-279
Skyline Steel, LLC, C-366
Sleep Inn, 143
Smithfield Foods, C-127
Smucker’s, 234
Snapchat.com, C-169
Snap, Inc., C-169
Snapper, 64
Sobeys, C-129
SolarCity, Inc., C-215
Solar Energy Industries Association, 112
Sonalytic, C-114
Sonoma County Economic Development Board, C-261
Sonoma State University, C-260, C-315
Sony, Inc., C-116, C-193
SoundBetter, C-114, C-115
Soundtrap, C-114
Soundwave, C-114
South by Southwest (SXSW), C-116
Southeast Asian Fisheries Development Center (SEAFDEC), C-400
Southern Methodist University, C-59
Southland Tube Corporation, C-367
South Pacific Steel Corporation, C-366
Southwest Airline Pilots Association (SWAPA), C-310
Southwest Airlines, 6, 31, 111, 132, 134, 284
Southwest Airlines, case, C-295–C-314
background of, C-296–C-299
compensation and benefits, C-309–C-310
core values—LUV and fun, C-311
culture-building efforts, C-311–C-312
employee productivity and effectiveness, C-311–C-312
employee relations, C-310
executive leadership, C-301–C-302
fare structure strategy, C-303–C-304
financial and operating performance of, C-299–C-301
management style, C-310–C-311
no-layoff policy, C-310
overview, C-295–C-296
promotion, C-309
Rapid Rewards frequent flyer program, C-304
recruiting, screening, and hiring, C-308
robust route network, C-303
superior financial position, C-304–C-306
topnotch travel experience, C-303
training, C-308–C-309
Space Exploration Technologies, C-214
SpaceX, 35
http://shoebuy.com/
http://snapchat.com/
Speedo International, C-70
S&P 500 index, C-166, C-167
Spirit Airlines, 134, 159
Sport Obermeyer, 314
Sports Authority, C-98
Sports Illustrated magazine, 145
Spotify Technology S.A., C-112–C-123
acquisitions, C-113–C-115
artists and “music for you platform,” C-120
company history, C-112–C-113
competitors, C-118
financial performance, C-121–C-123
growth year by year, C-113
IPOs and cumbersome, C-113
Originals & Exclusives (“O&E”) content, C-118–C-119
partnerships, C-115–C-117
royalties, artist compensation and, C-119–C-120
use of big data, C-117–C-118
web image matters, C-119
Sprouts Farmer’s Market, C-129, C-135
Spyder, 314
Square, Inc., C-317
Staples, Inc., 70, 291, C-35
Starbucks Foundation, C-337, C-348, C-349
Starbucks Global Farmer Fund, C-348
Starbucks, Inc., 3, 47, 108, 138, 188, 204, 282, 290, 319, 371
Starbucks, Inc., case, C-325–C-353
airport strategy, C-340–C-341
availability of order delivery, C-340
coffee market leadership in China, C-350–C-352
coffee purchasing strategy, C-345–C-346
coffee roasting operations, C-346–C-347
as coffee, tea, and spice company, C-328
competitive challenge from Luckin Coffee, C-352
corporate social responsibility strategy, C-347–C-349
expansion beyond Pacific Northwest, C-331
internal organization arrangements, C-339–C-340
mission and values, C-344–C-345
1988 to 2018, C-341–C-344
overview, C-325–C-326
as private company, C-330–C-331
Schultz’s purchase of, C-328–C-330
store ambience, C-334
store design, C-332–C-334
strategy of, C-335–C-346
Starwood Hotels and Resorts Worldwide, 108, C-3
Starz cable channel, C-145, C-289
St. Jude Children’s Research Hospital, 28
Stop & Shop, C-129
Strategic Planning Institute’s Council on Benchmarking, 111
Stride Rite, 134
Studio 360, C-116
Subway, C-129
Sumitomo Metal Industries, C-365
Sundaram Fasteners (India), 215
Sun Pharmaceuticals, 157
Sun Power, 112
Super Bowl, 127
Super 8 motels, 143
Surfers against Sewage, C-64
Suzuki Motor Co., 213
Swatch watches, 8
Sycamore Development Co. (Plank Industries), C-91
SYSCO Corporation, C-129, C-335
page I-7
T
Taco Bell, C-185, C-255
Target Stores, Inc., 8, 74, 153, C-23, C-35, C-56–C-57, C-74, C-129, C-165, C-337
Tata group, 239
Tata Steel (India), 3
TaylorMade Golf, C-109
Tazo Tea, C-336
TD Ameritrade, 75, 314
Teavana Tea, C-338–C-339
Technavio Research, C-190
Televisa (Mexico), 215
Tencent (China), 214, C-116
Tervis Tumbler Co., C-180–C-181
Tesco, C-129
Tesla Motor Corp., 8, 35, 76, 106, 115, 142, 175, 184
Tesla Motor Corp., case, C-212–C-237
background of, C-213–C-220
battery pack, C-228–C-229
challenges to, C-218
control and infotainment software, C-229–C-230
COVID-19 pandemic, C-233–C-234
design and engineering, C-230
distribution strategy, C-225–C-228
in global automotive industry, C-235–C-237
leasing activities, C-233
manufacturing strategy, C-230–C-232
marketing strategy, C-232–C-233
Model S and Model X, C-216–C-217
power electronics, C-229
product line strategy, C-222–C-225
regulatory credit sales, C-233
strategy overview, C-221–C-234
supply chain strategy, C-232
technology and product development strategy, C-228
Tesla Energy, C-234–C-235
in 2020, C-220–C-221
Texas Aeronautics Commission, C-296, C-297
Texas A&M University, C-2, C-7, C-51, C-68, C-109, C-173, C-184, C-279
Texas Tech University, C-96, C-173
Textile Exchange, C-64
Textron, 240
TGI Friday’s, C-129
3M Corporation, 31, 136, 264, 372
Ticketmaster, 184
Tiffany & Co., 171, 192, 208
Time Warner, C-145, C-146
Tim Horton’s, C-129
Tinder.com, 165
TJ Maxx, 81, 115
TJX Companies, Inc., 319–320
Tofurky, C-135
Tokyo Disneyland, C-281
Tommy Hilfiger, 173
TOMS Shoes, 29–30, 284, 289, C-73
TOMS Shoes, case, C-59–C-67
background of, C-59–C-60
COVID-19 pandemic, C-64–C-65
financial success of, C-98–C-99
industry background, C-60–C-61
social responsibility of, C-61–C-63
Toro, 64
Toronto Exchange, C-69
http://tinder.com/
Toyota Motor Co., 105, 111, 123, 139, 147, 306, C-231, C-236, C-237
Trader Joe’s, 148, 357, C-35, C-135
Trico Steel Company, C-365
Tsingshan Group Holdings, C-384
Tuck School of Business, Dartmouth College, C-59
Tune Hotels, 161
Tupperware, 372
Turing Pharmaceuticals, 365
21st Century Fox, 273, C-279–C-281, C-284
Twitter.com, 76
Twitter.com, case, C-161–C-172
brand image, C-164–C-165
competitors, C-167–C-170
financial performance, C-171–C-172
history of, C-161–C-164
restructuring, C-166–C-167
services, products and revenue streams, C-165–C-166
2020 performance of, C-171–C-172
Tyson Foods, 291, C-127, C-135
U
Uber Technologies, 29, 134, 161, 274, 341
Uber Technologies, case, C-315–C-324
business operations, C-320
California’s AB5, C-321
challenges of, C-316
competition, C-319–C-320
controversies over years, C-320–C-321
decision making, C-321–C-323
history of, C-317–C-318
key industry players, C-317
market size and forecasted growth, C-316–C-317
overview, C-315–C-316
target market, C-318–C-319
UCLA (University of California at Los Angeles), C-96
Udacity, 76
Under Armour, 10, 64, 173, C-82–C-83
Under Armour, case, C-86–C-111
competition: adidas Group, C-108–C-110
competition: Nike, Inc., C-104–C-108
distribution strategy in 2018 of, C-98–C-100
financial performance, C-102
growth strategy in 2020 of, C-92
inventory management in, C-101–C-102
marketing, promotion, and brand management strategy in 2018 of, C-95–C-98
overview, C-86–C-87
product design and development strategy in 2018 of, C-110–C-101
sourcing, manufacturing, and quality assurance in, C-101
UN Global Compact, 288
UNICEF, C-63, C-240
Unilever, 131, 204, 212, 286–288, C-335, C-336, C-339
Unilever, case, C-238–C-248
background of, C-238–C-239
challenges to, C-244–C-248
embedding sustainability, C-239–C-243
profit, C-243–C-244
Union Square Hospitality, C-257
United Airlines, 273, C-274
United Colors of Benetton, 177
United Nations Guiding Principles on Business and Human Rights (UNGPs), C-392
United Parcel Service, Inc., C-224
United States Army, C-280
United States Library of Congress, C-280
http://twitter.com/
http://twitter.com/
page I-8
Universal Studios, C-280
University of Alabama, C-18, C-68, C-86, C-124, C-140, C-212, C-295, C-325, C-354
University of California, C-96
University of Liverpool, C-51
University of Maryland, C-88, C-91, C-125
University of Miami, C-109
University of Michigan, C-134, C-250
University of Missouri, C-96, C-125
University of Pennsylvania, C-214
University of South Alabama, C-161, C-173, C-184, C-198
University of South Carolina, C-96
University of the Incarnate Word, C-112, C-173
University of Utah, C-96
University of West Florida, C-198
University of Wisconsin, C-96
UN Millennium Development Goals, 288
UPS, Inc., 102, 197, 339
Urban Outfitters, Inc., 121, C-59
USAA insurance, 154
US Agency for International Development, C-389
US Airways, 168
U.S. Army Medical Command, 34
U.S. Department of Energy, C-214
U.S. Department of Labor, C-395
U.S. Department of Transportation, C-309
U.S. Environmental Protection Agency (EPA), 44, C-233
US Foodservice, C-335
U.S. House of Representatives, C-298
U.S. Naval Academy, C-96
U.S. News & World Report, C-299
U.S. Postal Service, 339
U.S. Steel Corp., C-386–C-387
U.S. Supreme Court, 84, C-296
U.S. Women’s National Soccer Team, C-97
UTV, C-284
V
Valve Corporation, 325, 333
Vanguard investments, 133, 154
Vault.com, 369
Vector Products, 234
Verco Manufacturing Co., C-366
Verge, The, C-187
Verizon, Inc., 34, C-146
VF Corporation, 261
Viacom, C-148–C-149
Victoria’s Secret, C-83, C-84
Virgin Atlantic Airlines, 267
Visa credit card systems, C-336
Vision Spring, 283
Volkswagen AG, 29, 43–44, 47, C-236
Volvo Motor Co., C-236
Vulcraft Corporation, C-360
W
Walgreens Boots Alliance, 200
Walgreens, Inc., 144, 199–200, 218
http://vault.com/
Walmart Stores, Inc., 6, 70, 74, 80, 132, 134, 144, 153, 169–170, 368, 370–371, C-19, C-23, C-57, C-129, C-174,
C-204, C-224, C-337
Walt Disney Company, 3, 197, 209, 223, 230, 281, 371, C-145–C-146
Walt Disney Company diversification, case, C-279–C-292
corporate strategy of, C-284
direct-to-consumer and international, C-287–C-288
history of, C-280–C-283
media networks of, C-285–C-287
overview, C-279–C-280
parks, experiences and products of, C-285–C-285
performance of, C-283–C-292
studio entertainment business of, C-288–C-291
Walt Disney World Resort, C-281, C-284
Warby Parker, 103, 173, 282–283, 293
Warner Media, C-146–C-147
Washington Post, C-208
Waterford Crystal, C-25
Wayfair.com, 363
Waymo (Alphabet), 159
WeChat messenger app (China), 215–216
Wegmans Food Markets, 343–344, 349, C-129
Weinstein Company LLC, 273
Wells Fargo Bank, 34, 275, 287
Welsh Rugby Union, C-96
Wendy’s restaurants, 313
Westbeach Sports, C-68
WhatsApp.com, 108, C-169
WH Group, C-135
Whirlpool, 136, 208–209
WhiteSpot, C-129
WHO (World Health Organization), C-84, C-253
Whole Foods Market, 26, 144, 287–289, C-125–C-126, C-129, C-135, C-210–C-211
Widmer Brothers Brewing, C-15
Williams-Sonoma, 307
Wipro (India), 157
W. L. Gore & Company, 101, 354, 371
WNYC Studios, C-116
World Health Organization (WHO), C-84, C-253
World Resources Institute (WRI), C-134
Worthington Industries, C-365
X
Xbox, C-112
XcelHR, 176
Xcel Mobility, Inc., C-317
Xerox, Inc., 100, 111
Y
Yahoo.com, 31, C-169
Yamaha Corporation, 230, 239
Yardi Systems Inc., C-269, C-271
Yelp.com, 363, C-4
Yeti Holdings, Inc., C-173–C-183
financial condition, C-178
global sales, C-177
Innovation Center, C-177–C-178
IPO and stock, C-174
numerous small brands, C-182
outdoor and recreation products market, C-178
partnerships, C-178
http://wayfair.com/
http://whatsapp.com/
http://yahoo.com/
http://yelp.com/
product line of, C-175–C-176
sales channels, C-176–C-177
strategic situation in mid-2020, C-183
strategy of, C-174–C-175
Yoga Journal, C-74
YouGov Brand Index, 148
YouTube.com, 145, C-118, C-143, C-144, C-149, C-160
YPF oil production (Argentina), 193
Yuengling beers, 80
Yum! Brands, 197, C-256
Z
Zandbergen World’s, C-126
Zappos.com, 29, 115, 170, 283, 303, 357
Zara apparel, 309–310, 324
Zipcar, 142
http://youtube.com/
http://zappos.com/
page I-9
Name Index
A
Abboud, Leila, C–248
Acitelli, T., C–17
Acton, Brian, C–169
Agle, Bradley R., 295
Ahlstrand, Bruce, 48
Ahuja, G., 265
Alexander, Marcus, 223, 265
Allison, Ritch, C–249–C–250, C–254, C–258–C–259
Alvarez, Camelo, C–96
Ambroé, Milan, 350
Amini, Alen A., 274
Amit, R., 124
Amsden, Davida M., 350
Amsden, Robert T., 350
Anderson, Christy, C–260
Anderson, Eric T., 18
Anna, Issy, C–256–C–257, C–259
Anslinger, Patricia L., 185, 265
Antony, Jiju, 350
Anumonwo, Charles K., 165
Arcieri, Katie, C–259
Argandoa, Antonio, 294
Armin, C–172
Arnold, David J., 220
Arnott, Nina, C–257
Ascari, Allessio, 350
Austin, Nancy, C–388
Avins, Jenni, 283
B
Badal, Alen, C–51
Badaracco, Joseph L., 376
Badrinath, Dipti, 170
Bailey, Wendy J., 294
Bain, J. S., 88
Baires, Alex, C–178
Baldwin, Jerry, C–328
Ballard, John, C–259
Band, David C., 350
Barbieri, Scott, C–178
Barkema, H., 265, 326
