Document 1 of 100

The Water's Edge Apartments: Capital Budgeting In Real Estate Development

Author: Murtagh, James P

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Abstract:

The Water's Edge Apartments case provides intermediate finance students with an opportunity to apply capital budgeting analysis and decision- making techniques to a real estate development situation. The objective is to give students practice in identifying and estimating project cash flows to make a decision regarding the project. Students are encouraged to include basic sensitivity analysis in their recommendation. [PUBLICATION ABSTRACT]

Full text:

INTRODUCTION

The typical introductory finance textbook includes a chapter on capital budgeting decision criteria and another on estimating cash flows in a capital budgeting project. The chapter examples and end-ofchapter questions tend to focus on capital budgeting in a manufacturing setting. In these problems, taxes are usually determined as a fixed percentage of incremental taxable income and there is rarely a consideration of potential variation in the proposed cash flows. The Water's Edge Apartments case provides students with the opportunity to evaluate the cash flows for a proposed senior housing development.

The case presents enough information for cash-flow projections throughout a 30-year project life. An accelerated depreciation schedule and preferential tax treatment provide an opportunity for careful consideration of cash flow timing. The main driver of the cash flows and the NPV is rental income, contingent on the anticipated occupancy level. To simplify the analysis, the case specifies the cost of capital.

The case is challenging for students just beginning to learn finance principles, but is also rich enough to use with experienced students and executives. The main learning points of the case include the following:

* The basics of incremental-cash-flow analysis: identifying the cash flows relevant to a capital-investment decision

* The construction of a discounted-cash-flow analysis for a real estate investment decision

* How to adapt the NPV decision rule to account for sensitivity to occupancy rates or other key inputs

* The importance of sensitivity analysis to a capital-investment decision

THE WATER'S EDGE APARTMENTS

The Opportunity

In early 2008, JoIm Francis and Donald White met to discuss a potential real estate development opportunity. The Water's Edge property was created through the purchase of eight individual properties to create a single 9.66 acre footprint on the banks of the Mohawk River in Cohoes NY. When complete, the development would contain 132 individual units in two mirrored buildings with a private street separating them. The current developer of the project was experiencing financial difficulties and was seeking a buyer for the partially complete project.

John Francis is President of Francis Properties (FP), a real estate development and management firm specializing in multiple occupant facilities in the greater Capital District of New York. FP's projects include Greystone, a 38 unit senior living property and Windy Pointe, a 51 unit facility. Donald White is Managing Director of Alliance Venture Partners (AVP) and is a seed-stage investor in early stage technology companies. AVP also invests in commercial and residential real estate projects in metropolitan Boston and in the Capital Region of upstate New York.

Friends since childhood, John and Donald agreed to evaluate the acquisition of Water's Edge property as a joint venture between FP and AVP. Their first concern is to evaluate the potential value of the opportunity.

The Senior Housing Movement

America is a quickly graying country, with nearly 8,000 Americans turning 60 each day according to the US Census Bureau. The fastest growing segment of the US population is those over 85, with those of traditional retirement age (65) being the second fastest growth segment. Immediately behind them come the Baby Boomers, a two decade spanning group of over 70 million individuals with more wealth and inclination to spend it than any other time in US history.

The Albany region has a shortage of attractive senior living alternatives. Currently, senior living facilities in the area represent a total of less than 500 units. Potential customers prefer to relocate nearby their homes in order to retain connections to their local communities. Unfortunately, there are a limited number of appropriate undeveloped spaces in proximity to the population centers. Only one other major project has been announced locally, a $14M project of roughly 100 units to be started in early 2009 in nearby Saratoga Springs.

Acquisition Cash Flows

The partnership would to acquire the property for $9.5 million, 70% of which would be financed through an interest-only bank loan. Once acquired, the group anticipates investing an additional $5.5 million (equity) in year 0 to complete construction. The partnership intends to sell the property after twenty years.

Anticipated Project Cash Inflows

The cash inflows for the project are dominated by the monthly rents. The maximum monthly rents for Water's Edge would be $980 per unit per month by the end of Fiscal Year 2008. Assume no discounts for rent in Year 1 (2009, $ 1 ,050 per unit) and beyond, with rents increasing at 5% per annually.

Secondary cash flow comes from an arrangement with Time Warner Cable to purchase internet, cable TV, and digital phone services at a discount and resell these services to the residents for a profit. The current cost is $52 per month per unit. The services are resold at $100. The partners expect that 75% of the residents will purchase this service and that these costs and revenues will increase at 5% per year.

OPERATING COSTS

Employees

Based on his previous experience, Francis estimates that Water's Edge will require one full time employee acting as property manager. In the Capital District an appropriate individual for the demographics of Water's Edge (45-55 year old, college educated, good communication skills) would be about $4,500 per month for salary, with employee benefits and taxes adding $1,500 for a total of $6,000 per month. This number will increase at 5% annually for the term of holding of the property.

Maintenance

Initially, Water's Edge will require little maintenance ($50,000, year 0). Annual maintenance will increase in year 1 (2009) to $65,000. This value will increase $32,000 per year until the end of the holding period.

Insurance

Due to the design of Water's Edge, insurance costs are not as much of a burden as to be expected with a facility this size. The previous developer installed hydrants outside the buildings and sprinklers on every floor. There are Fire Control Panels and full monitoring, and relatively close proximity to both fire and police. The current policy on Water's Edge pre-completion is $45,000 per year, based on a $9 million value. Using a full value of $15 million, the estimated insurance cost is $75,000 for the year. Insurance costs are expected to increase at a 5% annual rate.

Depreciation Calculations

Normally a building is straight line depreciated over its usable life of 30 years. While the simplest manner, it is not nearly the most tax efficient as components other than the building itself (carpets, light fixtures, etc) can be depreciated in as little as five years. Based on preliminary estimates, Water's Edge enjoys $750,000 a year of accelerated depreciation each year for the first ten years of the project's life. After that time, normal depreciation of the structures and other long lived components gives $300,000 for the remaining years of ownership. Expected annual depreciation expenses are shown in Table 1 .

Taxes

Taxes for Water's Edge are on a per unit basis. As Water's Edge is not 100% completed at this point, it does not carry the full tax burden, and the Pilot Tax Program is not yet in effect. This tax incentive plan will go into effect upon assessment following completion and will last for ten years from that point.

The tax rate for the next two years is projected to be $8,333 per month until September 2009, when full assessment will be in effect. This number shall be used for Year 1 calculations. 75% of this ($6,248) shall be used in Year 0. Full assessment shall be used thereafter.

At full assessment, the tax rate is $1,100 per unit per year, for a full value of $145,200 per year. Due to the fiscal constraints of the current economy, 5% per annum tax rate growth will be utilized annually from full assessment.

The Pilot Tax Program (PTP) is built into the deed of Water's Edge. The PTP is a tax credit for 50% of the property tax bill in the first year of full assessment, decreasing at 5% per year until it has been eliminated in year 1 1 . Tax calculations for the purpose of this analysis will take into account the PTP.

Due to the tax schedule, September 1st shall be used as the start of the fiscal year for all calculations and projections for Water's Edge. Annual tax estimates are shown in Exhibit 2.

Interest Charges

Given the current credit markets, it is assumed that only 70% of the purchase value of Water's Edge can be leveraged via mortgage. An 8% assumption is used for interest only with a balloon beyond the holding time horizon.

THE EVALUATION

As the partners sat down to evaluate the project, White raised some of his concerns. "In order to determine the value of this opportunity, we'll need to clearly understand all the cash inflows and outflows. Is this project really worth the $15 million price tag? Our overall cost of capital on this project is 14%. Will the investment create value? I am sure that our lender will want to see our estimates."

Francis replied, "I agree that we need to value die project for the full twenty years, but I am concerned about the expiration of the Pilot Tax Program incentives. Should we consider selling after ten years instead? I am also concerned about keeping the apartments filled throughout the project. Let's plan on ninety percent occupancy in our calculations. We can use this format (Exhibit 1) as our guide."

TEACHING NOTES

Teaching notes and a copy of the excel solution are available from the author.

Subject: Real estate developments; Capital budgeting; Apartments; Estimating techniques; Decision making; Case studies

Location: United States--US

Classification: 9130: Experiment/theoretical treatment; 8360: Real estate; 3100: Capital & debt management; 9190: United States

Publication title: Journal of Business Case Studies

Volume: 6

Issue: 6

Pages: 1-6

Number of pages: 6

Publication year: 2010

Publication date: Nov/Dec 2010

Year: 2010

Publisher: Clute Institute for Academic Research

Place of publication: Littleton

Country of publication: United States

Publication subject: Business And Economics--Management

ISSN: 1555-3353

Source type: Scholarly Journals

Language of publication: English

Document type: Business Case, Feature

Document feature: Tables References

ProQuest document ID: 818381292

Document URL: http://search.proquest.com/docview/818381292?accountid=38610

Copyright: Copyright Clute Institute for Academic Research Nov/Dec 2010

Last updated: 2013-09-06

Database: ABI/INFORM Complete

Document 2 of 100

Organization Development Quality Improvement Process: Progress Energy's Continuous Business Excellence Initiative

Author: McCuiston, V E; DeLucenay, A

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Abstract:

As the recession intensifies, many organizations are rethinking their work processes for both efficiency and quality enhancement. Even though executives describe the battle to contain costs, productivity and productivity confidence are reportedly on the rise. The most commonly cited factor was not downsizing; it was redesign of work process, followed by quality and/or continuous improvement efforts, strong leadership and employee engagement (Blanchard, 2007; i4cp, 2009, September; i4cp, 2009, January; Rigby & Bilodeau, 2009). Strategies that identify and remove blockages (Six Sigma) and excesses (lean work management initiatives) have become embedded in the public and private sectors. This study of Progress Energy's Continuous Business Excellence strategy summarizes the process documentation and improvement process utilizing an organizational development model of continuous quality improvement (CQI), resulting in a streamlined process, training manuals, new online process update procedures, and substantial cost savings and avoidance. Implications for managers are provided. (145 words) [PUBLICATION ABSTRACT]

Full text:

INTRODUCTION

As the recession intensifies, many organizations are rethinking their work processes for both efficiency and quality enhancement. Even though executives describe the battle to contain costs, productivity and productivity confidence are reportedly on the rise. The U.S. government's lean green and low cost data identifies the highest rate of increase of any quarter since 2003. The classic reason cited in a productivity confidence survey was downsizing, requiring more work to be done per employee. The most commonly cited factor; however, was redesign of work process, followed by quality and/or continuous improvement efforts, strong leadership, and employee engagement (Blanchard, 2007; i4cp, 2009, September; i4cp, 2009, January; Rigby & Bilodeau, 2009).

Quality and Lean Trends

Reflecting the quality and lean trends, the majority of surveyed organizations deployed quality or continuous-improvement strategies, placed more importance on quality programs in 2008 than three years earlier, and spent more than they did in 2007 on more diversified quality applications (i4cp, 2008; Industry News, 2007). Strategies that identify and remove blockages (Six Sigma) and excesses (lean work management initiatives) have become embedded in the public and private sectors. According to the 2007 Industry Week/Manufacturing Performance Institute (IW/MPI) Census of Manufacturers, almost 70% of all manufacturing plants are employing lean as a critical continuous-improvement strategy, signaling a "lean revolution," while 29% said they deployed Six Sigma. However prevalent its usage, lean is not primarily a quick solution for cost savings and avoidance according to James Womack, Lean Enterprise Institute founder. It is fundamentally different from traditional management, requiring ability to inspire teamwork, strategic innovation, and a passion about the process (Blanchard, 2007; Gonzalez, 2003;Kleason, 2007; Maryland Department of Human Resources, 2009; Measuring.. .,2006)

Continuous Business Excellence In Action

Progress Energy's Continuous Business Excellence (CBE) strategy is designed to address the new economic realities, including rising fuel and commodity prices and the need for substantial capital investments. The CBE strategy, representing a fundamental change in the way Progress Energy manages business, is an ongoing effort with each utility and business unit taking actions to ensure increased productivity and proper alignment to deliver operational excellence (Bank of America..., 2009; CBE update, 2009; Continuous Business Excellence, 2009; Florida Public Service Commission, 2007; San Francisco..., 2009).

This article reveals the one-year CBE initiative focusing on the accounting function for customer-requested construction projects. A growing accounts receivable balance triggered further examination and led to a crossfunctional process-improvement initiative involving accounting, energy delivery, legal, customer service, and audit services. The article summarizes the process documentation and improvement process utilizing an organizational development model of continuous quality improvement (CQI), resulting in a streamlined process, training manual, new online process update procedures, and substantial cost savings and avoidance. The remainder of the article is divided into three sections. First is the current state of the industry with management tool trends; second, an overview of quality management development; and third, a summary of Progress Energy's Continuous Business Excellence initiative application for customer-requested construction projects resulting in substantial cost savings and avoidance. Finally the authors provide implications for management.

STATE OF THE INDUSTRY: MANAGEMENT TOOLS AND TRENDS

As executives rethink their strategic direction amid economic worries, they are changing the tools they use to manage their businesses. A large portion of organizations utilize quality or continuous-improvement strategies, however, the usage and satisfaction levels of specific quality tools vary according to multiple global surveys. Based on 231 responses to a 2008 Institute for Corporate Productivity survey, a majority of organizations (85.1%) deploy quality or continuous-improvement strategies with Total Quality Management (TQM) (41.5%) being the most used quality tool (i4cp, 2008; i4cp-Executive Summary, 2009). According to Bain & Company's top management tools surveys, based on 1,430 executives in 2008 and 1,221 in 2007 from North America, Latin America, Asia-Pacific, and Europe, usage of traditional quality management tools, such as lean Six Sigma (31%) and TQM (34%) dropped noticeably in 2008 from the 2006 levels. In contrast, satisfaction with lean Six Sigma rose, achieving one of the largest satisfaction-rate increases of the 25 tools ranked. Satisfaction levels for TQM were unchanged even though its ranking dropped from 6th to 16th. International executives used an average of 11 tools out of the 25 popular management tools, indicating a continuing downward trend from previous surveys for international executives. While overall tool use dropped in 2008, especially for long-term planning, usage is expected to change in 2009. Executives project a large increase, particularly among growth and innovation-related tools. As executives struggle through the worst downturn in their experience, many executives recognize the need to continue developing capabilities such as innovation and organizational effectiveness while they continue to trim their workforce (Rigby & Bilodeau, 2007; Rigby & Bilodeau, 2009; Rigby & Bilodeau, 2007). Table 1 illustrates usage and satisfaction levels for the 25 management tools.

Lean Management Strategies

Companies obtain the best results when they employ tools as part of a broad initiative, instead of on limited projects. Lean Six Sigma is the top-ranked tool in satisfaction when part of a major effort, but it ranks 24th when used on a limited basis. A total organizational culture shift is required for successful Six Sigma programs with change beginning at the top of the organization, spurred by executives who mandate quality strategies at every level of business operations. Prior to establishing a Six-Sigma culture, executives must grasp a company's core assets, vulnerabilities and challenges both internally and within their competitive environment. Six Sigma, a tool for statistical analysis and cost savings, is equally a strategy for leadership development. Concurrent with continuous training, cross-departmental teamwork and rewards programs, true quality leaders must develop quality entrepreneurs who promote innovation in statistical analysis, product design, and customer relations (Feigenbaum, 2007; D'Amore, 2006; Gonzalez, 2003a; Gonzalez, 2003b; Neuhaus & Guarraia, 2008).

According to the IW/MPI, the almost 70% usage of lean as a critical continuous-improvement strategy signals a lean revolution. Reports linking lean/Six Sigma hybrids to efficiency and productivity achievements could be attributing to this trend. Lean is not primarily a quick solution for cost reduction, however popular its usage. It is a fundamentally different system from traditional management (Blanchard, 2007; De Mars, 2007). A shortage of executives versed in lean work management strategies indicates that companies may need to train high-potential inhouse talent. Lean strategies, developed first by Toyota, are now designed to eliminate broader waste problems in both the service and manufacturing sectors. Lean strategies, which save on materials, money, time, and space, set the stage for the more finely- tuned quality strategies of Six Sigma (Measuring, 2006; George, 2005).

Sustaining a quality management process includes a chain or series of business operations that involve a circular progression in which continuance is the dominant concern. Business processes follow and lead into one another in an unending circular chain rather than being relegated to discrete action-units with distinct beginnings and endings. Throughout the process, values, tools, and techniques interrelate holistically and continue evolving, building on previous achievements and further developing in subsequent iterations. While the tools are similar across industries, use variance reflects different effects of the global downturn. By industry sector, the heaviest tool users are consumer products, pharmaceuticals and biotech, food and beverage, and chemicals and metals. The lightest users by industry sector are utilities and energy, construction and real estate, retail, and financial services (Svensson, 2006; Rigby & Bilodeau, 2009).

Optimism About Future Growth

One recurring theme is optimism about future growth. Confidence in productivity is confidence in the nitore of the economy. Results from the Productivity Confidence Index indicate an index increase from 20.3 in April to 22.1 in July. The study found that overall 62% of respondents expect productivity to rise in the next six months. U.S. government data has shown positive productivity news with the highest rate of increase of any quarter since 2003. Likewise, optimism about future growth is a recurring theme among executives (Vickers, 2009; i4cp, 2009; i4cp, 2008b; Rigby & Bilodeau, 2009).

Cost-Cutting is Key

A second recurring theme is cost-cutting. As the recession continues, executives increasingly focus on short-term cost-cutting goals. Executives' heavy use of benchmarking and business process reengineering costcutting tools is not uniformly supported by satisfaction with the results. Executives describe their attempts to contain costs by eliminating discretionary investments and using out-sourcing and off-shoring to maintain the lowest possible cost structure. All regions, however, are not focused on cost reductions. European and Asian executives are less concerned about meeting growth targets than their North and Latin American counterparts. Strategy is key for Latin American companies with the heaviest use of both strategic planning and growth strategy tools. In the Asia-Pacific region, however, Chinese executives are heavy users of cost-management and planning tools of benchmarking, strategic planning, supply chain management, and TQM.

QUALITY MANAGEMENT MOVEMENT

No discussion of the quality management movement would be complete without including Deming's 14 points or Juran's statistical formulations that led to Six Sigma and lean. According to Leadership Institute, Inc. analysts, W. Edward Deming's 14 points provide a philosophical framework for the quality management movement by hypothesizing that efficiency among employees is increased through self- and skill-improvement programs in an employee-morale-boosting work environment. He further identified numerical goals and short-term profits as impediments to sustained productivity, brand reputation, and long-term profits. Deming's plan was originally developed for Japan's automotive sector to make them more globally competitive. The plan emphasized an organizational commitment to a "constancy of purpose" in an ever-changing business environment. He believed that leaders, who can both model and drive quality strategies throughout an organization, are critical to quality success. Deming further emphasizes the benefits of quality by stating, the need for mass inspections can be eliminated by making quality control integral to innovation at every stage of product development (Leadership, 2008).

Joseph M. Juran first articulated his quality principles in 1928 in a pamphlet titled, "Statistical Methods Applied to Manufacturing Problems." Juran's statistical formulations aimed at reducing errors and waste in manufacturing and other business processes. Juran was among the first to stipulate customers' needs as critical to the design and marketing of products and services. He developed the Pareto principle (80-20 rule) which posits that 20%, or the "vital few," provide resources for 80%, or the "useful many." Juran's Six Sigma processes are diagramed by quality experts as a series of steps. The steps include a planning and design phase, an assessment of costs of poor quality and chronic waste phase, a development of improvement strategies phase, followed by new zones of quality control phase. Juran's Quality Control Handbook, published in 1951, remains the gold standard for quality managers today (Bunkley, 2008).

Some quality terms indicate statistical processes, which others have an international significance. Table 2 includes definitions of some of the most frequently used quality terms (isixsigma, 2008).

Conditions for Success

The call for effective quality management is considerably more urgent today than it was a quarter of a century ago. Six Sigma and lean strategies have become embedded in both the public and private sectors. Reports linking lean/Six Sigma hybrids to efficiency and productivity achievements are a source of stimulation for establishing the lean revolution. The chief barrier to Six Sigma success is the failure to promote a continuous improvement mindset throughout an organization. Senior management will have a key supportive role in the process of blending Six Sigma strategies with an organization's unique culture, says Webber of the Hackett Group; piecemeal Six Sigma implementation spells likely failure (i4cp, 2009; Neuhaus & Guarraia, 2008; Six Sigma, 2007). Learning to diversify Six Sigma applications can help leaders gain a broader understanding of the overall workings of an organization and help drive better business results while they gain skill at discerning the relative value of some Six Sigma measurements (Pande, 2008).

Challenges and Barriers

Leaders need to be aware of Six Sigma's sacred cows of elevating processes over people, always accepting the customer's point of view, and assuming there is only one correct solution to a problem or the notion that the key to better decision making is always better data. A critical requirement of successful Six Sigma is to maintain a balanced and flexible approach to such business paradoxes. Managers who face organizational resistance to building a quality culture may first have to demonstrate the value of quality in a contained and controllable project that arrives at measurable quality processes and improvements that can be standardized. Diligence, patience, and sustained enthusiasm are required as it often takes more than one successful event to change an organizational mindset. Six Sigma partnered with lean can save companies billions when applied to finance, IT, procurement and HR shared services, say analysts from the Hackett Group. Taken alone, Six Sigma may be a good strategy for attaining step-by-step improvements, but it is not the best tool when the goal is making broad organizational change (Six Sigma, 2007; Logan, 2008).

Benefits: Productivity and Innovation

While Six Sigma is a methodical, structured process, it can still serve as a vehicle for innovation. The goal in applying the Six Sigma methodology to business processes is to reap the benefits of improvements in efficiencies, reductions of waste, fewer variations and defects and other operational gains. Eichel posits that these gains translate into measurable savings which can be invested in exploring innovative ideas by freeing up employees to channel their expertise, energy, and time to generate new ideas instead of firefighting recurring problems. Firms that use a lean Six Sigma hybrid approach achieve both broad-based innovation and superior financial performance. Hot spots of innovation develop within an organization that can combine the right environment, the right culture, and the right attitude with a point of ignition, according to research from Lynda Gratton of London Business School. While the organization does not direct the emergence of such hot spots, the organization's leaders play a pivotal role in establishing the culture in which the hot spots may be seeded. In addition, taking a diagnostic x-ray assessment of hidden quality issues in advance, beginning with value-stream mapping that identifies processes, costs and inefficiencies, can optimize the results of lean Six Sigma deployment (Eichel, 2008; Neuhaus & Guarraia, 2008; Byrne, Lubowe, & Blitz, 2007; Hay Group, 2007; Vickers, 2007; Mandel, Hamm, & Farrell, 2006; George, 2005).

CONTINUOUS BUSINESS EXCELLENCE: A PROGRESS ENERGY SUCCESS STORY

Electric Utility Industry Challenge

The electric utility industry represents the second most capital-intensive sector in the U.S.A., surpassed only by the railroad industry. Many of the industry's costs stem directly from investments in and maintenance of the power plants, transmission and distribution lines, equipment, and structures that are used to deliver electricity where it is needed (Chupka, et. al., 2009, Cannell, 2009). The U.S. A electric utility industry is facing the greatest challenge in its history. According to Edison Electric Institute, the demand for electric service is increasing, reserve margins are shrinking and input costs to build infrastructure for all types of electricity production are soaring. Global climate change and other enviromnental issues are directing the industry toward greater development and use of energy efficiency products and services and low-emissions supply sources, all of which come with costs (Electric, 2009; About, 2009). Progress Energy is addressing the challenge through a systematic lean initiative.

Progress Energy

Progress Energy (PE), headquartered in Raleigh, North Carolina, U.S.A., is a Fortune 500 energy company with more than 21,000 megawatts of generation capacity and $9 billion in annual revenues. It consists of two high performing electric utilities with strong growth prospects - Progress Energy Carolinas (PEC) in Raleigh, North Carolina, and Progress Energy Florida (PEF) in St. Petersburg, Florida. PEC has 12,400 MW capabilities with 1.4 million customers; PEF has 9,400 MW capacities with 1.7 million customers (Johnson, 2008).

In February, 2009, Progress Energy initiated Continuous Business Excellence: Working together for a stronger future (CBE), described at the beginning of this article. The senior leadership team initiated the systematic lean effort even before the nation's financial crisis hit hard this fall. The CBE effort is to focus the entire organization on achieving sustainable efficiency and productivity gains every year - 3 percent to 5 percent annual improvement. CBE involves such things as streamlining work processes, taking advantage of new technology, and eliminating waste and low-value activities. It is about making structural changes so that PE can free up dollars to reinvest back into maintaining its current facilities, as well as fund the extensive capital projects critical to its future (CBE Update, 2009; Continuous, 2009).

CBE focuses on improvements in efficiency using lean tools. Lean focuses on eliminating waste in any process by establishing a forum for a systematic review of PE work processes. Each task is mapped so the team can evaluate the process in its entirety and identify inefficiencies. Employee involvement is essential, because our employees are the experts in our business processes, says Bill Johnson, Chairman, CEO, and President of PE (Continuous, 2009). According to the senior vice president leading the companywide CBE initiatives, the CBE program will focus on three areas; e.g, targeted lean deployment, business unit activities and projects, and employees ideas. The lead-and-implement charge of the CBE cross-departmental steering committee is to build a common understanding and alignment of CBE across business units; develop and tract metrics for measuring CBE progress; coordinate message communication; and strategically identify future process-improvement opportunities.

CBE in Action - CIAC

CIAC Defined. One of the CBE success stories at PEF is a cross-functional team that applied the lean tools to the contribution in aid of construction (CI AC) area. CIAC is a customer initiated request beyond the standard of service required by the Florida Public Service Commission. The standard of service in Florida is overhead power lines. If a PE residential or commercial customer requests that underground line be installed, the customer would have to pay for the difference in costs. Additionally, if a customer requests to have line lay beyond a maximum distance off of the main line, the customer will pay for the additional line. Per the Florida Public Service Commission Tariff, the PE is permitted to collect payment for these customer-initiated requests in advance of construction as the company is not allowed to terminate electric service for non-payment of this type of non-electric service account. Damage claim accounts are another type of non-electric service account.

Problem Identification. As there is no contract for customer initiated requests until the customer payment is received, the account information is setup at the time of payment receipt. When the payment is received, the Operation Support Assistant (OSA) sets up a non-service account and posts the charges. The payment is then set to Remittance Processing and posted to the account. Theoretically there should be accounts receivable for only the period between charges being posted and remittance being posted, approximately one week. The CIAC portion of non-electric service accounts should be only the accounts credited with the last week and would show up on the balance sheet only at an accounting period close. An unanswered question was the impetus for the CBE application. How can the accounts receivable balance for CIAC be over $4 million for payments that were collected in advance?

Participants. The senior business financial analyst in Regulatory and Property Accounting was selected to lead the CBE process focusing on the accounts receivable balance for CIAC projects. She had both experience and expertise in work process systems. A cross-functional team was established with representatives from each of the affected areas, Accounting, Distribution, Operations, Legal, and Customer Service. Figure 1 - PE Organization Chart identifies each of the functional areas and denotes key players.

Methodology: Continuous Quality Improvement Process. Utilizing an organization development (OD) action research approach (Cummings & Worley, 2009), a continuous quality improvement process (CQI) was implemented. The distinct phases of the OD approach were problem identification, data collection, data analysis, action plan, implementation, and separation. These phases were blended with the continuous quality improvement process into three phases; e.g, Phase 1 : Start Up; Phase 2: Deployment; and Phase 3: Integration. Each of the phases had specific activities and guidance for the activities. Figure 2 - Stages of OD Approach + Continuous Quality Improvement Model, illustrates the blending of the OD approach with the CQI model and identifies the activities involved.

Results. The results of the CBE study can be divided into four categories; e.g., monetary, process, training, and evaluation. The monetary results were significant. The accounts receivable balance for customer-initiated construction requests beyond the standard of service and damage claims decreased from $4 million to under $500,000 in less than five months. Process results produced a detailed documentation of the streamlined CIAC process, which is illustrated in Figure 3: CIAC Process Flow.

Training results consisted of an on-line CIAC process manual. The manual was designed to be a reference for coding and contacts and a step guide for new OSAs. The manual provided 1) a step-by-step process for anyone new to be able to complete the function without in-depth training, 2) a resource to those experienced in the position and as a source for newly-introduced processes; and 3) a reference for needed information. As the manual was in both printed and online format, it could be updated online. Training results also included four regional trainings that required participation of all OSAs and their managers. The training sessions were designed for both issues - identification and resolution, as well as CIAC work process education.

Evaluation results included evaluating all the deliverables. Additionally, after the final training session, a monitoring/tracking process was initiated through system reporting that revealed the substantia] reduction in accounts receivable from $4 million to under $500,000 in less than five months.

Implications for Management

Train in-house Talent. A shortage of executives versed in lean work management strategies suggests that organizations may need to train high-potential in-house talent in order to derive the benefits of lean work management strategies. Qualified candidates for lean management training must have the ability to inspire teamwork, strategic innovation, and a passion about the process. Look for candidates outside the organization's standard profile for continuous training and cross-departmental teamwork.

Change Corporate Culture: Establish a Top Management Support system that is engaged in any redesign efforts, as well as in achieving buy-in for those efforts from the employee population as a whole. Seek support at top management levels to change corporate culture. Implementation of Six Sigma or any other continuous process improvement method enables change by providing communication tools, success stories, software tools and measurement schemes. Senior management will have a key supportive role in the process of blending Six Sigma strategies with an organization's unique culture

Seek Lean Work Management Best Practices. Bone up on best practices. Learn from others' successes, but fine turn your continuous qualify improvement process to your organization's goals, values, and strategic imperatives. Learning to diversify Six Sigma applications can help leaders gain a broader understanding of the overall workings of an organization and help drive better business results while they gain skill at discerning the relative value of some Six Sigma measurements. Set a long-range timeline for achieving results. Celebrate successes in innovation, monetary achievements, process improvements, behavioral changes and development, and cultural changes

Jump-Start the Transformation. Initial efforts include dedicated training time, resources and start-up projects. Once processes and capabilities are established, ensure that the innovation climate endures.

SUMMARY

Economic challenges are forcing organizations to rethink their work processes for both efficiency and quality enhancement. Even though executives are concerned with cost containment, productivity and productivity confidence are reportedly on the rise. The most commonly cited factors for strengthening the confidence are redesign of work process, quality and/or continuous improvement efforts, strong leadership, and employee engagement. Strategies that remove blockages and excesses have become embedded in the public and private sectors.

Subject: Organization development; Business process reengineering; Total quality; Cost reduction; Employee involvement; Electric utilities; Case studies

Company / organization: Name: Progress Energy Inc; NAICS: 221122

Classification: 9130: Experiment/theoretical treatment; 2500: Organizational behavior; 2310: Planning; 5320: Quality control; 8340: Electric, water & gas utilities

Publication title: Journal of Business Case Studies

Volume: 6

Issue: 6

Pages: 7-18

Number of pages: 12

Publication year: 2010

Publication date: Nov/Dec 2010

Year: 2010

Publisher: Clute Institute for Academic Research

Place of publication: Littleton

Country of publication: United States

Publication subject: Business And Economics--Management

ISSN: 1555-3353

Source type: Scholarly Journals

Language of publication: English

Document type: Business Case, Feature

Document feature: Diagrams References Tables

ProQuest document ID: 818691109

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Copyright: Copyright Clute Institute for Academic Research Nov/Dec 2010

Last updated: 2013-09-06

Database: ABI/INFORM Complete

Document 3 of 100

Eight Years After The Fact Is SOX Working? A Look At The Brooke Corporation

Author: Hazels, Beth

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Abstract:

In 2002 the Sarbanes-Oxley Act (SOX) was passed; in addition, federal sentencing guidelines have been revamped and the Securities Exchange Act of 1934 has been brushed off, all in an attempt to codify the ethical behavior of companies, their executives, and their management. The goal was to make companies and employees behave ethically; however, whether that has worked or not is questionable. Many argue that the implementation and ongoing requirements of Sarbanes Oxley and other laws are costly, time consuming, and as yet ineffective. Recent evidence suggests that for some organizations these requirements and the associated punishments are not a sufficient deterrent. In many instances law has at best led to a culture of compliance rather than a culture of integrity. Even more disappointing is that too often the very activities Sarbanes Oxley was designed to prevent continue to slip past regulators until it is too late and the damage incurred. Brooke Corporation is one example where these laws have seemingly failed. With this in mind, this paper will attempt to: 1) provide examples from the Brooke Corporation that demonstrate the evolving culture of compliance vs. one of true integrity, 2) identify areas where the law continues to compete with long-standing corporate culture, 3) discuss those areas where additional work remains for Sarbanes Oxley to achieve its intended impact, and 4) discuss what work remains to be done to make other laws effective. [PUBLICATION ABSTRACT]

Full text:

HISTORY OF THE COMPANY

Brooke Corporation was once one of the largest franchisors of property and casualty insurance in the United States selling insurance and other products through its franchisee locations in Kansas, Oklahoma, California and several other states. In 1996, Brooke adopted a franchise approach to aid in the expansion of its business (Margolies, 2009, January 10).

Brooke Corporation (Brooke), and its subsidiaries, was founded by Robert Orr in 1986. The company began in Phillipsburg Kansas and moved to Overland Park Kansas in 1996 (Dornbrook, 2008, October 10). Robert Orr played a key role in management of the company. He held several key roles in the parent company and its subsidiaries. Most recently he was Director and chief finance officer of Aleritas, and Chairman of the Board and CEO of Brooke Capital and Chairman of the Board at Brooke Corporation. Robert's brother, Leland Orr, was also active in senior management of Brooke. He acted as a director and officer since the inception of Brooke. In addition, Robert Orr's nephew, Mick Lowry was the President of Aleritas.

