The CASE Journal Volume 5, Issue 2 (Spring

Transcription

The CASE Journal
Volume 5, Issue 2 (Spring 2009)
Page 1
The CASE Journal
The CASE Journal ~ Volume 5, Issue 2 (Spring 2009)
Table of Contents
Editorial Policy
Letter from the Editor
Reviewers for The CASE Journal, 2006-2009
Case Abstracts – Click on the case title to access the full case.
Cases
“ER Medical Director”
Charles M. Carson, Samford University
Jennings B. Marshall, Samford University
`
“Lessons From Computer Intrusion at TJX”
Benjamin Ngugi, Suffolk University
Glenn S Dardick, Longwood University
Gina Vega, Salem, Salem State College
“Ann Taylor: Survival in Specialty Retail”
Pauline Assenza, Manhattanville College
Alan B. Eisner, Pace University
Jerome C. Kuperman, Minnesota State University Moorhead
“Kija Kim and Harvard Design & Mapping Co.”
Lynda L. Moore & Bonita L. Betters-Reed, Simmons School of Management
“Teradyne: On the road to China”
Kuo-Ting Hung & Neil Hunt, Suffolk University, Gina Vega, Salem State College, Laurie
Levesque, Hasan Arslan & Christian DeLaunay, Suffolk University
“A Confrontation of Mindsets: French Retailers Operating in Poland”
Stephanie Hurt, Meredith College
Marcus Hurt, EDHEC Business School
“Financial Reporting for Investments: The Case of National General Insurance Company”
Kenton Swift, University of Montana
Mel McFetridge, Carroll College
“The Prize? The Price? Constellation Brands’ Proposed Merger with the Robert Mondavi
Company”
Armand Gilinsky, Jr., Sonoma State University
Raymond H. Lopez, Pace University
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The CASE Journal
EDITORIAL POLICY
The audience for this journal includes both
practitioners and academics and thus encourages submissions from a broad range of
individuals.
The CASE Journal invites submissions of cases designed for classroom use. Cases from all
business disciplines will be considered. Cases must be factual, and releases must be available
where necessary. All cases must be accompanied by an instructor’s manual which identifies the
intended course, relevant theoretical concepts or models that can be applied, and the research
methodology for the case. The instructor’s manual should also contain discussion questions and
suggested responses, and a teaching plan if not inherent in the Q&A.
The CASE Journal also invites submissions of articles relating to case teaching, writing,
reviewing, and similar topics. Conceptual papers and papers reporting original research as well
as the applied implications of others' research in terms of case teaching, research, and instruction;
and creative learning, research and writing methods are encouraged. We request that submitters
of empirical research provide appropriate data set analyses to allow for meta-studies (i.e.
correlations matrices and chi-alpha’s).
Because of the broad appeal of the journal to practitioners and academics, The CASE Journal
will not refuse to review a case or an article solely on the basis of format. However, if a case or
paper is accepted, the final version for publication will be expected to adhere to the publication
and manuscript guidelines. Cases and papers may be returned due to issues relating to writing
style and grammar.
The CASE Journal encourages authors to submit often to the Journal. However, authors who are
published in one publication year cannot be published a second time in that publication
year. Rather, additionally accepted papers will appear in subsequent publication years. This
policy does not apply to authors who submit papers for review with different second authors
from those on the first accepted paper in any given publication year.
CASES: Those wishing to submit a case for potential publication should submit the entire case
along with the completed teaching notes for review. If accepted for publication, only the case
will be published along with a note for interested readers to contact the case author for the
teaching notes. All review and publishing rules which apply to scholarly articles also apply for
cases. Also, upon acceptance for publication, The CASE Journal requires that the author(s)
submit a signed letter of liability release prior to publication. Authors are responsible for
distributing the teaching notes as requested by CASE Association members and their e-mail
addresses will be provided for such purpose.
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The CASE Journal
INITIAL SUBMISSION:
All cases and articles will be subject to a double blind review process. Our process is
developmental, and our reviewers will offer suggestions for improvement and revision, where
appropriate.
All manuscripts submitted are to be original, unpublished and not under consideration by any
other publishing source. To ensure the blind review, there should be no author-identifying
information in the text or references. An abstract of 150 words or less should accompany any
article, and should be included in the instructor’s manual accompanying any case. This journal
will only accept on-line submissions to the editor by email in MS-Word. A separate title page
must accompany the paper and include the title of the paper and all pertinent author information
(i.e. name, affiliation, address, telephone number, FAX number, and E-mail address), 75-100
word abstract, 3-5 keywords, and the following statement: “I have received all relevant releases
prior to submission of this case.” If any portion of the manuscript has been presented in other
forms (conferences, workshops, speeches, etc.), it should be so noted on the title page. Please see
The CASE Journal’s website, www.caseweb.org, for updated information.
COPYRIGHT: Authors submitting articles and cases for potential publication in The CASE
Journal warrant that the work is not an infringement on any existing copyright and will
indemnify the publisher against any breach of such warranty. Upon acceptance for publication,
authors must convey copyright ownership to The CASE Journal by signing a publication
agreement, signed and dated by all authors, which also certifies that the article/case is original,
not published elsewhere, and that they have permission to use all proprietary and/or copyrighted
material.
Cases published in The CASE Journal and their instructors’ manuals are also distributed through
the Primis Online and ecch distribution networks.
Circulation Data:
Reader:
Frequency of Issue:
Copies per Issue:
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Publishing Fee:
Sponsorship:
Academic and Practitioner
2 times per year (Fall and Spring, based upon available
accepted manuscripts)
n/a Internet publication
Free with membership in The CASE Association
None. However, at least one of the publishing
authors must be a member of the CASE Association at the
time of publication ($25 membership fee)
Professional Association
©2009 The CASE Association. All right reserved. Further reproduction by any means, electronic or mechanical,
including photocopying or by any information storage or retrieval system must be arranged with the copyright
holder.
If you wish to use any of these cases in your classes, you can arrange for their purchase through our distributors:
PRIMIS (www.primisonline.com) or ecch (www.ecch.com). Copyright law prohibits you from reproducing any
cases without permission EXCEPT cases you have written.
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The CASE Journal
LETTER FROM THE EDITOR
The spring issue (Volume 5, number 2) of The CASE Journal offers a wide range of cases. They cover a
variety of disciplines, from statistics, information systems, and finance to marketing and management.
Topics include diversity, leadership, human resources, entrepreneurship, supply chain management, and
retail and financial strategies. Three of the cases have an international focus. This issue has something for
(nearly) everyone!
This issue is my last as editor. Over the last three years, The CASE Journal has published more than 30
cases and case series and several articles. There are many more cases in the pipeline, some recently
submitted for their first review, some under revision (perhaps not the first), and some almost ready for
publication. The new editor, Dr. Gina Vega, will continue to oversee a rigorous yet developmental review
process. Gina is an extremely experienced case writer and reviewer, and is one of the most developmental
people I know. She has written her own manual for student case writers, and co-authored all three of the
Professor Moore articles that have appeared in my volumes. Gina will take the Journal to new levels of
operating efficiency, but more important will share her vision of what a good case should be. She will
also come up with her own ideas for new types of submissions that will enhance case writing, case
teaching, and case research.
The reviewers are the Journal’s most valuable resource. They have risen to the challenge of being both
developmental and rigorous, both considering how to help authors to improve their cases and instructors’
manuals and working toward cases of publishable quality. A complete list of reviewers appears in this
issue. It’s only a very small “Thank You” to the dedicated people who find time to read and reread and
think about someone else’s work, in addition to their own teaching/ writing/ grading, etc. My special
thanks to the individuals who make up the Journal’s Editorial Review Board: Chad Carson, Jim Carroll,
Alan Eisner, Tom Leach, Rebecca Morris, Bill Naumes, Ram Subramanian, and Stefanie Tate, who have
repeatedly offered their time and their expertise in a wide variety of disciplines. Special thanks also to
Alan Eisner who has made sure that the Journal got on the website. Thank you all!
If you would like to be part of the review process, working with authors to create truly excellent cases and
instructors’ manuals, please get in touch with Gina Vega, the new editor, at [email protected]. Gina
will also be looking for manuscripts, both cases (with instructors’ manuals) and articles. If you have ideas
for other features for the Journal, I am sure that she would be interested in them, also.
Thank you for your support – as authors, reviewers, and case users and readers – over the past three
years! Keep writing – there are never enough good cases!
Margaret Naumes
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The CASE Journal Reviewers, 2006 - 2009
Editorial Review Board
James Carroll, Georgian Court University
Charles M. Carson, Samford University
Alan Eisner, Pace University
Tom Leach, University of New England
Rebecca Morris, University of Nebraska at Omaha
William Naumes, University of New Hampshire
Ram Subramanian, Montclair State University
Stefanie Tate, University of Massachusetts-Lowell
Reviewers
Michael Merenda, University of New
Hampshire
Jim Morgan, Northern Arizona University
Janice Nath, University of Houston-Downtown
John Ogilvie, University of Hartford
Jerry Platt, University of Redlands
Anthony Pescosolido, University of New
Hampshire
Tim Redmer, Regent University
Dan Reid, University of New Hampshire
Marie Rock, Bentley College
Donald Schepers, Baruch College
Udo Schlentrich, University of New Hampshire
Christine Shea, University of New Hampshire
Herb Sherman, Long Island University
Diane Shichtman, Empire State College
Teresa Stephenson, University of Wyoming
Narendar Sumukadas, University of Hartford
Marilyn Taylor, University of Missouri – Kansas
City
Kathleen Terry
Gina Vega, Salem State College
Jonathan Welch, Northeastern University
Michael Welsh, University of South Carolina
Susan Williams, Northern Arizona University
Philip Wilson, Midwestern State University
Joan Winn, University of Denver
Craig Wood, University of New Hampshire
Margaret Ake, Endicott College
Joseph Anderson, Northern Arizona University
Jyoti Bachani, St. Mary’s College of California
Bruce Bachenheimer, Pace University
Rik Berry, University of Arkansas – Fort Smith
Bonita Betters-Reed, Simmons College
Lou Chin, Bentley College
Edward Desmarais, Salem State College
David Desplaces, College of Charleston
Tim Edlund, Morgan State University
Mary Foster, Morgan State University
Cynthia Ingols, Simmons College
Jill Kammermeyer, University of New
Hampshire
Kristine Kelly, Endicott College
Duncan LaBay, Salem State College
Kenneth Laird, Southern Connecticut State
University
Miranda Lam, Salem State College
Jackie Landau, Salem State College
Laurie Levesque, Suffolk University
Daphne Main, Loyola University
William Mathews
Jack McCarthy, Boston University
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The CASE Journal
CASE AND ARTICLE ABSTRACTS
Click on the case title to access the full case.
ER Medical Director
Charles M. Carson
Jennings B. Marshall
Samford University
Dr. Lawrence Frazier was an emergency room physician who was an employee of Honore
Staffing Services of Baton Rouge, Louisiana. He worked at Methodist Health System hospital in
Grant, Georgia. He had recently added the title of ER Medical Director and served as liaison
between Honore staffing and the Methodist hospital. His additional duties included overseeing
the other physicians which staff the emergency room. Methodist had a bonus system in place
based on obtaining 31 patients’ satisfaction surveys each month. Dr. Frazier believed that the
small sample lead to erroneous results and created problems for the physicians under his
supervision. He wanted to change the data collection process (e.g. sample size collected,
instrument), but encountered obstacles when he broached the subject with his hospital
administrators.
Key words: Likert scale, sample size, bias, error, performance evaluations, compensation / bonus
Lessons From Computer Intrusion at TJX
Benjamin Ngugi, Suffolk University
Glenn S Dardick, Longwood University
Gina Vega, Salem, Salem State College
In January, 2007, TJX reported that it had suffered from a computer intrusion. The company was
sure neither of the identity of the perpetrators nor of how many customers were affected. A
deeper analysis revealed that the intrusion had started earlier and affected more customers than
previously thought. Ensuing investigation concluded that TJX was collecting unnecessary
information, keeping it for too long and employing obsolete and insufficient safeguards. TJX
denied any wrongdoing but implemented most of the recommended remedies to strengthen their
security.
Keywords: computer intrusion, hacking, data protection, PCI compliance, layered defense,
identity theft, network security
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Ann Taylor: Survival in Specialty Retail
Pauline Assenza, Manhattanville College
Alan B. Eisner, Pace University
Jerome C. Kuperman, Minnesota State University Moorhead
Ann Taylor was founded in 1954, and its classic black dress and woman’s power suit were
staples for years. In 1995 Ann Taylor LOFT was launched to appeal to a more casual, costconscious consumer. Under Kay Krill’s leadership, the division began to outperform the original
flagship. When Krill was promoted to President/CEO of Ann Taylor Stores Corporation in 2005,
she was challenged with rebuilding the Ann Taylor brand – (i.e., meeting the “wardrobing needs
of the updated classic consumer”) while maintaining the image and market share of LOFT. By
mid-2008, an additional problem appeared: the macroeconomic climate was posing considerable
uncertainty, especially for retail businesses. Krill was firmly committed to long-term growth.
However, given the 2008 situation, what could she do to unleash what she believed was the
firm’s “significant untapped potential”?
Key Words: strategic management, strategic analysis, strategy formulation, generic strategies,
external environmental analysis, corporate strategy, marketing strategy, branding
Kija Kim and Harvard Design & Mapping Co.
Lynda L. Moore
Bonita L. Betters-Reed
Simmons School of Management
This case is about Kija Kim, a Korean born founder and CEO of Harvard Design and Mapping
Inc. (HDM). Founded in 1988, HDM is a cutting-edge GIS firm with $5 million in revenue and
35 employees in their Cambridge, MA and Washington D.C. offices. Through Kija Kim’s
leadership, HDM has become a significant niche player in homeland security and disaster relief.
The case ends in fall 2005 just after HDM provided Hurricane Katrina mapping support, and
Kija is nominated for the SBA Small Business Person of the Year. This case explores the
intersection between cultural heritage, leadership effectiveness and organizational behavior. It
particularly notes Kija’s ability to turn her immigrant female minority status into a business
advantage. This strength coupled with her ethos of care and ability to network in all walks of her
life contributes to her distinctive and integrated leadership style. Definitions of leadership
success and implications for decision making are also highlighted.
Key words: leadership, women's leadership, cultural diversity
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Teradyne: On the road to China
Kuo-Ting Hung, Suffolk University
Neil Hunt, Suffolk University
Gina Vega, Salem State College
Laurie Levesque, Suffolk University
Hasan Arslan, Suffolk University
Christian DeLaunay, Suffolk University
Jeff Hotchkiss, President of the Assembly Test Division of Teradyne, Inc., the largest electronics
testing company in the world, returned to the corporation where he had built his career after a
three-year hiatus as CEO of a VOIP start-up. Teradyne's operation was struggling through the
effects of a bad economy coupled with significant downturns in the electronics industry, and
Hotchkiss encountered numerous problems specifically in the China operation, including
customer dissatisfaction with service, price, and time required to implement changes. He
assembled a strategic team to address these issues and to recommend and implement an
accelerated turnaround in China. Students are challenged to design the turnaround plan.
Key words: supply chain management, international HRM
A Confrontation of Mindsets: French Retailers Operating in Poland
A Confrontation of Mindsets: French Retailers Operating in Poland traces the history of French
retailers setting up operations in Poland in the mid 90s. The case, however, is set in 2006 when a
top retailing executive recalls the important watershed period of 1996-97 when the expatriate
managers in charge of setting up the first hypermarkets encountered great difficulties with their
new Polish recruits. The managers were not succeeding in transferring the practices and routines
that were an essential part of their business model on the home market in France: their Polish
employees displayed work attitudes that were the contrary of the initiative and responsibility for
enlarged jobs that characterized employees back home. This situation called into question the
very viability of their business model in Poland. The case poses very clearly the question of what
actions the expatriate managers should decide to take to ensure the store launchings in Poland
and future growth. The issues raised concern global versus multi-domestic internationalization
strategies, business models, paradigms, corporate culture, management of expats, knowledge
transfer and the link between strategic implementation and organizational behavior.
Key words: internationalization strategy, retailing, business model, subsidiary management,
knowledge transfer, strategy implementation, organizational behavior
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Financial Reporting for Investments: The Case of National General Insurance
Company
Kenton Swift, University of Montana
Mel McFetridge, Carroll College
The financial statements of public companies located in the United Arab Emirates provide
excellent examples of the impact that reporting investments at fair value can have on net income.
This is because of the wide fluctuations in securities prices and real estate prices in recent years.
Using an actual company, National General Insurance, which is located in Dubai in the United
Arab Emirates, this case provides examples of the impact of fair value accounting for
investments under International Financial Reporting standards (IFRS), for both securities and
property investments. As US financial reporting moves towards harmonization with IFRS, it is
critical to understand how reporting for investments under US Generally Accepted Accounting
Principles (US GAAP) compares with international reporting standards. Specific learning
objectives include gaining an understanding of the reporting requirements for investments under
IFRS, understanding the difference between reporting requirements for investments under US
GAAP and IFRS, and understanding both the positive and negative impacts on reported net
income from using fair values for reporting investments.
Financial Accounting, international financial reporting standards, accounting for investments,
fair value accounting
The Prize? The Price? Constellation Brands’ Proposed Merger with the
Robert Mondavi Company
Armand Gilinsky, Jr., Sonoma State University
Raymond H. Lopez, Pace University
In October 2004, Mr. Richard Sands, CEO of Constellation Brands, evaluated the potential
purchase of The Robert Mondavi Corporation. Sands felt that Mondavi’s wine beverage
products would fit into the Constellation portfolio of alcohol beverage brands, and the
opportunity to purchase Mondavi for a highly favorable price was quite possible due to recent
management turmoil at that company. However, should it be purchased, strategic and
operational changes would be necessary in order to fully achieve Mondavi’s potential value. In
making a decision, students need to consider the attractiveness of the wine industry, its changing
structure, its share of the overall market for beverages, and rival firms’ strategies. As rival
bidders may emerge for Mondavi’s brands, Constellation must offer a price that demonstrates its
serious intent to acquire Mondavi.
Key words: strategy implementation, merger and acquisition analysis, financial analysis,
financial forecasting, corporate valuation
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ER Medical Director 1
Charles M. Carson
Samford University
Jennings B. Marshall
Samford University
As an aspiring medical student, Dr. Lawrence Frazier never pictured himself neck deep in the
management problems of his own emergency room. Instead of managing patients’ health
problems, he now had to manage other physicians along with daily interactions with hospital
administrators. As he perused his patient satisfaction scores printout, he realized that he needed
to find a strategic foothold between the company he worked for as an independent contractor and
the hospital he served as the Medical Director of the emergency room. Specifically, he had to
find solutions to a complicated problem involving sample size and data issues with the monthly
patient satisfaction scores that were used to calculate physician performance bonuses.
Background
Dr. Lawrence Frazier graduated from the University of Mississippi School of Medicine in
Jackson, Mississippi and knew that he had several options to pursue in terms of his postresidency employment. He considered offers to join an internal medicine clinic, his specialty, as
well as several opportunities at family practice in and around his hometown of Campbellsville,
KY. After stints at several area hospitals, Frazier settled in as an emergency room physician
working at the Methodist Health System hospital in Grant, GA. While Dr. Frazier worked at the
Methodist hospital, he was actually an employee of Honore Staffing Services based in Baton
Rouge, LA. Honore Staffing Services was a medical personnel provider for over 50 small to
medium sized hospitals in the Southeastern United States. Technically, Frazier was an
independent contractor servicing the Methodist Hospital in Grant through his contractual
relationship with Honore Staffing Services.
Frazier enjoyed his work and the camaraderie that he shared with his colleagues in the
Emergency Room. After only a few months of hourly shift work in the ER, Frazier was offered
an opportunity for an increased role with Honore Staffing. The position of ER Medical Director
became available and upper management at Honore had offered the position to Frazier. This
decision was based on his strong reputation among his colleagues and excellent referrals from his
patients. The primary responsibilities of the ER Medical Director were to oversee the four full
time and three part time physicians that worked in ER and to deal with patient-staff quality
issues. In essence, Frazier served as a liaison between Honore Staffing and the medical staff at
the Methodist Hospital. Frazier’s ER Medical Director duties were compensated on a salary
basis. Additionally, he continued to work his regular ER shift duties, which like all of the other
ER physicians, were compensated on an hourly basis.
1
Please direct all correspondence to the first author. An earlier version of this case was presented
at the 2007 Southwest Case Research Association meeting in San Diego.
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The Incentive Compensation System
The incentive compensation system was established and implemented by Methodist Health
System without any discussion with the ER employees or Honore Staffing. Methodist made
incentive payments directly to Honore Staffing who transferred the incentive payments on to the
respective doctors. When Dr. Frazier had addressed complaints to Honore about the incentive
system, Honore had shrugged those complaints off with little comment. Frazier pressed the issue
with Honore and they suggested that Frazier take any complaints that he had with the system
directly to the administration of Methodist Health System and in particular, his hospital
administrator.
Specifics of the System
Methodist had established two benchmarking levels for incentive compensation: Target and
Challenge. The Target and Challenge goals were established by Methodist corporate offices
which used national averages and percentile data provided by the Gallup Institute 2. Target goals
were the lower of the two. The benchmarks were established in four categories of performance
and were captured using the following questions.
Were you very satisfied (4), satisfied (3), somewhat dissatisfied (2), or very dissatisfied (1) with:
A.
B.
C.
D.
The amount of time the Emergency Department doctor spent with you?
The care and compassion shown by the Emergency Department doctor?
The Emergency Department doctor's willingness to answer questions thoroughly?
The quality of the Emergency Department physicians who treated you?
Each question represented a specific incentive compensation category. The following Table
shows the average scores required for a physician to meet both Target and Challenge Goals.
Table 1
Question
Average Score Needed
to Meet Target Goal
Average Score Needed
to Meet Challenge Goal
A.
B.
C.
D.
3.17
3.32
3.26
3.32
3.25
3.41
3.37
3.44
If a Target goal was met, each of the doctors would be compensated an additional $1.25 per hour
for that particular category. Physicians could earn an additional $5 per hour if all goals were met
at the Target level. This was then multiplied by the number of hours worked per month.
2
The Gallup Institute is a part of the Gallup Organization which collects and analyzes data on a wide range of topics
for both private and public sector entities. For more information please see their website at
http://www.gallup.com/corporate/115/About-Gallup.aspx
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Challenge goals worked in much the same way except that the compensation level was double
the Target level. For each category the physicians could earn an additional $2.50 per hour if they
met the Challenge goal level. If all four categories were met at the Challenge level, the
physicians could make an additional $10 per hour. Again, this would be multiplied by the total
number of hours worked per month. Methodist did allow the doctors to meet multiple goal
levels in a given month (i.e. doctors may be compensated at a Target level for “amount of time
spent” and at a Challenge level for “care and compassion”). Before any bonuses were added the
average ER physician compensation was $105 per hour.
In order to determine what level of incentive compensation, if any, the doctors would receive,
Methodist took the list of patients² seen during a given month (average of 1,400 patients per
month) and got 31 total responses by randomly calling patients and asking them the four
questions listed earlier. This calling was conducted by the Gallup Institute, which collected
satisfaction data for Methodist. There was no effort made by Gallup to ensure that each of the
ER physicians were evenly represented in the sampling, or represented at all for that matter. In
fact, all 31 responses for any given month could have been patients of one particular doctor.
A Doctor, A Manager, or Both?
Dr. Frazier strongly believed that this was not a representative sample from which to judge the
quality of contributions made by his Emergency Room physicians. He had suggested to multiple
hospital administrators that they should switch to the Press-Ganey company as the source of their
patient satisfaction data. Press-Ganey mailed out surveys with much more detail to every patient
seen during a given month. The Press-Ganey company had told Dr. Frazier that they believed
that they could provide at least 300 respondents each month. The problem with going to PressGaney was that the Grant, GA hospital was a part of the greater Methodist Health System which
valued uniformity in all of their survey methodology. Therefore, Frazier would have to
personally pursue or find an ally in hospital administration to champion this change to the entire
Methodist System.
His ability to make such a change was complicated because the other ‘system’ hospitals in his
geographic region did not place such a prominent emphasis on satisfaction scores. Additionally,
Methodist’s chief rival in the area, Kennedy Medical Center, had recently switched from Gallup
to Press-Ganey. Dr. Frazier did not know how this bit of information would be perceived by
hospital administrators. On one hand he had hoped to use it as ammunition for his arguments,
but he also knew that some in the Methodist system would want to avoid “copying” what
Kennedy was doing.
A second option would be to get more responses from Gallup. Previous administrators had told
Frazier that he could survey up to 60 respondents but that the additional costs would have to
come out of his emergency room budget and not from the hospital’s general operating budget.
This additional expense would run approximately $1,000 extra per month, an expense that his
budget could not bear.
________________________
2
It is important to note that hospitals are legally bound to treat patients that come to them regardless of their ability
to pay or insurance coverage.
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Dr. Frazier could not decide what to do. In his mind a response rate of 31 out of 1,400 was not a
large enough sample of patients to provide any valid inferences about the quality work that he
and his staff were doing. Would 60 respondents be any better, especially given the additional
costs? Lastly, he considered the more risky option of pursuing the Press-Ganey data collection
that would produce at least 300 respondents each month. He needed statistical evidence to help
him decide his next step; evidence that he could use when he had his monthly meeting with his
hospital administrator.
Dr. Frazier also was concerned with the actual questions that were being asked as well as the
response scale that was being used. Issues that troubled him deeply dealt with the four option
response format, the questions themselves, and the actual respondents that Gallup was getting to
answer their questions. He wondered if a “neutral” response would help his satisfaction scores.
He also believed that more and better questions would produce better data, but he did not know
how to approach this subject with the hospital administrators. Additionally, he was worried that
Gallup was only getting responses from generally more dissatisfied patients. In other words, he
believed that most of the truly satisfied patients had little to complain about and therefore would
not take the time to respond Gallup’s phone questionnaire.
Dr. Frazier had also pursued a “rolling 12” system for satisfaction data analysis. This system
takes the current month’s data and adds it to the previous 11 months to get a more
comprehensive, longitudinal look as satisfaction scores. Other areas of the hospital used a
rolling 12 but the hospital administrators had not yet allowed the ER to use such a system and
had not provided Dr. Frazier a compelling reason for this decision.
Complicating Dr. Frazier’s dilemma was the situation in his Emergency Room. At the Grant
Methodist hospital most of the patients were using the emergency room as their primary care
clinic, leading to a significant problem of overcrowding. These patients often did not pay the
hospital, therefore the hospital ended up writing these accounts off as bad debts. These patients
would visit the ER first because other physicians in the area made patients without insurance pay
for their services up front while the ER would service them regardless of their ability to make
payment.
Satisfaction scores were problematic in the ER because of this overcrowding. An additional
problem occurred when these non urgent patients were passed over for patients with more
pressing medical needs. The ER had a priority patient care system that dictates who got
treatment first. These decisions were based on a 1-5 system:
1 critical care situations (near death)
2 heart attacks
3 abdominal pains
4 bone injuries – anything needing x rays
5 regular doctor visit type situations (this is where most visitors to Dr. Frazier’s ER fell).
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Dr. Frazier was concerned that the patients in his ER did not understand the priority system and
certainly were not aware that their average length of stay (1.5 hours) was considerably shorter
than the other local hospitals in the Methodist system (4 hours).
Dr. Frazier was having a hard time convincing his ER physicians that the hospital was truly
committed to quality patient care. What other assumptions could they make given that the
administration refused to fund more data collection on satisfaction scores? He saw the fact that
satisfaction scores were only collected and reported for the ER doctors as a group and not
collected on a doctor by doctor basis as further support for his notion that the hospital was less
than truly committed to patient satisfaction and physician improvement and development. This
belief had also led to a problem with motivation in the ER. Dr. Frazier had a difficult time
inspiring his doctors because, collectively, they did not believe that the satisfaction scores
accurately captured their job performance.
Adding to this problem was the fact that these satisfaction scores were the only form of
performance evaluation conducted with the ER physicians. As Dr. Frazier looked at his year end
report of satisfaction scores (Exhibit 1) he doubted whether or not he held in his hands
information that could result in a valid statistical assessment of whether his employees were
performing in a satisfactory or unsatisfactory manner. The sample also concerned him from a
legal compliance / liability standpoint. If he had to make individual hiring / firing / promotion /
demotion / salary decisions using a faulty instrument with an inadequate sample size that
assessed group rather than individual performance, the hospital as well as he himself would be
facing unnecessary legal exposure to potential discrimination claims.
A few final issues filled Dr. Frazier’s mind. He knew that the variation in satisfaction scores had
resulted in an inability to establish good baseline numbers to work from or good numbers to
justify any expenditures to improve satisfaction or educational initiatives. He wrestled with the
question of how he could make any changes and know whether or not they were working given
his concerns over the sample size.
Dr. Frazier’s frustration had reached the boiling point. He had discussed these issues with the
four hospital administrators that he had worked for during his tenure at Methodist. He had had
no success in convincing them of his problem. At the end of his rope, he was considering taking
his problems to a higher level within the hospital’s governance structure with the hopes that his
voice would be heard.
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Exhibit 1
Year End Satisfaction Scores Report
A). Time: Mean
Standard deviation
B). Care: Mean
Standard deviation
C). Willingness:
Mean
Standard deviation
D). Quality: Mean
Standard deviation
n=31 per month
7/1/0x
3.03
1.11
3.23
.96
8/1/0x
3
1.16
3.19
1.18
9/1/0x
2.88
1.18
3.09
1.11
10/1/0x
3.19
1.16
3.32
1.19
11/1/0x
3.16
.97
3.35
.99
12/1/0x
3.28
.98
3.39
1.17
1/1/0y
3.13
1.14
3.29
1.13
2/1/0y
3.13
.99
3.35
.81
3/1/0y
3.16
1.15
3.47
.92
4/1/0y
3.13
1.14
3.29
1.07
5/1/0y
3.13
1.17
3.26
1.15
6/1/0y
3.1
1.08
3.33
1.16
3.26
1.05
3.19
.97
3.1
1.15
3.23
1.18
3.06
1.17
3.06
1.16
3.26
1.06
3.26
1.19
3.3
.97
3.43
.89
3.4
.81
3.37
.95
3.38
.92
3.25
1.11
3.31
.96
3.24
1.07
3.34
.88
3.31
.83
3.23
1.04
3.29
.97
3.4
.93
3.39
.95
3.27
1.04
3.4
.80
Challenge
Target
3.25
3.175
3.41
3.32
3.37
3.26
3.44
3.32
A. The amount of time the Emergency Department doctor spent with you?
B. The care and compassion shown by the Emergency Department doctor?
C. The Emergency Department doctor's willingness to answer questions
thoroughly?
D. The quality of the Emergency Department physicians who treated you?
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Lessons from Computer Intrusion at TJX
Benjamin Ngugi
Suffolk University
Glenn S Dardick
Longwood University
Gina Vega
Salem, Salem State College
ANNOUNCEMENT OF COMPUTER INTRUSION AT TJX
The TJX Companies, Inc. today announced that it has suffered an unauthorized
intrusion into its computer systems that process and store information related to
customer transactions. While TJX has specifically identified some customer
information that has been stolen from its systems, the full extent of the theft and
affected customers are not yet known,
read Dennis Frank from the TJX press statement [1] dated January 17, 2007.
It was almost the end of the fall 2007 semester. Dennis, an assistant professor of Information
Technology at a Boston university, was preparing a class presentation from his home office on
the importance of customer data protection when his mind immediately focused on the computer
intrusion at TJX earlier in the year. No other computer intrusion case could have been more
relevant; he knew that several of his students were either directly affected or knew someone who
had been affected by the TJX computer intrusion. Further, some of the issues that led to the TJX
intrusion were now finding their way to the public via the media and the Internet, so the students
would have ready access to research materials. He began analyzing all the TJX press statements
about the computer intrusion.
Dennis was distracted briefly by his wife who was furiously typing a holiday shopping list on her
computer. The holiday season had arrived and they were inundated with special offers from the
retail companies. First there was the Thanksgiving series of sales, and now the Christmas series
had started. He wondered whether to warn her to use cash when doing her shopping, as credit
cards were becoming unsafe despite their many benefits and the purchase protection they
afforded. He went back to the article that he was reading.
This intrusion involves the portion of TJX’s computer network that handles credit
card, debit card, checks, and merchandise return transactions for customers of its
T.J. Maxx, Marshalls, HomeGoods and A.J. Wright stores in the U.S. and Puerto
Rico, and its Winners and HomeSense stores in Canada, and may involve
customers of its T.K. Maxx stores in the U.K. and Ireland. The intrusion could
also extend to TJX’s Bob’s Stores in the U.S.
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“This has the potential of becoming a real disaster,” thought Dennis. “The stolen cards’ customer
information could be used to make counterfeit cards which could lead to an identity theft crisis.”
Complicating matters further was the fact that the theft was across the majority of the subsidiary
companies, which increased the scale of affected customers.
The Company immediately alerted law enforcement authorities of the crime and
is working closely with them to help identify those responsible. TJX is also
cooperating with credit and debit card issuers and providing them with
information on the intrusion,
the press release continued.
How long had it taken the company to disclose the computer intrusion to the public? Every day
wasted could make a difference in a victim’s journey through identity theft. However, the
company had to balance the need for disclosure with the conflicting need to keep quiet long
enough to give the law enforcement agencies time to catch up with the hackers.
With the help of leading computer security experts, TJX has significantly
strengthened the security of its computer systems. While no computer security can
completely guarantee the safety of data, these experts have confirmed that the
containment plan adopted by TJX is appropriate to prevent future intrusions and
to protect the safety of credit card, debit card and other customer transactions in
its stores.
Dennis was happy to see that the company had sought advice from experts on strengthening its
defense. The worst thing that could happen would be to have a repeat attack and theft of data.
That could take away any remaining investor-confidence in the company. He wondered how the
data thieves had penetrated the company’s security network and what layers of defense the
company had now erected to deter similar types of attacks in the future.
The TJX Companies, Inc
The TJX companies, Incorporated was one of the leading retailers of apparel and home fashions
in the USA and worldwide with annual sales hitting $17.4 billion in 2006 under the leadership of
Bernard Cammarata, Chairman of the Board, and Carrol Meyrowitz, President and Chief
Executive Officer [2].
The mission of the company was the delivery of an exciting, fresh and rapidly changing
assortment of brand-name merchandise at excellent values to their customers [2].
TJX traced its origin from the first Zayre discount department store [3] opened by cousins
Stanley and Sumner Feldberg in 1956 in Hyannis, Massachusetts. Zayre later incorporated in
1962 and went on to acquire several other companies. Zayres, Inc. was later renamed TJX Inc.
As of 2008, TJX operated eight businesses, including T.J. Maxx, Marshalls, Home goods, Bob’s
Stores and A.J Wright in the USA, Winners and Homesense in Canada, and T.K Maxx in
Europe [2]. The group had over 2,400 stores with approximately 125,000 associates and placed
133rd in the Fortune 500 company ranking [2].
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Update on the Computer Intrusion at TJX
Dennis moved on to the second press release from TJX dated February 21, 2007 [4] giving an
update on the computer intrusion.
While the company previously believed that the intrusion took place only from
May, 2006 to January, 2007, TJX now believes its computing system was also
intruded upon in July 2005 and on various subsequent dates in 2005.
Dennis could not believe what he was reading. Did this mean that the data thieves hacked into
the system and continued stealing customer data from July, 2005 all the way to December, 2006
without being detected? How could such a large company not detect an intrusion for eighteen
months? What level of IT security personnel were responsible for IT network security? Did they
have a specific group within the IT organization that was responsible for IT network security?
Did they have a layered network security plan in place? At a minimum, didn’t they employ
intrusion detection systems? Didn’t they examine their logs to check for unauthorized file
access?
Dennis had worked in the IT security industry and knew that it was now standard policy in most
organizations to employ top notch network security personnel. Such people would design the
right security policies and then institute several layers of security controls to enforce the policies.
Such controls would include segmenting the network into manageable units and putting in
firewalls and intrusion detection systems (IDS) to protect the data. The IDS would monitor and
detect abnormal/fraudulent user behavior and alert the network security officer. It was also now
standard procedure to monitor server log files to see who was accessing sensitive data files. He
felt it would not be asking too much to expect such a company to be doing the same.
In addition to the customer data the Company previously reported as
compromised, the Company now believes that information regarding portions of
the credit and debit card transactions at its U.S., Puerto Rican and Canadian stores
(excluding debit card transactions with cards issued by Canadian banks) from
January, 2003 through June, 2004 was compromised.
Dennis could understand why so many people were worried. Customers who had ever bought
something at any of the TJX group of companies had reason to fear that they would become
victims of identity theft, and things were getting worse. The hackers had accessed credit and
debit card information and were in a position to use this information to purchase things which
would be billed to the customers’ accounts.
TJX has found additional drivers' license numbers together with related names
and addresses that it believes were compromised.
Why was the company keeping driving license numbers? Dennis was even more worried when
he remembered that some customers used their social security numbers as their driver’s license
numbers, making that group the most vulnerable to identity thieves.
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He wanted a lot of answers and decided to look for an investigative report from a law
enforcement agency or some other independent institution. He searched the Internet for
“investigation on TJX computer intrusion,” and he got several hits. One was an investigation by
the Canadian privacy commissioner[5]. He downloaded the full report from the commissioner’s
website and sat down to read it.
Report of an Investigation into the Security, Collection and Retention of Personal
Information at TJX[5]
On January 17, 2007, the Office of the Privacy Commissioner of Canada (OPC)
and the Office of the Information and Privacy Commissioner of Alberta (AB
OIPC) were notified by TJX and by Visa that TJX had suffered a network
computer intrusion affecting the personal information of an estimated 45 million
payment cards in Canada, the United States, Puerto Rico, the United Kingdom
and Ireland.
Dennis sighed with consternation. Forty-five million customers were now at risk because of the
TJX computer intrusion. This would go down in history as one of the biggest hacks ever. He
could not remember any other computer intrusion with such a large number of affected
customers. The stakes were high, and the business case for putting safeguards into such an
organization was strong, as the damage would be enormous. He wondered if he was jumping to
conclusions and should first try to find out how the intruders had hacked into the TJX system. He
came to the paragraph describing the penetration:
TJX informed the investigators that “the intruder may have gained entry into the system outside
of two stores in Miami, Florida.” Dennis almost missed it. From outside a store? Without going
inside? Of course! The intruders must have hacked into the wireless system by positioning
themselves strategically outside the two stores where they could get the wireless signal without
going through the security guard at the door. This was getting interesting. He wondered whether
the company had performed a wireless security risk analysis to identify the vulnerabilities of
wireless security systems. What kind of security safeguards did the company have in place to
prevent this kind of attack? He continued to the next paragraph.
At the time of the breach, TJX had in place various technical measures in its
North American stores to protect personal information, including the Wired
Equivalent Privacy (WEP) encryption protocol.
