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The CASE Journal
Volume 3, Issue 2 (Spring 2007)
Page 1
The CASE Journal
Table of Contents
Click on the article or case title to go to that page
Editorial Policy
Letter from the Editor
Case and Article Abstracts
Cases
“Exploring Strategic Change: A Case Analysis of the ConocoPhillips Merger”
Kanalis A. Ockree, James Martin, & Richard A. Moellenberndt, Washburn University
“ABB Transformers - Denmark (A)” &
“ABB Transformers – Denmark (B): For Adults Only”
Mikael Søndergaard, Arhus University, & William Naumes, University of New Hampshire
“A Troubled Time in the Courtyard”
Arthur Sharplin & John Seeger, Bentley College
“Transition from Microfinance Institution to Regulated Bank: The Case of Fonkoze’s Transformation”
Michael Tucker, Winston Tellis & Dina Franceschi, Fairfield University
“Bright Lights: Exploring the Franchising Potential of a Not-For-Profit Organization” &
“Technical Note: Franchising”
Monica Godsey & Terrence C. Sebora, University of Nebraska
Integrative Case-Based Exercise
“Business Models and Financial Structures: A Strategy Mystery Game” &
“A Brief on ‘Business Models and Financial Structures: A Strategy Mystery Game’”
Stephanie Hurt, Meredith College, & Marcus J. Hurt, EDHEC Business School
Invited Article
“21st Century Learning: Leadership Lessons from Collaborative Case Research, Teaching and
Scholarship”
John F. McCarthy, University of New Hampshire, David J. O’Connell, St. Ambrose University, Douglas
T. Hall, Boston University, & Jan Eyvin Wang, United European Car Carriers
Membership Form
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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 what appears 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 and their e-mail
addresses will be provided for such purpose.
INITIAL SUBMISSION:
All cases and articles will be subject to a double blind review process. Our reviewers
believe that the process is developmental, and will offer suggestions for improvement and
revision, where appropriate.
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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 authoridentifying 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. Send one (1) copy to the
editor by e-mail in MS-Word and/or IBM text format. 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). 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.
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. Authors are responsible for distributing the
teaching notes as requested.
Cases published in The CASE Journal are also distributed through the Primis Online and
ecch distribution networks.
Circulation Data:
Reader:
Frequency of Issue:
Copies per Issue:
Subscription Price:
Publishing Fee:
Sponsorship:
Academic and Practitioner
2-3 times per year (September, January and April
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
($25 membership fee)
Professional Association
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LETTER FROM THE EDITOR
Margaret Naumes
Welcome to the second issue of Volume 3 of The CASE Journal. This edition offers five cases
(one a series), a case-based instructional exercise, and an invited article. As in the previous
issue, several of the cases are from Herb Sherman’s editorship. He continues to serve as my
informal advisor even as he moves on to other projects, now including serving as President of
The CASE Association, our parent organization. Congratulations, Herb!
This edition’s cases are from a variety of disciplines, representing the diverse areas where cases
are being used, from finance to organization theory, ethics, strategic management, and social
entrepreneurship. Their subjects range from small not-for-profit organizations to large
multinationals. All have thoroughly developed instructor’s manuals, sometimes longer than the
case, that offer pedagogical insights grounded in theory. The Journal does not publish the
instructor’s manuals, but they are a critical part of the review process. Faculty members adopting
a case should get in touch with its authors for the manual.
The first case in this edition is “Exploring Strategic Change: A Case Analysis of the ConocoPhilips Merger.” The authors provide extensive financial information on the two companies
before the merger as well as post merger data. Their objectives are to challenge students to
perform and interpret financial statement analysis. They ask students to explain to stockholders
the financial impact of the merger. They encourage students in advanced finance courses to use
financial research tools and to consider issues relating fair treatment of stockholders.
The “ABB Transformers – Denmark” case series also asks students to consider issues of
corporate strategy and fairness, this time from the point of view of a middle manager who is truly
“caught in the middle” of his company’s matrix structure. In the “A” case, he must make a
recommendation as to whether to move his plant from Denmark to Southeast Asia to his
superiors, the Country Manager for Denmark and the Product Manager responsible for global
production of electric transformers. The “B” case reveals the decision that had been made, but
that decision is now in question again, putting the manager back into his dilemma.
Organizational conflict and politics, culture and structure all come in to play.
From transnational, we move to a purely local situation, a Home Owners Association with
governance issues. Attempts to build a public trail along the lakeshore had led to lawsuits against
the association, the latest and most bitter in a history of conflict over the ownership and control
of “Common Areas.” The new president of the association campaigned for her office on a
platform of working to restore a spirit of neighborliness, but is now faced with trying to change
the culture of the organization and bring together its stakeholders.
Fonkoze is another small organization, a microfinance institution located in Haiti which is faced
with the challenge of how (and whether) to grow. Fundraising is taking up more and more time,
but is essential if Fonkoze is to be able to issue new loans. While Fonkoze’s director offers her
board a choice of several strategies, including becoming a commercial bank, students also have
to wrestle with challenges of doing business in a developing country.
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Growth is also the issue for Bright Lights, a non-profit that offers summer enrichment programs
for children. Here, too, post 9/11, fundraising is becoming more of a challenge. The Executive
Director is considering whether franchising might be a way to expand Bright Lights’ mission to
new areas as well as provide a source of funds. Designed for entrepreneurship/small business
students, this case offers the opportunity to discuss social entrepreneurship. The authors have
also provided a technical note on franchising to supplement conventional texts.
The common themes of strategies and finances are tied together in a challenging exercise, The
Strategy Mystery Game. It is definitely case-based: each of the 16 companies is depicted using
factual information, its industry and financial data. The difference is that the companies are not
named, and students are asked to use the financial statements to identify the companies by
industry. The exercise is only a few pages, but the authors have also provided a “Brief” to
introduce the very powerful linkages to strategic models and choices.
The final entry in this edition of The CASE Journal is an invited article, based on a plenary
session held at the combined CASE Association/Eastern Academy of Management meeting in
Saratoga Springs, NY in 2006. Writing a case on the organizational transformation of
Wilhelmsen Lines, a Norwegian shipping company that had lost its top management in an air
crash, was the beginning of a ten-year collaboration between three academics and two
international executives. The three faculty and the former president of Wilhelmsen describe their
relationship and the lessons they have learned from each other, including the impact on the
executives from being an on-going part of the case process. It’s a fascinating read!
I would be remiss to end without thanking the people who make this issue, and every issue,
possible: our authors and our reviewers. Case authors are special people; they have a story to tell
and the desire to help others learn from that story – and they are willing to put in the time and
effort to write and re-write to create a highly effective teaching tool. Reviewers are also very
special people. They volunteer their time to read and critique case drafts, not all of which are as
well written as those you will read here. Often they read a second version, and sometimes even a
third…. Without their anonymous input, these cases would not be as good as they are. Special
thanks also to my Associate Editor Alan Eisner who handled the process of creating the Journal
on-line, and to my Consulting Editor Jim Carroll who has advised me on many difficult
decisions.
I hope that you will enjoy this edition of the journal. Please feel free to e-mail your comments,
cases, articles and suggestions to me at [email protected].
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CASE AND ARTICLE ABSTRACTS
Exploring Strategic Change: A Case Analysis of the ConocoPhillips Merger
Kanalis A. Ockree
James Martin
Richard A. Moellenberndt
Washburn University
This is an illustrative case analyzing shareholder and accounting outcomes and legal
issues resulting from a merger of two major publicly traded companies. In today’s
business world, the “urge to merge” is tempered by heightened shareholder activism. In
response to this activism, boards must proceed with care when negotiating mergers.
Challenges to mergers that appear to be in the shareholders’ best interest occur often. As
is the case here, shareholders and their well funded legal representatives, seek damages
for alleged bad decisions. Conoco Oil and Phillips Petroleum announced their intention to
merge in November 2001. At that time the cost of gasoline spiraled ever upward and
large oil firms put heavy competitive pressure on smaller oil producer/refiners. The
merger described as a “merger of equals”, intimated that neither Conoco nor Phillips
shareholders would receive a financial advantage (or disadvantage) over other merging
shareholders following the completion of the merger. Immediately following the
announcement, Michael Iorio, a Conoco shareholder, filed a lawsuit, claiming damages to
Conoco shareholders from the merger of the two firms.
ABB Transformers - Denmark (A)
Mikael Søndergaard, Arhus University
William Naumes, University of New Hampshire
The ABB (A) case describes the situation leading up to a decision that has to be made
concerning closing a manufacturing subsidiary of ABB and moving its operations to
Thailand. The Plant/subsidiary manager is placed in a conflict position regarding this
decision due to the matrix form of management structure employed by the parent ABB.
His direct line manager in charge of the global product line wants the move to take place.
He has the support of his supervisor, who sits on the Executive Committee of the parent
company. The ABB Country Manager for Denmark wants the plant to stay where it is.
The subsidiary manager also reports to him, as part of the matrix structure. The
subsidiary manager has recently been promoted to his new position, with the support of
the Country Manager. The previous subsidiary manager had been promoted to head up a
larger, Danish subsidiary of ABB. The previous year, the Country Manager and the
previous subsidiary manager had managed to over rule the same request, in no small part,
due to their connections within ABB as well as within Denmark. The new subsidiary
manager needs to make a recommendation as to what should be done. The ABB
Transformers (A) case can be used separately, or in conjunction with the (B) case.
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ABB Transformers - Denmark (B): For Adults Only
Mikael Søndergaard, Arhus University
The (B) case follows up on the (A) case. The decision was made to leave the plant in
Denmark. It was revisited one year later, and the subsidiary manager is in even more of a
quandary. The former Country Manager has been promoted to the Executive Committee
of ABB. At a meeting of the new Country manager (not previously from within ABB),
the Product Manager, his supervisor from the Executive Committee, the former Country
Manager, and the subsidiary manager, the discussion is primarily between the new
Country Manager and the Product Supervising Executive Committee Member, who has
also been given added responsibility for all of Asia and the Pacific region. The former
Country Manager, now responsible for European operations, remains quiet during the
discussions. He later notes that this is a relatively small decision in the context of
European operations. The subsidiary manager still needs to make a decision, but is now
unsure of what has happened during the past year to allow this issue to be raised for the
third time. The (B) case can be used to demonstrate how politics, promotions, and
transfers can radically alter the environment within the context of a strategic decision.
The focus is now on organization culture and power, and on the problems of operating
within a matrix structure. The (B) case should be used in combination with the (A) case.
A Troubled Time in the Courtyard
Arthur Sharplin
John Seeger
Bentley College
The Courtyard Homeowners Association, Inc. (CHAI) was the governing corporation for
a 315-home development in Austin, Texas. In early 2001 Earline Wakefield took over as
president and resolved to "restore the spirit" of the neighborhood. Two of her directors,
both lawyers, had a history of success in expanding neighborhood rights to so-called
"Common Area," especially that along picturesque Lake Austin. But when they
collaborated in 1998 to construct a walkway along the lakefront behind the twelve lots
they met stern resistance from those wealthy, sophisticated owners. An intense political
and legal contest ensued. The case was referred to arbitration, culminating in enjoinment
of the walkway and costing CHAI and its errors and omissions (E&O) insurer an
estimated $350,000. One of the lawyers, then president, immediately promised to extend
the decision to the other six families, but not to pay their legal costs. Taking office soon
afterwards, Wakefield signs a document she thinks will carry out this promise. But two
of the six families affected object to the document and hire a prominent Austin attorney,
who contacts Wakefield. As she prepares for the August 2001 board meeting, Wakefield
finds her plan to “restore the spirit of the neighborhood” in jeopardy.
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Transition from Microfinance Institution to Regulated Bank:
The Case of Fonkoze’s Transformation
Michael Tucker
Winston Tellis
Dina Franceschi
Fairfield University
Fonkoze is the largest Microfinance Institution in Haiti whose clients are mostly poor
women. The authors had access to documents and meetings of the organization for an
extended period, and observed the growth of the organization from a single office to 21
branch offices. In so doing, their staff had to spend increasing time in fundraising so that
they could make more loans to the existing and new customers. This case presents the
decisions of the Board and the management to alleviate some of those problems. Against
a backdrop of political and civil turmoil, the case could be instructive for students and
instructors alike. The Board had to decide whether to apply for status as a regulated bank,
or to transform into some other financial entity.
Bright Lights: Exploring the Franchising Potential of a Not-For-Profit Organization
Monica Godsey
Terrence C. Sebora
University of Nebraska
Bright Lights is a small non-profit organization in Lincoln, NE offering a summer
enrichment program to school aged children. Post 9/11, the organization faces challenges
in its efforts to sustain financial resources. With enrollment and course offerings on the
rise, funding is more important than ever. At the second to the last meeting of the year at
which budgets are established, the Bright Lights’ Board of Directors asked the Executive
Director, Kathy Hanrath, and the Co-Owner/Director of Education Services, Barb Hoppe,
to come up with some alternatives for fundraising top present at the final yearly meeting.
Kathy has recently attended some sessions on franchising at a local entrepreneurship
conference and would like to explore franchising as an option for Bright Lights growth.
Kathy feels that franchising might have the potential to both increase performance and
funding. This case focuses on issues associated with the exploration of franchising as a
method of distribution and capital acquisition for a social organization. It calls attention
to the appropriate situations for franchising, the importance of organizational assessment
for franchise readiness, and other legal, economical, and organizational considerations.
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Business Models and Financial Structures: A Strategy Mystery Game and
A Brief on “Business Models and Financial Structures: A Strategy Mystery Game”
Stephanie Hurt, Meredith College
Marcus J. Hurt, EDHEC Business School (retired)
The ‘Game’ is really a multi-industry case that aims at developing participants’
awareness of the links between firms’ strategic choices and the financial structures the
choices engender. Participants are provided with Balance Sheet percentages and common
ratios for firms in 12 different industries and list of different businesses and asked to
match the figures with the kind of business. The goal is for participants to understand
how industries’ operating models impose certain financial structures.
The case is run as a kind of mystery game but leads to rather sophisticated analysis of
industry and business models. The case leads students to a better understanding of the
essential concepts of a business strategy course: 1) external analysis by helping students
‘see’ the structures of different industries; 2) making clear the link between the
competencies and capabilities needed by firms in their internal environment to
successfully compete in their industries by matching the key success factors at work; 3)
providing a tangible illustrations of the competencies that must be developed to
successfully pilot business strategies like cost leadership and differentiation; and, 4)
developing insight into integration and outsourcing strategies and their effects.
A detailed Teaching Note accompanies the case.
21st Century Learning:
Leadership Lessons from Collaborative Case Research, Teaching and Scholarship
John F. McCarthy, University of New Hampshire
David J. O’Connell, St. Ambrose University
Douglas T. Hall, Boston University
Jan Eyvin Wang, United European Car Carriers
Management scholars and researchers have long been concerned about the impact
and relevance of their work. Here we chronicle the teaching, research, management, and
personal leadership development lessons that have arisen from a collaborative, decadelong relationship between three management faculty members and the senior
management team of a major Norwegian-based global shipping and logistics company.
This relationship grew from the creation of a teaching case in 1997 to many years of
productive and meaningful work together, including the development and delivery of the
all-conference Plenary Session at the 2006 Eastern Academy of Management Meeting,
held concurrently with the annual CASE Association Conference. At the 2006 Plenary
Session, each of the authors expressed powerful personal and professional development
through their collaboration over the years, which is summarized in this article.
Reflections, lessons and future research directions are provided.
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Exploring Strategic Change
A Case Analysis of the ConocoPhillips Merger
Kanalis A. Ockree, PhD, CPA, CMA; Washburn University
James Martin, MPA, CPA; Washburn University
Richard A. Moellenberndt, PhD, CPA; Washburn University
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INTRODUCTION 1
On November 19, 2001, Michael Iorio filed a lawsuit against Conoco Inc. and its board of
directors in the Chancery Court in Delaware. The filing alleged that under the terms of the
proposed merger of Conoco Oil and Phillips Petroleum, announced that same date, that Conoco
and its Board failed to fulfill corporate responsibilities to Conoco shareholders. Among other
issues, this filing specifically alleged that Conoco failed to require a premium be paid to Conoco
shareholders to compensate said shareholders for their surrender of corporate control to Phillips
Petroleum. The filing document requested that the suit be treated as a class action in the name of
all Conoco shareholders rather than as an individual action.
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COMPANY HISTORIES AND BACKGROUND
Background
In 2001, with the price of crude oil averaging just over $30 per barrel (Energy Economists News
Letter, 2006), two major oil companies, Conoco, Inc. and Phillips Petroleum, announced a plan
to merge. Depicted by the two firms as a “merger of equals” (ConocoPhillips. 2001), the merged
firms hoped to compete more effectively with larger oil companies and to extend their history as
powerful participants in the volatile global oil industry. By 2005 the market price per barrel of
crude oil peaked at approximately $70 and during 2006 that peak increased to over $75. (USA
Today, 2006) The combination of historically high crude oil prices, lack of sufficient refining
capacity and damage to refineries in the gulf coast region of the U.S. from hurricanes forced U.S.
gasoline prices to record highs exceeding $3.00 per gallon in 2005. (ConocoPhillips, f) The
increased price of gasoline pushed corporate annual profits for ConocoPhillips, the newly
merged firm, to over $13.5 billion in 2005, (ConocoPhillips, 2006) from a pre-merger combined
net income of just $3.3 billion.
A
The Merged Corporation - ConocoPhillips
Before Conoco, Inc. and Phillips Petroleum merged in 2002, Conoco owned approximately 3%
of the nation’s refining capacity and generated about 3% of the U.S. gasoline sales. Phillips held
1
We are enormously grateful to Robert E. Hiatt, for providing legal research and analysis.
We are also deeply indebted to Herbert Sherman previous editor of The Case Journal, without
whose patient guidance and assistance we could not have completed this work.
Thanks also to James Keebler, former MBA director at Washburn University for supplying the
initial format for the development of the expanded DuPont Model and for making suggestions
regarding the nature of appropriate applications.
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approximately 10% of the nation’s refining capacity and produced about 9% of gasoline sales.
(Petroleum Supply Annual 2000, 2001) The two separate companies, although huge by most
standards, were viewed by many as too small to survive in a growing, ever-consolidating, global
energy marketplace.
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On November 19, 2001, after considerable negotiation, Conoco, Inc. and Phillips Petroleum
announced the merger of their two companies to form ConocoPhillips. At announcement, the
ConocoPhillips merger was touted as a growth story. This could be expected because prior to the
merger, both Conoco and Phillips experienced considerable independent growth. The historical
financial statements of both Conoco and Phillips evidenced this growth with marked increases in
property, plant and equipment [PP&E]. Announcement of the ConocoPhillips merger was also
accompanied by an announcement of expected workforce reductions that were to result in cost
synergies, cost savings to the resulting corporation. [ConocoPhillips Holding Co sec Rule 425
filing of 12/07/2001] Normally, many of these workforce reductions occur in the corporate
headquarters and result in decreases in selling, general and administrative expenses [SG&A].
Cost increases related to manpower reductions, such as severance payments are also normally
reflected in SG&A.
As is the case with most mergers, the announcement of the merger of Conoco and Phillips was
followed by a period during which management of the companies secured the required
regulatory body clearances and shareholder approvals. Following attainment of the necessary
approvals, closing the merger was a fairly mechanical endeavor. On August 30, 2002,
shareholders of Phillips Petroleum Inc. and Conoco Inc. surrendered their existing shares of
stock and received newly issued shares of stock in the merged company, ConocoPhillips. Phillips
shareholders received one share of ConocoPhillips stock for each share of Phillips stock
surrendered. Conoco shareholders received .4677 share of ConocoPhillips stock for each share of
Conoco stock surrendered. The merger was touted as a “merger of equals”. As such,
shareholders in neither merging company, Conoco nor Phillips, was to receive a premium above
market price for their stock. [ConocoPhillips Holding Co., SEC Rule 425 filing of 11/19/2001]
LL
The 2002 merger established ConocoPhillips as the 6th largest international oil firm, based on
hydrocarbon reserves, and as a major power in the international oil industry. The merged
company also gained status as the third largest US oil company. (Wall Street Journal, 2001) At
the end of 2005, ConocoPhillips operated in more than 40 countries, employed approximately
35,800 people worldwide, and held nearly $107 billion of assets. (ConocoPhillips, 2006)
A
History of Conoco Inc.
In 1875, Isaac Blake founded Continental Oil and Transportation Company in Ogden, Utah. The
company provided kerosene to pioneers in the new west at affordable prices. Blake later
constructed the first pipeline through California to supply kerosene to San Francisco. Standard
Oil acquired Continental Oil in 1885, then, relinquished ownership in 1913 by order of the U.S.
Supreme Court. By this time Continental Oil had become the leading marketer of petroleum
products in the Rocky Mountain region. Continental refined a large share of its crude oil into
gasoline in order to provide fuel for automobiles and in 1909, constructed the first gasoline
filling station in the western U.S. (ConocoPhillips, c)
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During the next 20 years, the company constructed more than 1,000 service stations in 15 states.
The continental soldier trademark decorated every station. (ConocoPhillips, a) Continental Oil
merged with Marland Oil of Ponca City, Oklahoma in 1928. The merged company, renamed
Continental Oil Company [Conoco], owned nearly 3,000 oil wells and thousands of retail outlets
in 30 states. (ConocoPhillips, c) Shortly after this merger, and just one month after Conoco stock
first began trading on the New York Stock Exchange, Conoco faced the momentous challenge
brought on by the stock market crash in October 1929. However, Conoco’s management met the
challenge by making some difficult decisions such as cutting salaries and abandoning some of its
oil exploration efforts. The money saved from these decisions helped Conoco expand refinery
capacity, build new pipelines and fund many new products. (ConocoPhillips, c)
The 1970s’ Arab oil embargos forced the price of gasoline in the U.S. up significantly resulting
in significant increases in Conoco’s revenues. The increased revenues funded Conoco’s
exploration for oil in new parts of the world, the development of new technologies for
stimulating older wells, and the creation of innovative synthetic and coal-based energy
alternatives. (ConocoPhillips, d)
DuPont Corporation acquired Conoco as a wholly owned subsidiary in 1981. After an 18 year
partnership, DuPont sold Conoco in a public stock offering in 1988. The separation of DuPont
and Conoco resulted in the largest IPO in the U.S. up to that time, amounting to nearly $4.4
billion. The sale of Conoco by DuPont reestablished Conoco as an independent corporation and
on October 22, 1998, Conoco stock began trading under a new ticker symbol, COC, honoring the
name the company held for so many years – Continental Oil Company. (ConocoPhillips, d)
History of Phillips Petroleum Company
Frank Phillips invested in speculative oil leases in Oklahoma and, along with his brother
L.E. began drilling oil wells in 1903. Following two initial dry holes the next 80 oil wells drilled
by the Phillips brothers produced gushers. Frank Phillips founded Phillips Petroleum Company
in 1917 in Bartlesville, Oklahoma, 14 years after his initial investment in oil property. (Business
& Industry Hall of Fame).
A
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Phillips Petroleum opened its first gas station in Wichita, Kansas in 1927. Phillips adopted its
well known logo three years later. The logo is said to come from the experience of a Phillips’
executive while driving an automobile on the newly constructed Route 66 to test a new gasoline
to be sold at the new station. While cruising along Route 66, the executive noted that the auto
reached a speed of 66 miles per hour. After relating this interesting coincidence at a company
meeting, Phillip’s management unanimously voted to call the new gasoline Phillips 66. Three
years later the company selected a symbol resembling a U.S. highway shield bearing the number
66 as the Phillips trademark. (Business and Industry Hall of Fame)
Phillips Petroleum developed and produced many new products over the years. These product
developments include propane gas [1929]; the first all season gasoline [1931]; high-octane
gasoline [1940]; cold synthetic rubber [1944]; polyethylene plastics [1951]; and the first all
season motor oil [1954]. In 1998 Phillips received its 15,000th U.S. patent. (ConocoPhillips, e)
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Phillips Petroleum drilled the first offshore oil well [1947], became the first oil company
approved to drill for oil in Alaska [1952] and discovered oil in the North Sea [1969].
(ConocoPhillips, e) At this time other major oil companies maintained relative control of oil
supplies out of the Middle East. Therefore, Phillips’ access to oil in the North Sea and on
Alaska’s North Slope combined with the relative independence from OPEC oil sources created a
major advantage for Phillips during the 1970s oil embargos. (Business and Industry Hall of
Fame)
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Legal Climate of the Merger
In the world of merger/acquisition transactions (and related shareholder effects) all major
mergers collide with the strike bar. The strike bar views major merger/acquisition transactions
through several legal “lenses”, depending on the structure of the transaction, in order to assess
the impact on shareholder interests.
Strike bar firms analyze the impact of merger of equals transactions on both sets of merging
shareholders to determine if the exchange of securities created some level of control being
surrendered or gained. (In an MOE, there should be no change of control and no control
premium paid.) If no exchange of control took place but one group of shareholders received a
control premium at the expense of the other group of shareholders the strike bar may take action.
Generally, strike bar firms generate their compensation on a contingency fee basis. Therefore,
they earn a fee only as a percentage of a court determined judgment or a court approved cash
settlement. In many cases these fees exceed 30% of the total judgment or settlement amount. In
cases with multimillion dollar awards or settlements, the pay-off to strike bar firms can be quite
substantial. Because of this, considerable competition exists amongst strike bar firms to be the
representatives in the “best” cases. If a case looks promising, strike bar firms then use various
methods to inform and solicit clients from among the merger firm(s)’ stockholders. The first time
potential clients learn of a possible legal problem with a merger may occur through the
solicitation activities of the strike bar.
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With potentially lucrative outcomes, sometimes described as opportunistic, comes even greater
chances that the strike bar firm will incur substantial investigative, solicitation and legal costs
and receive nothing for their efforts. Many investigations pursued by strike bar firms find no
grounds for legal action. Filed cases are at high risk for dismissal by a judge either due to the
facts of the case or due to competing filings by other strike bar firms. In these cases eliminated
strike bar firms normally do not recover the costs of investigation. Even if the case goes forward
the case may not result in a judgment or settlement in favor of the filing strike bar firm’s clients.
The strike bar has been depicted as either a champion of shareholder rights or a champion of
frivolous lawsuits depending on your point of view. Sharpe and Reid [1977] describe this group
of lawyers as follows:
“In the United States, the availability of class action procedures
combined with a contingency fee structure for plaintiffs’ lawyers has led
to the creation of an entrepreneurial sector of the legal profession known
as the “strike bar.” U.S. strike bar lawyers are motivated by sizeable
contingency fees and relative freedom to direct litigation according to
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their own interests. Even defendants who have done nothing wrong face
Hobson’s choice: to pay for a very expensive battle in the courts and
eventually risk a potentially exorbitant jury damage award, or settle.
Most defendants eventually swallow their indignation and make the
prudent economic choice and, as a result, settlement has become the
typical outcome of class action securities litigation in the United States.”
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One of the legal precedents cited by strike bar firms when filing such a shareholder suit is the
allegation that the board of the Target company did not meet its “Revlon duties” as set forth in
the 1986 Revlon legal decision. The court’s decision in this case instructed boards of directors of
companies entering into a business combination to seek the transaction offering the best value
reasonably available to the shareholder. [Revlon, 1986] While this decision did not mandate that
the board sell the company to the highest bidder, still a prudent Target company board would
follow a well documented process designed to provide nondiscriminatory access to interested
bidders in order to satisfy “Revlon duties”. If the board satisfies the required “Revlon duties”,
shareholders who give up control in their company could thus expect to receive an appropriate
control premium for their surrendered shares.
In mergers of equals, the boards of directors must follow the “Business Judgment Rule” rather
than fulfilling “Revlon duties” or other potential control related standards. The Business
Judgment Rule requires the exercise of “good faith and due care”. [Bainbridge, 2003] A much
lower legal threshold is established by the Business Judgment Rule than the one established in
the Revlon case (Revlon duties). As with many legal terms, the definition of the Business
Judgment Rule is subject to debate and interpretation on a case by case basis. In order to
substantiate a given (merger) proposal related to the “Business Judgment Rule”, detailed
financial analysis using the DuPont Model or other comparative financial analysis tools would
normally be undertaken by merging boards and their advisers.
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The Lawsuit
The ConocoPhillips merger, if truly a merger of equals, would not normally require a control
premium be paid to either shareholder group. Absent a change of control (and resulting control
premium), a strike bar firm would carefully evaluate the financial status of the pre-merger and
post merger firms and their shareholders to determine if “Business Judgment Rule” requirements
are satisfied in order to determine the potential for legal action. However savvy strike bar firms,
relying on the Revlon case, would also undertake a careful analysis of the merger agreement to
determine whether or not a control premium was improperly paid (or not paid, yet deserved) to
either set of stockholders. If the merger includes a control premium for either set of shareholders
without a related surrender of control, a potentially lucrative lawsuit could be filed. Conversely,
a surrender of control by either stockholder group would normally necessitate the payment of a
“control premium” to that group. If control is surrendered and a premium is not paid when
seemingly warranted, this situation could also give rise to a lucrative lawsuit.
Both sets of litigants, Iorio and Conoco executives and board members, must now support their
positions. Iorio, through transaction and financial analysis must prove the treatment of Conoco
stockholders to be improper. Conoco executives and board members, through the same types of
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analyses, must support the position that they fulfilled their” Business Judgment Rule”
responsibilities and that they are not subject to “Revlon Duties”.