Brooke Corporation's main business was to sell insurance and related services through franchises (Fidler, 2008, October, 31). This was supported through several subsidiaries and affiliates. Brooke Agency Services LLC (BASC LLC), formerly Brooke Franchise, dealt with the sales of insurance and other products through franchisees (McGraw-Hill Companies, Inc., 2009). Aleritas Capital Corporation (Aleritas), formerly known as Brooke Credit Corporation, provided lending services to franchisees (WorldScope, 2009). Brooke Brokerage sold insurance on a wholesale basis (Margolies, 2009, January 10). Brooke Capital Advisors was an insurance consulting agency providing, among other services, business valuation services to individuals interested in selling their insurance business. Brooke Savings Bank, formerly Generation Bank, provided retail banking services (McGraw-Hill Companies, Inc., 2009). In August 2007, Brooke Capital was approved for listing on the AMEX under BCP. Brooke Corporation itself was listed on the NASDAQ in October 2008 under BXXX (Everitt, 2007).

The financial demise of Brooke Corporation and its' subsidiaries started in 2008 and is continuing as bankruptcy proceedings and the resolution of several lawsuits continue. As the company began to falter it became embroiled in several lawsuits, starting with a lawsuit filed by Bank of New York. As a result of the lawsuits, a downturn in credit markets and other issues Brooke Corporation and Brooke Capital filed for bankruptcy. In October 2008, Brooke Corporation and Brooke Capital filed for Chapter 11 protection while Aleritas avoided bankruptcy (Fidler, 2008, October, 31). By November, 2008 Brooke Investments filed bankruptcy (Fidler, 2008, October, 31). Albert Reiderer was named as Special Master in the lawsuit (Fidler, 2008, October, 31). Attempts were made to save the company, but those attempts failed. Trading of the stock was stopped in October 2008 ("Trading halted," 2007) and Mr. Orr filed personal bankruptcy in December 2008("Brooke Corp. trustee," 2009).

BROOKE - A CULTURE OF COMPLIANCE VERSUS FNTEGRITY

The laws as they exist today create a corporate environment focused on compliance instead of integrity. In her book Cases In Leadership, Ethics and Organizational Integrity (1997) Lynne Sharp Paine states that "organizational factors play a critical role in fostering - or in discouraging - responsible behavior on the job" (Sharp-Paine, p. 89-90). She goes on to say ". . . behavior and values also are shaped by organizational factors such as opportunities, incentives and the example set by others" (Sharp-Paine, p. 90). Brooke's senior management set the example for the culture of the organization. The focus was on making money and not, apparently, on always behaving with integrity.

Two types of ethics strategies exist: compliance oriented or integrity oriented (Sharp-Paine, p. 9 1 and 95). Compliance oriented programs focus on legal compliance. Law defines their ethical standards. These compames "rely on rules, controls and strict discipline to maintain standards" (Sharp-Paine, p. 91). On the other hand, integrity oriented companies focus "on self-governance according to guiding principles" (Sharp-Paine, p. 93). Companies look at ethics as a "set of values to guide rather than just constrain behavior" (Sharp-Paine, p. 93). Companies are not focused just on complying with laws but also with creating an organizational culture that focuses on both being a successful business and on a "set of organizational ideals and responsibilities" and "supporting responsible behavior" (Sharp-Paine, p. 93). It seems apparent, by Brooke's alleged behavior, at most they have focused on compliance with laws and not on creating a culture focusing on integrity.

The business model at Brooke required that all insurance companies pay commissions to Brooke directly and not to the agent. Brooke then withheld any expenses owed by the agent and paid the balance to the agent. However, franchisee agents have complained for several years that Brooke would not send them commission reports from the insurance companies showing the total commissions earned ("ReportBrooke Franchise," 2007). In addition, there were claims that while payments for rent and utilities were withheld from commission checks those payments were not actually made to landlords and utility companies (Dornbrook, 2008, October 24). There are also concerns that Brooke may have left some policyholders without coverage when it held on to premiums instead of sending the payments to insurance compames (Johnson & Dornbrook, 2008, October 24). Additionally, as Brooke faced financial demise it stopped paying commissions to its franchisee agents and stopped paying rent and utilities (Aldridge, 2009). Franchisee agents were often unable to accurately verifying their pay. In addition, when Brooke did not make payments to landlords, utilities, etc. the franchisee agents were required to double pay in order to keep their business running. This often caused financial hardship. Technically Brooke has not violated any ethics laws; however, they are not creating a cultore of integrity.

Several agencies, both federal and state, have investigated Brooke and its activities. In the Fall of 2008 Brooke was being investigated by both the Kansas Insurance Department and the Missouri Department of Insurance. The agencies were investigating the stability of the company and the protection of customers covered by Brooke policies (Kansas Department of Insurance, 2008, Mo. Insurance, 2008). Both agencies were concerned that Brooke's lack of payments to insurance companies on behalf of the franchisee agents left clients exposed and without insurance they had paid for.

In December 2008 the FBI, FDIC and SEC all made requests to study Brooke documents (Dornbrook, 2008, December 19). The FBI in particular was investigating the "finances of bankrupt Brooke Corporation" ("FBI Launches Investigation," 2008). Due to the bankruptcy of Brooke, dozens of lenders have been left holding Brooke's bad loans and securities ("FBI Launches Investigation," 2008). These agencies were concerned with the financial integrity of the company. However, while initial investigations were made, no further inquiries have occurred.

These issues are just a few examples of Brooke's behavior. While it appears, based on several investigations, that Brooke is complying with the law it could be argued that they have not focused on integrity. They seem to have focused more on making money and much less on operating with integrity by running a business that was open, transparent, and fair.

LAW IS COMPETING WITH CORPORATE CULTURE

These laws created to address ethical behavior in compames are butting up against a deep-seeded corporate culture - that of making money. The traditional goal of business has been to make money, to make as much profit as possible. However, the requirements that companies now behave ethically, document their efforts, and provide that information to stakeholders conflicts with those traditional goals. Behaving ethically and making money do not always go hand in hand. Many argue that these laws are too expensive to comply with, are time consuming and some could argue they take the focus away from running a business and put it on compliance with laws. Like many businesses making the news today, Brooke established business practices that focused on making a profit and not necessarily on behaving in an ethical fashion.

Since the adoption of the franchise approach Brooke's general business model has been to generate revenue from franchisee agents. Brooke obtained revenue from its franchisee agents in a number of ways: franchise fees, consulting fees, shares of ongoing revenue and finance charges (Brooke Capital Corp., 2008). The initial franchise fees ranged from $150,000 to $165,000 regardless of whether the franchisee agent was starting a new office, purchasing an existing location, or converting their agency to a Brooke agency. According to company documents, this fee was to provide franchisee agents with the business model, use of the registered trade name, access to the products of insurance company suppliers, access to the advertising center, facility support and processing center, and use of the internet based information system. For franchisee agents starting a new business a Start-Up Assistance program was available at no additional fee (Brooke Capital Corp., 2008). The purchase price of the franchise was based on a multiple of the target agency's renewable commissions. In addition, there was a 10% broker fee included in the sales price. Brooke would then finance 90% with a loan at 3% above prime with a 3% loan origination fee. In addition, most franchisee agents were required to purchase the Buyers Assistance Plan. This was priced at 50% of the previous 12 months of commission.

Brooke subsidiary, Alteritas, provided almost all financing to franchisee agents and other Brooke entities were responsible for valuation and due diligence. Franchisee agents question the level of independence in these transactions and whether proper due diligence was actually performed. Many franchisee agents argue that the ten percent fee paid by the seller is a kickback. More importantly, franchisee agents argue that due to the lack of proper due diligence and valuation services, the purchase prices were incorrectly calculated. Because annual commissions were calculated incorrectly many franchisee agents lost their businesses back to Brooke because the actual sales the agency made were less than promised. That coupled with the overvalued loan made it impossible for the franchise to succeed (Aldridge, 2009).

Once sales of existing agencies slowed, Brooke initiated the Start Up Agency Program. The intention was to add to the franchise network by setting up people in brand new franchise agencies. The concept was sold to potential franchisee agents as a turn-key operation; Brooke would provide an office location, equipment and support staff. In addition, Brooke would provide agents with all necessary insurance company appointments and help them establish customers. Finally, Brooke would provide them with training and advance funds for at least the first six months of operation. The required franchise agreement was similar to the agreement signed by existing agents. The franchise fee was in excess of $150,000. Brooke provided the financing for the franchise fees and operating expense advances as they did for other franchisee agents. However, the franchisee agents argue that services were never provided as promised (Aldridge, 2009).

Brooke provided insurance consulting services to companies or individuals interested in selling their insurance business. For approximately ten percent of the sales price, Brooke provided valuation and other services (Brooke Capital Corp., 2008). One common business practice was for Brooke to purchase a business from a third party and instantly sell that same business to a franchisee agent. The third party was required to pay Brooke a 10% consulting fee. The sales price and purchase price were the same this resulted in a ten percent profit for Brooke which was not disclosed to franchisee agents (Aldridge, 2009).

As part of the Franchise Agreement, Brooke was responsible for accounting for premiums and commissions for franchisee agents. Based on Brooke's business model, insurance companies made all commission payments directly to Brooke, not the franchisee agent. After all commissions earned had been accounted for, deductions were made for outstanding loans, franchise fees and other fees or amounts owed. The remaining balance was then paid to franchisee agents. In addition, Brooke received a monthly franchise fee in the form of a percentage of ongoing revenues for each franchise, usually 15%. An additional share was charged for the optional use of service centers (Brooke Capital Corp., 2008).

Brooke, through Aleritas, loaned cash to franchisee agents to expand or purchase businesses. Brooke then bundled the loans and sold them to lenders. Lenders issued notes to investors, mostly banks. The notes were secured by the income and assets of the franchises. Revenue was "culled" from franchisee agents and placed into trusts that were tapped to pay off the debts (Bank of New York, 2008). This transaction was often done without notice to the franchisee agent.

In August 2008, Brooke entities stopped paying commissions, the primary source of revenue for agents. However, they were still charging franchisee agents for the loans as well as utilities and rent. In October 2008, Special Master Reiderer released the franchisee agents from their Franchise Agreements, but that doesn't clear them from their bank obligations. Some franchisee agents have multiple banks claiming ownership of their loans. In addition, franchisee agents have received eviction notices and had utilities shut off because Brooke has not made payments even though reports show that they did. These franchisee agents have not received the commissions owed to them for several months (Aldridge, 2009).

Brooke was very successful running its business in this fashion. The company was able to bring in funds from a number of sources. However, these business practices were not always beneficial to the franchisee agents. The corporation, as a whole, was quite successful, but often individual franchisee agents struggled to make their businesses successful and pay the required fees to Brooke. Brooke's business practices and actions have caused the financial demise of many franchisees. In addition, some of Brooke's behavior has caused them to become embroiled in several lawsuits.

Several lawsuits have been filed by franchisee agents against Brooke over the past few years with allegations of fraud, embezzlement, etc. Most of the suits relate to the management of funds, business valuations and financing, and repayment of franchisee agent loans ("Suite filed," 2007). BNY, in what appeared to be a foreshadowing of events, predicted correctly when it stated that Brooke faced a revolt from its franchisee agents ("Franchise Terminations," 2008). Dozens of franchisee agents have recently joined together to sue Brooke. Several franchisee agents sued claiming they overpaid for their franchises because the valuations done by Brooke Capital were incorrect ("Suite filed," 2007). In addition, they question the level of independence available when all transactions from valuation through payment were done by Brooke or its subsidiaries ("Suite filed," 2007). Franchisee agents feel that because everything was completed in-house they were not able to verify the accuracy of the numbers or question any of the information provided ("Suite filed," 2007).

In April 2009 dozens of franchisee agents filed a suit against Aleritas involving the sales and financing of franchises (Aldridge, 2009). Many of the issues in this case deal with fairness, independence, and accuracy on Brooke's part. The lawsuit alleged that the company "engaged in fraud and civil racketeering". The suit also accused Alteritas of "inflating the price of agencies sold to franchisee agents, receiving kickbacks from the sellers and setup up a system that benefitted from the failure of franchisees" ("Ex-franchiees sue," 2009). It also alleges that Brooke did not provide all "services and benefits promised" to the franchisee agents ("Ex-franchiees sue," 2009). However, in August 2009 a judge dismissed the lawsuit because the "accusations . . . were vague and did not meet legal standards to allege fraud and racketeering" ("Judge throws out," 2009).

In November 2009, Robert and Leland Orr were banned from the banking industry for the rest of their lives by the Office of Thrift Supervision. They voluntarily agreed to the prohibition "without admitting or denying that grounds existed" ("Feds ban Brooke," 2009). The order accused the brothers of allowing Brooke companies to become overdrawn at Generations Bank (now Aleritas) without collecting fees or interest charges. The agreement does not ban the Office of Thrift Supervision from further action. In addition, the men could be subject to punishment under federal law. In October, 2008 the OTS declared that Generations Bank (Aleritas) "failed to establish adequate internal controls or to comply with laws related to transactions with affiliates, credit underwriting, and maintenance of records." The OTS ordered Brooke to sell Aleritas by December 15, 2008 and provide a list and description of every transaction that occurred after January involving any affiliate insiders or related interests of insiders ("Brooke Insurance agencies," 2008).

The franchisee agents have argued that, in an attempt to make more money, Brooke treated them unfairly and, on occasion, put them in a position of personal financial risk. In addition, the OTS found that Brooke did not comply with laws by establishing proper internal controls. SOX requires internal controls and proper maintenance of records and all of these laws require ethical and honest behavior, buth they have yet to be raised against Brooke.

AREAS WHERE ADDITIONAL WORK REMAINS FOR SARBANES OXLEY TO ACHIEVE ITS INTENDED IMPACT

Laws regarding ethical behavior do not create enough of a deterrent to keep companies and employees from continuing current behavior. To-date, these laws have been ineffective because companies are rarely held accountable by them. Many companies have continued behavior that does not comply with laws and continued to profit greatly from that behavior. Even if companies are held liable the financial penalties are not significant enough to eliminate all profits made. Several allegations have been made regarding Brooke and potential illegal activity, but Brooke has yet to be held accountable for its alleged actions under any of these laws. Table 1 is a summary of the sections addressing ethics in the Sarbanes Oxley Act. Brooke's behavior should be evaluated under these sections.

The implementation of SOX has caused companies to evaluate their ethical behavior to ensure compliance. Several key sections of SOX address requirements for ethical behavior, and documentation of those requirements, by companies and their employees.

Section 302 gives corporate responsibility for financial reports. This Section requires that the "principal executive officer or officers and the principal financial officer or officers, or persons performing similar functions, certify in each annual or quarterly report filed or submitted" that the signing officer reviewed the report, that based on that officer's knowledge, the statements contain no fraudulent or misleading information, that the financial statements and other financial information fairly present all material aspects of the financial conditions and results of operation and that the signing officers have disclosed any fraud, material or not, to auditors and the audit committee. Section 401 addresses disclosures in Periodic Reports. This section requires that Pro Forma statements cannot contain fraudulent statements or omissions of material fact which make the statements misleading. Section 404 establishes rules for annual reporting. It places responsibility on management for "establishing and maintaining an adequate internal control structure and procedures for financial reporting". Section 805 addresses federal sentencing guidelines for obstruction of justice and extensive criminal fraud. The essence of this section is to ensure that the penalties are high enough to discourage violation of the act. In addition, the Act provides for the enhancement of the offense based on cases where "...the destruction, alteration, or fabrication of evidence involves a large amount of evidence, a large number of participants, or is otherwise extensive ... or the offense involved abuse of a special skill or a position of trust" (805(a)(2)). Further guidelines were established to enhance the punishment for a fraud offense that "endangers the solvency or financial security of a substantial number of victims" (805(a)(4)).

Around early to mid 2008 franchisee agents discovered that the loans they had used to finance the purchases of the businesses had been sold, transferred or assigned either all or in portion to third parties without their consent or knowledge even though, under the contracts they signed, consent was required. Until the summer of 2008, franchisee agents continued to receive reports indicating that loan payments were being made to Aleritas. However, it appears that not all the loan payments were being made to the correct parties. These loans are some of the same loans that are at issue in the BNY case (Aldridge, 2009). In September 2008, Aleritas was sued by Bank of New York Mellon for fraud, breach of agreements and misappropriation of funds (Fidler, 2008, October, 31). By October, a Special Master, Mr. Reiderer, was appointed and Trim Creek, an Illinois company, took over 44.3% control of Brooke's stock (WorldScope, 2009).

Brooke bundled the loans it made to franchisee agents and sold them to investors. The investors then hired an indentured trustee, BNY Mellon, to oversee the loans. BNY was responsible for collecting funds and controlling collateral. The collateral for the notes were virtually all of Brooke's assets including loans, other assets, special trust accounts, bank accounts and lock-boxes. Many of the loans included were loans made by Aleritas to insurance agents or agencies. The claim is that Brooke diverted funds from the Trusts into its own accounts through a bank it owns, Brooke Savings Bank, instead of properly funding the accounts and paying back the investors (Bank of New York, 2008).

The process established to collect funds was fairly complicated and was quite advantageous to Brooke. All funds, including commissions, were to be swept on a daily basis to a master account. This account was to be the main repository for all funds. Textron Business Services (TBS) was hired to maintain the asset pools; however, TBS then delegated those responsibilities back to Aleritas and Brooke Capital. In this role both Aleritas and Brooke Capital accumulated information and records regarding the status of Brooke Loans. Aleritas continued to provide financing services to franchisee agents. Brooke Capital continued to provide marketing services to franchisee agents. Through this delegation Brooke Capital and Aleritas were able to manage the reporting of the very assets they were to maintain as collateral (Bank of New York, 2008).

BNY has leveled several allegations against Brooke regarding the handling of of funds to be deposited in the master account. The most serious allegation is that Brooke misappropriated funds by failing to put all funds into the master account and by selling assets without authorization. BNY has also accused Brooke of altering computer systems to "conceal information regarding banks accounts and deposits made" so that it was difficult to find the money (Bank of New York, 2008).

Disbursements were made to investors based on the information provided by Brooke and the funds in the master account. BNY believes that Brooke falsified its financial reports in order to conceal the "misappropriation and misdirection of funds" (Bank of New York, 2008). In addition, BNY believes that Robert Orr directed the actions to alter the financial statements. BNY claims that Mr. Robert Orr directed BASC and Brooke Capital sales teams to continue depositing funds in the wrong accounts. Since the agreement, proceeds from the sales of an agency and insurance commissions have continued to be diverted to an account at Brooke Savings Bank. According to an employee email dated August 26, 2008 this was all done at the direction of Robert Orr (Bank of New York, 2008, Brooke Capital Comments, 2009). However, some of the parties to the lawsuit entered into an agreement. As part ofthat agreement Brooke agreed to pay all funds to the correct accounts.

The latest case involving Brooke was filed in June 2009. Albert Reiderer, the bankruptcy trustee for Brooke, sued to block bankruptcy protection sought by Robert Orr ("Brooke Corp. trustee," 2009). Mr. Orr filed personal bankruptcy in December 2008. As part of the bankruptcy he sought to protect himself from repaying debts he owed to Brooke Corporation, Brooke Capital, and Brooke Investments (Riederer, 2009). The suit alleged that Mr. Orr "transferred $4million from various Brooke accounts to Brooke Holdings. The suit alleges that money that was supposed to be captured on franchisee agent debt was, instead, diverted by Mr. Orr to Brooke Holdings. It appears that Mr. Orr intended the money go to his family. Mr. Riederer claims Mr. Orr did this "at a time when he knew that the Brooke companies would be unable to sustain their business operations for any significant period of time" ("Brooke Corp. trustee," 2009). In addition, the suit alleges that Mr. Orr transferred $14million to cover the debt of franchisee agents in order to hide the true financial condition of the company ("Brooke Corp. trustee," 2009). Finally, the suit alleges that he directed the diversion of another $4 million to cover an overdraft that the Brooke companies had at Generations Bank ("Brooke Corp. trustee," 2009).

The BNY case, and the Orr case show Brooke's failure to comply under Section 302. The BNY case may seem more obvious as one of the allegations clearly made is the case is that Brooke and its senior management knowingly manipulated financial statements. In addition, Mr. Orr could be liable in his own case if he did, indeed, misappropriate funds from the company as he would be signing financial statements knowing that they are false because he has taken funds from the company. In both the BNY case and franchisee agent case there were allegations of fraud. These allegations have been leveled at senior management of Brooke. Therefore, the senior management couldn't comply with the requirements under this section and sign the financial statements because they not only knew of the fraud, but caused it to happen.

Section 404 is where Brooke could most obviously be held liable. SOX requires adequate control structures for financial reporting. The franchisee agent case looks at both the reporting of commissions, payments and loans and the valuation of agencies purchased and sold. If proper financial reporting procedures had been in place neither of these issues could have arisen. The BNY case deals with financial reporting at a higher level as it looks at the manipulations of the actual financial statements. However, like the franchisee agent case, had the proper controls and procedures been in place these issues would never have arisen. The same can be said for the case against Mr. Orr. If proper procedures had been in place he would never have been in a position where he could successfully direct two different fund diversions. In addition, if proper procedures had been in place those diversions would have been caught and reported from internal, not external , sources.

Section 805 of SOX looks to ensure that penalties are severe enough to discourage misbehavior. Here punishment can be enhanced based on the severity of behavior. Looking at the franchisee agent case, Brooke could be facing a number of issues. First, they were in a position of special skill or trust. Franchisee agents relied on Brooke, because there were required to, for everything from business valuation and financing to accounting and support functions. They put themselves in a position of trust because there forced franchisee agents to rely on them so heavily. Second, the actions of Brooke threatened its own solvency and the solvency of its franchisee agents. By not properly completing due diligence or properly valuing businesses Brooke put franchisee agents in positions where they could not succeed. With the failure of so many franchisee agents came the failure of the whole organization.

The BNY case deals with another part of Section 805, the "destructions, alteration, or fabrication" of records. BNY alleges that Brooke manipulated both financial records and computer records. By doing so, Brooke was attempting to hide the money it had misappropriated by making it nearly impossible to figure out where the money had been moved. Because this money was hidden, agencies weren't paid commissions, utilities weren't paid, rent wasn't paid. All of this caused financial failure for several franchisee agents, the victims of this situation.

There are several allegations that Brooke financial statements have been falsified. The BNY case alleges that Brooke and its management falsified records in order to hide the misappropriation of funds owed to BNY. In addition, the trustee suit against Mr. Orr argues that he personally ordered such actions. The BNY case backs this up by saying that Mr. Orr not only knew about the falsification, but "caused and directed" (Bank of New York, 2008) others to commit these acts. However, regardless of how it appears, Brooke and its management have not had SOX raised against them. In all of the suits and investigations SOX has not once been raised.

WHAT WORK REMAINS TO BE DONE WITH OTHER LAWS

In addition to Sarbanes Oxley, several other laws address ethical expectations of compames and their employees, as shown in Table 2.

SECURITIES EXCHANGE ACT OF 1934

The Securities Exchange Act of 1934 contains several sections addressing the ethical behavior of organizations. Section 32 deals with willful violations through false and misleading statements. Under this section any person who "willfully and knowingly makes, or causes to be made, any statement in any application, report, or document required to be filed under this title . . .which statement was false or misleading with respect to any material fact, shall upon conviction" fined up to $5million, put in prison up to 20 years or both. However, when that "person" is a corporation the fine increase to $25 million. Of course, because it is a corporation, no prison time is feasible.

In addition, individuals within a corporation can be held personally liable for their actions. Section 32(a) states that "[a]ny officer, director, employee, or agent of an issuer, or stockholder acting on behalf of such issuer, who willfully violates" the law will pay fines up to $100,000 and spend up to five years in prison. In addition, the Commission could bring a civil action against the individual with a maximum penalty of $10,000.

Section 18 of the Securities Exchange Act of 1934 punishes those who "make false or misleading" statements with regard to a material fact that someone relies on in purchasing or selling a security. Individuals will be liable for the damages caused.

UNITED STATES SENTENCENG COMMISSION

The United States Sentencing Commission (2004) guidelines have recently been revised. Under the new guidelines organizations are scored based on six factors. This score is used by the sentencing court when considering punishment. Four of the factors can increase the punishment rendered and two factors can mitigate the punishment. Those factors that can increase punishment are: involvement or tolerance of criminal activity, prior history of the organization, violations of an order, or obstruction of justice (United States Sentencing Commission, p. 491). The factors that can mitigate punishment are: existence of an effective compliance and ethics program and self-reporting, cooperation, or acceptance of responsibility (p.491). The mere existence of the two mitigating factors is not enough, under the new guidelines, to reduce culpability. "[T]he New Guidelines expressly state that an organization will not be eligible to receive a downward adjustment for having an ECEP if the organization delays reporting an offense and/or if individuals within certain levels of the organization "participated in, condoned or were willfully ignorant of the offense"" (Association of Corporate Counsel, p. 7). The New Guidelines also establish rebuttable presumptions that no ECEP exists if individuals within certain positions at an organization or a small organization "participated in, condoned or [were] willfully ignorant of the offense" (p.7-8).

Under the Securities and Exchange Act of 1934 Brooke, as an organization, and Mr. Orr, individually, are potentially liable. In addition, those officers, directors, employees or agents who committed the acts could also be held liable. Section 32 deals with the corporation and individuals who knowingly cause such misrepresentations to be made. Here, both Brooke and Mr. Orr could be found liable for misrepresentations. Mr. Orr not only knew that the financial statements were being falsified, but he also allegedly ordered that the falsifications be made.

Section 32(a) of the Securities and Exchange Act of 1934 deals with those individuals who actually made the falsifications under somebody's direction. These individuals will be held personally liable if they "willfully" violated the Act. Further investigation will have to be made into the actions of the individuals. However, the August email of one employee demonstrates some unwillingness to participate in these actions. On August 27, 2008 an employee at Aleritas sent an email to several top company executives asking why proceeds from one loan were being sent to an entity that wasn't involved in the loan payoff process. Vice President Mick Lowry responded that misapplication of the proceeds was a confidential and internal matter. He said he was following instructions from Aleritas' CEO.

Under Section 18 arguably there are several instances where Mr. Orr and other members of senior management could be found liable. The stock was sold on an open exchange. Mr. Orr and others made statements regarding the health of the company and signed off on financial statements for the organization that they knew to be false. All of these could easily be used in making purchase or sale decisions for a company's stock.

Federal sentencing guidelines were established to encourage businesses to operate in an ethical manner. In this case, based on the behavior of Brooke and its senior management it seems unlikely that punishment could be mitigated. First, the guidelines indicate that punishment will not be mitigated for individuals within certain levels of the organizations who "participated in, condoned, or were willfully ignorant of the offense". Mr. Orr's actions certainly fit this definition. According to the allegations made, Mr. Orr not only knew of the inappropriate actions being taken, but at least in the case of the misappropriating funds, he directed those actions.

Second, at this point there does not appear to be "self-reporting, cooperation or acceptance of responsibility". Mr. Orr and other management admit to withholding funds from BNY yet they argue they were justified in such actions. As far as the issues with the franchisee agents there has yet to be acceptance of responsibility. Not only that, but to-date, Brooke and its affiliates have hidden behind the arbitration clauses written into franchisee contracts to avoid having to publicly admit wrongdoing.

It could be argued that Brooke and some of its executives have violated the laws of the Securities Exchange Act of 1934 and the Federal Sentencing Guidelines. However, these laws have not been raised against Brooke or any of its executives. These laws as they are enforced today are not enough of a deterrent. A law can only be a deterrent if it is properly and consistently enforced. Until that is done these laws will remain ineffective.

CONCLUSION

Brooke hasn't made big headlines for their potential violation of these laws. As a matter of fact, these laws, though clearly applicable, have not been raised against Brooke or any of its management. Regardless how much media coverage this case has received, the failure of Brooke has had a substantial impact. Several hundred franchisee agents have lost their businesses and livelihoods. Many of the franchisee agents are in financial ruin, having to file for bankruptcy and receiving negative credit reports because Brooke failed to pay rent, utilities, and loans even though franchisee agents had been charged.

What seems more disturbing is that these laws seem to have failed to do what they set out to do. It would be a sad consequence that so many franchisee agents lost their businesses, but it could be vindication had Brooke been found liable under any of these laws. Not only has Brooke not been found liable, but also these laws have not been raised against Brooke. In all the lawsuits and investigations, not one has raised an issue of ethics. It seems hard to imagine that any company or its executives would feel threatened by imprisonment and fines if the law is never enforced. The only hope these laws have of becoming effective is if they are actively enforced against companies and their management.

Biography

Subject: Public Company Accounting Reform & Investor Protection Act 2002-US; Business ethics; Insurance agents & brokers; Compliance; Corporate culture; Case studies

Location: United States--US

Company / organization: Name: Brooke Corp; NAICS: 524210

Classification: 9130: Experiment/theoretical treatment; 4120: Accounting policies & procedures; 4320: Legislation; 2410: Social responsibility; 8200: Insurance Industry; 2500: Organizational behavior; 9190: United States

Publication title: Journal of Business Case Studies

Volume: 6

Issue: 6

Pages: 19-29

Number of pages: 11

Publication year: 2010

Publication date: Nov/Dec 2010

Year: 2010

Publisher: Clute Institute for Academic Research

Place of publication: Littleton

Country of publication: United States

Publication subject: Business And Economics--Management

ISSN: 1555-3353

Source type: Scholarly Journals

Language of publication: English

Document type: Business Case, Feature

Document feature: Tables References

ProQuest document ID: 818384459

Document URL: http://search.proquest.com/docview/818384459?accountid=38610

Copyright: Copyright Clute Institute for Academic Research Nov/Dec 2010

Last updated: 2013-09-06

Database: ABI/INFORM Complete

Document 4 of 100

The Evolution Of The American Brewing Industry

Author: Warner, Alfred G

ProQuest document link

Abstract:

This case provides industry and historical background to firm specific cases in the brewing industry. It also stands alone as an industry evolution case. This case is intended for MBA or upper level undergraduate classes in strategic management. [PUBLICATION ABSTRACT]

Full text:

INTRODUCTION

Beer, if drank with moderation, softens the temper, cheers the spirit and promotes health. " (Thomas Jefferson)

"Let no man thirst for good beer. " (Sam Adams)

Beer has been brewed in the U.S. since the Pilgrims arrived - and it is held that they landed at Plymouth rather than further south because beer was running short on the Mayflower. According to the diary of one passenger: "We could not now take time for further search.. .our victuals being much spent, especially our beer..." (Beer Institute, 2010). Whether this is the case or, as others have it, the landing was motivated by sailors afraid of running out of beer on the homeward voyage, beer mattered. Production in the new colonies was in the form of ales and porters which had traveled with British settlers. Small breweries were operating in major cities well before the Revolutionary War. George Washington, for example, had a strong preference for porter, particularly from Philadelphia brewer Robert Hare (Baron, 1962) and as the epigrams indicate, other founding fathers had an equivalent appreciation. Still, beer was not by any means the most popular alcoholic beverage in the new country: whiskey, cider, and rum all outpaced demand for beer, particularly since brewing ales was an iffy proposition with respect to quality and the product was often sour. Preferences began to change in the 1840 's as a result of new beer styles accompanying German immigration.

Despite the colonial beginnings, the story of beer and brewing in the United States is mostly a German one. Immigration from Germany over the period 1840-80 constituted one of the two massive movements of people from Northern Europe to the United States. The Irish, in the other movement, were driven by the Great Potato Famine, but German immigration was driven mostly by political unrest and the failed revolution of 1848, though economic distress also played a role. Germany, at that time, was a loose confederation of states comprising the Federation, though it was dominated by the Prussians and Austrians militarily and politically. Both were reactionary and resistant to new political ideas spreading from America, France, and England, such as liberty or political freedom. A bitter struggle for control emerged between merchants, tradespeople, and industry on one side and the landowners and military powers on the other. Official repression initiated the emigration to the United States in the early 1840 's.

This reached a head when the French Revolution of 1848 triggered a similar rebellion by liberals in Germany ("liberal" here used in the classical sense, meaning those who espouse limited government and extensive individual political and commercial freedoms). Ultimately, this revolution was suppressed and in the aftermath, which lasted for decades, many of the participants and sympathizers were forced to flee. Many were young, educated or skilled, and reasonably well-to-do (Steiner, 2000). Thus, they were able to go beyond settling at a port of entry (as the Irish immigrants generally did) and push on to the Midwest. The largest centers of German immigration, at this time, included New York City and Baltimore, but also Milwaukee, St. Louis, and Cincinnati (the so-called "German Triangle"). By 1860, over 1.3 million German immigrants had entered the U.S., a number which grew to nearly three million by 1890 ("Germans in America", 2009).

The motivation for clustering together in these cities was to preserve some stability and security in an uncertain new world through continuation of older traditions and habits. In most areas where Germans settled, German bakers, butchers and dry grocers quickly set up shop and social groups, such as the Maennerchor (a singing society) or the Turners (derived from Turnverein; an athletic club), and German language newspapers (St. Louis had seven, at one time) sustained cultural identity. And, of course, a large contributor to both culinary habits and social ventures was the German brewing tradition.

German beers were Bavarian lager-styled; i.e., compared to the ales being brewed in the U.S., they were light, effervescent, lower in alcohol, and because of the fermentation conditions, more reliable in quality. They quickly caught on, not only with the immigrants, but also the larger American population. Breweries sprang up in most northern cities and towns in great numbers. The proliferation had several causes. Brewing was still very labor intensive; therefore, the scale of production was quite small. Also, transportation was not well developed, aside from water routes. Because beer couldn't be shipped long distances without spoiling, this meant that brewers had to be local. Most sold their output within just a few miles of the brewery. Even so, in cities such as Philadelphia and New York, the demand was so high that dozens of brewers could survive. By 1860, Brooklyn alone in New York City had 50 breweries and Philadelphia had near a hundred.