Barney, Jay B., 18, 124, 376
Barrett, Colleen, C–302
Barringer, Bruce, 48
Barthélemy, Jérôme, 185
Bartlett, Christopher A., 124, 185, 220, 326, 376
Basin, Kim, C–85
Batato, Magdi, C–389, C–397, C–400
Bates, Tony, C–188
Baum, J., 326
Baun, William B., 295
Beauchamp, T. L., 294
Beckard, Richard, 326
Beckham, David, C–110
Beckham, Victoria, 8
Benioff, David, C–155
Benner, K., C–6
Bennett, Drake, 145
Bergen, Mark E., 124, 184
Berger, Sephanie K., 148
Berlin, Lorin, 294
Berry, Leonard L., 295
Bettcher, Kim Eric, 294
Bezos, Jeff, 35, 324–325, 341, 370
Bhattacharya, Arindam K., 220
Bird, Larry, C–165
Blank, Arthur, 159
Bleeke, Joel, 220
Blue, Allen, C–169
Bluedorn, Allen C., 48
Boeing, William E., C–273
Boldin, Anquan, C–96
Bolman, Lee, 21
Bosa, D., C–6
Bossidy, Larry, 326, 376
Bower, Joseph L., 48, 185
Bowie, N. E., 294
Bowker, Gordon, C–328
Bowman, Jeremy, C–41
Boyle, M., 344
Bradsher, Keith, 312
Brady, Tom, C–96, C–98
Branagh, Nicole, C–97
Brandenburger, A., 18
Branson, Richard, 267
Brees, Drew, C–107
Brinkman, Johannes, 294
Brin, Sergey, 24, C–213
Bromiley, Philip, 47–48
Brooker, Katrina, C–314
Brotman, Jeff, C–19, C–22
Brown, Ethan, C–124–C–125, C–127, C–129
Brown, M., C–324
Brown, Patrick, C–138
Brown, Robert, 47–48
Brown, Shona L., 18
Brugmann, Jeb, 294
Brumley, James, C–211
Brunson, Rochelle R., C–43, C–273
Brush, T., 265
Bryant, Chris, 44, C–110
Bryant, Kobe, C–107
Bryce, David J., 184
Buckley, P. J., 219–220
Buffett, Warren, 35
Bündchen, Giselle, C–97
Burcher, Peter, 350
Burdakin, Anne, C–249, C–259
Burke, Ronald J., 350
Burke, Steven, C–147
Burnah, Phillip, 326, 350
Burns, Lawton R., 350
Burton, R. M., 326
Byrne, John, 326
Byrnes, N., 346, C–388
page I-10
C
Cai, K., C–324
Calhoun, David, C–277
Caliguiri, Paula M., 350
Cameron, S., C–6
Campbell, Andrew, 223, 265, 326
Camp, Garrett, C–315, C–317
Camp, Robert C., 125
Canfield, Jack, 3
Cannella, A., 265
Capron, L., 200, 326
Carasco, Emily F., 376
Carter, John C., 376
Carver, John, 48
Cavanagh, Roland R., 350
Cescau, Patrick, C–239
Chafkin, Max, 283
Champy, J., 350
Chandler, A., 326
Chapek, Bob, C–280–C–281, C–292
Charan, Ram, 326, 376
Cha, Sandra E., 376
Chatain, O., 185
Chatham, Jennifer A., 376
Chatterjee, S., 265
Chen, Chia-Pei, 294
Cheney, Lauren, C–97
Chen, Ming-Jer, 185
Chen, Roger, 294
Chesky, Brian, C–2–C–7
Chilkoti, Avantika, 219
Christensen, Clayton M., 18, 350
Ciechanover, A., 133
Clancy, Tom, C–145
Clark, Delwyn N., 376
Clarke, Joe Sandler, C–403
Clark, Robert C., 48
Coleman, Jenna, C–211
Coleman, W. C., C–182
Collins, James C., 47, 295
Collins, Jim, 297, 326
Collis, David J., 47–48, 265
Cook, D., C–324
Cooley, Brian, C–139
Cooper, Bradley, 145
Cooper, Robin, 125
Copeland, Misty, C–97–C–98
Copeland, Thomas E., 265
Correa, Carlos, C–110
Coster, Danny, C–197
Coster, Katherine, 200
Cotter, Frank, C–181
Covin, Jeffrey G., 48, 185
Cowlings, Al, C–48
Coyne, Kevin P., 185
Crandall, Jacob M., 44
Cremer, Andreas, 44
Cromme, Gerhard, 44
Crosby, Philip, 350
Cucuzza, Thomas G., 125
Curry, Stephen, C–94, C–97–C–99
Cusumano, M. A., 185
D
Daley, Robin A., 337
Dalton, Matthew, C–388
Danziger, Pamela N., C–58
Darr, Eric D., 350
D’Aveni, Richard, 184
Davidson, Hugh, 25, 47
Davidson, Wallace N., 294
Davis, Howlett, C–181
Davis, Scott, 184
Dawar, Niroj, 220
Day, Christine M., C–70–C–71, C–73
Dayton, Nick A., 350
Deal, Terrence E., 376
Dechant, Kathleen, 294
DeGeneres, Ellen, C–116, C–161, C–165
Dekkers, Marijn, C–243
Deshpandé, Rohit, 294
DeVarti, Dominick, C–250–C–251
Devinney, Timothy M., 294
Dezember, R., 200
DiCaprio, Leonardo, C–125
Dienhart, John W., 278
DiMicco, Daniel, 346, C–355, C–370
Disney, Roy O., C–281
Disney, Walt, 223
Donaldson, Gordon, 48
Donaldson, Thomas, 294
Donovan, F., C–324
Dorsey, Jack, C–161, C–163–C–164, C–166
Dosi, G., 326
Douglas, Donald, C–273
Doyle, Patrick, C–254
Doz, Yves L., 185, 220, 265
Dranikoff, Lee, 265
Drucker, Peter F., 265
Ducharme, Jamie, C–259
Duhigg, Charles, 312
Dunfee, Thomas W., 294
Durante, Kathleen T., 33
Durant, Kevin, C–97, C–107, C–111
Dussauge, P., 219, 326
Dutta, Soumitra, 350
Dyer, Jeffrey H., 184–185, 220
E
Eaglesham, J., C–6
Eberhard, Martin, C–213–C–214
Edison, Thomas, 51
Eichenwald, Kurt, 294, 376
Eisenhardt, Kathleen M., 18, 124, 265
Eisenstat, Russell, 124, 326
Eisner, Michael, C–281
Ek, Daniel, C–112, C–123
Elfenbein, Hillary A., 295
El-Jelly, Abuzar, 294
Embiid, Joel, C–96
Emerson, Ralph Waldo, 15
Entine, Jon, C–403
Erdogan, Recep, C–161
Ernst, David, 220
Evanson, Jeff, C–237
Ewing, Steve, C–50
F
Faheem, Hadiya, C–249
Fahmy, D., C–6
Fallon, Jimmy, C–164
Fantozzi, Joanna, C–259
Farkas, Charles M., 376
Farrell, Emily, C–315
Farrell, M., C–6
Faulkner, Lyndon, C–182
Fawcett, Stanley E., 326, 350
Federer, Roger, C–107
Felix, Allyson, C–83
Ferratt, Thomas W., 350
Ferrier, W. J., 184
Ferriola, John J., C–356, C–369, C–385
Fiegenbaum, Avi, 88
Fingus, John, C–139
Fleming, Molly, C–248
Florin, Larry, C–260–C–262, C–267–C–268, C–271–C–272
Floyd, Steven, 326
Foote, Nathaniel, 124, 326
Ford, Henry, C–43–C–44
Ford, William Clay, Jr., C–45
Fournette, Leonard, C–96
Francis, Pope, C–161
Franko, Lawrence G., 265
Freiberg, Jackie, C–314
Friedman, Josh, C–237
Friedrich, Bruce, C–138
Frisk, Patrik, C–88, C–91
Frojo, Renee, C–85
Frost, Tony, 220
Fulks, Kip, C–88
Furnari, C., C–17
G
Galanti, Richard, C–32, C–208
Galunic, D. Charles, 265
Gamble, John E., C–2, C–7, C–51, C–184, C–279, C–295
Garcia, Tonya, C–139
Garrette, B., 219
Garvin, David A., 48
Garza, Diana R., C–112, C–173
Gates, Bill, 353
Gennette, Jeff, C–51–C–52, C–58
George, S., 350
Ger, Guitz, 220
German, Kent, C–278
Germano, Sara, C–111
Geroski, Paul A., 185
Gerstner, Louis, 353
Ghanem, George, C–237
Ghemawat, Pankaj, 220
Ghoshal, Sumantra, 124, 185, 220, 326, 376
Gibson, Kelly, C–63
Gilbert, Clark G., 48
Gilinsky, Armand, Jr., C–260, C–315
page I-11
Glaister, K. W., 219–220
Glass, Noah, C–163–C–164
Glover, J., 265
Goffee, Robert, 376
Goldberg, Alan B., C–41
Golden, Timothy D., 294
Goldsmith, Marshall, 326
Goleman, Daniel, 376
Goodman, Paul S., 350
Goold, Michael, 223, 265, 326
Gordon, Joseph, 350
Gordon, Mary Ellen, 88
Gordon, M. Joseph, Jr., 350
Govindarajan, Vijay, 125
Graves, Ryan, C–317
Greatorex, Vedrana B., 133
Green, Dennis, C–111
Greenfield, R., C–6
Greenfield, W. M., 294
Greenhouse, Steven, C–41
Griffin, Brian, C–389
Griffith, E., C–6
Grimm, C. M., 184
Grind. K., C–6
Grono, Nick, C–398
Grove, Andy, 187
Guericke, Konstantin, C–169
Guido, Patrick, C–74
Guilford, Gwynn, 216
Gulland, Anne, C–259
Gunnarson, Sarah, K., 376
H
Haglage, Abby, C–403
Hall, Graham, C–244, C–248
Hambrick, Donald C., 185, 265
Hamby, Chris, C–278
Hamel, Gary, 185, 220, 265
Hammer, M., 350
Hansen, Suzy, 310
Hanson, James, 241
Harden, James, C–97, C–110–C–111
Hariharan, S., 88
Harper, Bryce, C–96
Harrison, Josh, C–110
Harris, Randall D., C–68
Hart, Maria, 237
Haspeslagh, P., 265
Hastings, Reed, C–149, C–151–C–152, C–154–C–156, C–158, C–160
Haugh, Meaghan I., 216
Hawthorne, Mark, C–403
Hayes, Robert H., 91, 326
Hayibor, Sefa, 295
Hayward, M. L. A., 265
Heeley, Michael B., 185
Heifetz, Ronald A., 376
Helfat, Constance E., 124–125, 326
Hempel, J., C–324
Hendricks, Kevin B., 48
Henriques, Adrian, 294
Herrera, S., C–324
Herrera, Tilde, 294
Heskett, James L., 350, 376
Hesselbein, Frances, 326
Hewitt, Ben, C–181
Hewlett, Bill, 31
Hewson, Marillyn, 35
Hill, Ronald Paul, 281
Hindo, Brian, 350
Hodgetts, Richard M., 350
Hoffmann, Melissa, C–238, C–248
Hoffman, Reid G., C–123, C–169
Hogan, Laurie Lynn, C–270
Holan, Michael, C–259
Holpp, Larry, 350
Homkes, Rebecca, 326
Hood, Robin, C–293–C–294
Hoopes, D., 18
Horn, John, 185
Hostetter, Martha, 337
Hottovy, R. J., C–254
House, Charles H., 47
Hout, Thomas M., 376
Hubbell, Victoria, 376
Hughes, Chris, C–167
Hult, G., 326
Humble, John, 376
Hutchins, Michele, 127
I
Iacobucci, Dawn, 125
Iger, Robert, C–279, C–281, C–285, C–292
Infante, J., C–17
Inkpen, A., 185
Iverson, F. Kenneth, C–354–C–355
Iwerks, Ub, C–280
J
Jackson, Amy Elissa, 362
Jackson, David, 376
James, LeBron, C–107
Jassawalla, Avan R., 376
Jay Z, C–113, C–118
Jelinek, Craig, C–18–C–19, C–22, C–24–C–25, C–27, C–32, C–41
Jemison, D., 265
Jenkins, George, C–198–C–200
Jenk, Justin, 185
Jennings, Brandon, C–96
Jobs, Steve, 329, 368
Johar, Samuel, C–244, C–246–C–247
Johnson, Dwayne, C–97–C–99
Johnson, Kevin, C–326, C–349
Johnson, Mark W., 18
Johnson, Ron, C–58
Jones, Gareth, 376
Jope, Alan, C–238, C–243–C–244
Jordan, Michael, C–61, C–107, C–117
Joseph, David J., C–358, C–368, C–369, C–375
Juran, J., 350
Justin, B.J., C–110
K
Kagermann, Henning, 18
Kahaner, Larry, 88
Kalanick, Travis, 274, C–315, C–317–C–318, C–320
Kale, Prashant, 185, 220
Kanai, Tsutomu, 187
Kanazawa, Michael T., 376
Kanter, Rosabeth Moss, 185, 220, 326, 376
Kaplan, Robert S., 48, 125
Karim, S., 326
Katila, R., 265
Kaufman, Rhonda, 48
Kaufman, Stephen P., 48
Keighley, M. P., C–272
Kelleher, Herb, C–296, C–298–C–299, C–301, C–308
Kelly, Gary C., C–302, C–306, C–310, C–313
Kelso, Alicia, C–259
Kendall, J., C–17
Kennedy, A. A., 376
Kerr, Steven, 350
Kershaw, Clayton, C–97
Kestenbaum, David, C–237
Khanh, Vu Trong, C–388
Khanna, Tarun, 220
Khatri, Bhumika, C–259
Khosrowshahi, Dara, C–315, C–318, C–321, C–323
Kimberly, John R., 350
Kim, W. Chan, 47, 185
King, Martin Luther, Jr., 267, 353
King, Rollin, C–296, C–301
Klebnikov, Sergei, C–237
Kline, Daniel B., C–259
Knight, Phil, 290
Koch, James, C–12, C–14
Koenig, David, C–278
Koller, Tim, 265
Kotler, Philip, 185
Kotter, John P., 25, 350, 376
Koum, Jan, C–169
Kowitt, Beth, 148, C–85
Kramer, Mark R., 294–295
Krieger, Mike, C–169
Kumar, N., 220
Kwak, Mary, 184
L
Lachenauer, Rob, 184
Laden, Osama Bin, C–165
Lady Gaga, C–164
Lagon, Mark, C–400
Lambert, Fred, C–237
Lampel, Joseph, 48, C–293
Lanzolla, Gianvito, 185
LaRose, Jason, C–111
Laurie, Donald L., 376
Lawrence, Anne T., 294
Lawrence, Sadé, 344
Lawson, Renee, C–210
Leahey, Colleen, C–85
Lee, Hau L., 125
Lee, Nicole, C–139
page I-12
Lee, Terry Nels, 350
Lemak, David J., 350
Lepitak, Stephen, C–248
Levesque, Lynne C., 48
Levicki, C., 326
Lieberthal, Kenneth, 220
Liedtka, Jeanne M., 265, 326
Lillard, Damian, C–110
Liptak, Andrew, C–160
Little, Royal, 240
Littman, Julie, C–259
Liu, John D., 297
Lorentzon, Martin, C–112
Lorsch, Jay W., 48, 376
Lozano, Jaview, 143
Lubatkin, M., 265
Lucas, Amelia, C–259
Lucas, George, C–279
Luhby, T., C–17
Ly, Eric, C–169
M
Macauley, Margaret W., 312
Mackey, John, C–210
MacMillan, Ian C., 184–185
Maddock, Angharad, C–257
Maddox, Bonnie, C–269
Madhok, Anoop, 185
Madoff, Bernie, 277
Madsen, T., 18
Magretta, Joan, 18
Mahomes, Patrick, C–110
Main, Jeremy, 220
Ma, Jack, 35, 216
Majchrzak, Ann, 350
Mangalindan, J., C–324
Mannix, E., 326
Marcus, Bernie, 159
Margolis, Joshua D., 294–295
Marie, Savannah, C–160
Markides, Constantinos C., 265
Markides, Costas, 18, 185
Martin, J., 124
Martin, T., 200
Marx, Matt, 350
Mather, Shaffi, 127
Mattoili, Dana, C–85
Mauborgne, Renée, 47, 185
Mayer, Marissa, 31
Mayers, Rakim, C–97
Maze, Jonathan, C–259
McCann, James, C–258
McCarthy, Barry, C–113
McCawley, Tom, 295
McCollum, Andrew, C–167
McDonald, Calvin, C–68, C–73–C–74, C–85
McDonald, Craig, C–85
McGrath, Rita Gunther, 184
McGregor, J., 346
McIntyre, Douglas A., C–111
McIvor, Ronan, 185
McKenzie, Brian R., 206
McNeany, Annie, C–268–C–270
Meers, Robert, C–69
Meij, Don, C–252
Meijer, Hendrik, C–210
Menkes, Justin, 326
Menor, Larry, 48
Messi, Lionel, C–110
Michael, David C., 220
Mickle, T., C–6
Miles, Morgan P., 48
Miles, Robert H., 376
Miller, C., 48
Miller, Danny, 124, 326
Miller, Ronald, C–281
Milne, George R., 88
Milne, Richard, 44
Minichiello, S., C–272
Mintzberg, H., 326
Mintzberg, Henry, 18, 48
Mintz, Charles, C–280
Mirobito, Ann M., 295
Mitchell, Tom, 219
Mitchell, W., 200, 219, 326
Mitts, Heather, C–97
Mokwa, Michael P., 88
Moline, Jeff, C–270
Monaghan, James S., C–250
Monaghan, Thomas S., C–250–C–251
Montgomery, Cynthia A., 18, 48, 88, 91, 124, 265, 376
Montgomery, Joseph C., 350
Moody, Rebecca, C–160
Moore, Daryl, C–330
Moskivitz, Dustin, C–167
Mroz, John Edward, 326
Muilenberg, Dennis, C–277
Mukherji, Biman, C–388
Murphy, Kevin, C–198
Murphy, Patrick E., 376
Muse, Lamar, C–296–C–298
Musk, Elon, 35, C–212–C–218, C–222, C–224–C–225, C–230, C–232, C–234
Mycoskie, Blake, 30, C–59–C–61, C–64–C–67
N
Nadal, Rafael, C–107
Nadler, David A., 48
Nakamura, Y., C–6
Nelson, R., 326
Ness, Joseph A., 125
Neuman, Robert P., 350