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Exhibit 1 - Phillips Income Statement
Years Ended
$
December 31
2001
2000
26,729
22,690
41
114
98
278
26,868
23,082
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Phillips Petroleum Company
Consolidated Statement of Income (in millions)
Revenues
Sales and other operating revenues*
Equity in earnings of affiliated companies
Other revenues
Total Revenues
Costs and Expenses
Purchased crude oil and products
Production and operating expenses
Exploration expenses
Selling, general and administrative expenses
Depreciation, depletion and amortization
Property impairments
Taxes other than income taxes*
Accretion on discounted liabilities
Interest expense
Foreign currency transaction losses
Preferred dividend requirements of capital trusts
Total Costs and Expenses
Income before income taxes, extraordinary item and cumulative effect
of change in accounting principle
Provision for income taxes
Income before extraordinary item and cumulative effect of change
in accounting principle
Extraordinary item
Cumulative effect of change in accounting principle
Net income
Page 17
$
14,535
2,688
306
946
1,391
26
3,258
14
338
11
53
23,566
12,131
2,176
298
626
1,179
100
2,323
369
58
53
19,313
3,302
1,659
3,769
1,907
1,643
(10)
28
1,661
1,862
1,862
The CASE Journal
Exhibit 2 - Phillips Balance Sheet
December 31
2001
2000
$
142
149
1,189
105
2,618
47
262
4,363
3,317
23,796
2,281
1,313
9
138
35,217
1,553
226
357
191
130
2,606
2,999
14,784
120
20,509
2,669
91
44
941
797
4,542
8,645
1,142
4,015
953
930
20,227
1,822
92
262
815
501
3,492
6,622
702
1,894
494
562
13,766
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Phillips Petroleum Company
Consolidated Balance Sheet (in millions)
Assets
Cash and cash equivalents
Accounts and notes receivable (less allowances of
$33 million in 2001 and $18 million in 2000)
Accounts and notes receivable--related parties
Inventories
Deferred income taxes
Prepaid expenses and other current assets
Total Current Assets
Investments and long-term receivables
Properties, plants and equipment (net)
Goodwill
Intangibles
Deferred charges
Total Assets
Liabilities and Stockholders’ Equity
Accounts payable
Accounts payable—related parties
Notes payable and long-term debt due within one year
Accrued income and other taxes
Other accruals
Total Current Liabilities
Long-term debt
Accrued dismantlement, removal and environmental costs
Employee benefit obligations
Other liabilities and deferred credits
Total Liabilities
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Exhibit 2 - Phillips Balance Sheet (continued)
650
650
538
9,069
(1,038)
(934)
(255)
(237)
7,197
14,340
$ 35,217
383
2,153
(1,156)
(943)
(100)
(263)
6,019
6,093
20,509
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Company-Obligated Mandatorily Redeemable Preferred
Securities of Phillips 66 Capital Trusts I and II
Common stock
Par value
Capital in excess of par
Treasury stock
Compensation and Benefits Trust (CBT)
Accumulated other comprehensive loss
Unearned employee compensation—LTSSP
Retained earnings
Total Common Stockholders' Equity
Total Liabilities and Equities
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http://www.tenkwizard.com/filing
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Exhibit 3 - Conoco Income Statement
Years Ended
December 31
2,001
2,000
$ 38,737
38,737
181
277
273
621
39,539
39,287
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Conoco Inc.
Consolidated statement of income (in millions)
Revenues
Sales and other operating revenues*
Equity in earnings of affiliates (note 15)
Other income (note 4)
Total revenues
Costs and expenses
Cost of goods sold**
Operating expenses
Taxes other than on income* (note 5)
Interest and debt expense (note 6)
Total costs and expenses
Income before income taxes
Income tax expense (note 7)
Income before extraordinary item and accounting change
Extraordinary item, charge for the early extinguishment of debt,
(net of income taxes of $33 note 8)
Cumulative effect of accounting change, (net of income taxes of $22
note 9)
Net income
* Includes petroleum excise taxes
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** Excludes refining depreciation
Page 20
23,043
3,053
888
378
1,811
6,983
396
36,552
2,987
1,391
1,596
$
23,921
2,215
794
279
1,301
6,981
338
35,829
3,458
1,556
1,902
(44)
--
37
1,589
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Exhibit 4 - Conoco Balance Sheet
Conoco Inc.
December 31
2001
2000
Assets
Accounts and notes receivable (note 9)
Inventories (note 10)
Net property, plant and equipment (note 11)
Investment in affiliates (note 12)
Goodwill (note 3)
Other assets (note 13)
Total assets
388
342
1,894
1,837
995
791
1,066
441
4,343
3,411
17,918 12,207
1,894
1,831
2,933
816
678
27,904 18,127
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$
$
Liabilities And Stockholders' Equity
Liabilities
Accounts payable (note 14)
Short-term borrowings and capital lease obligations (note 15)
Income taxes (note 7)
Other accrued liabilities (note 16)
Total current liabilities
Long-term borrowings and capital lease obligations (note 17)
Deferred income taxes (note 7)
Other liabilities and deferred credits (note 18)
Total liabilities
$
A
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5,502
8,267
3,975
2,346
20,090
1,723
256
665
1,543
4,187
4,138
1,911
1,926
12,162
1,204
337
1,897
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Commitments and contingent liabilities (note 26)
Minority interests (note 19)
Stockholders' equity (note 20)
Class A common stock, $.01 par value
Class B common stock, $.01 par value
Additional paid-in capital
Retained Earnings
Accumulated Other comprehensive loss (note 21)
Treasury Stock at cost
Total stockholders' equity
Total liabilities and stockholders' equity
1,950
1,125
530
$
2
6
4
5,044
4,932
2,537
1,460
(894)
(653)
(83)
(117)
6,610
5,628
27,904 18,127
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Exhibit 5 - ConocoPhillips Income Statement
ConocoPhillips
Consolidated Income Statement (in millions)
135,076
1,535
305
136,916
104,246 56,748
542
261
309
192
105,097 57,201
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Revenues
Sales and other operating revenues (1) (2)
$
Equity in earnings of affiliates
Other income
Total Revenues
Costs and Expenses
Purchased crude oil, natural gas and products (3)
Production and operating expenses
Property impairments
Taxes other than income taxes (1)
Accretion on discounted liabilities
Interest and debt expense
Foreign currency transaction (gains) losses
Minority interests and preferred dividend requirements of
capital trusts
Total Costs and Expenses
Income from continuing operations before income taxes
and subsidiary equity transactions
Gain on subsidiary equity transactions
Income from continuing operations before income taxes
Provision for income taxes
Income From Continuing Operations
Income (loss) from discontinued operations
Income (loss) before cumulative effect of changes in
accounting principles
Cumulative effect of changes in accounting principles
Net Income (Loss)
$
Years Ended December 31
2004
2003
2002
Page 22
90,182
7,372
2,128
703
3,798
164
17,487
171
546
(36)
67,475 37,857
7,144
4,664
2,179
1,950
601
592
3,485
2,223
252
177
14,679 6,937
145
22
844
566
(36)
24
32
122,547
20
48
96,788 55,060
14,369
_____14,369
6,262
8,107
22
8,309
___28
8,337
3,744
4,593
237
2,141
____2,141
1,443
698
(993)
8,129
8,129
4,830
(95)
4,735
(295)
(295)
The CASE Journal
Exhibit 6 - Conoco Phillips Balance Sheet
December 31
2004
2003
2002
$
1,387
490
307
5,449
3,339
3,666
986
194
15,021
10,408
50,902
14,990
1,096
444
92,861
3,606
1,399
3,957
876
864
11,192
7,258
47,428
15,084
1,085
408
82,455
2,873
1,507
3,845
766
1,605
10,903
6,821
43,030
14,444
1,119
519
76,836
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ConocoPhillips
Assets
Current Assets
Accounts and notes receivable (net of allowance of
$55 million in 2004 and $43 million in 2003)
Accounts and notes receivable—related parties
Inventories
Assets of discontinued operations held for sale
Investments and long-term receivables
Net properties, plants and equipment
Goodwill
Intangibles
Other assets
Total Assets
Liabilities And Stockholders' Equity
Liabilities
Current Liabilities
Accounts payable
Accounts payable—related parties
Notes payable and long-term debt due within one year
Accrued income and other taxes
Other accruals
Liabilities of discontinued operations held for sale
Long-term debt
Asset retirement obligations and accrued environmental costs
Other liabilities and deferred credits
Total Liabilities
$
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$
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$
8,727 6,598 5,949
404
301
303
632
1,440
849
3,154
2,676
1,991
1,215
1,346
1,351 1,471 3,075
103
179
649
15,586 14,011 12,816
14,370 16,340 18,917
3,894
3,603
1,666
10,385
8,565
8,361
2,415
2,445
2,755
2,383 2,283 1,803
49,033 47,247 46,318
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Exhibit 6 - ConocoPhillips Balance Sheet (continued)
Company-Obligated Mandatorily Redeemable Preferred
Securities of Phillips Capital Trust II
Minority Interests
Common Stockholders’ Equity at par value
Capital in excess of par value
Compensation and Benefits Trust (CBT) at cost:
Accumulated other comprehensive income
Unearned employee compensation
Retained earnings
Total Common Stockholders’ Equity
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1,105
842
7
7
26,054 25,361
816
857
1,592
821
242
200
16,128 9,234
42,723 34,366
350
651
7
25,178
907)
164)
218)
5,621
29,517
Total Liabilities and Stockholders’ Equity
2004, 2003 10 K 2004 filed 2005 accessed 6/27/05
2002 10k 2003 filed 2004 accessed 6/27/2005
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http://www.conocophillips.com/investor/sec/index.htm
For 2002, 2003, or 2004
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$
92,861
82,455 76,836
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Exhibit 7 – Iorio Case Filing
IN THE COURT OF CHANCERY OF THE STATE OF DELAWARE
IN AND FOR NEW CASTLE COUNTY
X
MICHAEL IORIO,
Plaintiff,
Civil Action No. 19265NC
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CLASS ACTION COMPLAINT
V.
CONOCO INC., RICHARD H. AUCHINLECK,
KENNETH M. DUBERSTEIN, CHARLES KRULAK, :
ANTONIO R. SANCHEZ. JR.. ARCHIE W. DUNHAM. :
RUTH P. HARKIN, FRANKLIN A. THOMAS, :
WILLIAM K. REILLY, WILLIAM R. RHODES, and :
FRANK A. MCPHERSON,
Defendants.
X
Plaintiff, by his attorneys, alleges upon information and belief except with
respect to his ownership of Conoco Inc. ( “Conoco” or the “Company”) common
stock, which is alleged upon personal knowledge, as follows:
PARTIES
1. Plaintiff is the owner of stock of defendant Conoco.
2. Conoco Inc. is a Delaware corporation with its principal executive offices
at 600 North Dairy AshfordRoad, Houston, Texas 77079. As of November 2, 2001,
approximately 625,479,OOOshares of common stock of Conoco were outstanding.
LL
3. Defendants Richard H. Auchinleck, Kenneth M. Duberstein, Charles
Krulak, Antonio R. Sanchez, Jr., Ruth R. Harkin,Franklin A. Thomas, William
K. Reilly, William R. Rhodes and Frank A. McPherson are Directors of Conoco.
A
4. Defendant Archie W. Dunham is Chairman, Chief Executive Officer and a
Director of Conoco.
5. The foregoing individuals (collectively the “Individual Defendants”),
directors of Conoco owe Conoco public shareholders fiduciary duties.
CLASS ACTION ALLEGATIONS
6. Plaintiff brings this action on his own behalf and as a class action on
behalf of the public shareholders of defendant Conoco (except defendants
herein and any person, firm, trust, corporation or other entity related to or
affiliated with any of the defendants) or their successors in interest, who
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have been or will be adversely affected by the conduct of defendants alleged
herein.
7. This action is properly maintainable as a class action for the following
reasons:
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a) The class of shareholders for whose benefit this action is brought is
so numerous that joinder of all class members is impracticable. As of
November 2, 2001, there were over 625 million shares of defendant Conoco
common stock
outstanding held by thousands shareholders of record scattered throughout the
United States.
b) There are questions of law and fact which are common to members
of the Class and which predominate over any questions affecting any
individual
members. The common questions include, among other things, the following:
i. Whether one or more of the defendants has agreed to sell Conoco
to Phillips Petroleum (“Phillips”) pursuant to a transaction that enriches
Conoco management at the expense of the Conoco public stockholders and
without an appropriate process to maximize the sale price of Conoco;
ii. Whether the Defendants have breached their fiduciary duties owed
to plaintiff and members of the Class, and/or have aided and abetted in such
breach, by virtue of their participation and/or acquiescence and by their
other conduct complained of herein; and
iii. Whether plaintiff and the other members of the Class will be
irreparably damaged by the transactions complained of herein.
8. Plaintiff is committed to prosecuting this action and has retained
competent
counsel experienced in litigation this nature. The claims of plaintiff are
typical of the claims of the other members of the Class and plaintiff has the
same interest as the other members of the Class. Accordingly, plaintiff is an
adequate representative of the Class and will fairly and adequately protect
the interests of the Class.
LL
9. Plaintiff anticipates that there will not be any difficulty in the
management of this litigation.
A
10. For the reasons stated herein, a class action is superior to other
available
methods for the fair and efficient adjudication of this action.
SUBSTANTIVE ALLEGATIONS
11. On or about November 19, 2001, Conoco announced a merger
agreement (the “Merger”) with Phillips Petroleum pursuant to which each share
of
Conoco common stock would be exchanged for 0.4677 shares of Phillips
following the Merger. This represents approximately $24.30 per Conoco share
based upon the
November 16, 2001 closing price of Phillips. Following the Merger, each
company will receive 8 of the 16 Board seats of the combined company and
James Mulva, Phillips’s current chairman and CEO, will be the combined
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company’s president and chief executive officer and will also become the
chairman of the combined company in 2004.
12. The transaction includes no premium for Conoco shareholders. James
Mulva, the Chairman and Chief Executive of Phillips reportedly called the
transaction “clearly the best alternative for both companies,” although no
canvas of alternatives for Conoco was apparently conducted. Indeed, tax
related consideration impeded an acquisition of Conoco prior to August 2001.
There is apparently no mechanism, such as a collar, to ensure that Conoco
shareholders receive any certain value of consideration in the transaction.
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13. The Director Defendants have a fiduciary obligation fully to inform
themselves and to proceed in the best interests of the shareholders,
including
conducting an appropriate market check and fully investigating alternatives.
The
Director Defendants failed to fulfill their obligations by not properly
seeking the best alternative for the shareholders of Conoco and acting
appropriately to protect the best interests of the Conoco public shareholders
in the Merger.
14. The Director Defendants’ fiduciary duties to Conoco shareholders require
the Director Defendants to act affirmatively to protect the interests of the
shareholders. The Merger will deprive Conoco shareholders of their stock for
consideration that does not reflect the true value of the Company. The
Director Defendants are not acting in accordance with their fiduciary duties
to protect the interests of the shareholders.
15. The conduct of the Director Defendants is, and unless corrected, will
continue to be, wrongful, unfair and harmful to Conoco’s public shareholders.
16. Unless enjoined by this Court, the Director Defendants will continue to
breach their fiduciary duties owed to plaintiff and the Class, all to the
irreparable harm of the Class.
17. Plaintiff has no adequate remedy at law.
WHEREFORE, plaintiff demand judgment as follows:
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(a) Declaring that this action may be maintained as a class action;
(b) Enjoining preliminarily and permanently the Director Defendants to
fulfill their fiduciary duties to protect the Conoco shareholders, and
not to take any action in furtherance of the Merger without properly
exploring available alternatives for Conoco shareholders and
without appropriate protections for the shareholders, such as a
collar;
(c) Requiring defendants to compensate plaintiff and the members of
the Class for all losses and damages suffered and to be suffered
by them as a result of the wrongful conduct complained of herein,
together with pre-judgment and post-judgment interest;
(d) Awarding plaintiff the costs and disbursements of this action,
including reasonable attorneys’ fees; and
(e) Granting such other and further relief as may be just and proper.
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DATE: November 19,200l
CHIMICLES & TIKELLIS LLP
[signature omitted]
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Pamela S. Tikellis
Robert J. KridJr.
Beth Deborah Savitz
One Rodney Square
P.O. Box 1035
Wilmington, DE 19899
(302) 656-2500
Attorneys for Plaintiff
OF COUNSEL:
WOLF HALDENSTEINADLER
FREEMAN & HERZ LLP
270 Madison Avenue
New York, N.Y. 10016
Telephone: (212) 545-4600
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[reproduction of actual Chancery Court of Delaware filing document]
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Appendix 1 – Merger Structure
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One common form of merger transaction occurs when a company (Target) decides to “put itself
up for sale”. In this example, the board and management of Target decide to negotiate with
acquirer(s) (Buyer) who wish to obtain control of Target. This type of merger transaction may
result in three possible outcomes: 1) Buyer purchases all of Target and merges Target into
Buyer’s existing corporation. 2) Buyer purchases all of Target stock and holds Target as an
operating subsidiary. Or, 3) Buyer purchases a controlling interest in Target allowing Target to
continue operations as a free standing unit. In any of these acquisition scenarios, Target
shareholders normally expect to sell their stock for a price that includes a “control premium”. A
“control premium” is the amount by which the per share price of Target shares exceeds the price
a willing seller would expect to receive without relinquishing control of the company being sold.
In other words, the buyer pays a price for the stock itself and an added “bonus” to also acquire
control of the target company.
Some mergers do not result in one merging company gaining control over the other company.
Such mergers are generally called “mergers of equals” (MOE) and no control premium is paid
for the target company stock. In a MOE, shareholders in two or more companies decide to
combine companies with no single entity surrendering control. Shareholders in all the combining
firms normally receive similar treatment with all stockholders receiving stock or securities
roughly proportional in value to the value of the security surrendered.
Typically, when evaluating a merger/acquisition, strike bar firms first evaluate whether Target
truly surrendered control to Buyer. If Buyer controls Target following a merger, strike bar firms
proceed to analyze the transaction to determine if an appropriate control premium resulted. That
is, did Target’s board negotiate an appropriate control premium for its shareholder base? If the
strike bar believes the board of Target did not do all that it could to maximize value for its
shareholders (obtain an appropriate control premium), the strike bar may seek (after finding a
client, preferably a stockholder group of clients) to initiate a Target shareholder suit against
Target and the Target board.
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Similarly, if Buyer does not acquire control of Target even though paying a control premium, the
strike bar may seek to organize Buyer shareholders into a class action suit against Buyer and its
board. Example: Company A and Company B merge to form Company C in a stated MOE. As
part of the transaction Company A shareholders receive $50 worth of C stock for each share of A
Company stock which exceeds the fair value of their stock surrendered by 20%. Company B
shareholders receive $20 worth of C stock for each surrendered share of their Company B stock ,
5% below the market price of B stock before the merger was announced. Strike bar firms can
then claim the merger transaction agreed to by B Company’s board and management and the
control premium paid to A shareholders harmed B shareholders by reducing the value available
to B shareholders without B Company actually gaining any control. Put another way, two
companies combine their assets but Company A shareholders walk away with more value than
what they contributed while Company B shareholders end up with less value than actually
contributed.
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Note that even in a merger of equals, shareholders of the two merging companies are not treated
identically from an economic point of view. As an example, if company X and company Y are
merging to form company Z, the pre-merger value of a share of company X stock is likely
different from that of a share of company Y stock. This is normally taken into consideration in
the merger process by allowing shareholders of companies X and Y to receive differing amounts
of company Z stock or perhaps one merging company’s shareholders receives additional
remuneration in the form of cash or another security. Shareholders of both X and Y thus receive
different values because they are surrendering stocks of different values.
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Because of differing values of unmerged company stock surrendered and differing values of
merged company securities received, one group of merging shareholders most likely will obtain
a financial advantage over the other group of merging shareholders. When evaluating which
shareholder group received a financial advantage in question 14 below, you should first
determine what was given up by each shareholder and compare this value with what each
shareholder received in exchange. The shareholder group receiving the financial advantage from
the merger can be identified by making a side by side comparison of the results of the analysis
for both merging shareholder groups. The following questions assist in that process.
Appendix 2 – Shareholder Expectations and Responses to Mergers and Acquisitions
Corporate boards, shareholders, and their attorneys make judgments when evaluating the level of
success or failure of a merger/acquisition-related growth strategy. One cornerstone of American
business requires that the actions taken by corporations, corporate boards of directors, and the
operating management must act in the best interest of their shareholders. Corporations, in
attempts to maximize value for shareholders, pursue diverse goals which cover the gamut from
focusing on a single core business to focusing on broad diversification. Corporate strategic
choices result in corporations initiating actions resulting in either growth or downsizing either of
the business as a whole or of specific operating units within the business. A growth strategy may
rely on either internal (organic) growth or external growth through merger or acquisition.
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Corporate mergers and acquisitions are generally agreed to after considerable negotiation
between the management and the boards of the merging companies. In many instances,
shareholders of the two companies vote on the combination before consummation. Typically
shareholders rely on recommendations they receive from the corporate board to decide their vote.
A positive shareholder vote then results in the merger closing with shareholders of the merging
entities surrendering their shares of the existing firms and receiving in exchange either 1)
common stock in a new merged entity, 2) cash , 3) security interest other than common stock, or,
4) some predetermined combination of the three. Potential shareholder actions following their
exchange of stock in unmerged companies for cash or securities in a merged entity include the
following: 1. If shareholders view the merger favorably they may signal approval by, a) voting to
re-elect the pre-merger board of directors or b) by investing in additional securities in the merged
entity. 2. If the merger is viewed unfavorably, stockholders may signal disapproval by, a)
refusing to re-elect the pre-merger board of directors, b) by voting with their feet (selling the
stock), or, c) by suing the new companies management and board of directors as well as the
management and board of the pre-merger firm(s).
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New York Stock Exchange Composite Transactions, (various year end dates) The Wall Street
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ABB Transformers - Denmark (A)
Mikael Sondergaard, University of Arhus, Denmark
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Mehus: “Closing the Odense plant is in the best interest of the BA. If we can move the plant to
Thailand, we will have a competitive advantage in a growing part of the world.”
Vagner:”But the Odense plant is now the most efficient plant in the entire BA. Why not move one
of the other plants, instead?”
Mehus: “As it stands now, the Odense plant is part of an over capacity problem in the European
market. There is not enough demand in Denmark to justify this plant. What demand there is can be
handled by the plants in Norway and Finland. Also, moving the Odense plant gives us a cost
advantage in Southeast Asia, because it is so efficient. We will need your cooperation to ensure
that the move is carried out effectively. Remember, that is how we do things at ABB.”
Johannes Prahl, CEO of ABB Distribution Transformer company in Odense Denmark, had just
come from a meeting with the Danish Country Manager (CM), Kaare Vagner, and Olaf Mehus,
the Business Area (BA) Manager in charge of the various transformer manufacturing companies
within ASEA Brown Boveri (ABB). At the meeting, they had discussed the potential closing of
the Odense Distribution Transformer plant and the transfer of all its equipment to a new plant in
Thailand. Prahl had (just) been promoted to the position of Managing Director of the ABB
Distribution Transformer company in Denmark, in late 1991.
The initial request that the Odense plant be closed had come from Olaf Mehus, the Business
Area manager for ABB’s transformer manufacturing companies. He had initially tried to close
the plant less than one year earlier, in early 1991, when Svend Aage Koch - Christensen was still
Managing Director of ABB Distribution Transformers. Prahl knew that he was now in a conflict
position, given the matrix organization form adopted by ABB after the merger of the two
predecessor companies. His line manager supervisor, Mr. Mehus had strongly recommended
that he accept the closing and transfer of the plant to Thailand.
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On the other hand, the Country Manager, Mr. Vagner, wanted to keep the Danish plant in
operation: "I want to keep the Odense plant open." Prahl knew that he had to come up with a
recommendation and rationale for proposing any action. Mehus, the BA manager, expected him
to act in the best interests of the Transformer BA, while the Country Manager, Vagner, wanted
the plant to remain in Denmark. Prahl knew that whatever position he supported had to be
explained to both of these managers.
Company History
The ABB - Denmark Transformer Company had its beginnings with the merger of two respected
Danish firms, Thrige and Titan. At the time of the merger, Thrige had specialized in highpowered transformers which serviced the generating plant segment of the market. Titan
specialized in the lower power, distribution segment of the market. Its products were used to
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transfer electricity from the power plants to the various distribution points, and, eventually, to the
customers. Theses operations were combined into the Transformer division to take advantage of
a growing market for transformers, as Danish power companies were expanding both the number
of power generating plants as well as the size and capacity of the distribution system.
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At the time of the merger of these two firms, ASEA owned an interest in Titan, and as a result
became a one third owner of the new company. A Swedish conglomerate, ASEA had set up a
shell company in Denmark to establish its presence as a trading company. There were few assets
in ASEA’s Danish company, however. It produced no products of its own. Its purpose was to
sell the products produced in other countries by ASEA subsidiaries. In 1979, ASEA bought the
transformer part of the business from Thrige-Titan. The transformer business was set up as
wholly owned subsidiary of ASEA and placed within this shell company. The Danish company
increased revenues, production capacity and profits under this arrangement. It sold primarily to
the Danish market, but was able to expand into the Swedish, and to a lesser extent, the German
markets, as well.
Other ABB Transformer Subsidiaries
In 1988, ASEA and Brown Boveri, a Swiss based firm, merged to form ASEA Brown Boveri,
(ABB). Brown Boveri had also had a presence in Denmark since 1920, before the merger with
ASEA, as an engineering firm.
ABB had developed a three prong strategy for growth that included expansion in Europe, Asia
and the Americas. Expansion in Europe focused on increased market share for the company.
ASEA had bought Stromberg of Finland in l987. Stromberg had a subsidiary that manufactured
both power and distribution transformers, and was a major competitor in the Scandinavian
transformer market. After the merger of ABB, the different divisions of Stromberg were divided
among the appropriate business segments within the company.
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Electric Bureau of Norway was acquired by ABB shortly after the merger of ASEA and Brown
Boveri. Electric Bureau also produced transformers in its National Transformer subsidiary. It
had plants in Norway and Sweden and was a major competitor of the Danish and Finnish
companies, primarily in the Norwegian and Swedish markets.
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ABB then bought a German maker of transformers. The German subsidiary manufactured a full
range of transformers. It sold, primarily, to its domestic market. The German subsidiary had
three plants, one of which was located in Berlin, and was heavily subsidized by the German
government for political reasons, according to Koch-Christensen. As a result, the German
company was heavily favored for any orders being placed by German government owned or
operated power companies, or even those companies regulated by the German government.
Each of these companies was set up as a country company reporting to appropriate Business
Area managers within the Transmission and Distribution Segment.
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ABB History and Culture
ABB was formed as merger of ASEA of Sweden and Brown Boveri of Switzerland, in 1988.
ASEA had been founded in 1883, and Brown Boveri had been founded in 1891. Each had a
strong, corporate culture of its own. ASEA had been strong in the manufacture and installation
of equipment for the electrical and electronics industries. Brown Boveri had been equally strong
in the construction of power and equipment plants. Both had extensive networks throughout
Europe. There were some overlaps between the operations of the two predecessor companies,
but the top management of the two companies had felt that the merger could lead to increased
efficiencies and growth opportunities for the combined company if it could overcome the
problems imposed by the long and established history, culture and organization structure of the
two firms.
According to company sources, the merger was divided into three phases. Phase One involved
full merger and acquisition of the assets and resources of the two companies. This was to take
place during 1989-1990. Phase Two was to involve the consolidation of existing facilities along
with targeted growth in major segments, occurring in 1991-93. Phase Three was to take place
starting in 1994. It was to focus on expansion in international markets and segments.
Percy Barnevik, CEO of ABB, called for the development of a company that "Thinks globally
and acts locally." This was to be accomplished through local facilities with local roots
throughout the world, to be supervised through a series of national companies with a Country
Manager (CM). The parts of the company would then share technology and know how through a
series of Business Segments, further divided into Business Areas. They would make use of
centralized Research and Development Centers which would then disperse new technology to the
various operating segments and Business Areas. These would, in turn, share the knowledge they
gain from implementing these new technologies, with other parts of the company.
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The concept of acting locally was formalized into an objective of promoting a Customer Focus,
in 1990. The question that company managers were supposed to ask was, "How can I add value
for the customer?" In 1992, the company added what was hoped would be a temporary objective
of recession management. This was to accommodate the economic slowdown that was being
experienced throughout much of Europe. While the United States was starting to recover from
its recession, that was not yet the situation in Europe. Financial results for ABB are presented in
Exhibit 1.
Percy Barnevik's example created a highly charged ABB culture. Values of this ABB culture
were work ethic ("leader must be a teacher"), emphasis on action, intensive communication
(constant travel to communicate), clear targets, delegation/decentralization, accountability, and
feedback.
ABB strategies were made with a rather long time perspective. For many ABB products, a
considerable period passed from the time the order was entered to the time the product was
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delivered to the customer. However, the deal was typically calculated in fixed prices, according
to Kaare Vagner, the Danish Country Manager.
ABB Matrix Structure
ABB was organized in a matrix structure. The individual operating companies at the country
level reported to the BA managers on one side and the CM's on the other side. They were
responsible for:
Country Manager (CM)
Global strategy
Worldwide results
Research and Development
Product and production coordination
Supply management
Know-how transfer
Regional strategy
Management of the local businesses
Customer relations
Human resource development
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Business Area (BA) Manager
This matrix form and sharing of responsibility was designed to allow the company to take
advantage of its global operations, while maintaining close ties with its local employees and
customers. This was also designed to improve the ability of the subsidiaries to meet customer
needs with greater speed and flexibility.
The businesses were divided into three Business Segments, each headed by a Corporate Vice
President, who was also a member of the ABB Executive Committee. The three areas were
Industrial and Building Systems, Transmission and Distribution, and Power Generation. The
head of the Transmission and Distribution Segment, in 1992 was Göran Lindahl. The BA
manager for Transformers, Olaf Mehus reported to Lindahl. ABB Distribution Transformers
was part of the Transformers BA.
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Operations were also divided into three geographic regions, each also headed by a Corporate
Vice President on the Executive Committee. Denmark was part of the Europe, Middle East,
Africa Region. The other two Regions were The Americas, and Asia Pacific, South Asia.
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ABB acquired the Westinghouse (US) global Transmission and Distribution Division in 1989, as
part of its strategy of expansion and consolidation. Most of this acquisition was allocated to the
Transmission and Distribution Segment. It was also consistent with the objective of expansion
into the Americas and Asia. The structure of the ABB organization is depicted in Chart 1.
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Chart 1
ABB Matrix Structure
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Executive Committee
Country Managers
Business area managers
Operating Companies
Percy Barnevik
Vice President
Region Europe
Lindahl (BS)
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Vagner (CM)
Mehus(BA)
Prahl
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Management at ABB
Percy Barnevik was the CEO of ABB. He had been the CEO of ASEA, prior to the merger with
Brown Boveri. It was generally regarded that Barnevik was the instrument of the new structure
and decision making process.