Many brewers, whose firms would later dominate the American market, got their start in Milwaukee during the pre-Civil War period. Jacob Best's brewery, which would later be called Pabst Brewing when his son-in-law, Frederick Pabst, took over the firm), began producing beer in 1844. Joseph Schlitz purchased a share in a brewery begun by August Krug in 1849, and by 1858, the firm was in his name. Miller Brewing began production in 1855 (Ogle, 2006).

A REVOLUTION IN BREWING: 1865-1900

"I am a firm believer in the people. If given the truth, they can be depended upon to meet any national crisis. The great point is to bring them the real facts, and beer. " (Abraham Lincoln)

"Oh, lager beer! It makes good cheer and proves the poor man's worth; It cools the body through and through, and regulates the health. " (Anonymous)

By the end of the Civil War, the U.S. had thousands of breweries operating. Most were very small: even the largest brewers operated plants in the 12,000 barrel (bbl)/year range. Within 30 years, the number of brewers would drop precipitously (see Figure 1), but large producers would be pushing the one million bbl/year scale and overall output increased by about 900%. What happened to the brewing industry was similar to what was occurring in American industry generally. This period of technological revolution, largely driven by the introduction of the steam engine, led to massive changes not only in transportation but also in production (Stack, 2000).

One cause of this shift was the emergence of Midwestern "shipping" brewers. Brewers in Milwaukee, Cincinnati, and St. Louis found that local demand was too small to absorb all the output of their plants so they began to seek new markets for their beer. Best Brewing, for example (as discussed above) was a Milwaukee brewer that had already been supplying the Chicago market. This worked for two reasons: first, access via Lake Michigan was inexpensive and effective. Second, Chicago was growing at a pace that outstripped the ability of home-town brewers to keep pace. Later, in 1871, fire would destroy much of the city's brewing capacity and Best Brewing expanded to fill the shortfall. Still, limitations in transportation technology made this a costly and uncommon approach. Brewers wanting to ship had to overcome not just the intrinsic costs of production but also the added cost of transportation relative to the product of local brewers. Longer distances meant higher costs, hence a less competitive position. In addition, transportation was relatively slow and beer has a limited shelf life. Lacking time and temperature controls, long distance shipping was not feasible.

The growth of the American rail network was one key to the shift. Between 1865 and 1893, over 150,000 miles of new track were laid, connecting major cities with ever larger numbers of smaller towns. The costs of transportation dropped significantly and the radius that could be profitably served by shipping brewers expanded greatly. Even so, in order to take advantage of this, several issues regarding how beer was shipped and marketed had to be resolved. Perhaps the most innovative brewer in this regard was Adolphus Busch.

Busch had married the daughter of Eberhard Anheuser, a very successful St. Louis soap maker who also owned (as part of a debt settlement) the Bavarian Brewery. Anheuser didn't know much about brewing and when the operation came close to failing in 1865, Busch stepped in to purchase a share and to take over operations. Busch was not a brew master but had worked in family breweries in Germany and after moving to St, Louis, had gone into business operating a brewing supply firm so he understood the processes and the inputs well. He soon decided that if he was to save the brewery, he would also have to expand beyond the city. Since the northern brewers had already penetrated the upper Midwest, he chose to target the southwest, including Texas.

Most brewers shipped beer in wooden kegs. As long as the brewer could control distribution through a company saloon, this presented no problems. However, it wasn't unknown for tavern owners to swap out the good beer in a keg with lower quality product while retaining a higher price. Busch recognized this would damage both sales and the firm's reputation, so he chose to fight potential fraud by shipping bottled beer - which required him to develop the first large scale automated bottling line. By 1872, his brewery was processing about 40,000 bottles per day. Subsequent advances such as an automatic bottle washing machine (1884) and the invention of the cork sealed bottle cap (1891) radically increased both use and scale.

Busch was also the first brewer to pasteurize beer. Pasteurization calls for heating the beer (and the bottles) to just below the boiling point to kill bacteria. This improved the longevity of the beer as it shipped and also made production more reliable and consistent. Finally, Busch was the first to use a refrigerated rail car for shipping (1874). These were packed at the ends with ice, but they did keep beer cool on the long trips to the southwest. Shortly, mechanically refrigerated cars would be available. By 1879, Busch had expanded well beyond his original strategy and was shipping beer to every state in the Union as well as Japan, England, France, Germany and to countries in Central and South America (Ogle, 2006).

Shipping brewers quickly adopted these innovations and developed their own such as the depots at major railheads, filled with ice and designed to store beer until it could be distributed locally. Their beers were soon competing effectively with home town brewers. In fact, the reliability and quality of the shipping brewers' products was placing significant pressure on those smaller firms who could compete only by dropping prices. However, the automation of brewing had continued apace and the large brewers had mechanized grain transport, malting towers capable of handling vast quantities of barley at one time, large brew kettles, huge, refrigerated lagering caverns and highly efficient packaging lines. For example, Pabst's bottling lines were so large that the bottle washing machine had 96 spindles, each processing 75,000 bottles per hour. Technological changes like these drove the minimum efficient scale of production in brewing to about 100,000 barrels per year by the 1890's.

Shipping brewers weren't the only firms attaining this size. Firms in large metropolitan areas like New York and Philadelphia were able to adopt most of the production technologies and were among the largest in the country until the 1890's. In 1884, Best Brewing was in a virtual tie with Hell Gate Brewing of Brooklyn at just over 200,000 barrels while the Bergner and Engle Brewery of Philadelphia and Schlitz Brewing were just behind them. Anheuser-Busch produced 141, 000 barrels that year. On the other hand, the number of breweries had dropped to roughly 2200, of which half produced less than 1,000 barrels and three-quarters less than 4,000 barrels per year (Stack, 2000). The cost of production differences were growing.

Supply problems and shifts in customer preferences also affected how beer was made in this era, with effects that persist today. The growth of industry output (per capita consumption increased from 3.4 gallons to 15 gallons over the 1865-95 period) and poor harvesting conditions had placed pressure on the use of six-row barley, the American standard. Moreover, consumers were seeking lighter and lighter beers. Six -row barley was high in protein and the lighter the color of the beer, the more likely unattractive globs of the protein or haze would be evident. Thus, American brewers began searching for adjuncts or replacement starches that could be brought into the brewing process. Yellow corn didn't work as the oils turned the brew rancid. It turned out that rice and white corn would work, but adding them was costly - but the changes in consumer tastes helped overcome the differential.

The lager beer introduced by German immigrants was called the Bavarian style to contrast it with a more recently developed (1840's) Bohemian lager. Inasmuch that Bavarian style beer had caught on in the U.S. because of its comparative lightness, Bohemian beer was even lighter and more effervescent. Original versions were brewed in the city of PiIs (hence the name Pilsner) and the style won international acclaim at the Vienna International Exposition of 1873. American brewers began experimenting to try and replicate the style with domestic ingrethents and it was found that a very acceptable version could be created with the use of white corn and rice as adjuncts - and sold for a premium price.

The most famous of these beers was the product of a partnership between Adolphus Busch and an importer named Carl Conrad. Conrad wanted a beer that would be distinctive in an increasingly crowded field and he wanted it to taste like a beer both he and Busch had tried before, from a small town called Budweis where the brew was called "the beer of kings". Although Busch ended up using American grains (including rice) he also specified distinctively flavored Saaz hops and a particular yeast from Bohemia. Busch also lined the aging vats with beechwood strips to capture yeast and impurities and make a cleaner beer (Ogle, 2006).

Budweiser was immediately successful. Conrad sold 250,000 bottles in 1876, the first year of production. From 1876 to 1882, 20 million bottles were sold. Competitors paid attention and Conrad and Busch fought a number of legal actions against brewers both large and small who sold beer under the Budweiser name, including Miller Brewing. (Anheuser-Busch ended up pursuing similar litigation until the 1970s: a small Pennsylvania brewer named Dubois Brewery produced Dubois Budweiser until 1972 (Grace, 2005)). Partially, competitors construed the Budweiser name as a style (the way Pilsner is in the style of PiIs) but there was no doubt that many were riding the coattails of Busch's success. Conrad eventually went bankrupt and sold the rights to the Budweiser label back to Busch in 1883 in settlement of debts.

By the late 1890s, the brewing industry was composed of a decreasing number of small, independent breweries, some middle tier breweries owned as investments by outside groups (the British were particularly prevalent in this) and the large shipping breweries, Pabst (formerly known as Best Brewing), Anheuser-Busch, and Schlitz were far and away the largest American firms and were, in fact, the three largest breweries in the world and Pabst was nearing the one million barrel per year output level.

THE "NOBLE EXPERIMENT" OF PROHIBITION: 1900-1932

"Prohibition makes you want to cry into your beer and denies you the beer to cry into. " (Don Marquis)

"I believe this would be a good time for a beer. " (Franklin Delano Roosevelt at the signing of the 21st Amendment)

Prohibition as the law of the land in the United States lasted from the implementation of the 16th amendment on Jan 16, 1920 until President Roosevelt signed off on revisions to the Volstead Act (the enforcement mechanism for Prohibition) on Mar 23, 1933. However, the factors driving Prohibition had been at work for decades and well before 1920 many states, counties, and cities had already implemented restrictions on alcohol sales and consumption. Nor did the desire to restrict or control alcohol end with the repeal of the 16th Amendment: even today, social attitudes toward alcoholism, drunk-driving, and the like have been characterized as "neo-Prohibition".

Until the 1840's, beer played little role in U.S. alcohol production or consumption for several reasons. Beer production wasn't suitable everywhere: for example, the climate in the southern states was too warm so beer was not an important beverage. In addition, even in the North, the labor needed to produce beer inputs like barley was deemed better used in more substantial food crops. Settlers often planted low maintenance apple and pear trees as the necessary inputs to (hard) cider and perry (the pear based equivalent of cider) as alternatives. Another factor was that molasses from the Caribbean was easily converted to rum. Finally, after the Revolution and the westward expansion into the Ohio Valley area, over-production of grains like corn and rye made distilling whiskey very feasible. In short, America of the early 19th century was a hard-drink (and hard drinking) society: "Americans' appetite for spirits stupefied and astounded foreigners. "I am sure", wrote an English visitor, "the American can fix nothing without a drink. If you meet, you drink; if you part, you drink. . .they quarrel in their drink, and they make it up with a drink"" (Ogle, 2006, p. 23). Put differently, in the early part of the century, there were about 200 ale brewers but over 14,000 distillers.

In the 1820s, the so called Second Great Awakening, a broad based religious movement, focused attention on a number of social ills, including drinking. Alcohol consumption was argued to lead to murder, prostitution, and gambling, to destroy marriages and families, and to crush initiative and ambition. Drink was positioned as a threat to the future of the country. This was a very effective platform as millions pledged abstinence from alcohol and a number of states and territories (Maine and Vermont leading the way) passed legislation to make it the rule for all. Still, the initial impetus for ending drink foundered on a number of factors. First, one of the other major social issues in this movement was abolition or the end of slavery. This assumed increasing prominence in the national discourse and ultimately diverted much energy from the temperance drive. Second, the passage of such draconian liquor laws spawned violent resistance with lethal riots occurring in Chicago and New York. There was the sense that the antialcohol movement had gone too far, too fast. Third, the massive immigration of Germans in the 1840's and '50s and the subsequent emergence of the German brewing tradition here was a direct repudiation to the more lurid claims of the temperance advocates. Germans brewed and drank beer copiously and yet were industrious and responsible, good citizens and good family people. Beer advocates argued this was because lager beer was not intoxicating (i.e., not alcohol in the sense the temperance people meant) and was in fact a wholesome and invigorating beverage. Finally, the Federal government had been applying excise taxes on alcohol sales and beer provided significant support to budget and expenditures.

The second round of the Temperance movement began roughly in the 1880's. Again, the drivers were social issues but now were arising from the increasingly rapid pace of industrialization and urbanization of American society. These were accompanied by increased poverty, deplorable working conditions, over-crowding in apartments and tenements, exploitation of workers, and overall corruption. Reformers of all sorts were motivated to attack these problems (such as child labor, food and water purity, truth in advertising, public health, a minimum wage, or the ends of patronage based political jobs); a number of groups such as the Women's Christian Temperance Union and the Anti-Saloon League (ASL) emerged to combat drink which was viewed as exacerbating the other problems. In particular, the tactics of the ASL were effective in tipping the argument toward prohibition. The ASL didn't focus so much on banning alcohol as much as cleaning up towns by eliminating the outlet. By positioning the saloon as iniquitous and a source of disease and depravity, the ASL made it difficult to publicly support drinking establishments. This, and other efforts focusing on local choice and electing anti-alcohol politicians, was effective: by 1909, about half the U.S. was under some form of dry or prohibition law. This was particularly important for brewers because they typically owned or operated the saloons and because beer consumption had soared while stronger liquor drinking had declined. Now, rather than being the healthful alternative to whiskey, beer was the target.

At the end of the Prohibition drive, World War I and anti-German sentiment became an organizing focus. To begin, the war imposed some production problems and the use of barley for beer rather than bread was portrayed as unpatriotic. In addition, most brewers were of German extraction. Supporting beer, by implication, supported Germans and Germany. A former lieutenant governor of Wisconsin (home of most of the largest American brewers at the time), John Strange, claimed that "the worst of all out German enemies, the most treacherous, the most menacing, are Pabst, Schlitz, Blatz and Miller" (Ogle, 2006, p. 173). Members of the Busch family (owners of Anheuser-Busch) were described as enemy agents and spies. Brewers were also accused of purchasing and using newspapers to spread propaganda for the Germans. None of these accusations could stick, but they did color the conversation. In early 1919, the last state required for ratification of the 16th Amendment passed the bill. With respect to the industry, the law was only adding insult to injury as the temperance pressures and changes in local laws had reduced the number of brewers to near 500.

Many brewers survived by turning to related businesses such as baking yeasts or malt syrup. Almost all produced some form of near beer (about 1/2 % alcohol content). Some produced soft drinks (both Anheuser-Busch and Pabst were in this business) or dairy products (Pabst again, for example, but also the Yuengling family which actually stayed in the ice-cream business until 1985). Most also sold off other assets such as real estate. Still, this usually was not enough to keep the doors open. By the end of Prohibition, fewer than 200 brewers were still functioning firms.

In 1928, as he prepared to run for the Presidency, Herbert Hoover called Prohibition a "noble experiment" but even then, it was creating difficulties and backlash. The primary reason was that making alcohol illegal had created a new, lucrative, and dangerous criminal class which smuggled alcohol in from Canada, particularly across Lake Erie, and from the Caribbean. Most of this was hard alcohol (beer being too low in alcohol by volume to be really profitable). Speakeasies or illegal saloons sprang up and not all were hidden. Illegal distilling in the Appalachians increased dramatically. The perceived flagrant disregard for the law was due in part to a notably understaffed enforcement agency, the Prohibition Bureau, which never had more than 3,000 agents. An additional blow to Prohibition came with the Great Depression and the affiliated unemployment. The Federal government had long since switched revenue streams from excise taxes on alcohol to income tax but the radical increase in unemployment meant that new revenue streams would be essential. By the early 1930's, the Democratic Party had made repeal part of its platform and Roosevelt carried through on this almost immediately upon taking office.

Even so, this was not a return to business as it had been practiced. Among the most significant regulatory changes was the termination of the "tied house" or brewer owned tavern. The Federal Alcohol Administration Act of 1935 established the three tier system of brewer, distributor, and retailer that we see today. More important, though, were the changes in taste and technology that had taken place in American society.

Nor did social concerns that led to Prohibition disappear although the approach has changed. The emphasis over the past several decades has been on controlling consumption ("responsible drinking") rather than completely eliminating it. This has come from public and private institutions that study alcoholism (a term that only since Prohibition has entered the lexicon) and have developed programs to control it. Other private groups have taken on drinking as well, such as Mothers Against Drunk Driving or the National Parent-Teacher Association. The effect has been realized in federal legislative changes that increased the legal drinking age to 21 in 1984 (the U.S. is very nearly alone in this: virtually all countries have established 18 as the minimum legal age (Hanson, 2009)), reduced the maximum allowable blood alcohol content level to .08% in 1998, and limited tax deductions for alcohol at meals. As baby boomers age, values have changed as well. Alcohol consumption during working hours is almost universally frowned upon, and the pursuit of healthy lifestyles has reduced alcohol consumption. In a very real sense, Prohibition was just a specific phase in an ongoing American conversation about personal rights and obligations and the nature of the moral life.

THE NEW AMERICAN BREWING COMPETITIVE LANDSCAPE: 1933-1990

In 1933, the year the Volstead Act was repealed and beer could be legally produced again, the number of brewers was around 200 though by year end had risen to a little over 300. Just one year later, though, over 750 brewers were in business and the total hit a peak in 1935 at 766 that wasn't exceeded until the 1990s. In fact, until the 90's, the population of brewers declined every year (McGahan, 1991).

The reasons for the initial surge in numbers are straightforward. Immediately, orders exceeded capacity for many brewers because it took time to ramp up from alternative projects (such as producing soft drinks or ice cream). This opened opportunities for new local brewers to enter. In addition, there seems to have been quite a few unscrupulous (or incredibly under-qualified) owners called "Wall Street" brewers who had snapped up assets of failed breweries at minimal cost. Once production was legal, they quickly solicited investment and started brewing. However, their lack of skills made for some very bad if not dangerous brew (Ogle, 2006).

After 1935, the brewery population dropped quickly. The post-Prohibition environment was very different from that of the years just before the Amendment was passed and these factors drove decades of consolidation.

One reason was that Prohibition had, in fact, been successful in terms of changing Americans' consumption patterns. Per capita beer consumption dropped from a high of about 21 gallons per person per year in 1914 to less than nine in 1933. Nor was demand likely to increase much soon: soft drinks had emerged as a strong substitute and consumer preferences for them stayed strong. Moreover, even though there was no Federal law prohibiting beer, local prohibition laws were widely implemented, particularly in the South. By some estimates, per capita consumption of beer didn't reach pre-Prohibition highs until the 1970's. In the short term, the brewing industry faced excess capacity problems which placed enormous cost pressures on inefficient brewers.

Other changes in consumption patterns also affected brewer survival. Prior to Prohibition, most consumption had taken place in taverns and saloons so the packaging was typically in wooden kegs. In the 1930's, the bias against saloons that had been a driver of Prohibition persisted, and consumers had switched to preferring to drink at home. In part, this was made possible because of two technological advances. First, mechanical refrigeration had penetrated the market rapidly. Prior to 1920, less than 1% of U.S. homes had a refrigerator but by 1933, that number had grown to 25%. Second, advances in packaging, particularly the development of the steel beer can (in 1935 and introduced by Krueger Brewing) helped amplify the home consumption trend. Small brewers often had difficulty with the capital cost of building canning lines and so faced significant demand constraints.

These forces (slack local demand and the control of packaging technology like can, bottle, or steel kegging lines) led to the increased prominence of "shipping" brewers. Larger brewers such as Schlitz, Anheuser-Busch, Pabst, and others had been shipping beer for decades but the development of a motorized delivery trucks, better roads, and large scale refrigerated storage facilities - and changes in the legal rights of brewers to forward integrate - changed how distribution was done. Just as the development of rail had expanded potential markets, new trucks and roads vastly expanded the serviceable area for brewers as they had previously been constrained to sites on the rail system. In addition, trucks and roads decreased the cost of distribution. Brewers also began to build up networks of distributors (the new rules of the game prevented ownership of retail outlets for brewers so distributors became the most cost effective way to reach them) in an expanding, regional way. The changes in packaging complemented these moves as canned beer and steel kegs were much more cost effective to ship. Shipping brewers were still almost always Midwestern firms as brewers in the East and in California usually had large enough metropolitan areas to support their businesses without reaching out.

Still, shipping over distance created costs for brewers that local brewers didn't incur. Shippers addressed these cost differentials in several ways. One was through continued improvement in production and packaging technologies. The minimum efficient scale (MES) for brewers had reached 100,000 barrels per year by 1877 but had not increased by the 1930's (McGahan, 1991). Nonetheless, in-line improvements had increased the cost penalty for not being at scale. These improvements included deployment of refrigeration and recycling technologies that produced a more consistent beer and reduced the need for post-brewing pressurization processes. Thus, technologically advanced shipping brewers could overcome part of the cost penalty of transportation through production efficiencies. Another tactic was to embrace the cost difference and charge a higher price. Shipping brewers preferred to do this because the consistency of their beers made them a premium product versus the more irregular quality local brews, called popular beers. Also, large brewers were wary of being too aggressive with pricing and driving local brewers out of business since one of the motivations for the repeal of Prohibition was increased employment. Aggressively driving local brewers out of business might have had adverse political consequences.

By the end of World War II, per capita consumption had increased by about 50% to 19 gallons in part because distilling had been severely curtailed during the war and beer drinking picked up as a substitute. Shipping brewers had augmented their strategy by opening up satellite breweries either through acquisition (preferred because it also provided access to the target brewer's distribution network) or new plant development. This became possible because the advances in brewing technology assured that local differences in water wouldn't adversely affect the taste of the beer. By 1946, firms such as Pabst, Schlitz and Anheuser-Busch had expanded into the New York metropolitan area with secondary breweries. Yet, after the war, beer demand leveled off then declined for the next fifteen years due in part to the resurgence of distilled spirits (per capita consumption increased significantly) but more importantly from demographic shifts. Beer was primarily consumed by younger men (20-40 years) and the size of this group was sliding toward a historic low (Ogle, 2006). Between these changes and the expansion and better utilization of existing facilities (not to mention an increase in MES to about one million barrels per year), the industry was again faced with surplus capacity. This led to price wars that drove additional geographic expansion (into Western markets and Florida), exit and consolidation. The concentration for the top five brewers increased from 21% in 1947 to about 31% in 1958 and the top brewers were now established as national firms (McGahan, 1991). Table 1 illustrates the dramatic changes in industry concentration up through 2005.

The increasing concentration trend persisted into the 1970's, but for somewhat different reasons than before. Since the 1950's, brewers had been converging toward a standard style American lager beer that deemphasized hoppiness and malt flavors in response to general shifts in American tastes toward a blander diet (Choi and Stack, 2005). Miller Brewing, for example, benefitted greatly from this as the Miller High Life recipe was right in line with these emerging preferences. On the other hand, as brews came to taste more and more alike (due both to convergence and improvements in processing that even smaller brewers could attain), the value of a premium label began to disappear and the industry saw a temporary resurgence of the mid-tier brewers who were able to gain ground by holding to a lower price point. Larger brewers responded by significantly increasing marketing expenditures, following the Procter and Gamble path of market and customer segmentation. Brewers bought or sponsored sports teams and events, explored advertising in established media (such as magazines and radio) and television. Miller, in resurrecting the High Life label, focused on women's magazines such as McCalls and Vogue. The ratio of expenditures to sales shot up rapidly: from less than 1% around WWII to 6-10% as a percentage of sales by the 1970s. National brands in all sorts of consumer goods were gaining power and this kept an almost unsustainable pressure on small brewers to keep up.

Some responded by merging with other firms to attain scale benefits. Alternatively, and in the usual 1950s and '60s way, many brewers merged with or acquired unrelated partners. For example, some brewers purchased olive oil producers, or a parts manufacturer for computers, or mining companies or fishing fleets. Still, most deals were within the industry and this process reduced the number of brewers. The most well known acquisition of the period was that of Miller Brewing by W. R. Grace, a very large conglomerate in 1966.

Just a few years later, Grace sold Miller to Philip Morris (PM). The marketing moves introduced by the PM management team significantly changed competition in the brewing industry in the 70 's. First, PM greatly increased national advertising for Miller and improved Miller's sales dramatically. Then, PM issued in the period of rapid product line extensions. Until then, brewers had generally focused on one or two beer labels. Demographic and taste changes were about to alter this. Americans were becoming more health and weight conscious and the brewing industry responded. Rheingold Brewing had introduced a new style "light" beer called Gablingers but the product flopped. Miller followed up by introducing Miller Lite in 1975 and with it the largest ad campaign in the history of the industry (Mittelman, 2008). The success of Lite eventually drove other brewers to introduce competitive labels and some also developed super-premium beers such as Michelob or Lowenbrau. The Miller management envisioned overtaking Anheuser as the nation's top brewer and in fact, Miller did grow substantially, but this was in large part by taking share away from former leaders such as Schlitz and Pabst.

The final major shift in the industry at this time was the emergence of Adolph Coors Brewing as a major player. Coors had been brewing since the 1870's in Colorado and by the standards of other brewers was something of an oddity in its degree of vertical integration and its brewing process. Coors produced only one beer and used "cold-filtering" rather than pasteurization to improve product life. However, this required strict control over temperatures (near freezing throughout) and therefore distribution (eleven states in the West). Coors' production methods intersected the drive toward the "real and sincere" movement in personal consumption (see below in Craft Brewing for a more detailed explanation) and Coors suddenly became famous as a "pure" (as in the spring water) beer. According to Maureen Ogle, some advocates went so far as to claim that Coors was "the Chateau Haut-Brion of American beers" (Ogle, 2006, p. 274). Sales rocketed and Coors moved from 12th largest brewer to fourth by the early 70's and third by 1980.

GLOBAL CONSOLIDATION VERSUS THE RISE OF THE SMALL BREWERS: 1990-2010

The last two decades have seen two disparate trends in place. On one hand, brewing is increasingly controlled by a small number of global firms, most recently reflected in the acquisition of Anheuser-Busch by InBev. Table 1 shows the changes in market control among the top ten brewers between 1950 and 2005. The period has also seen a remarkable shift in the U.S. industry with the emergence of micro or craft brewers which have come to be the most discussed (albeit still small) segment of the industry.

Up until 2004, A-B was the largest brewer by volume in the world in an industry characterized by fragmentation and national brand champions. On a global level in 1996, the top four brewers controlled just 20% of the market. Contrast this with soft drinks (78%), household goods (75%) or tobacco (60%). The real concentration in the brewing industry emerged at the national level where share controlled by the top three brewers in mature economies was generally in the 70% and up range (Benson-Armer, Leibowitz, and Ramachandran, 1999). Exceptions to this included Germany and China, where local preference persists (which is why SABMiller operates 64 breweries in China). However, these mature markets were slow to no growth markets. In the U.S., for example, growth had flattened since 1980 (see Figure 2). Increasingly, the opportunities for growth were perceived to be Asia (particularly China), Latin America, and Russia. This was occurring for several reasons.

First, these markets were not traditionally beer drinking cultures but increasing affluence had begun to alter this. Growth in Asian markets, for example, had been 6-10% over the 90's with no real reason to expect a change. Second, steep reductions in tariffs as a result of trade liberalization had made the price of imported goods much more competitive with domestic products. Third, customer preferences in beer were converging in ways that favored lagers and canning over ales and bottling. Finally, global brands were taking hold. This led to an initial race from the mid-90's to snap up domestic brewers and build brand through them.

Major players in this strategy included Heineken, South African Brewing, Interbrew, AmBev, and Fosters. Heineken, for example, expanded through Eastern Europe after the fall of the Soviet Union, picking controlling interest in breweries such as Krusovice and Zywiec in Poland, BBAG in Austria, Volga Brewery, Shikhan Brewery, and Patra Brewing in Russia and many others. The company had also purchased or taken stakes in breweries in Costa Rica, Panama, Nicaragua, and Chile as well as Middle Eastern breweries in Lebanon and Egypt. Heineken also purchased the leading Spanish brewer Cruzcampo from Diageo (the firm formed from the merger of Guinness and Grand Metropolitan in 1997). The company has also established a significant presence in Asia with breweries in China, Vietnam, Malaysia, New Zealand, among others (Dow Jones, 2004; Dow Jones, 2005; Devaney, 1998; DowJones, 2003; Ragahvan and Johnson, 1999). For a partial list of Heineken brands (see Table 2).

South African Brewing (SAB) focused initially on penetrating markets in Africa and Asia. This move began in the early 1970s after consolidating most of the brewing industry in South Africa. Initially, SAB acquired contrai of brewers in nearby countries in southern Africa such as Swaziland, Botswana, and Lesotho. In 1993, SAB made its first foray into Eastern Europe, acquiring the Hungarian brewer Drehar. The firm followed this with acquisitions in Poland, the Czech Republic, Romania, Slovakia, and Russia over the next five years. SAB also developed joint ventures in China and acquired the Foster brand and facilities in India in 2006 (SAB Miller, 2009). For a partial list of SAB brands (see Table 1 ).

Similarly, in this period, Interbrew of Belgium focused on developing a portfolio of specialty and regional beers such as Stella Artois, Hoegaarden, Labatt's, Rolling Rock, and nearly 200 other labels (du Bois, 1996). For a partial list of AB InBev's brands (see Table 2).

In contrast, American brewers made relatively small moves in these directions. In 1993, A-B purchased an 1 8% stake in Grupo Modelo, brewer of Corona that was ultimately expanded to about 50%. Modelo has been selling Budweiser in Mexico since the late 1980's and that relationship was expected to continue (Gibson, 1993). Also, in 1995, the company purchased control of Budweiser Wuhan in China. Miller Brewing, a division of Philip Morris, acquired a 20% stake in Molson Breweries in 1993. More decisively, Adolph Coors Co. purchased the English brewer Carling from Interbrew in 2001 for $1.7 billion. The product line included Carling as the top selling beer in England and three other brands which amounted to a 19% market share, second highest in the U.K., and four breweries (RealBeer, 2001). In 2004, Anheuser-Busch made its most substantial move by acquiring Harbin Brewery Group to complement its Wuhan operations.

In the second phase of consolidation, global brewers began to focus on deals between peers rather than penetration into new markets through acquisition of smaller brewers. The first move was by South African Breweries (SAB) when it purchased Miller Brewing from Philip Morris for about $5 billion in 2002. The move was driven by the need to develop revenues in US dollars versus the depreciating South African rand and to gain access to Miller's American distribution network, which would help the growth of SAB's recent purchase of Pilsner Urquell. The deal vaulted the newly named SABMiller into the global number two position in terms of annual volume, behind Anheuser-Busch. Two year later, Belgium's Interbrew and Brazil's AmBev announced plans to merge operations. This deal between the third and fifth largest brewers in the world would move them to number one in total brewing volume, displacing Anheuser-Busch. The new merged firm became known as InBev (Samor and Bilefsky, 2004).

Also in 2004, Adolph Coors Co. and Molson Brewing of Canada initiated merger discussions. The firms had been cooperating in cross marketing since 1998 but major differences in control over their respective markets (Molson was the largest Canadian brewer and controlled about 40% of the market while Coors was a distant third in the U.S. market with 11% share) led to a protracted battle among Molson shareholders. Moreover, since this was positioned as a merger of equals with no premium to Molson shareholders, Molson's institutional investors broadly opposed the deal, one investor arguing that while this made the new firm larger, on a global scale it wasn't large enough. Many supported a potential counter bid from Ian Molson, a disaffected family member and major share holder. The dispute dragged on until February, 2005 when shareholders finally approved the merger. Throughout this, SABMiller had been engaged in discussions with Ian Molson and late in the process sparked rumors that it was going to offer a counterbid of its own (Berman and Frank, 2004; Chipello and Frank, 2004; Frank, Lawton, and Chipello, 2005; Carter, 2005; Chipello and Lawton, 2005).

Two years later, SABMiller and Molson Coors reached an accord on a joint venture for the United States and Puerto Rico called MillerCoors. This venture would push combined share for the firms to about 30% and annual revenues to $6.6 billion. Deal benefits were predicated on combining the geographically complementary systems of the two firms to achieve economies in brewing, distribution, and transportation that were estimated to reach $500 million per year (Philips, 2007; Kesmodel and Ball, 2007).

In the most recent (and largest) move, InBev's bid for A-B broke on June 12, 2009, with an offer of $65 per share or a premium of 35% to Anheuser-Busch' s 30 day stock price average. The motivations included access to distribution in the U.S. for InBev and negotiating power over inputs. InBev was very strong in Europe and Latin America but marginal in North America and Anheuser-Busch was just the opposite. Both had operations in China. InBev's CEO Carlo Brito argues that the new firm could also gain some restructuring benefits through selling off theme parks and division that makes cans and bottles. Another possibility was reduction in advertising and marketing. Anheuser-Busch spends about $500 million in ads and $300 million in sport sponsorship per year though some analysts argue that in a flat market, this move could also trim sales. On the other hand, A-B' s brewery operations were already the most efficient in the industry and the lack of market overlap made economies of scope through joint transportation or production difficult. Nor was restructuring benefits through closing plants perceived as feasible (Economist, 2008a, 2008b, 2008c); Foust, Ewing, and Smith, 2008; Kesmodel and Kamitsching, 2008; Vranica and Kang, 2008).

Initially, this bid met with a great deal of resistance from the Busch family members on the board, St. Louis and Missouri politicians, and from "patriotic beer lovers" (Economist, 2008c) manifesting protectionist concerns. A-B' s executives described the bid as undervalued and proposed as an alternative, stock price strengthening moves such as selling the theme parks and the bottling/canning business for a combined $4.5 billion as well as implementing cost cutting measures that could save $750 million to $1 billion per year (Kesmodel, Kamitsching, and Cimilluca, 2008). A-B also tried to purchase the portion of Mexican brewer Modelo that it didn't already own (about 50%) as this could have made the firm too large to swallow. However, this plan fell through and in mid- July, InBev sweetened the deal to $70 per share or $52 billion. The A-B board capitulated. By November, 2008 shareholders from both firms had approved the deal and United States Department of Justice had also granted approval.