Dennis immediately identified one problem; WEP had been an obsolete encryption
technology for several years. Earlier in the year, he had attended a seminar on wireless
security and was well versed in the different wireless encryption technologies. The WEP
protocol had been known to be unsafe [6] since 2001; in fact, several programs were
widely available on the Internet that could be used to crack it in minutes. They could
even be executed on an IPAQ PDA (a small personal device) that could be brought into a
store undetected. The Institute of Electrical and Electronics Engineers (IEEE) was the
original drafter of the WEP standard. They later rejected WEP due to its insecurities and
strongly recommended that users should move to the new WPA (WI-FI protected access)
encryption system which had a more sophisticated algorithm and was, therefore, harder to
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break [7]. Dennis wondered why a company of TJX’s size and available resources in
terms of money and manpower would still be using such an outdated system.
He read on. The “intruders then used deletion technology to cover their tracks thus making it
impossible for TJX to determine the contents of the files created and downloaded by the
intruder.” Dennis could tell that these were professional hackers, not the usual high school kids
out to impress their peers with their computer hacking prowess. These were experts who deleted
the server logs to stymie detection of the intrusion and took pains to cover their tracks so that
they would not get caught by the law enforcement agencies. TJX could have avoided
compromising important data like credit card data files and the server logs by making regular
back-ups and keeping them at a different site. The backed up data could then have been used to
track the hackers. He went on to review the objectives and findings of the Canadian probe in the
TJX computer intrusion.
The goal of the investigation was to “examine the collection, retention and safeguarding
practices of the organization, in order to determine whether the breach could have been
prevented.” The investigators had set the right objectives. The issues of collection, retention and
safeguarding should form the core of a company’s information system security blueprint.
“Prevention is better than cure,” went the old adage. Keeping the collected information to an
absolute minimum would reduce the extent of the damage that could befall an organization like
TJX. Likewise, if only the absolute minimum of the collected information were retained, then the
amount of information to be protected was minimized. And finally, if the organization had strong
safeguards, then it meant that the information retained would be protected and therefore so costly
for hackers to access that it would not be worth the effort.
The first issue that the investigators were concerned with was “whether TJX had a reasonable
purpose for collecting the personal information affected by the breach.” This was very much in
line with the view of many IT security experts: only information that met a certain purpose
should be collected. Anything more would represent an unnecessary liability. Dennis could
understand why a company would want to collect names and addresses for credit card
verification. However, he could not understand why they had to store driver license numbers. If
they wanted a photo ID, they could ask for the driver’s license and compare it with the credit
card, but they did not need to enter this into the computer system.
The second issue that the investigators sought confirmation of was whether TJX’s retention of
customer data practice was in compliance with Canadian regulations. The investigators found
that the “collection of names and addresses was acceptable but that of driver license ID numbers
was excessive and contrary” to Canadian privacy laws. They determined that the TJX practice
contravened the privacy laws and regulations. Collecting and retaining unnecessary personal data
must have exacerbated the situation.
The third issue that the commission investigated was whether TJX had made reasonable security
arrangements to protect the personal information in its custody. Dennis knew that the
responsibility for protecting customer data lay with the company collecting the information. He
personally felt that the company should not have been using the WEP encryption protocol after
the IEEE declared it insecure.
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At the end of September, 2005, TJX made a decision to improve the protection of
its wireless networks by installing the Wi-Fi Protected Access (WPA) encryption
protocols in its stores.
Dennis sighed; it was good the company had eventually realized the danger of using
WEP, but it was too late by then. The press update [4] had stated that the first TJX intrusion was
in July, 2005, so by the time they started upgrading to WPA the intruders were already into the
system, siphoning customer data out. If they had changed to WPA earlier, they might have
prevented the intrusion. Dennis was pleased to see that the “organization undertook forensic and
other investigations to audit and analyze the security of the TJX computer system, and to
enhance the security of the TJX computer system in a continuing effort by TJX to safeguard
against future attempted unauthorized intrusions” and was taking steps to rectify the situation,
but he wondered why they had to be hacked to do what they should have done earlier. He was
angry that so much had been lost because of something that could have been prevented.
The total losses from the intrusion would not be known for some time. By the second quarter
earning report [8] in August, 2007, TJX had put aside $196 million before taxes as an estimated
provision to cover the liabilities in anticipation of the suits that were bound to follow. This was
in addition to the $25 million charge before taxes that they had taken earlier. The quarterly report
further suggested that the company might have “to take an extra $35 million in the next financial
year.” This totaled about $256 million, and the figure was increasing. In fact, some research
firms estimated that “the total loss from the breach could reach $1 billion once settlement and
lost sales were tallied.” [3[9] This was a monumental figure by any account.
It would be good to compare the total loss with what TJX would have spent to fix the initial
WEP problem and safeguard the customer data, thus avoiding the computer intrusion. Dennis
could not get any exact figure so he decided to make a rough estimate. He knew that retailers like
TJX that processed debit/credit cards from the major four credit card issuers (Visa, MasterCard,
American Express and Discover) had to meet certain standards [10] set by the payment card
industry (PCI). These consisted of twelve rules which were explicit in the layers of security
controls that had to be erected to protect credit card data. The rules called for the proper
installation of firewalls, access controls, encryption of data across open networks, regular
software updates and monitoring of networks, and maintaining a sound information security
policy. This layered defense would provide a formidable obstacle to hacking. (See Appendix A
for an illustration of the Defense-in-Depth Strategy).
Dennis emailed one of the leading security consultants he knew for an approximate figure on
what a company like TJX would have incurred in becoming PCI compliant.
“I cannot address TJX in particular but I know of an information-intensive
company that has spent more than $20 million in order to be PCI compliant. This
was a company that possessed many, many millions of individual personal
identifiers, including social security numbers and had to be PCI compliant, level
one, because it processes in excess of six million credit card transactions annually.
So obviously, it has a significant retail operation,”
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replied the security consultant. After chatting a bit longer, Dennis returned to his course
preparation and decided to use the given figure as an upper limit. He did further
investigation searching for real companies that had gone through PCI compliance. The
Wall Street Journal [11] reported that the “musical-instruments retailer Guitar Center Inc,
which operates more than 210 stores nationwide and processes several million paymentcard transactions a year, had purchased nearly $500,000 of new technology in the past
year in order to comply with the PCI standards.” Dennis could not do a direct
comparison as this company had 210 stores while TJX had 2,400 stores, so he computed
the cost per store of about $2,380. Multiplying the cost per store by TJX total stores gave
a figure of about $5.7 million. The same article stated that “the biggest merchants, those
that process six million or more payment-card transactions a year from any single card
brand, spent an average of $568,000 on new technologies to comply with the PCI security
standards, according to estimates from Gartner, Inc.” In the case of TJX, there were
embedded eight such large merchant businesses. T.J. Maxx, Marshalls, Home goods,
Bob’s Stores, and A.J Wright in the USA, Winners and Homesense in Canada, and T.K
Max in Europe were all subsidiaries of TJX and each processed six million or more
payment-card transactions a year from any single card brand.
Another way of getting an approximate figure would be to multiply the average cost by eight
which gave $4.8 million. Dennis concluded that TJX would have invested about $5-20 million to
become PCI compliant, but the final cost of the effects of the intrusion was going to be more
than ten times what it would have cost to fix the system in the beginning. “Here’s a lesson,”
Dennis thought, “for all companies about the importance of data security.”
Dennis wondered whether other retailers had learned the same lesson that TJX had learned. Most
of the retailers all over the United States used similar payment systems and were being guided by
the same PCI rules; how well were they implementing these rules? How well were they
protecting themselves now that they had seen one of their own lose so much and get so much
negative publicity? He decided to find out. He remembered reading that AirDefense, one of the
leading companies in wireless security, was doing a comprehensive national survey on the
wireless security of retail stores. He searched for the survey results from the company’s website
to see what they found out. What he was about to discover would shake his faith in the retail
industry.
On November 15, 2007, AirDefense published a survey [12] of the wireless data security and
physical security practices in place at more than 3,000 stores nationwide and also in parts of
Europe. Cities monitored were Atlanta, Boston, Chicago, Los Angeles, New York City, San
Francisco, London and Paris. Research was conducted in some of the busiest shopping areas in
the country, including: Rodeo Drive in Beverly Hills, Madison Avenue and 5th Avenue in New
York City, Michigan Avenue in Chicago, and Union Square and Market Street in San Francisco.
The company monitored 5,000 access points that connected wireless devices to wired computer
networks.
The results were shocking. Twenty-five percent of the networks were found to be unencrypted,
meaning that anybody could access them. Another 25 percent were using Wired Equivalency
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Privacy (WEP), the same encryption protocol that had allowed the intrusion at TJX. The rest of
the retail stores were using WPA, which was the recommended encryption protocol. Dennis was
amazed. He wondered what it would take for the retail stores to take information security
seriously. The net determination of the survey was that 50 percent of the retailers’ wireless
access points were not safe. This left the shopper at the mercy of hackers. It was as if the retailers
had learned nothing from the TJX computer intrusion. He wondered how long it would take
before another computer intrusion was perpetrated. For the second time that morning, he
wondered whether to advise his wife not to use her credit card at the retail stores.
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REFERENCES
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
13.
TJX Incorporation, The TJX Companies Incorporation Victimized by Computer Systems
Intrusion: Provides Information to Help Protect Customers in Business Wire. 2007, TJX,
Inc.: Framingham, Massachusetts.
TJX Incorporation, 2006 Annual Report. 2007: Framingham, Massachusetts.
Funding Universe. TJX Incorporation-Company History. 2002 [cited 2008 February];
Available from: http://www.fundinguniverse.com/company-histories/The-TJXCompanies-Inc-Company-History.html.
TJX Incorporation, The TJX Companies Incorporation Updates Information on Computer
Systems Intrusion in Business Wire. 2007.
Privacy Commissioner -Canada and Information & Privacy Commissioner-Alberta,
Report of an Investigation into the Security, Collection and Retention of Personal
Information at TJX. 2007.
Borisov, N., I. Goldberg, and D. Wagner. Intercepting Mobile Communications: The
Insecurity of 802.11. in 7th Annual Conference on Mobile Computing and Networking
(MOBICOM). 2001. Rome, Italy: ACM Press.
IEEE Computer Society, IEEE Standard 802.11i for Information Technology Telecommunications and Information Exchanges between Systems -Local and
Metropolitan Area Networks-Specific Requirements. 2004, IEEE: NewYork, USA.
TJX Incorporation, The TJX Companies, Inc. Reports Strong Second Quarter FY08
Operating Results; Estimates Liability from Computer Systems Intrusion(s). 2007:
Framingham, Massachusetts.
Goodin, D., TJX Breach was Twice as Big as Admitted, Bank Says, in Channel Register.
2007.
PCI Security Standard Council, Payment Card Industry (PCI) Data Security Standard.
2006: Wakefield, MA USA.
Tam, P.-W. and R. Sidel, Business Technology: Security-Software Industry's Miniboom;
As Merchants Upgrade Systems to Meet New Rules, Tech Firms Benefit, in Wall Street
Journal. 2007: New York, N.Y.
AirDefense. AirDefense's Comprehensive Survey of 3,000 Retail Stores Finds Many
Wireless Data Security Vulnerabilities as Holiday Shopping Season Nears. 2007 [cited
2008 March, 25th]; Available from:
http://www.airdefense.net/newsandpress/11_15_07.php.
Whitman, M. and H. Mattord, Principles of Information Security. 2nd ed. 2005, Boston,
Massachusetts, USA: Course Technology.
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Appendix A: Defense-in-depth Strategy
Fig 1: Illustration of the Defense-in-Depth Strategy [13]
The “defense-in-depth” strategy illustrated in Fig 1 involves setting up of overlapping layers of
security controls so that an intruder will have to overcome one level after the other before
reaching the protected resource. The weakness of one layer of security control is compensated by
the strength of another. The overall goal is to vigorously prevent, detect and mitigate intrusions.
Most intruders will give up after facing multiple layers. The type of controls should have a mix
of both technology- and people-oriented solutions. Figure 1 shows several examples of
technology based solutions that includes a firewall protecting the network and an intrusion
detection systems within the network monitoring for unusual behavior. Likewise, the figure
includes some people based solutions. Security to a large extent depends on having the right
policies and regulations. Equally important is well trained and compensated personnel who will
vigorously work to prevent, detect and mitigate security issues. The users should also be well
educated and aware of the common threats facing the organization; because they are on the
ground, they would be the first to notice unusual behavior or even attacks. Each of these
solutions supplements the other in different ways.
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Ann Taylor: Survival in Specialty Retail
Pauline Assenza
Manhattanville College
Alan B. Eisner
Lubin School of Business, Pace University
Jerome C. Kuperman
Minnesota State University Moorhead
In the summer of 2008, headlines announced that the declining economy was generating a “wave
of retail closures” among many well-known companies, including Home Depot, Pier 1 Imports,
Zales, Gap, Talbots, Lane Bryant, and Ann Taylor. The Chief Executive of J.C. Penney’s called
the 2008 situation “the most unpredictable environment in his 39-year retail career”. i One
industry group forecasted that nearly 6,000 retail stores would close in 2008, a 25 percent
increase from the previous year. A representative from the National Retail Federation (NRF)
suggested that these businesses should “look at where they’re underperforming and how can they
change their operations so that they have a little bit more power in another area, or a little bit
more growth potential.” ii Kay Krill, President and CEO of Ann Taylor Stores Corporation
(ANN), was already considering this advice.
Krill had been appointed President of ANN in late 2004, and succeeded to President/CEO in late
2005 when J. Patrick Spainhour retired after eight years as CEO. At that time, there had been
concern among commentators and customers that the Ann Taylor look was getting “stodgy”, and
the question was how to “reestablish Ann Taylor as the preeminent brand for beautiful, elegant,
and sophisticated occasion dressing”. iii In order to reestablish the brand, Kay Krill had
acknowledged the importance of the consumer, since for Ann Taylor to succeed long term,
“enough women still need to dress up for work”. iv
Krill’s challenge was based in the ANN legacy as a women’s specialty clothing retailer. Since
1954, Ann Taylor had been the wardrobe source for busy socially upscale women, and the
classic basic black dress and woman’s power suit with pearls were Ann Taylor staples. The Ann
Taylor client base consisted of fashion conscious women from the ages of 25 to 55. The overall
Ann Taylor concept was designed to appeal to professional women who had limited time to shop
and who were attracted to Ann Taylor Stores by its total wardrobing strategy, personalized client
service, efficient store layouts and continual flow of new merchandise.
ANN had two divisions focused on different segments of this customer base:


Ann Taylor (AT), the company’s original brand, provided sophisticated, versatile and
high quality updated classics.
Ann Taylor LOFT (LOFT) was a concept that appealed to women with a more relaxed
lifestyle and work environment and who appreciated the more casual LOFT style and
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compelling value. Certain clients of Ann Taylor and Ann Taylor LOFT cross-shopped
both brands.
Ann Taylor Factory was the company’s newest division. The merchandise in these stores was
specifically designed to carry the Ann Taylor Factory label. The stores were located in outlet
malls where customers expected to find these and other major label bargains.
ANN had regularly appeared in the Women’s Wear Daily “Top 10” list of firms selling dresses,
suits and eveningwear and the “Top 20” list of publicly traded women’s specialty retailers. The
listings recognized the total company, i.e., the result of the impact of all three divisions.
Financial data from 2004-2008 shows the performance of LOFT compared to AT (See Exhibit 1:
AT vs. LOFT Financial Performance 2004-2008.)
In October of 2004, for the first time, the LOFT division outsold the flagship Ann Taylor (AT)
division stores. v In the second quarter of 2004 LOFT had opened its 300th store, passing the Ann
Taylor division in total square footage. Since its emergence as a distinctly competitive division,
LOFT had been such a success for the company that some analysts credited the division for
“keeping the entire ANN corporation afloat”. vi
In the company’s 2007 Annual Report Krill acknowledged the ongoing challenge:
To be successful in meeting the changing needs of our clients, we must continually
evolve and elevate our brands to ensure they remain compelling—from our product, to
our marketing, to our in-store environment. vii
Although Krill believed that the overall Ann Taylor brand still had its historic appeal, the
question remained whether that appeal could be sustained indefinitely in such a risky and
uncertain specialty retail environment where success was so dependent on the “ability to predict
accurately client fashion preferences.” viii
Krill was evaluating the company and its growth prospects. Macroeconomic conditions had
worsened, and the retailing environment was being threatened by slowing consumer demand. As
one analyst put it,
More mature female shoppers are probably more likely to be very careful how they spend
their money in this economy. They are not your footloose-and-fancy-free teen shoppers.
These consumers are far more likely to open their pocketbooks only if the merchandise is
right (and now, probably only if the price is right, too). ix
Within the company, Krill was contemplating how to revitalize the flagship AT store brand, and
what effect that would have on the recent growth of LOFT. In addition, ANN had recently
launched a beauty business as a department within the AT and LOFT stores, had expanded the
high end fashion offerings in AT as a separate Collections line, announced the opening of LOFT
Outlet stores to complement Ann Taylor Factory, and was considering a new concept store
specifically targeting the “older” segment of women ages 55-64. Krill was firmly committed to
long-term growth, and felt that she could pursue that growth agenda even as the economy had
worsened. However, she was confronted with significant questions. For example, was her agenda
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too aggressive? Were the actions she had undertaken the kinds of moves needed to unleash what
she believed was the firm’s “significant untapped potential”? x
ANN TAYLOR BACKGROUND
Ann Taylor was founded in 1954 as a wardrobe source for busy socially upscale women. Starting
out in New Haven, CT, Ann Taylor founder Robert Liebeskind established a stand-alone
clothing store. When Liebeskind’s father, Richard Liebeskind, Sr., a designer himself, as a good luck gesture
gave his son exclusive rights to one of his best selling dresses, “Ann Taylor”, the company name was established. Ann Taylor was never a
real person, but her persona lived on in the profile of the consumer.
Ann Taylor went public on the New York Stock Exchange in 1991 under the symbol ANN. In
1994 the company added a mail catalog business, a fragrance line, and free standing shoe stores
positioned to supplement the Ann Taylor (AT) stores. The mail order catalog attempt ended in
1995, and the lower-priced apparel concept, Ann Taylor LOFT, was launched. LOFT was meant
to appeal to a younger more casual and cost-conscious but still professional consumer. CEO
Sally Kazaks incorporated more casual clothing, petite sizes, and accessories in an attempt to
create a one-stop shopping environment, to “widen market appeal and fuel growth”. xi
Following losses in fiscal 1996 that could be attributed to a fashion misstep – cropped T-shirts
didn’t fit in with the workplace attire - Kasaks left the company. New ANN CEO Patrick
Spainhour, who had been Chief Financial Officer at Donna Karan and had also had previous
experience at Gap, shelved the fragrance line, and closed the shoe stores in 1997.
Originally the LOFT stores were found only in outlet centers, but later expanded to other kinds
of locations. In 1998 the LOFT stores in the discount outlet malls were moved to a third division,
Ann Taylor Factory (Factory). The Factory carried clothes from the Ann Taylor (AT) line. The
concept offered customers direct access to the AT designer items “off the rack” without elaborate
promotion, and with prices regularly 25-30 percent less than at the high end Ann Taylor (AT)
stores. The LOFT concept was revamped and stores were opened in more prestigious regional
malls and shopping centers. By 1999 LOFT clothes were a distinct line of “more casual, yet
business tailored, fun, and feminine”, and were about 30 percent less expensive than the
merchandise at the flagship Ann Taylor (AT) division’s stores. xii At that time, the LOFT was
under the direction of Kay Krill, who had been promoted to the position as Executive Vice
President of the LOFT division.
Ann Taylor attempted a cosmetic line in 2000, which it discontinued in 2001. In 2000, the
Online Store at www.anntaylor.com was launched, only to be cut back in late 2001 when
projected cash flow goals were not met. In early 2001 Spainhour restructured management
reporting relationships, creating new President positions for both Ann Taylor (AT) and Ann
Taylor LOFT divisions. Kay Krill was promoted from executive vice-president to president of
LOFT. Spainhour commented that,
Kay has been instrumental in developing the strategy for the Ann Taylor Loft concept
since its inception. Her in-depth understanding of the Ann Taylor Loft client, and strong
grounding in the Ann Taylor brand, combined with her proven ability in driving the
development of this division, make her an ideal choice for the new President position. xiii
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Kay Krill was made president of the entire ANN corporation in 2004, bringing both Ann Taylor
and LOFT under her control. In February of 2005 Kay Krill announced that LOFT had reached
$1 billion dollars in sales, stating,
This is an important milestone for our Company. In an intensely competitive and
fragmented apparel market, Ann Taylor LOFT has been one of the industry's most
successful and fastest-growing apparel retail concepts since its launch in 1998. …
LOFT's success reaffirms the importance of maintaining a strong connection with our
client and evolving with her wardrobe needs over time. xiv
In June 2005 ANN completed a move to new headquarters in Times Square Tower in New York
City. xv In the fall of 2005, Chairman and CEO J. Patrick Spainhour retired and President Kay
Krill was elevated to the CEO position. In a conference call following her promotion, Krill stated
her goals as “improving profitability while enhancing both brands”, “restoring performance at
the Ann Taylor division and restoring the momentum at LOFT”. xvi
Krill felt the outlook for fiscal year 2006 was cautiously positive, and announced continued plans
for expansion and related capital expenditure. The stock responded with new highs, moving to a
peak of over $40 in late 2006. At that time, analysts were mainly supportive citing “confidence
in the retailer's strong management team, improving store products, and conservative inventory
management”. xvii ANN’s stock price subsequently retreated in 2007, along with the rest of the
retailing sector. (See Exhibit 2: ANN Stock Price 1992-2008; Exhibit 3: Stores Operational Data.
For full financials and operating statistics for 2004-2008, see Exhibits 4-6.)
Challenges in the macroeconomic climate prompted Krill to announce a restructuring plan in
2008. In the 2007 Annual Report letter to shareholders Krill said,
We understand that the economy invariably goes through cycles. We firmly believe that
the manner in which we approach growth and manage our business through these cycles
will differentiate us and determine our success in the market over the long term. In this
regard, we have planned fiscal 2008 cautiously and realistically, focusing on three key
areas—the evolution of our brands and channels, the reduction of our overall cost
structure, and the continued pursuit of growth. xviii
THE APPAREL RETAIL INDUSTRY
History Prior to the development of a retailing industry, the only option for upper class wealthy
women who desired to be fashionable was to hire local dressmakers to create one-of-a-kind
personalized garments. Women with more limited resources had few options until the 1800s.
Enterprising seamstresses began mass-producing dresses at that time, utilizing the increased
availability of textiles and the invention of the sewing machine. The increasing availability of
diverse products led to the creation of the variety store, the precursor of the current department
store. At the same time, entrepreneurial seamstresses previously working as personalized
dressmakers began to open specialty stores for fashionable women’s clothing. Thus came the
origins of modern retailing, with both department stores and specialty retailers co-existing in
many downtown locations.
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The movement of the U.S. population into the suburbs, along with an increasing use of
automobiles, led to the development in the 1930s and 1940s of planned shopping centers and
highway strips of unified shopping stores. This expansion included the first free-standing stores
with on-site parking, as run by Sears Roebuck & Co. The shopping mall concept expanded
further in the 1950s. Usually “anchored” by either supermarkets or department stores, these
shopping centers also allowed specialty and department retailers to co-exist in the same physical
location.
By the 1980s, there were 16,000 retail shopping centers in the U.S. xix However, as customers
showed their increased interest in more convenient and quicker service, alternatives to traditional
‘brick and mortar’ shopping centers appeared. They included non-store direct mail order,
infomercial and shopping channel TV venues, and online options. Many retailers also made a
strategic decision to create specialty clothing departments and focus on items such as sports
wear, or appeal to specific niches such as either large-sized or petite women. xx In addition,
response to the threat of discounter department stores like Target and Wal-Mart prompted some
established specialty firms to create separate divisions focused on lower priced fashions. xxi
Industry Sectors Practically speaking, industry watchers tended to recognize three separate
categories of clothing retailers. Industry publications such as the Daily News Record (DNR –
reporting on men’s fashions news and business strategies), Women’s Wear Daily (WWD –
reporting on women’s fashions and apparel business), and industry associations such as the
National Retail Federation (NRF) reported data within the clothing sector broken out by:
•
•
•
Discount mass merchandisers like Target, Wal-Mart, TJX (TJ Maxx, Marshall’s, A.J.
Wright, Bob’s Stores), and Costco.
Multi-tier department stores (those offering a large variety of goods, including clothing,
like Macy’s and J.C. Penney’s, and the more luxury-goods focused stores like
Nordstrom’s and Neiman Marcus).
Specialty store chains (those catering to a certain type of customer or type of goods, e.g.
Abercrombie & Fitch for casual apparel).
More specifically in the case of specialty retail, many broadly recognized primary categories
existed such as women’s, men’s, and children’s clothing stores (e.g., Victoria’s Secret for
women’s undergarments xxii, Men’s Wearhouse for men’s suits, abercrombie Kids for children
aged 7-14 xxiii). Women’s specialty stores were “establishments primarily engaged in retailing a
specialized line of women’s, juniors’ and misses’ clothing.” xxiv.
A unique form of organization that sometimes appeared as competition in the specialty retail
category was the clothing designer. Originally an evolution of the custom seamstress, for one-ofa-kind garments, fashion design houses such as Liz Claiborne and Ralph Lauren could also
produce their creations in bulk, as ready-to-wear clothing. These firms were generally considered
apparel wholesalers, with their items normally for sale to the clothing retailers, such as Macy’s,
but well-established designers could also build their own specialty stores to sell directly to the
consumer.
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SPECIALTY RETAILER GROWTH: BRANDING CHALLENGES
Unlike department stores that sold many different types of products for many types of customers,
specialty retailers focused on one type of product item, and offered many varieties of that item.
However, this single product focus increased risk, as lost sales in one area could not be recouped
by a shift of interest to another entirely different product area. Therefore, many specialty retailers
constantly sought out new market segments (i.e., niches) that they could serve. However, this
strategy created potential problems for branding xxv. A participant at the 2007 NRF convention
commented,
Brand building, acquisition, and tiering is hotter than ever in retail and consumer
products – so much so they may be contributing to shorter life spans for some brands and
perhaps diluting the value of all. In any event, the massive proliferation of brands in
recent years – some out of thin air, others even reborn from the grave – brings with it a
minefield of potential dangers. xxvi
Gap, Inc. was an example of a specialty retailer that had added several brand extensions to
appeal to different customer segments. In addition to the original Gap line of casual clothing, the
company offered the following: Old Navy with casual fashions at low prices, Banana Republic
for more high-end casual items, and Piperlime as an online shoe store. However, in 2005 Gap
had also spent $40 million to open a chain for upscale women’s clothing called Forth & Towne,
which closed after only 18 months. The store was supposed to appeal to upscale women over 35
– the “baby boomer” segment - but, instead, the designers seemed “too focused on reproducing
youthful fashions with a more generous cut” instead of finding an “interesting, affordable way”
for middle-aged women to “dress like themselves.” xxvii
Chico’s FAS, Inc. was another specialty retailer who tried brand expansions. Chico’s focused on
private-label, casual-to-dressy clothing to women 35 years old and up, with relaxed, figureflattering styles constructed out of easy-care fabrics. An outgrowth of a Mexican folk art
boutique, Chico’s was originally a stand-alone brand. Starting in late 2003, Chico’s FAS decided
to promote two new brands: White House/Black Market (WH/BM), and Soma by Chico’s
(Soma).
Chico’s WH/BM brand was based on the acquisition of an existing store chain, and focused on
women 25 years old and up, offering fashion and merchandise in black and white and related
shades. Soma was a newly developed brand offering intimate apparel, sleepwear and active wear.
Each brand had its own storefront, mainly in shopping malls, and was augmented by both mail
order catalog and Internet sales. The idea was that the loyal Chico’s customer would be drawn to
shop at these other concept stores, expecting the same level of quality, service, and targeted
offerings that had pleased her in the past.
Although Chico’s had been a solid performer during the decade, surpassing most other women’s
clothing retailers in sales growth, a downturn in 2006 caused Chico’s shares to fall more than 50
percent when the company reported sales and earnings below analysts’ expectations. Chico’s had
seen increasing competition for its baby boomer customers, and said it had lost momentum
during 2006, partly because of “fashion missteps” and lack of sufficiently new product designs.
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The company’s response was to create brand presidents for the three divisions to hopefully create
more “excitement and differentiation.” xxviii
In an attempt to better manage the proliferation of brands, many firms, similar to Chico’s,
created an organizational structure where brands had their own dedicated managers, with titles
such as executive vice president (EVP)/general merchandise manager, chief merchandising
officer, or outright “brand president.” xxix Since each brand was supposedly unique, companies
felt the person responsible for a brand’s creative vision should be unique as well.
An alternative to brand extension was the divestiture of brands. In 1988 Limited Brands xxx
acquired Abercrombie and Fitch (A&F) and rebuilt A&F to represent the “preppy” lifestyle of
teenagers and college students aged 18-22. In 1996 Limited Brands spun A&F off as a separate
public company. Limited Brands continued divesting brands: teenage clothing and accessories
brand The Limited TOO in 1999, plus-size women’s clothing brand Lane Bryant in 2001,
professional women’s clothing brand Lerner New York in 2002, and in 2007 the casual women’s
clothing brands Express and The Limited. Paring down in order to focus mostly on key brands
Victoria’s Secret and Bath & Body Works, the corporation had made it clear as of 2007 that it
was still not done reconfiguring itself xxxi
WOMEN’S SPECIALTY RETAIL –
COMPETITORS AND THE “OLDER WOMEN” SEGMENT
The National Retail Federation, a Washington, D.C.-based trade group, reported that the retail
niches showing the greatest growth in 2006 were department stores, stores catering to the
teenage children of baby boomers, and those apparel chains aimed at women over 35. xxxii The
four major women’s specialty retailers who were trying to target older upscale shoppers were
Ann Taylor, Chicos FAS, Coldwater Creek and Talbots. Ann Taylor was the only one of these
with a significant brand extension for the younger professional, but all four were promising a
shopping environment and merchandise clearly focused on women over 35. (See Exhibit 7:
Selected Retail Performers.)
Talbot’s CEO Trudy Sullivan noted,
Nobody is clearly winning in the 35+ consumer space right now … we need to absolutely
wow her with this irresistible product and none of us have done that. xxxiii
This group of women, born between 1946 and 1964, was part of the “baby boomer”
demographic, and the purchasing power of these women had not gone unnoticed. xxxiv Accounting
for nearly half of the $102.7 billion in women’s clothing purchases in 2007, these women were
very diverse, ranging from “traditional types who prefer flat shoes and ankle-length skirts to
women who resemble characters from Desperate Housewives.” xxxv
To respond to this diversity in the marketplace, woman’s specialty retailer Talbot’s Inc. acquired
catalog and mail order company J.Jill Group in 2006. J.Jill was a woman’s clothing specialty
retailer offering quality casual fashion through multi-channel mail order, Internet, and in-store
venues. J.Jill targeted women ages 35-55, while Talbot’s focused on the 45-65 age group. The
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acquisition positioned Talbot’s as “the leading apparel retailer for the highly coveted age 35+
female population,” and allowed the company to “protect the distinct identity of each brand,
while maximizing the synergies” in its business model. xxxvi
Coldwater Creek, with its large jewelry, accessory, and gift assortment in addition to apparel,
targeted women over 35 with incomes in access of $75K by appealing with a
Northwest/Southwest lifestyle approach that included a group of Spa locations. Coldwater’s
customer was not considered “trendy” by any means: “She’s never going to be a fashion leader
… but she wants to look modern.” xxxvii Coldwater Creek created a common brand identity for its
three distribution channels: catalog, Internet, and in-store shopping. This distinct brand image
yielded the best shareholder return in the group (Coldwater Creek, Chico’s FAS, Ann Taylor,
and Talbot’s) since 2002, with a 33.8% revenue growth in fiscal year 2006. xxxviii
Chico’s FAS was one of the first to introduce the concept of apparel designed for the lifestyle of
dynamic mature women who were at the higher age end of the boomer demographic. xxxix
Chico’s, along with Coldwater Creek, was one of the recipients of the 50+Fabulous Company
award in 2007, an award that promoted positive images of women who were in their 50’s or
older. The founder of 50+Fabulous had established this award to promote “the value of 50+
women in the workplace and beyond”, noting, “companies have been slow to recognize the vast
potential” of this demographic. xl
In August of 2007 Kay Krill announced ANN would be creating a new chain of stores expected
to launch sometime in 2008 or 2009, targeting this “older women” segment, stating,
While there are a number of companies that currently play in the broader boomer market,
we believe that this particular segment has been the most significantly underserved and a
huge opportunity for us. xli
Some analysts wondered about this move into an overlooked but risky market that “has tripped
up several competitors like Gap.” They pointed out that although ANN’s clothes were expected
to be more fashionable, the company still faced stiff competition, made even tougher given the
uneven performance of AT and LOFT. xlii In 2008, as a result of the overall economic conditions,
Krill announced that this new concept offering would have to be delayed at least until 2009. xliii
ANN OPERATIONAL INFORMATION xliv
At the end of fiscal year 2007, ANN had 929 stores in 46 states, the District of Columbia and
Puerto Rico, with flagship locations in New York, San Francisco, and Chicago. (See Exhibit 3:
Stores Operational Data for specifics.) The company had also had an online presence since 2000,
and transacted sales at www.anntaylor.com and www.anntaylorLOFT.com. This “very
profitable” Internet channel was considered “a meaningful and effective marketing vehicle for
both brands”, representing 10 percent of AT sales, less than that for LOFT, and was a way for
ANN to reach out to the international market. xlv
Substantially all merchandise offered in ANN’s stores was exclusively developed for the
company by its in-house product design and development teams. ANN sourced merchandise
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from approximately 231 manufacturers and vendors, none of whom accounted for more than 4
percent of the company’s merchandise purchases in Fiscal 2007. Merchandise was manufactured
in over 15 countries, including China, the Philippines, Indonesia, Hong Kong and Thailand.
ANN’s planning departments analyzed each store’s size, location, demographics, sales, and
inventory history to determine the quantity of merchandise to be purchased for and then allocated
to the stores. The company used a centralized distribution system with a single warehouse in
Louisville, Kentucky. At the store level, merchandise was typically sold at its original marked
price for several weeks. After that, markdowns were used if inventory did not sell. Store planners
recognized that the lack of inventory turnover could have been because of poor merchandise
design, seasonal adaptation or changes in client preference, or that the original price points had
been set incorrectly.
Recent ANN initiatives had focused on improving supply chain speed, flexibility and efficiency.
Reduced floor inventory levels combined with the use of new “quick-sourcing” software were
meant to help create quicker inventory turns. Faster turns would lead to continual updating of
floor merchandise and a greater emphasis on “full-price selling”. xlvi As a result, ANN was
hoping to see fewer markdowns and higher margins. The new “quick-sourcing” software was
just one example of continued efforts to improve the company’s information systems.
ANN had initiated a real estate reinvestment program focused on enhancing the look and feel of
43 stores in 2005, in a move toward the “store of the future”. xlvii In addition, the firm had begun a
real estate expansion program designed to reach new clients either by opening new stores,
relocating stores, or expanding the size of existing stores. Store locations were determined on the
basis of various factors including
• Geographic location
• Demographic studies
• Anchor tenants in a mall location
• Other specialty stores in a mall or specialty center location or in the vicinity of a
village location
• The proximity to professional offices in a downtown or village location
Two potential concerns were emerging for ANN as a result of its recent investments in store
expansion and remodeling. First, the increasing sales volume threatened to put stress on the
company’s internal distribution system. The distribution center in Louisville had been investing
in incremental improvements through automation and software integration. However the
distribution center had only sufficient capacity to supply 1,050 stores. After that, ANN’s
logistical experts cautioned that the building footprint would have to be expanded. xlviii
A second concern was whether projected earnings, given economic weakness, would actually be
able to cover the projected long-term lease obligations that were being added. One analyst had
warned,
Store expansion is a risk for all apparel retailers. Gap Inc., for example, spent massively
to add stores in the 1990s and … the stores became a big cost overhead once Gap’s
clothes stopped selling well. xlix
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ANN TAYLOR’S BRAND IDENTITY
When ANN went public in 1991, the Ann Taylor brand, with its historically loyal following, was
a candidate for brand extension. At one point in its history, the company had five separate store
concepts: Ann Taylor (AT), Ann Taylor’s Studio Shoes, Ann Taylor LOFT, Ann Taylor Petites
(clothing for women 5’4” and under), and Ann Taylor Factory. In addition, ANN’s management
had experimented with a make-up line and children’s clothes. By 2005, the company had closed
the shoe stores, reduced the accessories inventory that stores carried, and eliminated the make-up
line. However, ANN was still offering petites, as a separate section in the AT and LOFT stores,
and experimenting with children’s clothes and sleepwear through the LOFT division. A separate
maternity section in selected LOFT stores was also undergoing a trial period.
Since 1999 analysts had warned that ANN needed to be wary of cannibalization within the
brands. The analysts speculated that customers might turn away from Ann Taylor (AT) in order
to buy at LOFT. ANN had always tried to respond to the customer with “wardrobing”, a
philosophy of “outfitting from head to toe”, combining relaxed everyday wear with more dressy
pieces. l Since LOFT sold more relaxed but still tailored items at a lower price than AT, it was
possible that some of AT’s customers shopped at LOFT for things that they previously would
have bought at AT.
The industry was used to brand extensions such as Gap’s Old Navy chain. In contrast to Gap,
LOFT used “Ann Taylor” in its name, reinforcing the perception of customers that they could get
the same brand for less. As one analyst put it,
It’s not clear that the Ann Taylor customer will continue paying $88 for a silk cardigan
sweater when she knows she can pick up a similar cardigan for $39 … a few blocks away
at LOFT. li
As new CEO in the fall of 2005, one of Krill’s first actions was to recruit Laura Weil to a new
position as Corporate Operations Officer (COO). Weil came from American Eagle Outfitters
where she had focused on financial issues involving real estate, pricing, sourcing, and logistics.
In addition, Weil handled the divestiture of underperforming assets. In her role as COO at ANN
she would be expected to “focus on inventory management and merchandise planning,
information systems and supply chain operations”. lii
The appointment of Weil and four other staff changes reconfigured ANN’s top management
structure. Krill created three positions that reported directly to her - COO, Executive Vice
President (EVP) of planning and allocation, and EVP/chief marketing officer. The three
additional positions provided specific expertise while still allowing Krill to “lead both divisions
[AT & LOFT] in a more hands-on-way”. Krill then focused on merchandising and marketing,
especially brand differentiation. liii AT and LOFT continued to have separate EVP’s for
merchandising and design, and Senior Vice President’s for divisional marketing, design,
sourcing and store direction.
Krill had asked her staff to spend time with ANN customers and develop “brand books” or
profiles of the typical Ann Taylor (AT) and LOFT clients. liv The “Ann” (AT) marketing profile
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was of a married 36 year-old working mother with two children and a household income of
$150K. She would lead a busy, sophisticated life. When giving a presentation to a client, she’d
wear a formal suit with a blouse, not a camisole, underneath, and her idea of dressing down at
work might be a velvet jacket with jeans.