Newey, Sarah, C–259
Newson, Gavin, C–262
Niles-Jolly, Kathryn, 376
Noble, Breanna, C–50
Noble, Charles H., 88
Nohria, Nitin, 376
Nordhielm, Christie, 125
Norton, David P., 48
Nunes, Keith, C–259
O
Obama, Barack, C–165
O’Bannon, Douglas P., 295
Obel, B., 326
O’Connell, B., C–324
Oelkan, Ediz, C–49–C–50
Ogg, Jon C., C–111
Ohmae, Kenichi, 51
Olian, Judy D., 350, 376
Olsen, Dave, C–330
Olsen, E., 326
Olusoga, S. Ade, 88
O’Reilly, Charles A., 350
Osaka, Naomi, C–110
Osegowitsch, Thomas, 185
O’Sullivan, Mathew, 112
P
Paccamonti, Sara, 310
Page, Larry, 24, C–213
Paine, Lynn Sharp, 220, 294, 376
Palepu, Krishna G., 220
Pande, Peter S., 350
Pan, Y. G., 185
Parker, James, C–301–C–302
Pastermack, Alex, 216
Pasztor, Andy, C–278
Patterson, Scott, C–388
Peck, Emily, 294
Perry, Katy, C–161, C–165
Peteraf, Margaret A., 18, 124, 326, C–59
Peters, Bill, C–259
Peters, Tom, C–388
Peyster, Byron G., 288
Pfeffer, Jeffrey, 350, 376
Phelps, Michael, C–97–C–98
Phipps, Paul, C–111
Piëch, Ferdinand, 44
Pisano, Gary P., 91, 124, 185, 326
Plank, Kevin, C–86–C–88, C–90–C–91, C–93–C–95, C–100
Plank, Scott, C–88
Poetsch, Hans Dieter, 44
Polman, Paul, 288, C–238–C–239, C–243
Porrras, Jerry I., 47, 295
Porter, Michael E., 3, 18, 21, 58, 81, 88, 110, 125, 127, 189–190, 294–295, C–324
Poseley, Tara, C–71
Posey, Buster, C–96
Post, James E., 294
Pota, Pratik, C–255
Potdevin, Laurent, C–73
Powell, Thomas C., 350
Power, J. D., C–299
Prahalad, C. K., 185, 220, 294
Premji, Azim, 157
Prescott, Gregory L., C–198
Preston, Lee E., 295
Price, Raymond L., 47
Price, Sol, C–18–C–19
Priem, Richard L., 154
Pritzker, Nick, C–213
Purkayastha, Debapratim, C–238, C–249, C–389
Putnam, Howard, C–298
Q
Quelch, John A., 220
Quinn, James Brian, 350, 376
Qumer, Syeda Maseeha, C–238, C–389
R
Rafat, Ali, C–5
Rana, P., C–6
Rao, Ashkay R., 184
Reed, John, C–237
Reed, Marlene M., 162, C–43, C–273
Reed, Richard, 350
Reich, Jeremy P., 283
Reichow, G., 175
Reid, Joanne, 376
Reintjes, Matthew, C–173, C–177
Reiss, Dani, 145
Resor, Carry S., 30, C–59
Rhoads, Gary K., 326, 350
Richardson, Curt, C–181
Richardson, Sandy, 48
Ridderstrale, Jonas, 326
Rihanna, C–164–C–165
Ritter, Bill, C–41
Rivkin, Jan, 18
Robert, Michel, 25, 47
Roberts, D., C–17
Robins, J. Max, C–41
Rock, Melinda, 350
Rodgers, Aaron, C–110
Rodriguez, S., C–6
Roll, R., 265
Roman, Ronald M., 295
Ronaldo, Cristiano, C–107
Rose, Derrick, C–110
Rossmann, R., C–272
Rothschld, William E., 185
Rui, H., 220
Rukstad, Michael G., 47
Rynes, Sara L., 350, 376
S
Sacks, David, C–214
Sage, A., 175
Salam, R., C–272
Samedi, Faaez, C–403
Santry, Arthur J., 145
Sanyal, Rajib, 294
Sashittal, Hemant C., 376
Sathe, Vijay, 376
Saverin, Eduardo, C–167
Scanlan, Gerald, 350
Scarlett, Will, C–293
Schermerhorn, John R., 278
Schlangenstein, Mary, C–314
Schmidt, Brad, C–185
Schmidt, Doug, C–177
page I-13
Schmidt, Eric, 336
Schneider, Anton, 265
Schneider, Benjamin, 376
Schoemaker, P., 124
Schultz, Howard, C–326, C–328–C–331, C–338, C–341–C–344, C–347, C–353
Schwartz, Jan, 44
Schwartz, Mark S., 294, 376
Schweitzer, Tamara, C–67
Scott, Nate, C–111
See, K., 48
Seemuth, Mike, C–237
Seepersaud, Steve, C–111
Seiders, Roy, C–173–C–174
Seiders, Ryan, C–173–C–174
Shana, Lebowitz, 30
Shanghvi, Dilip, 157
Shank, John K., 125
Shapiro, Nina, C–41
Shaw, Gordon, 47–48
Shaw, Hollie, 145
Shein, Edgar, 376
Shih, Willy C., 185, 326
Shleifer, A., 265
Shuen, A., 124
Siater, S., 326
Siegel, Zev, C–328
Silberman, Edward J., 175
Simester, Duncan, 18
Simmon, Bill, C–115
Simmons, J. C., 337
Simons, Robert, 326, 350
Simpson, O.J., C–48
Sims, Ronald R., 294
Sinclair, Cameron, 267
Sinegal, Jim, C–18–C–20, C–22–C–25, C–32–C–33
Singh, Ayush, C–50
Singh, Harbir, 185, 220
Singh, Jang B., 376
Singh, Sunil, C–172
Sinha, Jayant, 220
Sitkin, S., 48
Skoll, Jeff, C–213
Slevin, Dennis P., 185
Smallwood, Marianne, C–389
Smith, C.R., C–273
Smith, Iain, 281
Smith, Kennedy, 350
Smith, K. G., 184
Smith, N. Craig, 294
Smith-Schuster, JuJu, C–110
Somerville, Iain, 326
Spaatz, Carl, C–273
Spangler, Todd, C–160
Speth, J. G., 294
Spicer, Andrew, 294
Spieth, Jordan, C–94, C–96–C–98
Stalk, George, Jr., 184
Stanciu, Tudor, 216
Stephens, Debra, 281
Stephens, Sloanne, C–96
Stevenson, Howard, 350
Stevenson, Seth, 310
Stone, B., C–6
Stone, Christopher “Biz,” C–163–C–164
Stone, Emma, 145
Stone, Reuben E., 125
Stroh, Linda K., 350
Stuart, H., 18
Stuckey, John, 185
Suarez, Fernando, 185
Sull, Charles, 326
Sull, Donald, 124, 326
Sunderam, A., 133
Supan, Joe, C–160
Swift, Taylor, C–113, C–161, C–164
Systrom, Kevin, C–169
Szulanski, Gabriel, 219
T
Takahashi, M., C–6
Tamberino, R., C–324
Tangel, Andrew, C–278
Tarpenning, Marc, C–213
Tatum, Donn, C–281
Taylor, Kate, C–259
Teece, D., 124
Tennent, James, C–403
Tesla, Nikola, C–213
Thomas, Danny, 28
Thomas, Howard, 88
Thomas, Terry, 278
Thompson, Arthur A., Jr., C–18, C–68, C–86, C–124, C–149, C–212, C–295, C–325, C–354
Thomson, Alan, 376
Thunder, Frances C., 26
Timberlake, Justin, C–161, C–165
Topalian, Leon J., C–356, C–385–C–387
Towson, Jeffrey, C–353
Trump, Donald, C–161, C–165, C–273, C–295, C–306
Tse, D. K., 185
Turnipseed, David L., C–161, C–173, C–184, C–198
Tushman, Michael L., 350
Twer, Doran, 350
U
Ullman, Myron, C–58
Upton, B. J., C–110
Upton, David M., 91, 326
Utley, Chase, C–110
V
Vaillant, Jean-Luc, C–169
Vanier, LJ, C–403
van Marrewijk, Marcel N. A., 294
van Putten, Alexander B., 184
Varlaro, John D., C–2, C–7
Veiga, John F., 350
Verhage, J., C–6
Vermeulen, F., 265
Viceira, L., 133
Vishney, R., 265
Vlastelica, Ryan, C–160
Vogelstein, Fred, 350
Vonn, Lindsey, C–98
W
Wade, Dwayne, C–107
Wakeam, Jason, 185
Walker, Esmond Cardon, C–281
Walker, G., 18
Walker, Kemba, C–96
Wallis, Andrew, C–401
Wally, S., 326
Walsh, J. P., 265
Walston, Stephen L., 350
Walton, M., 350
Walton, Sam, 370, C–19
Walt, Vivienne, C–248
Wang, Qianwei, 350
Washer, David B., 143
Waters, J. A., 18
Waterson, Sheree, C–71
Watson, Elain, 148
Watson, Gregory H., 125
Wayland, Michael, C–50
Webb, Allen P., 376
Webber, Jemima, C–139
Webber, Jude, 143
Weber, James, 294
Weed, Keith, C–242
Weiga, John F., 294
Wei, Lingling, C–388
Weiner, Russell, C–255
Weisberg, Rob, C–251
Weiss, Dan, C–155
Welch, Jack, 3, 91, 223, 326, 370
Welch, Suzy, 326
Wells, David, C–160
Wernerfelt, Birger, 88, 124, 265
Wesley, Norm, 240
Wessel, Godecke, 350
Wetlaufer, Suzy, 376
White, David, 185
White, Gordon, 241
White, Shaun, 306
Wiedman, Christine, 48
Wie, Michelle, C–107
Wilcox, Lindsey, 165
William, Prince, C–165
William, Serena, C–107
Williams, Evan, C–163–C–164
Williamson, O., 326
Williamson, Peter J., 154, 265
William, Venus, C–107
Wilson, Chip, C–68–C–71, C–73, C–81
Wilson, Stephen V., C–402
Winkler, Margaret, C–280
Winslow, John, C–181
Winterkorn, Martin, 44
Winter, Sidney G., 124, 219, 326
Wise, Harry, C–259
Wohlsen, M., C–324
Wollman. E., C–6
Woodman, Nick, C–185–C–188, C–197
Wood, Ryan, C–88
page I-14
Woods, Tiger, C–61, C–107
Wood, Zoe, C–248
Wooldridge, Bill, 326
Woroch, Scott, 206
Worrell, Dan L., 294
Wright, Jim, C–298
Wu, Jason, 8
Wulfhorst, Ellen, C–403
Y
Yang, Dori Jones, C–353
Yip, G., 220
Yoffie, David B., 154, 184–185
Yoon, Sangwon, 220
Z
Zaleski, O., C–6
Zbaracki, Mark J., 350
Zemsky, P., 185
Zeng, Ming, 154
Zetsloot, Gerald I. J., 294
Zhang, Sean, C–59
Zhengyao, Lu, C–352
Zhu, Pearl, 329
Zimmerman, Mike, C–67
Zimmerman, Ryan, C–67, C–97
Zollo, M., 125, 326
Zuckerberg, Mark, 35, C–167, C–169
page I-15
Subject Index
A
ACA (Affordable Care Act), C–10
Accommodation market, overview of, C–2–C–3
Acquisitions and mergers
in beer industry, C–12–C–13
capabilities acquired through, 307
diversifying by, 226–229
dynamic capabilities through, 106
international, 198
Kraft–Heinz merger, 237
Nucor Corporation, case, C–355–C–356, C–364–C–367
Spotify, C–113–C–115
of undervalued companies, 241
Actions defining strategy, 4
Activity, financial ratios on, 94–95
Adaptive cultures, 361, 363
Adaptive strategy adjustments, 9
Advertising. see also Marketing
Costco Wholesale, case, C–27
economies of scale in, 130
GoPro, C–193
Netflix, case, C–155–C–156
Starbucks, Inc., case, C–340
Affordable Care Act (ACA), C–10
Alliances and partnerships
benefits of, 179–180
capabilities acquired through, 308
collaboration in executing strategy, 322
drawbacks of, 180–181
in international markets, 191, 199–201
Shell Oil Company, 177
strategic, 177–179
successful, 181–182
Arm’s-length transactions, alliances advantage over, 181
Artificial intelligence (AI), medical applications of, 179
Audit committee, of corporate board of directors, 42
Authority delegation, in strategy execution, 317–320
Autonomous system technology, 76
Average collection period, 95
B
Backward integration
for buyer bargaining power, 71
difficulty of, 68
for greater competitiveness, 171–172
Tesla Motors, 175
Balanced scorecard, 32, 34
BAM (business activity monitoring) systems, 340
Bargaining power
of buyers, 69–72
for low-cost leadership, 131
of suppliers, 67–69
Barriers to entry
to international markets, 188, 196–201
to strengthen competitive position, 162–163
as test for diversification, 225, 228
types of, 62–63
Beer industry, key success factors in, 84. see also Craft beer industry, competition in
Benchmarking
competitive strength of rivals determined from, 116
for continuous improvement, 372
and ethical conduct, 113
in solar industry, 112
value chain, 110–112, 338
Best-cost provider strategy, 8
Best-cost (hybrid) strategies, 128–129, 146–149
Best practices, 111–114
Better-off test, for diversification, 225–226, 238
Big Data, Spotify, C–117–C–118
Biofuels, 288
Blue-ocean strategy, 160
Board of directors in strategy crafting and execution process, 41–44
Boeing 737 MAX, case, C–273–C–278
BPA (Bisphenyl-A) consumption, C–11
Brand management
to increase differentiation, 138
Nestlé, 100–101
Procter & Gamble (P&G), 96–97
Twitter.com, case, C–164–C–165
Under Armour, case, C–95–C–98
Brand recognition, as entry barrier, 62
Brands, Yeti, case, C–182
Bribes and kickbacks, 270–271
BRIC countries (Brazil, Russia, India, and China), 212
Broadcast radio industry, business models in, 13
Broad differentiation strategies
description of, 6, 128
pitfalls to avoid with, 141–142
success factors for, 140–141
superior value delivered via, 139–140
value chain management in, 136–138
Broad low-cost strategies
cost-efficient value chain management for, 129–132
description of, 128
pitfalls to avoid with, 135
revamping value chain for, 132–134
successful, 134–135
Business activity monitoring (BAM) systems, 340
Business models
Costco Wholesale Corporation, C–22
COVID economy, C–5–C–6
GoPro, C–190–C–191
Netflix, case, C–149–C–160
“power-by-the-hour” (Rolls-Royce), 12
radio industry comparison of, 13
sharing economy, C–3–C–4
strategy and, 11–12
Toms Shoes, case, C–61–C–63
Uber Technologies, case, C–318–C–321
Business plans, C–330
Business process management tools, 333–339
Business process reengineering
for continuous improvement, 372
continuous improvement programs versus, 337–339
for cost advantage, 131
for operating excellence, 333–334
Business risk, 173
Business strategy, 37–38
http://twitter.com/
page I-16
Buyers
bargaining power and price sensitivity of, 69–72
corporate social responsibility and, 289
differentiation in appeal to, 139–141
in international markets, 195–196
value-conscious, 147
vertical integration slowing accommodations to, 174
C
CAD (computer-assisted design) techniques, 131
CAFE (corporate average fuel economy) credits, C–233
CAFE (Coffee and Farmer Equity) Practices, of Starbucks, Inc., C–347
Cameras, wearable action-capture, 76
Capabilities of companies
acquiring, developing, and strengthening, 301–302
collaborative partnerships to access, 308
diversification fit with, 228
evaluating, 100–106
general, 231
internal development of, 305, 307
in international markets, 188, 207–210
of management team, 302–305
mergers and acquisitions to acquire, 307
Nike, Inc., C–107–C–108
specialized, 230–232
strategic offensives exploiting, 158
value chain related to, 115–116
vertical integration requirements for, 174
Capacity-matching, 174
Capacity utilization, 131
Capital requirements, as entry barrier, 63
Carbon footprint measurement, 286–287
Cash cows, 254
Cash hogs, 254
Casual dining industry, strategic group map for, 80
Causal ambiguity, 104
Centralized decision making, 317–319
Change-resistant corporate cultures, 364
Channel conflict, 173
Chief executive officer (CEO), strategy execution by, 35–36