InBev moved quickly to create a new cost-conscious environment in St. Louis. Anheuser-Busch had been long known as one of the best employers in the area. For example, employees typically received two cases of beer per month, the firm lavished tickets to the baseball Cardinals across the firm, and executives were accustomed to first class travel and accommodations. Now, even before the deal had completely closed, 1 ,400 employees (about 6% of the workforce) were laid off. By January, 2009, it had suspended retiree life insurance and plans to stop contributions to company pension plans by 2012. InBev put the fleet of A-B corporate jets on the market, slashed planned marketing expenditures for the Vancouver and London Olympics, and reduced new ad development significantly. In addition, InBev has changed the relationship with vendors by extending the terms on accounts payable to 120 days from 60 or fewer (Kesmodel and Vranica, 2009; Dalton, 2009).

CRAFT BREWING GROWTH

"Nothing quenches the thirst like a Wheat Beer, or sharpens the appetite like an India Pale Ale. Nothing goes as well with seafood as a Dry Porter or Stout, or accompanies chocolate like an Imperial Stout. Nothing soothes like a Barley Wine. These are just a few of the specialty styles of beer. " (Michael Jackson, the Beer Hunter, 1942-2007)

Small scale brewing in the United State is often described as "micro-brewing" but that term has some quite specific scale connotations and "craft brewing" is a more general term. According to the Brewers' Association, craft brewers can be defined as those who focus on traditional styles or beer (such as an all-malt flagship beer), are independent (less than 25% equity controlled by an alcoholic beverage industry firm that is not already a craft brewer) and are relatively small (less than 2 million bbl per year production) (Brewers Association, 2009a). From a scale perspective, the industry exhibits five or six segments. Microbrewers are firms that produce less than 15,000 barrels per year. Brewpubs are also small and sell at least 25% of the beer they produce on site (usually through a restaurant/ pub environment). Regional brewers are those that produce between 15,000 and 2 million bbl per year. These can be either craft brewers (like Sierra Nevada or Boulevard Brewing of Kansas City) or standard lager brewers. Large (also called national) breweries are those with over two million barrels of production per year. Finally, a contract brewer is a firm that hires another to brew for it, either on a complete basis or as a supplement to existing production facilities (Market Segments, 2009). The growth of craft brewing in the U.S. has been remarkable. In the mid 1980's, the number of breweries in the country reached an all time low (41 firms running 89 breweries) with the industry being divided into two sets: national brewers (some successful, some failing) and regional brewers, almost all of which were increasingly in economic straits. Since that time, the number of breweries has exploded to over 1,500 (see Figure 3). Given that the brewing industry exhibits concentration characteristics of maturity, what factors account for the dramatic change? There are likely a number of causes, both regulatory and demographic.

The prototype for the small brewer of the last two decades is probably the Steam Beer Brewery of San Francisco. Fritz Maytag (of the appliance Maytags) took an interest in and then sole control of this very old brewery which first opened in 1896 to make a peculiarly West Coast style lager. The brewery had limped along for several decades on the verge of failure, mostly because it made very bad, sour beer. Maytag took control of the brewery in 1 969 and changed the strategy to emphasize ingrethents such as European two-row barley and whole hops. He also understood that the small scale of the brewery meant that it would never be cost competitive with the large brewers. However, the local market was already open to higher priced beers from Europe so the newly named Anchor Brewing would stay small but dedicated to traditional brewing arts - at a premium price point. Within a few years, Anchor Steam was regarded as one of the best beers available and a sign that a small brewer could thrive (Ogle, 2006).

At about the same time (1978) President Carter repealed a regulatory artifact of the end of Prohibition that outlawed home brewing. This was perhaps more bowing to the inevitable as home brewing had never really died and was, in fact, becoming very popular on both coasts. Still, the repeal spawned a tremendous growth in the hobby as brewers could now acquire malted grains, yeasts and hops that let them create or replicate beer styles that were not possible to purchase. The skills that many home brewers developed in the garage or basement provided the technical foundation for the next step: commercial brewing. Jack McAuliff was an early home brewer (when it was still technically illegal) and went on to start New Albion Brewing, usually described as the first real microbrewery. While New Albion failed fairly quickly, it was at about the same time that two other home brewers - Ken Grossman and Paul Camusi - started up Sierra Nevada Brewing which ranked in 2009 as one of the top ten brewers in the U.S. Again - home brewers Michael Laybourn and Norman Franks started Mendocino Brewing in the late 1970s. This startup in Hopland, CA is notable because it was the first brewpub. Mendocino is still brewing beer.

The growth of "lifestyle" based consumption in the 1970's and '80s was another driver of the craft brewing movement. The 1980's and 90's saw the emergence of the "educated class" or the white collar meritocracy. The first great bump of baby-boomers graduated college in the 1970s. Since then, the growth of information technology (and the shifting nature of jobs around that technology) as well as the shift away from manufacturing employment has meant the development a large number of the well educated and well compensated. Brooks (2000) has argued this has led to a certain style of consumption. The educated class rejects conspicuous consumption of luxuries (such as boats or furs) but embraces spending a great deal for necessities (albeit at a very high end) and a cultivated appreciation of (versions of) commonplace goods. Brooks describes the ethos as one focusing on the "authentic, natural, warm, rustic, simple, honest, organic, comfortable, craftsmanlike, unique, sensible, sincere" (Brooks, 2000, p. 83; Binkley, 2007). Thus, we have seen the emergence of firms like Starbucks, Republic of Tea, Viking, Whole Foods, and so on.

These purchasing patterns readily extend to beer, particularly with respect to local breweries as an alternative to the uniform products of mega-breweries. Early on, this manifested as a growth in import beer sales in the early 1980s. While this has persisted, the real growth has been in the conscious consumption of locally and regionally produced beers that emphasize either a resurrection of old styles of beer (such as ales, porters, stouts, Iambics and the like) or particularly American interpretations of these styles such as American Pale and pumpkin ales, and rye and chile beer. As an illustration of this growth, the Beer Advocate website lists reviews of over 13,000 labels in the American Ale section (Beer Advocate, 2010). In addition, while beer is generally regarded as a bluecollar beverage and wine a more upscale and white collar drink, the craft brewing industry's approach to product development has tapped a demographic that overlaps with that of wine drinkers: craft brew consumers are young (wine drinkers tend to be older) but both are affluent, and well educated. In fact, many craft brew consumers are also wine drinkers, which is not true of more traditional beer consumers. This is why drinking craft beers is increasingly being positioned as a wine-like experience (Student, 1995; Adams, 2009; Hallinan, 2006).

In this context, then, the standard American lager may have been perceived as too mainstream, bland, or boring to fit well with the new consumption patterns. The arc of product development in American beer has always been toward lighter beers (lagers vs. ales in the 1840's, Bavarian vs Munich styles in the 1870s, the effect of prohibition on American tastes vis a vis bitterness, carbonation (the Coca Cola effect), the effect of increasingly national markets and subsequent product characteristics for single product solution, and changing economics of brewing). Over this period, brewers reduced the amount of malted barley in brew recipes from 36 pounds per barrel to 24 (which diminished the body of the beer), the total fermentables from 49 to 35 pounds (reducing alcohol content as well), and hops from 0.65 pounds to 0.22 (reducing the bitterness of the beer) (Choi and Stack, 2005). Another factor was the near universal penetration of refrigeration into homes. While refrigeration made packaging for home consumption possible (and profoundly changed industry distribution), it had another effect. Cold temperatures do not permit oils and esters in foods to become volatile so refrigerator-cold beer has very little flavor or aroma. Thus, what makes up a beer matters less and less as the dominant perceptions are of temperature and carbonation. Ultimately, these factors point toward a convergence of styles resulting in beers that are very uniform in terms of production and quality control but deficient in flavor and aroma compared to other styles of beer. This approach may have reached its nadir by 1984 when Falstaff introduced generic beer.

The confluence of these factors - changes in regulation, taste, and the experience in brewing - led to the dramatic growth in breweries in the U.S. in the 1990s. To be sure, this was not a smooth growth process. The industry has experienced an ongoing shakeout among small craft brewers for several reasons. First, many failed to make the production scale transition from kitchen to plant. Brewing 500 gallons of beer is a very different process than brewing five gallons. One of the results was that craft beer often wasn't that good. A 1996 Consumer Reports test indicated that many highly regarded craft beers were actually flawed, stale, or sour. Second, even if the early entrepreneurs knew how to make beer, they often weren't very effective business managers. According to one craft brew executive, the brewers who are succeeding "are the ones that have either made the transition themselves to learn how to be more savvy business people or created a partnership with someone who does" ("Craft Brewers", 2007).

Subject: Breweries; Strategic management; History; Case studies

Location: United States--US

Classification: 2310: Planning; 8610: Food processing industry; 9130: Experiment/theoretical treatment; 9190: United States

Publication title: Journal of Business Case Studies

Volume: 6

Issue: 6

Pages: 31-46

Number of pages: 16

Publication year: 2010

Publication date: Nov/Dec 2010

Year: 2010

Publisher: Clute Institute for Academic Research

Place of publication: Littleton

Country of publication: United States

Publication subject: Business And Economics--Management

ISSN: 1555-3353

Source type: Scholarly Journals

Language of publication: English

Document type: Business Case, Feature

Document feature: Graphs Tables References

ProQuest document ID: 818384027

Document URL: http://search.proquest.com/docview/818384027?accountid=38610

Copyright: Copyright Clute Institute for Academic Research Nov/Dec 2010

Last updated: 2013-11-06

Database: ABI/INFORM Complete

Document 5 of 100

Caravan Traders: A Tax Research Project For Pass-Through Business Entities

Author: Durant, Monique O

ProQuest document link

Abstract:

This paper presents a tax case simulating a real-world experience in the area of partnership or flow-through entity taxation. Students are presented with an open transaction, hypothetical data and business objectives of the partners. They are then requested to consider the tax rules and the impact on the parties based upon each of two options in order to determine the best business alternative. In order to do this, they rely on knowledge learned in the typical partnership taxation course and practice research and analytical skills to synthesize the most optimum outcome. Students are asked to deliver a tax memorandum that addresses a series of progressive issues, as well as two excels worksheets which outline the tax impact under each of the two options. As a result of this assignment, students discover the value of prudent and skillful tax planning and the beneficial impact that they can have on the financial affairs of their clients. [PUBLICATION ABSTRACT]

Full text:

CASE STUDY TEACHING NOTES

INTRODUCTION

One of the most valuable benefits that a tax professional can offer clients today is the resolution of tax issues through prudent and skillful tax planning. In a very real sense, tax professionals, whether in public or private practice, add value by advising their clients regarding ways to arrange their financial affairs which will minimize or postpone tax liabilities.

Undoubtedly undergraduate institutions are the appropriate venue to begin skill development in this area. In an article published in the January 2008 issue of The CPA Journal1 professors at Hofstra University and Lafayette College emphasize the need for development of research skills across the accounting curriculum. They state that:

The 21st century accountant is more of a consultant than in the past, and needs to be able to locate both financial and nonfinancial information. Accountants need to know what databases and other resources to access, how to extract the relevant data, and how to organize and analyze the data and develop recommendations. Accounting educators are responsible for teaching, students the skills that are essential to this research, [emphasis added]2

Further, the Model Tax Curriculum3 states that prior to entering the accounting profession, a student should have the ability to, among other things:

* Assess how taxes impact the economic decisions of taxpaying entities;

* Make supportable conclusions regarding tax issues by using research skills, including the assessment and interpretation of authorities, to evaluate strengths, weaknesses, and opportunities;

* Communicate tax conclusions and recommendations in a clear and concise manner to relevant stakeholders; and

* Develop technological skills needed to undertake tax planning, compliance, and research strategies.

Toward that goal, the purpose of this assignment is to teach and enhance the skills that are essential to tax research, and in doing so, initiate soon-to-be accounting professionals on a course of success and confidence in their first experiences as accounting and tax professionals.

TEACHING OBJECTIVE

The primary goal of this case is to allow students to explore the impact of IRC §834 in the context of the formation of partnership interests. IRC §83 has to do with property transferred in connection with performance of services. The general rule in IRC §83(a) provides that when property is transferred in exchange for services, the fair market value of the property over the amount paid (if any) must be included in the gross income of the person performing such services.5 In the context of partnership taxation, IRC §83 can be somewhat confusing, as it impacts the timing and valuation of the service partner's income, as well as the timing and valuation of the interest received in the exchange, the step-up in basis of various partnership assets and adjustments to the original partners' bases.

Recent legislation further complicates understanding of this section by providing that the service partner is deemed to have made the § 83(b) election to recognize income on the date of receipt (notwithstanding substantial risk of forfeiture), unless, within 30 days, the new partner elects out of current taxation under §83(c)(4).

The principles of §83 are frequently discussed in a course on flow-through entities, and students will understand these concepts in a general way from reading and lectures; however they do not always understand the impact, in real terms, of the "83(b)" (or now, the §83(c)(4)) election upon each of the partners or upon the tax basis balance sheet. This project gives them an opportunity to examine these factors and to compare the options (i.e., whether to make the election or not) in order to synthesize the best solution for these particular clients.

DESCRIPTION OF THE ASSIGNMENT - SYNOPSIS

Simulating a Real-world Experience

This assignment presents a fact pattern which is similar, in degree of difficulty and quality of information, to that which the tax professional normally receives for analysis.

Summary of the Fact Pattern

Bill and Steve Caravan are brothers and equal partners in a business that was inherited from their father several years ago. As Caravan Traders, they import and retail fine oriental rugs. They approach their tax advisor regarding the following prospective transaction:

* Bill and Steve propose to transfer an equal (one-third) share of the partnership capital interest to Omar Debashi in exchange for his services;

* Debashi brings with him significant industry knowledge and numerous trade contacts;

* The agreement is that if Omar leaves the partnership within three years for any reason, he must forfeit his partnership interest; and

* According to Bill and Steve's business plan, they expect that within three years with Debashi onboard, their partnership assets will increase in value by about two-thirds.

Issues Assigned

The student is asked a series of questions regarding a potential IRC §83(b) (or §83(c)(4)) election, including its impact on the partnership, existing partners, and new partner. In order to comprehensively address these questions, the student must make spreadsheet calculations comparing the potential tax liability with and without the election in place, as well as the impact of the transaction on bases of the partners. Additional questions are asked regarding the mechanics (i.e., the time, manner, and revocability) of the election.

HOW AND WHY THIS ASSIGNMENT FITS IN THE COURSE

A. This assignment builds on concepts learned.

Nature of the Assignment

This research project builds on concepts already learned in class. The topic (e.g., the contribution of services in exchange for a partnership capital and profits interest) is discussed early in the course with materials relating to partnership formation. Hence, the project is assigned at a point in the semester when students already have some familiarity with the subject; much as a practicing tax professional would have some knowledge in a given area of tax law when sitting down to research an issue.

Skills Developed and Assessed

Grading of the research project rewards analytical (application of rules to fact pattern) and synthesis skills (using critical thinking and decision-making skills, concluding an appropriate outcome), as well as organization and communication skills, all of which are essential to a successful result.

B. The assignment is formulated as an open transaction in order to promote skills needed for tax planning.

As tax educators are aware, tax planning consists of two major categories:

1. Closed transactions. These are transactions which the client has already completed; documents have been signed and titles transferred. Tax planning for closed transactions is generally limited to the presentation of facts in a manner which will produce the most favorable tax outcome, as well as an assessment of the likelihood of success before the Service.

2. Open transactions. These are transactions which have not yet been consummated. Decisions can still be made regarding their structure and manner of implementation, and planning is prospective. This is the area where the parties have the most control over the potential tax outcome and where savvy and prudent tax planning can have the most impact.9 Open transactions require that alternatives be weighed, requiring a higher degree of critical thought.

The benefits of presenting this assignment as an open (rather than closed) transaction are two-fold:

1. Enhances critical thinking. The goal of the assignment is to require students to do more than simply conclude on the correct reporting of a transaction and report back. The fact pattern compels students to weigh two competing alternatives (whether or not to take a §83(b)) and to quantify the financial and nonfinancial consequences of each alternative.

2. Allows students to experience the value that tax planning can provide. The assignment allows students to understand that tax planning provides benefits that can impact the growth and financial well being of businesses and their owners. In assessing the potential tax liability for the two alternatives, students are able to see the benefits that tax planning may produce (and perhaps produce increased interest in this regard).

RESULTS IN IMPLEMENTATION

Assigned for Two Semesters

This assignment was presented to students in the spring semester of two consecutive years (one section each year) with changes to the partners' names, industry, and balance sheet values the second year. Lessons learned in the earlier year resulted in modifications which were implemented in the second year with positive results.

Success in Critical Thinking and Analysis

Over all, submissions demonstrated rational analysis and critical thinking as adept as many early-career professionals; some submissions exceeded expectations altogether. In terms of critical thinking and analysis (application of facts, organization, continuity and technical integrity), the majority of submissions indicated an understanding of the subject matter and ability to relate the facts to the concepts, as well as an ability to communicate those findings in a rational and straightforward manner.

Considering Factors other than Tax Benefits

All but one student in the first year advised taking the §83(b)(l) election in order to save taxes. None considered non-tax issues, such as the time value of money or the advantage of deferring the tax liability; however one student did suggest passing on the election due to cash-flow constraints.10 In the second year, students were encouraged to consider non-tax reasons why or why not the parties would chose a §83(b)(l) election. As a result, many students in the second year considered concerns such as cash-flow constraints, as well as the risk that the arrangement might fail or that the value of the business might not increase as anticipated. Such concerns were appropriate and well-placed.

Student Demographics

The majority of students in both years were seniors in a four-year accounting program. Of the 24 students in the first year, all but seven were in their final semester before graduation, five would graduate the following semester or later, and two were recent graduates returning to fill state CPA (150 credit) requirements. Similar statistics would apply to the 24 students in the second year. All of the students in each year had taken an introduction to taxation (primarily personal taxation) course and all but three in each year had successfully completed the university's corporate taxation course." Grades earned on the assignment in both years indicate that those without the corporate taxation course were not at any quantifiable disadvantage compared to those who had completed the course.

Some exceeded Expectations

Several memoranda exceeded expectations and received extra credit accordingly. The application of law to the fact pattern, including calculation of potential tax liability, was exemplary in these papers, and the logical progression of ideas in these papers was concise and well-reasoned. These papers demonstrated the skill of professionals above the staff level, and were submitted by students who had otherwise excelled in the course. In the first year there were five in this category, including two students with industry experience. In the second year there were seven in this category, including two students with industry experience.

Shortcomings in memoranda could be easily remedied.

Shortcomings could be easily remedied by allowing revision, (something which was implemented for the second year) although it was not practical the first year due to time constraints. Allowing time for student revision during the second semester produced the benefits of enhanced organization and continuity of the memoranda.

Many shortcomings in second-year memoranda were in fact remedied.

Eight papers, representing twelve students (50% of the class) were resubmitted for grading. Interestingly, three of the resubmissions, representing four students, were papers which had originally earned a score of 80 or better. The average increase in score for all resubmissions was approximately 14.5 points, bringing the average score for the class from 81.7 to 88.0 for that assignment.

CONCLUSION

This tax return assignment is a successful introduction to tax research for accounting seniors, providing an opportunity for students to apply fundamental tax concepts and to demonstrate analysis and critical thinking skills in solving problems which are needed in actual tax practice.

STUDENTS' CASE STUDY

Caravan Traders: A Tax Research Project for Pass-through Business Entities

You are a tax manager at Bull & Bear, LLP, a CPA firm devoted primarily to serving closely-held companies, such as Caravan Traders, one of your best clients. Caravan Traders is a cash-basis general partnership in the business of retailing fine oriental rugs in Fairfield County and is presently owned by Bill and Steve Caravan, two brothers who each own 50% of the partnership capital and share profits and losses equally.

As of December 31, 2009 Caravan Traders assets have total fair market value of $1,800,000, comprised of the following:

Land and Building were inherited from Bill and Steve's father in 1997 and at that time were worth $425,000. Bill and Steve wish to have Omar Debashi join the partnership as an equal partner because Omar is very familiar with the Persian rug business and has contacts in the industry that provide the best quality rugs. To entice Omar to join the firm, Bill and Steve have offered Omar a one-third capital interest. The agreement would be that if Omar leaves the Caravan Traders within three years, for any reason, Omar, or any transferee of Omar, must forfeit his partnership interest.

According to their current business plan, Bill and Steve estimate that in three years, on December 31, 2012, partnership assets will have a total fair market value of $3,000,000:

Part 1: As their tax advisor, Bill and Steve come to you with the following questions:

A. What are the tax implications to the partnership as a result of this arrangement?

B. What are the tax implications to Bill and Steve personally as a result of this arrangement?

C. What changes would occur to the tax basis of certain partnership-held assets?

D. Will Omar's services qualify as ordinary and necessary business expenses?

E. Discuss the timing for each of these issues.

Part 2: Additionally, Bill and Steve want to assure themselves that Omar understands the tax implications to him and therefore ask the following questions:

A. What options does Omar have regarding recognition of receipt of the partnership interest?

B. Based on the figures from the business plan, would you recommend that Omar allow a deemed § 83(b) election, or would you recommend that he make an election under §83 (c)(4) (that §83 (b)(1) should not apply)? How does he go about making such an election? What is the timing for such an election? Can such election be revoked, and under what circumstances?

C. Will Omar be able to transfer his partnership interest at any point during the next three years?

Assignment:

A. Prepare a tax memorandum answering each of the issues stated above:

1. Use the format: Facts; Issues; Conclusion; and Discussion.

2. The memorandum should be no longer than seven (7) single-spaced pages.

3. Use fonts Times New Roman 10 or Arial Narrow 1 1 .

4. Cite liberally.

B. Prepare excel spreadsheets to be attached to the memorandum which present the following:

1. December 31, 2009 Balance Sheet for Caravan Traders, including columns for Books (FMV), Tax Basis, and Partners' Outside Basis.

2. December 3 1 , 2012 Projected Balance Sheet presenting the same information as in (a).

3. Using the balance sheets prepared in (1) and (2), show changes to the tax basis of assets, gain or loss recognized by the partnership and changes in the outside bases of Bill and Steve for each of the following scenarios:

a. Omar allows a deemed §83(b) election, and

b. Omar makes an election under §83(c)(4).

CASE SOLUTION

Caravan Traders: A Tax Research Project for Pass-Through Business Entities

Part 1: As their tax advisor, Bill and Steve come to you with the following questions:

A. What are the tax implications to the partnership as a result of this arrangement?

1. When a partnership transfers a capital interest for services, the partnership is treated as transferring an undivided interest in each of its assets to the new service partner in a taxable transaction and must recognize any gain or loss inherent in the transferred portion of each asset. [Regs. §1.836(b); McDougal v. Commissioner, 62 T.C. 720 (1974)].

2. The service partner is treated as re-transferring the assets back to the partnership in a tax-free §721 exchange.

3. Result: Change of adjusted tax basis (usually a step-up) of partnership's assets (inside basis), as discussed at (iii) below.

4. Generally the partnership may take a §162 business expense deduction for services rendered by the service partner, discussed at (iv) below.

B. What are the tax implications to Bill and Steve personally as a result of this arrangement?

1. Any gain recognized by the partnership should be allocated among all the partners other than me incoming service partner. [IRC § 706(d)]

2. An expense deduction (see (i)(c) above) will flow through to the existing partners, which may be accomplished by special allocation under § 704(b).

3. Result: Gain recognized by existing partners on the transfer of partnership interest. If Omar makes an IRC 83(b) election, there shall be a total taxable gain of $146,667 or $73,333 per partner in the current tax year. This will arise from the step-up in basis of the transfer of partnership interest to Omar Debashi. Of the total gain, $75,000 shall be classified as long-term capital gain from the partial constructive sale of Land and Building, and $71,667 shall be ordinary income from the partial constructive sale of Accounts Receivable.

4. Additionally, there is change in partners' basis in partnership interest (outside basis). Currently, the outside basis of Bill and Steve's partnership interest is $680,000. With the admission of Omar Debashi, such basis will be adjusted downwards to $453,000 (after the step-up in basis of $73,333 to each partner and $300,000 transfer from each partner to Omar).

C. What changes would occur to the tax basis of certain partnership-held assets?

1. The partnership is treated as if it transfers an undivided interest in each of its assets to the service partner and the service partner conveys his interest in the assets for an interest in the partnership. The partnership recognizes gain or loss in the exchange of its property for services to the extent of the difference between the value and basis of the interest in each transferred asset. The character of the gain or loss depends upon the character of the assets in the partnership. Since the service partner's basis in the assets when re-contributed equals their fair market value, the partnership's basis is adjusted correspondingly. [Regs. §183-6(b); Regs. §1.721-l(b)(l); IRC §723, 724,735]

2. Result: Currently the total adjusted basis of partnership-held assets (inside basis) is $1,360,000. If Omar makes the deemed IRC 83(b) election now, the new stepped-up basis of partnership-held assets shall be $1,506,667, to reflect the transfer of 1/3 undivided interest of partnership assets to Omar Debashi.

D. Will Omar's services qualify as ordinary and necessary business expenses?

1. If a capital interest is transferred in exchange for services, the partnership may take a §162 business expense deduction for the amount of ordinary income that is includible in the service partner's income in the taxable year that the income is recognized unless the nature of the services requires the partnership to amortize (in the case of nondeductible organization expenses) or capitalize (in the case of services related to the acquisition or construction of an asset) the expense. [IRC §83(h),Regs §1.83-6(a)(4); 1.72 1-1 (b)(2); 1.707-1(c)]

2. Any allowable deduction will be allocated to the existing partners and not to the new partner. This can be done by special allocation under IRC §704(b).

3. Result: A deduction will be allowed for services rendered by service partner Omar Debashi. The partnership will be able to deduct the amount of $600,000, representing the fair market value of the capital interest received by Omar, as a §162 business expense for services rendered to the partnership. Consequently the original partners, Bill and Steve Caravan, shall deduct $600,000 ($300,000 each) under §704 (mentioned above at (ii)(b)) against ordinary income.

E. Discuss the timing for each of these issues.

1. If the service partner's legal rights in his capital interest were not subject to any restriction, the partner must recognize compensation income in the year the interest is received.

2. However, as in this case, if the interest is subject to a substantial risk of forfeiture so that the partner's rights in the interest are non-vested, IRC §83(c)(4) permits deferral of the recognition of income until the risk of forfeiture lapses if an election to do so is made within thirty (30) days.

3. Result: With an IRC §83 (c)(4) election, the timing of these issues will occur when the risk of forfeiture lapses in three years. With a deemed IRC 83(b) election (whereby no IRC §83(c)(4) election is made within thirty (30) days), income is recognized for the year that the capital interest is received (e.g., the current taxable year).13

Part 2: Additionally, Bill and Steve want to assure themselves that Omar understand the tax implications to him, and therefore ask the following questions:

A. What options does Omar have regarding recognition of receipt of the partnership interest?

1. A partner receiving a capital interest in a partnership in exchange for services performed for the partnership has gross income under IRC §61 and 83(a) when the interest is either transferable or no longer subject to a substantial risk of forfeiture. If the interest is restricted or forfeitable, the service partner reports its receipt as compensation in the year it becomes transferable or the risk of forfeiture lapses. [IRC §83; Regs. 1.721-1(b)(1)]

2. The amount of compensation income is equal to the fair market value of the capital interest when it is included in income less any amount paid by the partner. [IRC §83; Regs. 1.72 1-1 (b)(1)]

3. Newly enacted IRC §83(c)(4) provides that, unless the service partner elects out under that code section within thirty (30) days, the service partner will be deemed to have made an IRC § 83(b) election to recognize income at the time he receives a partnership interest, notwithstanding a substantial risk of forfeiture.14 Unless the election is made, the new service partner reports the value of the interest at the time of receipt. If the interest is later forfeited, the electing partner cannot claim a loss deduction for the amount of income he reported at the time of the election. [IRC §83(b); Regs. §1.83-2(a)]

4. Result: Recognition of service partner's ordinary income. If Omar makes a deemed IRC 83(b) election, he will recognize taxable ordinary income of $600,000 in the current year in exchange for the capital and profits interest in the partnership.

5. If Omar makes the IRC §83(c)(4) election to postpone recognition of income until substantial risk of forfeiture lapses, the current business plan indicates that in three years, he will recognize taxable ordinary income of $1,000,000.

B. Based on the figures from the business plan, would you recommend that Omar make a deemed §83(b) election?

1. Absent other factors, the election is generally advisable if the partnership interest is expected to substantially appreciate in value. By including the value of the interest at its current lower value, the service partner defers recognition of the anticipated appreciation until such time as he disposes of his partnership interest, at which time he would recognize the gain as capital gain. With the IRC §83(c)(4) election, the partner reports the increase in value of his interest as ordinary income when the restriction or risk of forfeiture lapses. By allowing a deemed IRC §83(b) election, however, the partner accelerates the time at which he is taxable on the current value of the interest.

2. Result: Each student must arrive at a reasonable decision after synthesis of the facts and circumstances. Most students arrive at the conclusion that the deemed IRC §83(b) election should be made, but arriving at a business recommendation based upon sustainable reasoning is more important than the conclusion at which the student arrives.

3. How does Omar go about making an IRC §83 (c)(4) election?

a. The election is made by filing one copy of a written statement with the internal revenue officer with whom the person who performed the services files his return. [Regs. §1.832]

b. In addition, one copy of such statement shall be submitted with his income tax return for the taxable year in which the property was transferred. [Regs. §1.83-2]

c. Result: If Omar chooses to make the IRC 83(c)(4) election, he should file a statement with the IRS filing office where he normally files his return, and should attach a copy of the statement with his federal tax return for the year in which he receives the partnership interest.

4. What is the timing for such an election?

a. The election must be made within 30 days after the date of transfer, and may be filed prior to the date of transfer. [Regs. §1.83-2(b), (f)]

b. Result: If Omar Debashi elects to make the IRC §83(c)(4) election, such election must be make no later than 30 days following the date of his admission to the partnership.

5. Can such election be revoked, and under what circumstances?

a. The election cannot be revoked without the IRS's permission. [Regs. § 1 .83-2(b), (f)]

C. Will Omar be able to transfer his partnership interest at any point during the next three years?

6. Omar will be unable to transfer his partnership interest until such time as the substantial risk of forfeiture lapses, whether or not he makes a deemed §83(b) election. [§83(c)(2)]

An excel spreadsheet of the calculations as they pertain to Caravan Traders follows:

Subject: Pass through entities; Impact analysis; Corporate taxes; Tax elections; Case studies

Classification: 9130: Experiment/theoretical treatment; 2320: Organizational structure; 4210: Institutional taxation

Publication title: Journal of Business Case Studies

Volume: 6

Issue: 6

Pages: 47-58

Number of pages: 12

Publication year: 2010

Publication date: Nov/Dec 2010

Year: 2010

Publisher: Clute Institute for Academic Research

Place of publication: Littleton

Country of publication: United States

Publication subject: Business And Economics--Management

ISSN: 1555-3353

Source type: Scholarly Journals

Language of publication: English

Document type: Business Case, Feature

Document feature: References Tables

ProQuest document ID: 818381800

Document URL: http://search.proquest.com/docview/818381800?accountid=38610

Copyright: Copyright Clute Institute for Academic Research Nov/Dec 2010

Last updated: 2013-09-06

Database: ABI/INFORM Complete

Document 6 of 100

Bank Regulatory Reform In The United States: The Case Of Goldman And The Volcker Rule

Author: Holowecky, Elizabeth; Murry, Ashley; Staneva, Violeta; Fuglister, Jayne

ProQuest document link

Abstract:

This case is an ethics case. The focus is on corporate governance in a major Wall Street bank, Goldman Sachs. The case discusses what Congress has done in the past and what it may do in the future to prevent breaches in ethics relating to proprietary trading. In response to the current financial crisis, Congress has proposed many changes for the banking industry and the proposals have gained momentum because of the SEC's accusation of fraud at Goldman Sachs. One piece of proposed legislation, endorsed by President Barack Obama and former chairman of the Federal Reserve, Paul Volcker, is based on the Volcker Rule. This rule would return the banking industry to the decades of the Glass-Steagall provisions of the Banking Act of 1933. The Volcker Rule would reinstitute the separation of commercial and investment banking. [PUBLICATION ABSTRACT]

Full text:

INTRODUCTION

Banks and other financial institutions play an integral role in the functioning of the economy. They serve as financial intermediaries and without them funds from those who save would not be available to those with the ability to utilize funds for various investment opportunities. Financial intermediaries include depository institutions, contractual savings institutions and investment intermediaries. All financial intermediaries play a role in the economy, but the principal intermediary is the depository institution which includes commercial banks, savings and loan associations, mutual savings banks and credit unions. These institutions help ensure that the economy and financial markets run smoothly - supplying credit in the form of business, education, car and home loans and checking and savings account services (Mislikin, 2001, p. 211). The sources of funds for these financial intermediaries come in the form of deposits while the primary uses of those deposits vary according to the type of depository institution. Commercial banks have the widest range of uses for their deposits and are the largest type of depository institution in the United States (Mishkin, 2001, p. 38).

The purchase and sale of derivatives and other securities by commercial banks has proven to be an area of controversy due to its speculative and inherently risky nature. These activities are viewed by many to be suitable only for investment banks, not for commercial banks.

THE GREAT DEPRESSION

Prior to the Great Depression, commercial banks engaged in activities similar to investment banks and these activities are cited as a major cause of the financial panic from 1929-1933 . In efforts to increase profits commercial banks engaged in investment bank-like activities such as issuing, selling, and underwriting corporate and government securities and purchasing securities for their own accounts (so-called proprietary or "prop" trading), in addition to other speculative activities. "Many banks, especially national banks, not only invested heavily in speculative securities but entered the business of investment banking in the traditional sense of the term by buying original issues for public resale" (Benston, 1990, p. 11). This financial crisis not only crippled the U.S. banking system - more than 1 1 ,000 banks either failed or had to merge - but also caused many Americans to lose savings that were held at commercial banking institutions. The actions of these commercial banks contributed to a loss of confidence in the U.S. banking system. As a result, the Banking Act of 1933 was passed by Congress. This act, in addition to establishing the Federal Deposit Insurance Corporation, which provides insurance on bank deposits, established strict regulations on the commingling of commercial and investment banking activities.