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Göran Lindahl was Executive Vice President and a member of the Group Executive Committee,
and had held these positions since 1988. He was responsible for the Power Transmission
Segment. He had joined ASEA after obtaining a MS in Electrical Engineering in Sweden in
1971. He had held a series of increasingly important managerial positions within ASEA, rising
to Executive Vice President and member of the ASEA Group Executive Management Committee
prior to the merger with Brown Boveri. In 1992, he was given the additional operational
responsibility for the Asia-Pacific Region. He reported to CEO, Barnevik.
Olaf Mehus was the Manager for the Power Transformer Business Area. He reported directly to
Lindahl. He had received a MS in Electrical Engineering from the Technical University of
Norway. After serving as an Assistant Professor at that school for three years, he joined National
Transformers of Norway and spent the next 23 years with that company, rising to President of
the firm in 1986. After its acquisition by ABB, he was also named Business Area Manager for
Distribution Transformers, part of the Power Transmission Segment. He was a Norwegian by
nationality.
Kaare Vagner was the ABB Country Manager for Denmark. He had held that position since
1986. Prior to that, he had held a series of high ranking positions in several smaller, Danish
companies, before joining ABB. He was from a rural area just outside Odense. Vaagner was
well known and respected by most Danes due to his position as a former Olympic athlete.
Vagner reported to the Executive Vice President for the Europe, Middle East, Africa Region.
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Svend Aage Koch-Christensen had been CEO of ABB Transformers-Denmark from 1988-1991.
He then became CEO of ABB Electric, Inc., a larger operation located in Frederica, Denmark,
approximately 80 kilometers west of Odense. Koch-Christensen had joined Thrige-Titan after
completing a BS in electrical engineering, and had become a department head, prior to ThrigeTitan’s acquisition by ASEA. He had been assigned progressively more important positions at
ASEA, culminating in his appointment as CEO of ASEA Kraft, in Denmark, prior to being
named CEO of ABB Transformers. As CEO of ABB Transformers, he had reported to both
Vagner as Country Manager and Mehus as Manager for the Transformer Business Area.
Johannes Prahl Nielsen had been CEO of ABB Transformers-Denmark since 1991. He had
assumed that position after Koch-Christensen had been promoted to head up ABB Electric. Prior
to coming to ABB Transformers, Prahl had been a department manager and project leader at
ABB Electric, in Frederica, Denmark. He had worked there from 1972-1991, after receiving a
BS in electrical engineering. Prahl reported to both Kaare Vagner as the Country Manager for
Denmark, as well as Mehus, the Transformer Business Area Manager.
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The Transformer Market
The transformer market was split along several lines. The first constituted the market for power
transformers. These were produced for power plants and were used in the generation of
electricity. They were usually quite large machines. The principal demand for these machines
came from the development of new power generating stations or systems. In several of the
Northern European countries, the demand for new transformers had come from the installation of
a large number of windmills to generate power. This was a result of the environmentally
conscious "Green Movement" in Europe, especially in the northern countries.
The other area of demand came from the construction of new power lines. This was primarily a
function of the growth of the economy in the various countries, with its accompanying demand
for more power. As electricity traveled from the generating plant through transmission lines, it
would gradually lose voltage, due to resistance in the power lines. To overcome this loss, low
powered distribution transformers were placed periodically along the power lines to boost
voltage.
In both segments, there was a market for replacement transformers. This replacement market
was quite limited, however, due to the high quality, durability and long life expectancy of the
original equipment.
The market for transformers was at best stable in most parts of northern Europe. In some of the
regions, demand was actually declining. The demand for transformers in Southeast Asia,
however, was increasing at the rate of approximately 14% per year, according to Koch Christensen. ABB was placing greater emphasis in that region as noted by its opening of more
than 20 operating units in Asia.
Power transformers were big, bulky and expensive to transport. ABB operated with long term
contracts in fixed prices . The customers buying power transformers were rather affluent public
electricity companies.
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The Odense Plant
The ABB Transformer plant was located in the city of Odense. Odense was the third largest city
in Denmark with a population in excess of 165,000 people. Odense was the capital of the Funen
district and was located in the middle of the island of Funen at the end of a long fjord. Odense,
the birthplace of Hans Christian Anderson, was a major trade and cultural center in Denmark.
In 1989, the Danish economy was declining, as well as experiencing high inflation. There was
unemployment in excess of 9.5%. The government had decided to attack inflation at the risk of
increasing unemployment. By the end of 1991, inflation had been brought under control, but
unemployment continued at high levels. Unemployment and inflation rates for the country are
presented in Exhibit 2.
The Odense plant originally had produced both power and distribution transformers. According
to Koch - Christensen, the Odense plant had been given the responsibility for specializing in high
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power transformers, after the acquisition of the Norwegian and Finnish companies. The
Norwegian company was given the responsibility for producing low capacity, distribution
transformers. The Finnish company was allowed to continue to produce both power and
distribution transformers. According to Johannes Prahl, then a Project engineer and task force
leader for special projects in different parts of ABB Denmark, this gave the Danish transformer
division the ability to specialize in one side of the transformer business. He added that it also
opened up a global market to the Odense plant since ABB had indicated that it would support
sales of the plant’s products through its sales force.
Koch - Christensen noted that “after Stromberg was acquired, we were shut out of the Finnish
market. We had about 30% of the Swedish market before the Norwegian acquisition. Because
they had a plant in Sweden, we were then shut out of the Swedish market. National
Transformers already had the major part of the Norwegian market. We still commanded about
75% of the Danish market." He noted that the BA manager for transformers was trying to
rationalize the production and sales for transformers, particularly within the Scandinavian
countries.
Management Transition at ABB Distribution Transformers
Johannes Prahl had been an engineer and Project Manager at ABB Electric in nearby Fredericia,
Denmark. He was tapped to replace Koch - Christensen at ABB Distribution Transformers, in
Odense in early 1991. At that time, Koch - Christensen was promoted to the position of
Managing Director of ABB Electric. This was a more prestigious position within ABB because
of its size in sales, profits and number of employees.
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Koch - Christensen turned over a company that was in much better position than when he took
over. He noted that "The cores for the transformers used to be hand crafted. This was costly. I
had a special machine ordered to automate this process." According to Koch - Christensen, the
company that was contracted to build the new machine had thought that it would be able to
develop these machines as a new line of business. After three years of research and
development, the machine was finally delivered to ABB Transformers in 1989. Koch Christensen said that his company had a fixed price contract with the supplier. He felt that the
actual cost of the machine was probably two to three times what his firm had paid for it. The
supplier realized that it could not make a profit on this machinery line and decided to abandon
the product line after delivering the first machine to ABB.
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By then, Koch - Christensen noted, "We had instituted Activity Based Costing (ABC). This was
necessary to evaluate costs, especially since the market was declining.” ABC allowed
management to analyze the cost of each activity that the company used, not just each expense
item from the accounting statements. “With the new machine, we could develop a Return on
Sales of at least 2%. If we could improve our sales, we could approach the industry average of
10%." Prahl noted that, “with the new machine, the plant could just about break even at one shift
of operations. With two shifts, the plant was moderately profitable. At three shifts, the plant
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would be very profitable.” He felt that the combination of these factors had set the stage to make
the Odense plant the best within the Business Area.
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Koch - Christensen stated that "Right from the beginning of the merger of ABB, and the
acquisition of the other companies, we worked together and shared technologies. The purchase
of the new machine gave us the most efficient plant in Europe." He felt that there were problems
in working with the other companies, however. "Norway did not consider themselves ABB
Norway, but National Transformer. The same was true for Stromberg in Finland. It took a lot of
time to develop a common culture of the company. Denmark felt it was much more a part of
ABB. Denmark had reached that level. Norway and Finland had not." He felt that forcing the
Danish company out of both Sweden and Finland, while allowing the divisions from those
countries to compete in Denmark was indicative of the different perspectives of the three
companies.
Prahl noted that Koch - Christensen had developed a network within ABB, especially in
Denmark. Prahl felt that "If you have a management job at ABB, you need to be born in the
company. You need a network. It is very important." He went on to say that he was rather new
as an ABB team manager, but "There were a lot of good, old friends at the management teams."
Prahl stated that he knew that there were problems with keeping open the Odense plant before he
had accepted his position. He didn't know how serious these issues were until he started to
discuss them with the BA and CM managers, after he had moved into his new position.
The Decision
Prahl felt a certain amount of conflict in his position. "The company manager has to serve two
masters at ABB: The Country Manager and the Business Area Manager." Koch Christensen
earlier, and now Prahl had been giving information to the CM to help keep the plant open. They
had also been making an effort to influence the BA manager directly by noting that the Odense
plant was the most efficient one of all the ABB plants. The two upper
level managers had different goals, however. As Koch - Christensen had said, "Goals are
supposed to fit. But they never fit fully."
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Prahl knew that he would be rewarded based on increasing sales and profits for his company.
The CM would be rewarded similarly for the results of the all the ABB subsidiaries in Denmark.
The BA manager would be rewarded based on the global growth and profits of all the operations
reporting to him.
Prahl also felt that he would be rewarded by developing his subordinates as managers. He had
been told by Koch - Christensen that they were supposed to fit the role of an ABB manager.
This included the ability to work with their customers and with fellow ABB employees. They
should be able to demonstrate an ability to cooperate, both within their own company and within
ABB as a whole. Both Prahl and Koch - Christensen noted that ABB policy was that none of the
subsidiaries were to compete internally with each other
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Prahl wondered how he was going to reconcile these seemingly conflicting demands, in making
his recommendation. Even more importantly, how would he be able to implement any decision?
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Exhibit 1
ABB Financial Statistical Group Data (USD in Millions)
Consolidated Income Statement
1991
1990
1989
1988
29,109
28,443
26,337
20,260
17,562
Depreciation of
Fixed Assets
-901
-819
-750
-549
-514
Operating Earnings
after Depreciation (l)
1,219
1,417
1,386
918
543
Income before
Taxes (1)
861
997
1,052
872
495
Net Income before
Minority Interest
528
633
628
628
409
Net Income
505
609
590
589
386
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Exhibit I (cont)
Consolidated Balance Sheet
1991
1990
1989
1988
Cash and
Marketable
Securities
5,534
5,211
4,975
4,332
3,496
Other Current
Assets
11,432 1
2,688
12,848
10,470
9,272
Fixed Assets
8,983
10,157
10,286
7,743
4,597
Total Assets
25,949
28,056
28,109
22,545
17,365
Current Liabilities
13,203
15,394
15,441
13,209
9,193
Advances from
Customers
2,983
2,820
2,798
1,768
1,794
Medium- and
Long-Term Loans
2,993
2,496
2,712
1,746
1,541
Other Long-Term
Liabilities
2,384
2,547
2,442
1,447
1,329
Stockholders'
Equity incl. Minority
Interest
4,386
4,799
4,715
4,375
3,508
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Exhibit 1 (cont)
Consolidated Statement of Cash Flows
1992
1991
1990
1989
1988
Cash Flows from
Operating Activities 1,942
2,128
1,044
1,437
833
-373
-316
-1,024
Cash Flows from
Financing Activities
-477
-1,528
Effects of
Translation
Differences
-769
323
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Cash Flows from
Investing Activities
-580
218
3,323
-867
-48
405
27
-492
236
643
836
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Net Change in Cash
and Marketable
Securities
-3,951
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Exhibit 1 (cont)
Other Data
1992
Orders Received (1,2) 31,153
1991
29,209
Capital Expenditure
for Tangible Fixed
Assets
957
1,035
961
783
736
Capital Expenditure
for Acquisitions
253
612
677
3,090
544
2,386
2,342
1,931
1,361
1,255
340
330
300
290
200
213,407
214,399
215,154
-7
-950
-2,110
1989
21,348
1988
17,572
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Research and
Development
Dividends Declared
Pertaining to
Fiscal Year (Swiss
francs in millions)
Number of
Employees
1990
28,938
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189,493
-1,760
169,459
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Exhibit 1 (cont)
Ratios
1992
1991
1990
1989
1988
Operating
Earnings/Revenues (l)
4.2%
5.0%
5.3%
4.5%
3.1%
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Return on Equity
11.8%
13.9%
14.5%
16.8%
12.5%
Return on Capital
Employed (1)
14.7%
14.7%
17.3%
15.1%
11.6%
Notes to Financial statements
(1)
1988 to 1996 restated; refer to section N in the Principles of Consolidation.
(2)
1996 and 1997 restated to reflect the indefinite delay of the Bakun project.
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All numbers are derived from material supplied through ABB Corporate Communications.
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Exhibit 2
Danish Unemployment and Inflation Rates
Inflation Rate
3.1
5.0
5.2
3.1
2.6
2.1
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Unemployment Rate
1987: 7.9
1988: 8.7
1989: 9.5
1990: 9.7
1991: 10.6
1992: 11.3
Source: Statistisk tiårsoversigt 1997
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1.
This section was based on a presentation by Kim Kenlev, Group Executive Assistant, and
Assistant to the Denmark Country Manager, at the University of Odense, Odense, Denmark.
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Material Sources.
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Svend Aage Koch-Christensen, country manager, ABB, May 15', 1998.
Johannes Prahl, CEO, ABB Electric Inc., May 18th.,1998
Kim Kenlev, Group Executive Assistant, ABB. Presentation at OU,
Jesper Sorensen, IS & HR Manager, ABB Inc., May 19th, 1998
Kaare Vagner, Recorded Speech at Junior Chamber, Odense, 1994.
Ole Elsborg, technical manager of Transformer Plan, Notes, May 12th, 1998
Company Records & Slides.
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Appendix
Names in the Case
Born
1945
Position
Year
CEO ABB Electrics INC
1994 - 1999
CEO ABB Distribution Inc
1991 - 1994
Division Manager ABB Electric Inc
1972 - 1990
Bachelor in Science, electrical engineering
1971
Svend Aage
Koch-Christensen
1943
Country Manager ABB Holding Denmark
1994CEO ABB Electrics Inc
1991-1994
CEO ABB Distribution Inc.
1988-1990
CEO Asea Kraft Inc
1986-1988
Sales Manager in Asea Kraft Inc
1985-1986
Sales (chef) in Asea Kraft Inc
1983-1985
CEO in Dansk vinteknik Inc
1982
Plant Manager in Asea Inc
1980-1982
Department chief in Thrige-Titan Inc
1971-1979
1969
Kaare Vagner
Kim Kenlev*
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Name
Johannes Prahl Nielsen
President & CEO, ABB/Daimler Benz Transportation 1996 - 1999
Executive Vice President ABB (areas)
1992 - 1995
Country Manager ABB Holding Denmark
1986 - 1992
LK Inc
1982 - 1986
Danavox Inc
1979 -1982
Dansh SuccerPlants Inc
1972 - 1979
Ship engineering
1962
Director, Supply Management in BA-PHH
ABB IC Møller
1998 - 2000
Group Executive Assistant, ABB INC Denm 1996 - 1998
Executive Assistant, ABB Scandia INC
1994 - 1996
Executive Ass. for CEO Odense Steelyard
1990 - 1994
Superintendent Engineer, A.P. Møller
1989 - 1990
Engineer, B &W Energy Inc
1987 - 1990
1987
1939
CEO Gram
CEO B&C Textiler Inc
Country manager ABB Holdning Denmark
Manager Danfoss Inc
CEO, Kofa Inc
Chief of Economics department, Møller &Co.
BA (night classes) in Accounting
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Hans-Jørgen Gustavsen
1946
Göran Lindahl*
1945
19961994 - 1996
1993 - 1994
1972 - 1993
1969 - 1971
1961 - 1971
President and Chief Executive Officer
1997Executive Vice President & Member of the Group
Executive Committee, responsible for the Power
Transmission & Distribution Segment. Additional
operational responsibility for the Middle East and
North Africa.
1994 - 1996
Executive Vice President and Member of the Group
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1993 -19 94
1988 - 1993
1992 - 1993
1986 - 1987
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Transmission and Distribution Segment.
Additional operational responsibility for the Indian
sub-continent, Middle East and North Africa.
Executive Vice President and Member of the Group
Transmission Segment.Additional operational
responsibility for the Asia-Pacific region.
ASEA AB, Västerås, Sweden
Executive Vice President and Member of ASEA
Group Executive Management
President, Asea Transmission
BA World wide transformer operations
MS in Electrical Engineering
Olaf Harald Mehus*
1940
1985 - 1986
1971 - 1985
1971
Global Key Account Coordinator for the ABB Group 1995 -1998
Customer Focus Manager, Norway
1993 - 1998
Business Area Manager Distribution Transformer
1989 - 1993
President ABB National Transformer
1986 - 1989
Market Development Director,
ABB National Transformer
1981 - 1986
Export Sales Director, ABB National Transformer 1972 - 1981
Export Sales Manager, ABB National Transformer 1970 - 1972
Technicak Consultant, ABB National Transformer 1968 - 1970
Scientific Assistant, The Technical University of
1965 - 1968
Norway
M.Sc Electric Engineering
1965
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Source: Greens., *Persornal CVs.
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ABB Transformers – Denmark (B):
For Adults Only
Mikael Sondergaard, University of Arhus, Denmark
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Johannes Prahl, General Manager for ABB Transformer - Denmark, was confused and
disappointed as he left a meeting in the summer of 1992, with his Country Manager (CM), HansJorgen Gustavsen, and the European Region Manager (RM), Kaare Vagner. Prahl now realized
that he and the CM had little support from corporate headquarters to keep the Odense transformer
plant open. While he and the CM had argued strongly that the local plant should be kept open,
Olaf Mehus, the Business Area (BA) Manager for the Transformer Division worldwide
operations at ABB had argued just as strongly that the equipment from the Odense plant should
be transferred to a new plant in Thailand.
Actually, there had been two meetings. The first had also included the BA manager and his
direct supervisor, the Executive Vice President, Göran Lindahl, as well as the CM, the European
Manager and Prahl. At that meeting, most of the discussion had been between Gustavsen and
Lindahl. It was clear that they were making the points supplied to them by the Prahl on the one
side and Mehus on the other side. Vagner mostly remained silent during the discussion. It was
here that Lindahl sided with his direct subordinate Mehus, to transfer the plant to Thailand.
At the subsequent meeting in summer 1992, Prahl asked Vagner, who had previously been the
CM for Denmark, why he, Vagner, did not actively support the position put forward by Prahl and
Gustavsen to keep the plant open. Vagner looked at Prahl and replied “This is just a small plant.
It only affects a hundred people. I just closed a plant in Italy with several hundred workers.”
Vagner then left Prahl and Gustavsen to deal with what to do next.
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Key Management Personnel
Johannes Prahl joined AB shortly after receiving a Bachelor of Science in Electrical Engineering
in 1971. He had spent most of his time since joining ABB at their ABB Electric subsidiary, in
Denmark. He had risen through the engineering and research and development part of the
organization. Prior to his promotion to CEO of ABB Transformers - Denmark, Prahl had been a
plant manager at ABB Electric. Before that, he had been a manager for new product
development and manufacturing process development projects. He noted that “If you have a
management position at ABB, you need to be born in the company.You need to have a network.
It is very important.” Prahl noted that “everywhere I looked at ABB, there were a lot of old
friends working in teams” both within and between the subsidiaries. He felt that, although he
had spent his entire working life at ABB, because of his limited general managerial experience
before coming to ABB Transformers, he was new to the ABB team concept. He felt that this old
friends network had been a factor in the decision to cut ABB Transformers out of the Swedish
and Finnish markets.
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Kaare Vagner had been with ABB since 1986. He had been hired to head up the newly formed
ABB Holding company in Denmark after the merger of ASEA and Brown Boveri. Prior to
joining ABB as Country Manager and CEO of ABB Denmark Holdings, Vagner had a successful
career as a business man in a variety of high level management positions in several firms. He
was also one of the best known Danish athletes before embarking on his business career. He
often referred to himself, however, as a small town boy from the rural part of Funen, the island
where Odense was located. He was promoted to Executive Vice President Europe Area and
member of the ABB Group Executive Committee on November 12, 1992.
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Svend Koch-Christensen joined Thrige-Titan shortly after receiving a degree in Electrical
Engineering in 1969. He had spent ten years as department head at Thrige -Titan. From there,
he had been promoted to CEO of Dansk Vinteknit, an ASEA subsidiary. He then held a
succession of sales and management positions at ASEA Kraft before being promoted to CEO of
that company in 1986. He was selected as the CEO of ABB Transformers in 1988. He was then
selected as the CEO of ABB Electrics in 1991. He had viewed each of his assignments as
helping him to develop his management skills. He also felt that in each case he had been given
more responsibility. He had worked closely with other ABB senior managers while holding
these positions. As a general manager, he felt that it was his responsibility to develop a sense of
team work and responsibility in his subordinates. He felt that this became especially important
after ABB was formed. This meant that he had to incorporate the ABB culture of cooperation
and local involvement in his subordinates.
Hans-Jorgen Gustavsen was new to ABB. He had worked for a variety of Danish firms as a
General Manager and CEO. His first position with ABB was as the Country Manager and CEO
of ABB Denmark Holdings. Prahl had felt that Gustavsen was relatively unknown within ABB.
Göran Lindahl was Executive Vice President and member of the Group Executive Committee at
ABB. He had held this position since 1988. He had been given the additional responsibility for
the Asia-Pacific operations in 1992. He had been with ASEA since 1971, originally with ASEA
AB in a variety of positions, including reporting directly to Percy Barnevik, now the CEO of
ABB. In 1992, Lindahl had responsibility for strategic directions and operations for the Power
Transmission Segment of ABB and also operational responsibility of the Asia-Pacific region.
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Olaf Harald Mehus had been with ABB since shortly after the creation of ABB. He had come to
ABB in the acquisition of National Transformer. He had been with National Transformer since
1968, and had risen to the position of president after a number of operating management
positions. In 1992, he was Business Area Manager for the Transformer Distribution Division at
ABB.
The Plant Transfer Decision
Prahl was somewhat surprised when the issue of transferring the equipment from the Odense
plant to Thailand was reopened when he took over as company head in 1991. He knew from his
predecessor, Koch-Christensen, that the transfer had been proposed earlier. He also knew that
Koch-Christensen, and then-CM Kaare Vagner, had been able to keep the Odense plant open and
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operating. Prahl felt that, during his first year in charge of the plant, he had been able to show a
small profit from operations. Also, since this was the most efficient transformer plant in Europe,
it did not seem to make sense to move it to Thailand, where it would have to be used solely to
service the Southeast Asian market. Transportation costs of such heavy and bulky equipment as
transformers did not allow for export more than several hundred miles, unless there were no local
producers in the export market.
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Prahl and Gustavsen had made many of the same arguments at the meeting with Lindahl.that
Vagner and Koch-Christensen had made just a little more than a year earlier. Prahl wondered
about the impact of the transfer of Koch-Christensen, to the more prestigious position as head of
a larger Danish subsidiary of ABB, on the decision process. Both Vagner and Koch-Christensen
had received prestigious promotions within ABB after taking their positions on the closure of the
Odense plant. What had happened to cause the decision to be reversed? He also wondered what
could be done now, and what could be learned from this encounter.
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A TROUBLED TIME IN THE COURTYARD
Arthur Sharplin, Bentley College Center for Business Ethics
John Seeger, Bentley College
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How can people handle this kind of dispute without losing arms and legs on the
battlefield? It’s a terrible, terrible problem and it’s applicable far beyond the Courtyard.
Many homeowner associations and non-profits need to address it. What can you do,
when you’re in this situation? How do you get out of it? How can you step back, when
you’ve made your stand in public and the public agrees it’s right? How do you make
peace? James V. Hoeffner 1
These guys were trying to provoke class warfare, which was easy in such a disparate
neighborhood. It did not help that one of our number may have referred to the 110 or so
owners of the townhomes, a third of the Courtyard population, as “trailer trash.” Arthur
Sharplin
In January 2001, realtor Earline Wakefield stood for director of the homeowners association for
the Courtyard, a secluded neighborhood on the upscale west side of Austin, Texas (see Exhibit
1). Typical of HOAs 2 across the country, this one was actually a non-profit corporation, the
Courtyard Homeowners Association, Inc. (CHAI). At that time, HOAs governed 230,000 U.S.
communities with about 46 million residents, up from just 2.1 million in 701,000 communities in
1970. 3 In general, these “members,” 4 including some directors and officers, did not know their
HOAs were corporations, referring to them as “associations” and often believing them to be just
neighborhood clubs (see Appendix B).
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Wakefield, fiftyish but trim and pert, said she had "extensive experience with fiduciary
responsibility and board procedure." She had done volunteer work with several charities, such as
Reading Is Fundamental, and had chaired the Board of Commissioners of the Austin Housing
Authority. Moving temporarily to San Antonio in 1990, she supervised the sale of repossessed
properties in three states for the Resolution Trust Corporation (RTC), the federal agency set up to
manage the savings and loan (S&L) bailout. In 1997, she and her husband moved back to their
modest home on a quiet cul-de-sac in the Courtyard.
A
In her campaign mailout, Wakefield wrote,
I would like to work at several levels to restore the spirit of this neighborhood. The
1
By convention, this case contains few footnotes. However, the related working paper includes 250 citations.
This shorthand notation will be used throughout the case, but readers should keep in mind that these are usually
non-profit corporations, not associations in the usual sense.
3
By 2006, they would govern 286,000 communities with 57 million residents (source: Community Associations
Institute).
4
Similar in some respects to shareholders in commercial companies but lacking actual ownership of any particular
security or of any of the corporation’s property. Members became such by owning a lot in the community.
2
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Courtyard has been through a very troubled time. I believe that the listening and
questioning skills I have developed in my years of public service will serve our
community well as it moves forward.
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The "very troubled time" Wakefield mentioned was a two-year period of strife as community
activists led by former Marine Corps attorney Bob Rose and Bankruptcy lawyer Jim Hoeffner
tried to force a neighborhood walkway through twelve lakefront backyards. The yards extended
over land shown as “Common Area 5 ” on recorded plats. This resulting “Phase 3A dispute” (the
land involved was in Phase 3A of the Courtyard planned unit development, or PUD) had been
partly resolved by a December 2000 judgment against the HOA, which settled all issues for six
of the twelve affected families. And a promise by then president Hoeffner to extend the nonfinancial aspects of the decision to the other six had mollified them for a time.
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Two of the seven HOA directors were completing their three-year terms in 2001. Wakefield and
computer technician Dale Bishop were elected to fill the two open slots. Two candidates from
Phase 3A failed to get the board's endorsement and, although one of these received more
attendee votes than any other contender, both were defeated when board proxies were counted.
At the February meeting of the new board, Wakefield was elected president, replacing Hoeffner.
Hoeffner, with flowing dark hair and a sometimes mustache, could often be seen in shirtsleeves
and suspenders visiting with neighbors or driving his BMW sports car. He worked out of an
“executive suites” office in downtown Austin. Hoeffner once characterized his practice in the
bankruptcy court as similar to working in an insane asylum, a view voiced by other such
practitioners. 6
Continuing on the board with Wakefield, Bishop, and Hoeffner were Bob Rose, travel agent
Hershel Parish, real estate broker Jo Carol Snowden and IBM employee Judy Dutcher.
Parish, a former air traffic controller then in his sixties and somewhat overweight, led yearly
jaunts to various resorts, inviting present and former HOA officials along with some other
residents. He had openly maintained a personal relationship with developer Ash Creek Homes
during his tenure as president. Ash Creek built many homes in the Courtyard during the late
1990s, among them ten townhomes falling well below published square-footage requirements.
5
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After retiring from the Marine Corps, Rose had worked for a while at an Austin police station.
Nearing his eighties, Rose was a large man, well over six feet tall. Though slow-moving (one
observer said “dawdling”) he appeared to be in good physical condition and could often be seen
walking his dog Gypsie to and from the park, as he said he had done for many years. Rose
admitted that though he had experience in criminal law he knew little about the civil statutes.
Despite this shortcoming, Rose had been considered an authority in Courtyard legal matters since
the 1980s, later testifying, “When the board was meeting and they were discussing common area,
I attended.” Like Hoeffner, he was a stern advocate of covenant enforcement. Rose once moved
The term "Common Area" is capitalized here, as in the Courtyard covenants, to show that it has a technical
meaning, rather than its generic one. Though obviously troublesome when applied to land which was not really for
common use, such usage was not unusual. Indeed, the later Texas Uniform Condominium Act permitted "Limited
Common Elements" to be set aside for private use by individual members.
6
Indeed, bankruptcy practice tended to be exceedingly Machiavellian, with attorneys often being directed to “go out in
the hall and work it out.” Owing to their lack of lifetime tenure, controversial decisions by bankruptcy judges were
appealable de novo to cognizant federal district judges. See Arthur Sharplin, "Chapter 11: A Machiavellian Analysis,"
in Samuel M. Natale and John B. Wilson, ed., The Ethical Contexts for Business Conflicts (Lanham, MD: University
Press of America, 1989) 23-28.
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the board to establish a “Compliance Committee,” to be made up of persons known only to the
president. He also advocated distribution of anonymous complaint forms whereby homeowners
could secretly report alleged covenant violations by their neighbors. This procedure, never fully
implemented but still in place in 2001, formalized the common practice of a succession of HOA
officials to pursue complaints against members while keeping secret the names of accusers.
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Each of the 2001 directors, including Wakefield, had supported the walkway. This was true of
every director elected during the lengthy dispute. Further, none owned a waterfront lot or a
home abutting any of the available “Common Area,” which laced throughout the PUD and which
had been a source of neighborhood conflict for two decades. Wakefield’s situation as she
worked to “restore” the community spirit, will be described in more detail. But first, it is
important to understand the longer conflict.
HISTORY OF THE “COMMON AREA”
Many residents of the Courtyard believed that the "Common Area" strips shown on subdivision
plats, especially along the waterfront, were for the use of members at large. Indeed, there was a
plan during the 1970s, before construction started, to build community trails in these strips. But
the original developer had died, replaced by his son, and the idea was abandoned as amended
covenants were approved by the city in 1978 and 1979. A developer explained that by using the
so-called Common Area to extend the lots they intended to make homes built on the smaller ones
qualify for VA and FHA financing and to increase the market values of the others.
Yard Extensions
When title to the “Common Areas” in Phases 1 and 2 (shown as wooded strips in Exhibit 1) was
transferred to the HOA as part of the development process, the deeds reserved exclusive use and
control of the land "solely" for conveyance to owners of adjacent lots. 7 The attorney for the
main developer later confirmed that it had been their intention to dedicate "all" the Courtyard
“Common Area” for such yard extensions.