In contrast, the typical LOFT client was married, in her 30’s with children, worked in a laid-back
less corporate environment, and had a household income between $75K and $100K. She would
call her style “casual chic” and might wear pants and a floral top with ruffled sleeves to work,
while on the weekend she would wear a printed shoulder-baring halter top with cropped jeans.
Krill had always felt that both AT and LOFT were recognizably different from one another. In
2005, Krill stated that there was “a pretty clear differentiation”, with “special occasion and work
primarily being the focus” at AT, and “more relaxed, separates and fashion” at LOFT. lv
In support of the AT brand, the company also expanded its focus on special events with the
introduction of its Celebrations collection. The company introduced Celebrations into the AT
stores as a line of classic, elegant dresses and coordinating accessories for special occasion, such
as weddings and engagement parties. Of particular interest to long-term ANN customers was the
introduction of dye-to-match sashes and accessories for bridesmaids, with fully coordinated
jewelry and shoe styles, offered in petites as well as regular sizes (petites being women shorter
than 5’4” in height). The expansion of the selection in petite sizes, especially online, was seen as
a “great opportunity”, since some department stores had reduced their petite offerings. lvi
TOP MANAGEMENT TEAM TURNOVER
As Krill was working to resolve branding issues between divisions, improve efficiencies and find
ways to grow the company, she also had to deal with a variety of top management team
resignations. In the spring of 2006 COO Laura Weil left abruptly after only a few months. Weil’s
many responsibilities at ANN included merchandise planning; information systems; all supply
chain operations including sourcing, logistics and distribution; real estate; construction and
facilities, and purchasing; as well as finance, accounting and investor relations. lvii Krill decided
not to replace Weil and eliminated the position on the organizational chart. Krill assumed
leadership of LOFT again, playing a dual role while searching for a new divisional president.
Krill commented, “I believe that building a winning team is critical to fully realizing our
company’s full potential”. lviii However, it appeared that creating that “winning team” was taking
longer than anticipated. One source wondered about the pressure on Krill, especially since she
didn’t have a “strong operating partner” to help with merchandising and other creative
decisions. lix
Even though Krill had made differentiation between AT and LOFT a top priority, analysts
continued to challenge Krill’s efforts, noting that it had been hard to get both divisions moving
forward simultaneously. As one analyst said “it just seems like it’s a struggle to get both of these
divisions firing on all cylinders at the same time”. lx Krill responded to the comment that
consistency had been a problem:
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The notion that Ann Taylor got soft because I was supporting the LOFT team is really a
completely inaccurate comment. As CEO of the company I have to spend my time on
many things, and if one of our businesses is softening in any way I will focus extra time
on it. lxi
In August 2007, long-time CFO James Smith and Chief Marketing Officer Elaine Boltz both
resigned, and then in July 2008 long-time Chief Supply Chain Officer Anthony Romano also left
to “pursue other interests” lxii. Although she had hired a new CFO and Chief Marketing Officer in
late 2007, these departures left Krill once again without a lot of depth at the top. lxiii However,
Krill had had experience with management turnover as she had had to deal with seven
resignations, seven new hires, and two promotions in her upper management team over two
years’ time. As of the end of 2008 she had finally filled the AT and LOFT Divisional President
positions. (See Exhibit 8: Summary of Personnel Changes at ANN.)
FUTURE PLANS AND INITIATIVES
As part of a multi-year restructuring program begun in 2008, ANN was focused on reducing
excess costs, and planned to do so by closing underperforming stores, downsizing ANN’s
corporate and divisional staff by eliminating approximately 260 positions, reducing executive
compensation bonus payout as a result of higher performance goals, and consolidating “all
purchasing activities under a centralized strategic procurement organization to leverage scale”. lxiv
The restructuring program included a suspension of the share repurchase plan and a scale back of
capital spending, and was expected to result in ongoing annualized savings of approximately $80
to $90 million. lxv The pre-tax costs of this restructuring were forecasted to be $65 to $70 million
over the period from 2008 to 2010, but Krill felt the company was “well positioned to support
our brands and focus on strengthening our underlying business” due to the “debt-free balance
sheet and approximately $295 million in available liquidity”. lxvi
The company planned to open fewer stores in 2008 than in previous years. The shift of emphasis
was planned to “aggressively invest in factory channel expansion” for both the existing Ann
Taylor Factory Stores and a new Ann Taylor LOFT factory outlet concept. lxvii These stores
offered merchandise 25 to 30 percent less than at the AT or LOFT regular stores. The outlet or
factory business had delivered “strong gross margin” previously, and was considered “an
important growth driver” even though “the general economic softness” was “having some impact
on this price sensitive consumer”. lxviii
Krill had also announced that the Collections line, an augmentation of the Celebrations bridal
and special occasion wear line introduced in late 2006, would have its own department within the
Ann Taylor (AT) stores. With offerings 40 percent more expensive than regular AT
merchandise, it would be an effort to “grab more affluent working women who weren’t feeling
pinched in the pocketbook,” and would be built around the suits and dresses that created Ann
Taylor’s reputation. The plan was to introduce this upscale, expensive product in some of the
top-selling Ann Taylor locations around the country, where AT was already “sitting next to
Neiman’s, Prada, Gucci,” since, “we know there’s a client there who has an appetite for more
upscale, expensive product.” lxix
Page 23
The CASE Journal
Krill also announced that ANN would be developing an exclusive beauty business. The company
introduced Ann Taylor label fragrance and bath and body products as a separate department
within AT stores for the 2007 holiday season, and scheduled the launch of beauty products in the
LOFT division during 2008. Krill believed that specialty stores with only a 10 percent share of
the beauty products market were in a position to add to that share. Responding to comments
about ANN’s previous foray into the cosmetic business, Krill said, “in the past, we’ve dipped our
baby toes in, and have not done it justice. Now we are trying to find meaningful ways to grow
the business”. lxx
Krill planned to eventually expand the beauty collection into every ANN brand. Analysts
predicted this introduction could generate up to $15 million in sales in its first year, since it
represented a high-margin category that traditionally drew greater repeat traffic than apparel. It
could also be an important gift business, especially around the holidays. First quarter results in
2008 showed that although the fragrance line had done well, the body care component had not.
The line of maternity clothes in selected LOFT stores was also still undergoing a test of this
product’s viability. lxxi
Regarding ANN’s new initiatives, one brand consultant commented,
Tweaking a few elements of a product line doesn’t work. Branding is far more than just
product. It is about the entire entity and the perception that entity (in all of its
components) has created in the consumer’s mind … The most successful brands in any
category never fail to cater to and reward their core customers all the time. [And,
responding specifically to the announcement of the upscale Collections line,] … trying to
be too many things to a diverse audience under one roof is a losing business strategy for
an established brand. lxxii
Krill responded,
The Company remains firmly committed to long-term growth, and we believe we have
significant untapped potential ahead of us. … For fiscal 2008, we are relentlessly focused
on strengthening our business, improving our gross margins with tight inventory
management, executing our restructuring program with excellence, and pursuing growth
in a measured and prudent manner. Beyond 2008, we are confident that we have
positioned the Company for long-term growth and success. lxxiii
Krill appeared to be confident in her strategies for the future. However, the retail environment
was increasingly unpredictable. Had Krill’s new strategies been well considered, given the
ongoing challenges of AT and LOFT, and the difficult specialty retail environment in 2008?
What else could Krill have done to create growth? Should ANN have focused on improving its
current businesses, or on developing new initiatives?
Page 24
The CASE Journal
EXHIBITS
Exhibit 1: AT vs. LOFT Financial Performance 2004-2008
(Net sales in millions)
February 2, February 3, January 28,
2008
2007
2006
Total Company
$2,396.5
$2,343.0
$2,073.1
Ann Taylor
866.6
912.8
873.9
Ann Taylor LOFT
1,174.4
1,146.5
991.9
Other*
355.6
283.7
207.3
*Includes Ann Taylor Factory stores and Internet business
Comparable Store Sales Percentage
Increase (decrease)
Total Company
(3.3)%
2.8%
Ann Taylor
(3.7%)
3.1%
Ann Taylor LOFT (5.4%)
1.9%
0.1%
0.6%
(0.3)%
January 29,
2005
$1,853.6
854.9
826.6
172.2
January 31,
2004
$1,587.7
867.9
588.8
131.1
3.6%
(2.7%)
12.8%
5.3%
3.2%
9.4%
The following table provides consolidated income statement data expressed as a percentage of
net sales. All fiscal years presented contain 52 weeks, except for the fiscal year ended
February 3, 2007, which contains 53 weeks:
Net sales
Cost of sales
Gross margin
Selling, general & admin expenses
Restructuring & asset impairment
Operating income
Interest income
Interest expense
Income before income taxes
Income tax provision
Net income
% Change From Prior Period
Net Sales
Operating Income
Net Income
2/2/08
2.3%
(30.6%)
(32.0%)
February 2,
2008
100%
47.8
52.2
44.4
1.3
6.5
0.3
0.1
6.7
2.6
4.1%
2/3/07
13.0%
70.8%
74.6%
Source: Company financials at http://investor.anntaylor.com/
Page 25
February 3,
2007
100%
46.3
53.7
44.1
--9.6
0.7
0.1
10.2
4.1
6.1%
1/28/06
11.8%
24.8%
29.4%
January 28,
2006
100%
49.1
50.9
44.6
--6.3
0.4
0.1
6.6
2.7
3.9%
1/29/05
16.7%
(38.7%)
(37.2%)
The CASE Journal
Exhibit 2: ANN Stock Price 1992-2008
ANN vs. XRT (SPDR S&P Retail ETF)
XRT
ANN
$50
$45
Stock Price
$40
$35
$30
$25
$20
$15
$10
$5
8/2008
8/2007
8/2006
8/2005
8/2004
8/2003
8/2002
8/2001
8/2000
8/1999
8/1998
8/1997
8/1996
8/1995
8/1994
8/1993
8/1992
8/1991
$0
For comparison purposes, the adjusted close stock price of the Exchange Traded Fund (ETF)
S&P Retail SPDR is included. This fund began trading on 6/22/2006. The top ten holdings
(22.48% of total assets as of 8/2008) in this fund (in alphabetical order) consist of Aeropostale
Inc., AnnTaylor Stores Corp., Brown Shoe Co., Inc., Charming Shoppes, FootLocker, Inc.,
Genesco Inc., Limited Brands Inc., Ross Stores Inc., Supervalu Inc., and Tiffany & Co.
Derived from: http://finance.yahoo.com/q/bc?s=ANN&t=my&l=on&z=l&q=l&c=
Page 26
The CASE Journal
Exhibit 3: Stores Operational Data
Employees, Total
FY2007
18,400
FY2006
17,700
FY2005
16,900
FY2004
14,900
FY2003
13,000
Inventory Turns*
4.7
5.0
4.7
4.5
4.1
$474
$461
$471
$456
$130,227
$123,008
$124,743
$122,467
$457
Net Sales/sq ft
Net Sales
(Revenue)/Employee $130,603
Average sq ft/Store
Ann Taylor
5,300
Ann Taylor LOFT
5,700
Ann Taylor Factory
6,700
*Inventory turns can be calculated differently, depending on whether yearly average or year end
inventory values are used. These numbers are from ANN’s 10K filing.
Specific Store Detail
Fiscal
Year
Total Stores
Open at No. Stores Opened
During Fiscal
Beginning of
Year
Fiscal Year
No. Stores
Closed
During
Fiscal Year
No. Stores
Expanded
During Fiscal
Year
No. Stores Open at
End of Fiscal Year
ATS ATL ATF
ATS ATL ATF Total
2003
584
8
61
1
6
354 268
26
648
8
2004
648
10
77
8
5
359 343
36
738
6
2005
738
9
73
15
11
357 416
51
824
12
2006
824
11
52
7
25
348 464
57
869
16
2007
869
14
52
11
17
349 512
68
929
14
Source: Company Reports at http://investor.anntaylor.com/
Page 27
The CASE Journal
Exhibit 4: Income Statements
AnnTaylor Stores Corp.
Annual Income Statement
(In Millions of US$)
Jan08
Jan07
Sales
2,396.510 2,342.907
Cost of Goods Sold
1,028.442
980.007
Gross Profit
1,368.068 1,362.900
Selling, General, & Administrative Expense
1,063.623 1,033.173
Depreciation, Depletion & Amortization
116.804
105.890
Operating Profit
187.641
223.837
Interest Expense
2.172
2.230
Non-Operating Income/Expense
7.826
17.174
Special Items
(32.255)
0.000
Pretax Income
161.040
238.781
Total Income Taxes
63.805
95.799
Net Income
97.235
142.982
Source: Standard & Poor's
Page 28
Jan06
Jan05
2,073.146 1,853.583
923.336
827.378
1,149.810 1,026.205
908.966
842.590
93.786
78.657
147.058
104.958
2.083
3.641
9.318
5.037
(16.032)
0.000
138.261
106.354
56.389
43.078
81.872
63.276
Jan04
1,587.708
669.638
918.070
694.590
51.825
171.655
6.665
3.298
0.000
168.288
67.346
100.942
The CASE Journal
Exhibit 5: Balance Sheets
ASSETS
Cash and Equivalents
Short-Term Investments
Total Receivables
Inventories
Current Assets - Other
Total Current Assets
Gross Plant, Property & Equipment
Accumulated Depreciation
Net Plant, Property & Equipment
Intangibles
Deferred Charges
Other Assets
TOTAL ASSETS
Annual Balance Sheet
Jan08
Jan07
134.025
360.560
9.110
0.000
16.944
16.489
250.697
233.606
97.115
79.950
507.891
690.605
1,148.003 1,105.240
586.733
541.132
561.270
564.108
286.579
286.579
0.288
0.652
37.727
26.559
1,393.755 1,568.503
LIABILITIES
Accounts Payable
Accrued Expenses
Other Current Liabilities
Total Current Liabilities
Long Term Debt
Deferred Taxes
Other Liabilities
TOTAL LIABILITIES
EQUITY
Total Preferred Stock
Common Stock
Capital Surplus
Retained Earnings
Less: Treasury Stock
Common Equity
TOTAL EQUITY
TOTAL LIAB & COMMON EQUITY
Common Shares Outstanding
Jan06
380.654
0.000
17.091
204.503
73.964
676.212
995.897
483.132
512.765
286.579
1.017
16.333
1,492.906
Jan05
62.412
192.400
12.573
229.218
90.711
587.314
853.770
419.442
434.328
286.579
1.382
17.735
1,327.338
Jan04
337.087
0.000
12.476
172.058
55.747
577.368
542.449
276.880
265.569
286.579
4.886
17.471
1,151.873
125.388
132.924
54.564
312.876
0.000
1.960
239.435
554.271
106.519
139.910
52.989
299.418
0.000
219.174
518.592
97.398
114.272
45.916
257.586
0.000
200.838
458.424
88.340
116.514
38.892
243.746
0.000
156.848
400.594
52.170
77.330
32.120
161.620
125.152
34.465
321.237
0.000
0.560
781.048
762.948
705.072
839.484
839.484
1,393.755
60.880
0.000
0.559
753.030
664.934
368.612
1,049.911
1,049.911
1,568.503
69.373
0.000
0.558
711.224
527.325
204.625
1,034.482
1,034.482
1,492.906
72.491
0.000
0.545
657.382
445.410
176.593
926.744
926.744
1,327.338
70.632
0.000
0.336
510.676
393.926
74.302
830.636
830.636
1,151.873
68.067
Page 29
The CASE Journal
Exhibit 6: Statement of Annual Cash Flows
Annual Statement of Cash Flows
INDIRECT OPERATING ACTIVITIES
Jan08
Jan07
Net Income
97.235
142.982
Depreciation and Amortization
116.804
105.890
Deferred Taxes
(9.361)
(10.809)
Funds from Operations - Other
58.850
41.290
Receivables - Decrease (Increase)
(0.455)
0.602
Inventory - Decrease (Increase)
(17.091)
(29.103)
Accounts Payable and Accrued Liabilities - Inc (Dec)
0.550
37.580
Other Assets and Liabilities - Net Change
10.665
7.499
Operating Activities - Net Cash Flow
257.197
295.931
Jan06
81.872
93.786
(15.421)
28.022
(5.024)
24.715
28.185
75.188
311.323
Jan05
63.276
78.657
(5.022)
23.163
0.056
(57.159)
62.196
4.092
169.259
Jan04
100.942
51.825
3.771
13.133
(1.909)
10.926
12.725
(1.795)
189.618
INVESTING ACTIVITIES
Short-Term Investments - Change
Capital Expenditures
Investing Activities - Net Cash Flow
(16.422)
139.998
(156.420)
0.000
165.926
(165.926)
192.400
187.613
4.787
117.975
152.483
(34.508)
0.000
71.364
(71.364)
FINANCING ACTIVITIES
Sale of Common and Preferred Stock
Purchase of Common and Preferred Stock
Excess Tax Benefit from Stock Options
Financing Activities - Other
Financing Activities - Net Cash Flow
17.935
(347.575)
2.328
0.000
(327.312)
30.038
(185.129)
4.992
0.000
(150.099)
50.285
(48.153)
0.000
0.000
2.132
22.822
(121.698)
(0.022)
(98.898)
20.329
(12.781)
(1.536)
6.012
(226.535)
1.723
77.355
(20.094)
1.769
94.723
318.242
1.293
47.030
35.853
1.770
58.226
124.266
2.202
56.147
Cash and Equivalents - Change
Interest Paid - Net
Income Taxes Paid
Page 30
The CASE Journal
Exhibit 7: Selected Retail Performers, end of 2007
Company/
Ticker
Symbol
2007
Revenue
(millions)
Ann Taylor/
ANN
$2,396.5
Comparable
Stores Sales
Increase
(Decrease)
2006
2005
(3.3%) 2.8%
# of
Stores
Talbots/
TLB
$2,289.3
(5.7%)* 1.3%*
1,421
47 states
plus Canada,
United
Kingdom
Specialty – women’s
apparel, shoes,
accessories via store,
catalog, Internet
Chico’s FAS/
CHS
$1,714.3
(8.1%)
2.1%
1,070
47 states
plus U.S.
Virgin
Islands &
Puerto Rico
Coldwater
Creek, Inc./
CWTR
$1,151.5
(7.9%) 8.5%
averages
336
Specialty Women’s
– Privately branded
clothing, intimate
garments & gifts for
fashion-conscious
women with
moderate-high
income
Specialty Women’s apparel, accessories,
jewelry, gifts via
instore, catalog,
Internet, also Spa
locations
929
Locations
Served
Merchandise
Market Served
Comments
46 states
plus Puerto
Rico
Specialty Women’s
– private label “total
wardrobing strategy”
to achieve the “Ann
Taylor look” in suits,
separates, footwear
& accessories
Brands are Ann Taylor
for updated
professional classics,
Ann Taylor LOFT for
lower priced more
casual wear, Ann
Taylor Factory for
outlet priced garments
developed specifically
for this market
Brands are Talbots,
modern classics for
women; J.Jill for casual
women. Brands target
high income, college
educated professionals
35 years old & up.
Talbots Kids, Talbots
Mens were closed in
2007.
Brands are Chico’s for
women 35+, White
House/Black Market
for women 25+, Soma
intimates
48 states
Offers Coldwater Creek
brand of cosmetics,
personal care products
to women over 35 with
incomes in excess of
$75K. Socially
responsible.
* Does not include J.Jill Data Source: 10K filings, plus data from “Top 100 Retailers”, Stores: A magazine of the NFR, July
2008, downloadable by link at http://www.nrf.com/modules.php?name=News&op=viewlive&sp_id=543
Page 31
The CASE Journal
Exhibit 7, Continued: Selected Retail Performers, 2008 Financial Data
Company Name
Abercrombie & Fitch Co.
Charming Shoppes, Inc
Chico's FAS Inc
Coldwater Creek Inc.
Limited Brands Inc.
Talbots, Inc.
The Gap, Inc.
Total
Revenue*
$3,749.8
$2,396.5
$3,010.0
$1,714.3
$1,151.5
$10,134.0
$2,289.3
$15,763.0
Net
Income*
Inventory
Turnover
$475.7
$97.3
($83.4)
$88.9
($2.5)
$718.0
($188.8)
$833.0
Company Name
9.89
9.92
7.35
13.48
8.65
6.73
6.73
9.38
Revenue $ per
Employee
$37,981
$130,603
$99,941
$120,212
$87,665
$57,869
$138,288
$105,375
Selling Gen Gross
Operating Net Profit
& Admin Margin % Margin % Margin %
% Tot Rev
Abercrombie & Fitch Co.
47.54
66.97
19.75
12.69
44.38
52.21
6.48
4.06
Charming Shoppes, Inc
25.83
26.95
-2.62
-2.77
Chico's FAS Inc
49.44
56.53
7.08
5.18
Coldwater Creek Inc.
40.02
39.1
-0.93
-0.22
Limited Brands Inc.
26.27
34.95
10.95
7.09
Talbots, Inc.
33.1
32.12
-8.14
-8.25
The Gap, Inc.
36.11
8.34
5.28
N/A
Data from Mergent Online, as of 2008, *dollars in millions
Page 32
The CASE Journal
Exhibit 8: Summary of Personnel Changes at ANN Mid-2006 to End-2008
Note: These personnel changes represent seven resignations, seven new hires, and two promotions in Kay Krill’s
upper management team over two years’ time.
11/3/2008 New hire Gary Muto, President, Ann Taylor LOFT, came from Gap, Inc., most
recently as President of Gap Adult/Gap Body, had also been President of Forth & Towne
9/8/08 New hire Paula J. Zusi, EVP, Chief Supply Chain Officer, from Liz Claiborne
8/12/08 New hire Christine M. Beauchamp, President Ann Taylor Stores, came from Limited
Brands, most recently was President & CEO of Victoria’s Secret Beauty
8/12/08 Resignation Adrienne Lazarus, President Ann Taylor Stores, after 17 years
7/15/08 Resignation Anthony Romano, Chief Supply Officer, after 11 years at ANN
9/17/07 New hire Michael J. Nicholson, EVP, CFO, additional responsibility for Information
Technology and Global Procurement, came from Limited Brands
8/24/07 New hire Robert Luzzi, Chief Marketing Officer, from New York & Company
8/20/07 Resignation Elaine Boltz, Chief Marketing Officer, after three years at ANN
8/13/07 New hire Mark Mendelson, President New “Boomer” Concept, from Jones Apparel, was
at ANN in the early 1990s as General Merchandise Manager
8/10/07 Resignation CFO James Smith, after 14 years at ANN
7/10/07 Brian Lynch promoted from EVP to President AT Factory, will lead new LOFT Factory
concept as well, with launch planned in summer 2008. Given additional responsibility for ECommerce, and Corporate Real Estate and Construction, as President of Corporate Operations,
added on 7/15/2008
6/6/07 New hire Diane Holtz, EVP Merchandising & Design, LOFT, from The Limited, was at
ANN in late 1990s as General Merchandise Manager
1/22/07 Resignation Donna Noce, President LOFT, Krill to take over temporarily
6/6/2006 Adrienne Lazarus promoted to President Ann Taylor Stores from EVP Merchandise &
Design Ann Taylor Stores
5/4/2006 Resignation Laura Weil, COO, after eight months (hired 9/1/2005)
5/3/2006 Resignation Muriel Gonzalez, Chief Marketing Officer, after a little over a year
Page 33
The CASE Journal
i
Maestri, N. “Retailers try to thrive in tumultuous climate”, Reuters.com, 6/16/2008, from
http://www.reuters.com/article/email/idUKN1332245620080616
ii
Adams, T. 2008. “Economy generating ‘wave’ of retail closures”, Columbus Ledger-Enquirer, McClatchy Tribune
Business News, 6/14/2008.
iii
Krill, K. As quoted in “Q3 2005 Ann Taylor Stores Earnings Conference Call – Final”, Fair Disclosure Wire,
12/2/2005.
iv
Merrick, A. 2005. “Parent Trap: Once a bellwether, Ann Taylor fights its stodgy image”, Wall Street Journal
(Eastern Edition), 7/12/2005, p. A.1.
v
ANN representatives noted that there was no apparent cause and effect relationship between AT sales decline and
the growth of LOFT. Personal communication, Beth Warner, Director, Corporate Communications, Ann Taylor
Stores Corporation, July 2007.
vi
Tucker, R. 2004. “LOFT Continues to Pace Ann Taylor”, Women’s Wear Daily, 8/12/2004, Vol. 188, Iss. 21, p.
12.
vii
Letter to Shareholders, ANN 2007 Annual Report, at
http://investor.anntaylor.com/phoenix.zhtml?c=78167&p=irol-reportsAnnual
viii
Q1 2008 AnnTaylor Stores Earnings Conference Call, 5/22/2008, available at
http://seekingalpha.com/article/78473-ann-taylor-stores-corp-q1-2008-earnings-call-transcript
ix
Lomax, A, “More fickle fashion”, Motley Fool, 5/23/2008, at
http://www.fool.com/investing/general/2008/05/23/more-ficklefashion.aspx?terms=ann&vstest=search_042607_linkdefault
x
xi
Wilson, M. 1995. “Reinventing Ann Taylor”, Chain Store Age Executive with Shopping Center Age, New York,
January, 1995, Vol. 71, Iss. 1, p. 26.
xii
Summers, M. 1999. “New Outfit”, Forbes, 12/27/1999, Vol. 164, Iss. 15, p. 88.
xiii
“Krill promoted to President of the Ann Taylor Loft Division of Ann Taylor, Inc.”, 5/3/2001,
http://investor.anntaylor.com/news/20010503-40453.cfm?t=n
xiv
“Ann Taylor Announces LOFT Division Reaches $1 Billion in Sales”, 2/12/2005, from
xv
Curan, C. 2001. “Ann Taylor LOFTs expansion plans right into a storm”, Crain’s New York Business, 4/30/2001,
Vol. 17, Iss. 18, P. 4.
xvi
Krill, K. 2005, op. cit.
xvii
“Ann Taylor Stores Jumps on Strong Earnings”, Associated Press, 3/10/2006, from
http://news.moneycentral.msn.com/ticker/article.asp?Feed=AP&Date=20060310&ID=5570346&Symbol=US:ANN
xviii
xix
2000. “A brief history of shopping centers”, International Council of Shopping Centers, June 2000, from
http://www.icsc.org/srch/about/impactofshoppingcenters/briefhistory.html
xx
The “large-sized woman” market is best represented nation wide in shopping malls by Lane Bryant stores and
catalog sales, Fashion Bug Plus, and Catherine’s stores, all divisions of Charming Shoppes; and by Avenue stores, a
division of United Retail Group. Charming Shoppes also targets the petite woman, 5’4” and shorter, with its Petite
Sophisticate Outlet.
xxi
As an example, Gap, Inc. created the Old Navy division in 1994 to offer lower priced casual clothing. An apparel
retail industry overview by Encyclopedia of American Industries Online Edition. Thomson Gale, 2006, reported that
in 2002 nearly 35 percent of Target’s sales came from the clothing department.
xxii
Victoria’s Secret is a division of Limited Brands, which also operates Pink (a sub-brand of Victoria’s Secret
focused on sleepwear & intimate apparel for high school & college students), Bath & Body Works and C.O.
Bigelow (personal beauty, body & hair products), The White Barn Candle Co. (candles & home fragrances), Henri
Bendel (high fashion women’s clothing), and La Senza (lingerie sold in Canada & worldwide).
xxiii
Abercrombie & Fitch, as of 2008, had four brand divisions in addition to the flagship Abercrombie & Fitch
stores: abercrombie (the brand name is purposely lowercase) for kids ages 7-14; Hollister Co. for southern
California surf lifestyle teens; RUEHL No.925 for ages 22-35; and Gilly Hicks: Sydney, launched in 2008,
specializing in women’s intimate apparel.
Page 34
The CASE Journal
xxiv
http://www.census.gov/svsd/www/artsnaics.html, op cit.
According to the American Marketing Association (AMA), a brand is a “name, term, sign, symbol or design, or a
combination of them intended to identify the goods and services of one seller or group of sellers and to differentiate
them from those of other sellers. ... branding is not about getting your target market to choose you over the
competition, but it is about getting your prospects to see you as the only one that provides a solution to their
problem.” A good brand will communicate this message clearly and with credibility, motivating the buyer by
eliciting some emotion that inspires future loyalty. From
http://marketing.about.com/cs/brandmktg/a/whatisbranding.htm
xxvi
Felgner, B. 2007. “New challenges in branding”, Home Textiles Today, 2/5/2007, Vol. 28, No. 5, p. 1.
xxvii
Turner, J. 2007. “Go forth and go out of business”, Slate, 2/26/2007, at http://www.slate.com/id/2160668/
xxviii
Lee, G. 2007. “Chico’s outlines plan to improve on results”, Women’s Wear Daily, 3/8/2007, Vol. 193, Iss. 50,
p. 5.
xxix
The responsibilities of these positions include “creative vision” for the brand: marketing materials, store design,
and overall merchandising (developing product, ensuring production efficiency, monitoring store inventory
turnover, and adjusting price points as needed).
xxx
In 2007, Limited Brands owned the brands Victoria’s Secret (including Pink, a Victoria’s Secret sub-brand), Bath
& Body Works (the 2 major brands), and C.O. Bigelow, Henri Bendel, White Barn Candle, and La Senza.
xxxi
“Limited Brands cutting 530 jobs”, Columbus Business First, 6/22/2007, at
http://columbus.bizjournals.com/columbus/stories/2007/06/18/daily26.html
xxxii
Jones, Sandra M. 2007. “Sweetest Spots in Retail”, Knight Ridder Tribune Business News, 7/31/2007, pg. 1.
xxxiii
Sarkar, Pia. 2007. “Talbots still can’t find its way”, 10/24/2007,
http://www.thestreet.com/newsanalysis/retail/10386340.html
xxxiv
See, for instance, the website http://www.aginghipsters.com/ , a “source for trends, research, comment and
discussion” about this group.
xxxv
Agins, Teri. 2007. “The Boomer Balancing Act: Retailers say new looks for middle-age women are both
youthful and mature”, Wall Street Journal (Eastern Edition), 11/3/2007, pg. W3.
xxxvi
2006. “Talbots completes the acquisition of the J.Jill Group; combined company creates leading brand portfolio
for the age 35+ female market; key executives promoted to maximize growth”, Business Wire, 5/3/2006, from The
Talbot’s Inc. http://phx.corporate-ir.net/phoenix.zhtml?c=65681&p=irol-newsArticle&ID=851481&highlight=
xxxvii
Edelson, Sharon. 2007. “Coldwater Creek brings natural vibe to Manhattan”, Women’s Wear Daily, 8/13/2007,
Vol. 194, Iss. 32, pg. 4.
xxxviii
See, for instance, the graph at Coldwater Creek, Inc. 2006 Annual Report,
http://www.coldwatercreek.com/InvRel/. Doing a comparative analysis using any stock reporting tool shows both
Coldwater Creek and Chico’s beating Ann Taylor during the period from 2004 - mid 2007. Talbots trails them all.
xxxix
Some marketers believe the boomers are a bifurcated demographic: although the boomer market encompasses
those born between 1946-1964, boomers born between 1946-1954 have slightly different life experiences than those
born between 1955-1964.
xl
“50+Fabulous Awards Companies that Promote Positive Images of 50+ Women”, Business Wire, 01/30/2007.
xli
Kingsbury, Kevin & Moore, Angela. 2007. “Ann Taylor tires for a better fit”, Wall Street Journal (Eastern
Edition), 8/25/2007, p. B6.
xlii
Barbaro, Michael. 2007. “Ann Taylor said to plan boomer unit”, The New York Times, 8/13/2007, p. C3.
xliii
ANN 2007 Annual Report, at http://investor.anntaylor.com/phoenix.zhtml?c=78167&p=irol-reportsAnnual
xliv
Information in this section comes from ANN 10K filing as of FY2007.
xlv
xlvi
O’Donnell, J. 2006. “Retailers try to train shoppers to buy now; Limited supplies, fewer sales could get
consumers to stop waiting for discounts”, USA TODAY, 9/26/2006, p. B3.
xlvii
ANN 2005 Annual Report at http://investor.anntaylor.com/downloads/2005AnnualReport.pdf
xlviii
“Ann Taylor: Upgrade with style”, Modern Material Handling (Warehousing Management Edition), March
2006, Vol. 61, Iss. 3, p. 38.
xlix
Jones, S.D. 2006. “Moving the Market – Tracking the Numbers/Outside Audit: Ann Taylor’s Data Draw a Big
Critic; Research Firm Questions Retailer’s Earnings Quality Amid High Costs of Capital”, Wall Street Journal
(Eastern Edition), 7/17/2006, p. C3.
l
Kennedy, K. 2000. “This is not your momma’s clothing store – not by a longshot”, Apparel Industry Magazine,
Altanta, December 2000, Vol. 61, Iss. 12, p. 22-25.
xxv
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li
Curan, C. 1999. “Ann Taylor aims for LOFT-y goal with new stores”, Crain’s New York Business, 3/29/1999,
Vol. 15, Iss. 13, p. 1.
lii
Derby, M. 2005. “Wall Street bullish on Ann Taylor’s Weil”, Women’s Wear Daily, 10/3/2005, Vol. 190, Iss. 71,
p. 20.
liii
Moin, D. 2005. “Ann Taylor stores taps two to fill out executive ranks”, Women’s Wear Daily, 3/3/2005, Vol.
189, Iss. 45, p.
liv
Merrick, A. 2006. “Boss Talk: Asking ‘What Would Ann Do?’; In Turning Around Ann Taylor, CEO Kay Krill
Got to Know Her Customers, ‘Ann’ and ‘Loft’”, Wall Street Journal (Eastern Edition), 9/15/2006, p. B1.
lv
“Q3 2005 Ann Taylor Stores earnings conference call – final”, Fair Disclosure Wire, 12/2/2005.
lvi
“Ann Taylor and Ann Taylor Loft – The Specialty Resource for Petites”, 8/23/2006, from
lvii
Moin, D. 2006. “Laura Weil exits Ann Taylor”, Women’s Wear Daily, 5/5/2006, Vol. 191, Iss. 97, p. 2.
lviii
ANN 2005 Annual Report, at http://investor.anntaylor.com/annual.cfm
lix
Moin, D. 2006. “Rebound at Ann Taylor: CEO Kay Krill Fashions Retailer’s New Career”, Woman’s Wear Daily,
6/26/2006, Vol. 191, Iss. 134, p. 1.
lx
http://seekingalpha.com/article/68606-ann-taylor-stores-corporation-q4-2007-earnings-call-transcript?page=8
lxi
lxii
“Ann Taylor Announces Executive Management Changes”, 7/15/2008, from
http://investor.anntaylor.com/phoenix.zhtml?c=78167&p=irol-newsArticle&ID=1174968&highlight=
lxiii
Poggi, Jeanine. 2007. “Specialty Retailers see High Exec Turnover”, Women’s Wear Daily, 8/20/2007, Vol. 194,
Iss. 37, pg. 2-2.
lxiv
“Ann Taylor launches strategic restructuring program to enhance profitability; Multi-year program expected to
generate $50 million in ongoing annualized pre-tax savings; Company takes a conservative approach to new store
growth for fiscal 2008”, PR Newswire, 1/30/2008.
lxv
“Ann Taylor Expands Strategic Restructuring Program”, 11/6/2008, from
http://investor.anntaylor.com/phoenix.zhtml?c=78167&p=irol-newsArticle&ID=1223638&highlight= .
lxvi
Ibid.
lxvii
Ann Taylor launches strategic restructuring program. Op cit.
lxviii
lxix
Merrick, Amy. 2007. “Ann Taylor’s Loftier Goal: A more upscale shopper”, Wall Street Journal, 9/14/2007,
http://online.wsj.com/public/article/SB118972474680527004.html
lxx
Moin, David. 2007. “New in beauty: Ann Taylor taps Robin Burns to develop collection”, Women’s Wear Daily,
03/16/2007, Vol. 193, Iss. 57, pg. 1.
lxxi
lxxii
Eli, 2007. “Another mid-priced retail brand, Ann Taylor, trying to go upscale,” 9/14/2007, from
http://theportnoygroup.typepad.com/my_weblog/2007/09/another-mid-pri.html
lxxiii
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Kija Kim and Harvard Design & Mapping Co.
Lynda L. Moore
Bonita L. Betters-Reed
It was the fall of 2005, and the devastating wake of Hurricanes Katrina and Rita left Kija Kim
reflecting on the role her small company had played in these relief efforts in New Orleans and
the Gulf Coast of the United States. In fact, the events on 9/11/01 and now this hurricane disaster
relief had Kija pondering the role HDM played in the incredible Geographic Information
Systems (GIS) industry. Since 1988, when Kija founded Harvard Design and Mapping Co., Inc
(HDM), there had been many ups and downs, many challenges to Kija’s identity as a leader and
many conflicting answers to her ever present question, “what is success?” A $5 million dollar
company with 35 employees, two locations in Cambridge Massachusetts and Arlington Virginia,
worked with FEMA staff at the Mapping Analysis Center (MAC), HDM provided Hurricane
Katrina mapping support that included vital information on the extent of the damage.
Such “Damage Analysis Reports”, designed to help insurers assess property losses following a
natural disaster, were a new service to the insurance industry and HDM was able to deliver them
at a record turn-around time of only one day. Kija was proud of the fact that HDM made it
possible for the first time for insurers to email their potentially affected insurance property
addresses directly to HDM. In turn, HDM provided pre- and post-event satellite images overlaid
with official damage analysis data (flooding, saturation, wind damage) from remote sensing.
This was more than a small win, but was it enough? A niche player in homeland security and
disaster relief, a leader in the development of advanced geospatial technology with their
internationally recognized multi-hazard portfolio analysis…and yet all of this made Kija wonder,
was this where it ended? Could she sustain this distinct niche as supplier of software, systems
integration and geospatial data management services to “the big guys” in government and
Fortune 1000 companies? She had come a long way and she knew the answer was less about her
strategy and more about her sense of self. What would make her feel successful?
The Kija Advantage – Her Heritage
I’ve gone back and forth on whether being a woman, being a minority person or being an
immigrant was the most difficult part of breaking into business.
Kija Kim
Kija Kim was born and raised in Seoul, Korea during the post WWII era and the difficult days of
The Korean War. Kija’s mother was originally from North Korea where her older brother was
very active in the Korean independence movement against Japan. Kija’s mother, now in her 90’s
and living in New York City, had passed many stories on to her. One story Kija heard many
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times while growing up, claimed that her mother’s grandfather was the first person to be
converted to Christianity as a result of the American missionary program through the
Presbyterian Church. This Christian influence was blended with an already strong and time
honored heritage of both Confucianism and Korean Shamanism. Both of Kija’s parents “were
very religious” and her mother “gave a lot to the church in donations.” She told Kija not to wait
until she was “rich enough to give…you will never be rich enough; you have got to give when
you can.”