GLASS-STEAGALL

"The 'Glass-Steagair Act has come to mean only those sections of the Banking Act of 1933 that refer to banks' securities operations - sections 16, 20, 21, 32" (Benston, 1990, p.7). George J. Benston cites a brief filed by the First National City Bank: "The Glass-Steagall Act was enacted to remedy the speculative abuses that infected commercial banking prior to the collapse of the stock market and financial panic of 1929-1933" (1990, p. 11). It was a law meant to separate commercial and investment banking activities. The provisions of this act "prohibited commercial banks from underwriting or dealing in corporate securities [...] and limited banks to the purchase of debt securities approved by the bank regulatory agencies" (Mishkin, 2001, p. 250). The act also required commercial banks to discontinue their investment banking operations. Not only did this legislation restrict the activities of the commercial banks, it also prohibited investment banks from acting in a commercial banking capacity.

Provisions of Glass-Steagall

Sections 16 and 21 of Glass-Steagall - in reference to the direct operations of commercial banking institutions, prohibited member banks of the Federal Reserve from purchasing securities for their own account. These sections also prevented deposit-taking institutions from engaging in "issuing, underwriting, selling, or distributing , at wholesale or retail, or through syndicate participation, stock, bonds, debentures, notes or other securities" (Benston, 1990, p. 7). There were exceptions to those restrictions: "U.S government obligations, obligations issued by government agencies, college and university bonds, and the general obligations of states and political subdivisions" (Benston, 1990, p. 7). On the other hand, section 16 did permit commercial banks to purchase and sell securities directly on the order of and for the account of their customers. The banks were also permitted to act as advisers and agents in the private placement of commercial paper (Benston, 1990, p.7).

The remaining sections, 20 and 32, reference commercial banks' affiliations. Benston defines an "affiliation" to exist when "a common set of stockholders controls 50 percent or more of both the commercial bank and investment company" (Benston, 1990, p. 8). Under section 20, commercial banks were prohibited from "affiliating with a company engaged principally in the issue, flotation, underwriting, public sale or distribution at wholesale or retail or through syndicate participation of stocks, bonds, debentures, notes or other securities" (Benston, 1990, p. 8). "Principally engaged" is defined by the Federal Reserve to mean "activities contributing more than from 5 to 10 percent of the affiliate's total revenue" (Benston, 1990, p. 9). Future rulings from the Federal Reserve clarified the restrictions on commercial banks' affiliations, determining that commercial banks could acquire subsidiaries that provide both brokerage service and investment advice to institutional customers. Affiliates were also permitted to offer retail discount brokerage services due to the fact that these activities did not involve an underwriting of securities. Section 32 applied to senior management executives of member banks. Member banks were prohibited, under this section, "from having interlocking directorships or close officer or employee relationships with a firm that is principally engaged in securities underwriting and distribution" (Benston, 1990,p.7-8).

Rationale

There are many reasons why Glass-Steagall was incorporated into the Banking Act of 1933 and many arguments for its continuance. Glass-Steagall was thought to be the solution to the commercial and investment banking problems that were presumed to be the cause of financial panic. The attorney of First National City Bank, during a brief, cited "three well-defined evils [...] found to flow from the combination of investment and commercial banking" (Benston, 1990, p. 11): (1) banks chose to invest their assets in securities which resulted in risk to commercial and savings deposits; (2) unsound loans were made as a means to increase the price of securities or the financial positions of the companies in which commercial banks had invested their own assets; (3) a commercial banks' financial interest in the ownership, price, or distribution of securities encouraged bank officials to urge customers to invest in securities that it was under pressure to sell due to its own stake in the transaction (Benston, 1990, p. 11). In addition, former chairman of the Federal Reserve Paul Volcker, reasons that as the commercial banks became more involved in securities, the public lost its confidence in the banking system: "Confusion by the public as to whether they were dealing with a bank or its securities affiliate and loss of confidence in the banking system were also cited as adverse consequences of the securities affiliate system" (Benston, 1990, p. 12).

The integration of commercial and investment banking activities resulted or had the potential to result in a number of unwanted circumstances for the public, the U.S. government, and the entire banking system. By engaging in underwriting and holding corporate securities, the risk of loss to depositors and the federal government was substantial. The conflicting interests of the commercial banks involved in securities activities had the potential to result in harm to customers. Commercial banks also introduced unwanted competition to securities brokers and underwriters. The federal deposit insurance afforded member banks cheap deposits; thereby, providing an unfair competitive advantage to commercial banks engaging in securities activities. The investment banking activities of commercial banks brought with them the increased likelihood that the FDIC would be called upon to rescue failing member banks (Benston, 1990, p. 13). The prevention of the aforementioned consequences, however, did not protect the act from encountering opposition.

The Repeal

Daniel Tarullo describes the decades following the passing of the Banking Act of 1933 as "quiet and predictably if unspectacularly profitable" (2008, p. 34) for the banking industry. Despite the rationale behind a separation of commercial and investment banking and the seeming success of the Glass-Steagall provisions there was much opposition to this legislation. The principle argument against Glass-Steagall was that within such a rapidly changing financial environment, the restrictions of Glass-Steagall prevented commercial banks from remaining competitive (Tarullo, 2008, p. 34).

The affiliation restrictions "barred [commercial banks] from realizing what many believed to be a potentially important source of earnings diversification" (Tarullo, 2008, p. 34). As a result, commercial banks requested a relaxation of the prohibitions on their ability to explore new markets and lines of business. Concerned with the possibility that the banking system would be weakened if banks were constrained in their response to new competition, regulatory agencies began to relax or remove many of the regulatory devices that had insulated the commercial banks during the decades following the Glass-Steagall legislation (Tarullo, 2008, p. 35).

In 1987, the Federal Reserve used a loophole in section 20 of Glass-Steagall to allow bank holding companies to underwrite classes of securities previously prohibited. As described previously, section 20 only prohibited commercial banks from having affiliates that were "principally engaged" in securities activities. Thus, commercial banks began to permit their affiliates to engage in securities activities as long as the revenue from these activities did not exceed 10 percent of the affiliate's total revenue. This 10 percent threshold was later relaxed to 25 percent. Soon thereafter, banks began to enter the underwriting business and brokerage firms entered the traditional banking business (Mishkin, 2001, p. 259). "The pursuit of profits and financial innovation stimulated both banks and other financial institutions to bypass the intent of the Glass-Steagall Act and encroach on each other's traditional territory" (Mishkin, 2001, p. 259). In 1999, the Glass-Steagall Act was repealed.

2007-2009 FINANCIAL CRISIS

Ten years after the repeal of Glass-Steagall, the world is scrambling to recover from what has been deemed the worst financial crisis since the Great Depression. There are many factors that contributed to the current financial crisis. These factors include the development of the Community Reinvestment Act, the creation and securitization of sub prime mortgages, and the buying and selling of these securities by banks.

As a means to meet the requirements of the Community Reinvestment Act - an act implemented to increase the ability of all Americans to become homeowners - sub prime mortgages were created. Most of these sub prime mortgages were issued with variable interest rate terms that allowed borrowers to make monthly payments only towards interest, with no money being allocated to the principal amount of the loan. These interest-only payments would be in place for the first few years of the mortgage; thereafter, the monthly payment would increase substantially to include payments toward principal.

As interest rates rose, so did the monthly payments on the sub prime mortgages. At the same time, for many sub prime borrowers, the interest-only payments were converting to interest plus principal payments. The combination of those factors decreased the ability of borrowers to meet their mortgage obligations - they defaulted on loans and foreclosures skyrocketed.

The aforementioned factors combined to cause significant increases in unemployment rates, decreases in the amounts of credit banks are willing to issue, and numerous bank failures. The housing market has slumped considerably due to declines in the value of homes and the number of home foreclosures has increased astronomically. During recent months, the FDIC has forced several banks to close - continuing the trend of 2009 which saw 140 bank failures (Gordon, 2010, Para. 1). Approximately 15 percent of mortgages were either delinquent or facing bank seizure, during the final quarter of 2009 - the highest rate since 1972 (Merle, 2010, Para. 8). The value of the average home in the United States decreased by approximately 4.1 percent between 2008 and 2009 (Levy, 2010, Para. 10).

ROLE OF COMMERCIAL BANKS

It is difficult to quantify the extent to which the financial crisis is the result of the speculative activities of commercial banks. It is, however, somewhat easier to determine the actions of the commercial banks that contributed to the current financial crisis. The commercial banks' movement from risky business strategies to extreme risk aversion played an integral role in the current financial crisis. According to one economist, "commercial banks [have] made the large mistakes by having no conscience of the risk they were taking and then immediately becoming extraordinarily risk averse without taking any responsibility for the crucial role they play for the operations of the market" (Wyplosz, 2008).

As previously discussed, banks are intermediaries and they function to channel funds from lender-savers to borrower-spenders. It is crucial to keep these channels open in order for the economy to function effectively. Duca, DiMartino, and Renier (2009), of the Dallas Federal Reserve liken this critical flow to that of a cardiovascular system:

An apt metaphor is the cardiovascular system, which sustains the human body. In like fashion, financial flows provide critical sustenance to the economy, channeling funds to borrowers and payments back to lenders. In both biology and finance, blockages are unhealthy. Indeed, the financial system's seizing up in the last quarter of 2008 triggered the sharpest decline in domestic economic growth since the credit crunch of 1980. (Duca et al, Para. 3)

The commercial banks play a criticai role in the economy and undoubtedly had a role in the subprime mortgage process.

In the sub prime mortgage securitization process, commercial banks played the role of buying and selling securities that were backed by sub prime mortgages. In the pursuit for profits, these deposit-taking institutions engaged in risky securities dealings without much regard for the potential losses that could and, eventually, did occur.

Many of [the world 's largest banks] had bought huge amounts of what has come to be called toxic assets - based on mortgages and sub primes [...] without really asking any questions and without apparently understanding exactly what they were doing. [...] They were very brave and not very cautious when [trading] (Wyplosz, 2008).

Rising interest rates caused an increase in the rate of sub prime mortgage foreclosures. This had an inevitable effect on the value of the sub prime mortgage backed securities that were held on the books of commercial banks.

The foreclosure crisis began to noticeably affect the banking industry in the summer of 2007, when a number of European investment funds stopped their redemptions due to their inability to value portions of their portfolios that contained sub prime mortgage backed securities (Duca et al., 2009, Para. 9). This uncertainty in asset values triggered a desire in banks to increase their liquidity. "Institutions hung on to extra liquidity to meet their own funding needs. And they feared lending to institutions whose default risk had risen because of exposure to sub prime mortgages and other suddenly suspect assets" (Duca et al., 2009, Para. 9).

The freezing of the inter-bank lending market - which arose as a means to provide banks with unfunded investment opportunities the ability to borrow from other banks that carried excess funds, at low interest rates - prevented banks from relying on this market as a means to meet their funding necessities. The restrictions on the availability of these interbank funds caused banks to reexamine their lending policies.

As banks realized the toxicity of the securities that were being purchased and sold within the industry, they became extremely risk averse - credit lending policies were tightened, sub prime and commercial lending criteria strengthened, and inter-bank lending all but stopped. This blockage, according to Duca et al. (2009), resulted in the "significant choking off of economic activity" (Para. 5). The availability of credit is vital to the efficient functioning of the economy. The sudden movement of commercial banking institutions to risk-averse business models has helped to push the country from a financial crisis into an economic crisis.

THE VOLCKER RULE

In response to the current economic crisis, there have been many attempts by Congress to pass regulation that would prevent the country and the world from experiencing another debacle of this magnitude. The pace of financial regulation reform has been slow and there has not been much passed in the way of legislation. On January 21, 2010, President Barack Obama took a step in the direction of banking reform by announcing his support of The Volcker Rule.

The Volcker Rule - named for former Federal Reserve chairman and one of the largest proponents of banking reform, Paul Volcker - is the basis for proposed legislation meant to impose strict regulations on financial institutions with liabilities backed by the Federal Deposit and Insurance Corporation. The Rule calls for a separation of commercial and investment banking activities. The Volcker Rule would no longer allow banks to "own, invest, or sponsor hedge funds, private equity funds, or proprietary trading operations for their own profit, unrelated to serving their customers" (White House Press Release, 2010).

The proposals emphasize the need to eliminate the ability of those banks with access to the FDIC "safety net" and Federal Reserve to engage in speculative activities. U.S. Treasury Deputy Secretary Neal Wolin, who testified alongside Paul Volcker to the Senate Banking Committee, said "banks that do proprietary trading enjoy a cheaper cost of capital because of taxpayer backing of the deposit-funded sides of their business models, which is unfair" (Drawbaugh & Younglai, 2010, para. 20). When declaring his support for The Volcker Rule, President Obama stated the purpose of the Federal Deposit Insurance:

Our government provides deposit insurance and other safeguards and guarantees to firms that operate banks. We do so because a stable and reliable banking system promotes sustained growth, and because we learned how dangerous the failure ofthat system can be during the Great Depression. (White House Press Release, 2010).

Because many of the failing financial institutions were protected by the FDIC, the U.S. taxpayers have been forced to provide more than 200 billion dollars of bailout money in an effort to salvage the U.S. financial system. Many of those institutions that received a bailout from taxpayers chose to engage in overly risky speculative activities. The Volcker Rule is asking those institutions such as JP Morgan, Goldman Sachs, and Bank of America to choose which activities they want to conduct - those of investment banks or those of deposit-taking institutions. Those institutions that remain in the business of owning, investing and operating hedge funds, private mutual funds, and proprietary trading for their own profit will do so without the banking license (Volcker, 2010). According to Volcker, in reference to those institutions that choose to forgo their bank status, "if they got in trouble, the theory is they will not be rescued, but they will have an orderly demise where I think of as euthanasia rather than life support and that's a big difference" (Volcker, 2010).

Another issue addressed by The Volcker Rule, is the inherent conflict of interests that arises when a bank engages in both investment and commercial banking activities. A manager of an institution that is in the business of accepting deposits from consumers while also in the business of making speculative investments for its own profit, is unlikely to maintain his or her objectivity when managing the money of its depositors. Volcker describes this conflict as a difference in thinking between the proprietary trader and the commercial banker:

[...] basic commercial banking serving the public, sen'ing your customers, providing solid senices at reasonable costs and safely is a different mentality than the typical proprietary trader, typical hedge fund guy. I'm not saying it's wrong. It's just different. [,..]I also think it is apparent that a lot of this trading activity raises enormous conflicts of interest within these institutions which are themselves, at the veiy least, the most mildest comment I can make, are very difficult to manage. (Volcker, 2010)

CRITICS OF THE VOLCKER RULE

One argument against the separation of commercial and investment banking activities is that the commingling of these activities did not cause the current financial crisis, albeit they did play an integral role. Paul Volcker has admitted that such restrictions would not have prevented the problems at AIG and Lehman Brothers, but has also warned that without limits to proprietary trading, the country will experience another financial crisis (Drawbaugh & Younglai, 2010, para. 4). Regulation addressing not only the root cause of the crisis, but also the factors that contributed to its magnitude is necessary.

Douglas Elliot, a previous president and principal researcher for the Center on Federal Financial Institutions and an investment banker for two decades mostly at JP Morgan, criticizes the Volcker Rule because "the plan to limit proprietary investments is problematic for a number of reasons. It is so vague that we may find that the eventual details are downright harmful to the economy." He is quoted in a CNNMoney article as saying "The thing is, loans have become instruments that are pretty fairly traded. You can't tell me the characteristics of a loan that makes it different from a security."

Peter Wallison of the Wall Street Journal is another critic of the Volcker plan. He states that "Banks have been committing themselves increasingly to financing real estate. The reason for this is simple. Because they cannot underwrite or deal in securities, they have been losing out to securities firms in financing public companies - that is, most of American business other than small business. It is less expensive for a company to issue notes, bonds or commercial paper in the securities markets than to borrow from a bank."

SUPPORT FOR VOLCKER RULE

Volcker addresses both Elliot and Wallison' s arguments by asserting that it is not about the amount risk, but about which risk is essential to the functioning of the economy and which is not. According to Volcker, it is "hedge funds, private equity funds, and trading activities unrelated to customer needs and continuing banking relationships (that) should stand on their own, without the subsidies implied by public support for depository institutions."

While The Volcker Rule is bound to face much opposition, just as the Glass-Steagall Act faced decades ago, the proposal has also received much support from not only the American public, but from previous secretaries of treasury. A poll conducted in February of the current year by the Chartered Financial Analyst Institute showed that 68 percent of the 1 ,494 participants are in support of the proposed separation of commercial and investment banking activities (Weidner, 2010, para. 3). As recent as February 22, 2010, five previous secretaries of Treasury for both Republican and Democratic parties, have written letters in support of The Volcker Rule - W. Michael Blumenthal, Nicholas Brady, Paul O'Neill, George Schultz, and John Snow (O'Neill et al, 2010, para 1). A former opponent of the Volcker Rule, U.S. Senate Banking Committee Chairman Chris Dodd, has stated his strong support for the restriction of commercial banks from engaging in proprietary trading, owning hedge funds, or private equity arms (Boles, 2010, para. 1). Also the Merkley-Levin Amendment to the Senate bill 'creates a wall between hedge fund investments and deposits" (Newman, 2010). There is political support for a bill based on the Volcker Rule.

The repeal of Glass-Steagall in 1 999 introduced

...a system in which hedge fund s or private equity firms inside banks can place huge, risk)' bets that are subsidized by taxpayers [...] a system in which shareholders make money on these operations if the bank wins but taxpayers foot the bill if the bank loses. (White House Press Release, 2010)

A good number of institutions welcomed taxpayer deposits while also welcoming extremely risky business strategies and, due to a lack of regulation, the U.S. government was burdened to save them. Economist, Charles Wyplosz accurately describes tendencies of financial operators:

Financial operators love to take risks but they are not very great when the losses come. And when they make profits they are quick to pocket them; when they make losses they are quick to get public support to cover them and that is not right. (Wyplosz, 2008)

In the wake of this financial crisis, financial regulators and operators must remember the role of the commercial banks in our economy. These financial intermediaries have the role of channeling money from those who save to those who spend. According to Henry Kaufman, "financial institutions are not just the guardians of credit, but in a broader sense they are also the mechanisms that can either strengthen or weaken a market-based society" (2009, p. 44). Commercial banking was meant to be a heavily regulated industry - its liabilities are protected by the Federal Deposit Insurance; it has access to the Federal Reserve. The commercial bank should be able to be regarded as a safe haven for taxpayers' deposits.

The commercial bank should be seen as having a fiduciary responsibility to the public. "Substantial risk taking and entrepreneurial zeal belong properly in the world of commerce and trade, where large equity capital tends to reside, and not in financial institutions that are heavily endowed with other people's money" (Kaufman, 2009, p. 44). Those consumers with the desire to engage in investment activities can, and will, do so via the investment banking institutions. On the other hand, those risk-averse consumers should have the ability to depend on commercial banks to refrain from using customer deposits to engage in undesired risky activities.

The Volcker Rule, as did the Glass-Steagall provisions of The Banking Act of 1933, provides protection from the likelihood that the government and taxpayers will be held financially accountable for investment banking activities in the event of future financial crises. The Volcker Rule returns commercial banks to their core business. It is undeniable that financial institutions play a vital public role; therefore, this and other proposed banking regulation should be considered with little regard to inequities in the market today or the inflexibility of U.S. financial institutions to compete with growing financial markets in the United States and overseas (Kaufman, 2009, p. 45). After all, regulators considered these factors when the decision was made to repeal Glass-Steagall. Now, the United States and the world are struggling to bounce back from the biggest financial and economic crisis since The Great Depression.

THE CASE OF GOLDMAN

The Abacus Deal

In April, 2007 the investment bank, Goldman Sachs and hedge finn, Paulson & Co., brokered a deal in which Paulson selected bonds and Goldman packaged them into synthetic collateral debt obligations (CDOs), called Abacus 2007- ACI. Paulson selected the securities and then, with Goldman's knowledge, bet against them. Thinking that the portfolio of the CDOs was selected by a third independent party (ACA Management LLC), sophisticated clients bought the securities. Moody's Investors Service rated the CDO deal triple A. However, by May, 2009, the deal turned out to be worthless.

Mr. Chen, the former Moody's analyst, called the Abacus deal a "rating arbitrage" trade. In other words, despite the triple A rating, eventually the true, lower value of the bonds would be revealed.

... According to the SEC, investors in Abacus lost more than $1 billion. The Paulson finn profited by about $1 billion. " (Lucchetti and Ng, 2010).

Goldman Becomes A BHC

In 2008 after Lehman Brothers' failure and AIG's collapse, Goldman Sachs requested to change its status to a bank holding company. The transformation imposed higher capital requirements, additional disclosure regulations, and stricter government oversight. However, the shift was a strategic move for Goldman to organize commercial bank subsidiaries and to obtain access to the FDIC "safety net" and Federal lending. Part of the trade-off was the $10 billion received under TARP. By becoming a bank holding company. . .

it was a blunt acknowledgment that their [Goldman] model of finance and investing had become too risky and that they needed the cushion of bank deposits that had kept big commercial banks like Bank of America and JPMorsan Chase relatively safe amid the recent turmoil. (Corking and Baja, 2008)

SEC Allegations Against Goldman

Current SEC allegations that Goldman fraudulently provided inadequate disclosure to clients in the Abacus deal reveal that Goldman managed to enjoy the best of all worlds: Federal Reserve lending under TARP after they became a BHC, high-risk proprietary trading before they became a BHC, and trading in an environment with weak regulation before they became a BHC.

SEC Allegations Against Moody's

The SEC is investigating whether Moody's issued reckless descriptions of its credit-rating policies. On March 18, 2010 the SEC announced that the rating process may be the cause of an SEC lawsuit.

Audit Of The Fed And Goldman's Tarp Funding

In May, 2010 the Senate announced a GAO audit of the Federal Reserve Board's process in issuing TARP funds to Goldman. (Lightman, 2010)

Required:

1. What is the role of commercial banks in the U.S. economy?

2. Describe the operations of investment banks, as opposed to commercial banks.

3. What was the Glass-Steagall Act and why was it passed? Why was it repealed?

4. Do you think the Volcker Rule should become the basis of new bank regulations?

5. Do you think that Goldman defrauded its clients? If so, how?

6. Would a Congressional Regulation based on the Volcker Rule have stopped Goldman from its questionable business practices?

7. Would restricting Goldman's proprietary trading operations have limited systematic risk?

8. What action should Goldman take if the Volcker Rule is enforced?

9. What regulatory loopholes has the case of Goldman exposed?

10. What are the challenges of enforcing the Volcker Rule?

11. How are ratings agencies such as Moody's involved in the financial crisis?

12. How does the categorical imperative apply to the Goldman and Moody cases?

CONCLUSION

This ethics case demonstrates that behavior is fashioned by corporate culture, not by financial regulation. If the 'tone at the top' is to exploit clients for short term gains, then managers will find ways to circumvent financial regulations. New regulations will probably give rise to new ways to circumvent them. It also demonstrates that clients, especially institutional, need to do their own due diligence so they are not easy prey.

Subject: Regulation of financial institutions; Regulatory reform; Corporate governance; Business ethics; Case studies

Location: United States--US

Company / organization: Name: Goldman Sachs Group Inc; NAICS: 523110, 523120

Classification: 9130: Experiment/theoretical treatment; 4310: Regulation; 8100: Financial services industry; 9190: United States; 2110: Board of directors; 2410: Social responsibility

Publication title: Journal of Business Case Studies

Volume: 6

Issue: 6

Pages: 59-68

Number of pages: 10

Publication year: 2010

Publication date: Nov/Dec 2010

Year: 2010

Publisher: Clute Institute for Academic Research

Place of publication: Littleton

Country of publication: United States

Publication subject: Business And Economics--Management

ISSN: 1555-3353

Source type: Scholarly Journals

Language of publication: English

Document type: Business Case, Feature

Document feature: References

ProQuest document ID: 818381627

Document URL: http://search.proquest.com/docview/818381627?accountid=38610

Copyright: Copyright Clute Institute for Academic Research Nov/Dec 2010

Last updated: 2013-09-06

Database: ABI/INFORM Complete

Document 7 of 100

Proposal Of New Turkish Production System "NTPS": Integration And Evolution Of Japanese And Turkish Production System

Author: Siang, Yeap Yu; Sakalsiz, Mustafa Murat; Amasaka, Kakuro

ProQuest document link

Abstract:

The authors propose a New Turkish Production System (NTPS) with the objective of the integration and evolution of the Toyota Production System, the leading Japanese production system, and the Traditional Turkish Production System, for the growth of the next-generation automobile industry in the Republic of Turkey. [PUBLICATION ABSTRACT]

Full text:

INTRODUCTION

Amidst the rapid progress of globalization, the Republic of Turkey, one of the most prominent of Europe's newly emerging economies, is expected to achieve significant growth, centering on its manufacturing industries. Given its strong international competitiveness in terms of labor and raw materials, the country's automobile industry has particular potential for growth.

Therefore, as an opening move in Turkey's new global production strategy, the authors proposed a New Turkish Production System (NTPS). The NTPS has been developed by integrating the Advanced TPS, itself an evolved model of the current Toyota Production System, the leading Japanese production system, with the Advanced Turkish Production System, which is an evolved model of the current Traditional Turkish Production System. The integration of these two models was then further evolved to form the NTPS. As an opening move in Turkey's new global production strategy, therefore, the authors propose a New Turkish Production System (NTPS), which would represent the integration and evolution of the Advanced TPS, which is itself an evolved model of the current Toyota Production System, the leading Japan production system, and the Advanced Turkish Production System, which is an evolved model of the Traditional Turkish Production System cultivated to date.

CURRENT STATUS OF TURKEY1 S AUTOMOBILE INDUSTRY - INTRODUCTION OF THE TOYOTA PRODUCTION SYSTEM

Turkey currently ranks 16th in the world for production of automobiles, one of the highest rankings among the newly industrialized countries. The strategic advantages of its location, in terms of production and distribution, have enabled the Turkish automobile industry to establish its own unique production system of which reflects local industries, known as the Traditional Turkish Production System, while achieving steady growth at the same time.

In recent years, in an opening move in the global production strategy of the Turkish automobile industry, leading overseas companies have become increasingly active in local production. For example, since 1994, Toyota Motor Manufacturing Turkey (TMMT) has been conducting training in the Toyota Way at Toyota in Japan and has introduced the TPS (JIT, autonomation (jidoka)).

In the background to this is an undercurrent that Turkey has an environment that is amenable to the introduction of a Japanese- style production system, given the similarities in character between the Turkish and Japanese people and their belief that "success will come if one works hard."

THE JAPANESE PRODUCTION SYSTEM, TPS, AND ITS EVOLUTION

Development of the TPS

The Toyota Production System (TPS) lies at the core of manufacturing in Japan. In recent years, it has progressed as a core technology of "New JIT", a new principle of next-generation production management technology (Amasaka, 2002, 2009). Its main focus is to enable the strengthening and enhancement of the policies of "customer-first, emphasis on employees, and process management" through the incorporation of the four elements (a) to (d) shown in Figure 1 . As the diagram shows, the fundamental principle of TPS is to realize the strengthening and enhancement of customer-first, emphasis on employees, and process management policies through the incorporation of the four key elements: (a) production based on information, (b) production based on workplace configuration, (c) production based on technology, and (d) production based on management.

The first element that must be deployed is production based on information (a). This means innovation of the production management system that gives priority to quality information available both inside and outside of the company. This requires reformation of the production philosophy in order to break free from the conventional practices. Production based on workplace configuration (b) entails the creation of a rational production process and reform of the workplace configuration in accordance with this. Production based on technology (c) involves reinforcement of production technology through QCD research activities that utilize the latest production technology. Finally, production based on management (d) requires understanding the importance of human management and creating a highly creative and active workplace which utilizes and nurtures individuals' innate abilities.

The Evolved Model of the TPS: Advanced TPS

The authors (Amasaka, 2007 and Amasaka, 2010) proposed Advanced TPS, an evolved model of TPS for the strategic deployment of global production (see Figure 2), and have verified its effectiveness at Toyota.

The objective of this model is the systemization of a new, next-generation Japanese production management system, which involves the high-cyclization of the production process for realizing the simultaneous achievement of QCD requirements. The mission of Advanced TPS is to contribute to worldwide uniform quality and simultaneous launch (production at optimal locations) as a strategic deployment of global production and to realize Customer Satisfaction (CS), Employee Satisfaction (ES), and Social Satisfaction (SS) through high quality assurance manufacturing.

In order to make this model a reality, it will be necessary to adapt it to handle digitalized production and reform it to realize an advanced production management system. Furthermore, other prerequisites for realizing this include the need to create an attractive working environment that can accommodate the increasing number of older and female workers at the production sites and to cultivate intelligent production operators. These measures need to be organically combined and spiraled up in order to make the simultaneous achievement of QCD possible. One of the technical elements necessary for fulfilling these requirements is the reinforcement of maintenance and improvement of process capabilities by establishing an intelligent quality control system. Second, a highly reliable production system needs to be established for high quality assurance. Third, reform is needed for the creation of a next-generation working environment Üiat enhances intelligent productivity. Fourth, intelligent production operators need to be cultivated who are capable of handling the advanced production system, and an intelligent production operating system needs to also be established. Worldwide uniform quality and simultaneous launch (production at optimal locations) are being achieved through strategic management of these elements (Amasaka & Sakai, 2010).

PROPOSAL OF THE NEW TURKISH PRODUCTION SYSTEM

Having investigated the actual situation in Turkey, the authors propose a New Turkish Production System (NTPS) with the objective of the integration and evolution of traditional Turkish production systems and the aforementioned Japanese production system.

Concept of NTPS

Based on the research of Ramarapu et al (1995) and of Amasaka et al (Amasaka, 2004, 2007a, 2007b, 2008a, 2008b, 2009; Ebioka et al, 2007; Yamaji, et al, 2007, 2008; Amasaka, 2007; Amasaka et al, 2008), the authors (Mustafa, 2009) proposed, in Figure 3, a concept for NTPS.

The left side of the diagram shows the hierarchy of the Toyota Production System (TPS), which forms the foundation of Japanese-style production systems and its evolved model, Advanced TPS. Similarly, the right side of the diagram shows the Traditional Turkish Production System and its evolved model, the Advanced Turkish Production system.

In order to integrate and evolve the concepts of these two production systems, the common factors (elements) among the various production elements, such as JIT and the Lean System, in Turkey and Japan, as well as those factors (elements) that are unique to Turkey, must be taken into consideration.

Extraction of Important Keywords for NTPS

In order to extract the common factors (elements) and the Turkey-specific unique factors (elements) required for the NTPS, the authors (Mustafa, 2009) conducted field surveys of Japanese (Toyota Motor Corporation, Honda, Denso, Central Motors, Nihon Spring, and others) and Turkish local manufacturers (TOFAS, OYAK-Renault, FORD OTOSAN, TOYOTA Turkey, and DENSO Turkey).

In these surveys, approximately 500 language data were obtained from interviews, findings obtained from manufacturing plant tours, on-site case studies and reference literature. An affinity diagram of the data thus obtained, based on 5M-E (man, machine, material, manufacturing, measuring, environment), was used to investigate the relationships between the data based on empirical technologies.

As shown in Figure 4, the authors were able to extract, as important keywords for the NTPS, ten common factors - four unique factors specific to Turkey and two unique factors specific to Japan.

* The factors common to Turkey and Japan are (1) quality assurance, (2) SQC education, (3) QCD activities, (4) kaizen activities, (5) creative proposal programs, (6) improvements through environmental regulations, (7) automatic management methods, (8) global partnering, (9) safety, and (10) definition, awareness and elimination of muda (waste).

* The Turkey-specific factors are (11) Turkish-style human resources education, (12) production, quality, logistics and informational harmony with European manufacturers, (13) focused kaizen, and (14) production management through World-Class Manufacturing (WCM).

* The Japan-specific factors are (15) digital engineering/CAE, and (16) new, people-focused production approaches.

Text Mining Analysis

The authors further used text mining analysis to explore in more detail the relationships between the language data obtained in 4.2.

Examples of the results of analysis of the 5M-E keywords for the NTPS are explained below. First, the relationships between TPS and Advanced TPS (necessary keywords that each should possess) are shown clearly in Figure 5. Further, in a similar manner, the relationships between the Traditional Turkish Production System and the Advanced Turkish Production System are shown clearly in Figure 6.

Figure 5 shows that TPS, JIT, workplace environment, SQC, and standard work orientation have a high degree of relationship and that the key elements (factors) that should be present in Advanced TPS include worker education, assurance of high quality, DE, CG, SQC, Global Production, Virtual Plant, simulation and partnering.

Proposal for New Turkish Production System (NTPS)

Based on the results of analysis obtained, as described above, and the findings from same, the authors (Mustafa, 2009) have proposed, in Figure 7, a New Turkish Production System (NTPS).

The New Turkish Production System (NTPS) represents the integration and evolution of the Advanced TPS, which is itself an evolved model of the current Toyota Production System, and the Advanced Turkish Production System, which is an evolved model of the Traditional Turkish Production System cultivated to date.

As shown in the diagram, from the perspective of 5M-E, factors that are common to Japan and Turkey, Turkey-specific factors, and Japan-specific factors have been considered as the technological elements (factors) required for production.