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The recorded covenants authorized owners to fence and landscape the lot extensions without
architectural committee (ACC) oversight and, with such, to build various improvements there.
The plan was approved by the city and a court would later rule it proper under Texas Law. Such
exclusive use by adjacent owners was also described in disclosure statements to lot buyers during
the early 1980s. Copies of these disclosures were found in City of Austin records and in HOA
files. But certain unrecorded maps, including one published in the neighborhood directory,
showed the bands only as wooded areas, which some homeowners equated with park land.
A group of early residents campaigned to force the developers to give up rights to the “Common
Areas.” Letters were distributed to the community claiming that homeowners were owed a large
park and money to develop it and levying various accusations of developer misfeasance. As
Hoeffner later testified, such ideas, however ill-founded, became part of the “folk history” in the
7
Though not often done in PUDs, the setting aside of common land for private use was authorized in certain model
statutes, such as the Uniform Condominium Act later adopted in Texas. Such set-asides in condominium projects
were termed “Limited Common Elements.” In the Courtyard covenants, the set asides were accomplished through
“Limited Use Easements,” which conveyed full use and control of the land to the grantees.
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Courtyard. One apparent basis for such claims was a plan by a developer to build a “cabana and
beach area including adjoining parking,” but no evidence was found of any promise to donate
money to the HOA. 8
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A prominent Texas attorney who had represented a Courtyard developer called CHAI "one of the
most recalcitrant and aggressive associations who are hell-bent to get their way and to control
every aspect of development of the subdivision, irrespective of right, wrong or who will be
adversely financially affected." Indeed, several developers, including the son of the original one
mentioned above, went bankrupt after their investments in the Courtyard soured. Of course, in
the turbulent economic environment of that period, many developers and S&Ls failed, whether
or not they were confronted by obstinate HOAs.
Despite continuing pressure from community leaders, some developers and builders passed down
proper title to the back yard extensions. In certain cases, such easements (which, as noted above,
amounted to full use and control, plus the right to fence and landscape without ACC approval),
though initially perfected, were not properly deeded to subsequent owners. Over the years, a
succession of HOA officials refused to assist families in working out resulting title problems,
generally resisted encroachments of any kind beyond the original lot lines, often threatening
legal action. So dozens of Courtyard homeowners, even in 2001, would contend with brushy,
often rat-infested strips of land just outside their back fences, strips which had been officially set
aside for them, with city approval, but which they used only at peril.
LL
ROSE AND HOEFFNER ARRIVE
Rose came on the scene in 1983 and soon became active in neighborhood affairs, serving
as CHAI president during the mid 1980s. He led resistance to a developer's plan to build
townhomes in an area platted for that purpose. Among other interventions, Rose and his board
resisted necessary fences, driveways and walks across the so-called Common Area, negating
covenant provisions designed explicitly to allow those. They threatened a lawsuit and demanded
as much as $35,000 to permit one fence to stay in place. The townhome project faltered and
Rose soon announced the developer’s bankruptcy. Afterwards, foreclosing lenders, told of the
$35,000 demand, donated $15,000 to CHAI as payment for peace and deeded it the “Common
Area” among the townhome lots, constituting 4.54 acres. This was about a sixth of the
Courtyard total and its acquisition by Rose and the others set an example they would follow on a
larger scale in 1992 (discussed below). Both instances involved failed S&Ls and the millions of
dollars in value taken by the HOA were presumably repaid by American taxpayers, possibly
explaining the absence of effective resistance to such coercion during those years.
A
Hoeffner moved to the Courtyard in 1986 and began a liaison with Rose which would last for
nearly two decades, as they and others attempted to wrest control of the remainder of the socalled Common Area from developers. Like Rose, Hoeffner would serve in various HOA
offices, including treasurer, head of the architectural controls committee, and president. In the
latter capacity, he conveyed the 4.54 acres mentioned above to another corporation, which served
as HOA for one of the townhome subdivisions. This transaction was done without a vote by
homeowners and apparently without informing them. In fact, no authority for such a transfer
8
Westover Hills, Inc. (seller) and Annco, Inc. or its assigns (buyer), Earnest Money Contract, September 14, 1982,
11.
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appeared to exist in the covenants—with or without a member vote.
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Starting in the 1980s and into 2001, the HOA directors often pursued complaints submitted to
them by irate but anonymous members, despite a covenant provision providing for member-tomember notification and low-cost arbitration of such disputes. In 1986, CHAI sued a couple
claiming that their wood deck extended past a setback line. Rose said that “the preservation of
covenants and restrictions is the point of the lawsuit,” a theme to which he and Hoeffner often
returned. That same year, one matter was settled when an owner agreed to pay the HOA $746.
A judgment for $4,600 was gotten against another. Yet another was directed to convert his
office back to a “fully-functioning garage.” In the meantime, Rose reportedly circulated a
petition opposing an owner’s plan to build a three-story home on the lot beside his own, although
the covenants did not restrict the number of levels for homes. He later purchased the lot, which
remained vacant in 2001.
A CAMPAIGN OF ADVERSE POSSESSION
An uproar began in 1987 when homeowner Larry Taub started building a boat dock on an
easement in Phase 3A. The land involved had been purchased by the developer in 1982 and,
unlike “Common Area” in other phases, never deeded to the HOA. However, these excerpts
from 1998 HOA minutes suggest the seriousness with which this was viewed:
Gordon [Bomfalk] has contacted city officials about this matter and has pulled relevant
public records and plats, and has spoken to the general contractor…G. [Geoffrey] Palter
and B. [Bruce] Byron will, within seven days, establish contact with an appropriate law
firm and arrange a conference to review the documents provided by Mr. Bomfalk in order
to, at a followup, advise the Asoc. of its legal position, with a view towards establishing
the preeminence of the original deed restrictions and towards retaining control of the
promised common area…G. Bomfalk will draft a letter to both city departments
involved…
After letters from Palter and the CHAI’s lawyer, the Austin City Council voted to revoke Taub’s
permit for the boat dock, but later rescinded that decision.
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On March 8, 1988 Hoeffner executed a Proof of Claim in Austin’s federal Bankruptcy court,
attesting that the HOA corporation owned the so-called Common Areas “in fee” and that the
reorganizing debtor owed it not only the value of the land but $100,000 in “trust funds” as well.
A month later, the lender’s collateral was reappraised, apparently under the erroneous
assumption that the developer no longer owned his waterfront. The Chapter 11 9 reorganization
plan was then rejected and this developer, too, eventually failed. Asked why he had not
confronted Hoeffner, the developer explained that the plan had been carefully worked out in
collaboration with the lender and the court and that he only realized there was a problem when
the lender suddenly moved to dismiss the plan. He added that he first learned of Hoeffner’s
affidavit in 2001.
Placed under oath more than a decade later, Hoeffner testified that he had based his Proof of
9
The chapter of the U.S. Bankruptcy Code providing for re-structuring businesses rather than liquidating them.
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Claim on "folk history" and that his use of the word "trust" may have been "loose." Still, these
allegations were adopted at the time by other community leaders and readily accepted as fact by
eager Courtyard homeowners. For example, Snowden wrote a column on real-estate activity in
the Courtyard Caller and listed many Courtyard homes when they came up for sale. She
expressed surprise that anyone would question neighborhood rights to the Phase 3A backyards,
saying that she had "always told people they could walk down there." Though to all appearances
highly successful professonally, she lived in one of the older townhomes in the community.
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Rose and four of the early residents filed affidavits in the Taub lawsuit, all containing similar
allegations and all apparently produced in the same law office (revealed by initials on the
documents). Rose’s affidavit claimed that he had seen “maps [‘plats’ appeared here but was
marked out and initialed] and other exhibits which they showed me which unequivocally showed
that the areas designated as 'common areas' in said Phase 3A section would be for the use of all
residents of the Courtyard.” As mentioned above, recorded covenants (referenced on plats, but
perhaps not on other “maps” Rose had seen) and deeds along with formal disclosures issued and
signed by some owners before that time revealed precisely the opposite, that the areas were for
the exclusive use of adjacent owners.
The court in the Taub case was asked to affirm Hoeffner’s ownership claim. But the judge
refused to do so, although he did prohibit further construction of the boat dock. After the case
was decided, a vigorous publicity campaign led many residents to believe that the court had
validated the HOA’s title to the land. To buttress that idea, an “Affidavit of Ownership"
describing the waterfront property was filed in the public record by architect Bomfalk, then
president of the HOA. During the Phase 3A dispute, the affidavit would be cited as evidence
that CHAI owned the Phase 3A backyards in fee. That judge not only failed to treat the affidavit
as evidence of such ownership but voided it ab initio. 10
Minutes from 1988 outlined a neighborhood campaign apparently designed to gain title to the
waterfront through adverse possession. 11 Here are excerpts from those minutes:
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Camile Lyons: Would like to see homeowners take what we have (lake, etc.) and
improve on that…Camile moved that the board aggressively move to build and improve
the common areas in the boat dock area for our common use. Suzanne Hoeffner
seconded…A new motion by Gladys [Catchman] that the board present a site plan and
budget for the common area (dock area) to be built for all to use and that this should be
presented at a special meeting in 90 days. Jim Hoeffner seconded. Vote unanimous.
George Whiteside moved that we get volunteers to clean up the dock area while the river
is down…
Bruce stated that we should proceed to occupy the area by posting signs, locking the
area…Manley [Crider] asked how we could control our own access…The Association
now needs to go into the political aspects: First, contact Sunbelt Savings…advise the
title company that discussion will be brought to the press…Go to city council and legal
10
Meaning, according to Black's Law Dictionary, that it "at no time had any legal validity."
Black's Law Dictionary defines the term as “The use or enjoyment of real property with a claim of right when that
use or enjoyment is continuous, exclusive, hostile, open and notorious.”
11
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staff…Get city to defend us…If we run out of money with this expense on attorney’s
fees, we could “borrow” from the $13,000 Landscape fund and then “special assess” the
owners.
Recalling this period years later, Taub said, “I would go to meetings and sit in the back and hear
people accuse me of trying to steal their land. It was awful.”
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HARVARD SURRENDERS
The 20-acres and more Hoeffner had claimed for homeowners was a far cry from the "cabana
and beach area, including an adjoining parking area” planned by the original developer. Yet the
lakefront land and $100,000 were surrendered by developer Harvard Investments, Inc. in 1992.
Hoeffner was president at the time and Rose, in Hoeffner's words, "an honorary director." The
attorney for the reluctant donor later testified that Harvard only got "peace of mind" for its
concessions. The lakefront land, alone worth millions, was amenable to use as lot extensions
down to the lake, a public marina, and a large apartment complex, plans for all of which had
been formally proposed at one time or another.
Placed under oath in 2000, Hoeffner testified that a few days after his demands were agreed to he
released Harvard vice-president Craig Krumwiede and his boss, who was said to have fled the
country, from the abstract of a federal judgment in an unrelated case. Hoeffner said that the
timing of those releases was coincidental, that the part of the judgment owed by the two officials
had been paid and that the abstract had been left in the record through oversight. He explained
that it was not release of these men which motivated Harvard’s capitulation but what he called a
“lock-down” on approvals of new homes by the architectural committee; that is, no building
permits would be approved until Krumweide agreed to Hoeffner’s demands. Indeed, an
elaborate set of “architectural guidelines,” which went well beyond the covenants and cited no
authority in them, was adopted without a member vote during this time period. This document
would often be used even in 2001 to justify rejection of building plans.
THE PHASE 3A DISPUTE
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Hoeffner and Rose were highly respected by Courtyard residents. And few doubted their
confident assurances in 1998 that the community had rights to even more property, a 20-foot
waterfront "walkway" from the existing park 1,000 feet westward across the twelve Phase 3A
backyards. In September that year, a number of members led by Parish, Hoeffner, and Rose
quietly started a movement to take possession of this area.
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“WE WERE AMBUSHED!”
Though not directors at the time, Hoeffner and Rose attended a secret September 16, 1998 board
meeting. The meeting was chaired by Parish, who was president at the time. Minutes of that
meeting, obtained by subpoena, revealed that a motion was made there and a vote taken to
proceed with the expropriation. Preparations were immediately begun to start construction. One
Phase 3A owner remarked, "The first thing we knew about the walkway was when men with
clipboards showed up in our backyards. We were ambushed." Two early residents of Phase 3A
apparently had some idea that a claim was possible, because they had ended their fences some
distance from the water’s edge.
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Still, as owners in this recently-developed section of the Courtyard, the Phase 3A families said
that they were generally uninformed about the subdivision’s troubled past and, as one put it,
“completely naive” about the character of their opponents. Upon learning of the walkway plan,
Arthur Sharplin, a professor who was preparing to build in Phase 3A, wrote Parish pleading that
the board abandon or reconsider its decision. Mike Castleman, himself a nationally-prominent
real estate expert, asked Parish to look over urgently-assembled documents thought to disprove
the board's claims. Parish refused to take the papers and continued to insist that homeowners
owned the Phase 3A lakefront under the deal Hoeffner had made with Harvard. Moreover, he
wrote, a note on an unrecorded development plan "mandated" the walkway.
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Professor Sharplin wrote again, complimenting Parish for his past service and suggesting
conciliation. After this overture was rebuffed, the Sharplins cancelled their building plans.
Their lot would remain vacant in 2001. Another Phase 3A couple had contracted to sell their
home and to buy a condominium. Upon learning of the board's action, the buyer backed out.
The couple, elderly and disabled, said that they were forced to forfeit their deposit on the
condominium.
THE LAWYERS AGAIN TAKE CHARGE
Hoeffner and Rose took over the fight, each writing to homeowners that the walkway belonged
to the neighborhood. Rose, essaying anonymously in the Courtyard Caller newsletter, compared
the Phase 3A owners to the Oklahoma Land Grabbers, adding, “It’s the first man with a posthole digger wins.” Despite repeated inquiries, he would not confess authorship of the piece until
placed under oath a year later. Both lawyers joined Parish on the board in early 1999, with
Hoeffner becoming president. Rose would serve as vice president and, when litigation funds
began to run short, as treasurer, a function for which he repeatedly disclaimed competence.
Certain of the HOA directors and their spouses, along with other walkway proponents, began to
walk along the lake behind the Phase 3A homes. Hoeffner's wife would later testify that one of
the owners yelled at her as she lingered behind his house chatting with a friend. Another activist,
78-years-old, said that the child of one of the owners was discourteous when she fed his dog
through their back fence. Such alleged violations of covenants or decorum were publicized in
letters to the community, provoking angry, public condemnation of the Phase 3A owners.
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When the walkway dispute arose, one of the owners contacted Krumweide, seeking help.
Krumweide ignored the request. It was revealed weeks later that he and Hoeffner had been in
continuing telephone contact. "This was the guy who signed our warranty deeds," said one of
the owners, "And here he was having private discussions with a person who was contesting those
deeds." Threatened with legal action, Krumweide provided an affidavit and a deposition
supporting the claims of the Phase 3A owners.
LAWYER SHOPPING
In August 1998, the HOA’s Austin counsel, Larry Nieman, wrote the directors
highlighting "a long history of inconsistent, unfortunate, illegal, but probably good faith
decisions of past Boards of the Association." Nieman warned of possible lawsuits under Texas’
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Deceptive Trade Practices Act and defenses of estoppel 12 if the board were to continue past
practices. He recommended that issues involving the “Common Area” be referred to a
membership vote.
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Discharging Nieman a month later, Parish and the others replaced him with Houston lawyer
Bruce Schimmel. Schimmel spoke at the January 1999 annual meeting, saying that he
represented more than 400 HOAs and that he kept “suing and suing [developers] and winning
and winning.” He claimed to be so certain of neighborhood rights that he would likely win their
case by summary judgment. 13 Though Hoeffner protested that he was not involved in hiring
Schimmel, the two had each rented an office in the same Austin building during 1992, when
Hoeffner was making his deal with Harvard and Schimmel was suing a South Austin family
which had run afoul of their HOA by keeping twelve children for fee in their home.
Schimmel’s claim of litigiousness, if not success, was confirmed by a search of the Lexis-Nexis
database, which revealed that he had been involved in at least nine Texas appeals court cases.
His Austin case resulted in a $65,000 settlement to that family, who said they were financially
ruined and discredited before their neighbors during the four-year ordeal. And the manager of
that HOA said that Schimmel was “let go” after the settlement. He said that those directors then
arranged to hike their E&O insurance limit ten fold.
Apparently feeling themselves in similar peril after hiring Schimmel, the HOA directors soon
met in closed session and passed a resolution requiring homeowners to indemnify them, their
agents and contractors “to the maximum extent permissible under law.” Also, like the South
Austin directors, those in the Courtyard would demonstrate concern about the sufficiency of their
insurance protection. By November 1998 consideration was being given to raising the liability
limits on an umbrella policy at a cost of $500 per year for each $1,000,000 of extra coverage.
In May 1999, Schimmel wrote that if resistance to the walkway were to continue he would move
to expropriate the entire backyards of those owners, including boat docks and swimming pools,
and to build a walk path as close to their homes as possible. This threat was repeated by
Hoeffner, Rose, and Parish, provoking expressions of angry disbelief. Confronted by a member
about the use of such tactics, Rose quipped, “You’re a businessman; you know that in a lawsuit
you use whatever argument you can make.” “I know no such thing,” the member replied.
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In another instance, Schimmel wrote that he would move to have the Phase 3A owners' counsel,
a partner in the nationally prominent Jenkens and Gilchrist firm, disqualified. In yet another, he
demanded thousands of dollars in advance payments when the Phase 3A owners asked to see
HOA minutes and other records. Schimmel made a number of threats of legal action against
other individuals and groups, including the director who disclosed Nieman’s 1998 warning.
A WAR OF WORDS, DOG DOO, AND SPITTLE
The objections to the board’s walkway plan triggered a barrage of negative publicity, at board
meetings, in mailings to members, and in the Courtyard Caller newsletter. Over ensuing
12
Black’s Law Dictionary states, “’Estoppel’ means that party is prevented by his own acts from claiming a right to
detriment of other party who was entitled to rely on such conduct and has acted accordingly.”
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A judgment issued without the need for a trial.
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months, the Phase 3A owners reported increasing antipathy from their neighbors, some of whom
ignored salutations and even walked away to avoid contact.
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The Sharplin’s said that they had to carry their visiting grandchildren across clumps of dog
droppings dumped on their lot during the dispute. Another owner reported tacks strewn near her
driveway. And yet another said an angry owner spat toward him when he solicited a proxy. "I
suppose we all became a bit paranoid," Professor Sharplin said, "but this seemed so
Kafkaesque." In a lighter reference to the same theme, the director who had released Nieman’s
letter distributed a cartoon showing a man greeting three others at his door and saying, "Whew,
it's only the IRS. I thought for a moment you were from the homeowner association." That
director had resigned by this time, citing “the personal nature of the dispute.”
In early 1999, several Phase 3A owners sought to gain representation on the HOA board. They
adapted a standard solicitation form and attempted to collect proxies by mail. Noting that the
form was similar in appearance to an “official” one, Hoeffner and Rose said that it was easy for
residents to simply sign it without realizing they were giving their votes to board opponents. An
obviously enraged Parish dubbed this a "Trojan Horse" solicitation and wrote the neighborhood
condemning the Phase 3A owners for their "deceit." He, Hoeffner, and Rose then mounted a
successful community-wide campaign to have many of those proxies revoked and reassigned to
directors.
Letters to residents asserted that the Phase 3A members were attempting to take away their
property rights. The mailings asserted that the lakeside backyards were "Common Area" and
suggested that those owners were interlopers. Hoeffner entitled a section of one of his letters,
"MY BACK YARD, YOUR BACK YARD, OUR BACK YARD, COMMON AREA."
Attached was a pink sheet signed by Rose and another former president, commending Hoeffner
and concluding, "Jim is a straight shooter who doesn't obfuscate the facts." Noted for military
metaphors, Hoeffner wrote a former director, "The actions of the Phase 3A owners are so similar
to those of the Japanese during World War II it is eerie." Reflecting his acknowledged desire to
frame the dispute as being between the Phase 3A “interlopers” and the community, rather than
the HOA corporation, he used the word “neighborhood” 76 times in one letter.
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Members Lee Robinson, Carrie Crist, and Bill J. Ely wrote that a letter from Phase 3A members,
“not only reeks of personal agendas and half-truths, but without question is intended to incite
fear and further divide and already divided neighborhood.” The writers commended the
directors for their “efforts and hard work for all the homeowners.” Other owners wrote in
similar fashion and their letters were distributed among residents.
The relative wealth of the Phase 3A residents was often highlighted. Another heading in a
Hoeffner letter to the community asked, "WHO ARE THE SELECT FEW?" He suggested that
such rich owners might find it easy to pay "the price of a luxury car" for the board to desist and
wrote that the waterfront rights might be worth “$400,000, $500,000, or even $750,000” per lot.
No appraisal had been near that range, but all agreed that the contested lake frontage imparted
value to the respective homes. These homes were valued upwards of $800,000 each, compared
to an average of under $300,000 for non-waterfront homes and below $150,000 for the older
townhomes.
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The rancorous debate continued for months, waged in the Courtyard Caller, in mailings by both
sides, and in speeches. In some instances, the directors used volunteer couriers, avoiding the
mails. Parish wrote members that the Phase 3A owners "would attempt to diminish and/or
destroy your property rights to the 20' pedestrian walkway." Soon, Hoeffner prohibited the
Phase 3A owners from serving on any HOA committee. And, in a passionate speech at the
January 2000 annual meeting, he repeatedly called their letters "hate mail." Applause greeted his
conclusion: "Your directors will not roll over!"
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Townhome owner Allan Nilsson later explained, "It was hard for us, sitting on the sidelines, to
believe that a virtually unbroken string of Association officials could be so aggressively wrong,
when they didn't have a financial stake, and that the Phase 3A owners, who had an obvious
financial stake, were right." A widow who lived a block away in another townhome subdivision
wrote, "I live in a part of the neighborhood you consider 'trailer trash' and I consider you as
'newcomers and trouble makers.'" Sharplin wrote an academic colleague,
I have never seen such an effective whisper campaign. And the widow's statement, more
than the president's, may explain its success. These guys were trying to provoke class
warfare, which was easy in such a disparate neighborhood. It did not help that one of our
number may have referred to the 110 or so owners of the townhomes, a third of the
Courtyard population, as “trailer trash.”
GOOD FENCES MAKE MAD NEIGHBORS
After the board began seeking bids for actual construction of the walkway, several Phase 3A
owners erected fences across the area and asked to meet with the directors. Upon one such
request, made at a monthly board meeting, Parish exclaimed, "You take down your fences, we'll
build our walkway, and then we'll talk."
The directors voted on January 20, 1999 to sue all twelve families. One took their fences down
in what Hoeffner said was a commendable show of conciliation. But the others held fast. A
member remarked, "It was the fences which really set them off.” Confirming this, Parish said,
“Nobody pushes this board around."
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THE SPECIAL MEETING
As mentioned previously, Nieman had urged that issues involving the so-called Common Area
be submitted to a membership vote. Starting in early 1999, the Phase 3A owners insistently
pleaded that this be done, citing Nieman’s newly-discovered letter. When the request was
refused, they sought help from the directors’ errors and omissions (E&O) insurer, CNA
Companies, which ignored them at first.
In May of 1999, the directors met with the affected owners, but only under a pre-condition that
just the nature of the walkway would be discussed, not its legality. Afterwards, the Phase 3A
owners offered $50,000 “to avoid litigation.” Krumweide added $62,500, bringing the total to
$112,500. Both offers were rejected without referral to homeowners.
Sharplin wrote CNA's New York coverage counsel asking that she intervene. This lawyer
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contacted the board and Schimmel, whereupon the directors agreed to schedule a special meeting
of members to ratify their resolution to file suit. Rose emceed the meeting, held on June 27,
1999. Hoeffner repeated the arguments he and Parish had made in letters to the community.
Among other exhibits, he displayed a four-foot enlargement of a letter allegedly from a city
engineer, which Hoeffner said supported his contentions. It would be revealed during later legal
proceedings that Hoeffner had provided the city engineer a draft of the letter, which was edited
onto City of Austin letterhead. Upon being advised of a contrary opinion by a senior Austin
official, the engineer admitted error and confirmed that the official was the expert on the subject.
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Though attending homeowners undoubtedly believed Hoeffner’s claims and thought the letter
valid, the board's motion to sue failed to receive the required two-thirds majority—attendees
voted 71 to 55 in opposition. Hoeffner announced, to applause, "There's no lawsuit.”
Notwithstanding the membership vote, the directors refused pleas to revoke their resolution to
sue. And soon after the special meeting, Hoeffner wrote members that the directors were
seeking new ways to enforce community rights to the walkway.
THE LAWSUIT
By November of 1999, the HOA treasury was empty, according to Rose, and Hoeffner reported
that CNA had refused to help out unless the corporation itself was sued. In an apparent strategy
to provoke such a suit and thereby obtain insurer funding, Hoeffner, with Rose seconding,
moved the board to invoke the compulsory arbitration provisions of the recorded covenants,
based on the assertion that the Phase 3A owners were in violation of those covenants.
Specifically, Hoeffner claimed that the fences in the Phase 3A backyards and a woodpile within
the claimed walkway area were illegal, providing an affidavit by Parish in support of these
contentions. The provocation succeeded, although a court would later rule that the Phase 3A
fences had not violated any covenant. Further, the cited woodpile was not only in the park, 75
feet from the claimed walkway, but had apparently been placed there by park workers.
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By this time, the twelve families had spent about $80,000 on legal costs. Lawyers Title
Company, which insured six of them, then authorized an attorney to request a declaratory
judgment on their behalf. The attorney explained, "Title companies don't like arbitration if it is
not under court supervision, especially when the facts and law are on their side. Unsupervised
arbitration is not less expensive than litigation and these arbitrators tend to shoot down the
middle, whatever the facts." The Phase 3A owners requested neither damages nor
reimbursement of fees and costs, but only affirmation of their rights to their backyards.
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"anticipatory" violations of covenants by the Phase 3A owners, and to cover legal costs. From
this point on, CNA funded the board’s side of the litigation, appointing its own attorney to assist
Schimmel and, by one account, to “keep him under control.” Later, Rose confirmed that it was
their strategy to provoke a lawsuit in order to obtain insurer funding of their legal costs.
Chuckling, he explained, "We were dead in the water until you all sued us."
THE JUDGMENT
In late 2000, the trial judge referred the dispute to arbitration, which was conducted under rules
of the American Arbitration Association before three senior county judges. After a week of
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hearings, involving testimony by Hoeffner, Rose, Parish, several other homeowners, and two
expert witnesses, the judges ruled unanimously that neither the HOA nor members at large had
any right to the disputed property. Further, the HOA was enjoined from ever again undertaking
construction there. The ensuing judgment ordered the HOA to pay $228,000 to the Phase 3A
owners, in addition to its own costs—an estimated total exceeding $350,000. The court also
enjoined attempts to collect any part of the award, "directly or indirectly," from the Phase 3A
owners.
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The insurance attorney remarked, "I am at a loss to recall any other time during my more than
twenty years of real estate practice when, over objections, a litigant was awarded fees and costs
in a case of this sort." Most of monetary judgment along with the HOA’s legal costs was
reimbursed by CNA. With Rose serving as treasurer, homeowners were never given a
breakdown of these expenditures. But he and Hoeffner obtained $32,000 by selling perpetual
easements over a section of the park and other areas to SBC Corporation in 2000. And the
September 1998 cash balance of $66,000 along with assessments collected later were apparently
gone by that time. In fact, the treasury ran so short of funds in 2001 that volunteers were
recruited to take over landscaping and member donations were sought to buy plants.
The judgment only applied to six of the Phase 3A lots. As mentioned above, Hoeffner quickly
wrote the community promising to extend the "non-financial" benefits of the judgment to the
other six families. 14
WAKEFIELD AS PRESIDENT
Upon taking office in February 2001, Wakefield quickly began changing board procedures.
Monthly meetings were moved to an area with ample seating. In the previous venue, the only
seating was the sofas where the directors sat. The bylaws stated, "The books, records and papers
of the Association shall at all times, during reasonable business hours, be subject to inspection by
any member….copies may be purchased at reasonable cost." But Hoeffner had often refused
member requests to see minutes and financial records. And one owner was charged $1.06 per
page for documents he sought. Wakefield welcomed requests for financial statements and such,
approving several in the early months of 2001, at no charge.
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The Hoeffner board had adopted a number of important resolutions in closed, or “executive,”
sessions. Later asked why such actions were taken covertly, Hoeffner explained, “When you’re
planning strategy for a battle, you don’t usually invite the opposing general to join you in the
planning." Wakefield discouraged such sessions, reading aloud in open session minutes of the
few which were held.
As mentioned above, Hoeffner’s board had barred the Phase 3A owners from committees during
the dispute. With the case decided in their favor, several put their names on sign-up lists at the
2001 annual meeting and Wakefield encouraged their participation. One soon was selected chair
of the Landscape Committee, another of the Social Committee, and yet another of the Newsletter
Committee. Several more became ordinary members of such panels.
14
James V. Hoeffner et al. to Neighbors, January 2, 2001.
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A THREAT OF RENEWED LEGAL ACTION
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Several of the directors, especially Bishop and Hoeffner, continued to express fear of being sued
individually. They mainly attributed their concern to a letter from the Phase 3A members'
former attorney demanding that no CHAI records be disposed of for at least two years. But their
anxiety was doubtlessly heightened by a report that CNA might "non-renew" the E&O policy
after paying such a large claim (indeed, the policy would be non-renewed when it expired in
November 2001 and, though alternative insurance was obtained, the premium doubled, according
to Wakefield).
Schimmel had backed away, pleading illness. Parish affected not to speak to the Phase 3A
owners, sometimes crossing the street to avoid contact. Several of those owners continued to
criticize previous and current board actions, variously writing letters to Wakefield or asking
accusatory questions during board meetings. One suggested that the directors apologize for their
attack upon the Phase 3A owners and that Rose, Hoeffner and Parish resign.
In June 2001 Wakefield executed a document purportedly designed to fulfill Hoeffner’s promise
to the remaining six Phase 3A families. When this instrument was recorded in the county
records, several of the owners complained that it made the problem worse, not better. One, an
attorney himself, wrote that its existence in the public record might make all twelve of the Phase
3A lots un-salable.