Child Labor Monitoring and Remediation System (CLMRS), C–395
China, C–150, C–151
Starbucks, Inc., case, C–350–C–352
Client-owner business structure, 133
CMOs (contract manufacturing organizations), 312
Cocoa supply chain, Nestlé SA, case, C–392–C–395
Coffee and Farmer Equity (CAFE) Practices, of Starbucks, Inc., C–347
Combination organizational structure, 317
Command-and-control structures, 319
Common stock, dividend yield on, 95
Community-based marketing approach, Lululemon Athletica, C–80–C–81
Companhia Vale do Rio Doce (CVRD), Nucor Corporation, case, C–374
Compensation
Costco Wholesale, case, C–30–C–33
incentive, 345–347, 372
Nucor Corporation, case, C–377–C–378
“pay for performance” systems of, C–377–C–380
for top executives, 42–43
Competencies, identifying, 96–97, 100
Competition. see also Environment, external
adidas Group versus Under Armour, C–108–C–110
backward integration and, 171–172
benchmarking importance with, 112
Beyond Meat, Inc. case, C–134–C–139
BJ’s Wholesale Club versus Costco Wholesale, C–38–C–41
company strength versus, 116–119
forward integration and, 172–173
Lululemon Athletica, C–82–C–84
multimarket, 211
Nike versus Under Armour, C–104–C–108
Nucor Corporation, case, C–384–C–387
resources and capabilities of company versus, 103–106
Sam’s Club versus Costco Wholesale, C–36
SOAR Framework for analysis of, 80–83
strategy as differentiation from, 4–5
Twitter.com, case, C–167–C–170
Uber Technologies, case, C–319–C–320
unfair practices in, 274
Competitive advantage. see also Competitive position, strengthening
of cross-business strategic fit, 253–255
Diamond of National Competitive Advantage model, 189–190
financial performance improved by, 32
generic strategies and, 151–152
initiatives to build, 92
in international markets, 206–210
in strategic fit, 235–237
from strategy execution capabilities, 309–310
strategy in quest for, 5–8
strategy test based on, 14
unrelated diversification and, 243
value chain translated to, 114–116
VRIN (valuable, rare, inimitable, nonsubstitutable) tests for sustainable, 103–104
Competitive intelligence, 84
Competitive position, strengthening, 156. see also Competitive advantage
alliance and partnership strategies for, 182
defensive strategies for, 161
first-mover advantages, 163–165
horizontal merger and acquisition strategies for, 168
late-mover advantages, 166
outsourcing strategies for, 176
scope of operations changes for, 168
strategic offensives for, 158
vertical integration strategies for, 171–175
Competitive strategies. see Five generic competitive strategies
Competitive strength
of diversified business units, 248–252
performance test based on, 14
Complementors, 73–74
Composite organizational structure, 317
Computer-assisted design (CAD) techniques, 131
Consolidations in beer industry, C–12–C–13
Consumers
Airbnb, case, C–4–C–5
bargaining power of, 71
beer distribution effects on, C–10
Macy’s, Inc. case, C–55–C–56
sales direct-to, C–98–C–99
Continuous improvement programs, C–365
Continuous quality improvement, 137–138
Contract manufacturing organizations (CMOs), 312
Convergence of industries, 169
Copyrights, as intangible resources, 101
Core competencies, 96–97, 188
Coronavirus (COVID-19). see also COVID-19
Airbnb, case, C–2
beer industry, C–7
differential effects of, 56
http://twitter.com/
Ford Motor, case, C–48–C–49
Coronavirus Pandemic of 2020, 56
Corporate average fuel economy (CAFE) credits, C–233
Corporate governance
in company direction setting, 41–43
Volkswagen AG failure of, 44
Corporate parenting capabilities, 238, 240
Corporate social responsibility (CSR). see also Culture, corporate
Apple, Inc., 7–8
business case for, 289–292
core values of company in, 282
elements of, 280–282
moral case for, 289
Starbucks, Inc., case, C–347–C–349
strategies for, 287–289
Toms Shoes, case, C–63–C–65
triple bottom line and, 282–285
Corporate strategy, 222
business unit competitive strength in diversified companies, 248–252
diversification path
combination of businesses, 244
related businesses, 229–237
unrelated businesses, 237–244
diversification strategy, 224–229
goals of, 37–38
industry attractiveness in diversified companies, 248
resource allocation priorities in diversified companies, 256
resource fit in diversified companies, 252
strategic fit in diversified companies, 252
Corporate venturing, 227
Corrective adjustments, 22, 41
Cost drivers, 129–130
Costs. see also Low-cost strategies
comparative, in diversifying, 229
competition changes from differences in, 76–77
competitive advantage based on, 115
of entry, for diversification, 225
fixation on reducing, 135
levelized cost of energy (LCOE), 112
Nucor Corporation, case, C–358, C–360, C–369–C–370, C–373
remedying disadvantage in, 111–114
switching, 59, 67, 135, 164
value chain activities impact on, 106–110
in value-price-cost framework of business model, 11–12
Coverage ratio, 94
COVID-19
Airbnb, case, C–2
beer industry, C–7
Domino’s Pizza, case, C–253–C–258
economy, C–5–C–6
Ford Motor, case, C–44, C–48–C–49
GoPro, C–185, C–190, C–197
Lululemon Athletica, C–68, C–84–C–85
Macy’s, Inc., C–51, C–52, C–56
Netflix, C–156
Publix Super Markets, case, C–198
Southwest Airlines, case, C–296
Spotify, C–119, C–121–C–123
Tesla Motor Co., case, C–233–C–234
TOMS Shoes, C–59, C–66–C–67
Twitter.com, case, C–171–C172
Under Armour’s weak performance, C–102
Yeti, case, C–173, C–174, C–183
http://twitter.com/
page I-17
Craft beer industry, competition in, C–7–C–16
AB InBev profile, C–13–C–14
beer market, C–7–C–9
beer production, C–9–C–10
Boston Beer Company, profile of, C–14–C–15
consolidations and acquisitions in, C–12–C–13
Craft Brew Alliance, profile of, C–14–C–15
economies of scale in microbreweries, C–10
innovation and quality versus price as, C–11–C–12
legal environment of, C–10–C–11
overview, C–7
strategic issues facing, C–16
supply chain for, C–11
Crafting strategy in company direction setting, 22, 35
Cross-border alliances, 191, 199–201
Cross-functional capabilities, 103
Cross-market subsidization, 210–211
Cross-unit coordination, in executing strategy, 320–322
CSR (corporate social responsibility). see Corporate social responsibility (CSR)
Culture, corporate, 352–376
in alliances and partnerships, 179
Balanced Scorecard dimension of, 34
changing problem, 369
diversification and fit with, 259
of employee motivation, 132
healthy, 361
identifying key features of, 355–358
importance in strategy execution, 360–361
as intangible resource, 102
in international markets, 195–196
profitability ahead of ethical behavior, 276
Southwest Airlines, case, C–298, C–306–C–312
strategy execution leadership and, 369–373
strong versus weak, 358–359
unhealthy, 363, 365
variations in, 354
Current ratio, 94
Customers
Balanced Scorecard dimension of, 34
Costco Wholesale, case, C–29
Customer service, strategic fit with, 235
Customer value proposition
in business model, 11–12
radio industry example, 13
value chain activities impact on, 106–110
D
Dating service industry, 165
Debt-to-assets ratio, 94
Debt-to-equity ratio, 94
Decentralized decision making, 317–320
“Defeat devices” on Volkswagen diesel cars, 44
Delegation of authority, in strategy execution, 317–320
Deliberate strategy, 9
Demand conditions, in international markets, 189–190
Demographic differences in international markets, 195–196
Demographics, Costco Wholesale customers, C–29–C–30
Departmental organizational structure, 315–316
Design for manufacture (DFM) procedures, 131
Developing countries
competing in, 212–213
local companies defending against global giants, 214–216
DFW, Southwest Airlines, case, C–297–C–298
Diamond of National Competitive Advantage model, 189–190
Differentiation
broad strategies for, 128, 136–142
competitive advantage based on, 115
in five forces framework, 59
focused strategies for, 128, 144–145
forward integration for, 172–173
Digital marketplace, C–2
Direction of company, 20
corporate governance, 41–44
mission statement development, 27–28
objective setting, 31–34
overview, 22
performance evaluation, 41
strategic vision development, 24–27
strategy crafting, 35
strategy execution, 40–41
values linked with vision and mission, 30
Direct-to-consumer (DTC) model
entertainment programming as, C–279, C–287–C–288
Lululemon Athletica, C–78
Nike, Inc., sales as, C–105–C–106
Under Armour sales as, C–98–C–99
Discounting, exit barriers leading to, 60–61
Disruptive technologies
innovation as, 159
strategy changes based on, 9
Voice over Internet Protocol (VoIP) as, 225
Distribution
in beer industry, C–10
Costco Wholesale Corporation, case, C–28–C–29
as entry barrier or challenge, 63
forward integration as competition to, 173
as key success factor in beer industry, 84
Nike, Inc., case, C–104
Sam’s Club, C–38
strategic fit with, 235, 237
sustainable business practices for, 291
Tesla Motor Co., case, C–225–C–228
Under Armour, case, C–98–C–100
in value chain, 107
value chains related to, 114
Diversification
business unit competitive strength in, 248–252
to combination of businesses, 244
improving corporate performance in, 257
industry attractiveness in, 245–248
to related businesses, 229–237
resource allocation priorities in, 256–257
resource fit in, 252–255
strategic fit in, 252
strategy for, 224–229
to unrelated businesses, 237–244
Dividend payout ratio, 95
Dividend yield on common stock, 95
Divisional organizational structure, 316
DMADV six sigma process, 335
DMAIC (define, measure, analyze, improve, and control) six sigma process, 335–336
Domino’s Pizza, case, C–250–C–253
contactless delivery, C–254–C–258
Domino’s Pizza International (DPI), C–251
Driving forces in industry change, 74–78
DTC (direct-to-consumer) model. see Direct-to-consumer (DTC) model
Dumping below-market priced goods, C–383
Dumping low-priced goods, 211
Dynamic capabilities, 105–106
Dynamic fit test, for strategies, 12
E
E-commerce
Under Armour, C–99
Walmart acquisitions for, 170
Economics
experience, 131
experience-based versus ownership, C–4
in international markets, 192–193
macro environment, 53–54
sustainable business practices and, 291
as triple bottom line performance dimension, 283–284
Economies of scale
concentrating in a few locations for, 207
as entry barrier, 62
as first-mover advantage, 164
international markets for, 188
in microbreweries, C–10
in value chain management, 130
vertical integration as disadvantage in, 174
Economies of scope, from diversification, 235–237
Education, Internet impact on, 76
Emergent strategy, 9
Emissions testing, 44
Employees
in Costco Wholesale business principles, C–34
executive friendliness to, C–19
as independent contractors, C–315
monitoring performance of, 341
motivating, 132, 342–343
Nucor Corporation, case, C–378–C–380
as partners, 371
recruiting, training, and retaining, 303–304
reducing turnover of, 290
Starbucks, Inc., benefits for, C–341–C–344
Wegmans Food Markets, Inc., 343–344
wellness programs for, 290
Empowerment of workforce, 371
Energy
Costco Wholesale initiatives to reduce consumption, C–34–C–35
levelized cost of energy (LCOE), 112
renewable improvements, 81
Tesla Motor Co., case, C–234–C–235
Enterprise resource planning (ERP) systems
business process reengineering and, 334
for operating efficiency, 131
Entrepreneurship, internal, 363
Entry barriers
for international markets, 188
strategic options in international markets, 196–201
to strengthen competitive position, 162–163
as test for diversification, 225, 228
types of, 62–63
Entry cost test, for diversification, 225
Environmental forces in macro environment, 53–55
Environmental impacts, Beyond Meat, Inc. case, C–133–C–134
Environmental protection and sustainability
Costco Wholesale, case, C–22, C–34–C–35
Nucor Corporation, case, C–370, C–376
Starbucks, Inc., case, C–346
page I-18
Unilever Sustainable Living Plan (USLP), C–239
Environmental protection, as triple bottom line performance dimension, 283–284
Environmental sustainability strategies, 286
Environment, external, 50
company’s industry and competitive environment, 52
complementors and value net, 73–74
five forces framework
buyer bargaining power and price sensitivity, 69–72
competitive conditions match with company strategy, 73
competitive weapons, 61
profitability from, 72–73
rivalry among competing sellers, 57–60
substitute products, 64–67
supplier bargaining power, 67–69
threat of new entrants, 61–64