Kija’s father was from South Korea and in Kija’s words, “was always on his own”. Even before
Kija was born, he was in the construction business with many “ups and downs” especially during
the Japanese occupation of Korea. She fondly recalled:
[As a Korean father], my father was a very unusual father in some sense…he really took
care of the kids very well and he was very family-oriented. He was very proud of each
kid, whether a daughter or son. There was no distinction.
Both parents always encouraged Kija and her siblings to do what they wanted to do and as she
noted, “they were so proud that we were smart.” Her father continued to support her throughout
her education even though he harbored fears that she would “miss marrying…and become too
educated.” Following in her father’s footsteps and the path of her mother’s siblings, all of Kija’s
five siblings eventually became entrepreneurs.
In 1961 Kija started down the cartography career path at Seoul National University as a
geography major (See Exhibit I). Much of her four year college experience was spent under the
tutelage of Professor Yuk, a well-known economist as well as a professor of Geography. Dr.
Yuk was the brother-in-law of the President of Korea, Park Chung Hee. As Kija worked for
Professor Yuk, she also witnessed first hand his advisory capacity with President Park and the
establishment of a national economic plan. Kija remembered how poor Korea was right after the
war and the important role this plan served in reviving the economy. It was an incredible time,
especially when the first minister of the economic development department was appointed. He
was a gentleman who had his Ph.D. from Clark University in the U.S. She watched in awe as
their five-year economic development plan was successfully implemented in only three years.
As Dr. Yuk’s disciple, Kija graduated first in her class, no small feat at male dominated Seoul
National University, “the equivalent of Harvard in Korea”:
So that gave me the confidence that I am better than any man… that really formed my
character and confidence level…surviving and working in that environment – a man’s
world, because I grew up that way. I competed early on with men. So that’s why in the
business world I’m not shy – even when I started here men were more uncomfortable, but
I don’t feel uncomfortable at all.
On the advice of Professor Yuk, and qualifying for a Fulbright scholarship, Kija started in a
Ph.D. program in Geography at Clark University in Worcester, Massachusetts. She arrived in the
United States not quite prepared for the challenging transition:
The day I arrived in the United States, alone, with a suitcase in my hand, my American
family sponsors were not waiting for me at the airport in Philadelphia. I found a public
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telephone booth and tried to call them. The operator kept saying, “Please insert a
nickel.” I didn’t know what a “nickel” was. I had my first real English lesson right
there— a penny meant one cent, a nickel meant five cents, a dime meant 10 cents and
quarter meant 25 cents. Who knew?
Kija Kim, Multicultural Town Hall Speech, 2005
She had every intention of finishing her Ph.D. and returning to Korea, but it became clear she
would not be able to finish the doctoral program in the three years required by the Fulbright.
Kija gave up the Fulbright accepting a full scholarship from Clark to continue graduate studies,
married a Korean man and circumstances changed again. She explained,
Even then, I thought ‘as a woman in Korea, what was the highest career or the (most)
prestige you can achieve?’ I couldn’t see anything better than being a professor at Seoul
National University. So that was my dream. But along the way, I got married and had
two wonderful children, Kevin and Katherine. I had to put my dreams and ambitions on
hold.
Kija Kim, Multicultural Town Hall Speech, 2005
During this period of “trying to be a good mother”, Kija kept busy by volunteering in the
community. She was a Cub Scout den mother, volunteered for the American Cancer Society and
in her own words, “was learning the American system and culture the hard way” as she lived in
Indiana and New Jersey.
Later as a single mom, Kija said she pushed her two children to work hard and excel. She
counseled them not to complain about being an ethnic minority and having to work twice as
hard. She told them, “don’t take it (being an Asian American) as a negative, because you can
always be better than anybody.” Because of her two children, it was important to Kija that she
make it in America and it was equally important to her that her children be positive about being
different. She said, “I tried to give them confidence, (positive) self-esteem…it is different for
Asians growing up here. People coming from other countries are better off in that sense.” For
Kija, coming from the top of her class and coming from a different social context, she felt she
did not have “a chip on her shoulder”. In fact, Kija knew, “I’m the smartest when I came here
and I am better than anyone.”
Although Kija faced many hurdles throughout her life and career, she continued to see being
female, an ethnic minority, and an immigrant, as an advantage:
In the early days, in a lot of meetings, I was the only woman. And people said, ‘how do
you feel being the only woman’? I said, it’s great because they will all remember me.
I’m very unique.
And no one knew better how the Kija Kim advantage played out in the business setting than the
co-founder of Harvard Design and Mapping Inc. and Kim’s second husband, Jim Aylward. Jim
described Kija in this way:
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Kija leads by example. She has a very engaging personality. Everybody who has met her
likes her. Everyone remembers her. Very often at the beginning, she would be the only
woman, the only minority, in a group of contractors and she had the guts to stand up in
the middle and ask a question and say, “I’m Kija Kim from Harvard Design and
Mapping” . . . And there would be a crowd of 400 white males . . . and they’d look over
and say, “Who are you? This new kid on the block? You don’t look like everybody else”.
And you know, in a very big way Kija used that to her advantage. . . . She really used
what other people claim as impediments to business, as her great advantage in business.
HDM Start Up
Opportunity comes to the prepared mind.
-Kija Kim
In 1981, Kija took courses in Basic computer programming and Computer Aided Design (CAD).
She then landed a position with Charles Perkins Co., a Clinton, MA surveying firm. Kija started
right away with cartography work that she recalled as:
An extremely tedious job of manually drawing maps. I thought there was a better way to
automate the map-making process, or Automated Mapping, as it would soon be known.
She convinced the firm’s partners of the value of automation and persuaded them to purchase
computers and Computer Aided Design (CAD) software. Surveyors in the firm collected survey
data onto field survey devices and Kija downloaded it onto a CAD system, from which she was
able to generate maps. This birth of one of the first automated mapping systems “was so
wondrous to them”. It was the early stages of personal computers and soft ware in general in the
U.S. As Kija later noted, “Microsoft was about six years old. Bill Gates wasn’t even a
millionaire.”
As excitement and interest grew about this innovation, Kija recommended to the Charles Perkins
owners a new stand-alone business that would offer this service to other companies and leverage
the owners’ original investment. She suggested that she run the business and the owners act as
investors using their business connections to cultivate business development. The owners said
‘no’ several times. Although Kija recalled that she was …“innovative, patient and persistent”,
the discussions halted when the company’s accountant and lawyer advised the owners to not give
up equity, but rather hire her to run the company. Kija declined their offer: “I thought I could do
this by myself since I had come this far”.
Subsequently, Kija founded New England Mapping Company, her first entrepreneurial venture
in the automated business, in 1985. Kija’s early consulting clients were real estate firms and
engineering and survey firms in the greater Boston area. It wasn’t long before one of these
firms, Allen, Demurjian, Major and Nitsch (ADMN) asked her to join them. With this decision,
she learned a pivotal lesson that would guide her for years to come:
I thought I was asking for a lot of salary at that time, but it wasn’t that much money. The
principals and I got together at the University Club in Boston; they asked how much (do)
you want? I said, I thought, a lot of money, $40,000. They were surprised and said ‘ok.’ I
thought, oh my God, I should have asked for more. That was lesson number one.
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Kija met her future partner and husband, Jim Aylward, while at ADMN. Jim had a background
as a town administrator and came to the firm in 1986 to help them manage their town
government and utility relationships as part of the firm’s real estate development business. They
became friends during their frequent lunch encounters. As Jim says, “After 200 lunches we were
in business.” In 1988, Kija and Jim formed Harvard Design and Mapping Inc. (HDM). Their
original focus was on the real estate and government markets, capitalizing on Jim’s experience in
that area. “With my government background and her computer systems background, we thought
it made sense to target real estate developers and to continue to work with cities, towns, and the
state government”, Jim reflected.
The early years were tough. Kija and Jim did not pay themselves for eighteen months. While
recognizing this as a basic fact of small business start up, Jim acknowledged it was also a
sacrifice: “it was a long time when you’ve got mortgages to pay.” They were however
resourceful in their approach to financing the business itself. They borrowed $15,000 from
relatives, which they invested in a CD (certificate of deposit) and then used it for collateral for a
line of credit. Their first contract for tax mapping services with the town of Kingston, MA
generated a much welcomed $40,000.
Not long after obtaining this first contract, the real estate market went bust, and they focused
exclusively on government contracts. Their “big break” came in 1993 with the Massachusetts
Water Resources Authority’s (MWRA) need for environmental assessment with the Boston
Harbor clean up project, a $500,000 contract. HDM was earning the reputation for cutting edge
technology and demand for their services increased. Kija also registered with The Small
Business Administration (SBA) and was certified as a woman and minority-owned business.
This advantage enabled HDM to compete more effectively with big businesses for state and
federal contracts.
The MWRA contract coupled with a U.S. Coast Guard contract created a need for increased
technical and support staff. Kija quickly realized that a significant increase in salary expenses
mandated greater cash reserves. She and Jim prepared extensively for their first major loan
application and she was shocked when a large national bank rejected her application. She was
even more outraged when the bank officer told Kija that she would never get a loan from any
bank, “And I said, you will see. I will get it somewhere, because I was so mad at him. And I said
I’m going to get this loan from somebody. Literally, I was just so mad.” Determined, Kija went
to another loan officer at a local bank. This conversation was much more productive, especially
after the loan officer visited HDM’s facilities. He approved the maximum loan possible without
his bosses’ approval. The loan officer told Kija he was sticking his neck out because he trusted
her …”I know you won’t default on this loan”. For Kija, this whole experience was an important
lesson in business, “This is one of the most important things [in business], the bank
relationship…trust and the relationship…especially when we don’t have outside venture capital.”
Despite the fact that HDM’s early development was during the recession of the late 80’s and
early 90’s, Kija and Jim were able to counter the slow growth that plagued most start-ups. Their
combined ability to identify new business opportunities coupled with Kija’s pioneering spirit and
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Jim’s persistence, kept the business going.
“opportunity comes to the prepared mind.”
During HDM’s early years, Kija learned that
The 90’s
I think one of the most important things is the ability to change…fast.
Kija Kim
HDM got its first multi-million dollar contract in 1992 from the Federal Emergency
Management Agency (FEMA) by providing mapping software development services and quality
control of digital flood insurance rate maps. This new business and subsequent increasing
demands on Kija’s technical expertise, prompted her to hire Dr. Wei Du who later became the
Chief Technology Officer. In 1993, HDM won a multi-million dollar contract with Boston
Edison to help develop their geographic information system (GIS) platform. During this period
of rapid growth, HDM focused on delivering products and services at the expense of marketing
and new business contracts. When Boston Edison did not renew their contract, HDM was forced
to lay off some people and retrench. It was at this point that Kija realized their portfolio was too
dependent on government contracts:
I learned a lesson that, long before contracts end, you’ve got to renew or replace [them]
quickly. I’m much more conscious about that now. We couldn’t replace [the expired
contracts] fast enough and it was a very tough year.
The 90’s were slow growth for HDM as they built their reputation and explored new markets.
Kija and Jim accompanied Massachusetts Governor, Bill Weld, on trade missions to Asia and
Mexico and met with prescreened partners looking for U.S.-based Geographic Information
Systems (GIS) technology partners. Kija felt that HDM was too small to do a lot of international
business, and decided to focus on markets at home. Even though they did not go into
international business, they quickly developed a global perspective which they used to their
advantage in the U.S. Jim noted:
…we learned how people work and met with government officials in most places… [The
trade missions] were very important in understanding other cultures, which helps you
understand nationally the cultures that you come in contact with in the United States.
When the internet dot.com boom hit in the late 90’s Kija remembered thinking “Everybody’s
making millions…going dot.com and raising money. I said we’ve got to do something.” Kija
and Jim decided that Jim would start a dot.com business while Kija “would keep managing
HDM because that’s our bread and butter.” In 1999 Jim created smartcity.com, a real estate
location business, helping consumers sell their own houses without a real estate broker. He
raised one million dollars, built a management team, and created the software platform for this
new enterprise.
When in March of 2000 the dot.com bubble burst, Kija remembered thinking about their own
dot.com business and said “We’ve got to balance our risk and reward. If Smartcity makes big
money, we’re going to be rich and famous. But if it doesn’t we still have something.” Although
Jim kept Smartcity going into early 2001, the dot.com bust eventually forced it out of business
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along with many others. Kija reflected, “that was one of the good decisions; we didn’t change
the whole company to a dot.com; a lot of them failed at that time.” Throughout this period, Kija
ramped up her efforts on marketing and developed their business with the federal government.
In order to capitalize on successful contracts with over 20 federal agencies, she began to spend
most of her time in Washington D.C. They opened an HDM Washington office in 2000 and
found that clients responded positively and confidently to this new business site. In retrospect,
Kija reflected on HDM’s response to shifting markets:
I think one of the most important things is the ability to change, especially nowadays,
everything changes so fast. I started with the real estate sector and commercial sector.
When that didn’t work out quickly, I was able to get into the government sector
The 9-11 Story
Right place, right time, right technology.
-Kija Kim & Jim Aylward
On September 11, 2001, Kija Kim was on her way to the Washington D.C. for a 9:30 a.m.
appointment with a client at the U.S. Federal Transit Administration (FTA) headquarters. She
recalled that she had just been there a couple weeks previously to discuss a different contact
opportunity with the FTA’s Safety and Security division. They mentioned they had a pressing
directive from Norm Mineta, Secretary of Transportation, to have a transit security and
evacuation plan, in response to a potential terrorist threat. The FTA person asked Kija for “any
good ideas…because our deadline is coming soon”. On the subway in transit to her FTA
appointment on 9-11, she thought she heard rumblings of terrorism and remembered thinking,
“gosh, she’s fast…I can’t believe FTA is already putting this into (action).” When she arrived at
the FTA/DOT headquarters, the guard at the building said, “you can’t get in because everyone is
evacuating, everybody’s coming out.” The whole street was packed and the burning World Trade
Center was playing on the lobby television screens. The guard let her go up because Kija was
certain that her client, also a close colleague, would wait for her. Kija rushed up and her friend
grabbed her, saying “I knew you were coming so I was waiting for you.” They turned on the TV
in the adjacent conference room and “just sat there, numb” as the Pentagon was hit just over a
mile from where they were sitting. Cutting through the thick smell of smoke and crowds of
people, Kija finally made her way back to her D.C. office, thinking about the whole experience
and the pressing need for homeland security support.
Right after the terrorist attack on both the Pentagon and World Trade Center on September 11,
Jim, Kija and Wei Du, Chief Technology Officer, got together to brainstorm about the
implications of this disaster for HDM, Inc. Asking, “What can we do? How can our technologies
be used?” Kija said, “we’ve been doing this…emergency management work for over 12 years;
there has got to be a way we can help find terrorists and help prevent future attacks?” So they
immediately repositioned their technology to meet homeland security requirements. Kija
exclaimed:
We happened to have the right technology at the right time for the right cause…our focus
is in Homeland Security which combines all we have done for the last 15-16 years.
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Leadership Culture and Values
We are a small company, it’s almost like a family atmosphere...I’m very personable.
-Kija Kim
Kija Kim’s cultural values and leadership style were intertwined and embedded in HDM’S
corporate culture. Team work, hard work, a diverse and knowledgeable workforce, and high
standards were found in the context of a small family-like setting. For HDM, this strong culture
provides an advantage in the information industry, dominated by big players. In fact when IBM
became one of HDM’s customers this cultural difference became quite pronounced.
When we hired the new people in DC, I found a tabletop barbecue Korean restaurant,
and we took them (employees) out regularly. We also had pizza lunches a lot too. And
they thought it was the best. Once in a while, at IBM we take our people out and they
[IBM employees] are really envious.
Group pizza lunches were an established tradition from the early 90’s when the corporate offices
were in Cambridge Massachusetts and the staff was much smaller. As HDM grew, Kija made
sure to maintain those activities that made a difference for satisfaction and retention. She was
also willing to try new things if it helped get and keep the right people.
Kija recalled hiring Elena Bleakley for the Marketing Coordinator position. She had never hired
a part-timer for an important corporate position, but when she saw Elena in action on temporary
assignment, she re-evaluated her own notions about reliability. Due to family commitments,
Elena negotiated a part time position with flexible hours. Kija admited later that even though she
was initially worried about an employee who had to divide her time, she took the chance anyway
due to Elena’s impressive credentials and ability to “jump right in”. Kija took note that “they
(women) can be so productive and they manage multiple tasking so well.” Many years later, Kija
Kim had not only embraced family friendly organizational policies, but she had become a
spokeswoman for working parents. The following excerpt was from a speech Kija delivered for
Working Woman Mother’s Media Multicultural Town Hall program:
At HDM we have created a family friendly environment providing flexible hours to all
employees, and flexible working arrangements for working mothers. Working mothers
are much more efficient at multitasking and multidimensional. They also reciprocate by
being flexible when the company needs them. Most of them are part time workers, but
are as productive as a full time worker can be.
Wei Du, Chief Technology Officer, remarked that his children were “growing up with HDM.”
Additionally, he felt that HDM’s multicultural team was a unique benefit to the organization.
This benefit was also reflected in Kija’s organizational philosophy, “a good organization has a
balanced and diverse work force, is a reflection of the community we live in, and must contribute
to society.”
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The concept of a trusting team permeated the working relationships at HDM. For Kija Kim, trust
was gained through both interpersonal and technical competence. She tells the story of finding
Wei Du:
Dr. Gilbert White is a world-renowned geography professor…He’s in his 90’s now, but
he is [known as] the father of our flood plain management in this country. So at FEMA,
he is a god. Everybody knows [him]. The story goes, Dr. White went to China, and met
Wei at the Chinese Academy of Arts and Sciences and discovered that Wei was a genius
and brought him to Clark University for his Ph.D. When I mention Wei at FEMA, and
that he is a protégé of Dr. White’s, everyone says, ‘wow…he’s an unbelievable
guy’…they are so impressed.
When Kija hired Wei Du in 1992, she remembered the advice of her mother about the Chinese
people:
…it takes a little time to get to know them (the Chinese). But once you get to know them,
they give you everything. They are the most trustworthy people you can (know) and it’s
very different from any other Asian culture.
To Kija, the fact that Wei had the same values as she and Jim was very important. She
particularly valued their mutual respect and trust, “The trust we have is unbelievable and I think
that is a very important thing. I totally trust him when it comes to technology.” Likewise, Wei
Du explained how it is to work with Kija and Jim: “As a team, I think my personality fits. Kija
and Jim are my friends. A friend means that your life could depend on each other....we really
trust each other.” In the year 2000, Kija and Jim demonstrated their trust in Wei Du by asking
him to become a partner in HDM.
Wei knew he brought “logic and an engineering point of view” to the HDM strategic team. He
said that he “thinks about the company’s future and technological skills needed for future
projects.” What was important to Wei was that he enjoyed his work and he did it well. He
believed that “when people are satisfied, there are no complaints.”
Consistently Kija’s corporate team: Jim, Elena, Wei and John Walsh, the Controller, spoke of
Kija’s leadership as one that engendered mutual respect and a strong team. John described Kija
as:
She's a very outgoing, optimistic, fun-loving person and that to me makes it a lot easier to
work with. (She is) very approachable, you know, she'll get you an answer right away.
She stresses teamwork and everybody striving for the same goal for the company to be
successful.
John’s role in the team was self-described as “I'm the bad guy. I play the bad guy part,” that is to
say he controlled costs and told everyone they were spending too much on pizza. Even for the
tough roles and responsibilities like John’s, there was much support and good humor. There was
a strong work ethic that permeated the organization and even though everyone worked long
hours, a sense of community and fun dominated.
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There was no doubt that Kija Kim impacted HDM’s culture in ways that supported- but also
challenged- her team, a ying yang approach to leadership. Elena Bleakley remarked that Kija “is
a very charismatic woman” who valued hard work, dedication, commitment, intelligence and
education. As a hands-on manager, Kija’s imprint was indelible and impactful. Kija was known
for setting high standards, expecting the best not only from herself but also from others around
her:
I set the bar high so you have to perform, because I just don’t tolerate incompetence, and
they all [staff] know that . . . if you’re not competent, you don’t survive if you’re in HDM.
It’s kind of interesting. I take it as a compliment, right?
Killer Network: Networks, Partners, Community
Kija has a social responsibility to groups and brings her networking skills, a killer network. She
enjoys it; she does well by doing good.
Jim Aylward
Though Kija Kim had to put her dreams and ambitions on hold, she acknowledged that “I never
gave up. I stayed active in the community, even teaching U.S. history at our local high school.”
To her, being an active community volunteer and building her own networks served as a
foundation for what was to come later, “preparing her for the career that I would soon regain”.
In the early 1980’s, when Kija started her own consulting business she had to do everything
herself from marketing to technology and she realized the importance of the networks she did not
have:
I am a woman. I come from another country. I didn’t have a real network here. I realized
that with other companies, their business came through their networks, their friends. I
really do need a business network.
The lack of networks remained an issue through the startup of HDM. Jim Aylward noted that
building a network from the ground up took a tremendous amount of work,
Meetings at night, dinners, parties…lots of outside meetings, bringing people in, building
up those relationships…[it’s] very, very hard to do and she now has one of the best
networks going.
Jim proudly recounted Kija’s many network realms noting that she connected with the leaders
amidst them all: government, business, technology, minority communities, women advocacy
communities and even professional referrals for health care specialists. “She has friends
everywhere she goes…not too many companies get to 18 years in business, but the longevity…
is part of her network.”
Kija’s political network began with her active engagement in the fight to return Asian businesses
to the business affirmative action program that identified disadvantaged minority firms with the
U.S. Small Business Administration. Kija started getting faxes about a decision to take Asian
businesses out of this status and she joined others in an organized “push back” effort. She said,
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“that was my first wind of activism, you’ve got to get involved and fight…we started organizing
this group at that time and successfully…pushed back…that was very good.” Also during the
early ‘90’s, Kija accompanied Governor Bill Weld and his wife Susan, an Asian law scholar, on
the trade mission trip to Asia. Subsequently Governor Weld created the Massachusetts Asian
American Commission. With Kija’s appointment to the commission she increased her
community activism and became intimately familiar with the issues of the many different Asian
communities in the state. She commented, “I learned so much…we had town meetings, wrote a
lot of reports…and met (frequently) with the Governor...it was a really good time.”
As a result of her new notoriety within the Asian community and her up and coming recognition
as an enterprising woman business owner, she was invited to speak at the Massachusetts Political
Caucus Conference on The Glass Ceiling at the Kennedy School of Government at Harvard
University in 1992. After the conference, she was approached by a woman who asked her if she
knew Reverend Chen Imm Tan. Kija recollected the conversation:
I said no. She said, ‘you’ve got to meet her. She [Tan] is organizing an Asian battered
women’s shelter project because there are a lot of language problems due to so many
ethnicities in Asia. She really needs help, and you two should meet.’
Kija joined forces with Reverend Tan and The Asian Task Force Against Domestic Violence
(ATASK) taking on the demanding project of building a physical shelter for Asian women who
were in desperate need of protection and support. Finding out that their fund raising attempts to
date had only raised a small amount of money, Kija remembered saying, “God, we’ve got to
organize a big fundraising event. You’ve got to have some kind of signature event.” She
benchmarked similar organizations that were successfully raising $100,000, and further added,
“We can do better…let’s organize.” She remembered that everyone started to look at her
questioning if they could really do it…and recalled, “again, I didn’t know what it took…so I said
sure… we can do it.”
So in 1994, Kija Kim started The Silk Road Gala which was to become the major source of
revenue for The Asian Task Force Against Domestic Violence. Kija provided the overall
leadership and direction for the dinner and silent auction event, including securing sponsors. Ten
years later Silk Road and ATASK were recognized by the highest ranking state and local
governmental officials and community leaders as a model program for Boston and
Massachusetts. For Kija, “that [Silk Road] was my biggest accomplishment.”
Kija’s community involvement expanded, invitations to serve on organizational boards were
plentiful. She was driven by an unquenchable thirst for learning and a willingness to participate.
Jim indicated, “I think at one point she was on 14 boards at the same time, non-profits, and
corporate boards, and association boards… And I thought that was too much for her.” At Jim’s
recommendation, Kija cut back on these numerous board memberships heavily based in
Massachusetts (see Exhibit 2).
When HDM expanded their office in Washington D.C. their networks in that region were
primarily limited to customers. Jim took the lead in establishing these good contacts, as he said,
“building more from a business standpoint, building relationships with customers, doing a lot of
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bids, putting together a lot of proposals.” Regardless of where Kija and Jim lived or worked, a
lack of networks would never again be a barrier to her success.
Strategic Repositioning
We stopped doing what we were doing and started doing what we were thinking.
Jim Aylward
Following September 11, 2001, HDM reaffirmed its government focus and strategically
repositioned its technology on homeland security. Jim further explained what this strategic
repositioning entailed: “trying to stay ahead of the curve” through a focused commitment to
cutting edge technology. As Jim said “we stopped doing what we were doing and started doing
what we were thinking.” This shift in strategic action resulted in one of their most successful
innovations, the VBIZ tool suite, one of their open GIS tools. It provided the foundation for the
Hazards Map project and proved pivotal to future growth for HDM.
In 2000 Congress had created the Disaster Mitigation Act, which changed and enforced map
mitigation and lead to the Congressional Map modernization plan, known as Map MOD. In
addition to mandating a plan for modernizing flood maps nationwide it called for technology
sharing among multiple levels of local, state and federal government. In response to this new
demand for a new flood map system, FEMA started a new prototype system called
Hazardmaps.gov, and HDM was tasked to develop it. Kija saw this as one of HDM’s big
opportunities to move most of the staff to DC and focus new federal contracts and technology.
This decision paid off in 2004 when HDM was on multiple teams (all three final teams) in a Map
MOD competition. FEMA had designated HDM’s technology as a key component of this 5
year, $1B program. Michael Baker Corporation in conjunction with IBM won the contract for
which HDM provided the “HazardMaps.gov” based on technology, major software system
development and geospatial data management services. Kija realized that Hazard Maps would
become the company’s future. This technology allowed them to become well known and
respected within FEMA and the Flood Map Modernization program.
Post 9/11 Kija and her strategic team analyzed the situation and realized they were uniquely
situated to follow the growth of Homeland Security by developing products that could assist with
the safety and security of America. Due to their strong relationship with FEMA, they were able
to reposition their technology to sell products to the Department of Homeland Security (DHS).
Kija noted: “We need to really focus on government and Homeland Security because that’s our
bread and butter. That’s what’s growing and there’s a lot of work out there”.
Strategic repositioning required that they refocus their sales approach and shift Jim’s role. Jim
explained that they “organized their sales approach to be more product-centric,” meaning sales
were primarily generated on services gained through product sales.
Meanwhile, Jim assumed the role of business and customer development, submitting bids and
writing proposals. Additionally he turned his attention to developing existing relationships
through a more strategic point of view. For example, Jim’s relationship with the Homeland
Infrastructure Foundation Level Database Working Group (HIFLD) became part of an important
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growth strategy. Established post 9/11, HIFLD was designed to help intelligence agencies learn
about the United States, because prior to 9/11 the Department of Defense (DOD) and intelligence
agencies assumed terrorist attacks would not be US based. All involved organizations were
scrambling to shift their attention to Homeland Security. HDM was an integral part of this
Homeland Security effort.
HDM was becoming recognized as a key player in Homeland Security technology, which was
their major business focus. HDM had effectively carved out a competitive niche in the highly
fragmented GIS industry. For example Indus, a major competitor, only competed with HDM on
services within the Federal Government. Another competitor Plangraphics did not offer products,
either. Neither firm had the HDM advantage that the web portal security and software provided.
As numerous companies approached HDM to partner and to provide technology to Homeland
Security, Kija once again realized the need to remain agile. She figured that if the Homeland
Security industry declined, HDM’s work could be transferred to the private sector as it related to
infrastructure protection and hazard risk management. Kija realized that the singular focus on the
government sector had its down side:
I keep wondering about the commercial market. We don’t have the resources to
concentrate in that area now. We need to be careful about cash flow management and
make sure we won’t grow too fast. Yet, I am keeping the commercial market in mind if
the opportunity comes along.
Kija saw the need to balance their portfolio between government and private sectors. She also
saw that the portal technology HDM used for FEMA and IBM held promise for web service and
insurance companies in the private sector. Meanwhile, government budgets were tightening to
fund the war and the only budget increases were in DOD and DHS. Since the DHS and DOD
connection was increasing and they both already used HDM technology, this was a clear
opportunity for growth in the public sector.
By 2003, HDM posted approximately 1.9 million dollars in revenue and more than doubled this
figure in 2004 with approximately 3.2 million dollars. HDM was projected to grow twenty
percent in 2005, but Kija speculated that it might be as much as thirty-five percent. HDM’s
strategy was steady controlled growth with an emphasis on increased profit margin. Kija knew
that controlled growth would result from maximizing their technology and staying ahead of the
curve. HDM’s capability was put to the test when Hurricanes Katrina and Rita devastated New
Orleans and the Gulf Coast region of the U.S. Rising to this challenge and once again partnering
with FEMA, HDM proved to be an invaluable player with disaster analysis and relief. For HDM,
this was a watershed moment as the recognized need for their products in the marketplace grew
and they received more customers and visibility.
HDM reached its projected revenue target of $5 million in 2005 and appointed a new Vice
President and Manager of a new Government Solutions Division (GSD), David Chadwick, to
increase their organizational capability and better respond to increasing demands. Everything
was looking up. There seemed to be little doubt that HDM’s future was bright and Kija was
proud of her firm’s progress, their contributions to the GIS industry and more importantly their
ability to help rebuild communities impacted by natural and unexpected disasters.
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While Kija struggled with conventional definitions of success connected to greater profit and
significant size, she commented "But when I think about it, it really is something to stay in
business for eighteen years.” She knew that throughout HDM’s evolution, she had struggled
with issues of growth and profitability, but she also knew she had earned respect as a
technologically savvy, resilient, high quality, small player. Kija argued:
But then I realized that if we can still be small and make money, it doesn’t matter how big
you are. You can run it the way you want and make a good profit and have steady
growth, that’s the bottom line.
But as HDM faced the opportunity posed by homeland security and other unique applications of
their services and technology for increased profitability, Kija reflected upon her leadership of
HDM:
I often say if I had to do the business all over again I wouldn’t do it the same. [The
bootstrapping] is painful, it’s hard to grow. It was my first business and I didn’t know
any better. But if I started all over again I’d go out to venture capitalists, raise some
money and grow big, and exit.
While Kija Kim was reconsidering her own definitions of success, she received a call from the
U.S. Small Business Administration. The Director of Economic Development for the City of
Cambridge had nominated Kija Kim for Small Business Person of the Year. This nomination
surely recognized her leadership and HDM’s successful innovative culture, cutting edge
technology and their growing demand for products and services. Was this it? If this recognition
and all it embodied wasn’t success, what would make her feel successful?
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Exhibit 1
Kija Kim and HDM Timeline
1965
Graduated top of her class, Seoul National University
1966-67
Attended Clark University, Graduate School of Geography
1983
Joined civil engineering firm (Charles Perkins Company)
1985
Started New England Mapping Company, an automated mapping and
facility management business
1986
Joined Allen, Demurjian, Major and Nitsch, a Boston based civil
engineering firm; met future partner Jim Aylward
1988
Started HDM with Jim Aylward; won U.S. Coast Guard contract for
automated mapping and asset management system
1990-91
HDM moved to larger facility and obtained first line of credit from
Shawmut Bank; staff increased to 7 full time employees
1992
Dr. Wei Du joined HDM
1993
Awarded multi-million dollar GIS development contract by Boston Edison
Company (now NSTAR); project would go on to win an international
Utility GIS award
1994
Married Jim Aylward; started Silk Road Gala, largest fund raising event for
Asian Task Force Against Domestic Violence organization
1999
SmartCity.com spun off from HDM, led by Jim Aylward
2000
HDM focused on federal government efforts, expanded DC operation; Dr.
Wei Du became partner, moved to Washington D.C.
2001
HDM strategic repositioned on Homeland Security technology
2004
HDM (part of Baker / IBM team) won part of 5 year, $1B DHS/FEMA
Flood Map Modernization Program
2005
HDM reaches revenue target of $5million, appoints new VP and Mgr of
Government Solutions; Kija nominated for SBA Award
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Exhibit 2
Selected Board Memberships Held by Kija Kim
Boston Fed Bancorp (now merged with TD Bank North)
Clark University Board of Trustees
Massachusetts Software Council
Mass Health Data Consortium
Center for Women & Enterprise, CWE
Mass Jobs Council (co-chaired with then Lt. Governor Paul Cellucci)
Massachusetts Women’s Commission
Massachusetts Commission on Welfare to Work, Co-chair
Massachusetts Asian American Commission
Massachusetts Ambassadors Council
Asian Task Force Against Domestic Violence
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Teradyne: On the Road To China 1
Kuo-Ting Hung
Neil Hunt
Suffolk University
Gina Vega
Salem State College
Laurie Levesque
Hasan Arslan
Christian DeLaunay
Suffolk University
As Jeff Hotchkiss, President of the Assembly Test Division of Teradyne, Inc., approached
Teradyne's Chinese facilities, the downpour was washing away some of the unbearable air
pollution in Shanghai. His taxi fought a losing battle with the multitude of cars that were
converging on Pudong, the vast industrial park west of this bustling Chinese metropolis where
Teradyne facilities were located. Upon his arrival the previous day, Jeff had marveled at the
maglev high-speed train that connected Shanghai International Airport with his hotel downtown
and wondered why such state-of-the-art transportation was not available in Boston. Shanghai
was the place to be for Teradyne because most Chinese electronic manufacturers were located
either in this region or further south, in the Shenzhen region where Teradyne also had a sales
office.
“China is here forever,” Jeff had commented to his executive team. As president of the
Assembly Test Division of Teradyne, Inc, Jeff was responsible for overall sales of his division’s
complex testing systems and the revenues brought in by service contracts sold to customers after
the one-year warranties ran out. His recent return to Teradyne was intended to bring his
expertise to bear on one of the corporation’s larger divisions, one that was trying to improve its
market share in the emerging Chinese market. Jeff had found evidence that problems existed,
and he needed his division’s brightest minds to get to the source. The Chinese market would not
wait for them, and neither would their competitors.
Teradyne's History i
Teradyne, Inc. (Teradyne) was founded in 1960 by two MIT classmates, Alex d'Arbeloff and
Nick DeWolf, who reconnected after a decade of separate careers. The business started out
small, in a second story office in downtown Boston, convenient to public transportation. The
two men had the idea that testing of electronic components was going to be a growth industry,
and in 1961 they intended to get in on the ground floor by developing and selling a logiccontrolled go/no-go diode tester. The innovativeness of the product made it a hard sell.
However, once manufacturers realized that they could make up the tester's cost within two years
1
We thank the two reviewers and the editor who worked so hard with us to improve this case. We also offer special
recognition for the significant contributions to this project made by Shahriar Khaksari (Suffolk University) and Jeffy
Hotchkiss (President, Teradyne ATD).
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because of increased production throughput, the market exploded. A series of technology "firsts"
made Teradyne the industry leader in automatic test equipment, and it maintained this position
until 2006 (see Appendix A for a timeline of notable events).
Teradyne was structured in four divisions: Broadband Test (test systems for telephone and cable
service providers), Assembly Test (electronics testing and inspection of loaded printed circuit
boards), Semiconductor Test (test equipment for semiconductor devices), and Vehicle Diagnostic
Solutions (test and diagnostic solutions for transportation equipment manufacturers). Though
Teradyne’s corporate headquarters was located in Boston, Massachusetts, its divisions were
headquartered in Illinois and North Reading, MA in the United States, and Manchester in the
United Kingdom. Each division had its own management and internal structure and operated
semi-autonomously.
Teradyne had a flat organization structure with only two management levels separating engineers
from the division president. Groups of managers made their decisions collaboratively. Few, if
any, organization charts made their way into this company, and those that did appear arose for a
specific purpose and disappeared when no longer needed. This loose structure encouraged lots
of supporting relationships, but very few reporting relationships. Teradyne's collaborative
culture was perceived by management as one of its significant organizational strengths.
Jeff Hotchkiss – President
Jeff Hotchkiss was named President of the Assembly Test Division in 2004 after having served
as CFO of Teradyne from 1997 to 2000, and as a Vice President in the 1990s. He joined
Teradyne after he graduated from the Sloan School (MIT) in 1970. For the three years from
2000 through 2003, Hotchkiss was the Founder, Director, CEO, and President of Empirix
Corporation, a venture-backed Teradyne software spinoff that was to handle VOIP testing.
In 2004, Hotchkiss returned to Teradyne's Assembly Test Division with an executive team
comprising 8-10 direct reports, each of whom operated with broad responsibilities. For example,
the General Manager of the Commercial Business Unit made decisions for all of his products
internationally, with ongoing input from Jeff and higher-level input coming quarterly from the
corporate level CFO and CEO. With fewer than 12 direct reports himself, the GM was free to
deploy products anywhere in the world as long as he showed a profit.
The Electronics Industry
In 2005, the electronics industry represented over $1.2 trillion in sales. Over half of that amount
was in Asia, one sixth in Europe and the rest in the Americas. The industry was projected to
grow over five percent per/year worldwide, with Asia accounting for three quarters of that
growth. Within Asia, not only had China dominated growth in the industry at greater than 20
percent of sales in the 2002-2005 period, it was expected to continue growing at 12 percent per
year from 2005-2008. The rest of the industry's expansion in Asia was on a par with that of
Europe and the Americas – close to three percent per year.
China was producing between 25 and 30 percent of worldwide data processing, communications
and consumer electronics, and these three segments represented approximately three quarters of
the whole industry. Outstanding growth was also noticeable in the expansion of the top ten
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computer focused electronics manufacturing service companies in Asia, all of which doubled in
sales from 1998 to 2004 (from $40 billion to $80 billion).
A similar pattern appeared in the worldwide demand for “In Circuit Testing” (ICT) and therefore
in the market for Teradyne’s and its competitors’ ICT services (see Appendix B for glossary of
abbreviations). While the estimated $250 million ICT market was not expected to expand
substantially in the years 2006-2008, China’s importance in that market was expected to grow
from less than a tenth in 2002 to over a third in 2008. The rest of Asia made up another third of
the demand, while demand from Europe and the Americas was expected to shrink from half to
less than a third. Worldwide, the two major players in the ICT market were Teradyne and
Agilent Technologies, Inc. Other companies were significant competitors in regional markets,
such as SPEA in Europe or TRI in Taiwan. As noted by Tarun Goyal, (Electronic News April
16, 2001),
"The electronics industry is characterized by a highly fragmented supply chain.
Parts and products change hands constantly from component manufacturers to
component distributors, contract manufacturers, system distributors; resellers and
finally to the user. This fragmentation leads to the so-called bull-whip effect with
too little or too much inventory and poor business performance -- lower sales and
poor customer responsiveness”.
The cyclical nature of the electronics industry created brutal consequences during the downturns.