Prominent Austin litigator Mike McKetta contacted Wakefield on behalf of two of the families,
asking who had prepared the instrument. She allegedly replied that, according to Hoeffner, a
CNA lawyer was the drafter. Asked about this, the lawyer was said to deny authorship.
Hoeffner shortly resigned from the board for unannounced reasons.
As Wakefield prepared for the August 2001 board meeting, it was clear that her plan to “restore
the spirit of the neighborhood” was in jeopardy. Before resigning, Hoeffner had given his view
of the problem:
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How can people handle this kind of dispute without losing arms and legs on the
battlefield? It’s a terrible, terrible problem and it’s applicable far beyond the Courtyard.
Many homeowner associations and non-profits need to address it. What can you do,
when you’re in this situation? How do you get out of it? How can you step back, when
you’ve made your stand in public and the public agrees it’s right? How do you make
peace?
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APPENDIX A: THE COURTYARD
The 323-unit Courtyard subdivision was almost completely encircled by the Bull Creek
embayment of Lake Austin. This gave the development more than a mile of wooded lake
frontage, such as was generally valued at $2,000 and more per foot. Only the west side of the
community was open to entry and exit by auto. Even there, the busy Capital of Texas Highway
lay out of sight beneath a low cliff, forming a demarcation between the quiet neighborhood and
the shiny glass and aluminum complexes to the west, which marked the epicenter of Austin's
burgeoning high-tech industry.
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A low concrete sign near the main entrance, at the southwest corner of the development, bore the
inscription "The Courtyard Residential and Tennis Community," although the tennis club was
private and, contrary to early expectations, drew only a minority of its members from the
neighborhood. The Courtyard had been built on a former Boy Scouts of America campground.
A section of the old Scout lodge had been incorporated into the tennis club bar. And street
names such as Karankawa Cove and Scout Island Circle were suggestive of that history.
Many Courtyard residents, especially those active in neighborhood governance, had lived there
since the eighties, when the nearest commercial development was miles away. A number of
them recalled spending happy times at Camp Tom Wooten, as the campground had been called,
hiking its trails, swimming in its pristine waters, and camping among the deer, raccoon, and
coyotes, which could still sometimes be found along the lake.
Owing to the concentration of high-tech businesses nearby, the population of the Courtyard was
growing markedly younger after the nineties and, presumably, wealthier. Developed over more
than two decades by three major developers and builders and a dozen or more minor ones, the
community was, to say the least, eclectic. The tennis club, with its chain link fences and squat
structures, was located two blocks north of the main entrance. A modern three-story commercial
building at the northwest corner of the neighborhood housed offices of more than a dozen firms.
Its parking lot and that of the tennis club often overflowed onto adjacent streets, a matter of
continuing concern to nearby residents.
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The tennis complex was surrounded by about 110 townhomes, ranging from strings of aging
wood and brick flats to modern stucco "garden homes." Many of these, and a few of the larger
ones, were absentee owned. In addition to being members of CHAI, owners here were organized
into four sub-associations charged with various maintenance responsibilities. Assessments were
$189 a year for CHAI and sub-association dues added another $1,000 to $1,500 annually for
those owners.
Further east, along interior streets and coves, were about 140 rather conventional houses of
various designs, set the legal minimum ten feet apart at the sides. The small front yards were
neatly trimmed and ornamented with such plants as purple sage, Indian hawthorn, and crepe
myrtle. Oaks, sumac, and China berry trees lined the streets, hanging low over sidewalks in
some spots and forcing the dozens of daily joggers and walkers to detour into the streets.
Brushy, un-maintained strips of so-called "Common Area" laced behind these homes. Here and
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there, patches had been taken in by adjacent owners, extending those backyards. Many enjoyed
perfected titles 15 to these lot extensions, rights protected by title insurance. Others had been
given "licenses" by friendly CHAI boards to fence the land and improve it. For most, however,
their legal rights to the strips had not been included in successive title transfers and some
erroneously believed them to be common area in the usual sense; that is, areas owned by an
HOA corporation for use by members at large. Few knew that when the land in Phases 1 and 2
(see case Exhibit 1) was deeded to CHAI as "Common Area" all meaningful property rights had
been reserved "solely for the purpose of conveyance to adjacent lot owners."
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Along a semicircular cliff above the lake were 60 or so other residences, some dating from the
late seventies and of economical construction and others virtually new and showing the marks of
Texas' finest architects and builders. Many of the older homes were largely of wood, clapboard,
or other non-masonry construction, while most newer ones were clad in Texas limestone or
brick. Residents here generally enjoyed only laborious access to the waterfront, or no access at
all, although a few had striking views across the lake, where a bucolic nature conservancy and
the famous Austin Country Club provided the foreground for hillside scenes suggestive of some
European communities.
The cliff fell away to a shallow bluff at the southeast, allowing the extension of manicured
backyards down to the lake and the construction of private boat docks along with other amenities
expected of fine waterfront homes. Twelve of the nineteen residential lots here were in "Phase
3A," one of eleven subdivisions in the Courtyard, and the most exclusive. Here, too, was some
variety of construction, but these lot values alone ranged upwards of two hundred thousand and
one home was on the market for nearly two million. Another, designed by an internationally
prominent architect, won several awards and was featured on the cover of Southern Accents
magazine.
Beneath the cliff at the eastern and northern perimeter of the Courtyard was a gated
neighborhood park, encompassing twenty acres and more than a half mile of lake frontage. Park
amenities included toilets, post-mounted grills, a covered picnic area, a parking lot with a
mounted basketball goal, two boat ramps, rental spaces for boat trailers, a mile of hiking trails, a
lakeside sunning deck, and an eighteen-slip boat dock with spaces designated for nearby homes.
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“It’s a kinda nice place to live,” said one new resident. “Just don’t cross the homeowner
association,” quipped a neighbor.
15
I.e., “One which is good and valid beyond all reasonable doubt,” Black’s Law Dictionary.
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APPENDIX B: HOMEOWNER “ASSOCIATIONS”
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In 2001, HOAs governed about 230,000 communities in the U.S. with about 46 million residents,
numbers which had more than quintupled since 1980. 16 Most of these HOAs, including that for
the Courtyard, were not associations in the usual sense but non-profit corporations imbued with
regular corporate powers and acting as "persons" distinctly separate from their members. Such
members, though in some respects equivalent to shareholders in for-profit companies, possessed
no shares in their "association," nor did they own any of its property. Members became such
only by virtue of owning a home or lot in the community governed by the corporation, in this
case the Courtyard.
HOAs were generally set up by developers as a way of avoiding long-term responsibility for
management of subdivisions while ensuring that certain standards of decorum and aesthetics
were met. Many city governments required this. Most “declarations,” as initial covenants were
often called, provided for developer administration until a certain proportion of the lots were
sold, at which time the developer would step aside and allow homeowners to elect directors, who
would take control of the HOA. Often, the developer would “elect” homeowners to the board
while retaining majority control during a transition period. The Courtyard developer’s
temporary administration ended in 1983.
Within the limitations of applicable laws, articles of incorporation and bylaws, HOA
corporations, as is true for all corporations, could own and manage property, enter into contracts,
engage in business, and sue and be sued. In general, their legal relationships with members were
contractual and the standard contract was a lengthy document prepared by the developer and
recorded in county real estate records. These were called "covenants," "declarations," or
"restrictions.” A standard provision of such contracts allowed—but did not require—HOAs to
sue members accused of violating covenants. The names of accusers were often not made
public.
A number of factors tended to foster legal action by HOAs. First, the elected officials of such
corporations were typically ordinary citizens, with busy lives of their own. So they were
dependent upon specialized management companies to administer neighborhood activities.
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Second, HOA corporation officials could attack members with impunity and often did so on
behalf of anonymous complainants. A standard provision of covenants required an accused
family to pay legal costs if they lost but protected the corporation and its officials against any
such accountability. Resulting debts as well as unpaid assessments normally resulted in
automatic liens against member homes. Such provisions were strengthened by state laws,
specifically in Texas, prohibiting lawsuits against these neighborhood volunteers. Memberfunded indemnity and errors and omissions (E&O) insurance made the protection from personal
accountability practically absolute. Importantly, directors, at least in the Courtyard, often met in
“executive session” and exercised “lawyer-client privilege” to keep communications with
attorneys secret from members.
16
Source: CAI.
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Third, the power of directors to levy increased "assessments" and to borrow money to be repaid
out of such assessments often allowed them to outspend individuals who took them to court.
The covenants were binding on successive property owners and could only be amended by a
supermajority vote of membership, 90 percent for CHAI. Amendment of HOA bylaws and
articles of incorporation normally required lesser percentages; for CHAI a simple majority of a
quorum (a quorum was set at 30 percent of members) could amend the bylaws and 75 percent of
all members could alter the articles of incorporation.
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Most HOAs were permitted to report their income on a 2010-H federal income tax return, which
exempted the yearly membership fees, called "assessments," from taxes and provided in 2001
that other net income would be taxed at a flat 30 percent. In 2001, CHAI earned non-assessment
income from boat trailer parking space rental ($6,000) and from sale of two perpetual easements
over Common Area to Southwestern Bell Telephone Company ($32,000). Assessments that year
totaled about $60,000, approximately equal to budgeted expenses. The $32,000, which had
helped pay uninsured legal costs, was reported as exempt income, avoiding $9,600 in taxes but
raising questions among certain watchful members. After one complained, the tax return was
amended to correct the “mistake.”
Like public companies, HOAs typically employed proxy voting systems. Also like public
companies, they generally solicited proxies by mail, giving the directors majority control at most
meetings.
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The Community Associations Institute (addressed as www.caionline.org), with some 16,000
members in 55 chapters across the country, was the main national association of HOA
corporations, property management firms, and lawyers specializing in HOA work. Owing to the
thriftiness of most HOA boards, representing them was notoriously low-paying work, with
annual retainers of as little as $1,000. HOA lawyers who did best financially were those who
represented many HOAs and those who specialized in legal actions against errant homeowners.
CAI provided a wide range of services to its members, including vendor contacts, certification of
property managers, a statement of professional standards, and a complaint procedure. But it
directed much of its effort, and money, toward promotion of legislation to enhance the power
and profitability of member professionals. CAI had a special entrée’ to the Texas legislature, in
that Senator John Carona, a CAI member, owned a large property management firm. The
Courtyard HOA corporation and the real estate company it employed to manage its affairs were
CAI members, although no CAI-certified professional was involved in managing this HOA.
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MICROFINANCE INSTITUTIONS IN TRANSITION:
THE CASE OF FONKOZE’S TRANSFORMATION
Michael Tucker, Fairfield University
Winston Tellis, Fairfield University
Dina Franceschi, Fairfield University
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Anne Hastings, director of Fonkoze, Haiti’s most prominent microfinance institution (MFI), had
just returned from a fund raising trip to the US, and met with Fr. Joseph Phillipe later in the
afternoon. She had become increasingly concerned about the amount of time devoted to
fundraising she needed to do. She said to Fr. Phillipe: “Pe Jo this is my third trip to the US in
four months. Each time I leave here, I fall further behind in my work with Fonkoze and the staff.
We have to do something!” Fr. Phillipe thought for a moment and said, “You told me that
Fonkoze had savings deposits from all our members. Why don’t you use that money for loans
and reduce your travel?” Without missing a beat, Anne replied, “Don’t think I hadn’t considered
that. However, it is illegal for microfinance organizations to use members’ savings deposits.” To
which Fr. Phillipe replied, “Then let’s change our status!” Anne said, “We should think about it,
research it, and present alternatives to the Fonkoze’s US Board of Directors, along with our
recommendation.” Anne talked to other bankers in Haiti, and with some Fonkoze Board
members to become acquainted with the process to commercialize.
Anne soon learned that the Board members with whom she spoke, had concerns about “mission
drift” and conversion cost. One member asked her, “How will Fonkoze continue to serve the
poor, if it no longer has MFI or non-profit status?”
The following sections cover background material and lead up to Anne’s presentation to the
Fonkoze Board.
Introduction
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Fr. Joseph Phillipe of Haiti, newly ordained as a priest, completed his studies in Accounting and
Economics in 1995. This man of vision and grand plans was eager to respond to the immense
needs of the people in the cities and countryside of Haiti. It is easy to understand his urge to take
some action. Over the preceding years, Haiti’s forest cover was stripped to the extent that the
hills were now bare and eroded. Fr. Phillipe’s first foray into community organization was in his
own birthplace, Fondwa in the valley between Leogane on the Gulf of Cuba and Jacmel on the
Caribbean.
From Fondwa it took one hour to walk up steep hills to the nearest paved road. Fondwa had no
electricity, no schools, and most disturbing was the lack of employment. As in much of Haiti,
illiteracy hovered at around 55% while over two-thirds of the population has only informal
occupation 1 . The people were relegated to menial tasks and subsisting on produce from their
fruit trees, and vegetable gardens. The young men made their way to an already overcrowded
1
CIA Factbook, 2003
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capital Port-au-Prince, in search of employment. “We have got to do something to create
employment and hope for the people,” said Fr. Phillipe.
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Fr. Phillipe believed a cooperative association could be beneficial for the local farmers. Thus
Assosyasyon Paysan Fondwa (APF) - the Peasant Association of Fondwa was born. Fr. Phillipe
said, “It would be nice to have a cooperative that would help the family growers to learn better
techniques, be able to acquire seeds and get advice on managing their resources, and marketing
their products.” He created a village committee of respected individuals who ran open meetings
and made their decisions publicly. At the first meeting, the committee decided that they first
needed a school, then a convenient source of water, and better access to the main road than the
mountain trails they currently used. Since medical assistance was hours away, they planned to
build a clinic.
The Creation of Fonkoze as a Microfinance Institution
All these plans required an infusion of funds, which were clearly unavailable in this remote area.
They could not obtain bank loans because they lacked collateral. Fr. Phillipe began a sustained
effort to travel to places in the U.S., Europe, and Canada to find donors sympathetic to his
projects in Fondwa. His efforts were successful, but that success raised other issues. Some of his
benefactors asked him, “Who will manage the money that you raise? Who will invest the money
so that it will grow?” As a result, he wondered about starting some kind of financial institution.
After investigating the options thoroughly and given the poor position of the villagers, Fr.
Phillipe concluded, “microfinance is precisely the vehicle we need to help free the poorest
people in Haiti from their dependence on usurious moneylenders.” Following several trips to
locations around the Caribbean and Central America observing Microfinance Institutions (MFI)
first hand, he was convinced it was feasible to start one in Haiti. With the help of donor friends
in Canada, the United States, and Europe, he raised enough money to start Fonkoze as an MFI.
Fr. Phillipe said, “The goal is to lend money to the poor at reasonable interest rates and to
provide other support services.”
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Mohammed Yunus, an economics professor at the University of Chittagong, Bangladesh
originated the microfinance concept. In 1976, he began making small short-term loans to artisans
near the university to help them become self-reliant, and escape from the ruthless moneylenders.
Most MFI clients were poor, and thus had no collateral, so no commercial bank was willing to
loan them money. The typical MFI loan was $50 or less. MFIs usually loaned money to groups
(usually 4 or 5 people) rather than to individuals. It was the responsibility of each group member
to see that every member paid her or his monthly installment. Group members often knew each
other very well and knew that if they met their obligations, the next loan could be for a larger
amount. In effect, the MFI used social collateral.
In 1996, Fr. Phillipe with the late Fr. Jean-Marie Vincent founded an MFI that they called
Fonkoze (a Kreyol acronym that translates into “shoulder-to-shoulder”). Fr. Vincent was
assassinated during the 1996 coup that ousted the democratically elected President Aristide, the
same year Fonkoze opened its doors for business with a mission of making small loans to groups
of poor people. Fonkoze required borrowers to apply for loans in groups as most MFIs did. Most
of the customers were women street vendors called “ti machann.” Their only other source of
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funds was the usurious moneylenders. Fr. Phillipe said, “Moneylenders typically charged interest
upwards of 300% and required daily payments.” Often the ti machanns were caught in the cycle
of borrowing in order to pay back a previous loan from the moneylender. “Fonkoze” said Fr.
Phillipe “would free them from that enslavement, and allow them to dream beyond merely
securing a daily meal for the family.”
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Fonkoze is located in Port-au-Prince, Haiti. It is the largest Haitian organization that lends to the
poor. They have grown from just 600 accounts to over 20,000 accounts in 7 years. In the process,
they have exhausted the capability of their software to handle their activity, and their network
resources are strained.
Since they are the only financial organization in some areas of the country, they collect savings
as well. They now process over millions in savings deposits, but may not leverage those savings
into new loans because only a regulated bank may do so. Fonkoze deposited those funds in a
commercial bank. In 2001, depositors earned 6% while Fonkoze’s interest charged on loans was
37%. If Fonkoze itself changed status the organization would have access to those savings
accounts and thus to a ready source of funds that could be loaned out. Their projected deposit
growth was about 15% per year. Even assuming a 30% reserve requirements, that would still
leave 70% of deposits available for loans.
Growth of Fonkoze
Fonkoze started with an office in Port-au-Prince. They used the Grameen model of group lending
and community partnership developed in Bangladesh. Starting with a few ti machanns formed
into groups of four or five, they marketed Fonkoze’s services to street vendors with each
succeeding group of borrowers as eager promoters of the new MFI. Competing against the
moneylenders was not without risk. The moneylenders, who were losing many customers,
targeted Fonkoze culminating in the murder of a Fonkoze employee in 2000.
LL
As a condition of receiving a loan, Fonkoze required the borrowers to save twenty per cent of the
loan in a savings account, thereby becoming a savings institution for the poor. Fonkoze also
offered Literacy classes and Business Management classes for its customers. These services were
very important to the customers, many of whom were attracted to Fonkoze because of the
education services. Fr. Phillipe envisioned this aspect of Fonkoze’s mission as vital to the people
it served. From a business perspective, educated borrowers were more likely to repay their loans.
Loan default rates averaged 4%.
A
Unlike the background credit checks carried out in developed countries, Fonkoze staff members
in Haiti had to go to a potential member’s neighborhood and interview friends and relatives. The
interviews established the reputation of the applicant, personal stability and the size of the
family, and other character related details. This was a labor- intensive operation, but there was no
other way to verify an applicant’s reliability.
In 1997, Fonkoze had fewer than 110 borrowers and all the record keeping was manual. By
1998, their success at attracting the street vendors meant they were servicing 2,607 accounts with
the number of accounts topping 8400 by 2001 1 . Savings account growth was even more robust.
1 Stevens, 2002
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The number of accounts went from 193 in 1996 to just under 21,000 in 2001 1 . As a result, the
manual record keeping became impossible for Fonkoze. They needed computer hardware and
software. In addition, a rapidly expanding business in currency transfers was also becoming
unmanageable. Their customers were receiving U.S. Dollars from relatives abroad and
converting them to Haitian Gourdes through Fonkoze. Banking software would have to handle
multiple currencies in addition to its other functions.
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In 1998, undergraduate students at a Connecticut university acting as consultants investigated
different software options for Fonkoze. However, Fonkoze had no computers and erratic electric
service from EDH - the city service in Port-au-Prince. Since most organizations in Haiti were
familiar with the unpredictability of electric service, they arranged for alternative solutions.
Some used solar cells that energized batteries; others used generators. Fonkoze used both for
their existing operations in Port-au-Prince. Fonkoze expanded the number of solar cells and
installed the power strips for the additional PCs as a ready solution to provide sufficient power
for computers. Fonkoze acquired one PC with the recommended software. Soon the PC was
continuously busy with data entry just catching up with previous activity. In less than a year,
Fonkoze was clearly in need of additional computers.
Additional computers necessitated installation of a local area network so that all users could
share the data and software. Multiple users implied a new network-compatible version of the
application software. Once again, the Connecticut university students shared their expertise,
designed, and installed the network and the software. Fonkoze was therefore able to keep up with
the work. However, by this time Fonkoze had expanded to 18 branches located all over Haiti. All
but two of them had neither electricity nor telephones. Many were in extremely remote locations.
An employee rode a bus from each branch to the main office in Port-au-Prince each week to
deliver its transactions to the main office. That ride could take up to seven hours each way. The
logistical challenges were and still are a significant barrier to transacting business on a regional
basis in Haiti.
LL
Branches opened in Jeremie, Les Cayes, La Vallee, Jacmel, Fondwa, Trouin, Leogan, La Gonav,
Mirebalais, Hinche, Pont Sonde, Gonaive, Wanament, Fort Liberte, Cap Haitien, Port Margot,
Port de Paix, in addition to the main office in Port-au-Prince. Fonkoze was the only financial
organization in the country that had an office in every “Departement” (the equivalent of a state in
the U.S.) and its reputation was excellent. With rapid growth came new concerns for Fonkoze’s
management.
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Business Challenges in Haiti
Haiti is one of the poorest countries in the world. In 1999, the per capita income was about $400
per year, slightly more than $1 per day 2 . A population in 2003 estimated to be about 7.5 million
could grow to be over 13 million by 2025 under current trends 3 . How would nearly double the
number of people be accommodated in what has become an already crowded and barren
country? Nearly 43% of Haitians were under the age of fourteen, severely taxing limited social
2
Stevens, 2002
World Bank, 2003
3
CIA, 2003
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services 1 . Only 4% were over sixty-five 2 testifying to the difficulty of reaching old age amidst
such poverty. It is expected that the already overwhelmed natural environment will be exhausted
in the near future. At just 23,000 hectares, the remaining natural forest is unlikely to last more
than a few years into the 21st century.
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Anne Hastings was aware of the challenge when she left Washington D.C. in 1996 for “a couple
of years” at Fr. Phillipe’s invitation. She had been a management consultant, and stayed longer
than she had planned. Her management experience was invaluable during the first years of
Fonkoze, as Haitian middle management required mentoring from experienced Western
managers. As a policy, explained Anne, “Fonkoze hires underdeveloped Haitian individuals and
mentors them with foreign experts. Many trained individuals leave Haiti for the U.S., Canada,
and Europe. Several international organizations such as International Development Bank (IDB),
Consultative Group to Assist the Poorest (CGAP), and Development Alternatives Inc (DAI) have
made grants to Fonkoze to stem the brain drain. Fonkoze hopes to give them a reason to stay.”
The quandary for Fonkoze was whether slowing the brain drain by providing the local employees
with professional development was more important than providing financial services and
sustaining the organization.
Fonkoze Management
Fonkoze was an exceptionally transparent organization. Fr. Phillipe’s original concept of the
management of Fonkoze was a structure that would prepare the people for democracy. Fonkoze’s
constitution called for a Board of Directors in Haiti elected by its general assembly, which
consisted of representatives of peasant associations. The general assembly elected one or two
Board members depending on the size of the district. Fonkoze’s constitution called for nine
members made up of customers (those who borrowed money from Fonkoze) and were mostly
organizations like farmers’ associations. They had a U.S. auditor; they published their financial
statements, and reported to the board regularly.
A
LL
Fonkoze was incorporated in the U.S. as a 501c3. Its purpose was providing tax deductions to
donors. There was also a second Board of Directors in the U.S. Fr. Phillipe selected the initial
U.S. Board consisting of individuals who had demonstrated interest in and commitment to Haiti.
Some had carried out projects there. It was a group made up of racially, religiously and
professionally diverse women and men. They were from various countries and of varying ethnic
origins. Initially this group monitored the funds raised in the U.S. and Fonkoze’s use of the
money. Anne said, “It has evolved into a vital source of advice and guidance to the management
of Fonkoze.” The Board included members with senior banking management experience and
they were generous with their time, instructing the staff in Haiti when necessary.
Customer Profile
The profile of Fonkoze’s customers was consistent across the country. They were nearly all
women who were poor, mostly illiterate, and extremely hard working. They depended on each
day’s sales to generate income from which they had to repay their loan from Fonkoze, and buy
staples such as rice and beans with which they fed their families. There was little economic slack
for dealing with illness or any uncertainty. Often a wedding or a funeral would result in a missed
1
2
CIA, 2003
CIA, 2003
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loan payment. Their workday typically started as early as 3 a.m. or 4 a.m. and seldom ended
before sunset. In the rural areas, the vendors often walked for hours to get to the twice-weekly
market, which was the only place to obtain supplies since there were no stores.
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Making the Case for Transformation
As an MFI, Fonkoze could neither pay interest on deposits nor loan out those deposits. Deposits
were held by a regulated bank, which paid interest. Without access to deposits, fund raising was
required whenever Fonkoze wanted to expand the loan portfolio. The amount of money available
for loans was dependent on the borrowers’ prompt payment of installments. To expand the loan
portfolio, Anne had to spend an increasing amount of her time assisting the Fonkoze U.S.A.
development staff in fund raising. Her time spent on fund raising deprived Fonkoze Haiti of her
creative and supervisory skills. Table 5 projects forward Fonkoze’s loan capacity if no further
fund raising was to occur. Expenses approximating current operations are assumed to continue
their inexorable year-to-year increase eventually diminishing and eliminating funds available for
loans. Table 5 demonstrates that even though the value of deposits rises through 2005, because
they are unavailable for lending, loan capacity falls annually until it falls to just over $100,000 in
2005. Grants and outside loans have maintained the lending ability. Could making deposits
available for loans close the gap and make Fonkoze self-sufficient?
A
LL
The process of converting from MFI to regulated status in a developed country would involve
complying with the regulations set by the country’s Central Bank. Anne’s staff came across other
examples of financial institutions around the world in the same predicament as Fonkoze was in
now. In Kenya, which has areas comparable to Haiti, conditions could be similar so the report
was helpful to Anne in developing alternatives for the Fonkoze Board to consider. There was
invaluable guidance in the successful transformation of the Kenya Rural Enterprise Programme 1
(KREP). KREP had a similar pace of growth and faced the same choices as Fonkoze. KREP
decided to convert from an MFI to a regulated bank:
1)
Achieve institutional and financial sustainability through improved
governance and increased profitability
2)
Balance management time between profitable activities and
complementary services that usually require some degree of subsidization
3)
Gain access to additional sources of capital, particularly from client
savings, thereby reducing KREP’s dependence on donor funds, expanding
KREP’s market outreach, and recycling client savings to microenterprises rather
than channeling them through traditional banks to finance wealthier sectors of the
economy
4)
Offer additional financial services to microentrepreneurs and other lowincome populations.
In a developing country like Haiti, providing reliable electrical and telephone service to all the
branches was a major additional expense and added complexity. Fonkoze found that out very
quickly. As the number of branches expanded, and consequently the number of customers and
accounts, it strained the ability of the existing software to handle the volume of transactions.
1
Rosengard, Rai, Dondo, Oketch, 2000
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Fonkoze had become a large volume institution without the resources usually associated with an
institution of its size.
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Branches were in need of better of communication facilities. Fonkoze’s infrastructure
development plan called for solar cells in the rural offices and generators in the regional offices
to supply power that would be necessary to run office equipment. Satellite telephones would
have to be acquired for all offices. These two elements assured the modernization and
professionalism of the offices. More importantly, the branch offices could record the daily
transactions and transmit them to the main office at the end of each business day. The cost for
this project could be significant especially when combined with the software and hardware
acquisition that would be essential. The estimated total cost of hardware, software, and
telephones was US$600,000 (Table 1). A donor had indicated the willingness provide the
$600,000 sum as an outright donation in 2002 if the Board decided to go ahead with the plan to
apply for regulated institution status.
The Fonkoze Board Meeting
Anne gathered all the information and prepared for the impending Fonkoze Board meeting in
New York. Anne carefully presented her findings and summarized the options available to the
Board:
1) Stay at the current level without any further expansion
2) Merge with a bank or another MFI
3) Apply for status as a regulated bank
Each of the options for the future of Fonkoze presented common and unique difficulties. The
Fonkoze Haiti Board of Directors, the U.S. Board, and the management of Fonkoze including Fr.
Phillipe and Anne debated the options. The foremost concern of all participants was how the
new organization would continue to fulfill its mission to servicing the poor and preventing the
“mission drift” that might accompany a transition.
A
LL
Option one would preclude clearly needed expansion of the portfolio as shown in Table 5, and
could necessitate an increase in interest rates charged borrowers as well as a steady decline in the
loan portfolio. Since its inception, Fonkoze has not had a period without adding offices. Many
of the offices were created at the request of local residents. Without Fonkoze, there would be no
way for the people to get loans (except from the local moneylender) or to save money. It would
be difficult to keep pace with the growth of the recording and reporting demands without
continual technology upgrades. Those upgrades would further drain resources, again creating
pressure to raise borrower’s rates or risk financial collapse.
Anne reiterated her concern for the amount of time it was taking to assist in fund raising and
developing the supporting materials for grant applications. Even without additional growth,
Anne would need to continue her fund raising trips because relying solely only on loan
repayments for funds would prohibit expansion. While the repayment rate is extraordinarily high
in most MFIs, repayments also may not be timely, further decreasing loanable funds. An
additional consideration is that many of the current donors and investors in Fonkoze are religious
congregations. Many of those organizations were reducing their charitable activity due to
internal needs. Being located in Haiti is also not a plus for attracting donations. Searching
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through a list of possible foundations for grant policies matching Fonkoze’s needs often results
in listed restrictions that make Haitian institutions ineligible. Making matters worse was
Fonkoze’s lack of a full-time employee dedicated to grant-writing or fund raising. Over-reliance
on Anne was a problem. An organization’s survival should never rest on the efforts of one
individual. What would happen to Fonkoze if Anne were no longer available?
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The second option might also seriously compromise Fonkoze’s mission. How could Fonkoze’s
board be guaranteed the retention of the original mission if the MFI were merged with a larger,
commercial operation? Would some control necessarily be lost in such a joint venture? The
market possibilities for such a merger certainly existed. Of Haiti’s nine commercial banks, three
had begun MFI divisions in response to the huge success of Fonkoze and others in the market.
Did these commercial ventures have the same level of social devotion to the poor as Fonkoze?
Sogesol, a creation of the commercial bank Sogesbank, required borrowers to have collateral
when applying for a loan. A demand that was counter to Fonkoze’s policies. Micro Credit
National, an MFI largely owned by Haiti’s number two bank, Unibank, S.A., focused on higher
end loans averaging $1,000. Such a focus would leave the poor locked out of borrowing as they
were before Fonkoze.