industry and competitive environment, assessing, 57
industry dynamics, 74–78
key success factors, 83–84
macro-environment, analyzing, 52–57
profitability outlook, 84–85
SOAR Framework for competitor analysis, 81–83
strategic group analysis, 78–80
Equity compensation programs, C–33
ERP (enterprise resource planning) systems, 131, 334
Ethics
business case for, 277–279
competitive intelligence and, 84
in corporate culture, 355–356
Costco Wholesale, case, C–33–C–34
impact on crafting and executing strategy of, 272
integrative social contracts theory and, 271–272
moral case for, 277
school of ethical relativism, 269
school of ethical universalism, 268–269
Starbucks, Inc., case, C–343–C–344
strategy and, 9–11
unethical business strategies and behavior, 273
Evaluating companies, 90
competition versus, 116–119
front-burner problems, 119
resources and capabilities, 100–106
strategy, 92–95
strengths and weaknesses, 95–99
value chain activities, 106–110
value chain benchmarking, 110, 113
value chain translated into competitive advantage, 114–116
Exchange rate risks, 93–195
Executing strategy, 296; see also Culture, corporate
aligning organization structure with, 313–317
collaboration with external partners and allies, 322
in company direction setting, 40
components of, 298–300
critical resources and capabilities for, 305–310
cross-unit coordination, 320–322
delegation of authority, 317–320
internal versus outsourced value chain activities, 310–313
operations, internal, 330–333, 341–348
organization building for, 300–302
organization staffing for, 302–305
work effort structuring, 322–323
Exit barriers, 60
Experience-based economy, C–4
Experience economies, 131
Export strategies for entering international markets, 196–197
External fit test, for strategies, 12
F
Factors of production, in international markets, 190–191
Fair Labor Standards Act (FLSA), C–10
FCPA (Foreign Corrupt Practices Act), 270
Financial accounting
financial ratios for, 93
long-term objectives, 32
meeting objectives, 92–93
objectives on Balanced Scorecard, 34
performance test for, 14
reporting results of, 41–42
short-term objectives, 31–32
Financial performance
Ford Motor, case, C–43–C–49
GoPro, C–185, C–194–C–197
Spotify, C–121–C–123
Toms Shoes, case, C–65
Under Armour, case, C–87–C–91
Yeti, case, C–178
Financing Netflix content, C–158–C–160
First-movers into markets, 163–165
First-mover strategy
advantages of, 163–165
decision to be, 166–167
disadvantages of, 166
Nucor Corporation, case, C–369–C–370
Fit test, for strategies, 12
Five forces framework
buyer bargaining power and price sensitivity, 69–72
competitive conditions matched with company strategy, 73
competitive weapons, 61
profitability from, 72–73
rivalry among competing sellers, 57–60
substitute products, 64–67
supplier bargaining power, 67–69
threat of new entrants, 61–64
Five generic competitive strategies, 126
best-cost (hybrid) strategies, 146–149
broad differentiation strategies, 136–142
broad low-cost strategies, 129–135
contrasting features of, 149–152
focused differentiation strategies, 144–145
focused low-cost strategies, 142–144
overview, 128–129
risks in focused strategies, 146
FLSA (Fair Labor Standards Act), C–10
Focused differentiation strategies, 8, 128, 144–146
Focused low-cost strategies
attraction of, 144–145
description of, 6, 8, 128
examples of, 143–144
objectives of, 142
page I-19
risks of, 146
Foreign Corrupt Practices Act (FCPA), 270
Foreign subsidiary strategies for entering international markets, 198–199, 213
Forward-channel value chains, 110
Forward integration, 172–173, 175
Franchising, 197–198, 313
Free cash flow, 95
Fringe benefits, 342
Full vertical integration strategies, 171
Functional area strategies, 37–38
Functional organizational structure, 315–316
G
Generally accepted accounting principles (GAAP), 42
Generic competitive strategies. see Five generic competitive strategies
GHG (greenhouse gas) credits, C–233
Globalization, 75
Netflix, case, C–140–C–141
Global strategy for international markets, 203–205
Global supply chains, Nestlé SA, case, C–390–C–392
Government regulations
Airbnb, case, C–5
of craft beer industry, C–10–C–11
credit sales as offsets, C–233
Greed-driven corporate cultures, 365
Greenfield ventures, 198–199
Greenhouse gas (GHG) emissions, C–233, C–370
Grocery market, Publix Super Markets, case, C–202–C–205
Gross profit margin, 93
Growth strategy
Nucor Corporation, case, C–372–C–373
Starbucks, Inc., case, C–331–C–332
Under Armour, case, C–92
Guardian Sustainable Business Award, 293
Guerrilla warfare tactics, 159
H
Hard-to-copy resources and capabilities, 104
Healthy corporate cultures, 361
Higher education, Internet impact on, 76
High-performance cultures, 361
Home-country industry advantages, in international markets, 189–191
Horizontal mergers and acquisitions, 168–171
Horizontal scope of operations, 167
Human capital, Balanced Scorecard dimension of, 34
Hydrogen fuel cells, C–237
I
Incentives. see also Rewards
compensation as, 345–347
for employee motivation, 132
as intangible resource, 102
for strategy execution, 342–343, 372
Independent contractors, employees as, C–315
Industry attractiveness test, for diversification
competitive strength portrayed with, 249–252
evaluating, 245–248
overview, 225
in strategy analysis, 244–245
into unrelated businesses, 238
Industry dynamics, 74–78
Industry environment, 57
Information systems for internal operations, 339–341
Initial public offering (IPO), C–166, C–168, C–342–C–343
Innovation
Balanced Scorecard dimension of, 34
craft beer industry competition based on, C–11–C–12
Yeti, case, C–177–C–178
Intangible resources, 101–102
Intellectual property
differentiation based on, 138
as entry barrier, 62
for executing strategy, 302
as first-mover advantage, 164
as intangible resource, 101
Internal capital market, 253
Internal cash flow, 95
Internal development, diversifying by, 227
Internal fit test, for strategies, 12
Internal operations. see Operations, internal
Internal startups, 198–199
Internal “universities” for training, 309
International marketing, 186
Apple, Inc., 7
competing in developing countries, 212–213
competitive advantage quest in, 206–210
defending position in, 211
demographic, cultural, and market differences, 195–196
entering
reasons for, 188
strategic options for, 196–201
exchange rate risks, 193–195
global strategy for, 203–204
government policies and economic conditions, 192–193
home-country industry advantages, 189–191
local companies in developing countries, strategies for, 214–216
location-based advantages, 191–192
multidomestic strategy for, 202–203
strategic offensives in, 210–211
transnational strategy for, 204–206
Walt Disney Company diversification, case, C–287–C–288
Internet, industry change from, 75–76, 225
Internet of Things (IoT), 76
Intrapreneurship, 363
Inventory management
Costco Wholesale Corporation, case, C–22
in five forces framework, 60
turnover of, 95
Under Armour, case, C–101–C–102
Inwardly focused corporate cultures, 363, 365
IPO (initial public offering), C–166, C–168, C–342–C–343
ISO standards, C–370, C–376
ISO 9001 standards, 138
J
Joint ventures
capabilities acquired through, 308
cost reductions in diversifying by, 229
description of, 178
diversification achieved by, 227
entering international markets by, 199–201
Nucor Corporation, case, C–362, C–364, C–372–C–373
Just-in-time deliveries, 114, 132
K
Key success factors (KSFs)
overview, 83–84
quantitative strength ratings on, 116–118
Khosrowshahi’s decision, for Uber Technologies, C–321–C–323
Kickbacks and bribes, 270–271
Knowledge, as capability, 102
Knowledge diffusion, 76
Kroger Co., C–205–C–207
L
Labor cost disadvantage, C–386
Labor, underage, 269–270
Lagging indicators of performance, 32
Late-mover advantages, 166–167
LCOE (levelized cost of energy), 112
Leadership
Costco Wholesale founder, C–19–C–20
low-cost, 129
Lululemon Athletica, C–70–C–74
Southwest Airlines, case, C–301–C–302
of strategy execution, 369–373
Leadership in Energy and Environmental Design (LEED) certification, C–34, C–334, C–347, C–348
Leading indicators of performance, 33–34
Learning curve, 131, 164, 207
Leasing activities, by Tesla Motors, C–233
LEED (Leadership in Energy and Environmental Design) certification, C–34, C–334, C–347, C–348
Legal and regulatory factors in macro environment, 52–54
Legal environment of craft beer industry, C–10–C–11
Levelized cost of energy (LCOE), 112
Leverage, financial ratios to determine, 94
Liabilities, competitive, 97
Licensing
Airbnb, case, C–5
Starbucks, Inc., case, C–332, C–336
strategies for entering international markets, 197
Tazo Tea, Inc., C–336
Under Armour, case, C–95
Line-and-staff organizational structure, 315
Liquidity, financial ratios to determine, 94
Location-based advantages, in international markets, 191–192
Logistics, GoPro, C–192
Long-term debt-to-equity ratio, 94
Low-cost leadership, 129
Low-cost strategies
broad, 128–135
Costco Wholesale Corporation, case, C–22
in developing countries, 212–213
focused, 128, 142–144
page I-20
location advantages in international markets for, 192
Nucor Corporation, case, 347, C–355
provider, 6
at Walmart Stores, Inc., 170
Low-Income Housing Tax Credit (LIHTC), C–261
Loyalty, as entry barrier, 62
Lump-sum payments, for retail shelf space, 70
M
Macro environment, 52
Management. see also Executing strategy
Burbank Housing, case, C–268–C–270
Costco Wholesale Corporation, case, C–30
front-burner problems for attention of, 119
management by walking around (MBWA), 370
Nucor Corporation, case, C–376–C–377
Southwest Airlines, case, C–306–C–312
strategy and execution in, 15
strategy making at all levels of, 35
Manufacturing
GoPro, C–192
Nike, Inc. case, C–108
Tesla Motor Co., case, C–230–C–232
Under Armour, case, C–101
Manufacturing execution system (MES), 131
Manufacturing, strategic fit with, 234
Marketing
beer, C–7–C–9
BJ’s Wholesale, C–41
Costco Wholesale Corporation, case, C–27
differentiation created by, 138
GoPro, C–193
international differences in, 195–196
Netflix, case, C–155–C–156
Nike, Inc., C–105–C–107
retail, C–98
on social media, 76
strategic fit with, 234–235
Tesla Motor Co., case, C–232–C–233
Under Armour, case, C–95–C–98
in value chain, 107
viral, 165
Market penetration curve, 166
Marketplace, Lululemon Athletica, C–74
Market position. see Competitive position, strengthening
Market share
in beer industry, C–7
financial performance improved by, 32
higher profits not necessarily following, 135
performance test based on, 14
relative, 248–249
Southwest Airlines, case, C–299
as strategy success indicator, 93
Markups, retail, C–23
Mass customization, 204
Massive open online courses (MOOCs), 76
“Master product” business model, 12
Matrix organizational structure, 317
MBWA (management by walking around), 370
Media networks, C–285–C–287
Merchandising
BJ’s Wholesale, C–38–C–40
Costco Wholesale “treasure-hunt,” C–25
Mergers and acquisitions
alliances and partnerships advantages over, 180–181
in beer industry, C–12–C–13
capabilities acquired through, 307
horizontal, 168–171
Nucor Corporation, case, C–355–C–356, C–364–C–367
MES (manufacturing execution system), 131
Microprocessor industry, entry barriers to, 62
Mission statement
Boeing 737 MAX, case, C–275
Burbank Housing, case, C–270–C–271
Costco Wholesale Corporation, case, C–22
development of, 27–28
Starbucks, Inc., case, C–344–C–345
in strategic plan, 39–40
values linked to, 28–30
Mobile phone applications, for marketing, C–16
Mobility barriers, 81
MOOCs (massive open online courses), 76
Mortgage lending scandal, 275
Motivation
of employees, 372
practices for, 342–343
in vision statements, 27
Multibrand strategies, 146
Multidivisional organizational structure, 316
Multidomestic strategy for international markets, 202–203, 205
Multimarket competition, 211
Multinational companies, ethical relativism in, 271
Mutual restraint among international rivals, 211
N
NAFTA (North American Free Trade Agreement), C–326
Nanobreweries, C–10
Nationalization of industries, 193
National Renewable Energy Laboratory (NREL) Quarterly U.S. Solar Photovoltaic System Cost Benchmark, 112
Net profit margin, 93
Net return on total assets (ROA), 93
Network effects, as entry barrier, 62–63, 164–165
Network organizational structure, 322
New entrants, threat of, 61–64
New venture development, 227
Nike, Inc.