Not only will this enable the Turkish automobile industry to enhance its technological capabilities and increase production, but it will also lead to expectations of the production of high-quality products and the development of flexible production systems in the future.

CONCLUSION

This paper proposes a New Turkish Production System (NTPS), with the objective of the integration and evolution of the Toyota Production System (TPS and the traditional Turkish Production System, for the growth of the Turkish automobile industry.

Hereafter, the authors will conduct verification research into the effectiveness of the proposed New Turkish Production System.

Subject: Automobile industry; Production management; Lean manufacturing; Integration; Case studies

Location: Turkey

Classification: 9178: Middle East; 9130: Experiment/theoretical treatment; 8680: Transportation equipment industry; 5310: Production planning & control

Publication title: Journal of Business Case Studies

Volume: 6

Issue: 6

Pages: 69-76

Number of pages: 8

Publication year: 2010

Publication date: Nov/Dec 2010

Year: 2010

Publisher: Clute Institute for Academic Research

Place of publication: Littleton

Country of publication: United States

Publication subject: Business And Economics--Management

ISSN: 1555-3353

Source type: Scholarly Journals

Language of publication: English

Document type: Business Case, Feature

Document feature: Diagrams References Tables

ProQuest document ID: 818384026

Document URL: http://search.proquest.com/docview/818384026?accountid=38610

Copyright: Copyright Clute Institute for Academic Research Nov/Dec 2010

Last updated: 2013-09-06

Database: ABI/INFORM Complete

Document 8 of 100

Using Hyperlinks To Create A Lecture On Calculating Beta And The Beta Coefficient For Dow Chemical Company

Author: Harper, Nakita; Jordan, Keshawna; McGowan, Carl B; Revello, Benjamin J

ProQuest document link

Abstract:

In this paper, we show hyperlinked Power Point lecture slides that show how to calculate the beta coefficient for Dow Chemical Company using the S&P 500 as the market index. This paper shows how to collect data for both Dow Chemical and for the S&P 500 Stock Index, how to calculate monthly returns, and how to run a regression to calculate the beta. The data for both Dow Chemical and for the S&P 500, fifty-one month end prices including dividends, are down loaded from Yahoo! Finance and loaded into an Excel worksheet which is used to calculate monthly returns. The fifty monthly returns are regressed with the S&P Index return as the independent variable and the Dow returns as the dependent variable. The returns are graphed to check that the analyst ran the regression properly. [PUBLICATION ABSTRACT]

Full text:

MODERN PORTFOLIO THEORY

Markowitz (1952) develops the basis for modern portfolio theory by describing the relationship between risk and return for efficient portfolios on the efficient frontier. The efficient frontier is the set of all portfolios that have the highest rate of return for a given level of risk or the lowest level of risk for a given rate of return1. When the efficient frontier is combined with the utility preference function for the investor, a specific portfolio can be defined which will optimize utility for the selected investor. The optimal portfolio will provide the investor with the highest possible return for the given level of risk selected for the investor. Conversely, die optimal portfolio will provide the lowest possible risk for the given return level selected by the investor.

Tobin (1958) adds a risk- free asset to the investment universe which allows investors to separate the investment decision from the investing decision2. Each investor selects a mix of the risk- free asset and me market portfolio based on the individual investor's utility preference for risk and return. However, the capital market line, as it is called, only applies to efficiently diversified portfolios. However, not all portfolios are efficient, such as an individual stock.

Total risk can be decomposed into two components, systematic risk and unsystematic risk. Unsystematic risk is firm specific and can be diversified while systematic risk is market driven and cannot be diversified. Sharpe (1961) develops an asset pricing model for securities based on market risk only. Systematic risk is estimated for a single asset using the regression line of the linear regression between a market index and the returns for an individual stock. The slope of this regression is the beta coefficient for the stock and is the measure of systematic risk. The regression is usually performed with five years of monthly data or sixty monthly observations.

Beta is estimated using the market model in which the return for the stock is equal to the x-axis intercept, α^sub i^, plus the firm's beta, Ã^sub i^, times the return on the market, R^sub m^, plus the error term, Îμ.

R^sub i^ = α^sub i^ + Ã^sub i^ (R^sub m^) + Îμ

Koller, Goedhart, and Wessels (2005, pp. 313-314) suggest that regressions for individual companies be run with sixty monthly observations against a value-weighted index such as the S&P 500.

The regression demonstrated in this paper is performed with the return for the S&P 500 as the independent variable, that is, the market index, and the return for Dow Chemical is the dependent variable. Monthly returns are calculated for the S&P 500 and Dow Chemical for five years which yields sixty monthly returns.

The focus of this paper is to demonstrate a Hyperlinked, Power Point Presentation to perform the process of down loading the data needed to calculate the Characteristic Line for Dow Chemical Company using the S&P 500 Index as the independent variable3. We show how to download the data, how to manipulate the data to calculate the monthly returns, how to regress the data, and how to graph the results for comparison purposes.

THE POWER POINT PRESENTATION

There are nine separate Power Point files and three Excel files hyperlinked to the main file. Appendix A provides a list and description of the twelve files. There are a total of fify Power Point Slides. The master Power Point file hyperlinked to the other files and is called Regression Main. To execute this program, highlight the "Regression Main" icon and double, left click. This will call up the file which will then be run as a slide show by clicking "Slide Show" and "From the Beginning." The remaining PPT files are executed by clicking on each set of commands such as "Obtain S&P 500 Data." The Power Point files are available from the corresponding author.

Power Point Files - Hyperlinked

1. Obtain S&P 500 Data - download the S&P 500 monthly, dividend adjusted prices.

a. This file takes one to Yahoo! Finance where one clicks on "S&P 500".

b. Next, one clicks on "Historical Prices."

c. Set the "Start Date" and the "End Date" and indicate that you want to download "monthly" data. Click on "Get Prices." The data will appear in spreadsheet format.

d. Scroll to the bottom of the spreadsheet and click on "Download to Spreadsheet."

e. Select "Open with" Microsoft Office Excel (default)" to download the data into an Excel spreadsheet. Click "OK" at the bottom of the command window.

f. Click on the Microsoft Office Button in the upper left-had corner and select "Save As" to save the file. Type in the File Name such as "S&P500", select the file type Excel Worksheet, and click the "Save" button in the lower left-had corner of the command window.

2. Obtain Company Data - download the Dow Chemical monthly, dividend adjusted prices.

a. This file takes one to Yahoo! Finance where one enters the company "Ticker Symbol" in the space before the "Get Quotes." Command.

b. Next, one clicks on "Historical Prices."

c. Set the "Start Date" and the "End Date" and indicate that you want to download "monthly" data. Click on "Get Prices." The data will appear in spreadsheet format.

d. Scroll to the bottom of the spreadsheet and click on "Download to Spreadsheet."

e. Select "Open with" Microsoft Office Excel (default)" to download the data into an Excel spreadsheet. Click "OK" at the bottom of the command window.

f. Click on the Microsoft Office Button in the upper left-had corner and select "Save As" to save the file. Type in the File Name such as "Dow Chemical", select the file type Excel Worksheet, and click the "Save" button in the lower left-had corner of the command window.

3. Arrange Data - Combines the S&P 500 and Dow Chemical returns.

a. Click on the Microsoft Office Button and select "Open" and find the "Regression PP" folder and select "Save As" to save a new Excel workbook named "DOW Regression".

b. Click on the Microsoft Office Button and select "Open" find the "Regression PP" Folder and select the "S&P 500" workbook. Click "Open".

c. Copy the "S&P 500" date in Cells Al : A62 to the new workbook "DOW Regression" beginning in Cell Al.

d. Copy the "S&P 500" data in Cells G 1 to G62 to the new workbook "DOW Regression" beginning in CeIlBl.

e. Click on the Microsoft Office Button and select "Open" find the "Regression PP" Folder and select the "DOW" workbook. Click "Open".

f. Copy the "DOW" date in Cells A1:A62 to the new workbook "DOW Regression" beginning in Cell Cl.

g. Copy the "DOW" data in Cells Gl to G62 to the new workbook "DOW Regression" beginning in Cell Dl.

h. Compare the dates in Cells A2:A62 and C2:C62 to ensure that they are the same.

i. Highlight Cells Dl :D62 and select "Cut" with Ctrl-x. Click on Cell Cl and paste die "DOW" data by selecting Cntrl-v.

j. Rename Column B "Adj Close S&P" and Column C "Adj Close Dow",

k. Click on the Microsoft Office Button and select "Save" and find the "DOW Regression PP" file to save the data working file.

4. Arithmetic Return - Computes the monthly arithmetic returns for the S&P 500 and Dow Chemical.

a. Label Cell Dl "ROR S&P" and Cell El "ROR Dow."

b. Type = (B2-B3)/B3 in Cell D2.

c. Highlight Cell D2, align the cursor to the bottom right corner of Cell D2 until the small cross icon appears. Left click and hold and slide the Icon to the right into Cell E3 and then release. This copies me return calculation for S&P 500 one column to the right (Cell E2) which will calculate the return for Dow.

d. Highlight both Cell D2 and Cell E2, align the cursor to the bottom right corner of Cell E2 until the small cross icon appears. Left click and hold and slide the Icon down to the bottom of me data column, and then release. This copies the return calculation for S&P 500 one column to the right (Cell E2) which will calculate the return for Dow.

e. Format the cells with six decimals by highlighting the data from Bl to E60 and click on "Format", "Format Cells", "Number", and use "Up Arrow" to "6." Click "OK."

5. Load Analysis Tool Pak - Shows how to load the Analysis Tool Pak on the computer.

a. If you do not have Analysis Tool Pak installed on your computer, use this set of commands.

b. Left click the "Microsoft Office Button" and select "Excel Options"

c. Select "Add-Ins."

d. Highlight "Analysis Tool Pak" from the add-ins menu.

e. Click OK.

f. Click "Go."

6. Data Analysis - Performs the regression of the S&P 500 and Dow Chemical returns.

a. Left click the "Data" tab and you should see "Data Analysis" to the right. Left click "Data Analysis."

b. Highlight "Regression from the Analysis Tools menu and click "OK."

c. Set me input ranges. Set the "Input Y range" from E2:E61 and the "Input X range" from D2:D61 . The X range is the S&P data and the Y range is the Dow Chemical data. The X range is the independent variable and the Y range is the dependent variable. Default is to output the results in a new spreadsheet.

d. Click "OK."

7. Results

a. The output table for the regression results will be in a separate spreadsheet. The results include the adjusted R2, the F-statistic, and the regression coefficients.

b. For this regression, the adjusted R2 for the regression is 0.3282, the F-statistic is 29.82, and the regression slope coefficient is 1.13 and is statistically significant at the 0.0000 level.

8. Graph - Graphs the S&P 500 and Dow Chemical returns. A common mistake is to reverse the X range and the Y range. Graphing the data and getting the same results mitigates this problem.

a. Highlight Cell D 1:E61.

b. Click on the "Insert" tab b.

c. Click on the "Scatter" tab.

d. Select the "Scatter Plot" option. d.

e. Highlight one of the Data Points and then Right Click.

f. Select "Add Trendline" from the menu. f.

g. Select "Display Equation on chart" from the "Format Trendline" menu.

h .Close the "Format Trendline" menu. h.

i. Click and drag the equation from within the graph to the right side.

j. The slope and the intercept terms should be the same as calculated in the regression. Otherwise, you reversed the variables in the regression or the graph.

k .To format the axis, highlight the horizontal axis with a right click., Click "Format Axis" from the menu. Click "Number" and change 6 to 2 for the numbers on the axis. Repeat this process for the Y axis.

Everyone should have the same answers. If not, check the input data for similarity throughout the entire process. Typical errors involve students downloading different time periods or different a number of observations.

Table 1 shows the results for the regression of the S&P 500 returns and the Dow Chemical returns. The regression coefficient, beta, is 1.1333 and the intercept, alpha, is -0.0077, and the Adjusted R2 is 0.3282. The same statistics appear on the Graph in Figure 1 , indicating that the regression and the graph are correct.

SUMMARY AND CONCLUSIONS

This paper provides a Power Point file that can be used to teach students to how to collect data for the S&P 500 and Dow Chemical that can be used to calculate sixty monthly returns. These returns are used in the market model regression to compute the beta coefficient for Dow Chemical. This paper provides Power Point slides to demonstrate how to graph the data both to see the relationship between the returns for the S&P 500 and Dow Chemical and to function as a check to assure that the regression was run properly.

Subject: Chemical industry; Hyperlinks; Rates of return; Regression analysis; Models; Indexes; Case studies

Location: United States--US

Company / organization: Name: Dow Chemical Co; NAICS: 325188, 325199, 325211

Classification: 9130: Experiment/theoretical treatment; 8640: Chemical industry; 5240: Software & systems; 3400: Investment analysis & personal finance; 9190: United States

Publication title: Journal of Business Case Studies

Volume: 6

Issue: 6

Pages: 77-83

Number of pages: 7

Publication year: 2010

Publication date: Nov/Dec 2010

Year: 2010

Publisher: Clute Institute for Academic Research

Place of publication: Littleton

Country of publication: United States

Publication subject: Business And Economics--Management

ISSN: 1555-3353

Source type: Scholarly Journals

Language of publication: English

Document type: Business Case, Feature

Document feature: Tables Graphs References Illustrations

ProQuest document ID: 818381623

Document URL: http://search.proquest.com/docview/818381623?accountid=38610

Copyright: Copyright Clute Institute for Academic Research Nov/Dec 2010

Last updated: 2013-09-06

Database: ABI/INFORM Complete

Document 9 of 100

The Symphony Of Southeast Texas In 2010: Managing A Regional Orchestra In Modern Times

Author: Escamilla, Craig; Venta, Enrique (Henry R

ProQuest document link

Abstract:

The Symphony of Southeast Texas is a regional, professional symphony orchestra based in Beaumont, TX. The orchestra operates on an annual budget of approximately $550,000, and employs musicians on a per-service basis. In 2009, the orchestra hired a new Music Director following two years of searching and auditions. Chelsea Tipton, II, ignited a fire amongst all of the organizations constituents from his first visit to Beaumont for his audition in March 2009. Following his appointment as Music Director, the organization's members realized what a remarkable opportunity was at hand for the orchestra. The organization had to capitalize on the enthusiasm surrounding a new Music Director, but this came with a unique set of challenges. Orchestras, like non-profit organizations in general, struggle with maintaining a sustainable business model. This case study describes the opportunities, and the challenges associated with them, that regional orchestras, and similarly positioned small non-profit organizations, face. [PUBLICATION ABSTRACT]

Full text:

INTRODUCTION

On October 17, 2009, Chelsea Tipton, II, debuted as the new Music Director of the Symphony of Southeast Texas. With a record classical concert audience of over 1 ,000 attendees, number of tickets sold totaling almost 1,250, and media coverage generating an electric buzz in the community, the orchestra was moving forward into a new era. The success of the first concert, and the energy generated by it, presented previously unknown opportunities for the orchestra to achieve new successes. However, as with all nonprofit organizations, the Symphony of Southeast Texas was facing its share of challenges. The orchestra, coming off of an 80% turnover in staff, faced the opportunity for significant changes to allow greater growth into the future. With the selection of a new leader for the orchestra, one who could be present, active, and involved in the friendly and intimate community of Beaumont, Texas, the orchestra's Board and staff prepared for the best. However, constituents quickly realized that the growth and success of the organization could not depend only upon the new Music Director. Everyone had a responsibility to step up to the plate, and help guide the future of the organization. The orchestra's leadership began assessing all operations and found the following results.

OVERVIEW

Mission

The mission of The Symphony of Southeast Texas is to develop, maintain, and nurture a symphony orchestra of the highest achievable artistic quality that will, within a viable economic framework, play a major role in the education, entertainment and cultural enrichment of all residents of Southeast Texas.

History & Programs

The Symphony of Southeast Texas, based in Beaumont, is the area's only professional symphony orchestra. It is also the only professional orchestra between Houston, TX, and Lake Charles, LA. Four classical concerts and one symphony pops concert currently comprise the orchestra's subscription season. Additionally, the orchestra performs four free youth education concerts for area students, a free July 4 concert in conjunction with the City of Beaumont's festivities, and an occasional "run-out" concert in nearby towns. With the exception of "run-outs", all performances are at the Julie Rogers Theatre in Beaumont, and the season typically runs from October to April. The orchestra plans its concerts and guest artists approximately one year in advance, but often reserves concert dates two to three years in advance.

MUSIC DntECTOR SEARCH

2007-2008 Search

In 2006, me Symphony of Southeast Texas announced that its Music Director/Conductor would be leaving at the conclusion of the 2006-2007 season. During his tenure, the quality of the orchestral playing improved dramatically, a goal of me search committee that selected him in 2001. This improvement, however, came with a price: the replacement of many, long standing, Beaumont based orchestra members with "imported" players from Houston. The maestro 's relationship with the orchestra's Board and patrons can also be characterized as tense, but respectful. His goal was to broaden the audience's and orchestra's horizons, often through a combination of hard work and challenging, and sometimes unfamiliar, repertoire.

With the announcement of the maestro' s departure, the Board of Directors commenced with a search for a new Music Director. A thirteen-member committee, made of Board members, Symphony League members, and musicians, was assembled to drive the search process. Four candidates were selected, from nearly 150 applicants, to "audition" during the 2007-2008 season. The "audition" would consist of a variety of Board, Symphony League, and committee meetings, as well as die standard series of four rehearsals and one performance to conclude the week. The selection process began with the organization's previous Executive Director accepting and reviewing the initial pool of 130 applicants. With some help from two search committee members, the pool was cut approximately in half. The remaining candidates' resumes were presented to the Search Committee members for review. Each member ranked die candidates based solely on their resume. The rankings were combined, and the pool was narrowed to approximately twelve. The twelve remaining candidates submitted conducting videos, which were reviewed by the committee. Committee members also contacted references for these candidates. After reducing the number of candidates to five, the committee conducted telephone interviews, and selected the four finalists.

During the 2007-2008 season, the first candidate withdrew her name from consideration. While the three remaining candidates had their share of strengths, good ideas, and creativity, none of them felt like the perfect fit for die orchestra. Faced with the crucial, make or break decision of selecting the best new Music Director, the search committee opted to continue the search, with new candidates, during the 2008-2009 season.

The reaction to the decision to continue the search was quite harsh. Orchestra and audience members felt fhat their voice was not heard during die process. Several longstanding donors and supporters considered withdrawing their sponsorships. Advance season ticket sales declined from 2007-2008 to 2008-2009. However, the search committee remained confident that its decision would prove itself correct. With only four months to accept applications, and narrow the pool of nearly one hundred applicants to four candidates, the search committee worked diligently during the summer of 2008.

2008-2009 Search

Prior to reviewing any applications, the Search Committee members participated in a paired weighting exercise to determine the most desired characteristics in the new Music Director (See Exhibit I). The committee suggested fifteen potential characteristics for rating to determine those most desired in the new Music Director. Committee members compared each alternative choosing the one of the two that was most important to him/her. Each member then totaled the number of times he/she chose each number (1 through 15). The total for each number for each committee member was combined to create a master rating. The numbers were then ordered beginning with the one that had been chosen the greatest number of times by the group. The list of characteristics, and the number of votes each received, is shown below.

1. Sincerity/ Authenticity (55)

2. Conducting Skills (54)

3. Programming ability based on Symphony of Southeast Texas' needs (49)

4. Musicianship (48)

5. Ability to teach/develop the orchestra (47)

6. Commitment (43)

7. MD experience (34) tied with Collegiality (34)

8. Charisma (33)

9. Education Concert conducting experience (28) tied with Marketing experience (28)

10. Asst. Conductor experience (27)

1 1 . Fundraising experience (25)

12. National exposure (23)

13. Youthfulness (8)

The committee members agreed that the first six characteristics were indeed the most important to them. They also noted the significant drop in number of votes from item 6 to item 7. This drop indicates that after item 6, the remaining characteristics are not as important to the committee members. The committee was able to use this list as a basis for comparing the four finalists in the 2008-2009 season. The members were able to compare the candidates to the list, and to one another. The committee felt strongly that this exercise helped focus the group, and eventually led to the successful conclusion of the search.

Additionally, to narrow down the initial pool of nearly 1 00 new applicants, the committee hired Henry Fogel, President of the League of American Orchestras, to serve as a consultant. Mr. Fogel provided feedback about each of the applicants in an effort to assist the committee members in narrowing the pool to qualified candidates who might be a good fit for the Symphony of Southeast Texas. Mr. Fogel cautioned the committee members not to make the process too quantitative, but rather to "trust their gut" and look for the "right fit".

Four candidates were selected, and accepted the invitation to audition for the job. The orchestra's constituents were much more satisfied with the potential of one of the candidates from the 2008-2009 season to be the orchestra's next leader. At the conclusion of the season, with nearly unanimous orchestra, Board, and audience support, the orchestra hired Chelsea Tipton, II, as its new Music Director.

What set Maestro Tipton apart? One staff member notes, "I like Chelsea because he is such a genuine, 'down-to-earth' guy. He is forthright, honest, and just a nice guy, and I'm looking forward to working with him." A Board member commented on the Maestro's selection, "I'm glad the committee picked the one I wanted!" As Maestro Tipton prepared for his first season, he expressed a desire to focus on improving consistency of the orchestra personnel. It was his feeling that this consistency would lead to improved quality of playing, familiarity amongst the orchestra with his conducting style, and familiarity for the audience with the faces on stage. He also expressed a genuine interest in getting involved in the community, and making an impact in area school districts to emphasize the orchestra's role in local music education.

As the orchestra prepared for the 2009-2010 season, the Southeast Texas community was abuzz with excitement about the orchestra's new Music Director. The response was fitting considering that the short, opening work on his audition concert in March 2009 received a standing ovation at its conclusion. The enthusiasm following that concert was contagious, and the orchestra was thrilled with the opportunities that the new Maestro's appointment provided.

ORGANIZATIONAL STRUCTURE

Staff

A music director, an executive director, a director of operations, and an administrative assistant/bookkeeper comprise the orchestra's full time staff. The orchestra does not have a marketing director, or a development director.

The Music Director's responsibilities include conducting all of the orchestra's concerts and rehearsals, being the "face" of the orchestra to the community, working closely with the personnel manager on orchestra personnel issues, working with the librarian on musical repertoire issues, working with the Executive Director and the Board of Directors on programming and fundraising activities, and promoting the orchestra throughout the community.

The Executive Director is responsible for the oversight of all of the orchestra's operations, with primary focuses on human resource management, financial oversight, operations oversight, and ftmdraising/development/grant writing activities. Other responsibilities, primarily due to the small nature of the organization's staff, include writing/distributing press releases for performances, designing each concert's program book and the orchestra's bi-monthly newsletter, and similar tasks. Duties assumed by the Administrative Assistant include ticket sales management, database management, accounting and bookkeeping, and general administrative duties. The director of operations is responsible for assembling the necessary group of musicians for each performance, finding substitutes to fill temporary vacancies and/or musician absences, working with the Julie Rogers Theatre staff to ensure that the stage is set properly for each rehearsal and performance, and renting/distributing musical selections to the orchestra members prior to each concert.

The orchestra's financial resources prevent the offering of significant employee benefits. Benefits are limited to a minimal monthly health insurance reimbursement. Employees are expected to find their own insurance coverage toward which the aforementioned reimbursement may be applied.

Orchestra Musicians

The Symphony of Southeast Texas employs approximately 60 musicians for each performance. The musicians are paid per service. Services consist of rehearsals and performances. Each classical concert has four rehearsals and one performance, while the other concerts each have only one rehearsal. The typical four-rehearsal schedule involves Tuesday, Wednesday, and Thursday evening rehearsals with a dress rehearsal the afternoon of the concert day. The typical one rehearsal schedule involves a rehearsal the evening prior to the concert for daytime concerts or a rehearsal during the day for an evening concert. It is essential to have four full rehearsals for classical concerts because those rehearsals are the only time the orchestra works on the repertoire for that specific concert. Since the musicians do not play together on a weekly basis, four rehearsals are crucial for developing group cohesiveness and preparing the concert.

Although some musicians are members of the American Federation of Musicians, they are not under any type of collective bargaining agreement with the orchestra. A lack of string players in the Southeast Texas area necessitates supplementing local musicians with players from Houston. These supplementary players are often students or freelance musicians. A Board member says of the orchestra's makeup, "It's discouraging to know that mere are talented musicians in this area, quite capable of playing in our orchestra, who are not doing so." This quote summarizes the sentiment of many of the orchestra's patrons. However, another Board member says of the orchestra members, "If quality is compromised to ensure that there are more local players in the orchestra, I'm less likely to attend. I want to attend a good, high quality concert; otherwise, I can simply go to a Houston Symphony concert."

The orchestra's new Music Director, Chelsea Tipton, II, has mentioned many times that his biggest goal in his first season is to increase the consistency of orchestra personnel from one performance to the next. His next goal is to focus on improving the quality of the performances. In his opinion the two go hand in hand. As the orchestra began its strategic planning process in late 2009, musician representation in Board activities increased significantly, for the first time in recent history, with the inclusion of two musicians on the planning committee. The orchestra's management and Board members were surprised to hear the musician representatives' ideas about the organization overall, and that their ideas were not colored by complaints or personal agendas. Additionally, some of the best ideas during a roundtable discussion of what the orchestra does well and what it could do better came from the two musicians. The experience emphasized the value of good communication between constituents.

Board of Directors

The Board of Directors of the Symphony of Southeast Texas has 70 members, each elected to a 3-year term. Members' terms can be renewed an unlimited number of times, as long as the organization wishes to renew their term and they are willing to continue serving. 49 Board members and 3 Symphony League members are voting directors, while the remaining 2 1 are mostly honorary and advisory members. The by-laws indicate that the number of voting members cannot exceed 75, but cannot be less than 30. Local business owners/leaders, community figures, and educational leaders are members of the Board. Each member is asked to purchase season tickets, attend concerts regularly, contribute (or help raise) at least $ 1 ,000 each season, and attend Board and committee meetings regularly. However, only slightly more than 50% of the Board members fulfill any one of these opportunities to support the orchestra.

A 13-member executive committee leads the Board of Directors. (See Exhibit II) Each officer serves a oneyear term. A seven member nominating committee makes officer and new Board member recommendations. The membership votes on the recommendations at the annual meeting of the organization. Honorary and advisory members are not obligated to the commitments of regular, voting members. Honorary membership has gradually become easier to achieve because of a lack of argument on the part of the nominating committee when someone asks to become an honorary member. The by-laws, however, indicate that the Executive Committee shall recommend honorary members for their extensive contributions of time, services, or money to the orchestra. Additionally, honorary members who have moved away from the area, and have little or no active involvement in the orchestra's activities anymore, continue to be maintained as honorary members.

The Symphony of Southeast Texas Board of Directors is charged with the ultimate responsibility for the health and success of the organization. The chain of command for the orchestra can be seen as a pyramid with the Board President and Executive Committee at the top. The Executive Director and Music Director are equal employees at the second level, with the musicians under the Music Director, and the administrative staff under the Executive Director. The Board falls somewhere in between under the Executive Committee's supervision. The Board is made up of volunteers; no members are paid. This is important because technically a volunteer is in charge of the organization's activities.

Despite the large size of the Board, average attendance at Board meetings is about 35 directors. Board committees usually consist of 6-8 directors, although average attendance at committee meetings is about 3-4 directors. The orchestra faces the challenge of motivating a large and busy group of people around its cause. Potential director conflicts of interest, most of which relative to the Symphony of Southeast Texas are non- financial, must also be avoided. To do so, the orchestra implements a series of checks and balances, the most important of which is a thorough conflict of interest policy. Finally, the orchestra must identify and develop new leaders to carry the organization forward to greater successes.

One Board member notes, "I am curious to know if the orchestra plans to implement a process for identifying and developing new talent and leadership on the Board." Most of the Board members are older, wealthier, and well-established members of the community. Board members typically have little direct involvement in the daily operations of the organization, leaving these operations to the staff hired by the organization. This can, however, create problems when questions about operations arise because of the lack of direct, hands on experience on the Board's end. There is, perhaps, a tendency amongst Board members to reflect on the past, especially those who have been involved with the orchestra for many years. Comments from Board members often begin with "We used to..." or "Why don't we... anymore?" When new ideas are introduced, a frequent response is "We tried that once before, but it didn't work."

One Board member commented to the new Music Director, "Motivating the Board of Directors is very difficult. There are a lot of people, good people, involved with the orchestra, but some of them seem to be here only to list their involvement on their resume." Another Board member admitted "it frustrates me when Board members and musicians ask why we didn't avoid this or that conflict with ? community event. We have to plan our concerts years in advance, and can't constantly shift dates to avoid every possible conflict. There will always be something else going on, but it's the Board's job to advocate for the Symphony, and make it the primary event that people desire to attend." A member of the Executive Committee comments, "I don't think, as just a general member of the Board, I ever realized just how much work the small staff of the Symphony of Southeast Texas does. The resources are extremely limited, yet an enormous amount of extremely high quality work always gets done." Overall, the Board is very supportive of the organization, and is active in promoting the orchestra throughout the community. Motivation and communication are important tasks for the staff and Board to share. One Board member notes that the orchestra should make it a priority to focus more on "internal marketing" to its various constituencies.

Symphony League of Beaumont

The Symphony League of Beaumont supports the orchestra through various fundraising activities and contributions. The Symphony League has over four hundred members. More often than not, though, the same small group of volunteers can be found doing the majority of the work. Both organizations have a responsibility to motivate members to get more involved in the activities of both organizations. The orchestra is sitting on a goldmine of potential audience members. However, there is a perception that some of these potential audience members may not even realize that there is a connection between the Symphony of Southeast Texas and the Symphony League.

The organization holds two annual gala events to raise money for the orchestra, in addition to numerous smaller educational and cultural activities throughout the year. The organization focuses on cultural education and appreciation by middle and high school students in the area. The Symphony League is a separate organization from the orchestra, and is deeply involved in its various activities, most of which add great value to the community. Interaction between Symphony League members and the orchestra's staff, Board, and musicians, is limited. Although representatives of both organizations sit on each other's Boards, interaction is often limited to meetingoriented interactions.

FINANCIAL OVERVIEW

The Symphony of Southeast Texas is a 501(c)(3) non-profit organization. The organization's income comes in two forms: earned and contributed. Earned income is derived from ticket and program ad sales. As indicated by EXHIBIT III, earned income comprises slightly more than 20% of all income. Contributed income, derived from individual and corporate sponsorships, grants, and contributions from the Symphony League, and endowment income, comprise the remainder of the orchestra's income. This heavy reliance on contributed income is a concern for the orchestra's Board and staff. There are many reasons that may cause a donor to reduce, or eliminate entirely, his/her contribution to the orchestra. This uncertainty makes the budgeting process quite difficult. The current donor system is a tiered system featuring 8 different donor categories (based on amount contributed) and a permanent endowment category. Various benefits are available for donors at each level with the magnitude of the benefit increasing as the contribution increases.

Over the past few years, the orchestra's leaders have been extremely conservative when budgeting income, but extremely liberal when budgeting expenses. Artistic expenses make up slightly more than 50% of the operating budget. The administration considers this a reasonable and accurate percentage, since these funds are expended directly on performances, which are the main purpose of the organization's existence. Production and administrative expenses comprise the rest of the expense side of the budget. The goal of the Symphony of Southeast Texas is to keep administrative overhead expenses low, while using the majority of the organization's funds for its core activities. If a surplus exists at the year's end, it is expected that the excess funds will be reinvested into new projects and activities.

Where many for-profit organizations have numerous forms of controllable revenue, the Symphony's controlled streams are limited. Therefore, the question of how to increase ticket sales and attendance is crucial to the long-term survival of the organization. With a heavy dependence on contributed income, the Symphony of Southeast Texas derives its support from audience members' desire to be involved with the organization. Developing sympathy for the cause is an important responsibility for the Symphony of Southeast Texas. The orchestra wonders how it can break this cycle of uncontrollable dependence in order to free up more funding for expanding its program offerings. Leadership questions how to expand the audience, and whether to expand laterally, or to attempt to reach new audience segments. Ultimately, though, the goal is to figure out how to make each concert a must see event.

AUDIENCE INVOLVEMENT

The Julie Rogers Theatre, where the Symphony of Southeast Texas performs, seats 1,663 audience members. Average ticket sales for a Symphony of Southeast Texas concert, including those audience members who purchased season tickets, number approximately 1,200. However, actual concert attendance ranges from 700-800 people per performance. It is rare that a person who purchases a single ticket to a specific concert does not actually attend the performance. It is much more frequent for season ticketholders to miss various individual performances throughout the season. The orchestra's administration also questions the nearly 500-seat difference in sold tickets and available seats, and wonders how to increase demand. Traditionally, the orchestra's annual Pops concert sells many more tickets than the classical concerts, and often the full number of available tickets is sold. However, attendance, though higher at the Pops concert than the classical concerts, still remains low relative to the number of seats sold, with a number of ticket purchasers not using their tickets.

A Symphony of Southeast Texas concert usually lasts about two hours, including social time before and after the concert, and a twenty-minute intermission. This length is consistent with the average length of orchestra concerts across the nation. The orchestra moved its performances from Thursdays at 8:00 p.m. to Saturdays at 7:30 p.m.at the start of the 2004-2005 season. Since the change, a handful of longtime supporters have expressed dissatisfaction with the concerts on Saturdays because of the numerous other local activities that demand their time. Despite this small group's insistence that the change has upset a great number of concertgoers, die Symphony's Board and administration feel strongly that conflicts will both exist, and arise, regardless of the day and time of the performances. The orchestra faces competition from other local activities such as concerts, Broadway touring shows, movies, and high school sports. The latter conflict is predominant in the Southeast Texas area, and, for example, prevents the orchestra from holding any major activities on Friday evenings in the fall to avoid Friday night football.