The only MFI that was not affiliated with a regulated bank was ACME. Some of ACME’s
practices would challenge the mission of Fonkoze. For example, ACME required borrowers have
a fixed residence. An address in Haiti, particularly in rural areas where Fonkoze focused its
lending, was often an impossibility. ACME borrowed to obtain capital, turned around, and
loaned it out at a higher rate. Borrowers repaid loans at commercial bank branches. ACME did
not have offices per se. While this business plan worked for ACME it was radically different
from Fonkoze’s operating model.
A
LL
The third option, becoming a regulated bank, not only presented challenges in of adhering to
mission, but also a demand of profitability and meeting commercial standards. Fonkoze owed its
very existence to the loyal business of the ti machanns. Would they feel comfortable in a
regulated bank? There would be new stakeholders in the bank as well. Depositors would have to
receive the same level of service and concern as borrowers. As a regulated institution, Fonkoze
could set the interest rate as it set loan rates for borrowers. There would be tradeoffs to paying
higher rates and earning smaller profits. Other concerns were fees associated with conversion,
acquisition of appropriate software and hardware where necessary, and the hiring of local staff
with banking skills and training, including senior banking executives (see Table 3 of projected
operating expenses). A new hierarchy of senior executives would change the culture of Fonkoze.
Retaining senior executives could also prove difficult. Many of the most educated and trained
individuals leave Haiti to seek employment in other countries. The lack of infrastructure in Haiti
burdened all businesses. It meant that Fonkoze had to make its own communication and
electricity arrangements in its offices. Raising money to cover the cost of hardware, software,
and infrastructure could be an enormous burden for the development staff.
The Chairperson of the Board asked how Fonkoze would handle the bank’s reporting which
would include the ability to aggregate all branch operations on a daily basis in addition to
lengthy monthly filings. Anne Hastings told the Board that she did not expect The Central
Bank’s reporting requirements to be any more demanding than the present situation that required
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Fonkoze to respond to numerous different reporting requirements of donors. It might actually
simplify reporting since there would in the future be only one reporting format. The report must
give an account of profits and losses, and “all other information and data considered useful” 1 ,
including interest rates, rates of commission and other payments for operation.
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After looking at projections of operations through 2005 (Table 5) that showed declining
available funds for loans without further fund raising by Anne, the Board tabled the decision.
While leaning toward favoring the move toward becoming a regulated bank, the Board needed a
better sense of the structure of the bank and if in fact it could be a financially sustainable
enterprise. The Board asked Anne to develop financial projections for Fonkoze for years 2002
through 2006 based on current financial figures including the assumption that a bank would have
access to deposits beginning in year 2002. Loans made in the projections would constitute
deposits not required to be kept on reserve – 70% of deposits. Table 6 shows projected deposits
and loans that could be made under this scenario for 2002 and 2003. Using this approach, Anne
and the board would like to see the projections taken out through 2006 along with income
statements, statements of cash flows and balance sheets.
LL
If Fonkoze begins its transition to commercial status from its previous unregulated position,
many of the central banking regulations from which they were exempt as a microfinance
institution will become effective, changing their business practices, operating costs and profit
margin. For instance, reserve requirements for commercial banks between 1996 and 2001
fluctuated between 25 and 44% of deposits. The current reserve requirement is 30% 2 . These
reserve requirements dictate reserves that must be maintained in storage either at the central bank
or in the bank’s own vault on a daily basis to hedge against bank runs. In the past Fonkoze was
not regulated and therefore not required to keep any reserve on hand. After regulated status is
granted, Fonkoze at a minimum will be required to hold at least a quarter of its capital liquidity
in reserve. As dictated by the BRH, the minimum capital requirement for start up commercial
bank status was US$134,700. Fonkoze’s capitalization more than meets that requirement.
Keeping track of year-to-year reserve to deposits ratios in projections will be important in
ascertaining whether Fonkoze can meet possible requirements while keeping to its expansion
plans. Earnings on reserve deposits would be held in government bonds returning a meager 5%,
less than the 6% interest paid on deposits. This would more than be made up with the spread
between interest payments on deposits and interest charged on loans.
Financial Analysis
A
Table 1 shows Fonkoze’s progress from inception in 1996. Key statistics (Table 2) shows the
expected number of bank branches, clients per credit officer and average loan (in US dollars).
With deposit growth expected to take off, growing at a rate of 15%, interest rates paid to
depositors was an area of particular concern. Currently Fonkoze’s depositors receive 6% interest.
Since Fonkoze’s depositors have mainly been borrowers who had in turn been shareholders, they
would participate in the gains made by Fonkoze on interest rate spreads between loan interest
collected and deposits paid. As a regulated institution, many depositors may still be borrowers
1
2
BRH site, 2003
BRH site, 2003
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particularly if Fonkoze maintains the requirement that borrowers deposit 20% of their loans.
However, with regulation, it is also likely that many depositors will not be shareholders. This
may necessitate a rethinking of interest rates.
Employee turnover was an issue for Fonkoze. Training new employees would be expensive.
Keeping turnover to a minimum implies an increase in compensation. Cost per employee
includes training and benefits, as shown in Table 2. By US standards, these costs are quite low
but they are not unreasonable in Haiti’s economy. The problem for Fonkoze is that higher
salaries at commercial banks in the country could attract well-trained managers.
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Foreign exchange income earned on moving money mostly between the US and Haiti was
projected to rise 25% per year. An additional $1 million loan from an anonymous donor to
Fonkoze will strengthen capital structure (in 2003). This loan will be interest free until 2005
when it will be subject to 5% interest payments on the original $1 million principal payable in
US dollars. One question financial projections will address is whether or not this loan is needed.
If Fonkoze is sufficiently profitable, it may be able to reduce or eliminate the loan.
Annual cash flow consists of net income from operations, donations (including a 2002 $600,000
grant for communications upgrade which will be immediately spent) and receipt of donations
shown as accounts receivable in 2002, new loans ($1 million as a transition to regulated banking
loan in 2003), and new deposits. Deposit cash flow to reserves is reduced by funds allotted to the
loan portfolio, which in turn is limited to capacity to make loans as projected in Table 1. Table 8
projects cash flow for 2002. Even with the $600,000 donation, it is still a negative $812,130.
A
LL
Will Fonkoze, constituted as a regulated institution, be able to meet reserve requirements and
grow its loan portfolio without requiring additional donations? If this were not the case then
shifting to a regulated institution would have less upside for Anne since she would need to
continue raising funds. Projections for 2002 are not encouraging but 2002 is a transitional year.
Table 7 shows assumptions required to update income, cash flow and balance sheets through
2006. Some assumptions could be increased such as growth in deposits, currently projected to be
a modest 15% per year. Projections through 2006 will show where more work needs to be done
in trimming costs and raising revenues.
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TABLE 1
Fonkoze’s Progress
1996
1997
1998
1999
2000
2001
50
447
645
660
972
1613
Organization members
Number of savings
accts
Total deposits in (US$)
Number of active
solidarity group
borrowers
Volume of loans
outstanding US$
193
3444
5134
7900
13260
20854
$44,639
$124,273
$375,047
$714,515
$1,467,211
$2,540,758
110
1542
2607
2834
4794
8416
$13,231
$195,831
$267,220
$388,601
$802,416
$898,863
1
11
15
15
16
18
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Branch offices
TABLE 2
Key statistics and Projections
ACTUAL
Branches
Credit Officers
Clients per officer
Average Loan
Number of clients
PROJECTED
PROJECTED
PROJECTED
PROJECTED
2001
2002
2003
2004
2005
2006
18
18
19
20
21
26
28
38
40
67
85
98
303
320
361
411
448
476
$122
$130
$160
$194
$233
$254
8416
9162
13520
21360
29820
47140
252
260
404
520
580
680
$1,897
$1,925
$1,975
$2,000
$2,100
$2,125
303
320
361
411
448
476
$1,035,048
$1,580,800
$2,310,400
$5,342,178
$8,872,640
$11,848,592
Number of employees
A
LL
Average cost per employee
Maximum loans per credit
officer
Maximum Total Loans
Possible (Dependent on
Credit Officers)
PROJECTED
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TABLE 3
Income Statement (1/1/2001 – 12/31/2001)
Loans Made
$ 842,127
Less bad loans
Loans paying interest
INTEREST INCOME
Loan Interest Received
Interest earned on deposits, cash and
marketable securities
$ 180,540
$ 175,000
Interest earned on reserves in
government bonds
$
Total interest income
$ 355,540
Interest Paid to Deposit Accounts
$ 147,765
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-
NET INTEREST INCOME
$ 207,776
Write-off of bad loans
$
Operating Income
$ 159,230
(48,546)
OTHER INCOME
Foreign exchange income
$ 230,598
Fees
$
Operating Income
$ 458,796
68,968
OPERATING EXPENSES
Interest on existing debt
$
39,024
Interest on new l-t debt
$
-
TOTAL INTEREST PAID
$
39,024
Employee Compensation, Benefits
and training
$ 478,097
G&A Costs
$ 342,251
Technology
$
23,531
Depreciation
$
23,531
Operating Expenses
$ 945,458
EARNINGS BEFORE NON
OPERATING INCOME (EXPENSE)
$ (486,663)
LL
Electrification
$
NET INCOME
$ (486,663)
A
Tax
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TABLE 4
BALANCE SHEET 2001
ASSETS
Cash and Marketable Securities
$
Net loans
$
2,156,748
842,127
FIXED ASSETS
$
445,028
Accumulated depreciation
$
(93,242)
Fixed assets, net
$
351,785
$
178,286
Total Assets
$
3,528,947
$
2,540,758
Long-term debt
$
487,799
Other Liabilities
$
48,317
TOTAL LIABILITIES
$
3,076,875
Retained Earnings
$
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OTHER ASSETS
LIABILITIES AND EQUITY
Deposits
(323,462)
Contributed Capital (Donations)
$
775,535
Tot Liabilities & Equity
$
3,528,948
TABLE 5
Projections of Loan Capacity & Deposits without Obtaining Further Grants and Donations*
Credit officers
Average loan size
Maximum loans per credit
officer
Loan Capacity
Funds Available for Loans
2001
2002
2003
2004
2005
28
38
38
38
38
122
130
160
194
233
303
320
361
411
448
1,035,048
1,580,800
2,194,880
3,029,892
3,966,592
842,127
825,808
405,848
442,554
114,579
A
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*Assumptions used to generate these projections assume the number of credit officers
peaks at 38. Loan capacity rises as the efficiency of loan officers increases. Expenses
keep rising because of the number of branches and other costs.
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Table 6
Projected Deposits and Loan Feasibility
PROJECTED
2002
PROJECTED
2003
New Deposits
(15% growth
rate)
$
$
Deposits from
prior year
$ 2,540,758
381,114
438,281
$ 2,921,872
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ACTUAL
2001
Total Deposits
$ 2,540,758
Reserve
requirement
Deposits
available for
loans
Maximum
serviceable
loans
$ 2,921,872
$ 3,360,152
$
876,562
$ 1,008,046
$ 2,045,310
$ 2,352,107
$ 1,580,800
$ 2,310,400
Loans collected
from prior year
$
$ 2,045,310
New Loans
$ 1,203,183
$
$ 2,045,310
$ 2,352,107
$
842,127
37%
37%
$
A
LL
Total Loans
Made
Interest rate
received on
loans
Deposits
remaining after
reserves and
loans available
to earn interest
income
Page 88
842,127
842,127
306,797
37%
$ 2,045,310
The CASE Journal
Table 7
Assumptions to Create Proforma Income Statements and Balance Sheets
Interest rate earned on loan
portfolio
Interest paid on deposits
37%
6.00%
Interest earned on deposits
(government bonds) on Reserve
Deposits
5.00%
15%
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Total deposit growth per year
percentage of deposit to be kept
on reserve
30%
percentage of deposit avail for
loans
70%
growth in technology costs 2002
growth in technology costs 2003 G&A growth
15%
16%
percentage of loans that are nonperforming (not repaid)
4%
Foreign exchange income growth
25%
Donations in 2002 (no donations
subsequently) US$ for
Communication upgrade
Interest earned on cash &
marketable securities (per year).
Earned on prior year's balance
sheet cash & marketable securities
in US$ plus deposit not loaned out
Fees as percentage of loans made
LL
Depreciation as percentage of
prior year's assets
New fixed asset purchases per
year US$
A
315%
Tax on regulated banking
institution
New debt 2003 US$ --interest to
begin in 2005
$ 600,000
7.5%
6%
10%
$ 25,000.00
15%
$ 1,000,000
Interest paid on existing debt
(2001)
8%
Interest on new debt beginning
2005 -- in $US on $US
7%
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Table 8
Cash Flow Statement
Net Income
Loans Collected
Loans Made
New Deposits
Depreciation
2002
(591,438)
842,127
2,045,310
381,114
26,384
25,000
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Fixed Asset Purchases
cash flow from
operations
$
$
$
$
$
$
Donations
New Loans (to Fonkoze)
A
LL
CASH FLOW
Page 90
$ (1,412,123)
$
600,000
$
$ (812,123)
The CASE Journal
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BRIGHT LIGHTS:
EXPLORING THE FRANCHISING POTENTIAL
OF A NOT-FOR-PROFIT ORGANIZATION
Monica Godsey, PhD
University of Nebraska - Lincoln
Terrence C. Sebora, PhD
University of Nebraska – Lincoln
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Barbara Hoppe and Kathy Hanrath sat together at the July Bright Lights Board of Directors
meeting. While neither one of them anticipated that their summer enrichment program for
school-aged children would have come this far in the last fifteen years, both felt that they were at
a crossroads. Enrollment continued to increase and exciting new prospects were on the horizon,
including bringing in international students from Japan. Unfortunately, the economic conditions
meant that donations were down while competition for grants continued to increase. The Board
of Directors had just instructed them to begin looking for new sources of funding. They
anticipated presenting to the Board the possibility of expanding into events that, while used by
many non-profit organizations, would be new to them, such as a golf tournament or road run. An
alternative idea, franchising the Bright Lights concept to other communities, which had been
“floated” during the previous Board meeting, had gained most interest from the Board. While
intriguing, Barb and Kathy worried that this undertaking, which would be a new venture, could
detract from the mission of Bright Lights and might be more than this “perfect small business”
could handle.
THE ORGANIZATION
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Bright Lights, Inc. is a private, non-profit organization, specializing in summer hands-on
learning program that specializes in a number of creative subjects. Over half (almost 57%) of
Bright Lights operating income comes from student tuition and fees from these programs. Fortythree percent of the income comes from families, individuals, businesses, service organizations,
foundations and corporations (see Figure 1). Bright Lights challenges inquisitive, motivated
young people to explore materials that stimulate reasoning and logical thought, generate
enthusiasm for life-long learning, and enhance self-concept and creative expressions by offering
a thematic based, interdisciplinary curriculum. They offer classes with focused interests such as
dinosaurs, robotics, amphibians, bees, fashion design, improvisation, physics, Internet, and Web
page design.
Mission
Bright Lights is a non-profit organization that takes learning beyond the classroom by providing
youth with unique, motivating, hands-on learning opportunities. Bright Lights board members
believe strongly in the following Governing Values:
Learning can be fun.
Motivated peer groups enhance the educational experience using common interest as
a learning platform.
Kids and teachers should feel inspired, passionate, and curious about learning.
Learning can be a life-changing event.
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Access should be provided regardless of economic need.
Diversity (of program and people) teaches.
Life-long learning should be promoted.
Learning is enhanced in a safe environment.
Learning opportunities should be available beyond formal education.
Every child has talents and gifts.
Creative thinking should be pursued without limits.
It takes a community to educate a child.
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Figure 1: Break-down of funding sources for 2003 programs.
Funds for 2003 Operations
Interest Income, 0.50%
Individual Donations, 1%
Class Sponsorship, 13%
Grants, 29%
Student Fees, 56.50%
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History and General Information
Bright Lights was founded in the spring of 1987 in Lincoln, NE, by two moms, Barbara Hoppe
and Jan Dutton to provide youth summer enrichment classes as they began to see budget cuts in
the public school summer programs. The concept grew from a graduate school project, leaped
onto the kitchen table and took flight three months later. Barb and Jan funded the project equally.
They began by contacting and hiring teachers by reputation for utilizing hands-on learning
philosophies in the classroom. In addition, they solicited volunteers to help promote the program.
The first year, 28 classes with a total of 281 students were held in various non-air-conditioned
sites.
In 1988, Bright Lights obtained federal 501 (c) (3) status, allowing it to enter the fundraising
arena. A Board of Directors was assembled along with the Articles of Incorporation and ByLaws for the organization. Next, Bright Lights began building a working relationship with
Lincoln Public Schools in order to obtain more appropriate space to hold classes. During this
year, the Lincoln Public Schools (LPS) began a monthly student publication, Free Times, for
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non-profit organizations to buy space and advertise programs for Lincoln area students. The Free
Times immediately became the vehicle to deliver the Bright Lights summer schedule and
registration forms to thousands of homes.
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As the program grew, additional labs in middle school and high-school buildings allowed the
program to expand its offerings. Reaching out to various community sites extended the program
even further in program development and student school-to-career opportunities. In the third
year, several “family friendly” services were added in attempts to ensure that the program was
inclusive regardless of a family’s income. Funding was sought for both bus transportation from
selected low-income school districts and for a need-based scholarship program. In addition, a
community volunteer committee was formed to review and grant scholarship awards.
Some years later, day camps for intermediate aged students were developed. In 1992, a
supervised lunch hour program was implemented. For an additional $10 each, students could
create an all day program and catering more to working parents. In addition, an early hour
“Before Care Program” was added in 1993, in which parents could drop children off early for an
additional $10 per student in efforts to continue to meet the needs of families who found the
9:00am start time too late for parent working schedules. Despite these additions, Bright Lights
has worked hard to maintain an emphasis on enrichment and avoid the stigma of a child care
program.
CURRENT SITUATION
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Both the number of students enrolled and the number of classes offered have increased
significantly since the organization’s inception. In 1988, 474 students enrolled in 34 classes. In
2003, enrollment had grown to over 2,100 students with approximately 115 mini-classes and
several day camps. Today typical class offerings reflect 50% math/science/technology, 35% fine
arts, 15% social studies and 26% participate in "school-to-career" experiences. Course content
offers hands-on experiences. Classes have the feel of a summer mental Olympics, and are offered
in two formats:
Mini-Classes
Completed K through completed 9th grades
Class meets for one week, M-F
Half-day sessions, morning or afternoon, 3 hours each day, 9-noon; 1-4
15 hours of instruction
One master teacher plus one or two assistants
Maximum of 18 students per class
Over 100 mini-classes offered during the 3 summer weeks of Bright Lights operation,
morning or afternoon sessions
Tuition: $85 per class
*An all-day program can be created by combining 2 mini-classes with supervised lunch.
Day Camps – exploration of in-depth areas during a fun-filled week of hands-on experiences.
Post 4th grades and up
Camps meet for one week, M-F, summer
All-day, 9 a.m. to 4 p.m.
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Students clustered in groups of 10-15
Master teachers plus assistants or counselors
Tuition: $170 per camp
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Teaching staff is recruited annually, in December, and selected based on program needs.
Currently, approximately 80% of the teaching staff has taught for Bright Lights in the past. New
teachers usually teach only one class and are required to submit an idea for the class and
description by early January. Teachers are paid, but need not have a teaching certificate.
Teachers are selected on their passion for teaching, ability to work with children, and their
subject area expertise.
Key Players
Currently, Bright Lights employs four full-time and four seasonal employees (See organizational
Chart, Figure 2). Each employee has a diverse job description covering multiple activities within
the organization – workloads are large.
Figure 2: Bright Lights Organizational Chart
Barb Hoppe
Kathy Hanrath
Co-Founder/Education Director
Program
Development/Donor
& Scholarship
Coordinator
Executive Director
Promotion
Coordinator
Communication
Specialist
Technology
Specialist
Seasonal Employees
Building and Snack
Coordinators
Classroom Assistant
Coordinator
Registration/Class
Site Coordinator
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Since the organization became a 501 (c)(3), only one of the original founders remains active in
the administration of the program. Barb Hoppe acts as the Education Director/Fund Raiser and
Kathy Hanrath was brought on to act as the Executive Director. The key decision-makers in this
situation include the following:
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Barb Hoppe. Barb Hoppe, one of the co-founders of Bright Lights in 1987, currently serves as
Development and Education Director for the program. A 1971 English Education major from the
University of Colorado, Barbara also has her Masters in Education from the same university as
well as graduate hours in Administration and in Gifted Education, University of Nebraska Lincoln. She taught secondary English for five years.
Kathy Hanrath. Kathy Hanrath, Executive Director, has been with the program since 1988. As
Executive Director, she provides direction for the administration of the program and is
responsible for planning, organizing and directing activities with the staff and the Board of
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Directors. Previously Kathy worked nine years as a program coordinator for a consortium of area
colleges and universities in the areas of teaching methods and student learning.
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Board of Directors. The Board is comprised of the standard officers and several carefully
selected members. The current President of the Board is the Principal at a local elementary
school. The Vice President is the Associate Superintendent for Business Affairs in the local
public school system. The Treasurer is a Deputy Regional Credit Officer at Wells Fargo Bank.
The Secretary is the Principal of a local Catholic school. And, the past President is a local
attorney. Remaining Board members consist of a diverse cross-section of individuals serving the
local community. Each of the primary business functions are represented with individuals who
are well connected in the Lincoln Community. In addition, Bright Lights has selected a number
of education experts and community representatives. The Bright Lights Board maintains
responsibilities similar to those of a traditional organization.
Funding Context
Since 2001, Bright Lights has been hit hard by the weakening economy. Their investments have
lost a considerable sum of money (see “Financial Background” section below). Additionally,
because companies which usually donate funding to support Bright Lights programs, have been
affected by the downturn, Bright Lights, along with all of the other not-for-profits in the
community, is beginning to lose many long-term donors. Barb is concerned that strong
competition puts Bright Lights at risk for losing many previously held local grants due to
qualification restrictions.
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Financial support is crucial at a time when enrollment is on the rise. Since tuition only covers a
portion of the costs, higher enrollment necessitates more donors and grants. Bright Lights began
to get creative in seeking funding. In the summer of 2001, Bright Lights was host to
approximately 80 Japanese middle school students for a week of classes, which brought in
dollars above and beyond the cost of including the students in the classes. A second funding
option, proposed by one of the newer Board members is a road run to fill the vacancy left when
the Arthritis Foundation Jingle Bell Run was discontinued. After further discussion, the idea was
shelved for the time being, realizing that after the amount of work and money required, there was
a good possibility that the race would only break even or lose money for the first few years. A
proposed alternative to the run was a golf tournament; however, Bright Lights employees and
Board members agreed that this may not be consistent with the kid-involved, experiential
learning-focused image Bright Lights wished to maintain.
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One final proposed option was franchising, which could provide fees to supplement funds from
grants. In addition to its recent international attention, the program had generated a good deal of
interest from other Midwestern communities. Since its inception, Bright Lights has been
approached by various outside organizations to start up satellite programs and/or to provide
guidance in establishing similar programs. Two former Bright Lights Board members, now
employed by the Colorado Springs school system contacted Bright Lights for material to
demonstrate their expectations of a theme-based after school program. In addition, Bright Lights
has freely advised a number of programs in Lincoln, NE and boards in the surrounding towns to
help them start similar programming. The eleven-year-old SEEK program in Beatrice, NE, is the
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longest running program modeled after Bright Lights. Advising was also done for the Horizon
Program serving low-income students in Lincoln, NE.
When considering the franchising option, Bright Lights can explore the following criteria to
determine whether or not it is a good candidate for franchising: the more criteria the organization
meets, the better the chances for success:
A good product or service is offered.
A profitable prototype exists for the business.
The business works well in bad times.
People have inquired about buying a franchise.
The system can easily be taught to others.
Estimated startup costs for a franchise are reasonable.
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1.
2.
3.
4.
5.
6.
Barb and Kathy agreed with Michael Gerber’s contention in his book, The E Myth Revisited 1 ,
that a “turnkey revolution,” based on the business franchise format, was taking place. According
to Gerber, a franchise format provides a system for reproducing a successfully operating
business. The “product” of a franchise is the organization itself – an organization that provides
predictable satisfaction to its customers through proven systems, codified in operating manuals.
Bright Lights had predictable success, in good economic times and in bad. Barb refers to it as
“the perfect small business”; one that can be catered to local interests in terms of both
community support and course offerings. It had operating manuals refined and tested in its
“model store.” And, Barb and Kathy had a strong desire to enable others to help the youth of
their communities. They seem to have the franchise format. Now, they needed the rest of the
franchising process.
Prior to beginning the franchising process, it is important to determine if the business is
“franchisable”. According to the Franchising Law: Practice and Forms handbook 2 , a lawyer will
assess whether or not a business can typically experience rapid growth through franchising by
investigating the following:
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Is the business capital intensive or management intensive?
Does the business have profit margins sufficient to support an additional entity, the
franchisee in the distribution chain?
Can the franchisor provide valuable services the franchisee cannot obtain independently,
such as entry level assistance regarding site selection, advertising, inventory and supplies,
and additional on-going services? (Unique operating skills or attributes)
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•
•
Franchising Bright Lights would require a significant amount of frontloading and a large initial
commitment of already scarce resources. The need for such things as improved procedure
documentation, increased marketing efforts to find interested parties, travel and training, and
potentially hiring new employees, is likely to involve a large capital outlay, along with
increasing already full staff workloads. There is also a fear among staff members that losing
1
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Michael Gerber, 1995.
Fern, Martin, D., Kenneth R. Costello, Richard M. Asbill, and W. Andrew Scott., 1996.
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direct control of the organization and allowing use of the Bright Lights name could result in a
compromised reputation, effecting the flagship organization in Lincoln.
On the flip side, the staff at Bright Lights has examined a number of potential benefits associated
with a franchise. First and foremost, franchising is a means of distribution. Like most nonprofits, Bright Lights is driven by serving a social mission, measuring performance in terms of
population served rather than profits. The passion of Bright Lights is keeping the minds of
children active year round through fun, hands-on learning. Franchising seems a logical means of
increasing the population served, while at the same time increasing funding.
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In general, the primary benefits of franchising include accessing capital, acquiring highly skilled
management, and rapid and efficient expansion. Besides increasing performance, as defined in
terms of population served, Bright Lights hopes to use franchising as a means of becoming more
self-sustaining, focusing on capital acquisition.
Bright Lights is not necessarily a “cookie cutter” operation. While it enjoys a great deal of
flexibility, operating Bright Lights requires a dedicated staff, strong community support, and
excellent teachers who are willing to work hard to provide true hands-on experiences. It is an
organization run from the heart. The staff and the Board are currently not interested in straying
from their governing values. But, on the other hand, Barb, her staff, and the board have invested
a significant amount of time perfecting the Bright Lights systems and developing documentation
for the programs and the teachers. While any undertaking that might be considered would
judged against the mission statement and Bright Lights’ governing values, nothing in them
prevents Bright Lights from making it possible for other communities to have similar programs
without the years of trial and error learning.
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Operations
Like many organizations, Bright Lights operates on a cycle. Naturally, there are some aspects of
operation that are specific to a certain year, but for the most part, Bright Lights has clearly
distinguished the primary necessary tasks to be accomplished throughout a year. After fifteen
years, many of the procedures used by Bright Lights have become systematic and would be able
to be adopted by others. It is important to note that many of these processes and procedures are
dependent upon the very supportive community in which Bright Lights operates. In addition to
the funds they raise, Bright Lights focuses on “raising” a number of “friends that will help ensure
its smooth operations. Brights Lights has been very successful in attracting these resources too.
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The Board of Directors. Bright Lights has carefully formulated and communicated guidelines
and expectations for the Board and its membership. The board contains between 18 and 25
members at all times. Members are asked to serve on a standing committee that most fits their
expertise and/or interest.
Teachers. Primary tasks surrounding teachers include recruitment, communication, and
compensation. Most teachers are returning from previous summers. New teachers are recruited
by recommendation only. After being recommended, teachers are contacted and asked to submit
a proposal for new courses or existing course content, in order to ensure that he/she is passionate
about the subject matter and that the content is appropriate. Teachers can apply online via Bright
Lights’ website www.brightlights.org. Once the proposal and teacher are accepted, Bright Lights
touches base with them throughout the course of the year to communicate course times, sites,
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etc., and then brings them together for a final meeting just before the summer’s beginning. Bright
Lights has created a process ensuring that teachers are paid on the last day of their session.
Returning teachers are paid $350 per class plus a $25 per year bonus based on the number of
years teaching, while new teachers are paid $350 per class.
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Students. Primary tasks surrounding students include recruitment and registration. Bright Lights’
principal student recruitment tool is their annual course schedule included in a free publication
for the public school system. To date, students are required to register via US mail. Bright Lights
hopes to be able to take registrations via the web in the near future, which would make for much
more efficient use of resources, including time, postage, paper/printing, and associated labor.
Bright Lights maintains specific restrictions in terms of course size. Therefore, enrollment takes
place on a first-come-first-served basis (according to post-mark) beginning April1 of each year.
It costs Bright Lights a total of $163 for each registrant to complete a course.
Scholarship Program. The scholarship program is Bright Lights’ way of remaining consistent
with its mission by making it more inclusive to children in low income families. Bright Lights
uses the public school system’s guidelines to determine which populations are considered “low
income” and offers need-based scholarships to these individuals. Qualifying students are allowed
a scholarship for only one class each summer. A committee meets once in mid-April and again in
mid-May to make the financial awards. The Ameritas Foundation, Dillon Foundation, the
Sowers, US Bank Foundation and Wells Fargo are among those that sponsor the scholarship
program.
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Marketing and Promotions. Bright Lights has two populations to which they need to market: 1)
potential donors and 2) potential students. They have established several campaigns for each
population. Marketing to donors is a year-round process, from implementing the various
campaigns, such as the Bright Lights Adopt One program, to adding a donation information link
on their website. Bright Lights also makes good use of free promotions including newspaper
articles and radio interviews. Some marketing to students, such as billboards and radio spots,
takes place year-round. Again, the course schedule that is distributed to the public schools is key
in marketing to students. The organization’s new website is an effective promotional tool for
both populations, providing basic information and course offerings. Bright Lights has registered
its name and the tag line “Summer learning adventures” with the state of Nebraska and has
considered Trade Marking its logo.
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Program Administration and Evaluation. Administration of the program includes establishing
sites, arranging transportation, and supplying classrooms and teachers with course necessities.