manufacturing, C–108
marketing, promotions, and endorsements, C–105–C–107
overview, C–104–C–105
resources and capabilities, C–107–C–108
Under Armour versus, C–104–C–108
Nine-cell industry-attractiveness-competitive-strength matrix, 249–252, 256
North American Free Trade Agreement (NAFTA), C–326
NREL (National Renewable Energy Laboratory) Quarterly U.S. Solar Photovoltaic System Cost Benchmark, 112
O
Objectives
competitive, 81
setting, 22, 31–34
in strategic plan, 39–40
stretch, 345
Oil and gas industry, alliances and partnerships in, 178
Omni-channel retailing, 170
One for One model, at TOMS Shoes, 30
Online auction industry, 161
“Online Experiences” market, C–6
Operating profit, 93
Operating strategies, 37–39
Operations, internal, 328. see also Executing strategy
allocating resources to strategy execution for, 330
business process management tools for, 333–339
changes in scope of, 167–168
incentives and motivational practices for, 342–343
information and operating systems for, 339–341
low-cost, C–25–C–27
rewards and punishment balance, 343–345
rewards linked to achievement of outcomes, 345–348
in value chain, 107
Opportunities, strengths and weaknesses in relation to, 95–99
Organization
aligning structure with strategy execution, 313–317
building for strategy execution, 300–302
staffing for strategy execution, 301–305
Original-equipment manufacturer, 70
OTT (Over-the-Top) content delivery, C–288
Outsourcing
alliances to manage, 181
capabilities acquired through, 308
cost advantages of, 131–132
as scope of operations decision, 167
to strengthen competitive position, 176–177
value chain activities, decisions on, 310–313
Overcharging, as strategy mistake, 142
Over-differentiating, as strategy mistake, 142
Over-the-Top (OTT) content delivery, C–288
P
Packaging, sustainable design of, 287, 291
Parenting advantage, 242–243
Parenting capabilities, of corporations, 238, 240
Parks and experiences, of Walt Disney Company, C–284–C–285
Partial vertical integration strategies, 171
Partnerships and alliances
benefits of, 179–180
capabilities acquired through, 308
collaboration in executing strategy, 322
drawbacks of, 180–181
in international markets, 191, 199–201
Shell Oil Company, 177
Spotify, C–115–C–117
strategic, 177–179
successful, 181–182
Yeti, case, C–178
“Pay for performance” compensation systems, C–377–C–380
Peer-to-peer ratings, C–4
Performance
Beyond Meat, Inc. case, C–124–C–128
Costco Wholesale Corporation, case, C–20–C–21
in diversified companies, 224, 257
evaluation of, 22, 41
GoPro, C–197
lagging indicators of, 32
leading indicators of, 33–34
pressure to meet short-term, 275–276
page I-21
Publix Super Markets, case, C–202
strategy test based on, 14
tracking systems for, 340–341
Twitter.com, case, C–166–C–167, C–171–C172
Walt Disney Company diversification, case, C–281–C–283, C–283
PESTEL (Political, Economic, Sociocultural, Technological, Environmental, Legal/ regulatory) analysis, 53–55
Piece-rate incentive plan, 347
Pioneer, market, 163–164
Policies and procedures for strategy execution, 331–333
Political factors in macro environment, 52–54
Political risks in international markets, 193
Politicized corporate cultures, 364
Portfolio approach for financial fit, 254
Position, strengthening. see Competitive position, strengthening
“Power-by-the-hour” business model (Rolls-Royce), 12
Prestige of products, 7
Price gouging, 274
Price sensitivity of buyers, 69–72
Pricing
Costco Wholesale ultra-low, C–22–C–23
craft beer industry competition based on, C–11–C–12
for low-cost leadership, 134–135
mass retail, 310
Nucor Corporation, case, C–363–C–364
premium, 7, 142
Starbucks, Inc., coffee purchasing strategy and, C–345–C–346
strategic offensives lowering, 158
in value-price-cost framework of business model, 11–12
Private-label manufacturers, 7
Proactive strategy, 9–10
Product design and development strategy, Lululemon Athletica, C–78–C–79
Production-related R&D, 137
Productivity
Balanced Scorecard dimension of, 34
business process reengineering to improve, 333–334
as evidence of strategy success, 92–93
Products
Costco Wholesale limitations on, C–23–C–25
Ford Motor, case, C–45, C–48
GoPro, C–191–C–192
Nike, Inc., C–105
Starbucks, Inc., case, C–334–C–339
substitute, 64–67
Tesla Motor Co., case, C–212–C–216, C–222–C–225, C–228–C–230
Twitter.com, case, C–165–C–166
Under Armour, case, C–92–C–95, C–100–C–101
Walt Disney Company diversification, case, C–284–C–285
Yeti, case, C–175–C–176
Profitability
in business model, 11–12
in competitive strength scores, 249
Costco Wholesale membership fees for, C–22
in developing markets, 213
financial ratios to determine, 93
five competitive forces and, 72–73
industry outlook for, 84–85
performance test based on, 14
radio industry examples, 13
in value chain, 108
Promotional allowances, 70
Promotion from within, 343
Promotions
Nike, Inc., C–105–C–107
Under Armour, case, C–95–C–98
http://twitter.com/
http://twitter.com/
Property rights protections, 164
Pseudo-businesses, C–5
Public recognition for performance, 342
Publix’s Mission, Publix Super Markets, case, C–199–C–200
Purchasing power, international markets for, 188
Q
Quality
Balanced Scorecard dimension of, 34
continuous quality improvement, 137–138
craft beer industry competition based on, C–11–C–12
QS 9000 certification, 215
Under Armour, case, C–101
undifferentiated products and, 72
R
Radical transparency, 109
Radio industry, business models in, 13
Reactive strategy, 9–10
Realized strategy, 9
Recruiting employees, 303–304
Regulations
Airbnb, case, C–5
of craft beer industry, C–10–C–11
credit sales as offsets, C–233
as entry barriers, 63
in international markets, 192–193
in macro environment, 52–55
Related versus unrelated businesses. see Diversification
Relationship management, 322
Relative market share, 248–249
Representative weighted competitive strength assessment, 117–119
Reputation-damaging incidents, reducing risk of, 289–290
Resource bundles, 103
Resources of companies
allocation of financial, 256–257
allocation priorities for, 241, 256–257
competitive power of, 103–106
concentrating in a few locations for, 207
diversification fit with, 228, 230, 252–255
evaluating, 100
for executing strategy, 301, 305–310
general, 231
generic strategies based on, 149–150
international markets for, 188, 207–210
Nike, Inc., C–107–C–108
specialized, 230–232
strategic offensives exploiting, 158–159
strategy execution allocations of, 330
value chain related to, 115–116
vertical integration requirements for, 174
Restricted stock units (RSUs) compensation programs, C–33
Restructuring
diversified companies, 241, 260
Twitter.com, case, C–166–C–167
Retaining employees, 303–304
Return on assets, 93
Return on capital employed (ROCE), 93
Return on invested capital (ROIC), 93
Return on stockholders’ equity (ROE), 93
http://twitter.com/
Rewards. see also Incentives
outcome achievement linked to, 345–348
punishment balanced with, 343–345
Rivalry among competing sellers, 57–60
Robin Hood, case, C–293–C–294
RSUs (restricted stock units) compensation programs, C–33
S
Sales
after-sale support and, 7
direct sales force, 132
direct-to consumer, C–98–C–99
GoPro, C–192
Nike, Inc., C–105–C–106
Nucor Corporation, case, C–363–C–364
strategic fit with, 234–235
in value chain, 107
Yeti, case, C–176–C–177
Sarbanes-Oxley Act, 272
School of ethical relativism, 269–271
School of ethical universalism, 268–269
SCM (supply chain management). see Supply chain management (SCM)
Scope, economies of, 235–237
Scope of operations, 167–168
Self-dealing, 275
Self-driving vehicles, C–318
technology for, 76
Service economy, C–165–C–166
Service, in value chain, 107
Sexual harassment, C–320
Shareholders, C–34
Sharing economy business model, C–3–C–4
Short-termism, 276
Simple organizational structure, 315
Single-business companies, strategy levels compressed in, 39
Situational analysis, 96
Six Sigma programs
for continuous improvement, 372
methodology for, 131
for quality control, 333, 335–339, 345
Slogans, vision essence in, 27
Slotting fees, for retail shelf space, 70
SOAR Framework for competitor analysis, 81–83
Social complexity, 104
Social initiatives, as triple bottom line performance dimension, 283–284
Societal shocks, 55
Sociocultural forces in macro environment, 53–54
Solar industry, benchmarking in, 112
Solar power, C–34
Sourcing, C–101
Speed, in entering new business, 228–229
Spin-offs, 259
SRB (sustainable responsible business), 282
Stakeholders of companies, 43
Standardization, 130, 204
Steel industry worldwide, C–359–C–360, C–380–C–384
Stock brokers, discount online, 75
Stock market, Publix Super Markets, case, C–202
Strategic fit
in competitive strength scores, 248
competitive value of, 252
cross-business, in decentralized structure, 320
in economies of scope and competitive advantage, 235–237
page I-22
in international alliances, 191
overview, 229–230
value chain and, 232–235
Strategic group analysis, 78–80
Strategic group mapping, 78–80
Strategic objectives, 31–32
Strategic offensives
for competitive position, 158–161
in international markets, 210–211
Strategic plan. see Direction of company
Strategy. see also Executing strategy
Beyond Meat, Inc. case, C–128–C–133
BJ’s Wholesale Club, C–38
business model and, 11–12
as competing differently, 4–5
as competitive advantage, 5–8
Costco Wholesale Corporation, case, C–22–C–27
ethics and, 9–11
evaluating current, 92–95
evolution of, 8–9
five generic competitive strategies, 128–152
Strategy—Cont.