In the "bubble-building" years of 1997-1999, Teradyne had roughly 38 percent of the ICT market,
to 37 percent for Agilent. This followed the profitability of the 1980s, when inventories were
built in anticipation of steep demand. However, when the market changed, the result was
overcapacity and large amounts of warehoused product. This experience was magnified by the
implosion of the 2000-2001 internet bubble which spread through the computing industry, and
by extension through the ICT companies whose market shrank by roughly two thirds between
2000 and 2002. Teradyne's market share declined every year from 1997 to 2003 (except for
small gains in 2002), then recovered somewhat in 2004 when it regained some ground compared
to its major competitor, Agilent. (Appendix C). Agilent had managed to keep its market share
during this period and in the post-bubble years of 2002-2004, it averaged 37 percent to
Teradyne’s 28 percent. Moreover, despite the vicissitudes of the electronics business cycle, this
period saw the growth of yet another competitor, Aeroflex, which went from a negligible market
share in 1997 to almost seven percent in 2004.
The Business Model
Teradyne sold its products primarily through its direct sales channels in North America, Europe,
and Asia and had small engineering organizations in China, Japan, and Germany (See Appendix
D for information about Teradyne’s global supply chain and related information). In 2005,
Teradyne had sales of about $1.08 billion with about 4,000 employees worldwide. ii Its direct
competitors within the industry designation of Semiconductor Equipment & Materials were
Agilent Technologies Inc., Advantest Corporation, and Credence Systems Corporation.
Teradyne’s Assembly Test Division (ATD) in North Reading, MA and Poway, CA provided
electronics testing and inspection solutions to original equipment manufacturers (OEM) and
electronics manufacturing services suppliers. Their in-circuit test systems were used by
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customers to verify electrical assemblies in commercial and military avionics systems where
reliability, time-to-market, and in-line process were keys to success. Specific products and
services from ATD included In-Circuit Board Test Systems, Functional Test Systems,
Automated X-Ray Inspection, Military and Aerospace Test Solutions, and Service Offerings.
Although ATD maintained its major engineering and manufacturing facilities in New England,
its primary sales and support offices were located throughout the Americas (U.S., Canada,
Mexico, and Brazil), Europe, and Asia Pacific (offices in Shanghai and Shenzhen in China, and
in Singapore, Taiwan, Korea, and Japan). Overall, there was an ATD presence in nearly 30
countries throughout the world (Appendix E).
Teradyne’s daily operations were full of challenges. Its automatic test devices were sold with a
one-year warranty that covered all repairs; after that, Teradyne attempted to sell service contracts
to customers to cover the downtime and repair of these complex products, which could cost up to
$1 million. Demand for the testing devices fluctuated wildly as customers often waited until the
last minute to choose a final configuration. Teradyne also relied heavily on outsourced
manufacturing. On average, Teradyne’s products required 3,000 to 5,000 components, some of
which were very expensive. These components came from suppliers from all over the world.
When repairable parts failed, customers returned them to a Teradyne repair depot in the
Philippines or Costa Rica for rework at a significant cost to the customer.
The variety of suppliers and the need to replace and replenish so many parts led Teradyne to coin
the term “glass pipeline,” to emphasize the necessity of visibility in inventory distribution. To
Teradyne, a glass pipeline implied the ability to monitor their own and supplier inventories at the
level of the individual components to avoid the need to overstock inventories as a buffer. This
reduced the amount of funds tied up in expensive inventory components. Visibility of
components through the entire supply chain allowed Teradyne to conduct risk assessments
continuously on each player in the chain through an array of performance attributes such as
availability and cost. Teradyne thus maintained an aggregated view of supply and demand,
controlled supplier relationships as manufacturing was outsourced, and cut delivery lead-time for
quotes and deliveries by half of what they had been before. By reducing delivery quantity,
Teradyne shipped more quickly with an aim to smoothing the production flow in its pipeline and
reducing variation in its own operations and that of its customer. Collectively, smaller delivery
quantity and lead-time often improved quality as the feedback lead-time from customers
regarding product quality was reduced.
As of 2006, Teradyne had inbound, outbound, and demand visibility, and also knew what was
happening within its core group of suppliers and manufacturers, including Electronics
Manufacturing Services (EMS) providers who supplied components to Teradyne (see Appendix
D for a section of a TestStation supply chain). Teradyne’s supply chain management effort was
broadly recognized for its excellence. For 16 years running, VLSI Research named Teradyne as
a “10 Best Supplier” in the semiconductor equipment market, based on scoring by users
worldwide.
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Step I: Recognizing the Problem
When Jeff returned to Teradyne in late 2003 with the customer focus mindset that drove success
at Empirix, he noticed things were not going well. The market was in freefall, the acquisition
and merger of General Radio Corporation (GenRad), a manufacturer of electronic test equipment,
with ATD had forced a series of tough human resource, economic, and product line decisions,
and Teradyne's market share in China was a surprising one third of what it was in Europe and
North America. Jeff decided to tour the Chinese operation to see for himself what the problems
were. His whirlwind tour of China included visiting 20 customer locations in two weeks and
holding multiple meetings with the expatriates leading the Chinese operations.
The typical expense to multinational corporations (MNCs) in China for expats averaged between
$300,000 and $500,000 per expat per year, and Teradyne's costs were no different as they
included a cost of living adjustment, a bonus for expatriation, transportation and a chauffeured
car, moving and relocation expenses, school allowance, insurance and extended vacations. Some
MNCs even offered spouse salary buyback, family visits and a health club or golf membership
(See Appendix F for a full description of the use of expatriates). In return, the expatriates
provided technical expertise and a link to Teradyne's management in the U.S. The impact of all
these benefits was startling from Jeff’s birds-eye view upon his arrival at the Chinese facility.
As he arrived at Pudong Park, Jeff noticed a row of Volkswagen Passats, each driven by a
chauffeur. He first thought some official delegation was visiting the plant. Countless bicycles,
some powered by tiny engines puffing black smoke, were converging on the company. Many
other employees were walking stoically in the unrelenting rain. As Jeff strode toward the main
entrance, he realized the passengers of these chauffeured cars were Westerners. As he
recognized most of them, it dawned on him they were parent company nationals (PNCs). These
expatriates from Teradyne U.S. were software engineers and managers on temporary assignment
in China. They greeted their wet Chinese colleagues as they entered the building. Since public
displays of emotion were considered improper behavior by the host country nationals (HCNs), it
was difficult to determine the feelings of the Chinese engineers and technicians from the
greetings, yet Jeff could not help but wonder if the obvious difference in status and pay affected
the relationship between the locals and the expatriates.
Local expertise was difficult to secure as the annual double-digit growth of China over the
previous decade meant a sharp demand for graduates from local technology institutes and
universities. As with everything else in this rapidly developing country, the situation was
changing quickly. From 2002 to 2005, the number of expatriates legally employed in China
doubled, reaching 150,000. iii The U.S. National Academies reported in 2005 that more than
600,000 engineers graduated from institutions of higher education in China, versus 350,000 in
India, and about 70,000 in the U.S. iv However, these numbers were somewhat misleading as
they included both short cycle formations (three or fewer years of University training) and auto
mechanics (who were not considered “engineers” in most other countries). Furthermore, a 2005
McKinsey Global Institute study found that only 10 percent of Chinese engineers and 25 percent
of Indian engineers were capable of competing for outsourced work v. Nevertheless, nearly half
of all Chinese undergraduate degrees were in scientific fields, compared to five percent in the
United States, vi and as local training was catching up with the insatiable demand for talent, the
cost of a qualified local engineer, while remaining substantially lower than its western equivalent,
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was increasing rapidly. According to Mercer Human Resources Consulting, the base pay for a
software development engineer in China in 2005 was $13,400, a fifth of its US counterpart vii.
Even Indian outsourcing companies such as Infosys were subcontracting some of the work in
China. "We need a deep reservoir of talent as well as an alternative low-cost center like India as
we continue to grow," said Nandan Nilekani, chief executive of Infosys, “And only China can
match up. China has some 200,000 information technology workers (compared with India's
850,000) in 6,000 local companies, but more than 50,000 Chinese software programmers are
being added to this pool annually.” viii Moreover, Infosys was not alone; Tata Consultancy
Services (TCS), one of India's four largest exporters of software, had begun to offshore its staff.
By 2005, TCS planned to have 3,000 software engineers, or 15 percent of its global work force,
in China. ix
Considering the expanding available talent pool and the enormous cost of the expatriates, Jeff
wondered if the expatriates were having “too good a life” in China; while he understood the
rationale for not driving in Shanghai x, he thought this situation was both unfair and untenable in
the long run. Up to this point they had not given much attention to human resource issues beyond
incentives used to get expats to China to focus on production and sales.
After meeting with people at all levels in their customers’ organizations, Jeff had heard a number
of complaints. From earlier reports, he had anticipated complaints about sales and product
support. What he had not expected was a series of additional complaints about both pricing and
performance:
• "I remind Teradyne to be aware that there are alternative channels to source new and
repair spare parts; current pricing not acceptable and must be reduced by 40-50 percent."
• "Teradyne is a good supplier but I'm very concerned about your consistent capability to
deliver spare parts on time."
• "Teradyne offers good but complex products and therefore we need your support to get
the maximum value out of your equipment."
At the conclusion, it was clear to Jeff that the situation was critical – immediate action was
necessary to stem the further loss of market share. Up to that point, Teradyne's Chinese
operation consisted of manufacturing plants that built sub-assemblies for the testing equipment.
They got their boards from various Asian sub-contractors who did the initial assembly on site,
then shipped the boards back to the United States for final assembly, configuration, and testing.
The Chinese operation was overseen by PCNs, English-speaking American expats who had little
direct contact with the customers. Sales to Taiwanese firms in mainland China were performed
by Taiwanese, who were considered third country nationals (TCNs) hired by Teradyne to work
in the host country. Board repair service to all customers (Chinese and Taiwanese) was provided
in facilities located in the Philippines and Costa Rica.
For some time, Teradyne’s business in China had been run with an eye to maximizing service
profitability at the expense of the core business, selling ATD products. Since service of these
products was a derivative of the core business of selling them, any loss of core business
automatically resulted in future service losses. By diverting sales efforts to the service
component, the single-minded focus on service had become a drain on the core. Jeff replaced the
existing manager with an interim manager who struggled for several months with little success to
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understand the business needs in China. He also failed to make a positive impact, and Jeff
decided to wipe the slate clean and start all over again. He pulled together an executive team
that was launched in survival mode. Their mission was to stem the financial losses that came
from decreased sales and the subsequent loss of service revenue.
"China is here forever," commented Jeff Hotchkiss to his executive team, comprising three men:
Tony DeMambro, Rod Willis, and Stefan Granitzer. Tony Demambro had joined Teradyne in
2001 after having been associated with GenRad Inc. for over 18 years in a variety of
manufacturing related functions (worldwide distribution strategies, operations engineering
manager, strategic outsource model development). Tony’s strengths at ATD were operational
cost reduction as a percentage of revenue, quality improvements, facility consolidation and
warranty conversion strategies. Based at Teradyne’s corporate USA headquarters, Tony had
responsibility for worldwide ATD support and operations. His new assignment was to devote
fully half his time to the China project, with the remainder allocated to the rest of ATD's support
worldwide.
An electronics engineer educated in and assigned to the UK location, Rod Willis had a reputation
as a skilled executive, sales and operational manager and adroit trouble-shooter over the course
of a diverse 20-year career in all aspects of high-tech manufacturing. He worked on the
integration of Teradyne's acquisition of GenRad, identifying the size and support structure of the
European Technical Operation, and held the title of European Support Manager, responsible for
pan-European technical teams based throughout the Continent. During a two-year break from
his employment at Teradyne, Rod was Managing Director for MPP (UK) Ltd., where he had
major account development responsibilities. It was here that he honed his negotiating skills,
acquiring funding to start the UK electronics manufacturing company, ISIS-MPP. Rod's
management of Teradyne's European support operations led his group continually to outperform
the Teradyne business model, for which he was selected to play a lead role in the ATD China
project. His goal was to increase support contract conversion rates of customers' expiring
warranty contracts.
Stefan Granitzer, an Austrian national educated in Australia, contributed a broad range of service,
product, pricing, and team building experience to the ATD China project. With more than 12
years' experience in high tech manufacturing, he had most recently been responsible for defining
and implementing Teradyne's Eastern European Service Product Strategy. He led a team that
defined and implemented a local service product strategy that resulted in a re-engagement of
Teradyne's customer base, improving account relationships and profitability. Stefan was selected
for the team to provide insight on numerous facets of customer support services, skill
development of the multi-national sales force, and development of the local component repair
capabilities. His goal was to transfer the skills and experience evidenced by his success in the
Eastern European emerging market to the Chinese emerging market.
Tony DeMambro was put in charge of "fixing the problem," along with this team of innovative
and knowledgeable Teradyne managers. Rod Willis, Business Development Manager,
coordinated the operation from the UK, and Stefan Granitzer, Product Manager Asia Service,
who had Chinese contacts, moved from Germany to China to hold the front line.
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Where Do We Go Now?
"Our business plan in China has failed," Jeff admitted to the team. Although Teradyne’s
products were getting awards and breaking new ground, it was losing sales and follow-up service
contracts in China. "We've been operating as engineers; we need to get back to the customer.
My conversations with customers in China have shown that we're in real trouble. You've got to
find the source problem, and quickly. Don't spend too much time analyzing, because as a
company we've become slow to act."
Tony, Rod, and Stefan had a huge challenge. They first needed to decide if a problem actually
existed, and if so whether it related to market share, customer retention, supply chain issues, or
something else. It would appear that while customers were concerned about the purchase cost of
equipment from Teradyne, they were also unhappy about many other issues. Several ideas, such
as product quality, service level, and variability in these, surfaced as potential candidates, but the
team was not sure. It was unclear where they should start in identifying the problem and
designing a strategy to resolve it. The team needed to figure out if they collectively had
sufficient knowledge and experience to solve any problems, and what information had to be
gathered to determine what was wrong. Jeff clearly had charged them to resolve any issues, and
to do so quickly. Rod had the final word, "It is all too easy for Westerners to believe they know
what needs to be done in locations such as China without actually performing adequate
discovery."
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Appendix A
Key Events in Teradyne's History
1960
1961
1966
1970
1971
1973
1970s
1979
1980s
1987
1990s
1995
1999
2000
2001
2003
2004
Teradyne founded
Introduction of the D11 diode tester
Introduction of the J259 integrated circuit tester
Went public
Nick deWolf left Teradyne; Alex d'Arbeloff named President
Established sales organization in Tokyo, Japan
Introduction of memory devices and test systems for electronic subassemblies
First traded on NYSE (TER);
First Teradyne test system shipped to China (Guangzhou Eastern Factory)
Acquisition of Zehntel (a leading manufacturer of in-circuit board test systems)
First analog VLSI test system (interface between analog and digital data systems)
Acquisition of Megatest Corporation (semiconductor test company);
Introduction of the Tiger and Catalyst test systems (SOC – systems on a chip);
Acquisition of multiple ventures for testing software, computerized telephone
systems, computer networks, and the Internet.
Jeff Hotchkiss was Vice President of Teradyne (1990-1999) and CFO (1997-1999)
Passed $1 Billion in sales;
George Chamillard succeeded Alex d'Arbeloff as President and COO; d'Arbeloff
remained Chairman and CEO
Included in S&P 500
Acquisition of Herco Technologies and Synthane-Taylor;
Alex d'Arbeloff retired from Teradyne; Chamillard became Chairman, President, and
CEO
Hotchkiss left to head Teradyne’s spinoff, Empirix Corp
Acquisition of GenRad (circuit board test and inspection leader) and merger to ATD
(Assembly Test Division)
Teradyne tapped Chinese market with Shanghai facility for manufacturing, sales, and
marketing products to the Chinese market;
Mike Bradley named President of Teradyne
Mike Bradley named CEO (Chamillard continued as Chairman)
Jeff Hotchkiss returned to Teradyne and named President of the Assembly Test
Division
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Appendix B
Commonly Used Acronyms at Teradyne
ATD
EMS
ICT
GCS
OEM
Assembly Test Division
Electronics manufacturing services
In circuit testing
Global customer services
Original equipment manufacturers
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Appendix C In Circuit Testing (ICT) Worldwide Market
Source: ATD Marketing Department
Market Share in percentage
Market Share in Percentage
50%
45%
Percentage Market Share
40%
35%
30%
25%
Teradyne
20%
Agilent
Aeroflex (IFR)
15%
SPEA
TRI
10%
5%
0%
1997
1998
1999
2000
2001
2002
2003
2004
Year
Total Market
Total ICT WorldwideMarket ($Million)
$800
$700
Total Market in $Millions
$600
$500
$400
$300
$200
$100
$0
1997
1998
1999
2000
2001
Year
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2003
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Appendix D – Looking at the Global Supply Chain
A supply chain is a system of firms that transform or transport raw materials and components
into a finished product from suppliers to customers, with the coordination of firm activities,
resources and information. Firms in a supply chain are often described with the following
categories according to their roles in the supply chain:
• Original Equipment Manufacturer (OEM): An OEM is a firm that acquires components
and incorporates them into a new product with its own brand name.
• A Tier One (or first tier) supplier supplies components to an original equipment
manufacturer.
• A Tier Two (or second tier) supplier supports a Tier One supplier in the delivery of
goods and services to an original equipment manufacturer.
Part of Assembly Test Division's Global Supply Chain for TestStationTM
Source: ATD
In the case of the supply chain for TestStationTM, the design was done in the ATD facility in North
Reading, USA, while its parts manufacturing and subassembly operations were completely
outsourced to Asian electronics manufacturers. These parts and subassemblies were shipped from
manufacturers in China to the North Reading facility for final assembly, configuration, and testing.
Completed TestStationTM units were shipped to Asian customers and other global destinations.
Tier Two Supplier
(Custom ASIC from US)
Tier Two Supplier
(Raw PCB from China)
The CM managed over 1000
unique components from Tier 2
suppliers
Note:
Tier One Supplier
(High volume PCBA’s
from Computer
Manufacturer in China)
Tier One Supplier
(Power Supplies from the
Philippines.)
ATD managed @ 300 parts
for Conjuration and Test
Customer
(X in China)
Assembly Test
Division
(Configuration and Test
in N. Reading MA)
Customer
(X in Romania)
ASIC: Application Specific Integrated Circuit
PCB: Printed Circuit Board
PCBA: Printed Circuit Board Assembly
An Application Specific
Integrated Circuit (ASIC)
Printed Circuit Board (PCE)
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An Abstract Representation of Assembly Testing Division Global Supply Chain, 2006 (Source: ATD)
ATD Headquarter
ATD Repair & Service Center
ATD Suppliers
ATD Sales & Support Presence
Straight arrows show the partial global supply chain of TestStation
Curved Arrows show the partial worldwide distribution of TestStation
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Appendix E - Map of Assembly Testing Division’s World Wide Presence, 2006 (Source: ATD)
ATD Headquarter
ATD Repair & Service Center
ATD Sales & Support Presence
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Appendix F
CHINA, TAIWAN, AND THE USE OF EXPATRIATES
The People's Republic of China was formed in its current state on October 1, 1949. Its
population in 2005 was estimated to be 1.2 billion, with a labor force of over 790 million people
and a 90 percent literacy rate. The official language of China was Mandarin, and there were
many dialects spoken as well. The two major dialects were Cantonese (spoken in Guangdong
Province and in Hong Kong) and Hokien (used in Fujian Province and Taiwan). Shanghainese
(spoken predominantly in Shanghai) was spoken by relatively few people in China; however,
many affluent Chinese were from Shanghai. English, although rarely spoken in mainland China
was still considered the language of business.
China had numerous natural resources, and the world’s largest hydropower potential. Its
industries ranged from mining and ore processing to electronics to automobiles, toys, and
satellites. While China was officially atheist, the religions practiced include Taoism, Buddhism,
Christianity (3 to 4 percent), and Islam (1 to 2 percent). Chinese society and its citizens were
still very influenced by Confucianism in all aspects of their daily life. They took a very longterm view of life and business. Quick decisions and action were considered foolish and ignorant,
and excluding Chinese from the decision making process was insulting. The Chinese respected
status and rank, and it meant a lot to them to be given the rationale behind decisions, be asked for
their feedback, and be allowed to collaborate in decisions, even simple ones. In addition to
signaling respect for them, inclusiveness could increase their commitment to decisions.
Collectivism in China was rated highest of the Asian countries, and this affected not just how
work was accomplished but expectations for socializing. Bosses who organized sporting or
social events for employees gained greater loyalty.
Politically, China considered Taiwan its 23rd province and did not recognize it as an independent
nation, therefore there were many rules for business between the two. Chinese mainlanders were
not allowed to work in professional positions in Taiwan. However Taiwanese were often
employed as supervisors in mainland China companies due to Taiwan’s more advanced
information technology sector. The Chinese respected technological abilities, and many MNCs
(multinational corporations) chose expatriates who were technically skilled line managers.
MNCs that sent Taiwanese to mainland China as managers often selected them not only for their
functional skills, but also for their knowledge of local culture and language, an ability to speak
both Mandarin and English and work experience in the US. As it was understood that
Americans were likely to make cultural faux pas, they were given more latitude than local or
Taiwanese managers. In China, Taiwanese managers had a reputation for arrogance, and hostility
often existed between them and local workers. However, there were many things that prevented
US expatriate managers from interacting with the local Chinese: expats were segregated in hotels
or compounds, had few non-work activities to choose from, were unable to speak the local
language and had available to them a community of other expats with whom they could socialize.
Most mainland Chinese did not have overseas work experience. This lack of exposure to other
cultures and business practices meant they did not ask questions, say no, admit if they did not
understand something, or recognize that there could be a positive side to risk taking and mistakes.
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Peter Morris wrote in Asia Times (March 27, 2004), “It is an open secret that the key to a
successful China business strategy lies in finding a good Taiwanese manager. Shanghai's
business elite, if they are not local Chinese, are disproportionately comprised of either Taiwanese,
American-born Taiwanese or overseas Chinese from other countries who have returned to their
ancestral homeland to make a fortune.” He gave the computer industry as an example, stating
that many US firms put their Taiwanese engineers or programmers (or American employees of
Taiwanese descent) in leadership positions when expanding to China.
While Americans tended to rush in with an efficiently organized business, the Chinese sought
those that have had input from locals or are supervised by locals who better understood the needs,
customs, and way of life in that area. Expats or non-nationals working in China could violate
business etiquette in many ways, in how or to whom they spoke, in meeting and greeting
business guests and colleagues, at meals, when exchanging business cards, and using gestures or
touches considered appropriate in their home country. Expats underestimated the importance
placed on trust, personal relationships and mutual obligations, and how such “guanxi” was
essential to do business in China. Technically, guanxi stands for any type of relationship. In the
Chinese business world, however, it was also understood as the network of relationships among
various parties that cooperated and supported one another. The Chinese businessperson’s
mentality was very much one of "You scratch my back, I’ll scratch yours.” In essence, this
boiled down to exchanging favors, which were expected to be done regularly and voluntarily.
There were many nuances when it came to guanxi, understood by locals.
There was an enormous hurdle to expats who did not understand the Chinese culture, language,
or writing system. This could be seen in all areas of life, including transportation – simply
getting to work every day. Many MNCs paid for cabs or local drivers to take these individuals to
the office or plant. Expats avoided driving, not just because they were required to get a license
from the local vehicle administrative department, but due to the hazards and frequent accidents.
The roads were crowded with pedestrians and bicyclists who, from an expat’s perspective, did
not follow their conventional driving rules and regulations.
Sources:
http://www.cia.gov/cia/publications/factbook/geos/ch.html CIA The World Factbook: China
http://workabroad.monster.com/articles/chinaetiquitte Negotiation: Go Back with a Deal
http://www.cyborlink.com/besite/china.htm Geert Hofstede Analyis China
http://taiping.blogspot.com/2005_03_01_taiping_archive.html The Black China Hand
http://www.expatfocus.com/ Global Relocation Advice, Services, and Community
http://app1.chinadaily.com.cn/star/2001/0405/fo5-1.html Expats on Wheels
http://www.atimes.com/atimes/China/FC27Ad02.html (Taiwan may hold key to China hi-tech
dilemma, Peter Morris, Asia Times Online Co, Ltd., March 27, 2004.)
http://www.amcham.com.tw/publication_topics_view.php?volume=31&vol_num=9&topics_id=
131 Vol. 31 - No. 9, White-Collar Workforce Wars
http://www.amcham.com.tw/publication_topics_view.php?volume=31&vol_num=10&topics_id=1
48 Shanghai Surprise
http://voc.ed.psu.edu/projects/publications/books/Spring2004/WEF_spring2004.2.html
Intercultural Adjustment Issues and Training Implications
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Endnotes
i
Some information is drawn from www.teradyne.com/corp/history.html (retrieved March 2006).
Teradyne’s corporate profile, Finance Yahoo, http://finance.yahoo.com/q/ks?s=TER, (retrieved March
2006).
iii
China Ministry of Labour and Social Security;
http://www.chinacsr.com/2006/04/04/expatriates-continue-to-pour-into-china
ii
iv
Top Advisory Panel Warns of Erosion of U.S. Science, Friday, October 14, 2005.
http://scienceandreason.blogspot.com/2005_10_01_scienceandreason_archive.html
v
McKinsey Quarterly number 4, 2005.
http://www.mckinseyquarterly.com/article_page.aspx?ar=1685&L2=18&L3=31
vi
Demagoguery Aside, Outsourcing of Jobs Is a Real Threat to U.S. Morton M. Kondracke, Executive
Director, AILA Issue Papers, Department of Homeland Security; May 17, 2004.
http://www.aila.org/content/default.aspx?docid=10140
vii
It is worth noting than according to the same survey, Indian software engineers were even less costly at
$10,300.
Sumner Lemon, IDG News Services, 11/17/2005.
http://www.networkworld.com/news/2005/111705-software-developers-salary.html
viii
Nov 2, 2004 http://www.sepiamutiny.com/sepia/archives/000629.html
ix
Will India price itself out of offshore market? , Mike Yamamoto, CNET News.com, March 29, 2004.
http://news.com.com/2100-1022-5180589.html
x
Shanghai authorities did not know the exact number of local inhabitants. Estimates ranged from 9 to 18
million, varying with the inclusion of Shanghai suburbs and the “floating” 2 million people in transit, or
migrating from the rural areas, desperately attempting to get day jobs in construction or anywhere else
daily laborers were needed. Millions of bicycles were being quickly replaced by millions of cars and
most Chinese were new to the “driving” experience. Rules of the road were often ignored, seatbelts were
removed from taxis, and the use of lights was not required for night driving. As a result, an estimated
200,000 Chinese died every year on the roads and few Westerners dared to join the fray.
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A Confrontation of Mindsets:
French Retailers Operating in Poland
Stephanie Hurt
Meredith College
Marcus Hurt
EDHEC Business School
It is 9:00 a.m. in the office of Gérard Chatillon on the second floor of a major hypermarket on
the outskirts of Warsaw, Poland, November 29, 2006.
Gérard Chatillon * was reading over an email he had received from Ted Cross. Ted Cross was a
writing a series of articles about Western food retailers in Central Europe for one of the leading
British business magazines. He had asked Chatillon for an interview and they had spoken a
couple of times over the phone. The interview was for 11:00 that morning. Cross wanted to see
Chatillon, because he was VP of Operations for Poland of a large French food retailing chain
implanted on the Polish market and had been in the country since 1993, the very beginning of
that implantation.
In the e-mail that Cross had sent, the question that Chatillon found most interesting was:
Mr. Chatillon, you have been here for some 13 years, since the very beginning of
your company’s move into Poland, yet you mentioned on the phone that 1996 to
1997 was really a ‘watershed period’ for your firm’s internationalization process in
this part of the world. Can you tell me why that time was so important?
Chatillon was glad that Cross was not due for another two hours. It would give him time to get
his thoughts together about that ‘watershed period’ that had caught Cross’s interest. That
‘watershed’ was the period when they had first faced serious problems with their Polish
employees; problems that called into question the very survival of their operations in Poland and
forced them to make some major decisions about how to run their business in the country.
Chatillon got up, took out some records that he had kept over the years, minutes of meetings,
personal notes, staff lists and some correspondence, sat down with them and began to put them
and his memories together. True, it was 13 years ago when he and his team members all received
their internationalization assignment in France before their departure for Poland. At the same
time, other retailing firms were giving similar assignments to their internationalization teams.
THE INTERNATIONALIZATION OF FRENCH RETAILERS
All the French retailing giants, Carrefour, Casino and Auchan, had begun to seriously
internationalize in the early 90s. In this, the retailers were acting like firms in many European
industries that were gearing up to take advantage of the greater freedom of movement of capital
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and business that the establishment of the European Union in 1993 was to bring about. In 1993,
many of the controls and restrictions that had previously slowed cross border investment and the
strategic positioning of European firms would dissolve. It is true that Carrefour had set up
operations on a minor scale in Latin America in the 70s and 80s and Auchan had made
investments in Spain and Italy; however, these investments were made in markets felt to be
‘psychologically close’ to the French market. The retailers’ real commitment to
internationalization would only come in the 90s which constituted a major watershed for
European firms. ‘Globalization’ became a buzzword in a Europe marked by two almost
simultaneous events: the creation of the EU and shift of the previously Communist Central
European societies towards a market economy.
Throughout continental Europe and the UK, food retailers had been consolidating their
positions—as they would continue to do throughout the 90s—and were entering a clear maturity
phase of the retailing industry. In France, the legislature, feeling the country was saturated with
hypermarkets, had severely restricted the number of new superstores that could be opened, and
the liberalization of cross border trade brought in new and tough competition from German
discounters. These discounters made it very difficult for the French retailers to maintain their
low-cost leadership strategies. Also, any meaningful differentiation between the French chains
had become impossible; the retailers were practicing a strategy of fast-paced copycatting of each
others’ offers and diversifications. They were all moving into financial, insurance and tourism
services, expanding their product assortments, and becoming, in essence, the new department
stores. The stress was on ‘one-stop shopping’ where consumers could find everything they
needed within one mall with the hypermarket as anchor. Market share gains were made through
acquisitions and internal development of other retailing formats: supermarkets and convenience
stores, and in some cases, diversification into other retailing categories. Growth opportunities on
the home market were few; the only real growth possible was in going international! This was
the reason why the opening of stores in Poland was a godsend.
Central Europe, and particularly Poland, had looked like a market with great potential, Chatillon
recalled. As the momentum towards a market economy gathered speed in the region, the retailers
perceived many apparent similarities with their home market. First, Poland seemed
‘psychologically close’: it had a long shared history with France, was definitely ‘Western
European’, and shared a common religion. Moreover, it was ‘ready’ for mass consumption. For
50 years the Poles had lived in an economy of constant shortages and the population clearly
showed its interest in buying every kind of Western good, but especially foods and household
staples. The distribution and retailing infrastructure in Poland, a legacy of the Communist period,
was chaotic: no clear channels seemed to exist that could get large quantities of food and
household goods to the new would-be Polish consumer. The country also had a large population
(38 million) and a number of densely populated major cities which could provide customers for
shopping centers located on the outskirts of the cities, the model French retailers had developed
at home. On the economic side, growth in Poland’s GDP was the highest in Central Europe, and
despite the country’s high unemployment rate, it seemed to have brought its initially rampant
inflation under control by 1993.
There were drawbacks; it is true. First, high unemployment might hold back the development of
a consumer society, which was the foundation for the French mass retailing model, particularly
in a society where purchasing power was much lower than in France. But the retailers were
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confident: over the years their own growth in the Polish economy would create the consumer
society they needed, and high unemployment would ensure a ready and willing labor force.
Second, the retailers would need to develop a network of suppliers similar to the one they
enjoyed in France and Western Europe; no such network existed for the time being.
But perhaps the most important reason to move into Poland was that, like most of Central
Europe, it was territory that was unoccupied by retailers. With their home market saturated, the
retailers needed to set up a beachhead before others did. By the early 90s, they had imitated each
other so often in their maturing industry at home, that if one of them went abroad, they would all
have to go! And other European retailers were acting fast, namely the Dutch and the Germans.
THE INTERNATIONALIZATION ASSIGNMENT
THE MANAGERS RECEIVED IN 1993
The future expatriates, including Chatillon, had received their assignment through a series of
briefings at the home office in France before they packed up and moved their families to Poland.
Chatillon often wished he could have recorded the briefings, but of course that was not allowed;
secrecy was an obsession with his firm—as it was in all the retail chains. Chatillon knew that all
of them were managed and operated in very much the same way, but during their years of
growth, French retailers got in the habit of watching each other’s prices, specials, and new
products very carefully and sent out ‘shoppers’ to report back to the home office on what the
competition was doing. Secrecy surrounded everything they did.
The assignment they were given was very clear—and challenging. The briefings were delivered
by top managers of the company; this fact drove home the message of how significant the
challenge was and how strongly success or failure could impact their careers. Top management
told them they intended to ‘replicate’ their hypermarket business model exactly on international
markets; the model had been successful in France, and they would do business and manage just
as they had done at home. They called it ‘photocopying’ the model. The model had developed
over 40 years on the French market; it was very complex and depended on the interlinking of
many components. It was a model that had ‘solidified’ in a mature market, but they were going
to export it to a market where retailing, although not really ‘infant’, was going to be
‘transformed’ into something entirely different that the Poles, largely isolated from the West for
five decades, had ever known. In their opinion, the fact that no real Western-style retailing
infrastructures or channels existed would make it all the easier for them to photocopy their model
exactly.
Basically, during the briefings, the future expats were told about the different stages they would
carry through in transferring the whole retailing business model, first on to one store and then
extending it through store after store. With hindsight, Chatillon realized that it would have been
better if top management had broken the model down into ‘hard’ and ‘soft’ components. His
experience in Poland between 1993 and 1996 had made the difference between those two aspects
of the model quite clear. But in 1993, nobody was thinking clearly about the ‘components’ of
their business models or how to effectively transfer them internationally.
In Chatillon’s view, the ‘hard components’ of the model included the store itself, its layout and
merchandising, and its product assortment. Other aspects that were ‘hard’ included the retailers’
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supply chain relations, the training and management of their suppliers, in-house logistics and JIT
inventory management. To a large extent, the retailers managed to transfer or reproduce these
components between 1993 and 1996. It had not been easy, but they had done it. They worked
closely with the Polish government and authorities to secure prime locations for their
hypermarkets; they convinced the government to build the necessary transport infrastructure to
bring shoppers to their stores. Finding that no real supply chain for food retailing on a massive
scale existed in Poland, they contacted potential suppliers and trained them to think in Western
terms about quantities, quality, deadlines, prices, contract terms and rebates—so many ideas that
were alien to firms that had produced under the Communist economic system. They also brought
the suppliers of Western goods into Poland with them and set up logistics and supply
arrangements. Then they organized and oversaw the construction of their first hypermarkets. It
had not been perfect; it had been arduous—but basically, it had worked.
It was in only in 1996, when the managers first started hiring and training masses of Polish
recruits, that Chatillon started realizing that the ‘soft components’ had always been far more
complex—they were all people related. The most serious problems they were experiencing in the
‘watershed period’ of 1996 and 1997 were people problems Chatillon remembered how
clairvoyant one top manager had been about the importance of the ‘soft components’ at a
briefing session just before the expats’ departure for Poland.
Don’t forget. Our force lies in the way we teach our employees to do things the way
we have always done them. It all starts on the store floor! We take the new people
and we work side by side with them until they pick it up and are doing it
automatically. Then they themselves are ready to train the younger recruits. Then
we’re on our way!
Easy to say, Chatillon thought. Actually, what had to be learned was quite complex, based on
well-tested practices and procedures, and learned mostly by ‘doing’. And in 1996, they were
certainly not managing to get these practices across to the Polish employees!
THE BEGINNING OF THE ‘WATERSHED”: 1996
By 1996, Chatillon had been put in charge of setting up the first hypermarket his firm had
scheduled for opening by the end of 1996, only a few months away at that time. One day of that
time stood out in his mind particularly. He was walking down the hall on the second floor and
stopped half way down the hall to look over the railing down onto the tremendous space of the
hypermarket. It would be the biggest store Poland had ever seen, he thought—over 200,000
square feet of tiled floors soon to be filled with gondolas stocked with food, personal care
products, meat, frozen goods, wines and spirits; most of this from Western Europe. It would
constitute a consumer revolution for this population that had spent the last 40 years in an
economy of shortages under the Communist regime, a population of potential shoppers that had
never known a really consumer-oriented economy.
Chatillon remembered how excited they all were at the prospect of helping bring so much of
Western abundance to an emerging economy. But his firm was not the only French retailing
company working on setting up hypermarkets in Poland. Other food retailing firms had made the
same decision at the same time and expatriated some of their best store managers to Poland.
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Chatillon knew that other hypermarkets were being planned for opening around Warsaw at
exactly the same time. These stores were to be only the beginning. Once the newly recruited
Polish personnel had been adequately trained, French retailing managers from all the chains
hoped they would be moving on to setting up other stores and gradually cover Poland with
hypermarkets as they had done in France. Of course, the chains were all watching each other’s
progress carefully.
Chatillon remembered that when he looked down on the store floor below that day, the view was
also frightening—the store was so empty! Would they meet the deadline? Would they get all that
space stocked, organized and run with the efficiency that they were used to in France? Would
their new Polish employees be able to run the 50 or more checkout stands and handle the
thousands of shoppers they expected every week? Would some of the recruits develop
managerial skills and rise to supervisor positions and even management level, so Chatillon and
his team could move on to the next store and leave the first store in Polish management hands?
From the beginning the French managers had been nagged by problems with their Polish
recruits. The Poles did not act at all like French employees when it came to learning their jobs.
They were not acquiring the routines and practices that were essential to efficient store operation.
They did not seem ambitious or ready to take responsibility. As time grew shorter, their attitudes
and behavior were becoming an ever more urgent matter. Their ability to reproduce the behavior
of retail employees back in France was absolutely crucial to the success of doing business as it
was done on the home market!
Over the next hour, Chatillon had short conversations with a few members of his team. These
confirmed his fears. The canned food category manager said he could not seem to get across to
the recruits how to set up the gondolas, how to stock them and how to plan for stock-outs. He
also couldn’t get half of them to show up to work on time—or show up at all! Although the
French were working through translators; this was only partly helping the situation, because the
translators themselves admitted they had trouble understanding what the expats meant about
merchandising, attractive displays, correct pricing and so on. Thus, it was difficult for them to
communicate what they themselves did not understand fully. Very often, the words did not exist
in Polish. The meat cutters they had brought in from France were also having a very difficult
time training the butcher staff to cut meat like they wanted. The feedback from the soft drinks
section was similar. The recruits could not merchandise and they were not taking any initiative.
Basically Chatillon’s team said they had to watch over the recruits all the time. They didn’t see
any future managers there.
After this series of conversations, Chatillon called a meeting of the whole team for 7:00 that
evening. Then he walked back to his office to plan what his team was going to discuss that
evening at the meeting. He was sure that the managers of the other food retailing chains setting
up operations in Poland were experiencing the same problems he was facing. But how could he
get a handle on the situation: how could he understand its nature and how could he turn it
around?