The Symphony of Southeast Texas has been evaluating its involvement with audience members before, during, and after performances. The orchestra began holding pre-concert discussions during the 2009-2010 season. The discussions provide an opportunity for audience members to dive a bit deeper into the repertoire to be performed that night. They usually take place about 30-45 minutes prior to the performance, in the theatre. The discussions are very common at other orchestras. The orchestra has volunteers on hand at the performance to take ticket stubs and distribute program books, but no one to direct patrons to their seats, or assist in other usher-like ways. Another type of audience engagement is a post-concert discussion during which the conductor, and possibly guest artist, sits on stage following the concert and interact with audience members who choose to stay. The Symphony of Southeast Texas is exploring this concept.

The average audience member's demographic is similar to Board members'. This conforms to the usual standard for orchestras around the country. One Board member notes, "I see more young people beginning to attend our concerts, and I think it's a good thing. I wonder, beyond offering $5 student rush tickets, how we can continue to attract younger audience members." A Symphony staff member comments, "I do think it's important to attract younger audience members, however, I can think of at least 100 potential audience members in their 40s or 50s who may not even know there is a Symphony of Southeast Texas. I'm equally interested in finding ways to attract those potential patrons." Finding ways to resume relationships with audience members who have lost contact with the orchestra is an important goal of the Symphony of Southeast Texas.

MARKETING

Since 2007, the local cable company in Beaumont, TX, has generously agreed to donate three weeks of complimentary advertising, across all 78 channels, for each Symphony of Southeast Texas concert during the season. Another generous underwriter sponsored the development and production of the ad spot. The Symphony of Southeast Texas has no other television advertising spots beside the aforementioned donation. These spots run with increasing frequency as the concert approaches, and the average exposure is about one hundred, two hundred, and three hundred spots for weeks three, two, and one away from the concert, respectively. However, with increased use of the Internet, especially by younger potential audience members, the Symphony questions whether television ads, even complimentary ones, are effective means of developing new audiences.

The Symphony of Southeast Texas also receives complimentary radio advertising time on several local stations, but does not receive complimentary production of these ads. This has been a significant deterrent to any major radio campaigns, because production can quickly become very expensive. The orchestra also purchases an ad for each concert, for the week preceding the performance, in the local newspaper. Readership has declined significantly in recent months, though, and the newspaper production's relocation to Houston following Hurricane Ike has reduced the amount of local news and event coverage. Therefore, whereas the orchestra previously depended on a feature article covering the concert, plus the newspaper advertisement, the leadership now sees an ad in a small paper reaching a small readership.

The orchestra distributes a press release prior to each concert it performs. The release reaches local daily and weekly publications, local television, and local radio stations. Often the releases are overlooked, or copied (with severe edits) into the publication with little or no genuine interest or support. Appearances on local morning radio and television shows get a face for the orchestra before the public, but exposure at prime air times and on prime programs, is limited or nonexistent. The Symphony of Southeast Texas tends to receive the most attention for its annual pops concert, when local media outlets lavish extensive attention on the orchestra's upcoming performance. However, the organization's leadership wonders how to bring that same interest and energy to its classical performances.

The orchestra does not participate in Internet advertising, other than its website, designed at the organization's office. The Symphony of Southeast Texas pays for the services of a local advertising agency to assist with the preparation, production, and distribution of ads. However, the company is stretched entirely too thin, and the need for advance exposure before a Symphony concert is often not a priority for the last minute ad design world. The lack of controllable revenue streams prevents the orchestra from allocating significant amounts of money toward advertising.

The Symphony of Southeast Texas, like all orchestras, faces the challenge of differentiating one classical concert from another in press releases. For example, the orchestra may play an overture by Beethoven on its first concert, and a symphony by Beethoven on its second concert. To the average media reporter there may seem to be no difference between the two concerts, when in reality, the Beethoven work on the first concert may be a 1 0 minute long concert opener, while the Beethoven work on the second concert may be his 35 minute Symphony No. 5, arguably the most famous piece of music ever written. Thus, a lack of clear differentiation may be a detriment to the orchestra's publicity efforts. The orchestra, like most, is probably deficient in this area.

Without a marketing staff member, the orchestra's administration is uncertain about the best publicity vehicles to promote its product. The limited time that the small staff, and the volunteer Board, has to devote to marketing prevents any real focused, planned, and innovative strategies for increasing public exposure. In 20092010, the orchestra plans to heavily promote its new Music Director, but the administration is concerned about interest in him past the first concert of the season.

WHAT IS NEXT?

The Symphony of Southeast Texas' leadership is determined to find the best way to achieve its goals and to bring its message to a broader constituency of the Southeast Texas area. However, many challenges and roadblocks exist for the orchestra to overcome. A responsibility to aggressively seek, recognize, invest in, and develop local talent and leadership is crucial to the organization's continued success. The new Music Director has a responsibility to be a true community player and advocate for the organization throughout Southeast Texas. A need to aggressively monitor the Symphony's financial situation and to not only maintain stability, but to seek new funding opportunities, is also essential to the orchestra's continued success. Finally, a need to reach out to new groups, via new and unique means, is a component that will ensure genuine interest and involvement for years to come. With 56 years behind the organization, the groundwork must be laid now to ensure at least 56 more years of success. The orchestra's leadership agrees that stability and status quo are not enough - that only growth, expansion, and new horizons will suffice. In an effort to grow and expand, the leadership is enthusiastic about finding new ways to achieve greatness for the Symphony of Southeast Texas.

Subject: Orchestras; Nonprofit organizations; Business models; Directors; Case studies

Location: United States--US

Company / organization: Name: Symphony of Southeast Texas; NAICS: 711130

Classification: 9190: United States; 8307: Arts, entertainment & recreation; 9540: Non-profit institutions; 2310: Planning; 2110: Board of directors; 9110: Company specific

Publication title: Journal of Business Case Studies

Volume: 6

Issue: 6

Pages: 85-95

Number of pages: 11

Publication year: 2010

Publication date: Nov/Dec 2010

Year: 2010

Publisher: Clute Institute for Academic Research

Place of publication: Littleton

Country of publication: United States

Publication subject: Business And Economics--Management

ISSN: 1555-3353

Source type: Scholarly Journals

Language of publication: English

Document type: Business Case, Feature

Document feature: Tables

ProQuest document ID: 818381386

Document URL: http://search.proquest.com/docview/818381386?accountid=38610

Copyright: Copyright Clute Institute for Academic Research Nov/Dec 2010

Last updated: 2013-09-06

Database: ABI/INFORM Complete

Document 10 of 100

Strategic Recruiting: A Human Resource Management Case Study

Author: Murray, Lynn M; Fischer, Arthur K

ProQuest document link

Abstract:

This is a Human Resource Management (HRM) case used to encourage student thought and discussion following a class segment on recruiting. Midwest Education, Inc.: A Human Resource Management Case is used to exemplify many of the human resource problems encountered in a typical complex organization. It provides history and background of the company, Midwest Education, Inc. (which is closely modeled after a major developer and supplier of educational materials). The case presents the three major divisions of the company and shows how each is following a different strategy. With this background, the case presents the current problems which arise as the company seeks to change from ad hoc recruiting practices to a planned, strategically aligned process. As the case develops, it is seen that corporate headquarters is challenging the HR directors of each of the operating divisions to address recruiting issues through a systematic approach. Readers are challenged to determine what issues are most pressing during the recruiting process, and to develop comprehensive recruiting plans for the divisions. [PUBLICATION ABSTRACT]

Full text:

INTRODUCTION

Midwest Education, Inc. is a major supplier of educational materials for the United States. The company focus is on learning tools and systems for use in technology, science and business classrooms. In addition, it develops and provides books, manuals, videos, software and hardware used in the fields of technology education, instructional development and business applications.

The company has its headquarters and primary manufacturing plant in a major Midwest commumty. In addition, the Creative Development offices are located in Massachusetts and California. Transportation, Service and Maintenance facilities are headquartered out of Texas, with major branches in Baltimore and Phoenix.

The three main divisions exemplify three different strategies: c ost-reduction, quality enhancement, and innovation (as discussed by Schüler and Jackson, 1987).

Transportation, Service and Maintenance

The primary strategy of the Transportation, Service and Maintenance Division is cost-reduction. Midwest Education, Inc. has long been known for providing service and maintenance programs which are very reasonably priced.

Manufacturing

The primary strategy of the Manufacturing Division is quality enhancement. Midwest education, Inc. has an enviable history of providing the highest quality products which have been adopted by first-rate schools and corporate training programs.

Creative Development

The primary strategy of the Creative Development Division is innovation. Midwest Education, Inc. is widely known for providing truly cutting edge teaching materials which always mirror the latest techniques and processes.

COMPANY HISTORY

Midwest Education was started by Henry and Mary Dalton in 1975. Dr. Henry Dalton was an industrial arts teacher before he got his MBA and went on to get his Ph.D. in Technology Education. Mary was a software developer who also taught business seminars. At that time a new wave of emerging technology was beginning to alter the way people learn and communicate. By developing Midwest Education, Inc. the Daltons began work in an exciting new field. They found a vast market for quality tools mat educated people on how to use all the new technology. Dr. and Mrs. Dalton are in semi-retirement now and travel extensively, but remain major shareholders in the business. They personally hired the CEO when they went into semi-retirement.

The company started with about fifty employees, but has grown consistently and now has a total of 416 employees within its three major divisions: 183 employees work in the Manufacturing Division, 123 work in the Creative Development Division and 135 work in the Transportation, Service and Maintenance Division. There are also 71 employees working at the headquarters in Kansas City (including the corporate staff).

At the beginning on the 1990s it became apparent that international business was becoming the rule rather than the exception. The company went international in 1994 and now is exporting to three European, two Latin American, and two Pacific Rim countries. The Global Operations Division is located within the headquarters.

Headquarters

The corporate headquarters are in Kansas City. The CEO of Midwest Education, Inc. is Judith Lund. Ms Lund was hired by the Daltons in 1994 when they decided to take a less active role in the company while remaining major shareholders. Ms. Lund has an MBA in business management, and was previously the CEO of a small telecommunications company. In her previous position, Ms Lund had successfully steered the company out of financial difficulties by raising stock value. She had initiated a strong advertising campaign and had put the company 'in the black' for the first time in seven years.

The COO of Midwest Education, Inc. is Frank Rose. Frank has been with the company since 1989. Mr. Rose, a cousin of Dr. Dalton, had a successful career with an international business training group in California. His desire to move back to his home town of Kansas City came at a time when the Daltons were looking for a COO. He has worked out well for the company.

The Human Resources Department is also located at the headquarters. The Vice President for Human Resources is Lawrence Wilson. Mr. Wilson has a degree in industrial and organizational psychology and an MBA. He has been with the company for 1 1 years. He started out as a generalist and was promoted as he showed good judgment with hiring and earned his MBA at the same time.

Within the Human Resources Department there are four sections:

1. Staffing, the head of this section is Patrick Shew.

2. Compensation and benefits section, headed by Michael Martin.

3. Labor management relations section, headed by Keith Lane.

4. Training, career development and performance appraisal section, headed by Cynthia Bums.

There are also human resource specialists in each of the three divisions around the country.

Manufacturing Division

The mission statement for the Manufacturing Division is:

The aim of the Manufacturing Division of Midwest Education, Inc. is to continually improve the quality and strength of all our products. The superior products for which we have become world renowned will still be manufactured along with new and innovative products and ideas. We will work hard to keep quality high and cost down while supplying customers with the best possible products in the shortest possible time. The Manufacturing Division follows a strategy of quality enhancement.

The main manufacturing plant is located on the outskirts of Kansas City, not far from the company headquarters. The president of the Manufacturing Division is Max Thorn. Mr. Thorn has been with the company almost since its inception. He was one of the first employees hired by the Daltons. He started writing programs for the company and originally worked alongside the Daltons in interviewing and hiring many other employees.

The head of human resources for the Manufacturing Division is Janine Woods. She has a staff of five generalists who assist her in meeting HRM needs for the Manufacturing Division.

The Manufacturing Division used to be housed in the same building as the headquarters. As the business expanded and more room was needed, the division moved to the suburbs into a large factory site. There are 158 employees in the Manufacturing Division. They are divided into ten teams, each team works at producing and packaging a specific product at a time. There are five supervisors who each supervise two teams: Doris Malone, John Fizer, Sandi Cross, Wendy Atchison, and Ian Carpenter.

The Manufacturing Division usually has a long lead time on orders and can anticipate what will be needed. The factory has flexible work areas that can be re-tooled and rearranged for the changeover from one product to another in less than four hours. The pay in this Division starts at $6.25/hr for production workers and has a full benefits package. Most employees seem happy with their work. Max Thorn is generally thought of as a good, easy-going man to work for.

Creative Development Division

The mission statement for the Creative Development Division is:

In the Creative Development Division of Midwest Education, Inc. we will strive to bring our customers the most innovative and cutting edge programs and products in the world. Our team of creative professionals is constantly working to improve, upgrade, and create the most useful products to bring to our customers. This division follows a strategy of innovation.

The Creative Development Division has two locations; a headquarters in California and a branch located in Massachusetts. The president of the Creative Development Division is Serena Tibaldo. Ms. Tibaldo recently joined the company. Previously she was a software developer for a large computer game producer. She has a bachelor's degree in business and a computer programming master's degree, and is doing very well at Midwest.

The head of human resources for the Creative Development Division is Amelia Chi, who is located at the California headquarters. Ms. Chi has a staff of five assistants. The head of the human resource section at the Massachusetts branch is Virginia Fox. Ms Fox has a staff of two assistants.

There are 90 people employed at the California plant and 38 at the Massachusetts location. The California location opened in 1980 and the Massachusetts branch was opened in 1993. In the 1970's and 1980's many computer software programmers moved to the west coast to be located in Silicon Valley. Most people hired by Midwest Education, Inc. transferred from wherever they lived to the California branch, with the company paying all relocation expenses. By 1990 some employees desired to live in the east. The Daltons decided it was time to expand the company and in doing so decided the next branch would be in the Massachusetts area. Most of the long time elected to remain California. The majority of recent hires are in Massachusetts.

Transportation, Service and Maintenance Division

The mission statement for the Transportation, Service and Maintenance Division is:

The Transportation, Service, and Maintenance Division is committed to providing the fastest and most cost effective way of safely shipping our product to our customers. No effort will be spared as we streamline and improve our fast and friendly service. The Transportation, Senice and Maintenance Division follows a strategy of cost-reduction.

The Transportation, Service and Maintenance Division headquarters is located in San Antonio, Texas. There are major branches in Baltimore, Maryland and Phoenix, Arizona. The President of the Transportation, Service and Maintenance Division is Mark Derrick. Mr. Derrick is based in San Antonio. Mr. Derrick has been with Midwest Education, Inc. for 13 years. He personally hires the managers for the other branches in Maryland and Arizona.

The head of human resources for the Transportation, Service and Maintenance Division is Salvador Vasquez. Mr. Vasquez has a staff of five assistants. Mr. Vasquez appoints HR heads to the other branches. Often they are employees from San Antonio that he knows well and trusts.

The Transportation, Service and Maintenance Division was originally based in Kansas City. As the company grew a decision was made to relocate the division to Texas. The other branches are newer, with Maryland opening in 1989 and Arizona in 1996. There are 55 employees in San Antonio, and 40 in each of the other two branches.

SITUATION - Recruiting Case

As the company grew, it relied predominately on referrals from existing employees and ad hoc recruiting. Now, however, the pace of growth and acquisitions has outpaced the ability of Midwest Education to rely on these methods. The HR department has been tasked with developing recruiting plans to hire employees who will prove to be long-tenured, productive employees - in other words, employees who fit the corporate cultore of Midwest and its various divisions. This task is further complicated by the differing skills, abilities, and output required by each division. Wilson and his staff have met to discuss the needs of each division in its recruiting efforts.

"Welcome to Kansas City - 1 know for some of you, August in KC is a sweltering change fi-om the usual.

"We've got a big task ahead of us. By the end of this week I'd like to have a preliminary recruiting plan for each division to take to the executive committee meeting scheduled for late next week. Our agenda for today's session is to talk about the requirements of each division and brainstoim how we might target each division 's recruiting efforts. I want to emphasize that we will not be abandoning our reliance on hiring referrals fi'om current employees - in fact, I'd like us to play with some way of systemizing our referrals and encouraging more. Let's go ahead and get started. Janine [HR director for the Manufacturing Division] can you tell us about our manufacturing needs? "

Janine: "Thanks, Lawrence. I think our staffing and recruiting requirements are pretty basic. We have about 160 positions on the line. These are divided into ten teams with each team focusing on manufacturing and packaging a specific product. When we hire for these positions, we aren't looking for previous experience as much as we are looking for the ability to work with a group. I rarely actively recruit externally. We really rely on current employee referrals to fill any empty position. Not only do I tend to get a better employee, but the referring employee will help ensure that the new employee is successful - peer pressure can be a great thing!"

"I am starting to see some issues with my hiring of supervisors. We are starting to see more Hispanic immigrants (legal, of course) on the lines, and I'd like to reflect that in my front-line supervisors, whether through promotions or new hires. We know that recruiting for Hispanic persons can be quite different, largely because of the role their family orientation plays. "

"One last thing: one of the reasons we don 't see much turnover in our line people is because of Max. He really sets the tone in the division and our staff likes working for him. We don 't differ in our pay or benefits from other places our employees could work. What makes the difference is the culture at the plant. We really need to emphasize this in our recruiting efforts and the different activities we pursue."

"Thanks, Janine, " Wilson said. "Your current situation seems well-in-hand; however, please consider what it would mean if we were to increase production by 25-40%. Could you handle the staffing requirements through referrals? "

Janine looked veiy doubtful. "OK. Start thinking about how you might recruit applicants for new positions - both line and supervisory. Amelia, you 're up. "

Amelia Chi [head of HR for the Creative Development Division] : "Our situation in Creative differs significantly from Manufacturing. We strive for innovation, and we need to hire for a combination of creativity and programming skills. We look for evidence of these in previous projects, types of experience, and training and education. I've got three big issues: making the right hire, developing the right work environment, and office space. "

"My biggest concern is making the right hire - these folks aren 't only high salaries, they 're also expensive to source and recruit. I need to somehow make sure they have the skills and abilities we need and to make sure they can fit into our work environment. "

"I also have to make sure that I can keep those creative and programming juices flowing. These aren 't typical 95ers - they tend to work crazy hours and are demons for sugar, caffeine, and games.

"My final concern is office space. As you know, our division is located in two of the most expensive locales in the country - Silicon Valley and Massachusetts. I'd like to explore some telecommuting options as well as job- and office-sharing arrangements. "

"Finally, I'd like to explore the possibility of using contract employees. This could be a way for us to provide a realistic job preview for prospective employees and for us to get to know them before we hire them permanently. "

Wilson turned next to Salvador Vasquez [director of HR for the Transportation, Sendee and Maintenance division]. "You 're up, Sal. "

Salvador Vasquez. "Thanks, Lawrence. Our focus in TSM is on cost efficiency - 'we ship cheap ' is our unofficial motto. We've found that inexperience hurts: we hire people who have warehouse and trucking experience, but we also need people who can work with automation, as we have automated as much as possible. We tend to get the best hires for our warehouse positions when we hire a supenisor from another distribution center (whether its a center like Wal-Mart or Sysco) and the new supenisor brings his or her best people along. "

"What we tiy to do is to keep processes and working conditions in each of our three branches as similar as possible - it helps that Mark [Derrick, president of TSM] hires managers for all the branches. "

"As to being ready for an increase of 25-40% of product moved, we already operate at capacity. We '11 need to hire more people and increase our investment in capacity. "

Wilson put his pen down and stood and stretched. "Let 's take a break. We 'Il reconvene in 15 minutes and start brainstorming. "

STUDENTS will be divided into teams, with each team analyzing a different division. Each team will address the following needs for its division:

1. Provide a summary of the HR concerns and challenges of the division.

2. Outline a recruiting plan for the division. What activities would be most important? Why?

3. What external recruiting activities should the division use if workload picks up and the company needs to grow?

FOR THE INSTRUCTOR

Specific questions might be addressed for each division (e.g. Manufacturing - How would you develop a referral program for the division? Creative Development - What are the advantages and disadvantages to using contract staff? and For which positions is a realistic job preview most appropriate? Why?)

Subject: Recruitment; Employment practices; Case studies; Human resource management

Location: United States--US

Classification: 9130: Experiment/theoretical treatment; 2500: Organizational behavior; 9190: United States

Publication title: Journal of Business Case Studies

Volume: 6

Issue: 6

Pages: 97-102

Number of pages: 6

Publication year: 2010

Publication date: Nov/Dec 2010

Year: 2010

Publisher: Clute Institute for Academic Research

Place of publication: Littleton

Country of publication: United States

Publication subject: Business And Economics--Management

ISSN: 1555-3353

Source type: Scholarly Journals

Language of publication: English

Document type: Business Case, Feature

ProQuest document ID: 818381297

Document URL: http://search.proquest.com/docview/818381297?accountid=38610

Copyright: Copyright Clute Institute for Academic Research Nov/Dec 2010

Last updated: 2013-09-06

Database: ABI/INFORM Complete

Document 11 of 100

Calculating The Beta Coefficient And Required Rate Of Return For Coca-Cola

Author: Gardner, John C; McGowan, Carl B; Moeller, Susan E

ProQuest document link

Abstract:

In this paper, we demonstrate how to compute the required rate of return for Coca-Cola using modern portfolio theory with data downloaded from the internet. We demonstrate how to calculate monthly returns for the index and Coca-Cola and how to use the returns to compute the beta coefficient and the required rate of return using the downloaded data. We show how to validate the data for the market index and the company and how to compute the returns using the dividend and stock split adjusted prices. We demonstrate how to graph the characteristic line for Coca-Cola and use the graph to check that the regression was run correctly. We use Coca-Cola and the S&P 500 Index in this paper, but any company listed on Yahoo! Finance can be used as the example. This paper can be used as the basis of a lecture on intermediate corporate finance or investments to demonstrate the process using a real company. [PUBLICATION ABSTRACT]

Full text:

INTRODUCTION

Warkowitz1 (1952) began modern portfolio theory (MPT) which can be used to explain me relationship between risk and return for assets, particularly stocks. Stock of companies that have higher rates of return have higher levels of risk. In order to achieve a lower level of risk, an investor must accept a lower expected rate of return. This concept is called the dominance principle and allows for the creation of the efficient frontier. MPT partitions risk into non-systematic risk, which can be eliminated from a portfolio through diversification, and systematic risk that is market wide and cannot be diversified. Non-systematic risk is company specific and is reduced to zero in a large, well diversified portfolio. In order to determine systematic risk for a stock, we use the market model developed by Sharpe2 (1964). The returns for a stock are regressed as the dependent variable against a market index used as the independent variable. The slope coefficient of the regression is the measure of systematic risk for the stock. Systematic risk measures the degree to which a stock moves with the market. A higher beta coefficient implies that returns for the stock move more than the market and a lower beta coefficient implies that returns for the stock move less that the market. The former are aggressive stocks and the latter are defensive stocks.

In this paper, we show how to retrieve data from the internet, how to compute returns for both the market index and the stock, and how to run a regression to determine the beta coefficient to measure the systematic risk for the stock. In addition, we show how to graph the data with a trend line and statistics to verify that the first regression is run correctly; that is, with the correct variable as the independent variable. We show how to do all of this analysis using Excel.

DOWNLOADING DATA FROM THE EVTERNET

The data used for the analysis discussed in this paper are downloaded from the internet using the Yahoo! Finance website. The URL for Yahoo! Finance is http://finance.yahoo.com/. Once one arrives at the Yahoo! Finance website, the S&P 500 data can be found by clicking on the "S&P500" icon and then, clicking on the Historical Prices" icon. Click on the "Monthly" indicator to download monthly data and enter the dates. For this paper we download sixty-one monthly, observations in order to calculate sixty monthly returns. The data columns are: Date, Open, High, Low, Close, Average Volume, and Adjusted Close. The index and the Coca-Cola price are adjusted for splits and dividends. Move the cursor to the bottom of the data and click on "Download to Spreadsheet". Save the data to a spreadsheet and repeat the process for the Coca-Cola data. Begin by entering the Coca-Cola ticker symbol, KO, and download and save the data for the save time period.

CALCULATING RETURNS FOR THE S&P 500 INDEX AND FOR COCA-COLA3

In this paper, we use arithmetic returns to compute the beta coefficient for Coca-Cola. Arithmetic returns are calculated by dividing the ending index or stock value, (Valued, by the beginning value, (Value0), and subtracting one as in Equation [I]. An alternative method to calculate the return is to subtract the beginning value, (Value0), from the ending value, (Valued, and dividing by the beginning value, (Value0), as in Equation [2]. Both returns are adjusted for dividends and stock splits. The returns used in the regression analysis are arithmetic returns.

Five years of Monthly data are used to generate sixty data points4.

CALCULATING BETA FOR COCA-COLA5

Modern Portfolio Theory shows that investors are rewarded for the systematic risk of an investment and not for the total risk of an investment because total risk includes firm specific risk that can be eliminated in a well diversified portfolio. The specific risk of an individual stock is the slope coefficient of the characteristic line which is the regression line between the monthly returns for the individual security and the monthly returns for the market index. Beta coefficient lines are calculated using a sixty month regression. In this example, the beta coefficient for Coca-Cola is calculated using sixty monthly observations of returns for Coca-Cola from 09/02/2003 to 08/01/2008 and returns for the S&P 500 Index for the same time period. Beta is the covariance between returns for Coca-Cola and returns for the S&P 500 divided by the variance for the S&P 500.

Appendix A contains the data used to compute the Coca-Cola beta and are downloaded from Yahoo! Finance. Column 1 shows the date and Columns 2 and 3 contain the stock split and dividend adjusted index and price values, for the S&P 500 Index and for Coca-cola stock, respectively. The independent variable is the return for the S&P500 (Column 4) and the dependent variable is the return for Coca-Cola (Column 5). The returns are calculated by dividing the ending index or stock value by the beginning value and subtracting one. An alternative method to calculate the return is to subtract the beginning value from the ending value and dividing by the beginning value. Both returns are adjusted for dividend and stock splits. The returns used are arithmetic returns.

Table 1 contains the regression results for the regression between the return for the S&P500 and for CocaCola using Excel. The independent variable is the return for the S&P500 (x-axis) and the dependent variable is the return for Coca-Cola (y-axis). Both returns are adjusted for dividends and stock splits. The adjusted R2 for the regression is 0.23 and the F-statistic is 18.65, both of which are statistically significant at the 0.0000 level. The regression coefficient is 0.7560 and has a t-statistic of 4.31 and is significant at the 0.0000 level.

Figure 1 is a graph of the data used to compute the Coca-Cola beta, which is the characteristic line for Coca-Cola. Figure 1 was created in Excel using the Chart function. The independent variable is the return for the S&P500 (x-axis) and the dependent variable is the return for Coca-Cola (y-axis). Both returns are adjusted for dividends and for stock splits. The chart contains the trend line and R2. The statistics in the graph are the same as the regression statistics in Table 1 . The pedagogical purpose of the graph is to chart the characteristic line for CocaCola and to confirm that the regression was run with the correct independent and dependent variable. If the trend line and statistics in the graph are not identical to the numbers in the regression, the student has reversed the variables.

CALCULATING THE REQUIRED RATE OF RETURN FOR STOCKS6

Graham and Harvey (2002) find that 73.5 percent of respondents to their survey indicate that the company of the survey respondent uses the capital asset pricing model (CAPM) to determine the component cost of common stock equity capital. In this paper, we use the CAPM to compute the required rate of return for Coca-Cola. The required rate of return for Coca-Cola is the minimum rate of return demanded by stockholders of Coca-Cola stock. The model used in this paper is based on the CAPM derived from the work of Sharpe (1964).

The required rate of return for Coca-Cola is the risk-free rate of return plus the risk premium for CocaCola. The risk premium is the beta for Coca-Cola time the market price of risk.

COMPUTING THE REQUIRED RATE OF RETURN FOR COCA-COLA (KO) USING THE CAPM7

The risk free rate is the total return (income plus capital appreciation) on Long-term Government Bonds taken from SBBI 20078. For the years from 1926 to 1976, SBBI uses the Government Bond File from the Center for Research in Security Prices. For the period from 1976 to 2006, the returns in SBBI 2007 are computed from data taken from the Wall Street Journal. The yield for the bond is the discount rate that equates the expected future cash flows, coupon payments and maturity value, to the current price. Table 2 contains a summary of the input data and sources ofthat data.

We use the security market line to compute the required rate of return for Coca-Cola. We use the longterm bond rate taken from SBBI (2007) which equals 5.8% and the long-term market return of 12.3%. The market risk premium is 6.5%. This yields a cost of equity for Coca-Cola of 10.77%.

The required rate of return for Coca-Cola stock is 10.77%.

SUMMARY AND CONCLUSIONS

In this paper, we demonstrate how to compute the required rate of return for Coca-Cola using modern portfolio theory. Data is downloaded from Yahoo! Finance for both Coca-Cola and for the S&P 500 Index. The adjusted stock price for Coca-Cola and the S&P 500 Index are used to compute a five-year, monthly series of returns. The characteristic line is the regression line from the regression in which the monthly returns for the S&P 500 Index are the independent variables and the monthly returns for Coca-Cola are the dependent variables. The regression is run using the Data Analysis Tool Pak in Excel and the Chart function. We use SBBI 2007 data to compute the required rate of return using the market model. We compute a required rate of return for Coca-Cola equal to 10.77%

The objective of this paper is to demonstrate how to download the data needed to compute the required rate of return for Coca-Cola using Modern Portfolio Theory. We demonstrate how to calculate monthly returns for the index and Coca-Cola and how to use the returns to compute the beta coefficient and the required rate of return using the downloaded data. We show how to validate the data for the market index and the company and how to compute the returns using the dividend and stock split adjusted prices. We demonstrate how to graph the characteristic line for Coca-Cola and use the graph to check that the regression was run correctly. We use Coca-Cola and the S&P 500 Index in this paper, but any company listed on Yahoo! Finance can be used as the example. This paper can be used as the basis of a lecture on intermediate corporate finance or investments to demonstrate the process using a real company.

Subject: Rates of return; Soft drink industry; Corporate finance; Indexes; Dividends; Case studies

Location: United States--US

Company / organization: Name: Coca-Cola Co; NAICS: 312111

Classification: 9130: Experiment/theoretical treatment; 3400: Investment analysis & personal finance; 8610: Food processing industry; 9190: United States

Publication title: Journal of Business Case Studies

Volume: 6

Issue: 6

Pages: 103-109

Number of pages: 7

Publication year: 2010

Publication date: Nov/Dec 2010

Year: 2010

Publisher: Clute Institute for Academic Research

Place of publication: Littleton

Country of publication: United States

Publication subject: Business And Economics--Management

ISSN: 1555-3353

Source type: Scholarly Journals

Language of publication: English

Document type: Business Case, Feature

Document feature: Tables Graphs Equations References

ProQuest document ID: 818384219

Document URL: http://search.proquest.com/docview/818384219?accountid=38610

Copyright: Copyright Clute Institute for Academic Research Nov/Dec 2010

Last updated: 2013-09-06

Database: ABI/INFORM Complete

Document 12 of 100

Sugar Cane Refining And Processing Company: A Comprehensive Case In Capital Budgeting

Author: Boudreaux, Denis O; Rao, S P

ProQuest document link

Abstract:

The Sugar Cane Refining and Processing Company is a comprehensive case covering a firm's investment decision in fixed assets or capital budgeting. Most senior level undergraduate and graduate corporate financial management courses cover advanced topics in capital budgeting, including measuring complex cash flows, biasness in the capital budgeting process, agency issues, managerial options and risk adjusting techniques. To cover these relevant topics in a single case, the invented or "armchair" approach is used. This case is completely contrived but is very educationally effective. [PUBLICATION ABSTRACT]

Full text:

INTRODUCTION

Investment decisions involving fixed assets or capital budgeting are extremely important to the firm's success, cash flows, risk and, to a very large part, its market value (Bierman and Smidt 1988). Many financial economists consider capital budgeting to be the most important task facing the financial manager. Finance research has made major advances in theory that provide the tools to correctly evaluate capital investment decisions. These tools are taught in undergraduate and graduate finance classes (for an excellent reference book see Brigham and Capenski 2008). The estimate of true increment cash flows and discounting those projected to cash flows to present value at the appropriate required rate of return has proven to be the correct theoretical method to value a capital project (Woods and Randall 1989). In the last twenty years, possible bias in capital investment decisions' importance has been recognized and addressed in the literature (Pruitt and Gitman 1987). It has been found mat many firms error when considering how to include opportunity costs and sunk costs in their cash flow estimates (Reinhardt 1973). Risk has been a very intriguing component in the analysis of cash flows in capital budgeting. Scenario analysis is a very powerful risk investigating technique that considers both the sensitivity of the net present value to changes in key variables and the range of likely variable values (Hiller 1 963). The risk-adjusted discount rate approach (RADR), although having a slight theoretical flaw, is the most frequently used in practice (Robichek and Myers 1966). Managerial options in capital budgeting have been given much research attention and gaining interest by the business executives (Kulatilaka and Marcus 1992). How to adjust for inflation in capital budgeting is an interesting and well investigated topic (Home 1971).

THE CASE

Patricia Hotard, the senior manager and top executive of Sugar Cane Refining and Processing Company (SCRPC), picked up the telephone to call Jimmy Cohan, the firm's marketing manager. Cohan had sent her a email earlier that morning suggesting mat SCRPC might be able to increase its sales and profits substantially if the "old" or "new" manufacturing plants were allowed to increase me production capacity for making maple-flavored pancake syrup, a high-margin product that is sold primarily in bulk to large grocery chains and restaurants for bottling and sale under their own store and restaurant labels.