Bright Lights works with the public schools system to locate local school buildings available for
summer usage, based on their programmatic needs. Transportation is also arranged through the
public school system in order to expand Bright Lights’ offering. In terms of supplying the
classrooms and teachers, Bright Lights acquires general school supplies and requests that
teachers needing specific supplies obtain them on their own. The program is evaluated by
students, parents, and teachers. At the end of each session, students are given a developmentally
appropriate evaluation form to fill out. In addition, teachers fill out an evaluation form for their
own classes. Parents are solicited on a regular basis to provide constructive criticisms of the
program. Changes are made to the summer program based on these evaluations.
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As mentioned above, while Bright Lights has implemented a number of operational practices.
The documentation of the practices, while fine for a single organization, would need some
improvement. Bright Lights has recently begun a system of notebooks, in which the processes
associated with the major operational areas are documented that may be helpful. Neither Kathy
nor Barb has written these notebooks for operations, marketing, or human resources documents
for Bright Lights with others using them in mind. They are unsure how to value the intellectual
capital invested in their years of operating Bright Lights.
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Financial Background
Bright Lights has an established financial committee that has a primary goal of developing a
financial plan that identifies new sources of funding. For 2003, this committee was also charged
with developing a Fund Development Committee that will aid in fundraising. Over the years,
Bright Lights’ financial committee has stressed developing reserves for the “rainy day” and, in
January, 2002, $100,000 had been invested in mutual funds. While these investments have
grown some, as of fiscal year end 2002, fundraising was still at the forefront in the minds of
Bright Lights’ employees and board members.
Financial support has grown to a broad base of support. Funding sources are tuition based, with
assistance from foundations, businesses, community service groups, families, and individuals. In
early years, four foundations supported the tuition income. In comparison, there are 21
foundations ($250 to $20,000 each), 78 businesses ($75 to $1,500 each), a dozen families with
generous donations ($200 to $2,000 each) and three dozen families with smaller contributions
($5 to $150) supporting Bright Lights today. Background checks, classroom rental, teacher pay,
classroom supplies for more than 100 classes, snacks, need-based scholarships, a summer health
technician, postage, database management, printing and bus transportation from low-income
schools are among the operating costs. Bright Lights also depends on volunteers to help keep
costs low. Recent fundraising campaigns have included the following:
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Bright Lights Adopt One. Several years ago, Bright Lights implemented a campaign in which
donors were allowed to adopt one of the 130 classes offered in a summer. In this Program,
donors select a class, typically in accordance with their individual interests, to fully fund for one
summer. Donors are sent content information about their class, contacted by the instructor, and
invited to attend the class, as a means of facilitating “ownership” in their investment. This
campaign has been a successful tool for acquiring class-specific funds, however, there are still
administrative tasks for which funding is necessary.
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Bright Lights International. Trickling down from the local university’s foreign exchange
program, Bright Lights began hosting Japanese middle school students in 2000, when 80 eighth
grade students from Japan came over to attend two weeks of classes. Students completing the
eighth grade in a private Japanese school were brought over for a middle school graduation
experience. The inaugural success of the experience helped to foster a relationship with the
school, and to date, between 60 – 90 students have returned annually at increased weekly tuition
rates, providing a significant source of revenue for Bright Lights. Because of the added expenses
associated with hosting these students, Bright Lights charges $250 per student in tuition.
Financial summaries for the years 2002 and 2003 can be found in Tables 1 and 2.
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Table 1: Bright Lights statement of financial position 2002 – 2003.
ASSETS
Current Assets
Cash - checking and money market
Cash - temporarily restricted
Cash - brokerage account
Cash – mutual funds
Accrued interest receivable
Prepaid expenses
2003
73,981
28,356
15,738
166,057
1,279
2,317
287,728
Total property and equipment
38,241
(16,711)
21,530
44,539
(23,681)
20,858
313,464
308,586
2,634
2,241
249,591
61,239
310,830
277,989
28,356
306,345
313,464
308,586
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Total current assets
2002
81,665
61,239
9,836
133,241
1,580
4,373
291,934
Property and Equipment
Equipment
Less accumulated depreciation
TOTAL ASSETS
LIABILITIES AND NET ASSETS
Current Liabilities
Payroll taxes payable
Net Assets
Unrestricted
Temporarily restricted
Total net assets
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TOTAL LIABILITIES AND NET ASSETS
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Table 2: Bright Lights statement of activities 2002 – 2003.
Unrestricted
154,454
105,199
11,252
148
1,194
61,239
333,486
EXPENSES
Advertising and promotions
Brochures and newsletter
Classroom supplies
Conferences and meetings
Depreciation
Fundraising expenses
Insurance
Miscellaneous
Office expense
Payroll taxes
Postage
Professional fees
Rental space
Scholarships awarded
Strategic planning
Student snacks
Teachers, teacher assistants and casual labor
Telephone
Transportation expense
Employee benefits
Wages and salaries
Total expenses
22,993
10,217
9,994
2,282
6,970
128
3,459
1,181
9,042
8,057
5,368
2,037
15,980
21,434
5,315
1,517
93,305
2,974
3,373
9,628
69,834
305,088
2002
Total
2003
Total
150,145
167,395
12,998
(205)
1,370
154,454
133,555
11,252
148
1,194
(61,239)
(32,883) 331,703
300,603
28,356
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REVENUES
Tuition and fees (includes scholarships
awarded)
Donations and grants
Investment income
Gain (Loss) on sale of investments
Miscellaneous
Net assets released from restriction
Total revenues
Temporarily
Restricted
CHANGE IN NET ASSETS
16,849
6,897
12,873
469
6,551
863
3,491
2,032
8,537
7,390
4,749
1,610
13,841
18,127
2,175
88,284
2,741
2,659
4,384
65,095
269,617
22,993
10,217
9,994
2,282
6,970
128
3,459
1,181
9,042
8,057
5,368
2,037
15,980
21,434
5,315
1,517
93,305
2,974
3,373
9,628
69,834
305,088
28,398
(32,883)
(4,485)
62,086
NET ASSETS, beginning of year
249,591
61,239
248,744
310,830
NET ASSETS, end of year
277,989
28,356
310,830
306,345
CONCLUSION
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The Board has requested that Barb and Kathy be armed with some supported funding alternatives
at their November meeting (the last meeting of the year, determining budget allocations for the
upcoming year) in order that there is plenty of time to rearrange the budget, if necessary. The
week after the July Board meeting, Barb and Kathy come together with the information provided
by the intern to discuss their next course of action. Kathy recently attended a local
entrepreneurship conference session on franchising and considers it a smart, feasible solution for
Bright Lights in its current situation. While this would certainly be a large undertaking and the
concerns the staff and Board have about “McDonald-izing” the operation are real, the long term
benefits seem substantial. Barb and Kathy have approximately three months to answer the
following questions: Is it truly possible to franchise a non-profit organization? Is franchising a
good idea for Bright Lights? What needs to be done to get the franchising process started? What
are the legal implications for franchising a not for profit organization? Are there other, more
valuable opportunities available to this organization? Does Bright Lights need to rethink their
service mix and current growth strategy?
REFERENCE LIST
Michael Gerber (1995). The E Myth Revisited, HarperCollins Publishers (ISBN: 0887307280).
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Fern, Martin, D., Kenneth R. Costello, Richard M. Asbill, and W. Andrew Scott. (1996).
Franchising Law: Practice and Forms. Technical Publication Specialists. North Vancouver,
B.C. Canada
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TECHNICAL NOTE: FRANCHISING
Monica Godsey, PhD, University of Nebraska - Lincoln
Terrence C. Sebora, PhD, University of Nebraska – Lincoln
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Franchising is a method for distributing goods and services through a chain of relatively uniform
outlets, some of which are independently owned and operated by franchisees. As the practice of
franchising has grown dramatically over the past 35 years, so has the regulation surrounding it.
Those that consider entering the franchising field can look forward to many new and unfamiliar
challenges. While these potential franchisors may be experts in the business which they plan to
duplicate, they are required to confront and entirely new array of considerations. The franchisor
has dual functions: to provide the individual franchisee with the necessary tools and guidance to
operate a successful enterprise and to develop a network of franchise operations that creates a
mutual support system.
Franchising Pros and Cons
If it were determined that a business was “franchisable”, a business should look at the pros and
cons of franchising in general. It is important for a potential franchisor to realize that franchising
is not a business, but a method of distributing goods or services. This method is most effective
under a couple of specific circumstances: capital intensive and management intensive businesses.
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Franchising is a very valuable tool for aggregating capital, thus when a business is capital
intensive (when the development of an individual unit requires a large capital investment or an
extensive credit line), it is a good choice for distribution. It is important to remember, however,
that the franchisor should obtain enough necessary capital to offer the services to franchisees
prior to beginning the franchise program. If the business is dependent upon the initial franchise
fees to support the franchise program, the initial collection of fees may be considered an offer
and sale of securities according to the Securities Act of 1933. In addition, it is unlikely that initial
franchise fees collected at the inception of the franchise program will be sufficient to cover costs
associated with establishing the necessary infrastructure. It is of the utmost importance that
potential franchisors understand that franchising is effective for using the capital of others to
establish retail outlets and should not be misused to capitalize the franchisor.
A
Franchising has also proven to be one of the most effective means of acquiring and retaining
skilled management, making it highly functional in management intensive industries or
businesses (when long-term retention of quality management is important to develop a multi-unit
chain). Franchises are flexible devices that are applicable in a number of contexts. They afford
an organization the opportunity to allocate the risk of failure of any single unit to the franchisee,
who owns and operates that unit. In addition, franchising serves to increase the success of all
involved parties. Other advantages include efficiency, rapid expansion, economies of scale,
maximizing income, and franchisee involvement with franchisor control.
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On the other hand, franchising requires a large initial capital outlay. In addition, there are greater
costs and administrative burdens associated with conducting business through multiple entities.
There are also a number of laws regulating franchising with which the organization needs to be
concerned. Franchising can also require a high degree of standardization, potentially limiting the
amount of customization available to each location. Other disadvantages to consider include
early profits could be low, an early failure could be devastating, legal expenses could be high,
sales driven nature, some loss of control, difficulty managing growth, and potential litigation
from unsatisfied franchisees.
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Franchising Legal Issues
Franchising is regulated on both the state and federal levels. The Federal Trade Commission (the
FTC Rule), “Disclosure Requirements and Prohibitions Concerning Franchising and Business
Opportunity Ventures”, requires franchisors to meet various pre-sale disclosure requirements, but
does not contain filing or registration requirements. Franchise regulating state statutes fall into
two categories: 1) state laws mandating filing or registration of franchise offerings and/or
disclosure, and 2) state statutes regulating the relationship between franchisors and franchisees,
dealing with issues such as termination, non-renewal, discrimination, and similar matters.
The FTC Rule regulates two types of business relationships, both of which are considered
franchises under the meaning of the Rule. The first form of franchise is known as “package and
product franchise”, involving the following three characteristics:
1. The franchisee sells goods or services which are required (or advised) to meet the
franchisor’s quality specifications (in cases where the franchisee operates under the
franchisor’s trademark, service mark, trade name, advertising, or other commercial
symbol designating the franchisor), or which is identified by the franchisor’s mark;
2. the franchisor exercises or has the authority to exercise significant control over the
franchisee’s method of operation, or gives the franchisee significant assistance therein;
and
3. the franchisee is required to make or commit to make a payment to the franchisor, or a
person affiliated with the franchisor as a condition of obtaining or commencing the
business.
LL
The second form of business relationship is known as a “business opportunity venture”, and
involves the following three characteristics:
A
1. The franchisee sells goods or services which are supplied by the franchisor or a person
affiliated with the franchisor;
2. the franchisor secures retail outlets or accounts for the franchisee, or secures locations or
sites for vending machines, rack displays, or other product sales displays, or provides the
services of a person able to do either; and
3. the franchisee is required to make or commit to make a payment to the franchisor or a
person affiliated with the franchisor as a condition of obtaining or commencing the
business.
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The FTC Rule also contains four exemptions and four exclusions, which except for express
exemption/exception would fall within the definition of a franchise. Exemptions include:
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1. Fractional Franchise: a business relationship having the characteristics of a franchise in
which the franchisee has been engaged in the type of business represented by the
franchise relationship for a period of two or more years, and the agreement between the
two parties anticipated that at the time the agreement was reached, the sales arising from
the franchise relationship would represent no more than 20% in dollar volume of the
franchisee’s business.
2. Leased Departments: relationships commonly known as department store concessions,
whereby the “franchisee” leases space in a department store from the “franchisor” and
conducts business from the premises, independently, under the department store name.
3. Minimal Payments: business arrangements in which the payments made from franchisee
to franchisor as a condition of obtaining or commencing the business aggregate less than
$500 during the period from any time before to within six months after commencing
operation.
4. Oral Agreements: no writing which evidences any material term or aspect of the
relationship or agreement exists.
Exclusions include:
1. Employment/Partnerships: the relationship between an employer and employee or among
general business partners.
2. Cooperatives: membership in a bona fide cooperative association.
3. Certification Agreements: an agreement for the use of a “trademark, service mark, trade
name, seal, advertising, or other commercial symbol” that designates an entity offering a
bona fide service for evaluation, testing or certification of goods, commodities or
services.
4. Unique License: a license of a trademark, trade name, or service mark granted to a single
licensee.
LL
The California Franchise Investment Law provides a typical example of the definition under
state law. According to this law (Section 31005 of the California Cooperation Code), a franchise
is defined as any contract or agreement, either express or implied, oral or written, between two or
more persons by which:
A
1. A franchisee is granted the right to engage in the business of offering, selling, or
distributing goods or services under a marketing plan or system prescribed in substantial
part by a franchisor; and
2. The operation of the franchisee’s business pursuant to such a plan or system is
substantially associated with the franchisor’s trademark, service mark, trade name,
advertising, logotype or other commercial symbol designating the franchisor or its
affiliate; and
3. The franchisee is required to pay, directly or indirectly a franchise fee.
According to this definition, five elements need to be present in order for a franchise to exist:
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1. There must be a contract between the parties.
2. The franchisee must be granted the right to engage in a business.
3. The franchisee is given the right to use the franchisee’s name or mark to identify his
business.
4. The franchisee is required to pay something of value to the franchisor.
5. The franchisor “prescribes” a marketing plan for the franchisee.
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Statutes may differ by state. State administrative agencies often disseminate regulations and
interpretive opinions which are very useful in determining whether or not a particular
distribution technique is a franchise within the statute outlined in a particular state.
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BUSINESS MODELS & FINANCIAL STRUCTURES
A STRATEGY MYSTERY GAME
Marcus Hurt, EDHEC Business School (retired)
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On the following pages, you will find Balance Sheet figures and common ratios for a total of 16
firms. However, these firms are not identified; they are simply lettered: A, B, C, etc. You will
also be given a list of 16 different kinds of businesses. The goal is for you to match up the kind
of business with its financial figures. The purpose of the game is to train you to observe the link
between the kind of business model the firm is using and the financial structure that model
entails.
A
LL
The 16 firms are presented as two different sets: the first set of 4 firms is a Practice Exercise that
you will work on as part of an interactive lecture session with your strategy instructor. With this
exercise you will start to understand how financial figures can reveal industry structure. The
second set of 12 firms is for you to work on in teams or individually, depending on how your
instructor wishes to proceed. You will be assigned one firm to identify out of the 12 and asked to
explain how the business works and why it generates the kind of financial structure it does. At
the end, all 12 different businesses should be correctly identified, and what is meant by industry
structures should be much clearer.
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Business Models & Financial Structures
A Strategy Mystery Game
The Practice Exercise
Low-cost airline
3
Full-service airline
2
Computer maker
4
Diversified computer maker
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Company
A
B
C
D
Balance Sheet Percentages
%
%
%
%
Cash & Equivalents
Accounts Receivable
Inventory
Other Current Assets
Net PP&E
Intangibles
Other Long Term Assets
42.2%
19.0%
2.0%
9.5%
72.7%
7.3%
0.0%
19.9%
18.0%
12.8%
8.9%
16.3%
56.0%
8.3%
25.9%
9.7%
17.8%
1.8%
1.1%
4.8%
25.5%
66.3%
0.0%
8.2%
9.5%
4.3%
1.0%
7.2%
22.0%
68.4%
2.0%
7.6%
100%
100%
100.0%
100%
Accounts Payable
Short-term Debt
Taxes Payable
Accrued Liabilities
Other Short-Term Liabilities
Long-Term Debt
Other Long-Term Liabilities
Total Liabilities
Stockholders' Equity
42.6%
0.0%
0.0%
26.3%
0.0%
68.9%
2.2%
11.0%
82.1%
17.9%
13.2%
2.4%
3.1%
17.1%
8.0%
40.7%
4.4%
6.8%
51.9%
48.1%
3.7%
4.2%
0.0%
14.6%
4.6%
27.1%
9.8%
16.2%
53.1%
46.9%
3.1%
0.2%
0.0%
14.3%
9.5%
27.1%
7.2%
197.8%
232.1%
-132.1%
Total liabilities & equity
100%
100%
100%
100%
A
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Total Assets
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Company
A
B
C
D
Selected ratios
Leverage ratios
Financial Leverage (Total Assets/Equity)
Debt/Equity (LT Debt/Equity)
3.58
0.08
2.08
0.14
2.13
0.30
___
___
1.20
1.01
11.9%
1.38
0.76
15.4%
0.94
0.72
-1.6%
0.81
0.51
-5.0%
Efficiency ratios
Days sales outstanding
Days inventory
Payables period
Inventory turnover
Asset turnover (Sales/Total Assets)
29.9
3.6
73.6
102.3
2.3
42.4
38.3
53.8
9.5
1.1
12.2
___
___
___
0.6
18.8
113.8
318.9
3.2
0.9
18.3%
8.6%
0.4%
6.2%
14.3%
47.6%
0.3
23.4%
4.0%
1.0%
2.8%
3.1%
6.4%
2.1
100.0%
10.8%
0.7%
7.2%
4.3%
9.0%
2.1
96.1%
-1.3%
-120.6%
-121.9%
___
___
(1.3)
___
16.6
3.9%
23.4
8.0%
17.1
___
1.0
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Liquidity ratios
Current Ratio
Quick ratio
Net Working Capital to Total Assets
Profitability ratios
Gross Profit
Operating Profit
Net Interest Income & Other
Net Income
ROA
ROE
Equity/Assets
A
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Sustainable Growth
Price Earnings P/E
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Business Models and Financial Structures
The Case
On the following two pages you are given Balance Sheet Percentages and Selected Common Ratios from 12 firms. The 12 firms are:
1
2
3
4
5
6
Car Dealership
Life Insurance Company
Provider of food management and janitorial services
Provider of temporary office and other staff
Jewelry Chain
Major e-tailer
7
8
9
10
11
12
Consulting firm
Electric Utility
Discount retailer
Restaurant Chain
Hotel chain
Branded Food Products firm
A
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Each column on the following two spreadsheets provides a financial breakdown corresponding to one of the above firms. Using these
figures you are to work out which column of figures best represents the Business Model of each firm. After some analysis you should
be able to say that a certain kind of Business Model would most likely generate a financial structure similar to the one shown in
columns A, B, C, etc……
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A
B
C
D
E
F
G
H
I
J
K
L
Balance Sheet Percentages
%
%
%
%
%
%
%
%
%
%
%
%
4.4% 32.9%
8.2% 10.2%
2.1% 13.2%
4.6%
0.0% 19.6% 57.6% 10.3% 14.7%
3.6%
1.4%
3.5%
0.0%
0.0% 11.9% 41.3%
2.5% 24.5%
3.5% 22.2%
3.2%
2.0%
2.3%
5.6%
1.5%
11.4% 74.7% 69.0% 34.4% 60.4% 24.9% 32.0%
70.7%
7.7%
3.5% 20.5%
8.8% 34.1% 57.0%
6.3%
4.2% 22.6% 28.0% 29.3% 29.7%
9.0%
11.6% 13.4%
4.9% 17.1%
1.6% 12.3%
2.0%
1.1%
15.7%
9.4%
1.8%
28.0%
23.5%
38.0%
10.6%
1.5%
0.5% 54.1%
5.4%
2.5%
2.9%
7.4%
7.5%
0.0%
2.7% 15.3% 63.6%
-4.1%
4.4%
2.4%
9.1%
-0.1% 10.5% 79.2% 85.6%
0.0% 76.6%
9.4% 11.6%
1.0%
0.0%
4.3%
0.0%
99.0% 12.8%
7.0%
2.8%
100%
100%
100%
100%
100%
100%
100%
100%
100%
Accounts Payable
Short-term Debt
Taxes Payable
Accrued Liabilities
Other Short-Term Liabilities
Long-Term Debt
Other Long-Term Liabilities
Total Liabilities
Stockholders' Equity
5.0%
3.2%
0.9%
6.6%
7.3%
23.0%
4.6%
12.7%
40.3%
60.5%
9.0%
0.3%
9.3%
20.8%
24.1%
54.3%
0.5%
26.3%
81.1%
18.9%
12.3%
4.7%
7.9%
18.7%
2.7%
46.3%
8.5%
6.6%
61.4%
38.5%
11.2%
6.8%
5.4% 39.5%
1.2%
0.0%
6.6%
6.5%
1.2%
0.0%
25.6% 52.8%
39.0%
8.6%
12.0%
4.4%
76.6% 65.8%
24.6% 34.2%
0.0%
0.5%
0.5%
0.0%
9.3%
10.3%
40.9%
17.1%
68.3%
32.2%
18.0%
6.5%
1.1%
10.1%
1.1%
36.8%
19.7%
3.6%
60.1%
41.1%
Total liabilities & equity
100%
100%
100%
100%
100%
100%
100%
A
Total Assets
LL
Cash & Equivalents
Accounts Receivable
Inventory
Other Current Assets
Net PP&E
Intangibles
Other Long Term Assets
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100%
100%
11.3%
0.0%
0.9%
0.3%
0.0%
0.0%
17.2%
0.0%
0.0% -0.3%
29.4%
0.0%
34.8%
2.5%
10.1% 91.5%
74.3% 94.0%
25.7%
6.0%
3.1% 37.0%
6.0%
0.0%
0.3%
0.0%
2.0% 15.2%
2.1%
0.0%
13.5% 52.2%
32.2% 41.2%
26.3%
0.0%
72.0% 93.4%
28.3%
6.7%
21.4%
0.0%
4.0%
11.9%
4.0%
37.2%
38.4%
2.1%
77.7%
22.3%
100%
100%
100%
100%
100%
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The CASE Journal
A
SELECTED RATIOS
Leverage ratios
Financial Leverage (Total
Assets/Equity)
Debt/Equity (LT
Debt/Equity)
Liquidity ratios
Current Ratio
Quick ratio
Net Working Capital to Total
Assets
Efficiency ratios
Days sales outstanding
Days inventory
Payables period
Inventory turnover
Asset turnover (Sales/Total
Assets)
B
C
D
E
F
G
I
J
K
L
1.65
5.28
0.03
4.06
2.93
3.11
2.43
3.89
16.55
3.53
15.02
4.48
0.11
0.04
0.34
1.80
1.41
1.29
0.64
1.39
0.46
1.42
6.18
1.72
0.52
0.20
1.37
0.97
0.01
0.01
1.41
0.84
1.14
0.32
2.42
1.70
0.90
0.17
0.95
0.57
___
___
0.80
0.26
1.52
1.18
2.30
0.35
-10.8% 20.4% 22.6%
7.0%
7.5%
14.0%
-3.7%
-1.5%
0.0%
-2.6% 27.1%
48.4%
0.0
18.8
20.3
19.4
36.5
___
20.2
___
73.0
___
19.1
___
44.8
77.2
71.8
4.7
15.9
59.2
8.5
6.2
23.9
0.0
0.0
0.0
1.9
46.6
34.1
7.8
26.1
17.6
21.2
20.7
77.0
___
___
___
30.0
498.3
577.7
0.7
10.2
29.6
70.9
12.3
11.4
223.2
78.4
1.6
2.0
2.0
2.8
0.9
3.2
0.5
2.5
2.2
0.1
0.4
2.5
1.8
9.5% 100.0% 94.6% 24.0%
5.3%
9.7% 21.9% 5.1%
-1.2%
0.0% -5.7% 0.0%
2.6% 10.4% 11.7% 4.2%
49.6%
-2.6%
-2.5%
-5.6%
62.7% 29.8% 18.3% 36.0% 15.6% 100.0% 22.9%
7.9% 12.4% 2.7% 12.9% 2.8% 18.1% 5.9%
-0.4% 0.6% 0.3% -4.9% -0.9% -3.8% -0.4%
4.9% 5.5% 1.6% 8.5% 0.9% 10.4% 3.6%
ROA
ROE
Equity/Assets
9.8% 11.1% 4.6% 7.4%
14.7% 59.4% 12.0% 34.2%
0.6
0.2
0.4
0.2
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Profitability ratios
Gross Profit
Operating Profit
Net Interest Income & Other
Net Income
9.2% 55.4% 10.1% 11.5%
20.6
22.2
20.4
28.3
2.9%
9.1%
0.3
5.4% 9.1% 5.8%
17.1% 22.1% 23.4%
0.3
0.3
0.4
1.1% 4.1% 10.3% -10.3%
17.9% 15.2%
_ _ _ -40.2%
0.1
0.3
0.1
4.5
8.7%
14.6
14.6% 14.6% 18.6%
26.9
18.0
0.2
14.6%
17.0
A
Sustainable Growth
Price Earnings P/E
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4.6%
17.4
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45.9
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A Brief on Business Models & Financial Structures:
Marcus J. Hurt, EDHEC Business School (retired)
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FOCUS OF THE CASE
The Business Models & Financial Structures case is deceptively simple. It is run like a strategy
mystery game. The six pages of the case itself contain only brief instructions for the student, a
Practice Exercise on four different rather easy-to-identify firms and, then, on the three pages
following, twelve more firms for the students to identify using their knowledge of financial
accounting and corporate strategy. This apparent simplicity disappears as the instructor leads the
students through the ‘sleuthing’ part of the game, tying the financial structure of each firm to its
business model. In its application the case makes clear the way the firm works in its industry,
based on the forces at work in the industry and its position on the industrial chain. Therefore, the
case moves well beyond the application of financial accounting logic to explore strategic forces
at work in industries and the financial effects of the choices made by the firms.
The case is meant to be used in a course on Strategic Management, Corporate Strategy or
Business Policy. It should be applied after the students have covered approximately one half a
classical course in these subjects, i.e., after they have covered the external environment, the
internal environment and business strategy. Most corporate strategy texts are organized so that
the first four or five chapters deal with 1) introduction to what strategy is and why it is important,
basic strategy concepts: mission, vision, etc; 2) analysis of the firm’s external environment,
including the macro-environment and Porter’s five forces model; 3) analysis of the firm’s
internal environment, its value chain, competencies and capabilities; 4) business-level strategies
from cost leadership to differentiation, possibly vertical integration and outsourcing (which may
be dealt with at the corporate level). The learning objectives of the case parallel this course
chronology.
LL
CASE LEARNING OBJECTIVES
A
Positioning the case after the above strategy subjects have been covered means that its learning
objectives are multiple:
1. Driving home aspects of external analysis by helping students ‘see’ the structures of
different industries as they are reflected in firms’ financial structures. The idea of
industry structure is usually insufficiently assimilated by students. Despite coverage of
the IO approach to strategy and Porter’s work, particularly the Five Forces Model,
students often have difficulty understanding the link between structure and industry
attractiveness. The purpose of this case is to drive home that link and clarify what is
meant by attractiveness.
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2. Making clear the link between the competencies and capabilities needed by firms in their
internal environment to successfully compete in their industries by matching the key
success factors at work.
3. Getting students to understand what competencies must be developed to successfully
pilot business strategies like cost leadership and differentiation and how these
competencies translate financially.
4. Developing insight into integration and outsourcing strategies and their effects.
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Taken as a set, these multiple objectives mean that the case is used to tie together students’
learning about strategic management before they move on to corporate strategy where they may
have to apply their financial analysis tools to measure the performance of different businesses of
a diversified firm.
The case has been thoroughly tested in the classroom and experience has shown that students
also learn to apply financial analysis more effectively in their corporate strategy course than they
usually do. Too often, because of time constraints, instructors simply tell the students to carry out
financial analysis on a firm covered in a case and refer to the standard list of ratios that may be
included in the course text. The students are left on their own to execute the analysis and
‘understand’ its meaning; thus, their use of financial tools applied to strategy is often
disappointing.
Student feedback has been very positive concerning their new-found insight into the relation
between strategic choice and finance.
THE CASE TEACHING NOTE
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Unlike the case, the Teaching Note is not deceptively simple. The forty-six page Note provides a
complete support package including background on the case, a detailed teaching plan and
debriefing, as well as slides for instructor use. The teaching plan includes guidelines for
interactively leading the Practice or warm-up exercise blended with lecturettes linking strategic
concepts to the financial figures. It also suggests the tried and tested ways for leading the
mystery game during which the remaining twelve firms are identified and discussion. The plan
contains a section with detailed commentaries on each firm, clearly tying financial figures to the
firms’ business models, with comments on the industry. Very importantly, the teaching plan
manages the important involvement of students in the ‘fun’ aspects of the case and the very real
strategy learning taking place.
There are also colored answer sheets highlighting the relevant Balance Sheet percentages and
ratios for the 4 firms in the Practice Exercise and the 12 firms to be identified in the actual game.
The figures and ratios that are most important as clues for identifying the different firms are set
off in a variety of colors to assist the instructor in keeping in view the essential figures to
comment on as they lead the students through this fast-moving case. A color chart is provided,
where the meaning of each color is given.
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Accompanying the slides at the end of the Teaching Note, there is a list of the Ratios used in the
Business Models and Financial Structures case with an explanation of how they are usually
calculated and interpreted.
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21st Century Learning:
Leadership Lessons from Collaborative
Case Research, Teaching and Scholarship
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John F. McCarthy, University of New Hampshire
David J. O’Connell, St. Ambrose University
Douglas T. Hall, Boston University
Jan Eyvin Wang, United European Car Carriers
ABSTRACT
Management scholars and researchers have long been concerned about the impact and relevance
of their work. Here we chronicle the teaching, research, management, and personal leadership
development lessons that have arisen from a collaborative, decade-long relationship between
three management faculty members and the senior management team of a major Norwegianbased global shipping and logistics company. This relationship grew from the creation of a
teaching case in 1997 to many years of productive and meaningful work together, including the
development and delivery of the all-conference Plenary Session at the 2006 Eastern Academy of
Management Meeting, held concurrently with the annual CASE Association Conference. At the
2006 Plenary Session, each of the authors expressed powerful personal and professional
development through their collaboration over the years, which is summarized in this article.