Ford Motor, case, C–49
GoPro, C–190–C–191
importance of, 14–15
Lululemon Athletica, C–74–C–82
Macy’s, Inc., C–58
Netflix, case, C–149–C–160
Nucor Corporation raw materials, C–373–C–376
Nucor Corporation value-added products, C–371–C–372
proactive and reactive, 9–10
Southwest Airlines, case, C–302–C–306
Starbucks, Inc., coffee purchasing, C–345–C–346
Starbucks, Inc., corporate social responsibility, C–347–C–349
Starbucks, Inc., overall, C–334–C–339
success of, 12–14
Walt Disney Company diversification, case, C–283–C–284
Yeti, case, C–174–C–175, C–183
Strategy-execution process, factors shaping decisions in, 23
Strategy-making process, factors shaping decisions in, 23
Strategy overcrowding, 141
Strengths, weaknesses, opportunities, threats (SWOT) analysis, 96–99
Stretch objectives, 31, 345
Strong corporate culture, 359
Studio entertainment business, C–288–C–291
Subscription-based business models
Amazon Prime, C–144–C–145
Disney+, C–145–C–146
Hulu streaming service, C–145–C–146
Netflix, C–144–C–149
Walt Disney Company, C–145–C–146
Subscription video on demand (SVOD), C–289
Substitute products, 64–67
Supply chain management (SCM)
bargaining power of suppliers in, 67–69
Beyond Meat, Inc. case, C–132–C–133
carbon footprint measurement of, 286
cooperative relations in, 73–74
Costco Wholesale Corporation, case, C–28–C–29, C–34
cost-efficient, 131
for craft beer industry, C–11
differentiation from coordination of, 138
site audits to ensure standards compliance, 312
strategic fit in, 234
Supplier Code of Conduct, C–63–C–64
Tesla Motor Co., case, C–232
in value chains, 107, 110, 114
Sustainability
best practices for, 285–287
business case for, 289–292
business practices for, 286
of competitive advantage, 6, 8
Costco Wholesale Corporation, case, C–34–C–35
moral case for, 289
strategies for, 287–289
Toms Shoes, case, C–64
Unilever, case, C–239–C–243
Sustainable responsible business (SRB), 282
SVOD (subscription video on demand), C–289
Switching costs, 59, 67, 135, 164
SWOT (strengths, weaknesses, opportunities, threats) analysis, 96–99
Synergy effect, 225
T
Tangible resources, 101
Tapered vertical integration strategies, 171
Target market
for best-cost strategies, 147
at Uber Technologies, C–318–C–319
Tax credits, Burbank Housing, case, C–261
Technology
acquisitions to access, 169
differentiation based on, 137, 141
first-mover advantage of standards setting for, 164
as force driving industry change, 75–77
leapfrogging first-mover products from, 166
macro environment affected by, 53–55
strategic fit in, 234
strategy changes based on advances in, 9
Tesla Motor Co., case, C–228–C–230
vertical integration slowing adoption of, 173–174
Tests of corporate advantage, for diversification, 225
The Nestlé Cocoa Plan (TNCP), C–394, C–402
Think global
act global approach, in international markets, 203–204
act local approach, in international markets, 204–206
Threats
external, 95–99
of new entrants, 61–64
Times-interest-earned ratio, 94
Total debt-to-assets ratio, 94
Total economic value, generic strategies and, 151–152
Total economic value produced by company, 103–104
Total quality management (TQM) programs
benefits of, 338–339
business process reengineering versus, 337–338
for continuous improvement, 372
cost advantage from, 131
description of, 333–335
Total return on assets, 93
Trademark infringement, C–11
Trade policies, as entry barriers, 63
Trade secrets, as intangible resources, 101
Training employees
strategic role of, 309
for strategy execution, 303–305
Transaction costs, 229
page I-23
Transnational strategy for international markets, 204–206
Triple bottom line, in corporate social responsibility (CSR), 282–285
Turnaround capabilities, 241
U
Umbrella brands, 240
Underage labor, 269–270
Undocumented workers, 10
Unethical corporate cultures, 365
Unhealthy corporate cultures, 363, 365
Unilever, case, C–244–C–248
Unilever Sustainable Living Plan (USLP), 288, C–238–C–240
Unions, bargaining power of, 67
Unitary organizational structure, 315–316
United Nations Guiding Principles on Business and Human Rights (UNGPs), C–392, C–397
Unrelated versus related businesses. see Diversification
V
Valuable, rare, inimitable, nonsubstitutable (VRIN) tests for sustainable competitive advantage, 103–105
Value chain
activities in, 106–110
benchmarking, 111, 338
competitive advantage translated from, 114–116
Costco Wholesale Corporation, case, C–22
cost-efficient management of, 129–132
cross-business strategic fit along, 232–235
differentiating attributes from managing, 136–138
diversification to leverage, 224
diversifying into related businesses and, 230
for high turnover and traffic, 310
international location-based advantages for, 192
Nucor Corporation, case, C–363
outsourced versus internal, 310–313
outsourcing as risk to, 177
revamping to lower costs, 132–134
Value drivers, 136–138
Value net, 73–74
Value-price-cost framework, 11–12, 151–152
Values
broad differentiation strategy to deliver, 139–140
in corporate culture, 355–356
corporate social responsibility and company, 287–289
Costco Wholesale Corporation, case, C–33–C–34
Starbucks, Inc., case, C–344–C–345
strategic fit leading to gains in, 236
unrelated diversification to build, 238–242
in value-price-cost framework of business model, 11–12
vision and mission linked to, 28–30
Vanguard Effect, 133
Vertical chain. see Value chain
Vertical integration
alliance and partnership advantages over, 180–181
cost advantages of, 131–132
disadvantages of, 173–175
in fresh meat category, C–24
functional organizational structure and, 315–316
to strengthen competitive position, 171–173
Vertical scope of operations, 167
page I-24
Video market, C–144–C–149
Video-on-demand (VOD), C–148
Viral marketing techniques, 165
Vision, strategic
development of, 22–27
in strategic plan, 39–40
values linked to, 28–30
Voice-over-Internet Protocol (VoIP), 75, 225
VRIN (valuable, rare, inimitable, nonsubstitutable) tests for sustainable competitive advantage, 103–105
W
Warehouse management, C–30, C–41
Weak corporate culture, 359
Weapons, competitive, 61
Wearable action-capture cameras, 76
Websites
for brewery marketing, C–16
Costco Wholesale sales on, C–27–C–28
“We have done it this way for years” syndrome, 364
Wellness programs, 290
Wholesale sales strategy, Lululemon Athletica, C–78
Work effort structuring, in executing strategy, 301, 322–323
Work environment, 343
Workforce, C–30–C–33
Workforce diversity, 7
Working capital, 94
World Trade Organization (WTO), 211
Z
Zero emission vehicle (ZEV) credits, C–233
Cover
Halftitle
Title
Copyright
Dedication
About the Authors
Preface
The Business Strategy Game or GLO-BUS Simulation Exercises
Connect
Brief Contents
Contents
Part 1: Concepts and Techniques for Crafting and Executing Strategy
Section A: Introduction and Overview
Chapter 1: What Is Strategy and Why Is It Important?
What do We Mean by Strategy?
Strategy Is about Competing Differently
Strategy and the Quest for Competitive Advantage
1.1 Apple Inc.: Exemplifying a Successful Strategy
Why a Company’s Strategy Evolves over Time
A Company’s Strategy Is Partly Proactive and Partly Reactive
Strategy and Ethics: Passing the Test of Moral Scrutiny
A Company’s Strategy and Its Business Model
What Makes a Strategy a Winner?
1.2 Pandora, SiriusXM, and Over-the-Air Broadcast Radio: Three Contrasting Business Models
Why Crafting and Executing Strategy are Important Tasks
Good Strategy + Good Strategy Execution = Good Management
The Road Ahead
Chapter 2: Charting a Company’s Direction
What does the Strategy-Making, Strategy-Executing Process Entail?
Stage 1: Developing a Strategic Vision, Mission Statement, and Set of Core Values
Developing a Strategic Vision
Communicating the Strategic Vision
2.1 Examples of Strategic Visions—How Well Do They Measure Up?
Expressing the Essence of the Vision in a Slogan
Why a Sound, Well-Communicated Strategic Vision Matters
Developing a Company Mission Statement
Linking the Vision and Mission with Company Values
2.2 TOMS Shoes: A Mission with a Company
Stage 2: Setting Objectives
Setting Stretch Objectives
What Kinds of Objectives to Set
The Need for a Balanced Approach to Objective Setting
2.3 Examples of Company Objectives
Setting Objectives for Every Organizational Level
Stage 3: Crafting a Strategy
Strategy Making Involves Managers at All Organizational Levels
A Company’s Strategy-Making Hierarchy
Uniting the Strategy-Making Hierarchy
A Strategic Vision + Mission + Objectives + Strategy = A Strategic Plan
Stage 4: Executing the Strategy
Stage 5: Evaluating Performance and Initiating Corrective Adjustments
Corporate Governance: The Role of the Board of Directors in the Strategy-Crafting, Strategy-Executing Process
2.4 Corporate Governance Failures at Volkswagen
Section B: Core Concepts and Analytical Tools
Chapter 3: Evaluating a Company’s External Environment
Assessing the Company’s Industry and Competitive Environment
Analyzing the Company’s Macro-Environment
3.1 The Differential Effects of the Coronavirus Pandemic of 2020
Assessing the Company’s Industry and Competitive Environment
The Five Forces Framework
Competitive Pressures Created by the Rivalry among Competing Sellers
The Choice of Competitive Weapons
Competitive Pressures Associated with the Threat of New Entrants
Whether Entry Barriers Are High or Low
The Expected Reaction of Industry Members in Defending against New Entry
Competitive Pressures from the Sellers of Substitute Products
Competitive Pressures Stemming from Supplier Bargaining Power
Competitive Pressures Stemming from Buyer Bargaining Power and Price Sensitivity
Whether Buyers Are More or Less Price-Sensitive
Is the Collective Strength of the Five Competitive Forces Conducive to Good Profitability?
Matching Company Strategy to Competitive Conditions
Complementors and the Value Net
Industry Dynamics and the Forces Driving Change
Identifying the Forces Driving Industry Change
Assessing the Impact of the Forces Driving Industry Change
Adjusting the Strategy to Prepare for the Impacts of Driving Forces
Strategic Group Analysis
Using Strategic Group Maps to Assess the Market Positions of Key Competitors
The Value of Strategic Group Maps
3.2 Comparative Market Positions of Selected Companies in the Pizza Chain Industry: A Strategic Group Map Example
Competitor Analysis and the Soar Framework
Current Strategy
Objectives
Resources and Capabilities
Assumptions
Key Success Factors
3.3 Business Ethics and Competitive Intelligence
The Industry Outlook for Profitability
Chapter 4: Evaluating a Company’s Resources, Capabilities, and Competitiveness
Question 1: How Well is the Company’s Present Strategy Working?
Question 2: What are the Company’s Strengths and Weaknesses in Relation to the Market Opportunities and External Threats?
Identifying a Company’s Internal Strengths
Identifying Company Internal Weaknesses
Identifying a Company’s Market Opportunities
Identifying External Threats
What Do the SWOT Listings Reveal?
Question 3: What are the Company’s most Important Resources and Capabilities, and will They Give the Company a Lasting Competitive Advantage?
Identifying the Company’s Resources and Capabilities
Types of Company Resources
Identifying Organizational Capabilities
Assessing the Competitive Power of a Company’s Resources and Capabilities
The Four Tests of a Resource’s Competitive Power
A Company’s Resources and Capabilities Must Be Managed Dynamically
The Role of Dynamic Capabilities
Question 4: How do Value Chain Activities Impact a Company’s Cost Structure and Customer Value Proposition?
The Concept of a Company Value Chain
Comparing the Value Chains of Rival Companies
A Company’s Primary and Secondary Activities Identify the Major Components of Its Internal Cost Structure
4.1 The Value Chain for Everlane, Inc.
The Value Chain System
Benchmarking: A Tool for Assessing the Costs and Effectiveness of Value Chain Activities
4.2 Benchmarking in the Solar Industry
4.3 Benchmarking and Ethical Conduct
Strategic Options for Remedying a Cost or Value Disadvantage
Improving Internally Performed Value Chain Activities
Improving Supplier-Related Value Chain Activities
Improving Value Chain Activities of Distribution Partners
Translating Proficient Performance of Value Chain Activities into Competitive Advantage
How Value Chain Activities Relate to Resources and Capabilities
Question 5: Is the Company Competitively Stronger or Weaker than Key Rivals?
Strategic Implications of Competitive Strength Assessments
Question 6: What Strategic Issues and Problems Merit Front-Burner Managerial Attention?