That afternoon, in the hours that preceded the meeting that was to help catalyze so many
important decisions of the coming months, Chatillon had decided to try to get down on paper
how important people were to the way their business worked. First he wrote at the top of his
sheet “employees and our business” and then had scratched it out and wrote s “the soft
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components of the business model”. He was aware this was more abstract, but he thought in the
end, if he could think through exactly what his firm was trying to reproduce (no, he said to
himself, remember: ‘photocopy’) in Poland, he could get by ‘what was not happening’ and see
what he could do about ‘what could be made to happen’.
CHATILLON’S DESCRIPTION OF THE ‘SOFT’ COMPONENTS
OF THE BUSINESS MODEL
Although hypermarket retailing was very capital intensive, with expensive fixed assets, it was
also a very human-resource intensive business. A large hypermarket in France had a
management staff of some 13-14 persons, category managers and department heads of about 20,
and a total floor staff of some 400. The store organization was very flat and had a very wide span
of control. This meant that personnel had to be very thoroughly trained in the methods and
practices that characterized the chain. Processes, systems, organizational structure, knowledge
transfer methods, routines and human resource management—all built around people—were the
internal managerial practices that were the real foundation of a successful hypermarket
operation.
Over the years, French retailers had developed a ‘model’ store, with fine-tuned procedures for
opening new stores and operating processes for everyday management covering the three months
before opening and the three months after. Organization charts, staffing, and all activities had
been identified, standardized and codified. For instance, all the activities that had to be
accomplished on the way to the final opening were laid out in detail as D-Day minus 120, minus
90, minus 60, and so on. This quasi military rigor depended greatly on the speed with which
recruited personnel could assimilate the firm’s methods and learn its routines.
As the industry matured, management style had become more top down and decisions were more
centralized. With increasing investment and heightened competition between the retailers,
figures had become key to measuring performance. General store managers had very little
latitude and were responsible, above all, for reaching targets set by the home office. Working
methods on the floor were standardized, personnel breaks were timed and merchandizing
controlled. Energy was focused on meeting consumers’ needs better than the competition—
business could only be gained at the other’s expense. Team work on the floor was encouraged—
as was initiative, although strictly within the bounds of time-tested routines. Suggestions for
improving results were welcome, but not meant to call into question the ‘way we do things’.
Routines were the keystone of the retailers’ knowledge transfer system. In France, new personnel
were often trained in methods and procedures in special seminars provided for recruits; however,
routines were mostly inculcated through ‘learning by doing’, by learning on the spot while
working with experienced personnel.
The need to have new employees master the routines had an effect on hiring, training and
promotion. In France, the retailers typically hired in young people right after schooling rather
than hiring them away from other companies; this ensured that the recruits would learn the right
ways of doing things and not bring in outside ideas and work habits. This is also why they rarely
hired graduates of business schools. The recruits were hired in at the ground level and required to
be trained ‘on the floor’, working their way through all the departments and services of the store.
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The expatriate managers intended to apply this same system in Poland, replicating the practices
they used in France. Rotating the Polish recruits through all the jobs in the stores would help
them learn their new employer’s business model and company culture. It seemed all the more
necessary to duplicate both their hiring and training procedures in Poland as there was no
retailing sector to hire away from in 1996.
As also had been the rule in France, Polish employees selected for promotion would be those
who had demonstrated mastery of the routines, fit into the company culture and had shown that
they could then train others in the routines. Every employee to be promoted had to leave his
successor trained to take over his job. Rotation also ensured that employees understood their role
in the whole operation and could be assigned to responsibility. It was very important that the
employee could take responsibility not just for a task, but for a result—for instance, a completely
customer-ready and well-managed section or department. This job enlargement was what made
possible the very flat organizations and wide span of control; little supervision was needed if the
routines had become ingrained; employees could be said to be ‘on automatic’.
The top echelons of both store and company management had almost always followed this path;
they had made their way ‘up from the ranks’, developed their careers with the same firm, been
formed by and integrated its culture. Chatillon himself had followed this path. They were
managers who—as they rose—had gained a vision of all the components that made up the
business model and could ensure its continuance.
Customer relations were another of the ‘soft’ components of the modern model in France. In the
90s, as competition grew tougher between the retailers, service and friendliness to shoppers
became essential to creating customer loyalty. Check-out and stock personnel were trained in
customer contact skills; training programs focused on the ‘customer is king’ approach.
Simultaneously, the diversification into appliances and electronics required personnel who not
only had good contact skills but could advise shoppers and demonstrate some technical
knowledge. Here again initiative was expected of employees who wanted good performance in
sales and good career prospects. The Polish retailing recruits had not yet been really tested for
their customer contact skills, but when he was out shopping, Chatillon had had ample
opportunity to see that generally the Poles were rather sharp with customers, or ignored them.
There were no automated checkout stands with scanning technology, bagging and friendly
checkout staff. Neither checkout nor stock personnel had been trained in customer contact skills.
In summary, the ‘soft’ components of the French hypermarket business model had produced a
set of managerial practices that worked well with employees who demonstrated a corresponding
set of attitudes: employees that understood the importance of competition and efficiency, were
very attentive to costs, showed initiative in improving the functioning of the existing business
model, were loyal to the firm and identified with it, saw their future in terms of a company
career, and took responsibility for an enlarged range of activities to ensure good performance and
profitability. These were the kinds of employees they could find in France.
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THE EVENING MEETING OF THE MANAGERS
Chatillon recalled the meeting that evening as if he had filmed it:
Management meetings were very convivial when the French were among themselves, without
Polish staff and translators attending. After all, there were only seven of them and they lived in
the same neighborhood, sent their kids to the same schools and saw each other socially very
frequently, as ‘expats’ usually do. They kept alive their French life styles as much as possible.
Like many expatriate managers on assignment all over the world, they sometimes felt they were
living on an island surrounded by the local population. The French management teams of the
different chains usually numbered only six to seven persons who would be managing over 400
Polish employees for the first store openings. It had always been intended that the first stores
would spawn others very swiftly and be a training ground for the management of the following
stores—Polish management. It had never been intended to have a large number of French
expatriate managers living in Poland. The stores were to be run with primarily Polish
management and staff. As growth in the number of stores was meant to be very rapid, this meant
that a very large number of Polish employees, supervisory staff and managers would need to be
trained and move on to open other stores; therefore, learning would have to be fast! That’s what
this meeting was about.
The air was full of electricity. They were getting closer to opening date and they knew the home
office was getting worried by the slow progress. Feeling the tension, Chatillon decided to
provoke everybody with a question he already knew the answer to:
How’s the prep going? Are we on schedule?
That opened the floodgates.
Look, the first thing is that we work through translators. These people are all young
university graduates in Romance languages—that’s why in the Hell they speak
French—literary types you know, trying to translate our ways of doing business,
which they don’t understand themselves, to a bunch of workers who …
Translators or not, the real problem is that these Poles refuse to learn. They just sit
on their hands and wait until we spell everything out for them…
Hold on. We’ve been through these gripe sessions before, but time is growing short.
We need to take a careful inventory of the things that are bothering us and see if we
can find a logical way of dealing with them. OK Jean, you kick off. Franck, you step
up to the flipchart and take notes, please…
The session was rough. They wrote down a lot of things, and then went through them again and
again to come up with a list they could get their minds around. Towards the end of the session,
the flipcharts basically listed a mixture of things not easy to relate: just simple facts about Polish
recruits as well as bothersome behavior or attitudes. They were too exhausted to comment on the
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final list and decided to sleep on it. They went home at 11:30. They left the flipcharts up behind
locked doors to go over the next day. The flipcharts read as follows:
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
Many of our recruits are older and have work experience but it is the wrong kind of
experience
Some workers are found to be drunk on the job
Many workers do not show up for work
They take long breaks and whenever they want
There is a high rate of tardiness
They leave work early in the day
Workers pay little attention to deadlines
They do not understand why goods should be displayed or organized the way we do it
There is a lot of pilfering of equipment and merchandise
Employees pay little attention to making the store attractive or laying out goods in an
attractive manner
They are very passive and wait for us to tell them what to do, they take no initiative
They cannot prioritize
They only work on their part of the store, if they see debris or dirt somewhere else they
walk by it
Employees put in supervisor positions do not take responsibility for their subordinates
work
Supervisors attending management meetings just listen, they do not contribute
Most supervisors have been chosen as supervisors because of their decent French
Employees do not ask questions
After we have told employees in charge of a section what needs to be done, the next day
nothing has been done
They do not understand that shelves should be kept fully stocked
Chatillon too had gone home exhausted. But he got to work early the next morning and found
that Franck was already there. They had morning coffee together in the meeting room with the
flipcharts from the night before staring at them before the floor crew started to show up.
What does it all mean Gérard? I’ve been here two years and I thought we were
moving ahead and I don’t know what to do about this. How are we going to open?
How can we count on our so-called supervisory staff to take control in this one
store? I can’t imagine us moving on to the next store opening unless there are some
people here who can get things moving, make the store attractive, get people to buy,
run a tight ship, control costs and so on. You know back home we run a store of this
size with 400 people. Right now it looks like we’re going to need some 600 to 700 to
get done what we do back home with 400! And we still can’t do the same job as well.
I don’t really know. I’ve been thinking about what makes this business tick and it’s
certainly people on the floor—and managers who come from the floor!
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Look Gérard, remember that researcher who’s been interviewing all of us retailing
managers over here because she writing papers on Poland and businesses operating
in an emerging economy. She’s an international business professor or something;
she’s Polish in origin and has been studying Polish firms and the changes after the
Communist regime. Why don’t you give her a call and let us interview her for a
change. Maybe she can throw a little insight on things.
Chatillon had his assistant track down the professor. Unfortunately, she was not in Poland at the
time. He did something that normally he would not have done, because of the company stress on
secrecy; he had the flipcharts typed up and faxed to her with an accompanying letter that laid out
his problems and asked for her comments. He knew she understood retailing very well and had
had contacts with the home offices of most of the retailing chains. He was pleased that she
answered immediately. He had kept the fax all these years.
THE FAX FROM THE PROFESSOR
Well, Mr. Chatillon, I won’t try to go through your list of problems. Probably the
best thing I can do is describe what I have come to understand about the work
attitudes you are facing by studying a number of previously state-owned Polish firms
that privatized after the end of the Communist regime in 1990. The people who led
the privatization of these firms faced serious problems in trying to change their
employees’ behavior to succeed in a market economy.
In Communist society most workers did not think in terms of having a trade or a
profession. A job was not a job; it was a position; everyone had a government
assigned and guaranteed position in a firm. Concepts like personal productivity,
motivation, and empowerment were completely lacking. All firms were overstaffed
and typically the position was for life. Most workers took little interest in their onthe-job activities and dealt uninvolvedly and slowly with their daily tasks; if they
were not in production (which was the purpose of the economy), they ‘administered’.
Absenteeism was rampant and workers rarely put in a full day of work. Alcoholism
was widespread, particularly among the men. Being a “part of the organization”, or
“a productive member of the organization”, were not expressions that were used in
Poland or, as I understand it, in other Communist countries in Central Europe.
Loyalty to the firm did exist in Poland, particularly in the form of pride in production
technology and technical skills, but it was very unevenly shared out; there were just
as many workers who plodded through their work days and motivation was most
often left for off-the-job activities with friends and family. The idea of loyalty could
only have been tested in a free labor market where there was bidding for personnel,
but under the Communist system there was no competition for good employees.
There were constant shortages of all goods. It was not a market economy but a stateplanned economy, where public officials decided what goods in what amounts should
be produced. Most often, even basic staples were scarce. Employees would close
their shops or information windows in public administrations whenever they wanted
and go hunting for supplies. Competition among Poles was not oriented towards
winning customers away from other sellers but in personally obtaining goods in
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short supply for one’s family. This meant that the very idea of ‘customer’ itself was
lacking. Service personnel in stores were used to seeing long lines of people waiting
at the counters to buy whatever goods were available that day and were usually very
curt with shoppers. The state-guaranteed position would be there the next day
whether anything had been sold or not. The very idea of attracting and pleasing
customers was inexistent, thus merchandising, advertising and store embellishment
were inconceivable.
Polish workers learned to conform, to fit in. In a society of routine and monotony,
processes were standardized. Creativity was discouraged, since suggestions of any
kind might be considered an attack on the foundations of the system. This led
employees to unlearn initiative during the Communist period. Above all, they learned
not to rock the boat. Employees learned not to think about the quality of their
superiors’ decisions. Managers most often were political appointees and were not
promoted because of their managerial skills. They could influence the employees’
chances of acquiring a car or being allotted an apartment more quickly, therefore, it
was more judicious to be quiet. This completely separated the relation between
power and merit. As in other cultures, for other reasons, the boss was there to make
the decisions. It would have been out of place to show any initiative. Therefore,
Polish employees confined themselves to doing exactly what was assigned;
responsibility for enlarged responsibilities was avoided, as it might invite rebuke.
The Poles learned not to seek information—or clarity. What was the use of
information if it could not be used? The most useful sources of information under the
old regime were typically underground and concerned ways of obtaining basic
commodities. Moreover, frank curiosity could be interpreted as a kind of
insubordination or subversion.
I would say, Mr. Chatillon, that the flipchart lists you sent me are the reflection of
what I have just described. I hope this is useful to you.
*****
It is 11:00 a.m. in Gérard Chatillon’s office November 29, 2006
Ted Cross arrived on the dot and Chatillon went down to meet him at the administration
reception to the large hypermarket. It took a good hour for Chatillon to sum up his personal view
of the years leading up to 1996. He had just shown Cross the original flipcharts and the fax from
the professor. However, he asked Cross not to report the information in detail but only include it
in his report in a summary fashion.
Then Chatillon continued:
After this fax from the professor, I met with my team and over a period of weeks and
even months over 1996 and 1997 we took a series of steps to deal with our
difficulties. The professor helped us understand our employees better, but she did not
tell us how to solve our problems. We realized we were caught in a bind. There were
several important issues:
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The home office had laid out a clear strategic plan and operating procedures that
were the very essence of a tried and true business model. This model was highly
codified and was to be photocopied on every international market. The home office
was impatient to see us successfully launch our hypermarkets in Poland. Our Polish
employees were not responding to our methods and we were facing a real shortage
of managerial staff needed to fuel our expansion. We knew that other markets were
being studied for entry—Thailand, China, etc. We were a test case and what we did
would probably influence our firm’s internationalization process in other markets.
Ted Cross leaned forward and sipped his coffee.
So, what did you do, Mr. Chatillon?
__________________
1
Although this case is factual, the name of the company and individual names have been disguised.
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Financial Reporting for Investments:
The Case of National General Insurance
Company
Kenton Swift
University of Montana
Mel McFetridge
Carroll College
Overview
National General Insurance Company (NGI) was one of the leading insurers in the United
Arab Emirates. NGI was headquartered in the Emirate of Dubai and had recently added
branches in the Emirates of Abu Dhabi and Sharjah as part of its expansion plans. It offered a
wide range of commercial and personal insurance products.
The Company was formed in 1980 and was listed on the Dubai securities exchange (Dubai
Financial Market) in 2002. Prominent shareholders included Emirates Banks, Commercial
Bank of Dubai, Zarouni Group, and Dubai Investments. The Company also partnered with
Aviva Ltd, part of the British insurance giant Aviva Plc, to offer a range of life insurance and
investment products. NGI was rated BBB by Standard & Poors.
The Company’s mission stated:
To achieve market supremacy through the provision of Total Insurance
Solutions and dedicated premier services which not only meet but also exceed
our customers’ expectations.
To ensure our commitment to our customers first and foremost in all aspects
of our activities thus ensuring the enhancement, expansion and growth of the
Company to the long term, sustainable benefit and satisfaction of our
stakeholders.
The United Arab Emirates (UAE) was a rapidly developing country located at the
southwestern end of the Arabian Gulf Peninsula. It was a country where significant oil and
gas wealth had been reinvested in economic development. The real Gross Domestic Product
(GDP) rose 7.4% in 2007. According to the International Monetary Fund, the GDP per capita
for 2007 was estimated to be $42,437. This compared favorably with an estimated GDP per
capita in the US of $45,725.
The UAE’s rapidly expanding economy led to a big demand for housing, and real estate
prices increased at a rapid pace beginning in 2005. The Dubai Financial Market (DFM) also
had a big increase in 2005 with the general securities index surging to about 8,500. After that
time stock prices dropped significantly with the DFM General Index leveling off at about
4,500 by 2007. It is worth noting that the United Arab Emirates was a country that is less than
40 years old, and formal securities markets were only created in the year 2000. Thus, the
Dubai Financial Market had not yet developed the same level of regulation and sophistication
as more mature markets.
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Reporting Issues for National General Insurance Company
As an intern at a major brokerage firm you have been asked to review the financial
statements of National General Insurance Company and report to senior management about
any significant findings. NGI’s audited financial statements are provided in Exhibit 1. An
initial review of the financial statements indicates the following.
Public companies in the United States are required to prepare their financial statements using
US financial reporting standards (US GAAP). However, the auditors’ report for NGI stated
that the financial statements were prepared in compliance with International Financial
Reporting Standards (IFRS), not US GAAP. It should also be noted that the financial
statements were denominated in UAE dirhams (AED). A quick review of currency exchange
rates shows that UAE dirhams were tied to the US dollar at an exchange rate of 3.678
dirhams per 1 US dollar.
An examination of the balance sheet shows that most of the Company’s assets were securities
investments and real estate investment properties. The total value of all investment securities
was AED 173,662,949 at December 31, 2006 when combining the three categories:
Investments held to maturity, Investments available for sale, and Investments fair valued
through profit and loss. And investment properties totaled AED 66,579,000 at December 31,
2006.
NGI appeared to have substantial equity with shareholders’ equity totaling AED 209,629,395
at December 31, 2006 compared to total liabilities of AED 190,374,675. Also, the Company
had positive working capital with its current assets of AED 254,239,724 exceeding current
liabilities of AED 178,538,084 by AED 75,701,190 at December 31, 2006.
The income statement for NGI showed a small net income for 2006 of AED 237,482. The
income statements for both 2005 and 2006 also showed substantial gains and losses from fair
value fluctuations of investments. In fact, for 2006 the fluctuations in “Unrealized
(losses)/gains on investments” and “Fair value changes in investment properties” were
sizeable in relation to the underwriting profit of AED 34,261,517. As net income is an
important input into a company’s valuation, it is important to investigate these fluctuations.
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Exhibit 1 – National General Insurance Financial Statements 1
National General Insurance Co.
INCOME STATEMENT
For the years ended December 31, 2006 and 2005
2006
(UAE
Dirhams)
2005
(UAE
Dirhams)
Accident and liabilities
Marine
Fire
Group and individual life
27,064,587
1,438,499
1,208,390
4,550,041
12,167,062
908,563
752,263
606,249
Total underwriting profit
34,261,517
14,434,137
4,781,649
1,461,142
(6,905,529)
(66,584,581)
6,600,000
26,173,000
1,302,605
764,317
1,782,900
469,017
48,035,148
24,214,958
12,902,837
6,000,000
5,006,304
159,444
1,854,120
113,004,745
(1,616,638)
(4,851,945)
237,482
108,152,800
0.002
1.070
Net Underwriting Profit
Interest income
Dividend income
Realized (losses)/gains on sale of investments
Unrealized (losses)/gains on investments
Profit from the sale of investment properties
Fair value changes in investment properties
Rental income from investment properties
Other income
General and administrative expenses
Net profit for the year
Earnings per share
1
The financial statements for National General Insurance Company were retrieved from the website
of the Emirates Securities and Commodities Authority, which is the regulatory body for publicly traded
securities in the UAE.
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The CASE Journal
Exhibit 1 (continued)
BALANCE SHEET
At December 31, 2006 and 2005
2006
(UAE
Dirhams)
2005
(UAE
Dirhams)
2,135,471
66,579,000
14,821,520
62,228,355
806,775
37,000,000
10,510,250
16,086,469
96,613,074
58,751,705
2,907,394
12,547,260
24,679,251
58,741,040
254,239,724
140,635,395
24,416,471
967,745
9,706,777
10,503,653
70,403,960
256,634,001
85,167,194
227,118
48,508,227
44,635,545
178,538,084
30,872,688
803,398
35,937,358
26,768,418
94,381,862
Net current assets
Life assurance fund
75,701,640
(11,836,591)
162,252,139
(6,057,703)
Assets employed
209,629,395
220,597,930
101,430,000
18,361,456
17,745,470
72,450,000
18,337,708
17,721,722
(649,372)
72,741,841
3,311,645
108,776,855
209,629,395
220,597,930
Assets Employed:
Noncurrent assets
Property and equipment
Investment properties
Investments held to maturity
Investments available for sale
Current assets
Investments fair valued through profit and loss
Trade receivables
Due from a related party
Other receivables
Reinsurers' share of outstanding claims
Cash in hand and at bank
Current liabilities
Accounts payable and accruals
Bank overdraft
Unearned premium reserve
Outstanding claims reserve
Shareholders' equity
Share capital
Legal reserve
General reserve
Fair value reserve for investments available for
sale
Retained earnings
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The CASE Journal
STATEMENT OF CASH FLOWS
2006
(UAE
Dirhams)
Operating activities
Adjustment for:
Depreciation
Provision for doubtful account
Profit on sale of investment properties
Profit on sale of investment held to maturity
Unrealised losses/(gains) on investments
Realised losses/(gains) on sale of investments
Gain on fair value adjustment of investment properties
Increase in unearned premium reserve and life fund
Operating profit before changes in working capital
Cash flows from working capital
Purchase of investments fair valued through profit and
loss
Proceeds from sale of investments fair valued through
profit and loss
Increase in trade and related party receivables
Increase in other receivables
Increase in accounts payable & accruals
Increase in net outstanding claims
Net cash flows from operating activities
Financing activities
Dividend paid
Net cash flows from financing activities
Investing activities
Purchase of property and equipment
Purchase of investment properties
Purchase of investment held to maturity
Purchase of investment available for sale
Proceeds from sale of investment properties
Proceeds from sale of investment available for sale
Maturity of investments held to maturity
Net cash flows for investing activities
Net (decrease)/increase in cash and cash equivalents
Cash and cash equivalents at the beginning of the year
Cash and cash equivalents at the end of the year
Page 86
2005
(UAE
Dirhams)
237,482
108,152,800
781,791
150,000
(6,600,000)
66,584,581
6,905,529
(26,173,000)
18,349,756
419,711
143,651
(12,902,837)
(78,198)
(24,214,958)
(48,035,148)
(6,000,000)
16,769,994
60,236,139
34,255,015
(65,153,608)
(165,846,187)
35,685,820
(43,541,424)
(2,840,483)
40,091,508
3,691,525
28,169,477
132,570,992
(7,464,707)
(6,752,776)
6,365,679
5,028,305
(1,843,679)
(7,245,000)
(7,245,000)
(6,300,000)
(6,300,000)
(2,110,487)
(7,086,459)
(9,311,270)
(50,102,900)
31,600,000
(32,370,969)
(2,771,824)
70,003,800
3,751,698
5,000,000
(32,011,116)
38,612,705
(11,086,639)
69,600,561
58,513,922
30,469,026
39,131,535
69,600,561
The CASE Journal
STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
As at January 1, 2006
Share
Legal
General
Fair Value
Retained
Capital
(UAE
Dirhams)
Reserve
(UAE
Dirhams)
Reserve
(UAE
Dirhams)
Reserve
(UAE
Dirhams)
Earnings
(UAE
Dirhams)
Total
(UAE
Dirhams)
72,450,000
18,337,708
17,721,722
108,776,855
220,597,930
237,482
237,482
(7,245,000)
(7,245,000)
(28,980,000)
0
(23,748)
0
(23,748)
0
3,311,645
Dividends paid
Issue of bonus shares
28,980,000
Transfer to legal reserve
23,748
Transfer to general reserve
Adjustment to fair value for
investments available for sale
As at 31 December 2006
As at January 1, 2005
23,748
(3,961,017)
101,430,000
18,361,456
17,745,470
63,000,000
7,522,428
6,906,442
(649,372)
Dividends paid
Issue of bonus shares
9,450,000
Transfer to legal reserve
10,815,280
Transfer to general reserve
10,815,280
Directors' remuneration
Adjustment to fair value for
investments available for sale
As at 31 December 2005
(3,961,017)
72,741,841
209,629,395
40,004,615
117,433,485
108,152,800
108,152,800
(6,300,000)
(6,300,000)
(9,450,000)
0
(10,815,280)
0
(10,815,280)
0
(2,000,000)
(2,000,000)
3,311,645
72,450,000
Page 87
18,337,708
17,721,722
3,311,645
3,311,645
108,776,855
220,597,930
Auditors’ Report
The Shareholders
National General Insurance Co. (P.S.C.)
Report of the Auditors
We have audited the accompanying financial statements of National General Insurance
Co. (P.S.C.) (“the Company”), which comprises the balance sheet as at 31 December
2006 and income statement and cash flows for the year then ended, and a summary of
significant accounting policies and other explanatory notes.
Management’s responsibility for the financial statements
Management is responsible for the preparation and fair presentation of these financial
statements in accordance with International Financial Reporting Standards. This
responsibility includes: designing, implementing and maintaining internal control
relevant to the preparation and fair presentation of financial statements that are free
from material misstatements, whether due to fraud or error; selecting and applying
appropriate accounting policies; and making accounting estimates that are reasonable
in the circumstances.
Auditors’ responsibility
Our responsibility is to express an opinion on these financial statements based on our
audit. We conducted our audit in accordance with International Standards on Auditing.
Those standards require that we comply with relevant ethical requirements and plan
and perform the audit to obtain reasonable assurance whether the financial statements
are free of material misstatement.
An audit involves performing procedures to obtain audit evidence about the amounts
and disclosures in the financial statements. The procedures selected depend on our
judgment, including the assessment of risks of material misstatement of the financial
statements, whether due to fraud or error. In making those risk assessments, we
consider internal control relevant to the entity’s preparation and fair presentation of the
financial statements in order to design audit procedures that are appropriate in the
circumstances, but not for the purpose of expressing an opinion on the effectiveness of
the entity’s internal control. An audit also includes evaluating the appropriateness of
accounting principles used and reasonableness of accounting estimates made by
management, as well as evaluating the overall presentation of the financial statements.
We believe that the audit evidence we have obtained is sufficient and appropriate to
provide a basis for our opinion.
The CASE Journal
Opinion
In our opinion, the financial statements present fairly, in all material respects, the
financial position of the Company as at 31 December 2006, and its financial
performance and its cash flows for the year then ended in accordance with International
Financial Reporting Standards and comply with the relevant Articles of the Company
and the UAE Federal Law No. 8 of 1984 (as amended).
Report on other legal and regulatory requirements
As required by the Federal Law No. 8 of 1984 (as amended), we further confirm that we
have obtained all information and explanations necessary for our audit, that proper
financial records have been kept by the Company and the contents of the Directors’
report which related to these financial statements are in agreement with the Company’s
financial records. We are not aware of any violation of the above mentioned Law and
the Articles of Association having occurred during the year ended 31 December 2006,
which may have had a material adverse effect on the business of the Company or its
financial position.
KPMG
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The CASE Journal
Selected Footnote Disclosure
2.
Significant Accounting Policies
g)
Financial Instruments
Classification
Held-to-maturity investments are financial assets with fixed or
determinable payments and fixed maturities that the Company has the
positive intent and ability to hold to maturity. These include certain debt
securities.
Available-for-sale assets are financial assets which are not classified as
financial assets at fair value through profit or loss, loans or receivables, or
held to maturity. Available-for-sale assets include certain debt and equity
investments. These assets may be sold in response to needs for liquidity
or changes in interest rates, exchange rates, or equity prices.
Investments fair valued through profit and loss are financial assets which
are acquired principally for the purpose of selling in the short term or if so
designated by management.
Recognition
Financial assets and liabilities are recognized on the balance sheet when
the Company becomes a party to contractual provisions of the
instruments. From this date any gains or losses arising from changes in
fair value of assets or liabilities designated as fair value through profit or
loss or available-for-sale assets are recognized.
Held-to-maturity investments are recognized on the day they are acquired
by the Company.
Receivables are recognized on the day they are transferred to or acquired
by the Company.
Measurement
A financial asset or a financial liability is recognized initially at its fair value
plus, in the case of a financial asset or a liability not at fair value through
profit and loss, transaction costs that are directly attributable to the
acquisition or issues of the financial assets or financial liability.
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Subsequently to initial recognition, all financial assets at fair value through
profit and loss and available-for-sale assets are measured at fair value,
except that any instrument that does not have a quoted market price in an
active market and whose fair value cannot be measured reliably is stated
at cost, including transaction costs, less impairment allowances.
Derecognition
A financial asset is derecognized when the Company loses control over
the contractual rights that comprise the asset. This occurs when the rights
are realized, expired or are surrendered. A financial liability is
derecognized when it is extinguished.
Financial assets through profit and loss that are sold are derecognized
and corresponding receivables from the buyer for the payment are
recognized as of the date the Company commits to sell the assets. The
Company uses the weighted average method to determine the gain or
loss recognition.
Available for sale financial assets that are sold are derecognized and the
cumulative gains or losses previously recognized in equity are recognized
in profit or loss.
h)
Investment properties are stated at fair value determined annually by an
independent registered valuer. Fair value is based on current market
prices for similar properties in the same location and condition. Any gain
or loss arising in fair value is recognized in the income statement.
4.
2006
AED
2005
AED
At January 1
Additions – acquisitions
Deductions – sales
37,000,000
28,406,000
(25,000,000)
56,000,000
(25,000,000)
Total
Fair value adjustment
40,406,000
26,173,000
31,000,000
6,000,000
At December 31
66,579,000
37,000,000
Investment properties represent residential villas and land in Dubai and are
carried at fair value. The villas are valued by an independent valuer having an
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The CASE Journal
appropriate recognized professional qualification and experience. Additions
pertained to the land purchased in Dubai on which a prepayment of AED 7
million in 2005 was transferred from Other receivables and an AED 14 million is
still payable to the developer as at 31 December 2006. The land has been valued
by the directors based on evidence of trades of land of similar size and location.
Such trades were carried out between AED 100—AED 150 and the board of
directors accepted the lower value of AED 100.
The Company measures the property investments at fair value. For the villas,
AED 14 million was recognized as unrealized gain and AED 12 million for the
land in Dubai.
5.
Investments held to maturity
2006
AED
Emirates floating Rate Notes–July 2006
Mashreq Bank Int. Rate Notes–June 2007
Sukuk Bond – February 2008
2005
AED
5,510,250
9,311,270
5,000,000
5,510,250
____-
14,821,520 10,510,250
6.
Investments available for sale
2006
AED
Externally managed funds – Unquoted
Equity investments – Quoted
Equity investments – Unquoted
Sukuk Bond – February 2008
2005
AED
45,000,000 10,000,000
2,122,455
6,083,469
3,000
3,000
15,102,900
____62,228,355 16,086,469
7.
Investments fair valued through profit and loss
AED
Equity investments – Quoted
2006
AED
2005
96,613,074 140,635,395
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The Prize? The Price?
Constellation Brands’ Proposed
Merger with the Robert Mondavi
Company
Armand Gilinsky, Jr.
Sonoma State University
Raymond H. Lopez
Pace University
In late summer 2004, Richard Sands, CEO of Constellation Brands (Constellation), had just
learned of the decision by management of the Robert Mondavi Company (Mondavi) to split that
firm into two parts. Mondavi’s luxury wine division was to become a privately held entity, while
its popularly priced “lifestyle” wines would continue to be produced and sold by the Mondavi.
Sands was convinced that this decision would be a strategic and financial mistake for Mondavi,
however, it could create a “once-in-a lifetime” opportunity for his firm to purchase all of the
Mondavi brands and integrate them into the Constellation wine portfolio.
In Sands’ estimation, this could be the right time for Constellation management to make a bid for
Mondavi. If consensus from his management team about a Mondavi acquisition could be
reached, the next challenge for Sands would be to determine a takeover price that would not only
satisfy Mondavi’s shareholders, but also result in higher future returns for Constellation’s
shareholders. Like Mondavi, Constellation was a public company; its shares were traded on the
New York Stock Exchange under the stock symbol “STZ.”
According to Sands:
Our breadth across product lines and geographies affords us growth-generating
investment prospects unrivaled in the industry. Furthermore our extensive range
diminishes the inherent volatility and potential vulnerability that sometimes accompanies
growth. As one of the world’s largest beverage alcohol companies, our scale gives us
stronger routes-to-market, thereby leveraging our investments. Together, this unequalled
breadth and scale propels our focus beyond short–term gain to investment opportunities
based on growth and profitability over the long term. 1
The histories of the Mondavi and Sands families’ businesses shared some similarities. Robert
Mondavi (in 1943) and Marvin Sands (in 1945) had respectively founded their family firms.
Both had followed a strategy of expansion through acquisitions as well as internal product
growth. Both parents turned over management to their sons. However, while the Mondavi family
at times disagreed on most aspects of their business, the Sands brothers guided Constellation to
become, according to its most recent annual report, “efficient, effective, aggressive, profitable
and generating growing shareholder value consistently over decades.” 2
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During the 11 years of leadership by brothers Richard and Robert Sands, Constellation had
purchased eleven companies. In the early 1990’s the firm embarked upon a growth strategy of
external expansion through acquisitions. These businesses were primarily focused on the same
market segments already operated by the firm, but would add scale and scope to company
operations. Integration of facilities helped achieve economies in production and distribution
while new brands helped expand the firm’s product portfolio. 3 (See case Exhibit 1.) Starting
with smaller deals in 1991, the Sands brothers acquired Guild Wineries and Distillers, which
produced Cook’s champagne. The brothers moved up the price and acquisition size scale with
Blackstone ($140 million) and Ravenswood ($149 million). In 2003, they completed their
biggest wine company deal to date, the purchase of Australian wine conglomerate BRL Hardy,
for $1.4 billion.
Meanwhile, over at Mondavi, the trials and tribulations of the family had been making headlines
for more than a year. In the early 2000s, disagreements over strategic direction had arisen
between Robert and his two sons, Michael and Tim, which resulted in the hiring of professional
management. In 2004, disputes had broken out between the Mondavi brothers and the
professional mangers that had been hired to operate the firm in 2002. 4
While Constellation had recently eclipsed E & J Gallo as the world’s largest wine company and
as the U.S. market’s second largest wine company, it still had some gaps in its product portfolios.
One gap was in the California-produced $6 – $8 price range. The leading player in that sector
was Woodbridge by Robert Mondavi. Not yet spun off into a private company, Mondavi’s
premium priced (over $9.99 at retail) wine brands from Napa grown grapes would make an
excellent addition to Constellation’s fine-wine portfolio. Robert Mondavi Private Selection, at
the $10 price point, was a rapidly growing brand in a rapidly growing segment. It would add to
strong brand names the firm already owned, such as Blackstone and Ravenswood Vintners’
Blend. With the successful competition of a Mondavi acquisition, Constellation would become
the number one retail dollar wine company in the U.S., the number one premium wine company
in the U.S. and attain a 4.5 percent global market share in the wine industry. 5
THE U.S. BEVERAGE INDUSTRY
Consumption of beverages consumed in the U.S. had grown steadily, yet unspectacularly from
1994-2004 (Exhibit 2). Total annual consumption per capita fluctuated between 164 gallons and
171.5 gallons. Soft drinks retained its title as the largest beverage category. At a level of 52.5
gallons per capita in 2004, soft drinks represented 31.5 percent of total beverage consumption
and 27.7 percent of spending at retail. This was one of the few beverage categories that had
grown in both absolute and relative terms in the last ten years (Exhibits 3 and 4).
Bottled water had emerged as the beverage story of the 1994-2004 decade. Bottled water
experienced the largest relative growth rate in both consumption per capita and retail sales. Per
capita consumption grew by 51.4 percent, while retail sales had grown 129.7 percent.
Beer consumption had grown by 7.8 percent over the eight years, although per capita
consumption of beer actually declined by 1.8 percent. Yet retail sales of beer expanded
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The CASE Journal
significantly in this period, by 45.7 percent, primarily due to a shift in consumption to higher
priced brands, particularly imports. Beer retail sales level surpassed the soft drink category for
the first time in 2004. The beer segment was the largest in terms of consumption per capita,
though growth had been quite small over the years.
The distilled spirits market was the smallest in terms of consumption per capita and had actually
declined slightly over the last decade. However, due to its high price points it generated retail
sales that made it the third highest beverage category.
U.S. wine consumption
During the period from 1981 to 2004, wine consumption per capita declined from the peak years
of 1985 to 1986, bottoming out in 1993, but had grown steadily since that year. On the basis of
retail spending, wine ranked a bit higher when compared to other beverages, but total spending
on wine was still quite moderate compared to soft drinks and beer (Exhibit 4). While growth in
U.S. wine consumption slowed considerably in the 1990’s, there has been a pickup in demand
and consumption, especially in the domestic table wine segment, in the early 2000s (Exhibit 5).
Major segments in the wine industry included the following broad categories; table, fortified,
vermouth, sparkling, coolers and ciders. Domestic table wines captured an 88.5 percent market
share in 2004, an increase over an 84.5 percent share of the category in 1991 (Exhibits 6 and 7).
Within the table wine segment, imported wines increased their share from 13.0 percent in 1991,
to 24.6 percent in 2004.
Within the table wine segment were a broad variety of products, generally distinguished by their
price ranges. While most categories contributed to the industry’s growth in consumption and
retail sales values, the higher priced premium categories drove industry dollar sales growth.
Consumers typically learned about wine through consumption of lower-priced brands and then
moved up the price and quality scale as their incomes and lifestyles developed. Since 2001, some
of the lower price premium categories grew significantly, as value-priced quality imports from
Chile and Australia became quite successful in the U.S. The growth of one Australian brand,
Yellowtail, was exceptional, expanding from 200,000 cases in 1999 to over 7 million cases
estimated for 2004.
Table wines were defined as those with 7 to 14 percent alcohol content by value, and
traditionally consumed with food. In contrast, other wine products such as wine coolers, pop
wines, fortified wines and sparkling wines (champagnes) were usually consumed as stand-alone
beverages. Table wines that retailed at less than $3.00 per 750 ml. bottle were generally
considered to be generic or “jug” wines, with a more recent classification as low end or
economy. The sub-premium category had a price range of $3.00 to $6.99 per bottle. 6
Premium wines generally had a vintage date on their labels, which meant that the product was
made with at least 95 percent of grapes, harvested, crushed and fermented in the calendar year
shown on the label. The grapes were also grown in the appellation of origin (i.e. Napa Valley,
Sonoma Valley, Central Coast, etc.). The premium table wine category had two segments,
middle and high end (deluxe). In the middle category, premium wines sold for $7.00 to $9.99 per
750 ml. bottle while Super-Premium wines sold for $10.00 to $13.99 per bottle. The high-end
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The CASE Journal
(Deluxe) category also had two components. Ultra-Premium wines sold for $14.00 to $30.00 per
bottle while Luxury wines sold for more than $30.00 per bottle. 7 (A few years earlier the luxury
category began at the price point of $20.00 per bottle.)