Reflections, lessons and future research directions are provided.
INTRODUCTION AND OVERVIEW
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How do 21st century managers and scholars learn? In what ways can scholars and managers
collaborate to learn and grow together? During the all-conference Plenary Session at the 2006
Eastern Academy of Management (EAM) 43rd Annual Meeting, held in Saratoga Springs, NY
concurrently with the 30th Annual CASE Association Conference, a senior business executive
and three management faculty members and organizational researchers examined these questions
through their collective 10-year journey together, which was founded in a case study research
project. The executive, Mr. Jan Eyvin Wang, is CEO of United European Car Carriers and was
formerly the President of Wallenius Wilhelmsen Americas, major Norway-based ocean transport
shipping firms, who served as the Plenary Session’s Keynote Speaker. The three management
faculty members originally worked together in the School of Management at Boston University,
where they met and conducted original case research together beginning in 1996 on the
Wilhelmsen organization, Mr. Wang’s former company.
At the 2006 Plenary Session, each of the participants described and highlighted the many
teaching, research, management, and personal leadership development lessons that have directly
arisen from their collaborative research and teaching relationship over the past decade, starting
from an initial teaching case to many years of productive and meaningful work together. This
was also an especially fitting dialogue in that the CASE Association, a developmental
organization of management faculty and scholars whose mission is to “foster case research,
writing and instruction” (see www.caseweb.org), was formally celebrating its 30th Year
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Anniversary at the 2006 conference, emphasizing the value and importance of case study
research and teaching. The conversations at the Plenary Session explored how the scholarship
and work with Mr. Wang and the Wilhelmsen organization has served as a real-life case study of
leadership development principles; the Plenary session generated engaging and interesting
dialogue, which many attendees reported as being an extremely valuable and worthwhile session
at the conference.
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Many leadership lessons continue to emerge for the faculty members as well as business
executives from their ongoing teaching, research and discussions. In concert with the EAM 2006
conference theme of “Management Scholarship, Teaching, and Learning in the 21st Century,”
contemporary management education requires scholars and practitioners to blur traditional
boundaries and forge new relationships to learn from each other in understanding the realities of
the 21st century organization. This article summarizes the key themes and salient points about
personal leadership development from this rich 10-year relationship, as expressed at the 2006
Plenary Session.
PROFILES
Prior to his current leadership role, Mr. Jan Eyvin Wang previously served as President of
Wallenius Wilhelmsen Americas, a large operating division of a $2 billion global firm that was
initially profiled in a teaching case, Ingar Skaug and Wilhelmsen Lines: Leadership and
Organizational Transformation (O’Connell, McCarthy & Hall, 1997), which won the “Best Case
in Progress” Award by the CASE Association at the 1998 EAM Annual Meeting in Springfield,
MA. The case, which was authored by the three management faculty panelists from the 2006
Plenary Session, told the story of Wilhelmsen Lines, a major Norwegian-based shipping firm,
following a terrible tragedy in 1989, when 50 employees, including the company’s entire senior
management team, were killed in a plane crash on the way to a ship-naming ceremony. In the
years after the tragedy, led by a dynamic new leader, Mr. Ingar Skaug, a former executive at
SAS airlines, Wilhelmsen Lines underwent remarkable organizational development and dramatic
transformation processes. The entire firm was rebuilt to become radically changed, extremely
successful, and remains the industry leader in its segment today.
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Mr. Jan Eyvin Wang was a senior Wilhelmsen executive for many years and led the firm’s
Commercial Division throughout this change process and was instrumental in developing and
executing key aspects of the company’s strategy and turnaround, including coordination of a
major merger in 1999 with Wallenius Lines, a global Swedish-based shipping competitor. He
later led the combined firm’s Americas Region, encompassing North and South Americas, Latin
America, Mexico and the Caribbean operations, to success. Mr. Wang has held executive posts
in the US, Korea, and in Europe, currently serves on the Board of several international
companies, and has worked closely with academia in leadership development, values research,
and improvement of business systems. Mr. Wang attended Oslo Economic College and is a
graduate of Herriot Watt University in Edinburgh, UK, where he received a degree in Business,
and also completed the Advanced Management Program at Harvard University.
Prof. Hall, a distinguished scholar and leading global expert on executive development and
careers, has served as a mentor, boss, colleague, and friend to Professors O’Connell and
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McCarthy. The three faculty members, now at three different universities across the US, continue
to collaborate on leadership-related research based on their initial work together on the
Wilhelmsen case study. More detailed profiles of Mr. Wang and the faculty members are
provided on Appendix A.
GENESIS
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The research relationship began in 1996 when Mr. Ingar Skaug, then CEO of Wilhelmsen Lines,
served as a guest speaker in a Leadership class session at Boston University taught by one of the
authors (Hall), with the other two faculty authors sitting in on that class session as doctoral
students. Mr. Skaug, who served as a member of the Board of Governors of the Center for
Creative Leadership (CCL) along with Prof. Hall, where they had met, told the gripping story of
his firm’s recovery from terrible tragedy to become a dominant competitor in the global shipping
and logistics industry through a remarkable organizational development and transformation
process. That evening, plans for the development of a teaching case about Wilhelmsen were
formally launched. Mr. Wang was a key member of the firm’s senior management team in
Norway at the time and became one of the very first respondents interviewed for the case study
project.
Since then, in addition to the publication of the Wilhelmsen Lines teaching case (O’Connell,
McCarthy & Hall, 1997), which has been taught at many university settings in the US and abroad,
the leadership lessons have been featured by the co-authors as research articles (McCarthy,
O'Connell & Hall, 2005; O'Connell, McCarthy & Hall, 2004) and at major management research
conferences (McCarthy, 1999, 2002; McCarthy, O'Connell & Hall, 2003; O'Connell & McCarthy,
2000; O'Connell, McCarthy & Hall, 2001). Also, one of the co-authors (McCarthy) used the
Wilhelmsen organization in 2000 as the site of his doctoral dissertation, conducting research in
company offices in Norway, Sweden, Australia, and the US, (McCarthy, 2002) with additional
publications in progress (McCarthy, 2007). Discussions remain ongoing about the development
of new Wilhelmsen “D, E and F” case sections (since parts A, B and C were published in the
original 1997 case), with an update to the firm’s evolution and present day challenges.
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McCarthy, who, like Hall and O’Connell, studies leadership as a primary component of his
research agenda, sees how the leaders at the Wilhelmsen organization crafted an extremely
successful strategy and built an innovative, people-driven firm. He explained at the 2006 Plenary
Session,
As leadership scholars, we became very well aware of this notion of knowing oneself,
being clear on one’s value foundation before being asked to lead. Mr. Skaug and Mr.
Wang also, for us as researchers, embodied that and showed us what it was like to lead
authentically: To deal with mistakes as well as successes and to take an organization to
a place where it would never have been. Today’s vision statement in the Wilhelmsen
organization talks about a philosophy of leading empowered employees in an
innovative learning organization as a competitive advantage and meeting the needs and
wants of our customers.
The company no longer talks about shipping. Linking with the analogy of the railroad
industry not understanding that they are in the transportation business, Wallenius-
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Wilhelmsen sees as itself as a logistics company. The company has acquired a number
of logistics providers, domestically in the U. S., in Europe, as well as in Asia, and now
blankets the market and sees their core competency as delivering logistic solutions to
customers, including those customers who happen to have stuff on their boats. It is
really remarkable to those who have studied long-term strategic changes to see that in
action, to see that organization transform from a shipping company to something much
different.
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The lessons from the richness of the initial teaching case study led to follow-up research studies.
As the faculty members moved to different universities, we continued to collaborate and to use
the Wilhelmsen Lines case as a component of our pedagogy. We also remained in close contact
with the senior executives at the Wilhelmsen organization as the firm continued its
organizational development and strategic change processes.
COLLABORATION AND LEARNING
As part of this ongoing teaching and learning process, Mr. Wang has also traveled from his
firm’s headquarter offices in Norway each year to participate in Boston University’s Executive
MBA program’s core residence week on Leadership for the teaching of the Wilhelmsen Lines
case study (O’Connell, McCarthy & Hall, 1997). The main protagonist in the case study, Mr.
Ingar Skaug, the former CEO at Wilhelmsen Lines, and Mr. Wang’s former boss, also comes to
Boston for this class session. It is a rich, valuable and dynamic learning environment with
lessons from real-life leaders, which students report as being a highlight of the program.
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Mr. Wang has often acknowledged the value of the case research for his management practice
and sees the case study and these ongoing class visits as an integral element of his own continued
personal leadership development, where he is challenged by students and faculty to openly
reflect on his leadership successes and failures, dating back to the original case study and
through his current-day challenges. At the 2006 Plenary session, Wang discussed the importance
of the case study and his travels to Boston to help teach the case in class, saying,
This leads me to the need to stay in touch, and not only within your own organization
because there are more forces here than just within my company. So, it is the trends and
factors which influence people in society at large, and this is where I have found great
pleasure and learning in coming and spending time with academia. Jack talked about
the Wilhelmsen Lines case, for which we are invited to attend up at BU. To be able to
go up there once a year, I have to read the case again, even though I know it. But it is
time for me to reflect. To reflect on what you did and why you did it. And I guarantee
you, at the time we did it we thought it was pretty brilliant, but if I now go back and
think “would I have done it the same way again?” I would have said “wow, this is old
fashioned stuff,” because we change. Not only us as people, but society. And the
students up there they say, “how could you do this, it doesn’t make sense anymore?”.
So this is about spending time reflecting why we did what we did and answering some
pretty pointed questions, which make a lot of sense. But it is also about hearing from
these students and being able to find out what is on their minds. Because it is also about
learning from my point of view, where I can go and listen to what their priorities are.
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This learning is not, however, a one-way process. The faculty members and others in the
university community, well beyond the participating in-class MBA students, see how the CEO
visits contribute to their learning and development. As Hall recalled at the Plenary Session,
The long-term relationship has been wonderful for all of us; not just working with Jan
Eyvin and Ingar and people at the company, but also for those of us on the BU side, it
has been a wonderful experience. I know for me it has been very important, and I
realize we first talked about this with Ingar. I was talking to him at a CCL board
meeting the second week of May in 1996, so this [2006 Plenary session] is the 10th
anniversary of the beginning of it. You’ve heard the value that it has had for BU in
terms of teaching and research, about how it has affected all of our lives and all of our
careers. It also has been helpful on the service side. We have had articles in our school
magazine. The Dean spends time with Jan Eyvin and Ingar when they come, and he is a
CEO himself; he was head of Ford Europe before he came to Boston University. They
have talked to other people in this school, the international management club. So there
is a service component to this as well as teaching and research.
COLLABORATIVE RESEARCH
The three management faculty members, in preparing to teach the case as well as continuing to
develop related streams of research, have also grown together as colleagues and scholars, and
they use the case to reflect and reconnect, personally and professionally. As O’Connell
summarized at the 2006 Plenary Session,
We got this crazy idea saying, “Maybe there is something about the way we teach cases
we can learn from this case.” I heard that Ingar Skaug was coming to BU, and said, “I
think we have a quasi-experiment here.” So we devised this quasi-experiment where we
taught the case just using the print and discussion. Then, in addition to the print version
of the case, we brought the CEO in by videotape, and then in another session he
appeared as a “live respondent.” We said “maybe we could learn something about
what people get out of a case when it is mediated in different ways”.
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And so that became our study. We brought it to the Organizational Behavior Teaching
Conference and then it got published in The Journal of Management Education. It was
a great way to leverage a teaching tool into a pedagogy-learning tool for us… So, it’s
raised some questions for us about how do we engage students when we have the
opportunity to bring a live executive into the classroom? How do we do a better job of it
when we don’t have the live executive to come into the classroom? It has opened some
more doors for us to think about pedagogy, and it all came out of this initial
relationship with an executive and a company willing to tell their stories.
Additional opportunities for learning emerged as we continued to work together. We realized
that there were many personal development lessons as well as professional learning from our
teaching and research. A notable example is the challenge of work and family balance, especially
for the hectic travel schedules of busy corporate executives and, to a lesser extent, as researchers
and consultants managing research projects. We were able to expand the dialogue through
expanding the relationships; as McCarthy remarked at the Plenary Session,
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I have had a wonderful experience using this organization from a research point of view.
Another moment came last January [2006] when Jan Eyvin joined us…in the leadership
program in the executive MBA course at BU, where we use the Wilhelmsen case as a
midweek development point. For years Ingar and Jan Eyvin have come, and this past
year Ingar brought his wife. Then, the conversation immediately shifted to work and
family balance, when he talked about the 200 days per year that he traveled when he
had children and being a global CEO. And Jan Eyvin, as the top lieutenant in that
organization, was also traveling frequently.. This year we have invited Jan Eyvin’s wife
[who was in the audience at the 2006 EAM Plenary Session] to come with us [to the
2007 EMBA program at BU] and talk about that from a work and family balance point
of view. It is critical to find those global leaders who worry about those things and deal
with those things. Because we all are, as I tell my undergraduates, working in a global
economy; whether you have a one person shop or a large firm, the advent of the
Internet has changed the way that we think about business, and we all face that balance
and those global boundaries.
This past year, in January 2007, the spouses for both Mr. Wang and Mr. Skaug indeed attended
and participated in the EMBA class sessions. The class discussion analyzed the strategy and
leadership at Wilhelmsen, based on study of the case, as well as the personal challenges senior
executives and their families face in today’s global environment. This was particularly
meaningful for EMBA students, who are often contemplating taking on more responsibilities or
making career changes as they complete their degree program. Being able to discuss these
difficult choices with experienced executives and experienced family members provided
extremely powerful and valuable dialogue.
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Clearly, at a fundamental level, our relationship as colleagues has been enlivened and enhanced
by working together on the Wilhelmsen research and teaching projects.
As Dave O’Connell said at the Plenary Session,
Jack and I have common ground, I think, that both of us were in industry for 14-15
years before we became doctoral students at BU. I know one of the things that I missed
the most leaving industry was the relationships with a small group of key people I
worked with closely. I was blessed to rediscover relationships in academia with Tim
and with Jack and with others. It is out of these relationships that some of the best stuff
has happened. The best stuff in my development happened not in the doctoral class
rooms – I can say that because I did not take a formal class from Tim. But projects like
this is where I learned the most; that’s where I grew the most, and has impacted my
career the most without a doubt.
McCarthy echoed these sentiments, adding,
And, as Dave said, we have been blessed with the relationship working with all of us,
and I hope to go to Norway again – when the weather is nice!
We also see value in the collaborative relationship across the professional boundaries – and
across the Atlantic Ocean to Norway. As Hall said at the Plenary Session,
You’ve heard Jan Eyvin talk about the value of reflecting. Another Yogi-ism [from
Yankee baseball Hall of Famer, Yogi Berra] that I like is “You can observe a lot by
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watching”. He was specifically talking about being a catcher. Casey Stengel, his
manager, pointed out to him, “You know Yogi, you are the only person on the team who
can see the whole team and the whole field. You have a perspective there from the
catcher position.” Well, we don’t all have that kind of thing, but if you have a chance
to as Gordon Sullivan, former Chief of Staff of the US Army, said “to get up on the
balcony you can have that perspective.” I think, as Jan Eyvin said, and Ingar has said,
that having a chance to come over here, read the case again, you are sitting on the
plane preparing at 30,000 feet, you can get up on the balcony. And the chance to
reflect is important.
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Also, in terms of leadership, I have seen ways that meeting with the students has been
helpful for these great executives. I remember on two occasions when Ingar came to BU
he was really down; there were problems with the business. There were very difficult
challenges going on, and I could just see the energy he got from the response from the
class. It just kind of pepped him right up, and he said later on how much it meant for
him; you know, after getting beaten up by his board or by co-workers or whatever, to
come here and to get feedback, and realize that “This is important work that we are
doing. We are doing good things even though we have these everyday problems that we
have to deal with.” So, it is encouragement, it provides further challenge for them to
sort of live up to their press notices – I think it represents a kind of inspiration. So, in a
funny way, we look at the leadership lessons from Jan Eyvin and Ingar, but hopefully
there has been a leadership effect going back to them and the company as well.
LL
As Jan Eyvin Wang took the center stage at the Plenary Session and shared some of his views
and leadership philosophies, we heard some familiar lessons about being grounded in one’s
values, being reflective and open to learn, and about creating an environment where people at
all levels feel valued and encouraged to succeed. As Wang stated in his closing remarks,
The more difficult part [of management] is what I would call the “soft stuff”. I would
dare say that most business acquisitions or mergers fail not because of lack of brilliant
ideas, but the leaders have not spent enough time preparing the companies for the
change they’re about to undertake. I am not referring to the amount of information,
which passes through the organization; that is done quite effectively today. What I am
talking about is the need to identify what kind of values, of culture, you need to have as
a company to succeed with your strategy.
A
Let me stress that the values that the company has had should be directly tied to the
company’s vision and strategy. Having done that, then leaders need to spend an awful
lot of time, much more than I think is really normally being done. And this is not a HR
thing. This is a leadership thing, and most companies they put cultures and values on
the agenda for the HR departments. I truly believe that it really has a purpose and it
needs to be one of the most important jobs any leader has. You can draw upon the HR
department to help guide the process, but it must be clearly understood by anyone in the
company, from the CEO on down, and not something you do because HR said so.
People now want more than just a job. People want to mature, it is not just about the
technical job of building a bridge or ship or whatever. People want more, about “What
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is in it for me as a person? How do I evolve and what can you, as a company, do to
help me evolve as a human being?” If you are not careful, these people will leave, they
will not stay unless you prepare the organization and give them a chance to grow in
their jobs – from a technical skill point a view, but, even more importantly, the “soft
stuff”. This is where this journey is so enjoyable because people really enjoy maturing
as human beings. It is amazing what energy you really are able to generate and free up
if people are able to open up and share and be part of the process.
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The moral is that the world may not be what we think it is. At best it is more complex.
We all have our filters and these can hinder both personal and professional growth. The
decision that we all have to make is whether we want to learn and grow as human
beings and, assuming we do, how do we best capture new knowledge?
I personally have found that staying close to academics has allowed me not only to
spend time on reflection, but also debate and discuss with people who had different
opinions and views and were very much more knowledgeable in many areas than I am.
To get full benefits requires not wanting to be in the state of mind where we kind of say,
“Now I will tell you what is according to me.” But it is instead about, “Now I will
share with you what I know.” The real learning is when you share back. Then you
create learning synergies. This is a journey that starts at the time when we are born and
hopefully for most people it will last until we leave this wonderful place we call earth.
You, as academics, you pass on students into the world of professional people. What I
think is important, and your challenge, is how can you stay connected, and, equally
important, how can I contribute to your growth as well? Because you have to change
along the same way as society and organizations change, otherwise your value becomes
less and less and that is your challenge just as it is mine. And having said that, the “soft
stuff” is actually the hard stuff but it is also the most enjoyable.
LL
As the 2006 Plenary Session came to a close, and as the audience shared their applause to
hear such a successful senior executive talk so openly about the value of academic-based
research, we realized how fortunate we have been to share in this collaborative process over
the past 10 years. Our relationships here are founded on the central notions of learning,
growth and discovery; although we all bring different perspectives and varying roles – and we
may not always agree – we look forward to continuing our collaboration well into the future.
A
LEARNING FROM CASE RESEARCH
As we step back and reflect on the plenary session we see connections with lessons shared by
case research scholars. It has been suggested that there are three reasons for writing a case:
serendipity, closing gaps between theory and pedagogy, and writing to learn (Naumes & Naumes,
2006). In our situation here, all three factors came into play. It “just so happened” that Hall
came to serve on the board of CCL with Skaug. Did it start by serendipity? It also “happened”
that Skaug arrived to tell his story at a meeting of the Executive Development Roundtable
(EDRT), a research center at Boston University founded and headed by Hall, then at an MBA
leadership class when O’Connell and McCarthy were doctoral students, more than willing to get
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involved in an interesting field study. An invitation from Skaug to explore the story of
Wilhelmsen Lines in detail provided an opportunity for all three of the academics to learn
through collaborative writing. Each brought different backgrounds and skills to the table. It was
an opportunity to learn from the content of the story and from one another. There was also a
connection between theory and pedagogy, as the case became an opportunity to explore
transformational leadership in organizational change. The theoretical connections were enriched
over time as insights emerged about Skaug’s style and how his identity and adaptability were
intertwined with the leadership challenges he faced (McCarthy, O'Connell & Hall, 2005). These
lessons and findings were mirrored in the leadership development observed and discussed with
Jan Eyvin Wang at the 2006 Plenary Session.
Students can develop several skills through the use of cases. These include analytical, decision
making, application, oral communication, time management, interpersonal, creative, and written
communication skills (Leenders, Maufette-Leenders & Erskine, 2001). While these and others
were hoped-for outcomes for students, skills have developed and learning has accrued to the case
researchers and organizational members involved.
While case research can generate persuasive accounts (Siggelkow, 2007), provide rich and
nuanced insights into complex situations (Weick, 2007) and can serve as the basis for generating
theory (Eisenhardt & Graebner, 2007), we have discovered that it can also provide the platform
and context for mutual learning among researchers and organizational members. While not done
intentionally, we moved away from narrowly defined roles as “researchers” and “subjects”.
While we as case researchers may consider ourselves to be teachers, it was the many members of
the Wilhelmsen organization who opened their doors and their stories to become both active
research informants and our teachers. As they gave feedback on draft insights they became active
participants. As the exchanges continued beyond the initial case writing they were co-creators of
knowledge. This makes sense, as qualitative research “champions the interaction of researcher
and phenomenon” (Stake, 1995). As they critiqued and actively participated with university
students, they themselves were acting both as students and teachers imparting and acquiring new
knowledge and insights.
REFLECTIONS AND LESSONS
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This line of thought leads to some initial theory-building of our own. We see a ladder of
collaboration between researcher and researched, with some of the rungs of involvement for
organizational members proposed as follows: Subjects, informants, participants and co-learners.
While not fully engaging in participatory action research with a problem-solving bent (Whyte,
1991), this does move us quite a distance from an objectivist view, where scientists in the field or
the sages in classroom examine and expound on the objects of inquiry. We view this as a fertile
ground for future research and theoretical development.
The value of the collaborative relationship comes from the differences in views provided by
those inside and outside the key organizations studied (Bartunek & Louis, 1996). While
differences in experience, perspectives and interests among insiders and outsiders can present
difficulties, this is also where the treasure lies. The skills sets of academics and managers differ
and overlap one another. When case research is at its best, we can leverage our differences and
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exploit our similarities to accelerate and enhance personal development and the mutual
development of organizations and communities in which we work.
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In the end, it is the journey we value, rather than the destination. The experiences and memories
we build are far more precious than the specific steps, accomplishments and milestones we
achieve. And, since we surely live in a complex, global, interconnected world, it is true now
more than ever that no one walks alone. To make sense of the events we face in our everyday –
and future – work lives, we need the knowledge, wisdom, support and friendship of others. The
richness and depth of the relationships we have forged here – across organizational, professional,
hierarchical, geographic, and cultural boundaries – serve as an exemplar of how we see the
continued evolution of 21st century learning. More importantly, for us, these relationships have
made the journey worthwhile.
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Bartunek, J. M., & Louis, M. R. (1996). Insider/outsider team research (Vol. 40). Thousand
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Eisenhardt, K. M., & Graebner, M. E. (2007). Theory building from cases: Opportunities and
challenges. Academy of Management Journal, 50(1), 25-32.
Leenders, M. R., Mauffette-Leenders, l. A., & Erskine, J. A. (2001). Writing cases (fourth ed.).
London, Ontario: Ivey Publishing.
McCarthy, J. F. (1999). Talking through tough times: Organizational stories at Wilhelmsen lines.
Paper presented at the Institute of Behavioral and Applied Management, Annapolis, MD.
McCarthy, J. F. (2002). Short stories and tall tales at work: Organizational storytelling as a
leadership conduit during turbulent times. Boston University, Boston.
McCarthy, J. F. (2007). Short stories at work: Storytelling as an indicator of organizational
commitment. Group and Organization Management, Forthcoming.
McCarthy, J. F., O'Connell, D. J., & Hall, D. T. (2003). Leading beyond tragedy: The power of
the leaders' personal identity and adaptability. Paper presented at the Annual Meeting of
the Eastern Academy.
McCarthy, J. F., O'Connell, D. J., & Hall, D. T. (2005). Leading beyond tragedy: The balance of
personal identity and adaptability. Leadership and Organizational Development Journal,
26(6), 458-475.
Naumes, W., & Naumes, M. (2006). The art and craft of case writing. Armonk, NJ: M. E.
Sharpe.
O'Connell, D. J., & McCarthy, J. F. (2000). Live or Memorex: The blessings and curses of using
video in teaching leadership with the case method, Organizational Behavior Teaching
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O'Connell, D. J., McCarthy, J. F., & Hall, D. T. (2001). Print, video, or the CEO: The impact of
media in teaching leadership with the case method. Paper presented at the Conference for
the Institute for Behavioral and Applied Management, Charleston, SC.
O'Connell, D. J., McCarthy, J. F., & Hall, D. T. (2004). Print, video, or the CEO: The impact of
media in teaching leadership with the case method. Journal of Management Education,
28(3), 294-318.
Siggelkow, N. (2007). Persuasion with case studies. Academy of Management Journal, 50(1),
20-24.
Stake, R. (1995). The art of case study research. Thousand Oaks, CA: Sage.
Weick, K. (2007). The generative properties of richness. Academy of Management Journal,
50(1), 14-19.
Whyte, W. F. (Ed.). (1991). Participatory action research. Newbury Park, CA: Sage.
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APPENDIX A
EXECUTIVE AND FACULTY PROFILES
Currently, Jan Eyvin Wang is Managing Director (CEO) of United European Car Carriers. Prior
to his current position, he was President of Wallenius Wilhelmsen Lines Americas, where he was
the head of activities in the Americas Region encompassing North and South America, Latin
America, Mexico and the Caribbean.
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Mr. Wang started with Wilh. Wilhelmsen Ltd. ASA in their Strategic Planning and Analysis
Department in Oslo, Norway in 1981 and soon moved to the United States in 1982 where after
being Sales and Marketing Manager was promoted to Vice President of Barber West Africa Line
in 1985. In 1986, Mr. Wang began working for Norwegian Specialized Auto Carriers (NOSAC),
where he held positions in both the United States as well as two years in Seoul, Korea until he
became President of NOSAC, Inc. in 1990. Mr. Wang joined Wilhelmsen Lines, Oslo in 1994
where he was Vice President, Commercial. In 1995, Wilhelmsen Lines acquired NOSAC. As
head of commercial activities, Mr. Wang was responsible for integrating the two companies’
global commercial organizations as well as outlining a new global strategy for the integrated
company. With the merger of Wallenius Lines and Wilhelmsen Lines on July 1, 1999, Mr.
Wang was appointed Senior Vice President, Head of Global Commercial located in Oslo. On
March 1, 2000 he assumed the position of President of Wallenius Wilhelmsen Lines Americas.
Mr. Wang is a second lieutenant in the Norwegian Army. He attended Oslo Economic College
and is a graduate of Herriot Watt University in Edinburgh, U.K. where he received a degree in
Business. Mr. Wang also completed the Advanced Management Program at the Harvard
Business School. Mr. Wang, a native of Norway, is married and the father of three sons.
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Douglas T. (Tim) Hall is the Morton H. and Charlotte Friedman Professor of Management in the
School of Management at Boston University, where he is also Director of the Executive
Development Roundtable and Faculty Director of the MBA Program and serves as a core faculty
member of the Human Resources Policy Institute. Tim is the author of numerous influential
books and research articles on career development, women’s careers, career plateauing,
work/family balance, and executive succession. He is a recipient of the American Psychological
Association’s James McKeen Cattell Award (now called the Ghiselli Award) for research design,
the American Society for Training and Development’s Walter Storey Professional Practice
Award, and the Academy of Management’s Everett C. Hughes Award for Careers Research. He
is a Fellow of the American Psychological Association, the Society for Industrial and
Organizational Psychology, and of the Academy of Management., where he served as a member
of the Board of Governors and as President of the Organizational Behavior Division and cofounder and President of the Careers Division. He was also a member of the Board of Governors
of the Center for Creative Leadership. He has served on the editorial boards of ten scholarly
journals and has served as a consultant to many major global organizations.
David J. O’Connell is Associate Professor of Managerial Studies at St. Ambrose University,
where he previously served as faculty director of the DBA Program. Dave has published articles
and cases on team development, leadership competencies, adaptability and case pedagogy.
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Currently he is researching the development and dissemination of organizational vision. Prior to
doctoral studies, Dave served the Public Service Company of New Mexico in a number of
communications and research capacities, from 1979 through 1993. While a graduate student at
Boston University, where he earned his DBA, he worked with the Executive Development
Roundtable, the Human Resources Policy Institute and the Boston University School of Public
Health.
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John F. (Jack) McCarthy is Assistant Professor of Business at the University of New Hampshire
and serves as Program Coordinator for the undergraduate business program at the university’s
urban campus in Manchester NH, where he was the college’s recipient of the 2005 Teaching
Excellence Award. He is also a Visiting faculty member in the Executive MBA Program at the
Graduate School of Management at Boston University, where he previously earned his DBA and
currently serves as the Director of Planning and Membership for the Executive Development
Roundtable. He is also a former Board Member of the CASE Association, and served as 2006
Vice President of Program-elect and 2007 Vice President of Program. With research and
teaching interests in leadership and organizational change, Jack’s work has been published in top
academic journals and he has led workshops and presented papers and case studies at numerous
professional conferences. Serving over fifteen years as a financial professional and senior
executive in the engineering, high-tech and health care industries prior to his career shift into
academia over ten years ago, McCarthy draws heavily upon his real-world management
experience in his teaching, consulting and research.
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The CASE Association
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Please fill in the following information. Mail this form to the VP for Membership
whose name and address appear at the bottom of the page.
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__ I already paid my 2007-2008 membership through NACRA (you must have
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