Section C: Crafting a Strategy
Chapter 5: The Five Generic Competitive Strategies
Types of Generic Competitive Strategies
Broad Low-Cost Strategies
The Two Major Avenues for Achieving a Cost Advantage
Cost-Efficient Management of Value Chain Activities
Revamping of the Value Chain System to Lower Costs
5.1 Vanguard’s Path to Becoming the Low-Cost Leader in Investment Management
Examples of Companies That Revamped Their Value Chains to Reduce Costs
The Keys to a Successful Broad Low-Cost Strategy
When a Low-Cost Strategy Works Best
Pitfalls to Avoid in Pursuing a Low-Cost Strategy
Broad Differentiation Strategies
Managing the Value Chain in Ways that Enhance Differentiation
Revamping the Value Chain System to Increase Differentiation
Delivering Superior Value via a Broad Differentiation Strategy
When a Differentiation Strategy Works Best
Pitfalls to Avoid in Pursuing a Differentiation Strategy
Focused (or Market Niche) Strategies
A Focused Low-Cost Strategy
5.2 Clinícas del Azúcar’s Focused Low-Cost Strategy
A Focused Differentiation Strategy
When a Focused Low-Cost or Focused Differentiation Strategy Is Attractive
5.3 Canada Goose’s Focused Differentiation Strategy
The Risks of a Focused Low-Cost or Focused Differentiation Strategy
Best-Cost (Hybrid) Strategies
When a Best-Cost Strategy Works Best
5.4 Trader Joe’s Focused Best-Cost Strategy
The Risk of a Best-Cost Strategy
The Contrasting Features of the Generic Competitive Strategies
Successful Generic Strategies Are Resource-Based
Generic Strategies and the Three Different Approaches to Competitive Advantage
Chapter 6: Strengthening a Company’s Competitive Position
Launching Strategic Offensives to Improve a Company’s Market Position
Choosing the Basis for Competitive Attack
Choosing Which Rivals to Attack
Blue-Ocean Strategy—a Special Kind of Offensive
Defensive Strategies—Protecting Market Position and Competitive Advantage
6.1 Etsy’s Blue Ocean Strategy in Online Retailing of Handmade Crafts
Blocking the Avenues Open to Challengers
Signaling Challengers That Retaliation Is Likely
Timing a Company’s Strategic Moves
The Potential for First-Mover Advantages
6.2 Tinder Swipes Right for First-Mover Success
The Potential for Late-Mover Advantages or First-Mover Disadvantages
To Be a First Mover or Not
Strengthening a Company’s Market Position via Its Scope of Operations
Horizontal Merger and Acquisition Strategies
Why Mergers and Acquisitions Sometimes Fail to Produce Anticipated Results
6.3 Walmart’s Expansion into E-Commerce via Horizontal Acquisition
Vertical Integration Strategies
The Advantages of a Vertical Integration Strategy
Integrating Backward to Achieve Greater Competitiveness
Integrating Forward to Enhance Competitiveness
The Disadvantages of a Vertical Integration Strategy
Weighing the Pros and Cons of Vertical Integration
6.4 Tesla’s Vertical Integration Strategy
Outsourcing Strategies: Narrowing the Scope of Operations
The Risk of Outsourcing Value Chain Activities
Strategic Alliances and Partnerships
Capturing the Benefits of Strategic Alliances
The Drawbacks of Strategic Alliances and Their Relative Advantages
How to Make Strategic Alliances Work
Chapter 7: Strategies for Competing in International Markets
Why Companies Decide to Enter Foreign Markets
Why Competing Across National Borders Makes Strategy Making more Complex
Home-Country Industry Advantages and the Diamond Model
Demand Conditions
Factor Conditions
Related and Supporting Industries
Firm Strategy, Structure, and Rivalry
Opportunities for Location-Based Advantages
The Impact of Government Policies and Economic Conditions in Host Countries
The Risks of Adverse Exchange Rate Shifts
Cross-Country Differences in Demographic, Cultural, and Market Conditions
Strategic Options for Entering International Markets
Export Strategies
Licensing Strategies
Franchising Strategies
Foreign Subsidiary Strategies
Alliance and Joint Venture Strategies
7.1 Walgreens Boots Alliance, Inc.: Entering Foreign Markets via Alliance Followed by Merger
The Risks of Strategic Alliances with Foreign Partners
International Strategy: The Three Main Approaches
Multidomestic Strategies—a “Think-Local, Act-Local” Approach
Global Strategies—a “Think-Global, Act-Global” Approach
Transnational Strategies—a “Think-Global, Act-Local” Approach
7.2 Four Seasons Hotels: Local Character, Global Service
International Operations and the Quest for Competitive Advantage
Using Location to Build Competitive Advantage
When to Concentrate Activities in a Few Locations
When to Disperse Activities across Many Locations
Sharing and Transferring Resources and Capabilities across Borders to Build Competitive Advantage
Benefiting from Cross-Border Coordination
Cross-Border Strategic Moves
Waging a Strategic Offensive
Defending against International Rivals
Strategies for Competing in the Markets of Developing Countries
Strategy Options for Competing in Developing-Country Markets
Defending Against Global Giants: Strategies for Local Companies in Developing Countries
7.3 WeChat’s Strategy for Defending against International Social Media Giants in China
Chapter 8: Corporate Strategy
What does Crafting a Diversification Strategy Entail?
When to Consider Diversifying
Building Shareholder Value: The Ultimate Justification for Diversifying
Approaches to Diversifying the Business Lineup
Diversifying by Acquisition of an Existing Business
Entering a New Line of Business through Internal Development
Using Joint Ventures to Achieve Diversification
Choosing a Mode of Entry
The Question of Critical Resources and Capabilities
The Question of Entry Barriers
The Question of Speed
The Question of Comparative Cost
Choosing the Diversification Path: Related Versus Unrelated Businesses
Diversification into Related Businesses
Identifying Cross-Business Strategic Fit along the Value Chain
8.1 Examples of Companies Pursuing a Related Diversification Strategy
Strategic Fit in Supply Chain Activities
Strategic Fit in R&D and Technology Activities
Manufacturing-Related Strategic Fit
Strategic Fit in Sales and Marketing Activities
Distribution-Related Strategic Fit
Strategic Fit in Customer Service Activities
Strategic Fit, Economies of Scope, and Competitive Advantage
From Strategic Fit to Competitive Advantage, Added Profitability, and Gains in Shareholder Value
8.2 The Kraft–Heinz Merger: Pursuing the Benefits of Cross-Business Strategic Fit
Diversification into Unrelated Businesses
Building Shareholder Value via Unrelated Diversification
8.3 Examples of Companies Pursuing an Unrelated Diversification Strategy
The Benefits of Astute Corporate Parenting
Judicious Cross-Business Allocation of Financial Resources
Acquiring and Restructuring Undervalued Companies
The Path to Greater Shareholder Value through Unrelated Diversification
The Drawbacks of Unrelated Diversification
Demanding Managerial Requirements
Limited Competitive Advantage Potential
Misguided Reasons for Pursuing Unrelated Diversification
Combination Related–Unrelated Diversification Strategies
Evaluating the Strategy of a Diversified Company
Step 1: Evaluating Industry Attractiveness
Calculating Industry-Attractiveness Scores
Interpreting the Industry-Attractiveness Scores
Step 2: Evaluating Business Unit Competitive Strength
Calculating Competitive-Strength Scores for Each Business Unit
Interpreting the Competitive-Strength Scores
Using a Nine-Cell Matrix to Simultaneously Portray Industry Attractiveness and Competitive Strength
Step 3: Determining the Competitive Value of Strategic Fit in Diversified Companies
Step 4: Checking for Good Resource Fit
Financial Resource Fit
Nonfinancial Resource Fit
Step 5: Ranking Business Units and Assigning a Priority for Resource Allocation
Allocating Financial Resources
Step 6: Crafting New Strategic Moves to Improve Overall Corporate Performance
Sticking Closely with the Present Business Lineup
Broadening a Diversified Company’s Business Base
Retrenching to a Narrower Diversification Base
Restructuring a Diversified Company’s Business Lineup
8.4 Restructuring Strategically at VF Corporation
Chapter 9: Ethics, Corporate Social Responsibility, Environmental Sustainability, and Strategy
What do We Mean by Business Ethics?
Where do Ethical Standards Come from—are They Universal or Dependent on Local Norms?
The School of Ethical Universalism
The School of Ethical Relativism
The Use of Underage Labor
The Payment of Bribes and Kickbacks
Why Ethical Relativism Is Problematic for Multinational Companies
Ethics and Integrative Social Contracts Theory
How and Why Ethical Standards Impact the Tasks of Crafting and Executing Strategy
Drivers of Unethical Business Strategies and Behavior
Faulty Oversight, Enabling the Unscrupulous Pursuit of Personal Gain and Self-Interest
9.1 Ethical Violations at Uber and their Consequences
Heavy Pressures on Company Managers to Meet Short-Term Performance Targets
A Company Culture That Puts Profitability and Business Performance Ahead of Ethical Behavior
Why should Company Strategies be Ethical?
The Moral Case for an Ethical Strategy
The Business Case for Ethical Strategies
9.2 How PepsiCo Put Its Ethical Principles into Practice
Strategy, Corporate Social Responsibility, and Environmental Sustainability
The Concepts of Corporate Social Responsibility and Good Corporate Citizenship
Corporate Social Responsibility and the Triple Bottom Line
9.3 Warby Parker: Combining Corporate Social Responsibility with Affordable Fashion
What Do We Mean by Sustainability and Sustainable Business Practices?
Crafting Corporate Social Responsibility and Sustainability Strategies
9.4 Unilever’s Focus on Sustainability
The Moral Case for Corporate Social Responsibility and Environmentally Sustainable Business Practices
The Business Case for Corporate Social Responsibility and Environmentally Sustainable Business Practices
Section D: Executing the Strategy
Chapter 10: Building an Organization Capable of Good Strategy Execution
A Framework for Executing Strategy
The Principal Components of the Strategy Execution Process
What’s Covered in Chapters 10, 11, and 12
Building an Organization Capable of Good Strategy Execution: Three Key Actions
Staffing the Organization
Putting Together a Strong Management Team
Recruiting, Training, and Retaining Capable Employees
10.1 Management Development at Deloitte Touche Tohmatsu Limited
Developing and Building Critical Resources and Organizational Capabilities
Three Approaches to Building and Strengthening Organizational Capabilities
Developing Organizational Capabilities Internally
Acquiring Capabilities through Mergers and Acquisitions
Accessing Capabilities through Collaborative Partnerships
The Strategic Role of Employee Training
Strategy Execution Capabilities and Competitive Advantage
10.2 Zara’s Strategy Execution Capabilities
Matching Organizational Structure to the Strategy
Deciding Which Value Chain Activities to Perform Internally and Which to Outsource
10.3 Which Value Chain Activities Does Apple Outsource and Why?
Aligning the Firm’s Organizational Structure with Its Strategy
Making Strategy-Critical Activities the Main Building Blocks of the Organizational Structure
Matching Type of Organizational Structure to Strategy Execution Requirements
Determining How Much Authority to Delegate
Centralized Decision Making: Pros and Cons
Decentralized Decision Making: Pros and Cons
Capturing Cross-Business Strategic Fit in a Decentralized Structure
Providing for Internal Cross-Unit Coordination
Facilitating Collaboration with External Partners and Strategic Allies
Further Perspectives on Structuring the Work Effort
Chapter 11: Managing Internal Operations
Allocating Resources to the Strategy Execution Effort
Instituting Policies and Procedures that Facilitate Strategy Execution
Employing Business Process Management Tools
Promoting Operating Excellence: Three Powerful Business Process Management Tools
Business Process Reengineering
Total Quality Management Programs
Six Sigma Quality Control Programs
11.1 Charleston Area Medical Center’s Six Sigma Program
The Difference between Business Process Reengineering and Continuous-Improvement Programs Like Six Sigma and TQM
Capturing the Benefits of Initiatives to Improve Operations
Installing Information and Operating Systems
Instituting Adequate Information Systems, Performance Tracking, and Controls
Monitoring Employee Performance
Using Rewards and Incentives to Promote Better Strategy Execution
Incentives and Motivational Practices That Facilitate Good Strategy Execution
Striking the Right Balance between Rewards and Punishment
11.2 How Wegmans Rewards and Motivates its Employees
Linking Rewards to Achieving the Right Outcomes
Additional Guidelines for Designing Incentive Compensation Systems
11.3 Nucor Corporation: Tying Incentives Directly to Strategy Execution
Chapter 12: Corporate Culture and Leadership
Instilling a Corporate Culture Conducive to Good Strategy Execution
Identifying the Key Features of a Company’s Corporate Culture
The Role of Core Values and Ethics
Embedding Behavioral Norms in the Organization and Perpetuating the Culture
The Role of Stories
Forces That Cause a Company’s Culture to Evolve
The Presence of Company Subcultures
Strong versus Weak Cultures
Strong-Culture Companies
Weak-Culture Companies
Why Corporate Cultures Matter to the Strategy Execution Process
Healthy Cultures That Aid Good Strategy Execution
High-Performance Cultures
12.1 PUMA’s High-Performance Culture
Adaptive Cultures
Unhealthy Cultures That Impede Good Strategy Execution
Change-Resistant Cultures
Politicized Cultures
Insular, Inwardly Focused Cultures
Unethical and Greed-Driven Cultures
Incompatible, Clashing Subcultures
Changing a Problem Culture
Making a Compelling Case for Culture Change
Substantive Culture-Changing Actions
Symbolic Culture-Changing Actions
How Long Does It Take to Change a Problem Culture?
12.2 Driving Cultural Change at Goldman Sachs
Leading the Strategy Execution Process
Staying on Top of How Well Things Are Going
Mobilizing the Effort for Excellence in Strategy Execution
Leading the Process of Making Corrective Adjustments
A Final Word on Leading the Process of Crafting and Executing Strategy
Part 2: Cases in Crafting and Executing Strategy
Section A: Crafting Strategy in Single-Business Companies
Case 1: Airbnb in 2020
Case 2: Competition in the Craft Beer Industry in 2020
Case 3: Costco Wholesale in 2020: Mission, Business Model, and Strategy
Case 4: Ford Motor Company: Will the Company’s Strategic Moves Restore its Competitiveness and Financial Performance?
Case 5: Macy’s, Inc.: Will Its Strategy Allow It to Survive in the Changing Retail Sector?
Case 6: TOMS Shoes: Expanding Its Successful One For One Business Model
Case 7: lululemon athletica’s Strategy in 2020: Is the Recent Growth in Retail Stores, Revenues, and Profitability Sustainable?
Case 8: Under Armour’s Strategy in 2020: Can It Revive Sales and Profitability in Its Core North American Market?
Case 9: Spotify in 2020: Can the Company Remain Competitive?
Case 10: Beyond Meat, Inc.
Case 11: Netflix’s 2020 Strategy for Battling Rivals in the Global Market for Streamed Video Subscribers
Case 12: Twitter Inc. in 2020
Case 13: Yeti in 2020: Can Brand Name and Innovation Keep it Ahead of the Competition?
Case 14: GoPro in 2020: Have its Turnaround Strategies Failed?
Case 15: Publix Super Markets: Its Strategy in the U.S. Supermarket and Grocery Store Industry
Case 16: Tesla’s Strategy in 2020: Can It Deliver Sustained Profitability?
Case 17: Unilever’s Purpose-led Brand Strategy: Can Alan Jope Balance Purpose and Profits?
Case 18: Domino’s Pizza: Business Continuity Strategy during the Covid-19 Pandemic
Case 19: Burbank Housing: Building from the Inside Out
Case 20: Boeing 737 MAX: What Response Strategy is Needed to Ensure Passenger Safety and Restore the Company’s Reputation?
Case 21: The Walt Disney Company: Its Diversification Strategy in 2020
Case 22: Robin Hood
Section B: Crafting Strategy in Diversified Companies
Case 23: Southwest Airlines in 2020: Culture, Values, and Operating Practices
Case 24: Uber Technologies in 2020: Is the Gig Economy Labor Force Working for Uber?
Section C: Implementing and Executing Strategy
Case 25: Starbucks in 2020: Is the Company on Track to Achieve Attractive Growth and Operational Excellence?
Case 26: Nucor Corporation in 2020: Pursuing Efforts to Grow Sales and Market Share Despite Tough Market Conditions
Case 27: Eliminating Modern Slavery from Supply Chains: Can Nestlé Lead the Way?
Guide to Case Analysis
Indexes
Company Index
Name Index
Subject Index