Exhibit 8 data show another significant change in the tastes and preferences of the American
consumer for wine products by color mix profile. While white wines were consistently the “color
of choice” since the 1970’s, red wine represented the greatest increases in terms of consumer
demand. In their peak year, 1985, white wines represented 62.3 percent of the market. By 1990,
white wines had declined to 50 percent of a market that had also declined in absolute size. Since
that time their consumption grew steadily yet had not reached the 1985 level by 2002. By
contrast the red wine category grew consistently since 1990. By 2002, red wine represented 41.5
percent of the total wine market. White wine was still number one, at 42.9 percent, but the trends
suggested that red wines might soon overtake white wines in terms of popularity.
U.S. wine production standards
Grape quality used to produce table wines could vary considerably, based on soil conditions and
weather in grape growing regions. Varietals were delicate, thin-skinned grapes grown on vines
that can take four to five years after planting to bear fruit. The Bureau of Alcohol, Tobacco and
Firearms’ truth-in-labeling standards specified that one variety — the name of a single grape —
may be used if not less than 75 percent of the wine was derived from grapes of that variety, the
entire 75 percent of which was grown in the labeled appellation of origin. Appellation denoted
that “…at least 75 percent of a wine’s value was derived from fruit or agricultural products and
grown in place or region indicated…” 8
To develop the typical varietal characteristics that resulted in enhanced flavor, taste and finish
could take another 2 to 3 years of vine growth. To enhance product quality, wineries had to make
increasing investments in vineyard and production facilities.
Distribution channels
A variety of state laws and regulations were in place to regulate and restrict the sale of alcoholic
beverages. For the wine industry, the result had been a requirement to use a “three-tier”
distribution system (winery to distributor to retailer to customer). In the 1990’s an increasing
number of wine distributors went out of business through either termination or acquisition. Vic
Motto of Motto Kryla Fisher, a respected Napa Valley wine consulting and accounting firm,
reported that there had been 10,940 wine distributors operating in the U.S. in 1990, but only
5,134 by 2000. By 2003, there were only two or three major distributors in each state. The top
ten distributors in 1993 accounted for 33 percent of wine sales while, by 2003 they controlled 60
percent of the business. In California alone, the number of distributors decreased from 28 in
1976 to 15 in 1986 and to five in 1999. 9
One result of this consolidation trend was that marketing and disseminating product information
through distributors had become less effective. Wholesalers or distributors that once represented
only a few wineries now might represent a hundred or more. More than a few wineries,
especially smaller ones, began to take on the burden and cost of developing their own sales and
marketing programs.
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Consolidating distribution channels tended to increase barriers to new market entry for small
“boutique” wineries. Low volume production, inadequate product mix across price and varietals
segments, and unknown brands posed challenges for smaller wine producers in the U.S. and
limited the access of these producers to the second (distribution and wholesale) and third tiers
(retailer) of the three-tier system.
In 2004, a case still pending at the U.S. Supreme Court could have an unknown impact on the
wine industry and change the distribution system significantly. The case, Granholm v. Heald,
contended that current state laws discriminated between in-state products and products from outof-state. Small wineries hoped that the Court would rule in favor of increasing liberalization of
shipping wine across some state lines. If a decision came down in favor of producers and
consumers, one possible result would enable wineries to ship their products directly to retailers,
restaurants and consumers, circumventing the wholesalers and distributors who remained quite
powerful in many U.S. states. While smaller wineries might benefit under certain circumstances,
if this case were to be resolved in favor of the wineries (over the states), larger firms were likely
to enhance their market shares even further.
Increasing polarization of the wine industry
In order to meet the evolving demands of consumers for wines of different varieties at different
price points, to cope with consolidation in the distribution chain, and to increase the
competitiveness of their operations, the industry structure began changing in the early 1990’s. At
the upper end of the size spectrum, i.e. those firms producing in excess of 8 million cases per
year, consolidation became the norm, both domestically and globally.
Economies of scale and scope could be achieved through business combinations. Redundant
administrative and service expenses were likely to be reduced. Larger firms could negotiate
better terms with independent grape growers. They could also achieve better terms with
equipment and packaging suppliers. Sales forces could be combined and overlaps eliminated,
with enhanced efficiencies. Finally, larger firms could leverage their strongest brands with
wholesalers and distributors. Larger firms generally had broad product portfolios and wellconceived acquisition strategies could fill gaps in their product lines.
At the other end of the size spectrum were the “elite” brands, generally producing no more than
10,000 cases per year, often on allocation to wine club members or selected on-premises
accounts such as high end hotels and restaurants. There was a good deal of owner involvement in
the production and marketing of these brands, mostly to greatly enhance perceived quality and
support high retail prices.
A bit further up the size scale, to 50,000 cases per year, were small wine producers that strove to
be considered as producers of “boutique” brands. Some might be successful, but the costs of
marketing and administration were becoming a major challenge.
The mid-sized wineries, producing between 100,000 and one million cases per year were feeling
pressure from the “giants” and were most likely to become part of the consolidation trend. Their
production volume was, relative to the “giants,” too small to have any effect on negotiations with
grape growers, wholesalers, or distributors.
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Yet despite all the acquisition activity that occurred between 1990 and 2004, the wine industry
remained highly fragmented, when compared to other beverage segments. For example, in soft
drinks, the top few firms controlled 70 percent of the worldwide market, according to Robert
Nicholson, president of International Wine Associates. In distilled spirits the comparable figure
was 50 percent, and in the beer segment 26 percent. The top five wine-producing firms supplied
just 6 percent of global volume. 10
Competition
Inasmuch as the beverage alcohol industry was highly competitive, Constellation and Mondavi
competed on the basis of quality, price, brand recognition, and distribution strength. Their
beverage alcohol products competed with other alcoholic and non-alcoholic beverages for
consumer purchases, as well as shelf space in retail stores, restaurant presence and wholesaler
attention. 11
For example, according to its 2004 Annual Report, Constellation’s Wines division competed
with many equally large producers, including E & J Gallo Winery, The Wine Group, Beringer
Blass, Diageo’s Chateau & Estates wine division, Mondavi, and Kendall Jackson in the U.S. In
Australia, large producers included Southcorp Wine, Orlando Wyndham and Foster’s-owned
Beringer Blass and Southcorp Wines. In the world’s largest export market for wine, the United
Kingdom (U.K.), strong competitors included E & J Gallo Winery, Southcorp, Western Wines,
Halewood Vintners and Pernod-Ricard.
Also, Constellation’s Beers and Spirits division competed with Foster’s Group, Heineken USA,
Molson, Labatt USA and Guinness Import Company in the imported beer category. Domestic
producers included Anheuser Busch, Coors and SAB-Miller. Major producers of distilled spirits
included large, financially strong firms, Diageo, Brown-Forman Beverages, Pernod-Ricard, Jim
Beam Brands and Heaven Hill Distilleries. 12
CONSTELLATION BRANDS IN 2004
Since its founding in 1945 under its original name Canandigua Wine Company, the Sands’
company had grown through a combination of internal growth and acquisitions. Internal growth
had been driven by leveraging the company’s exiting portfolio of leading brands, developing
new products, new packaging and line extensions and focusing on the fastest growing sectors of
the beverage alcohol industry. 13
The architect of many of these changes was the eldest son of founder Marvin Sands, Richard,
who joined the firm in 1979 after his undergraduate education at the University of California at
Berkeley, Washington University in St. Louis, and the University of Vermont. He ended his
formal education with a doctorate in social psychology from the University of North Carolina.
Richard then worked under his father’s tutelage to learn the family business. 14 Under Richard’s
direction the company intended to become a major player in the wine “cooler” and wine- and
fruit-juice-cocktail fads of the 1980’s. His introduction of Sun Country, a wine cooler, resulted in
a doubling of company revenues within two years. Richard was named President of Canandaigua
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Wine Company in 1986. He continued to pursue the firm’s growth-by-acquisition strategy using
long-term debt to complete most deals, as the firm at that time did not carry an investment grade
bond rating, thus increasing its cost of capital. 15 He also stated his operating strategy for the firm:
“The presidents of the companies have complete control. We like CEOs who know their
companies better than we do.” 16 In 1993, Richard replaced his father as President of the entity
that was then renamed Canandaigua Brands. Richard was named chief executive in 1996.
Richard’s younger brother, Robert, also became active in the business, serving as chief executive
for international operations, vice president and general counsel of Canandaigua Brands (the
parent company), as well as chief executive of the Canandaigua Wine Company. 17
Following its purchase of BRL Hardy in 2003, Canandigua Brands was again renamed, as
Constellation Brands, in early 2004. At the same time the structure of its internal organization
was simplified from five to two business units, Constellation Wines and Constellation Beers and
Spirits, each now led by a chief executive who reported directly to Robert Sands, the company’s
chief operating officer.
Constellation Wines
This division produced 90 million cases annually, comfortably exceeding the previous market
volume leader E & J Gallo’s reported 70 million cases. Constellation Wines sold a large number
of wine brands across all market segments — table wine, dessert wine and sparkling wine — and
across all price points, popular, premium, super-premium and ultra (luxury) premium. Its
portfolio of super premium and ultra premium wines was supported by vineyard holdings in
California, Australia, New Zealand and Chile.
According to Euromonitor, in the U.S., Constellation Wines sold 18 of the top selling 100 wine
brands and had one of the largest fine wine portfolios. 18 In the U.K., it had 7 of the top selling 20
table wine brands sold to the off-premises market, 3 of the top selling 10 table wine brands in the
on-premises market and the best selling brand of fortified British wines. In Australia, it had wine
brands across all price points and varieties, including the most comprehensive range of premium
wine brands, and was the largest producer of cask (oak) wines. Constellation Wines was also a
leading independent beverage wholesaler to the on-premise trade in the U.K. and had more than
16,000 on-premise sales accounts. Its wholesaling business was led by wine products, but also
involved the distribution of branded distilled spirits, cider, beer, RTDs (ready-to-drink) and soft
drinks.
Constellation was the second largest producer and marketer of alcoholic beverage cider in the
U.K., with leading brands, Blackthorn and Gaymer’s Olde English. For the U.K. on-premises
market, Constellation produced and marketed Strathmore, a leading bottled water brand.
Constellation Beers and Spirits
This operating division imported and marketed a diversified line of beer and produced, bottled,
imported and marketed a diversified line of distilled spirits. It was the largest marketer of
imported beer in 25 primarily western U.S. states, where it had exclusive rights to distribute the
Mexican brands in its portfolio. For its non-Mexican beer brands the company had exclusive
rights to distribute product in all 50 states. Distribution included 6 of the top 22 imported beer
brands in the US; Corona Extra, Modelo Especial, Pacifico, Corona Light, St. Pauli Girl and
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Negra Modelo. Corona Extra was the best selling imported beer in the U.S. and the seventh best
selling beer overall in the U.S. Constellation also imported the Tsingtao beer brand from China.
Constellation Beer and Spirits was the third largest producer and marketer of distilled spirits in
the U.S. and exported its distilled spirits to other major distilled spirits consuming markets. Its
principal brands included Black Velvet, Barton, Skol, Fleischmann’s, Canadian LTD,
Montezuma, Ten High, Chi-Chi’s prepared cocktails, Mr. Boston, Inver House and Monte
Alban. Substantially all of this segment’s distilled spirits unit volume consisted of products
marketed in the value and mid-premium priced category. The division also sold bulk distilled
spirits and other related products and services.
CONSTELLATION’S OPERATIONS
Marketing and distribution
Constellation employed full time, in-house marketing, sales and customer service organizations
within its business segments to focus on each of its product categories. 19 These organizations
used a broad range of marketing strategies and tactics to build brand equity and increase sales,
including market research, consumer and trade advertising, price promotions, point-of-sale
materials, event sponsorship and public relations. Where opportunities existed, particularly with
national accounts, the company leveraged its sales and marketing skills across the organization.
In North American markets, the firm’s products were distributed primarily through more than
1,000 wholesale distributors as well as state and provincial alcoholic beverage control agencies.
Products sold through state or provincial alcoholic beverage control agencies were subject to
obtaining and maintaining listings to sell the firm’s products in that agency’s state or province.
Governments could affect prices paid by consumers of company products through imposition of
taxes or, in states or provinces in which the government acts as a distributor, by directly setting
retail prices for company products. In other markets, products were primarily distributed either
directly to retailers or through wholesalers and importers. In Australasia, distribution channels
were dominated by a small number of industry leaders. The U.K. wholesaling business sold and
distributed the firm’s branded products as well as those of the other major drinks companies
through a network of depots located throughout the country.
Production
In the U.S., Constellation operated 17 wineries where wine was produced from a variety of
grapes grown principally in the Napa, Sonoma, Monterey and San Joaquin regions of California.
In Australia, Constellation operated 11 wineries where wine was produced from many varieties
of grapes grown in most of that country’s major viticultural regions. Grapes were crushed at
most of these wineries and stored as wine until packaged for sale under the firms’ brand names
or sold in bulk. Most of the wine was purchased and sold within 18 months after the grape crush.
In the U.S., inventories of wine were usually at their highest levels in November and December,
immediately after each year’s harvest and grape crush. Inventories were reduced substantially by
the next year’s crush. Similarly, in Australia, inventories were normally at their highest levels in
April and May, immediately after that year’s grape crush. Substantial reductions in inventories
took place during the year and were lowest before the next harvest and crush. Constellation also
operated one winery in Chile and two wineries in New Zealand.
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The company marketed bourbon whiskeys and domestic blended whiskeys, each produced and
aged at its distillery in Bardstown, Kentucky. The primary distilled spirits bottling facility was
located in Owensboro, Kentucky; Canadian whiskeys were produced and aged at distilleries in
Lethbridge, Alberta and Valleyfield, Quebec. Sources of Scotch whiskey, tequila, mescal and
natural grain spirits used in the production of gin, vodka, and other spirits products were
purchased from various suppliers.
In the U.K., Constellation operated three facilitates that produced, bottled and packaged wine,
cider and water. To produce Stowells, wine was imported in bulk from various countries and
packaged at the company’s facility in Bristol. This facility also produced fortified British wine
and wine style drinks. All cider production took place at the company’s facility in Skepton
Mallet. Its Strathmore brand of bottled water was sourced and bottled in Forfar, Scotland.
Sourcing
The principal components in the production of branded beverage alcohol products were
agricultural products such as grapes and grain, and packaging materials (primarily glass). Most
of the firm’s annual grape requirements were purchased from each year’s harvest. In the U.S.
grapes were purchased from approximately 800 independent growers. With a majority of these
growers the firm had entered into written purchase agreements, with prices varying each year
based on market conditions. The company purchased a majority of its Australian grapes under a
long-term agreement from a growers’ cooperative comprising some 1,450 growers.
Constellation Brands owned or leased approximately 14,500 acres of land and vineyards, either
fully bearing or under development, in California, New York, Australia, New Zealand and Chile.
Most of this acreage was directed towards production of grapes for the firm’s production of
super-premium and ultra-premium brands. The great majority of the firm’s grape requirements
come from independent grape growers. Over the years the firm continued to consider the
purchase or lease of additional vineyards and additional land for vineyard plantings, as part of its
strategic plans to supplement its grape supply.
Distilled spirits production required various agricultural products, neutral grain spirits and bulk
spirits. These requirements were met through purchases from various sources by contractual
agreement as well as purchases in the open market. For example, in the U.K., the company
sourced apples for hard cider production primarily through long-term supply contracts with
owners of apple orchards.
Packaging materials included glass or plastic bottles, caps, corks, capsules, labels, wine bags,
and cardboard cartons. In the U.S. and Australia the glass packaging industry in particular was
highly concentrated, i.e., there were only a small number of producers. Almost all of
Constellation’s glass bottles were supplied by one U.S. producer, and the same was true in
Australia. While there had been no supply problems in past years, there was the risk that any
problems at these firms could adversely impact Constellation’s cost of goods sold, as packaging
costs represented a major portion of this account.
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Seasonality
Due to the agricultural nature of the firm’s products, growing seasons and harvests played a
critical role in product supply, especially in the wine segment. By diversifiying into the
Australian wine growing business, Constellation had balanced its seasonal cash needs. The
growing seasons, harvest times and grape crush periods in these two major supply regions were
almost exactly counter seasonal, adding an element of stability to company operations.
In the sales category, seasonal patterns of demand created more challenges for management. In
response to wholesale and retail demand patterns, which precede consumer purchases, the
company’s wine and spirits sales were typically highest during the third quarter of its fiscal year
(September through November) primarily due to seasonal holiday buying. Imported beer sales
were typically highest during the first and second quarter of the firm’s fiscal year (March
through August), spring and summer in the U.S. Seasonal cash flow volatility could be reduced
by these diversified beverages business segments.
Corporate strategies
Constellation’s management team believed that it had been and would continue to remain
focused across the beverage alcohol industry by offering a broad range of products in each of the
firm’s three major market segments; wine, beer and spirits. They intended to keep their portfolio
positioned for superior top-line growth while maximizing the profitability of its brands. The
company continuously strived to increase its relative importance to key customers in major
markets by increasing its share of their overall purchases. In a consolidating industry this was
considered to be a very important aspect of their business model. Their strategy of breadth across
categories and geographies, and strengthening scale in core markets, was designed to deliver
long-term profitable growth. This strategy allowed the company to take advantage of more
investment choices, provided flexibility to address changing market conditions and create
stronger routes-to-market.
The alcoholic beverage industry was experiencing consolidation at every step in the distribution
process. Grocery chains were consolidating and using their buying power to reduce prices from
wholesalers. Wholesalers were consolidating and demanding better prices from distributors. As
the consolidation trends among distributors continued, mounting pressures to keep prices down
were being felt by beverage producers. 20
Constellation’s businesses fell within one of two areas: growth or scale. The growth businesses
represented approximately 60 percent of Fiscal 2004 net sales and included approximately half
of the firm’s branded wine business (specifically premium wine in the U.S. and wines in the
U.K.), imported beer in the U.S., and the U.K. wholesale business. The scale businesses
represented approximately 40 percent of Fiscal 2004 net sales and included spirits, the remaining
half of the branded wine business, cider and non-branded sales. The scale businesses were
operated to maximize profitability and cash flow and to maintain strong routes-to-market. With a
solid foundation of growth and scale businesses, management expected to continue to be able to
leverage sales growth into even higher growth in earnings and cash flow. Constellation Brands
was committed to its long-term financial model of growing sales, both organically and through
acquisitions, expanding margins and increasing cash flow to achieve superior earnings per share
growth, improve returns on invested capital and maximize shareholder values.
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Financial performance
Since the 1980s, Constellation had financed its aggressive acquisition and expansion programs
by utilizing cash from borrowed funds. The result had been that, on a book value basis, debt had
consistently reached 50 to 60 percent of total capital. The debt markets reacted by keeping the
firm’s ratings below investment grade, with the results being relatively high interest rates having
to be paid to investors, along with significant guarantees and the use of the firm’s assets as
collateral (Exhibits 9, 10 and 11).
Given the speed and size of the firm’s external growth initiatives, even these sources were not
always adequate to finance all the deals. In March 2001, the company completed a public
offering of 8,740,000 shares of Class A common stock. Net proceeds to the firm after deducting
discounts and expenses, were $139.4 million. Funds were used to repay revolving loan
borrowings under the senior credit facility and contributed to an increase in the firm’s debt
capacity.
In October 2001, the company sold 645,000 shares of Class A common stock in a public
offering, receiving $12.1 million after deducting all expenses. Constellation was able to repay
borrowings under the senior credit facility with these funds. 21
During July 2003 another public offering was completed. The company sold 9,800,000 Class A
common shares, collecting net proceeds after underwriting discounts and expenses, of $261.2
million. In addition, 170,500 shares of its 5.75% Series A Mandatory Convertible Preferred
Stock were sold to the public. Net proceeds (after deducting underwriting discounts and
expenses) were $164.9 million. Most of the funds generated by these equity offerings were used
to repay bridge loans that were incurred to partially finance the Hardy acquisition. The remaining
funds were used to repay term loan borrowings made under the March 2003 credit agreement. 22
ROBERT MONDAVI – 2004
The Robert Mondavi Corporation was incorporated under the laws of California in 1981 as a
successor to Robert Mondavi Winery, formed as a California Corporation in 1966. The firm was
a leading producer and marketer of premium table wines. Its core brands included Robert
Mondavi Winery, Robert Mondavi Private Selection and Woodbridge. Robert Mondavi Winery
accounted for 3 percent by volume and 11 percent by net revenues for each of the last three fiscal
years’ (2004, 2003 and 2002) sales. Robert Mondavi Private Selection accounted for 16 percent,
15 percent and 14 percent by volume and 20 percent, 19 percent, and 19 percent by net revenues
of the company’s fiscal 2004, 2003 and 2002 sales, respectively. Woodbridge accounted for 71
percent, 75 percent and 76 percent by volume and 52 percent, 57 percent, and 57 percent, by net
revenue of the company’s fiscal 2004, 2003 and 2002 sales, respectively. 23
Mondavi also produced and marketed five wines under the following labels: La Famiglia,
Kirralaa, Byron Vineyards and Winery, Io, Arrowood Vineyards and Winery, and Grand Archer
by Arrowood. The company produced Opus One in partnership with Baroness Philippine de
Rothschild of Chateau Mouton Rothschild of Bordeaux, France; Luce, Lucente, Danzante and
Ornellaia in partnership with Marchesi de Frescobaldi of Tuscany, Italy; and Seña and Arboleda
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in partnership with the Eduardo Chadwick family of Viña Errazuriz in Chile. During the third
quarter of fiscal 2004, the company dissolved its joint venture with the Robert Oatley family and
Southcorp limited which produced the Kirralaa and Talomas brands. The firm continued to
produce Talomas wines for Southcorp Limited under a production agreement while Southcorp
produced Kirralaa wines for the company under a similar production agreement.
Sales volume for the fiscal year ended June 30, 2004, increased by 4 percent to 10.1 million
cases. Net revenue in that year increased by 3.4 percent to $468 million. Net revenues per case
declined from $46.67 to $46.39 as a result of increased sales incentives, which were recorded as
a reduction of revenues. Net income of $25.6 million ($1.55 per diluted share) for fiscal 2004
compared favorably with net income of $16.7 million ($1.02 per diluted) share for fiscal 2003.
This performance was primarily due to increased investment in the firm’s core brands, continued
development of new products and the positive impact of streamlining company operations and
organization structure in the second half of fiscal 2003 (see Exhibits 12, 13 and 14).
MONDAVI’S OPERATIONS
Marketing and distribution
The Mondavi sales force was composed of approximately 190 employees. Its wines were
available through all principal retail channels for premium table wine, including fine restaurants,
hotels, specialty shops, supermarkets and club stores in all fifty states of the U.S. as well as 90
countries throughout the world. Sales of company products outside the U.S. accounted for
approximately 10 percent, 8 percent and 9 percent of net revenues for fiscal years 2004, 2003
and 2002, respectively.
Mondavi’s wines were primarily sold to distributors who then sold them to retailers and
restaurateurs. Domestic sales were made to more than 100 independent wine and spirits
distributors. International sales were made to independent importers and generally were arranged
through brokers.
Mondavi had distribution agreements in California, Florida, Pennsylvania, Nevada, Hawaii,
Kentucky, Illinois and New Mexico with Southern Wine and Spirits, a large national beverage
distributor. Nationwide sales to Southern Wine and Spirits represented 28 percent, 32 percent
and 29 percent of the company’s gross revenues for fiscal years 2004, 2003, and 2002,
respectively. In fiscal 2004, sales to Mondavi’s 15 largest distributors accounted for 64 percent
of gross revenues. These distributors also offered premium table wines of other companies that
directly competed with Mondavi products.
Sales of the company’s wines in California accounted for 17 percent, 17 percent, and 19 percent
of gross revenues for fiscal years 2004, 2003, and 2002, respectively. Other major domestic
markets included Florida, Texas, New York, Massachusetts, Pennsylvania, New Jersey and
Illinois where annual sales represented collectively 34 percent, 33 percent and 31 percent of
gross revenues for fiscal years 2004, 2003 and 2002, respectively.
Grape supply
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Mondavi controlled approximately 8,820 acres of vineyards in the top winegrowing regions of
California, including Napa Valley, Lodi, Mendocino County, Monterey County, San Luis Obispo
County, Santa Maria Valley, Santa Barbara County and Sonoma County. Approximately 8,430
acres of the company-controlled vineyards were currently planted. In addition, the firm’s joint
ventures controlled approximately 570 acres of vineyards in the top wine growing regions of
Chile and Italy.
In fiscal 2004, approximately 16 percent of the company’s total grape supply came from
company-controlled vineyards, including approximately 66 percent of the grape supply for wines
produced at the Robert Mondavi Winery in Oakville. The balance of California grape supplies
were purchased from approximately 210 independent growers including approximately 40
growers in the Napa Valley. These contracts ranged from one-year spot market purchases to
intermediate- and long-term agreements.
Winemaking
Mondavi’s winemaking philosophy was to make wines in the traditional manner by starting with
high quality fruit and handling it as gently and naturally as possible all the way to the bottle. The
company emphasized traditional barrel aging as a cornerstone of its winemaking approach. Each
of the firm’s wineries was equipped with modern equipment and technology that was appropriate
for the style and scale of the wines being produced.
Mondavi employed approximately 940 regular, full time employees in all phases of its business.
It also employed part-time and seasonal workers for the vineyard, production and hospitality
operations. None of these employees were represented by a labor union and the firm believed
that it maintained good relationships with its employees.
THE PRIZE?
The Mondavi family had been making news quite regularly since 2000. In June 2000, an article
in The Wall Street Journal described their expansion initiative in France and the reactions of the
French: “All hell has broken out in the little French town of Aniane, near Montpellier, where 75
year-old vigneron Airne Guibert has declared war on octogenarian California winemaker Robert
Mondavi over his plans to invade France.” 24 Guibert, among other local winemakers, was
vehemently opposed to Mondavi’s deal with the Aniane local council to clear 125 acres of virgin
forest in the southern coastal plain and plant it with vineyards.
By 2003, Robert was publicly and privately criticizing his sons’ management of the firm and the
strategies they had been pursuing. The sons had emphasized the inexpensive Mondavi brand,
Woodbridge over the firm’s premium wine brands. Woodbridge wines retailed for $5 to $7 per
bottle and accounted for 60 percent of the firm’s revenues. In contrast the premium wines in the
Mondavi brand portfolio sold for up to $150 per bottle.
In 2003, Robert Mondavi told a reporter from The New York Times, “We concentrated too much
on Coastal and Woodbridge and now we’re known for wines at $7 and $9 a bottle. We’ve got to
get our image back, and that’s going to take time. We made mistakes in our public relations and
marketing, but now we know the problem, we understand it and we’re correcting it.” 25
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Mondavi also commented that his sons, “were interested in making money, and they forgot to
promote Robert Mondavi Napa Valley wines. We have to protect our tradition.” 26
The investment community was not pleased with the firm’s financial performance. Shares sold
below book value and hit a seven years low in early 2003 (see Exhibit 15). Having dropped
below $20 per share in 2003, Mondavi’s stock price had fallen markedly from its 1997 high of
$56.00 per share. Recent annual share price ranges for both Mondavi and Constellation Brands
are shown in Exhibit 15.
Another conflict erupted in 2003. After a management shuffle, Michael decided to re-brand some
of the firm’s lower priced wines as the Robert Mondavi Private Selection to take advantage of
the family’s reputation. Tim and his father opposed the move, believing that these moves would
adversely affect their other brands. 27
Michael prevailed, but the move proved to be a disaster. The new brand was undercut by rapidly
growing bargain wines, such as “Two-Buck Chuck” from the Charles Shaw Winery sold at
Trader Joe’s stores, as well as growing imports of competitively priced wines such as Yellowtail
from Australia and Concha y Toro from Chile. 28
In the spring of 2003, Tim left the firm for a six month “sabbatical” in Hawaii. He also had
financial problems from two divorces.
In January 2004, the family and outside directors replaced Michael as Chairman of the company
with Ted Hall, a former McKinsey consultant who had been recruited to the board just one
month earlier. Robert agreed with the company’s advisors that the business needed to be run by
professionals and that his two sons should be given time off.
During their times away from the firm both Tim and Michael sold shares in the company. They
converted their Class B shares into regular voting Class A shares. In February 2004, Tim sold
$2.7 million, while Michael had sold $2 million since his sabbatical. 29
In August 2004, Mondavi’s board of directors proposed a share reorganization plan that would,
for the first time in its history, leave the Mondavi family without a controlling interest in the
business. It was reported that the family would agree to convert their Class B shares into Class A
shares in the ratio of 1 to 1.165. There would also be a buyback of up to $30 million of stock if
and when the Class B shares were eliminated. Family ownership would increase from
approximately 36 percent to about 39 percent, while voting control would drop from just under
85 percent to just below 40 percent. 30
The company also took the first step in separating its everyday (lifestyle) wines business from its
luxury brands. “It has become increasingly clear in the new wine environment that $50 Napa
Valley cabernet and $6 premium wines require different business models,” Greg Evans,
president and Chief Operating Officer, said in a statement, “Therefore our board has elected to
develop separate operating plans for each business, which will provide greater focus and
additional opportunities to enhance value.” 31
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In September of 2004 the announcement was made. Mondavi planned to focus on its inexpensive
wines like Woodbridge, La Famiglia, Robert Mondavi Private Selection and Kirralaa and sell its
namesake winery as well as its high-end brands and ventures. These ventures included the firm’s
50 percent interest in Opus One, the Napa Valley winery joint venture with the owners of
Chateau Mouton-Rothschild in Bordeaux, France; the Arrowood and Byron wineries in
California; 50 percent interests in high-end Tuscan wineries Ornellaia and Lice del la Vita in
Italy; and Viña Seña in Chile. After sale of these operations, the Mondavi family would still
share ownership of an entity that, in turn, would own the Robert Mondavi trademark. That new
entity would license the Mondavi name back to each of the co-owners for a royalty fee. 32
THE MARKET REACTS
These restructuring and repositioning announcements did not sit well with analysts and the
investment community. Mondavi’s stock price declined by almost $3 per share the following
day, opening at $42.59, and closing at $39.68. Some analysts suggested that investors were
reacting to a proposed $200 million pre-tax restructuring charge, to be taken against current
quarterly earnings. 33
Ted Hall believed that a high-end, low volume winery that sold hand-crafted wines to an
exclusive group of buyers was not the sort of operation that could withstand the demands of
publicly held, profit-driven companies. Mondavi’s luxury assets were currently valued at 10 to
15 percent of the value of the firm, or $4 to $6 per share. If they could be sold within
management’s estimates they would yield upwards of $20 per share for existing shareholders.
Eighty percent of revenues and an even higher percent of earnings before interest, taxes,
depreciation and amortization (EBITDA) were coming from the “lifestyles” brands. “We are the
leading industry player that is a pure play” said Hall. 34
Greg M. Evans, President and CEO of the Robert Mondavi Corporation, presented
management’s strategic plans at the 34th Annual Investment Conference sponsored by Bank of
America in San Francisco:
Our goal is to enhance our position as a leading premium lifestyle wine
company with strong profitability and financial returns, and significant
growth opportunities in a very attractive category. Premium wine volumes
in the U.S. continue to grow at over 4 percent per year, and the growing
population of baby boomers suggests that these trends will continue for
the next five years. Our company expects to realize between $400 and
$500 million in net after-tax proceeds from the divestitures that
significantly exceeded current public market values, and achieving
financial flexibility through these cash proceeds to pursue value enhancing
strategic and financial opportunities. If we successfully complete the asset
divestitures we should have the flexibility to pursue attractive strategic
opportunities such as increasing organic growth, developing new products,
and expanding international business and to consider other ways to
enhance shareholder value. 35
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Under the newly proclaimed corporate strategy of focusing the firm on lifestyle wines and
divesting the luxury brands and wines to a private buyer, both Michael and Tim Mondavi
resigned their managerial positions in the firm, but retained their positions on the board of
directors. Their sister, Marcia Mondavi Borger, who was not in company management but also
had a seat on the board, voted with her brothers against the divestiture plan. 36
CONSTELLATION ACTS
Given all these activities swirling around the Mondavi Corporation, most experts felt that it was
not for sale — not on any terms. Richard Sands had other ideas and set them in motion by hiring
Merrill Lynch in June 2004 to analyze a potential purchase. 37
Plans laid idle until the Mondavi announcement of a recapitalization project to sell the premium
labels and its world-renowned winery in Oakville. Richard Sands quietly convened a meeting
with his brother Robert (Constellation’s chief operating officer), Merrill Lynch investment
bankers and takeover lawyers from Wachtell, Lipton to put together a financial package and
execute a bid. 38 See case Appendix A, Tables 1 – 4 for estimations of Mondavi’ expected
performance, as prepared by Constellation’s corporate planning department with guidance from
investment banking advisors at Merrill Lynch.
Price and form of an offer were the final questions that had to be answered. One option was a
share exchange, which would result in a tax free deal for selling shareholders. However, such a
deal had uncertain value, since investors’ valuation estimates could affect stock prices on a daily
basis. Constellation had utilized cash for most of its acquisitions over the last decade. While not
a tax-free exchange, cash did eliminate the uncertainty in the value of a deal.
The next question had to do with price. In the press, Mondavi management had estimated the
value of their restructuring and refinancing of the firm was worth between $749 million
($45.28/share) and $929 million ($56.17/share). 39 Averaging these numbers came out to
approximately $860 million. If this was indeed a fair market value for Mondavi, was there
potentially added value that could be extracted from a deal that kept the entire firm intact and
enhanced its operations? Such estimates needed to be made before any offer was publicly
announced. See case Appendix B for the company valuation estimates prepared by CEO Ted
Hall, subsequently made public by Mondavi.
Approximately one month after the Mondavi restructuring announcement, Richard Sands made
his move. In an October 12, 2004 letter he outlined his firm’s offer for the entire company.
Constellation was prepared to offer $53 per share for all Class A shares, $61.75 per share for all
Class B shares, for a total fully diluted value of approximately $970 million. The offer
represented a 37 percent premium over the prior day’s closing stock price on the NYSE. He also
urged Ted Hall, Mondavi board chairman, to “refrain from disposing of any assets or otherwise
pursuing a restructuring plan that would adversely affect the premium we can make available to
your shareholders.” 40
Page 108
The CASE Journal
WHERE WERE THE “WHITE KNIGHTS”?
The next few weeks of October proved to be a period of waiting for Constellation management,
hoping for a Mondavi response and waiting to see if any other firms would bid for either the
luxury asset package or the whole firm. A number of interested firms were named in various
newspaper and magazine articles, but as the days went by there was only one player who put
“money on the table.” 41
E & J Gallo was one of the firms whose name came up quickly. However, an industry analyst
opined, “an acquisition of this size is probably outside Gallo’s modus operandi, and the familyrun giant may struggle with competition issues, too, especially with their own lifestyle products.”
Representatives of Allied Domecq stated that, “Mondavi is not something high on our radar.” 42
Fosters’ Group Chief Executive Trevor O’Hoy said that his company was “at least 12 to 18
months from making acquisitions.” 43
“I’d like to help them if I could, but we don’t have the resources,” said Jess Jackson, the 74 yearold founder and chairman of Kendall-Jackson Wine Estates. 44
A representative of Diageo plc stated publicly that the U.K.-based beverage company probably
would pass on the opportunity. 45
Southcorp (an Australian wine conglomerate) also said publicly that it was not considering
acquisitions. 46
The only serious contender was French giant Pernod Ricard. Pernod Ricard was in a strong
position owing to the weakness of the dollar and the strength of its own stock price. It was keen
to expand its North American presence and would be comfortable with the broad range of
Mondavi brands. Other industry observers commented that Pernod Ricard would be more
interested in the purchase of its British rival, Allied Domecq.
SANDS’ EVALUATION OF MONDAVI
Significant cost savings could be envisioned by integrating Mondavi’s luxury brands within
Franciscan Estates, operating as a separate estate with Franciscan management responsible for
sales. Mondavi lifestyle brands would be integrated into the Constellation Wines U.S. units,
resulting in added synergies and efficiencies.
Sands also expected that a change in marketing strategy could add to the future value of Mondavi
operations. Mondavi’s sales force sold both Woodbridge and Private Selection brands, yet the
latter brand sales had lagged because such fine wines were not typically pushed by sales
personnel to retail chain stores. Sales persons also need to make calls to fine wine shops and
sommeliers at white tablecloth restaurants, which were better outlets for fine wines but tended to
be lower volume purchasers than retail chains. Constellation had conquered these marketing
challenges by establishing multiple sales forces. Franciscan Estates’ fine wine division was a
completely separate entity, from the ground to the consumer. The Robert Mondavi winery brands
would need to be separated from Private Selection and Woodbridge, in order to provide them the
focus and hand-selling to build their reputation and volume. 47
Page 109
The CASE Journal
Earnings and cash flow from the Mondavi operations could also be enhanced by bringing grape
costs down to market levels. In recent years, the Mondavis had entered into contracts for grapes
at high levels and these needed to be renegotiated. Mondavi also had excessive costs growing its
own grapes as well as substantial investments in vineyards. These were potential areas for
additional cost savings and operating efficiencies.
Exports were another market segment that could be exploited through Constellation facilities.
Constellation had some of the strongest routes-to-market, with its presence in the U.K. and
Mainland Europe. Constellation’s U.S. wines enjoyed a very significant quality-value
proposition outside the country. While Mondavi’s brand awareness was strong, the brand itself
was underdeveloped. Constellation’s marketing strengths were expected to result in expansion of
sales, especially in the Woodbridge brand, in the millions of cases over the next few years.
Richard and Robert Sands waited patiently as the days of October 2004 elapsed. The brothers
were ready, but would the Mondavi ownership be inclined to go along with the latest offer? Only
time would tell, but the Sands brothers retained the courage of their convictions.
Page 110
The CASE Journal
Exhibit 1
Constellation Brands
Merger & Acquisition History, 1987 – 2004
Year
Company
acquired
1987
Widener Wine
Cellars
Manischewitz
1991
1993
Guild Wineries and
Distillers
Barton
International
Vintners
International
Product lines &
brands
Market
segment(s)
Price
($millions)
Financing
$ 125.0
Debt (cash)
Table wine
149.0
Debt
Table wine
Table wine
Cribari
Dunewood
Cook’s
Corona Beer
Modelo Especial
St. Paul Gin
Barton Gin
Barton Vodka
Montezuma Tequila
Paul Masson
Taylor California
Cellars
Great Western
Table wine
Champagne
Imported
beer
Spirits
1994
Heublein Wine
brands
Inglenook
Almaden
Table wine
131.0
Debt
1995
Certain assets of
United Distillers
Glenmore
Kentucky Tavern
Fleischmann’s
Canadian Whiskey
Spirits
142.0
Debt
1998
Matthew Clark, plc
Producer & distributor
of cider, wine, bottled
water, house brands
Wine
Cider
Bottled water
475.0
Debt
1999
Franciscan Estates
Franciscan
243.0
Debt (cash)
Simi Winery
Simi
58.0
Debt (cash)
Black Velvet (from
Diageo)
Black Velvet
Premium
table wine
Premium
table wine
Beer
186.0
Debt
Table wine
4.5
Cash
Premium
152.0
Debt (cash)
2000
Forth Wines Ltd.
2001
Ravenswood
Ravenswood
Page 111
The CASE Journal
Year
2003
Company
acquired
Winery
Corus Brands
Product lines &
brands
Price
($millions)
Financing
52.0
Debt (cash)
Turner Road
Vintners (from
Sebastiani
Vineyards)
Pacific Wine
Partners (joint
venture with BRL
Hardy)
Blackstone Winery
(by Pacific Wine
Partners)
Talus
Vendange
Nathanson Creek
Heritage
Hardys
Leasingham
La Baume
295.0
Debt (cash)
from senior
notes
Table wine
33.0
Cash
Blackstone
Cordera
Premium
table wine
138.0
$69 million
from
Constellation,
$69 million
from BRL
Hardy
BRL Hardy
Yellow Tail
Banrock Station
Nobilo (New Zealand)
Barossa Valley
Chateau Reynella
Farallon
Popular &
premium
table wine
1,114.0
$660.2
million from
2003 credit
agreement;
$400 million
from Bridge
Loan
Agreement;
and
3,288,913
shares, $77
million value
Columbia
Covey Run
Market
segment(s)
table wine
Popular &
premium
table wine
Sources: Constellation Brands’ Annual Reports and 10-K.
Page 112
The CASE Journal
Exhibit 2
U.S. Beverage Consumption by Category, 1997-2004
(in millions of gallons)
Category
2004P
2003
2002
2001
2000
1999
1998
1997
Soft Drinks
15,413
15,308
15,200
15,023
14,925
14,895
14,820
14,385
Coffee
7,810
7,790
7,770
7,710
7,700
7,750
7,800
7,854
Milk
6,900
7,000
6,950
6,910
6,885
6,918
6,880
6,890
Beer
6,383
6,338
6,356
6,241
6,202
6,136
6,002
5,922
Bottled Water
6,200
5,800
5,250
5,400
4,950
4,570
4,070
3,730
Tea
1,985
1,950
1,940
1,910
1,870
1,850
1,825
1,788
Juices
1,880
1,860
1,830
1,790
1,750
1,720
1,710
1,702
Powdered
Drinks
1,300
1,310
1,320
1,340
1,350
1,370
1,360
1,365
Wine
637
614
584
557
552
538
519
512
Distilled Spirits
394
378
365
357
354
343
334
320
Cider (alcohol)
10
11
11
11
10
10
9
7
48,912
48,358
47,576
47,249
46,548
46,101
45,329
44,485
Totals
Notes: P = Preliminary
Totals may not add up due to rounding
Sources: Adams Wine Handbook 2003, 2005.
Page 113
The CASE Journal
Exhibit 3
U.S. Beverage Consumption, 1997-2004
(gallons per person)
Category
2004P
2003
2002
2001
2000
1999
1998
1997
Soft drinks
52.49
52.58
52.63
52.49
52.69
55.41
54.94
53.77
Coffee
26.60
26.76
26.90
26.94
27.18
28.83
28.92
29.36
Milk
23.50
24.04
24.06
24.14
24.31
25.74
25.51
25.75
Beer
21.74
21.77
22.01
21.80
21.90
22.83
22.25
22.14
Bottled water
21.11
19.92
18.18
18.87
17.48
17.00
15.09
13.94
Tea
6.76
6.70
6.72
6.67
6.60
6.88
6.77
6.68
Juices
6.40
6.39
6.34
6.25
6.18
6.40
6.34
6.36
Powdered drinks
4.43
4.50
4.57
4.68
4.77
5.10
5.04
5.10
Wine
2.17
2.11
2.02
1.95
1.95
2.00
1.92
1.91
Distilled spirits
1.34
1.30
1.26
1.25
1.25
1.28
1.24
1.20
Cider (alcohol)
0.03
0.04
0.04
0.04
0.04
0.04
0.03
0.03
166.56
166.10
164.72
165.08
164.34
171.50
168.04
166.28
Totals
Page 114
The CASE Journal
Exhibit 4
U.S. Retail Sales and Share of Retail Dollar by Beverage ($ millions)
2004P
2003
2002
2001
2000
1999
1998
1997
Beer
$82,20
0
$78,100
$74,435
$69,940
$67,400
$63,850
$59,811
$56,398
Soft drinks
81,762
79,612
75,915
74,700
73,100
70,980
68,913
66,171
Distilled spirits
49,443
45,498
42,150
39,502
37,317
35,770
34,014
33,600
Wine
23,100
21,800
20,530
19,020
18,120
16,600
14,535
13,718
Milk
21,440
20,300
18,765
18,400
17,700
17,495
17,153
17,166
Juices
14,890
14,694
14,360
14,000
13,400
13,140
13,066
13,002
Coffee
10,220
10,127
8,150
8,040
8,050
8,165
8,112
8,050
Bottled water
9,350
8,700
7,100
6,210
5,545
5,120
4,480
4,070
Tea
1,390
1,404
1,340
1,300
1,280
1,265
1,252
1,225
Powdered drinks
980
943
860
870
880
888
885
887
Totals
$294,7
75
$281,178
$263,605
$251,982
$242,792
$233,273
$222,221
$214,287
Category
Page 115
The CASE Journal
Exhibit 5
Wine Consumption in the U.S.
Year
Total wine
(millions of
1
gallons)
Total wine per
3
capita (gallons)
Total table wine
(millions of
2
gallons)
Total table wine
per capita
3
(gallons)
2004P
668
2.27
591
2.01
2003
643
2.21
574
1.97
2002
612
2.12
546
1.89
2001
572
2.00
512
1.79
2000
570
2.01
510
1.80
1999
543
2.02
475
1.77
1998
526
1.95
466
1.73
1997
519
1.94
461
1.72
1996
500
1.89
439
1.66
1995
464
1.77
404
1.54
1994
458
1.77
394
1.52
1993
449
1.74
381
1.48
1992
476
1.87
405
1.59
1991
466
1.85
394
1.56
1990
509
2.05
423
1.70
1989
524
2.11
432
1.74
1988
551
2.24
457
1.86
1987
581
2.39
481
1.98
1986
587
2.43
487
2.02
1985
580
2.43
378
1.58
1984
555
2.34
401
1.69
1983
528
2.25
402
1.71
1982
514
2.22
397
1.71
1981
506
2.20
387
1.68
Notes
Page 116
The CASE Journal
1
All wine types including sparkling wine, dessert wine, other special natural and table wines.
2
Table wines include all still wines not over 14 percent alcohol content.
3
Per capita consumption based on the resident population of the U.S.
Sources: The Wine Institute, www.wineinstitute.org,and Gomberg, Fredrikson & Associates.
Page 117
The CASE Journal
Exhibit 6
U.S. Wine Sales:
Domestic Shipments and Foreign Products Entering U.S. Distribution Channels,
1991-2004
(millions of gallons)
Total retail
value ($
billions)
Champagne/
sparkling wine
Total wine
48
30
667
$23.90
571
41
29
640
22.20
2002
546
38
28
612
21.60
2001
512
35
25
572
20.20
2000
510
33
27
570
19.30
1999
475
31
37
543
18.10
1998
466
31
29
526
17.00
1997
461
29
29
519
16.10
1996
439
31
29
500
14.30
1995
404
30
30
464
12.20
1994
394
33
31
458
11.50
1993
381
35
33
449
11.00
1992
405
37
33
476
11.40
1991
394
39
33
466
10.90
Year
Table wine
2004
590
2003
1
Dessert wine
2
3
Notes:
1
Includes all still wines not over 14 percent alcohol; excludes Canadian coolers (made from malt).
2
Includes all still wines over 14 percent alcohol.
Source:
The Wine Institute, www.wineinstitute.org
Page 118
The CASE Journal
EXHIBIT 7
Wine Consumption in the U.S. by Category, 1991-2004
(thousands of 9-liter cases)
Table
Other
Total
Table
Other
Total
Total Wine
Year
Domestic
Domestic
Domestic
Imported
Imported
Imported
Consumption
2004
183,140
19,020
202,160
59,690
6,212
65,902
268,062
2003
177,380
19,150
196,530
55,670
6,032
61,702
258,232
2002
170,583
20,074
190,657
49,695
5,916
55,611
246,268
2001
164,844
21,077
185,921
42,807
5,705
48,512
234,433
2000
164,734
20,747
185,481
39,755
6,035
45,790
231,271
1999
161,179
23,070
184,249
34,117
7,030
41,147
225,396
1998
156,174
22,279
178,453
32,549
5,595
38,144
216,597
1997
151,918
24,862
176,780
31,314
5,588
36,902
213,682
1996
147,163
27,417
174,580
28,831
5,487
34,318
208,898
1995
138,437
27,692
166,129
25,675
5,203
30,878
197,007
1994
132,309
30,530
162,839
24,659
5,547
30,206
193,045
1993
126,611
34,860
161,471
22,017
5,082
27,099
188,570
1992
128,358
42,572
170,930
24,661
5,233
29,894
200,824
1991
119,977
52,400
172,377
20,367
5,426
25,793
198,170
Sources: www.beveragehandbooks.com, Jobson's Wine Handbook, 1992–1996;
Adams/Jobson Wine Handbook, 1998; Adams Wine Handbook, 1999 - 2005
Page 119
The CASE Journal
EXHIBIT 8
U.S. Table Wine Market Color Mix Profile(1)
(millions of 9-liter case shipments)
Notes:
(2)
Year
Red
White (2)
Rosé/Blush (3)
2002
88
91
33
212
2001
81
84
33
198
2000
79
81
34
194
1999
74
74
38
185
1998
66
74
38
178
1997
61
76
39
176
1996
55
74
38
167
1995
46
71
39
156
1994
41
71
39
150
1993
36
68
38
143
1992
36
69
42
147
1991
26
67
40
133
1990
25
68
44
136
1985
33
99
27
159
1980
41
80
30
151
1975
36
27
21
83
1970
28
14
14
56
(1)
Totals
(4)
Consumption of Domestic and Imported Wine.
Includes white wine produced from white grapes only.
(3)
Includes all wines labeled “rose” or “blush” and all wines labeled “white” produced from red
(4)
Addition of columns may not agree due to rounding.
grapes.
Source: “The U.S. Wine Market,” Impact Databank: Review and Forecast, 1998, 2001, 2003.
Page 120
The CASE Journal
EXHIBIT 9
Constellation Brands Income Statements
Fiscal Year Ending February 2000 – 2004
(in thousands)
Sales
Less - Excise taxes
Net sales
Cost Of Production
Gross Profit
Selling, General & Administrative
Expenses
Acquisition Related Integration
Costs
Restructuring & Related Charges
Operating Income
Income on Derivatives
Equity in earnings of equity method
invests
Net Interest Expenses
Income Before Income Taxes
Provision for Income Taxes
Income Before Extra Ordinary
Items
Extra Ordinary Items
Net Income
Dividends on preferred stock
Income Available to
Shareholders
2004
2003
2002
2001
2000
$4,469,270
(916,841)
3,552,429
(2,576,641)
975,788
$3,583,082
(851,470)
2,731,612
(1,970,897)
760,715
$3,633,958
(813,455)
2,820,503
(1,901,462)
919,041
$3,154,294
(757,609)
2,396,685
(1,639,230)
757,455
$3,088,699
(748,230)
2,340,469
(1,618,009)
722,460
(457,277)
(350,993)
(576,560)
(486,587)
(481,909)
(31,154)
487,357
1,181
(47,640)
404,958
23,129
0
342,481
0
270,868
(5,510)
235,041
542
(144,683)
344,397
(123,983)
12,236
(105,387)
334,936
(131,630)
1,667
(114,189)
229,959
(91,984)
(108,631)
162,237
(64,895)
(106,082)
128,959
(51,584)
220,414
203,306
220,414
(5,746)
203,306
0
137,975
(1,554)
136,421
0
97,342
97,342
0
77,375
77,375
0
$214,668
$203,306
$136,421
$97,342
$77,375
Source: Company 10K Reports
Page 121
The CASE Journal
EXHIBIT 10
Constellation Brands Balance Sheets
(in thousands)
2004
2003
2002
2001
2000
Cash and cash investments
$37,136
$13,810
$8,961
$145,672
$34,308
Accounts receivable, net
635,910
399,095
383,922
314,262
291,108
1,261,378
819,912
777,586
670,018
615,700
137,047
97,284
60,779
61,037
54,881
2,071,471
1,330,101
1,231,248
1,190,989
995,997
Property, Plant & Equipment
1,097,362
602,469
578,764
548,614
542,971
Goodwill
1,540,637
722,223
668,083
Intangible Assets
744,978
382,428
425,987
Other Assets
104,225
159,109
165,303
772,566
809,823
$5,558,673
$3,196,330
$3,069,385
$2,512,169
$2,348,791
$1,792
$2,623
$54,775
$4,184
$28,134
Current maturities of long-term debt
267,245
71,264
81,609
54,176
52,653
Accounts payable
270,291
171,073
153,433
114,793
122,213
48,465
36,421
60,238
55,954
30,446
442,009
303,827
245,155
198,053
204,771
1,029,802
585,208
595,210
427,160
438,217
1,778,853
1,191,631
1,293,183
1,307,437
1,237,135
Deferred Income Taxes
187,410
145,239
163,146
131,974
116,447
Other Liabilities
184,989
99,268
62,110
29,330
36,152
Assets
Inventories
Prepaid expenses and other
Total current assets
Total Assets
Liabilities & Shareholders Equity
Notes payable to banks
Accrued excise taxes
Other accrued expenses and liabilities
Total current liabilities
Long Term Debt
Stockholder's Equity
Preferred Stock, $.01 par value-
2
Page 122
The CASE Journal
Class A Common Stock, $.01 par
value- Outstanding shares of 194.3
Million on February 2004
1,943
814
793
374
364
291
146
146
74
75
Additional paid-in capital
1,022,931
469,724
431,216
267,655
247,730
Retained earnings
1,010,193
795,525
592,219
455,798
358,456
372,302
(59,257)
(35,222)
0
0
0
(26,004)
(4,149)
2,407,662
1,206,952
989,152
697,897
602,476
(29,993)
(31,817)
(33,366)
(81,478)
(81,636)
(50)
(151)
(50)
(151)
0
2,377,619
1,174,984
955,736
616,268
520,840
$5,558,673
$3,196,330
$3,069,385
$2,512,169
$2,348,791
Class B Convertible Common Stock,
$.01 par value - Outstanding shares of
29.1 Million on February 2004
Accumulated other comprehensive
income
Cumulative translation adjustment
Less-Treasury stock
Less-Unearned compensationrestricted stock awards
Total Stockholders' Equity
Total Liabilities & Stockholder's
Equity
Page 123
The CASE Journal
EXHIBIT 11
Constellation Brands Statements of Cash Flow
(in thousands)
2004
2003
2002
2001
2000
$220,414
$203,306
$136,421
$97,342
$77,375
Depreciation of property, plant and equipment
80,079
54,147
51,873
44,613
40,892
Deferred tax provision
31,398
21,050
3,675
6,677
800
-
21,875
5,942
33,531
25,770
23,831
5,127
7,263
324
2,356
(2,003)
233
100
101
280
856
93
60
516
503
427
(542)
(12,236)
(1,667)
-
-
(1,181)
(23,129)
-
-
Cash flows from operating activities
Net income
Adjustments to reconcile net income to net cash
provided by operating activities
Non-cash portion of loss on extinguishment of debt
Amortization of intangible and other assets
Loss on disposal of assets and asset impairment
charges
Stock-based compensation expense
Amortization of discount on long-term debt
Equity in earnings of equity method investments
Gain on change in fair value of derivative
instruments
Extraordinary item, net of income taxes
1,554
Change in operating assets and liabilities, net of
effects from purchases of businesses:
(63,036)
6,164
(44,804)
(27,375)
(10,812)
96,051
(40,676)
(19,130)
(57,126)
1,926
2,192
(11,612)
566
(6,443)
4,663
(61,647)
10,135
19,069
(11,354)
(17,070)
7,658
(25,029)
4,502
26,519
(18,719)
11,417
42,882
30,996
4,333
44,184
Other, net
(10,624)
(2,314)
(4,228)
(2,320)
4,005
Total adjustments
119,893
32,747
76,878
6,433
70,680
$340,307
$236,053
$213,299
$103,775
$148,055
(1,069,470)
-
(472,832)
(4,459)
(452,910)
(105,094)
(71,575)
(71,148)
(68,217)
(57,747)
Inventories
Prepaid expenses and other current assets
Accounts payable
Accrued excise taxes
Other accrued expenses and liabilities
Net cash provided by operating activities
Cash flows from investing activities
Purchases of businesses, net of cash acquired
Purchases of property, plant and equipment
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Investment in equity method investee
-
-
Investment in joint ventures
-
-
35,815
2,009
14,977
(77,282)
Payment of accrued earn-out amount
(2,035)
(1,674)
849
-
13,449
1,288
-
-
3,814
0
0
0
0
(1,158,487)
(71,961)
(585,447)
(70,667)
(495,680)
1,600,000
10,000
252,539
319,400
1,486,240
36,017
28,706
45,027
13,806
3,358
3,481
2,885
1,986
1,547
1,428
(1,282,274)
(151,134)
(260,982)
(221,908)
(1,059,952)
(1,113)
(51,921)
51,403
(23,615)
(60,629)
(33,748)
(20)
(4,537)
(5,794)
(14,888)
(3,295)
-
Proceeds from equity offerings, net of fees
426,086
0
151,479
0
0
Net cash provided by (used in) financing
activities
745,154
(161,484)
236,915
83,436
355,557
Effect of exchange rate changes on cash and cash
investments
96,352
2,241
(1,478)
(5,180)
(1,269)
Net (decrease) increase in cash and cash
investments
23,326
4,849
(136,711)
111,364
6,663
CASH AND CASH INVESTMENTS, beginning of
year
13,810
8,961
145,672
34,308
27,645
$37,136
$13,810
$8,961
$145,672
$34,308
Proceeds from sale of marketable equity securities
Proceeds from sale of assets
Proceeds from sale of equity method investment
Proceeds from sale of business
Net cash used in investing activities
Cash flows from financing activities
Proceeds from issuance of long-term debt
Exercise of employee stock options
Proceeds from employee stock purchases
Principal payments of long-term debt
Net repayment of notes payable
Payment of issuance costs of long-term debt
Payment of preferred stock dividends
CASH AND CASH INVESTMENTS, end of year
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EXHIBIT 12
Robert Mondavi Corporation Income Statements
Fiscal Year Ending June 30, 2000 – 2004
(in thousands)
2004
2003
2002
2001
2000
$491,957
$475,478
$463,587
$529,473
$447,881
23,910
22,805
22,229
23,646
20,158
Net revenues
468,047
452,673
441,358
505,827
427,723
Cost of goods sold
283,849
280,957
249,593
264,739
226,493
Gross profit
184,198
171,716
191,765
241,088
201,230
Selling, general and administrative expenses
132,259
129,993
125,760
157,354
125,072
(1,531)
(1,965)
--
0
4,076
12,240
0
0
53,470
39,612
53,765
83,734
76,158
Interest, net
21,382
22,414
23,306
21,411
16,041
Equity income from joint ventures
(6,685)
(9,423)
(8,868)
8,606
5,977
Other
(1,580)
89
(255)
(537)
1,495
40,353
26,532
39,582
70,392
67,589
Provision for income taxes
14,769
9,817
14,844
27,098
26,004
Net income
$25,584
$16,715
$24,738
$43,294
$41,585
Revenues
Less excise taxes
Gain on sale of assets, net
Special charges, net
Operating income
Other (income) expense:
Income before income taxes
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EXHIBIT 13
Robert Mondavi Corporation Balance Sheets
(in thousands)
(In thousands, except share data)
2004
2003
2002
2001
2000
$48,960
$1,339
--
$7,189
$3,002
94,549
96,111
92,555
104,555
77,662
387,940
392,635
388,574
358,756
298,487
7,025
12,545
12,179
10,400
4,331
538,474
502,630
493,308
480,900
383,482
397,699
416,110
323,582
338,935
312,065
29,607
30,763
27,220
31,311
32,720
Restricted cash
6,184
5,143
Other assets
6,206
6,531
11,455
13,212
6,676
$978,170
$961,177
$855,565
$864,358
$734,943
Notes Paybles to Banks
--
--
$2,734
$15,800
$19,700
Short-term borrowings
--
5,000
4,400
Accounts payable
26,037
28,727
23,012
29,752
24,540
Employee compensation and related costs
15,905
13,987
11,044
19,835
13,725
6,967
7,115
7,453
Other accrued expenses
14,693
7,317
13,673
12,360
7,343
Current portion of long-term debt
18,910
9,837
12,568
15,823
10,102
82,512
71,983
74,884
93,570
75,410
363,289
397,889
316,169
335,970
280,790
42,773
30,610
24,039
23,454
21,850
Deferred executive compensation
7,484
6,508
5,657
5,128
8,575
Other liabilities
2,312
3,193
3,537
3,767
150
498,370
510,183
424,286
461,889
386,775
ASSETS
Current assets:
Cash and cash equivalents
Inventories
Prepaid expenses and other current assets
Total current assets
Property, plant and equipment, net
Investments in joint ventures
Total assets
LIABILITIES AND SHAREHOLDERS'
EQUITY
Current liabilities:
Accrued interest
Total current liabilities
Long-term debt, less current portion
Deferred income taxes
Total liabilities
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Shareholders' equity:
Preferred Stock: authorized - 5,000,000
shares; No issued & Outstanding
Class A Common Stock, authorized 25,000,000 shares; without par value;
outstanding - 10,676,399 & 9,734,645 shares
99,268
95,909
93,827
91,214
83,161
Class B Common Stock, without par value:
authorized - 12,000,000 shares; without par
value; outstanding - 5,770,718 and 6,621,734
shares
9,256
10,636
10,677
11,059
11,732
13,347
11,579
11,025
10,547
5,780
359,436
333,852
317,915
292,399
249,105
(534)
--
(1,011)
(1,269)
(1,716)
(2,750)
(1,610)
38
287
(449)
0
0
479,800
450,994
431,279
402,469
348,168
$978,170
$961,177
$855,565
$864,358
$734,943
Paid-in capital
Retained earnings
Deferred compensation stock plans
Cumulative translation adjustment
Forward contracts
Total shareholders' equity
Total liabilities and shareholders'
equity
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EXHIBIT 14
Robert Mondavi Corporation Statements of Cash Flow
(in thousands)
2004
2003
2002
2001
2000
$25,584
$16,715
$24,738
$43,294
$41,585
9,283
10,815
(6,054)
(3,482)
873
Depreciation and amortization
25,348
25,239
24,512
21,861
18,901
Equity income from joint ventures
(6,685)
(9,423)
(8,868)
(8,606)
(5,977)
7,648
9,388
9,132
--
4,076
10,320
2,451
11,565
3,750
(1,531)
(1,965)
--
2,238
1,472
315
307
(2,320)
1,562
(3,556)
12,000
(26,236)
4,375
Inventories
6,173
(16,839)
(33,814)
(40,926)
(37,014)
Other assets
5,303
(5,306)
5,531
(99)
1,038
Accounts payable and accrued expenses
4,921
(542)
(7,344)
15,634
4,216
189
(544)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income
Adjustments to reconcile net income to net cash flows
from operating activities:
Deferred income taxes
Distributions of earnings from joint ventures
Special charges, net
Inventory and fixed asset write-downs
Gain on sale of assets, net
Other
Change in assets and liabilities, net of acquisitions:
Deferred revenue
Deferred executive compensation
Other liabilities
Net cash flows from operating activities
976
851
529
(3,447)
1,150
(332)
(344)
(230)
(383)
(85)
$82,939
$42,146
$34,517
($1,894)
$26,198
($16,502)
($36,148)
($137,698)
($50,465)
($78,005)
3,788
24,967
12,553
3,716
--
--
--
15,657
(14,191)
--
(1,750)
--
7,232
5,714
CASH FLOWS FROM INVESTING ACTIVITIES
Acquisitions of property, plant and equipment
Proceeds from sale of assets
Distributions from joint ventures
Issuance of notes receivable to joint ventures
Distributions from joint ventures
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Contributions of capital to joint ventures
Increase in restricted cash
Net cash flows from investing activities
--
(1,814)
(7,287)
(628)
(12,603)
(1,041)
(838)
(402)
($13,755)
($13,833)
($117,177)
($56,086)
($84,894)
--
(2,734)
2,734
(19,000)
(22,400)
(19,600)
(18,828)
17,800
5,102
10,625
105,195
85,000
50,000
(8,797)
(13,831)
(14,856)
(10,115)
(11,218)
475
514
571
560
536
1,504
1,527
2,776
6,820
1,063
--
--
(1,116)
(847)
(675)
(233)
(1,270)
(1,027)
($21,563)
($26,974)
$75,471
$62,167
$57,154
47,621
1,339
(7,189)
4,187
(1,542)
1,339
--
7,189
3,002
4,544
$48,960
$1,339
-
$7,189
$3,002
CASH FLOWS FROM FINANCING ACTIVITIES
Book overdraft
Net repayments under credit lines
Proceeds from issuance of long-term debt
Principal repayments of long-term debt
Proceeds from issuance of Class A Common Stock
Exercise of Class A Common Stock options
Repurchase of Class A Common Stock
Other
Net cash flows from financing activities
Net change in cash and cash equivalents
Cash and cash equivalents at the beginning of the
fiscal year
Cash and cash equivalents at the end of the fiscal
year
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Exhibit 15
Constellation Brands and Robert Mondavi Corporation
Annual Stock Price Ranges, 1994 - 2004
Year
Constellation
Brands
Mondavi
Low
High
Low
High
2004
$14.70
$23.90
$31.00
$43.50
2003
$11.00
$17.40
$18.50
$40.60
2002
$10.60
$16.00
$28.10
$39.80
2001
$6.70
$11.50
$27.70
$54.60
2000
$5.00
$7.40
$29.40
$54.70
1999
$5.40
$7.70
$29.00
$41.40
1998
$4.70
$7.50
$20.10
$50.25
1997
$2.00
$6.70
$36.00
$56.75
1996
$2.90
$6.60
$24.75
$38.25
1995
$3.70
$6.00
$10.38
$32.50
1994
$2.50
$4.00
$6.50
$11.88
Notes:
Mondavi went public in 1994.
Constellation prices have been adjusted for 2 for 1 splits in 2001, 2002 and 2005.
Constellation common stock was listed on the NYSE in 1999.
Source: Value Line Ratings and Reports for Constellation Brands and Robert Mondavi
Corp.
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APPENDIX A
Report from the Constellation Corporate Planning Department to Mr. Richard Sands Regarding
Expected Performance of the Robert Mondavi Company Operations: Under Present Management
and Constellation Brands’ Management
Our department has completed a study of the brands and operations of the Mondavi company, and it is
our opinion that a number of areas can be rationalized and enhanced if they are incorporated into our
business model.
The firm has struggled with its marketing plans in recent years, resulting in net sales that have not even
kept up with the overall wine industry. In fact, production and sales levels were higher a few years ago
than they were in fiscal 2004. This has been due primarily to their emphasis on marketing the “lifestyle”
products while the premium products have not been managed effectively. Our specialized marketing
strategies for life style and premium wines should be able to restore some of the luster that has been lost
by their premium products. We expect to be able to grow their entire brand portfolio at an average of 8
percent per year over the next ten years, higher than an estimate of 6.25 percent per year if current
management strategies are implemented. (See attached tables for details)
On the cost side of the business we envision the following opportunities for enhanced efficiencies and
productivity. As their high cost grape contracts wind down, we will substitute our purchasing
management and achieve savings spread out over the next decade. Consolidation of bottling and
packaging operations will also generate cost savings that current management could not match.
SG&A is another area targeted for significant improvement. Integrating the Mondavi product portfolio
into our offerings and restructuring marketing and advertising programs should generate results that
Mondavi management could not achieve as a standard firm.
We have also provided estimates of the asset structure that would be expected under these two scenarios.
See Tables 1 and 2. While both alternatives would result in inventories growing more slowly than in the
past, Constellation is expected to achieve even greater economies. We also expect to be able to collect
accounts receivable a bit more efficiently than current management.
Lower asset levels will naturally result in lower financing needs under Constellation. We would expect to
be able to achieve more favorable credit terms from one supplier. All of these improvements will
contribute to added cash flows for our firm.
Financing cost levels at Constellation are also more favorable than those of Mondavi as a stand-alone
firm. New long-term debt would probably cost us 7.5 percent, compared with at least 8.25 percent for
Mondavi. While our historical price-earnings ratio has been between 10 and 12 Mondavi’s range has been
wider, between 10 and 14. Beta (β) for Constellation is currently 0.9 compared with 1.4 for Mondavi,
reflecting the overall strengths of our diversified product portfolio. For cost of equity estimates using
CAPM, a market (equity) risk premium of 5 percent seems reasonable. Using the bond yield plus risk
premium method, a bond risk premium of 4 percent is used. Calculating the WACC at either market or
book value for equity, Constellation’s cost structure is lower than Mondavi as a stand-alone entity. Thus,
our valuation of Mondavi business is greater than their valuations.
In conclusion, the results of these initiatives should make this deal a very successful decision for
Constellation Brands. We should be able to out bid rivals for Mondavi, if they surface before we close on
a deal. We can structure the deal as tax-free, if necessary, although it seems likely that a cash transaction
Page 132
The CASE Journal
is being sought by most of Mondavi’s shareholders, especially family members. It would be prudent to
line up financing through our excellent banking relationships, and ultimately restructure our balance sheet
after the deal is completed and at the most advantageous time in the capital markets.
Table 1
Assumptions Used to Evaluate the Robert Mondavi Corporation, prepared by
Constellation Brands’ corporate planning department
Items
Income Statement Under
Current Management
Income Statement Under
Constellation
Management
Total Revenues
4.5% per year
10% per year
Net Revenues
4.5% per year
10% per year
2005-6
61% of Net Revenues
60% of Net Revenues
2007-8
59% of Net Revenues
58% of Net Revenues
2009-10
56% of Net Revenues
56% of Net Revenues
2011-12
54% of Net Revenues
54% of Net Revenues
2013-14
53% of Net Revenues
52% of Net Revenues
2005-6
28% of Net Revenues
27% of Net Revenues
2007-8
28% of Net Revenues
26% of Net Revenues
2009-10
28% of Net Revenues
25% of Net Revenues
2011-14
28% of Net Revenues
24% of Net Revenues
7% of PP & E
7% of PP & E
37% of Net Income
37% of Net Income
Terminal Value (1)
12 x Net Income in 2014
12 x Net Income in 2014
CF (in 2014)/r-g (2)
r = WACC
r = WACC
g = 4%
g = 4%
Cost of Goods Sold
SG&A
Depreciation & Amortization
Expenses
Corporate Income Tax Rate
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Table 2
Assumptions Used to Evaluate the Robert Mondavi Corporation
prepared by Constellation Brands’ corporate planning department
Items
Balance Sheets Under
Current Management
Constellation
Management
Cash
2% of Net Revenues
2% of Net Revenues
Accounts Receivable
20% of Net Revenues
18% of Net Revenues
2005-7
74% of Net Revenues
72% of Net Revenues
2008-10
71% of Net Revenues
69% of Net Revenues
2011-14
67% of Net Revenues
65% of Net Revenues
Prepaid Expenses
2% of Net Revenues
2% of Net Revenues
2005-7
77% of Net Revenues
77% of Net Revenues
2008-10
73% of Net Revenues
73% of Net Revenues
2011-14
68% of Net Revenues
68% of Net Revenues
Invest. in Joint Ventures
6% of Net Revenues
6% of Net Revenues
Other Assets
1.5% of Net Revenues
Assets
Inventories
PP & E
Page 134
The CASE Journal
Table 3
Assumptions Used to Evaluate The Robert Mondavi Corporation, prepared by
Constellation Brands’ corporate planning department
Items
Current Management
Short Term Liabilities
20% of Net Revenues
20% of Net Revenues
Accounts Payable
Employment Compensation
5% of Net Revenues
5% of Net Revenues
5% of Net Revenues
5% of Net Revenues
Constant
Constant
From Income Statement
From Income Statement
Constellation
Management
Liabilities & Capital
Other Accrual Liabilities
Current Portion of Long
Term Debt
Deferred Income Taxes
Deferred Executives’
Compensation
Other Liabilities
Long Term Debt – PLUG
(Total Assets – Liabilities
excluding Long Term
Debt)
Other Items
Retained Earnings
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Table 4
Selected Financial Markets Data -- from Federal Reserve Statistics
September
October
November
2004
2004
2004
90 days
1.68
1.79
2.11
6 Months
1.91
2.05
2.32
1 Year
2.12
2.23
2.5
5 Years
3.36
3.35
3.53
10 Years
4.13
4.1
4.19
20 Years
4.89
4.85
4.89
Aaa
5.46
5.47
5.52
Bbb
6.27
6.21
6.2
4.58
4.75
4.93
Finance
1.81
1.97
2.2
Non - Finance
1.75
1.95
2.18
Treasury Rates
Notes and Bonds
Bonds
Corporate Bonds
(Moody's)
Floating Rates
Prime Rate
Commercial Paper (3
Months)
Page 136
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Appendix B
Ted Hall’s Valuation of Mondavi Luxury Brands’ Vineyards and the Oakville Winery
CEO Ted Hall’s estimate of the value of assets to be sold amounted to between $400 and $500
million. In contrast, Vic Motto, head of the Napa-based wine consultancy Motto Kryla Fisher,
said this range represented the company’s “dream number” for the sale. Based on operating
income of these assets, other analysts pegged the value of the luxury division at not more than
$320 million. The $500 million number would equate to 31.25 times operating earnings, more
than double the 14 times paid by Constellation Brands for BRL Hardy in 2003.1
Real estate agents in the Napa Valley routinely sold vineyards in the area and felt confident in
the following ranges for Mondavi acreage:
To-Kalon Vineyard
Acreage
Price Per Acre
Value
550
$150,000 - 250,000
$82.5m - $137.5m
40.0m - 60.0m
(in Oakville)
Acres
Stags Leap
400
100,000 - 150,000
Carneros’ Huichica
450
75,000 - 125,000
160
50,000 - 90,000
33.75m - 56.25m
Creek
Vineyard near Napa
8.0m - 14.4m
$164.25m - $268.15m
Page 137
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Hall noted that a financial analyst at D.A. Davidson had written in a September 2004 newsletter
that the Mondavi interests in Opus One, Arrowood, Byron and Omallia operations could sell for
between $140 and $210 million. That analyst had also put a value on the Oakville winery at
between $100 and $150m.
Low
High
Vineyards
$164.25
$268.15
Brands
140.00
210.00
Winery
100.00
150.00
$404.25
$628.15
The Oakville winery had a permit that allowed for wine production of up to 1.6 million gallons per
year, along with numerous opportunities for public and private events. No new winery would be
able to obtain these retail privileges in today’s environment. The winery’s location was also a
key factor in its value to a buyer. It was located further south than many of the other large tourist
stops in the valley. Therefore, it was well positioned to draw visitors driving from the Bay Area.2
1
San Francisco Chronicle, September 21, 2004.
2
Friedman, G., “Trying to put a price on key winery assets,” Napanews.com, October 20, 2004.
Endnotes
1
Sands, Richard, Chairman of the Board of Directors, Constellation Brands 2004 Annual Report, 4.
Annual Report on Form 10K, Constellation Brands 2004, 15.
3
Annual Report, Canandaigua Brands, 1995.
4
Siler, J. F. (2007). The House of Mondavi: The Rise and Fall of An American Wine Dynasty. New York: Penguin.
2
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5
Shanken, M. R. (2005, April 30) “How Constellation captured Mondavi’s empire,” Wine Spectator, 82-92.
Impact Databank, 2003.
7
Ibid.
8
United States Department of the Treasury, Title 27: Part 4 of the Code of Federal Regulation, Bureau of Alcohol,
Tobacco and Firearms, Regulatory Agency.
9
Huneeus, A.F. (2001). In Moulton, K. and J. Lapsley, (eds), Successful Wine Marketing, Gaithersburg, MD: Aspen
Publishers.
10
McGinn, D. and Joseph, N. (2006, February 20). “Having great expectations,” Newsweek, E-12.
11
Ibid.
12
Ibid.
13
Annual Report on Form 10K, Constellation Brands, 2004.
14
Prial, op cit.
15
Fitch, S. (2000, March 20). “Up from the gutter,” Forbes, 68-70.
16
Prial op cit.
17
Fisher, op cit.
18
Anon, (2004, July). 2004 State of the industry report. Beverage Industry, 95(7), 12-30.
19
Annual Report on Form 10K, Constellation Brands, 2004, 4-5.
20
Fitch, S., op cit., 70.
21
Annual Report on Form 10 K, Constellation Brands,2004, 27.
22
Ibid.
23
The Robert Mondavi Corporation, Form 10K, June 30, 2004, 1.
24
Levy, Paul, “ Mondavi Moves in, and the French Cry Foul,” The Wall Street Journal, June 14, 2000.
25
Prial, F. J. (2003, July 2) “With head held high, Mondavi, at 90, faces a storm,” The New York Times.
26
Ibid.
27
Flynn, J. (2004, June 3) “Inside a Napa Valley empire, a family struggles with itself,” The Wall Street Journal.
28
Ibid.
29
Ibid.
30
Prial, F. J. (2004, August 25). “Mondavi family to loosen control over winery,” The New York Times.
31
Ibid.
32
Prial, F. J. (2004, September 16) “The grapevine is whispering; the name it says is Mondavi,” The New York
Times.
33
Claire, J. (2004, September 16) “Mondavi stock drops, but some say sale is smart move,” napanews.com.
34
Anon., (2004, September 23) napanews.com.
35
Press release, The Robert Mondavi Corporation, September 4, 2004.
36
Claire, J. (2004, Oct. 7) “Michael Mondavi asked to resign for ‘violating confidentiality of board discussions,’”
napanews.com; Carson, L. P. (2004, Oct. 7) “Tim Mondavi resigns as shake-up continues,” napanews.com.
37
Goldman, L. (2005, January 10). “Big Gulp,” Forbes, 68-73.
38
Ibid.
39
Current book value on a fully diluted basis was $29/share, while shares were selling at $36/share on the NYSE.
40
Letter to Ted Hall from Richard Sands, October 12, 2004.
41
Just-drinks.com editor’s weekly highlights, Issue 242, October 24, 2004. Just-drinks.com, op cit.
42
Hall, J. (2004, October 19) “Mondavi to get wined and dined by Constellation,” Company News.
43
Ibid.
44
Berman, D. K. & Flynn, J. (2004, October 27) “Bidders develop taste for Mondavi,” The Wall Street Journal.
45
Ibid.
46
Just-drinks.com (2004), op cit.
47
Ibid.
6
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