"Your suggestion interests me," said Patricia, "but I can't give you an answer until the "financiáis" have been worked up. Also, we are at or near full capacity at our bom locations so we would have to expand one of our current facilities or look for another location. I am not sure we can expand enough at eitiier site but talk to "production" and get their thoughts. Not to bias you or put any pressure but I really hope the increase in sales looks as good as you say. You know we will both probably get a "sweet" bonus and a nice increase in salary if we can markedly increase sales and profits. We must find out if profits from the increased sales you expect to get will give us a big enough return on our capital investment. As soon as you have firm estimates for sales, and how much money you will need for advertising and promotions, get with Stephanie Boudreaux (the company's controller). She can get the other data she needs to make the calculations from purchasing and production, and I will ask her to send me her capital budgeting analysis and recommendation by early next week. If it is as profitable as you think it will be, we will move on it immediately."

SCRPCs first plant ("old plant") which is the focus of dus capital budget study is located on the outskirts of a mid size city in soutìi Louisiana and had been in operation for over 50 years. It was the first sugar refinery to locate in the heart of what was a newly developing sugar cane growing area, and it remains by far the largest processor in the region. SCRPC leased the facility under a long-term contract for many years. In recent years, the property owner and SCRPC agreed to shorten the lease to eight years with provisions to break the lease. For the first twenty years, SCRPC would refine the sugar cane into sugar and package and sell the finished sugar under its own label. In the last twenty years, SCRPC added a processing plant to this refinery that converts the sugar into syrups and other sweetener products. Ten years ago, SCRPC added a second processing plant and built its corporate headquarters at this new site. The newer plant is located in another city that is 30 miles away.

Although a conglomerate acquired the company in the 1960s, it continues to operate autonomously. In addition to the title of senior manager, Patricia Hotard also serves as a vice-president of the parent conglomerate in charge of agricultural product operations. SCRPC plant now produces a range of products, from granulated sugar, maple flavored syrup, buttered syrup, fruit flavored syrups molasses to specialty sweeteners used by other food and beverage processors. The plant has a small section devoted to producing certain sugar based candies (candy cigarettes, love hearts and candy canes). Approximately 20 percent of the plant's current output are sold under the SCRPC label, with the remaining production sold under other firm's names/labels.

The product line (maple flavored syrup), which Jimmy Cohan wants to expand, was first introduced in 1944 under me SCRPC brand name, but its real sales growth came in the early 1980s. At that time, contracts were signed that provided for bulk delivery to several regional grocery chains and small restaurant chains for bottling and sale under their own labels. In the past few years, Cohan has had inquiries from several larger grocery chains and expanding restaurant chains (I-HOP, INT'L PANCAKES, etc) about similar arrangements, but the present production facility is already producing at its maximum design capacity. Additionally, these chains have hinted mat they would consider purchasing other (buttered and fruit flavored syrups) existing SCRPC products if the bulk maple-flavored syrup arrangement "works out."

Jimmy Cohan's staff has just completed a marketing study, which indicates that several large grocery chains would like to purchase and sell under their own names, powdered sugar. Although SCRPC is not producing powdered sugar, Üiis product could be manufactured using the same equipment and technology used to manufacture granulated sugar and syrup. The profit margin on this product, powdered sugar appears to be very high.

After talking to Patricia Hotard, Jimmy Cohan discussed the expansion idea with Jamie Fontenot, plant manager of the old facility and Justin Taylor, head of production at both plants. According to Fontenot, there is not enough room to significantly expand production capacity at the old facility. It is located what has turned into a heavy industrial zone with all types of manufacturing plants located very close to it. The old plant is also located over forty miles from me headquarters which houses marketing, accounting and senior management as well being collocated with the manufacturing facility for sweeteners. Justin Taylor reveals that the new facility is also land locked and expansion is not an option. Other tenants presently occupy all of me land and buildings adjacent to the new plant.

Justin Taylor tells Jimmy Cohan and Jamie Fontenot that he knows of a company that has recently been placed in receivership whose manufacturing facility is both very near the SCRPC new plant/headquarters and is available for lease. It has much more than enough floor space and utilities in place, and it can be leased for 5 years at $500,000 per year. "I've wanted to get rid of the old syrup facility for years," said Taylor. "It's a real inconvenience to have to go all the way over there whenever they have a problem - and they have quite a few since they operate at full capacity all the time. Besides being time consuming and inconvenient to visit and support this plant, it is difficult to get big trucks in and out of me plant. There have been several accidents and near accidents in the past three years and our insurance rates have skyrocketed. Moving to a location practically across the street from me new plant and expanding capacity would really make things better. Also, we should save a lot of money by reducing the cost of transferring of raw/processed sugar from the old plant to the new plant."

Jimmy learns that at the old site, the lease is for another five years but we can break if we pay them $1,000,000. Jamie Fontenot tells Jimmy and Justin Taylor, "There are some very big advantages and disadvantages of me move. As stated earlier, the old site has big logistic problems. If we do move, we could use state of the art equipment to manufacture our products and even have enough space for future expansion. With new equipment and economies of scale we could lower our per-unit cost. Also, we could finally offer our employees a decent break room and maybe even perks such as a recreation room and shower area. This is all very positive. However, there are some major negative points. We just spent over $600,000 on lease improvements that I had requested and had to beg the top brass. I have my name on that yellow slip and depreciation has not even started. We cannot transfer these improvements to the building so that would be lost. I can not just throw away $600,000 (you can expense this loss as well as the $1,000,000 to break the lease). The rent is going to increase by 500% and the new equipment and lease improvements will cost $2,200,000. That means more fixed cost to cover. If we have a major down turn in the economy like 6 years ago, we might be in trouble. Not only that but I don't know if all of the employees would drive an additional hour or so to work. It would be very costly to hire and train a large number of new employees and we may have some major down time because of this. My step-son works there and I know he won't drive an extra 2 hours round trip and I don't want him moving back in my house. I don't know if you can count on my help on convincing the boss to make the move. I must review the analysis when we finish the study"

Working with Taylor, Jamie and Cohan, Stephanie Boudreaux prepared the preliminary analysis shown in Exhibit 1.

As the four sat down to discuss their analysis, Boudreaux remarked 1.37 year payback and a net profit of over $10,000,000 was hard to beat. She said the payback is less than three years, which is our corporate benchmark, so it is definitely a "GO."

She also noted that Hotard wanted to move on the project quickly, so she hoped that no one would delay in passing the proposal on to Hotard with everyone's full support.

After glancing at the figures shown in Exhibits 1 and 2, Hotard noticed major problems with the financial analysis. She had recently been to financial seminar sponsored by a local university One topic that was covered quite thoroughly was capital budgeting.

Although Hotard had no evidence, she was concerned that an increase in sales of maple-flavored syrup may take away sales from the company's other products, specifically buttered syrup (approximately $200,000 loss in cash flow to buttered syrup).

The figures for the first two years shown in Exhibit 2 represent an introduction period in which marketing efforts are to be directed at several potential customers. Faulkner also knew that sales increases of this order of magnitude would require substantial amounts of new working capital. Accounts receivable and inventory would have to increase and accounts payable would increase but not at me same level. From her recent training and talking to Boudreaux, she estimated that the current net working capital level of $420,000 would be sufficient if me move is not made to the new location and sales were not changed. However, if the move is made, a total of $725,000 invested in net working capital will be needed by the end of the first year (that is, an increase of $305,000 is required at t = 1). Net working capital would rise to a total of $1,300,000 at the end of year 2 (mat is, an increase of $575,000 is required at t = 2). For year 3 a further increase to a total of net working capital is expected to be $1,800,000 (that is, an increase of $500,000 is required at t = 3) in Year 3.

A question about the equipment that is to be moved from the old to the new facility arose. That is, the cooking kettles and handling equipment. It is still on the books at a value of $15,000, and the depreciation is $3,000 per year for the next five years. It will cost us $25,000 to dismantle it, move it to the new building, and reinstall it. If we wanted to get rid of it and buy all new equipment, I could probably sell it for its book value, but the new equipment we would have to buy will cost over $500,000. Should me company replace the current equipment, after all there are no cost advantages with new kettles and the old ones are all in good shape?

Everyone agrees that the new facility should be able to operate profitably for many years. Senior management requires that a study life of five years, the standard used by the corporation, would be employed in the analysis. At the end of five years, the company's market value of the plant and equipment is assumed to be zero as it is part of the lease agreement mat improvements will remain. The full value of the change in working capital can be recovered. When evaluating capital projects, the corporation uses a tax rate of 40 percent. SCRPC has a policy of using straight-line depreciation.

After contacting SCRPC concerning the firm's required return, a risk adjusted discount rate (RADR) schedule was communicated.

The Corporate Headquarters uses the following risk adjusted discount rate (RADR) schedule for its major capital budgeting projects:

REQUIREMENTS

1. Critique the Preliminary Profitability Estimates provided in Exhibit I. Suggestion, go through the statement, item by item. Were all of the real costs for the move included? Look at their overall economic approach.

2. Boudreaux used the payback period as an indicator of the merit of the move to the new facility. Is this the only decision criterion that should use? What problems are there with the payback approach?

3. Should me firm buy new kettles or move the old ones? You do not have to do the math. Is this a capital budgeting project?

4. Calculate the INITIAL INVESTMENT, OPERATING CASH FLOWS and TERMINAL CASH FLOW. Assume that the improvements at the old site, the kettle moving expense and the fee for breaking the lease can be written off or charged off immediately (EXPENSED) for tax purposes. Assume the depreciation provided is correct. Present in a table the firm's incremental cash flows for the initial investment, the operating life and the terminal flow.

5. Determine and report the "move's" NPV, IRR, Profitability Index, Payback Period and Modified IRR. Write the model or equation for each technique and list the advantages and disadvantages of each technique.

6. Are there additional benefits (managerial options) for the move other than that which is directly expressed and included in the cash flow estimates? If so list and discuss. Define managerial options.

7. Are there problems (called externalities) associated with the move that are not addressed and accounted for in your objective analysis (hint labor problems, sales, etc)? Define externalities.

8. Is there an agency issue? How should we include any conflicts in the analysis? Define agency issue.

9. If there was a probability of 25% that the increase in sales for the expansion could be lower by 50% each year which will be called the "worst case" scenario, a 25% probability that the increase in sales could be higher by 50% per year which will be called the "best case" and a probability of 50%, that the sales level estimated by the marketing department are correct, which will be named the "most likely" scenario, what is the expected NPV, the standard deviation and the coefficient of variation for the move? Make sure you adjust the CGS with the lower sales level. If the average CV for this firm is 1.88, what does this imply about the project's risk and return?

10. If we are using debt to finance this project, should we use the interest expense as cash outflows in the analysis? Explain.

11. If we believe inflation will increase over the next several years at a higher rate than we are using to predict future sales, cost of goods, etc., should we use a dollar value that reflects the nominal dollar values/true sales figures for the analysis or should we use the "real" values (adjusted for inflation in today's dollars)? Why?

12. Are we abandoning a previous capital budgeting project by leaving the old facility and does that mean we made an error in the past? How can an abandonment option have value?

13. What discount rate or rate of return should SCRPC use for this project? Describe the differences between the Certainty Equivalent Approach and the Risk Adjusted Discount Rate Approach.

LEARNING BENEFITS

Students will have to use important critical trhnking skills to complete the assignment. The measure of incremental cash flows for the project requires a good understanding of sunk costs as well as opportunity costs. Important finance theories are covered including agency issue, incremental analysis, risk, externalities, managerial options and inflation. After successfully completing this case, the student will have demonstrated a thorough knowledge of capital budgeting.

Subject: Capital budgeting; Food processing industry; Sugarcane; Case studies

Classification: 9130: Experiment/theoretical treatment; 3100: Capital & debt management; 8610: Food processing industry

Publication title: Journal of Business Case Studies

Volume: 6

Issue: 6

Pages: 111-117

Number of pages: 7

Publication year: 2010

Publication date: Nov/Dec 2010

Year: 2010

Publisher: Clute Institute for Academic Research

Place of publication: Littleton

Country of publication: United States

Publication subject: Business And Economics--Management

ISSN: 1555-3353

Source type: Scholarly Journals

Language of publication: English

Document type: Business Case, Feature

Document feature: Tables References

ProQuest document ID: 818384206

Document URL: http://search.proquest.com/docview/818384206?accountid=38610

Copyright: Copyright Clute Institute for Academic Research Nov/Dec 2010

Last updated: 2013-09-06

Database: ABI/INFORM Complete

Document 13 of 100

THE MERGER OF AOL AND TIME WARNER: A CASE STUDY

Author: Malone, David; Turner, James

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Abstract:

When A OL and Time Warner announced their proposed merger in January 2000, the securities of both firms experienced significant price adjustments. Initially, prices of both securities rose on the news. When details of the proposal became clear, the security price of Time Warner fell back somewhat, but remained approximately 30% above its pre-announcement selling price, AOL shares, however, retreated to a price about 15% below its pre-announcement price. Both of these prices were significantly below consensus price targets set by analysts. Of special interest is the relative price level at which the two securities settled soon after the announcement. The merger proposal called for the issuance of a new security representing common ownership in the new firm. One share of the new security would be issued for each share of AOL, while each share of Time Warner would be exchanged for one and one-half shares of the new security. As weeks passed beyond the announcement date, the ratio of the Time Warner shares to the AOL shares ranged from just less than 1.4: Ito 1.5:1 (rather than settling at and sustaining the 1.5: !ratio one would expect from the agreement.) This case presents the circumstances surrounding the merger of AOL and Time Warner, including their respective business strategies, markets, financial structures, and price movements during the period leading up to the merger. [PUBLICATION ABSTRACT]

Full text:

INTRODUCTION

Very early on Monday, January 10, 2000 news began to appear on wire services suggesting that an announcement was forthcoming of the merger between America Online (AOL) and Time Warner (TWX). At that time, the capitalized market values of AOL and TWX were $ 1 64 billion and $97 billion respectively. Value of the combined company was estimated at $361 billion (based on the $1 10/share value assigned to TWX in the merger agreement), making it one of the ten largest firms in the world as measured by capitalized market value. The $190 billion in stock AOL agreed to issue to acquire Time Warner made it the largest merger in U.S. history at that point in time. Together, AOL and TWX offer significant brand recognition including AOL, Warner Bros., HBO, NetScape, Time, CNN, TNT, CompuServe, Warner Music Group, Sports Illustrated, Fortune, People, and numerous others. TWX also brought with it a broadband distribution platform from which to expand significantly AOL' s interactive market. As was later mentioned in the combined firm's annual report for fiscal 2000, executives felt the merger had the potential to "combine the power of the Internet with the world' s most trusted information and entertainment brands."

A BRIEF COMPARATIVE ANALYSIS OF AOL AND TIME WARNER

AOL was founded in 1 985 as Quantum Computer Services. After a name change in 1 99 1 , AOL underwent its initial public offering in 1992. As mentioned before, AOL was and continues to be the world's largest internet service provider, with in excess of 20 million customers. At a P/E ratio of 245 in early January, 2000, an investment in AOL stock prior to the merger was one reliant on persistent growth in cash flows. During the period between 1996 and 2000, AOL realized an 86% compound annual growth rate in revenues and 106% in stock price.

By comparison, Time Warner was more established and far more complex. During the same four years referred to above, TWX realized compound revenue and stock price growth of 18% and 36% respectively. As a result of the combination of Time Inc. and Warner Bros., TWX not only had an established history of operations, but had diversified into media industries including published, broadcast and other entertainment media. The company listed in its 1999 annual report five businesses as its principal sources of revenues: cable networks, publishing, music, filmed entertainment, and cable systems. Selected statistical and financial data prior to the merger announcement are provided in Appendix A.

A telling comparison between the two firms comes from an examination of their respective cash flows. From its previous year-end cash flow statement, AOL had cash flows from operations of $1.1 billion, compared to $1.8 billion for TWX. AOL, however, used $1.8 billion in cash for investing activities compared to $353 million listed as sources of cash from investing activities for TWX (i.e., TWX was actually realizing a net disinvestment from its holdings. In years before the most recent one, TWX did have cash outflows from investing, but those were negligible.) As one might deduce, AOL supplemented its investing activities through additional financing, with a source of cash of $886 million by financing activities. TWX, in contrast, was using its operating cash flows to pay down its substantial debt and to pay dividends. Cash used by financing activities for the year amounted to $2.4 billion.

FINANCIAL EFFECTS OF THE MERGER ANNOUNCEMENT

The merger agreement between AOL and TWX called for the issuance of a new stock, to be named AOL Time Warner. For each share held of AOL, shareholders were to receive one share of AOL Time Warner. For each share held of TWX, investors in that stock would receive 1 .5 shares of the new security. On the day of the announcement, although it opened with an initial surge, AOL closed at 72 5/8. The following day, the price fell to 64. TWX surged in pre-market trading and never looked back, gaining 27.5 points to close at 92 1/4. The ratio of prices of the two securities at the end ofthat first day following the announcement was 1.27:1, far short of the ratio of 1.5:1 established by the merger agreement.

Over the next few days, as the market digested the implications of the merger, arbitrageurs began seizing on what appeared to be a profit opportunity, effecting a January 1 1 closing price for AOL of 64, down 8 5/8, with TWX closing at 86, off 6 1/4, leaving the ratio at 1.34:1. Two weeks after the initial announcement, shares of AOL were trading at 62, with TWX at 87 5/8, a ratio of 1 .41 : 1 . Two weeks later AOL was at 57 13/16 while TWX was at 84 5/8 (closing prices, Friday, February 4) for a ratio of 1.46:1. Appendix B shows the ratio of prices as they emerged in weeks following the merger announcement. The mean value of the ratio in the two months following the announcement was 1.42:1, with a standard deviation of 0.05.

Following the announcement date, several key news reports by both company and government officials were issued that would serve to mollify concerns over potential antitrust conflicts or other reasons the merger might not be completed. SEC Chairman Arthur Levitt in a January 1 1 interview with Reuters news service, labeled the combination of AOL and TWX as "smart." On January 12, Jon Friedman of CBS MarketWatch reported that several large shareholders of AOL had endorsed the concept of the merger. AOL, in past years, had petitioned the FCC to require cable companies to open their broadband networks to competitors in order to enhance competition. On January 19, FCC Chairman William Kennard pointed to the merger of AOL TWX as an example where the market could solve its own problems with threats to competition. Shortly thereafter, AOL TWX announced that they would open their cable systems to competitors (offering additional evidence that competitiveness in the cable media markets would be enhanced rather than inhibited). On February 3, Joe Wilcox of CNET News concluded, from interviews with several legal experts, the merger between AOL and TWX would very likely pass through antitrust scrutiny without difficulty. Senator Orrin Hatch (R-Utah), however, offered a cautionary note. Hatch, in a public statement reported by Bloomberg News on January 12, pointed out that internet combinations such as that represented by the AOL TWX merger could pose the same antitrust threats as those encountered in both railroad and oil industry combinations at the end of the 19th century.

EPILOGUE

Problems arose almost as soon as the merger was completed. The merger was finalized on January 11, 2001; shortly after, in 2002, the internet bubble burst, taking down share prices of internet companies generally, even those with positive earnings like AOL. The share price of the merged firm, which closed at $47.23 the day the merger was completed, fell to a low of $9.64 on July 25, 2002.

Time Warner shareholders initially seemed to be receiving a huge premium for their shares in the merger. (Under the terms of the merger, AOL's shareholders would take ownership of only 55% of the new firm, even though AOL's share of the combined market capitalization of the two firms was 65% at the time the merger was announced.) After the merger, former Time Warner shareholders saw the value of their investment fall precipitously, with share prices of the combined firm dropping 90% from their peak value. (Economist AOL Time Warner: A Steal? Oct 24th 2002) Several shareholders filed lawsuits claiming that AOL executives deliberately and fraudulently inflated the value of AOL shares prior to the merger, partly by covering up steep declines in advertising revenue. At about the same time, news came out that 14 AOL Time Warner executives had sold hundreds of millions of dollars worth of shares shortly after the announcement of the merger. AOL eventually paid $2.4 billion to settle these claims.

In the intervening years, several business publications analyzed the merger, with several calling it the "worst deal in history." Most writers faulted the execution of the merger or its timing however, rather than the logic behind the merger itself. The two companies had very different corporate cultures and there was serious friction after the merger between AOL executives and employees and Time Warner executives and employees. Very few executives from either company had been in on the merger negotiations and Time Warner executives in particular (other than the very few who worked on the merger) were reluctant to work with AOL. In fact, the original idea behind the merger, pairing Time Warner's content with AOL's delivery capabilities was turned on its head - the AOL website was the one place that Time Warner content could not be found.

When the internet bubble burst, it took down nearly any and all companies that had participated in the earlier internet craze; AOL Time Warner was no exception. Because of this it is difficult to untangle the effect of the merger alone on company value from the effect of the general market downturn. As much as five years later, Steve Case continued to defend the logic behind the merger, noting that "AOL needed Time Warner for its cable division," while accepting blame for the failure of execution.

On May 28, 2009 Time Warner Inc. announced that it would spin off AOL; the news came as no surprise. At least one publication again defended the concept of the merger, noting that while the merger may have been the worst deal in history, it didn't have to be. The day Time Warner announced the AOL spinoff, Steve Case, no longer with Time Warner, posted a Twitter entry that said, "Thomas Edison: 'Vision without execution is hallucination' - pretty much sums up AOL/TW - failure of leadership (myself included)."

Subject: Acquisitions & mergers; Entertainment industry; Stock prices; Search engines; Case studies

Location: United States--US

Company / organization: Name: Time Warner Inc; NAICS: 511120, 515120, 517210, 517510; Name: AOL Inc; NAICS: 518210, 519130

Classification: 8331: Internet services industry; 3400: Investment analysis & personal finance; 8307: Arts, entertainment & recreation; 9190: United States; 2330: Acquisitions & mergers; 9130: Experimental/theoretical

Publication title: Journal of the International Academy for Case Studies

Volume: 16

Issue: 7

Pages: 103-109

Number of pages: 7

Publication year: 2010

Publication date: 2010

Year: 2010

Publisher: Jordan Whitney Enterprises, Inc

Place of publication: Arden

Country of publication: United States

Publication subject: Business And Economics

ISSN: 10784950

Source type: Reports

Language of publication: English

Document type: Feature, Business Case

Document feature: References Tables

ProQuest document ID: 814791842

Document URL: http://search.proquest.com/docview/814791842?accountid=38610

Copyright: Copyright The DreamCatchers Group, LLC 2010

Last updated: 2013-09-10

Database: ABI/INFORM Complete

Document 14 of 100

Composite Manufacturing Company: A Financial (MIS) Statement Case

Author: Kostolansky, John W; Stanko, Brian B; Landgraf, Ellen L; Pakter, Michael D

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Abstract:

Composite Manufacturing is a thriving privately-held company, whose owners need to attract outside investors. Composite's financial statements have not been professionally prepared nor audited. Although there is no fraud or intentional wrongdoing, the inexperience of the owners and their bookkeeper has resulted in improper financial reporting. In this case students will have to identify and restate revenues, expenses, assets, liabilities, and retained earnings in so far as they are not reported in accord with generally accepted accounting principles. Students are provided with a "Student Adjustment Template" and a 'Student Worksheet Template" that allow them to make correcting entries in an organized manner as well as make subsequent changes to the financial statements. Instructors will be provided with teaching notes, a "Student Adjustment Template Solution" and a "Student Worksheet Template Solution" upon contacting the authors. [PUBLICATION ABSTRACT]

Full text:

BACKGROUND

Composite Manufacturing ("Composite") is an innovator in the solar lighting field. The Company's only product is the "Sunpipe" - a highly reflective, maintenance free, natural light system that allows daylight to illuminate homes and offices. Daylight is reflected through the "Sunpipe" from a small rooftop dome to a translucent ceiling fixture, which magnifies and diffuses natural light into the room. The "Sunpipe' s" revolutionary design efficiently reflects energy- free daylight from dusk to dawn at a fraction of the cost of electric lighting.

The Company is equally owned by two brothers, James and John Little. James is responsible for most corporate functions, overseeing credit, finance, sales, quality control and human resources. John is the plant manager and is in charge of production. The brothers developed and patented the "Sunpipe" in 1995 and incorporated the Company in 1998.

Sales have increased dramatically over the past two years, causing growing pains. After several unsuccessful attempts to borrow the needed funds, the Little brothers are seeking to sell 20 percent of the firm to outside investors.1 Consequently, the Company has asked its bookkeeper, Angel, to prepare a more complete set of financial statements to present to potential investors.

Angel acquired his bookkeeping skills while maintaining the accounting records for his father's farm. He obtained some free accounting software and is thoroughly familiar with using it. He also reviewed the financial reports of several publicly-traded companies' in an attempt to professionalize the appearance of the Composite Company's financial statements.

FINANCIAL REPORTING REQUIREMENTS

Generally accepted accounting principles require revenues to be recognized when the earnings process has been completed and collection is reasonably assured. Specifically, Concepts Statement 5 (http://www.fasb.org/pdf7aop C0N5.pdf) states:

"Revenues and gains of an enterprise during a period are generally measured by the exchange values of the assets (goods or sendees) or liabilities involved, and recognition involves consideration of two factors, (a) being realized or realizable and (b) being earned... Revenues and gains are realized when products (goods or services), merchandise, or other assets are exchanged for cash or claims to cash. Revenues and gains are realizable when related assets received or held are readily convertible to known amounts of cash or claims to cash... [RJevenues are considered to have been earned when the entity has substantially accomplished what it must do to be entitled to the benefits represented by the revenues."

Expenses should be recorded in the same period as the revenue to which they are related. Losses should be recorded when it is probable that an impairment of asset value has occurred or that an obligation has been created. The Financial Accounting Standards Board wrote the following:

'Expenses and losses are generally recognized when an entity 's economic benefits are used up in delivering or producing goods, rendering sendees, or other activities that constitute its ongoing major or central operations or when previously recognized assets are expected to provide reduced or no further benefits.

'An estimated loss from a loss contingency (as defined in paragraph 1) shall be accrued by a charge to income if both of the following conditions are met:

1. Information available prior to issuance of the financial statements indicates that it is probable that an asset had been impaired or a liability had been incurred at the date of the financial statements. It is implicit in this condition that it must be probable that one or more future events will occur confirming the fact of the loss.

2. The amount of loss can be reasonably estimated."

The general principle for revenue recognition is modified when customers are granted a right to return merchandise. In such situations, Statement of Financial Accounting Standards No. 48 (http ://www. fasb . org/pdf/aop F AS4 8 .pdf) specifies that revenue can be recognized at the time of the sale only if the following six conditions are all met:

1. The seller's price to the buyer is substantially fixed or determinable at the date of sale.

2. The buyer has paid the seller, or the buyer is obligated to pay the seller and the obligation is not contingent on resale of the product.

3. The buyer's obligation to the seller would not be changed in the event of theft or physical destruction or damage of the product.

4. The buyer acquiring the product for resale has economic substance apart from that provided by the seller.

5. The seller does not have significant obligations for future performance to directly bring about resale of the product by the buyer.

6. The amount of future returns can be reasonably estimated. . .'"

YOUR ROLE IN REVIEWING THE FINANCIAL STATEMENTS

As an intern to a private equity firm that may buy a stake in Composite, you have been asked by the Director of New Business Development to perform a preliminary financial ratio analysis" of Composite. The ratios she has asked you to prepare include the following as shown in Table 1 :

Once you complete your preliminary financial analysis, the Director would like you to proceed with a more thorough analysis of Composite's financial statements and the related notes to determine if Composite is properly reporting its financial position, operating performance, and cash flows in accord with generally accepted accounting principles. Although your work will be reviewed by one of the principals of the firm, you are aware that most successful accounting internships lead to full-time employment upon graduation. Thus, you are determined to independently conduct an impressive analysis of the situation.

The financial statements (Tables 2-4) and notes (Exhibit 1) prepared by Angel are presented on the next pages. In particular, you should review the notes to the financiáis to learn how Composite has recorded its revenues and expenses. Keep in mind that revenues affect not only the reported earnings on the income statement but also the amount of assets in the balance sheet. Expenses likewise have a dual effect on income and assets (or income and liabilities). As you are reading the notes, consider whether each item has been properly classified in the financial statements. Improper classification can affect a firm's financial ratios and your analysis. Review the notes carefully to determine the questionable accounting issues that require your attention. All correcting entries should be recorded in the Student Adjustment Template that follows the Ratio Analysis Information page.

Using the Student Worksheet Template provided in a Exhibit 2, enter the changes that must be made to Composite's financial statements (taken from your Student Adjustment Template) to bring them into conformity with generally accepted accounting principles. Once you prepare the revised set of financial statements, recalculate the financial ratios that you reported in step 1 . Compare and contrast these measures of performance and use this information as a basis for your conclusion. When you complete your review, the following documentation should comprise your case study analysis:

1. A one-page business memo which includes your tentative recommendation as to whether or not your firm should buy a stake in Composite based upon your preliminary ratio analysis and other business risks. The preliminary ratio analysis is easily calculated on the Student Worksheet Template.

2. A succinct report (1-2 pages) outlining the areas of reporting concerns.

3. A revised set of financial statements as well as the recalculated financial ratios based upon your recommended correcting entries.

4. A statement summarizing the materiality of the financial misstatements.

5. A final recommendation on whether or not your firm should buy a stake in Composite.

Your firm is depending on you to review and revise (if necessary) the financial information provided by Composite. It is essential that you conduct your analysis using the correct amounts of revenues, expenses, assets, and liabilities. Only then can an informed decision be made. Even relatively small errors in financial reporting can lead to an incorrect decision and ultimately weaken your company's shareholder returns.

EXHIBIT 1

Note 1 - Summary of Significant Accounting Policies and Business of the Company

Business of the Company

The company manufactures and sells super reflective natural light systems within the United States and the European Economic Community.

Estimates

The preparation of the company's financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that reflect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and reported amounts of revenues and expenses during the period. Actual results could differ from these estimates.

Accounts receivable

Our accounts receivable includes accounts receivable reduced by an allowance for doubtful accounts. The allowance is based on historical experience as well as any known trends or uncertainties related to customer billing and account collectability. The adequacy of our allowance is reviewed quarterly.

In the first quarter of 2008, the Company recorded sales of $167,000 of light systems to Anjinu Design, a startup firm specializing in environmentally green building designs. Given the uncertainties inherent in startup businesses, the Company has required that Anjinu submit monthly reports of "Sunpipe" installations accompanied by payment for the systems sold. To date, Anjinu has not sold any systems and has not made any payments on the purchased light systems.

Inventory

Inventory is valued using the first-in, first-out method.

As a result of increased economic pressure, Composite negotiated a 20% volume discount on an end-of-year $100,000 raw material purchase. The discount was recorded as revenue at the time of purchase.

Property, plant, and equipment

Property, plant, and equipment are stated at cost.

Depreciation is provided utilizing the straight-line method over estimated useful lives ranging from 5 to 40 years for buildings, 15 to 31.5 years for leasehold improvements, and 5 to 12 years for all other property and equipment.

Income Taxes

The company elected to be taxed as an "S" corporation under the Internal Revenue Code effective January 1, 1993. In lieu of corporate federal tax, the stockholders of an "S" corporation are taxed on their proportionate share of the corporation's income. However, the corporation is required to pay certain state income taxes.

Note 2 - Inventory

Inventory consists of the following as shown in Table 5:

(Amounts in $ thousands)

At the close of 2008, $50,000 of raw material was left in an unheated storage area of Composite's warehouse. The raw material was unsalvageable, could not be used in the manufacturing process, and subsequently was omitted from the year end physical inventory count.

Note 3 - Related party transactions

In December, 2008, the Company sold to its affiliate $246,000 of "Sunpipe" systems, which were subsequently returned in February. The Company included $246,000 as Amount Due from Affiliate and in Net Sales for 2008. The affiliated company is controlled by the Company's shareholders.

Note 4 - Property, plant, and equipment

Property, plant, and equipment consist of the following as shown in Table 6:

(Amounts in $ thousands)

Note 5 - Long-term Debt

Long-term debt consists of the following as shown in Table 7 (Amounts in $ thousands)

Note 6 - Commitments

The Company leases its warehouse facilities in Miami, Florida from an entity controlled by the Company's stockholders. The lease expires April 30, 2011. Rent expense aggregated $105,394 and $100,963 for the years ended December 31, 2008 and 2007 respectively.

In 2005, the Company entered into an agreement to sublease a portion of its warehouse. The terms of the sublease require monthly payments of $3,600 through April 30, 2011. The subleased portion of the warehouse contains $109,000 of leasehold improvements which are not being utilized by the lessee. Consequently, the company has ceased depreciating the improvements. The sublease rental income is reflected as a reduction of rent expense.

Note 7 - Litigation

In May, 2008, the Company received a $1,000,000 settlement of its patent infringement claim against Sunburst Solar Tubes, bringing a five-year lawsuit to a close and strengthening the Company's patent. The settlement amount was included in sales revenue.

Note 8 - State Grants

In October, 2008, Composite applied to the State of Illinois for a grant to develop "Sunpipe" systems for several state and city government buildings. The State of Illinois Grant Board acknowledged receipt of the grant request in the amount of $255,000 and has begun processing the request. Composite has recorded a sale and an Other Current Asset for $255,000.

Note 9 - Contingencies

The Company is the defendant in a $4,000,000 product liability suit arising from the explosion of translucent light fixtures. The Company's fault in the matter is not being contested. Although the Company carries adequate liability insurance, there is a $500,000 deductible on the policy. A court decision is expected in early 2009. It is the Company's policy to delay recognition of lawsuit settlements until cases have been decided.

The Company is in negotiations with the Environmental Protection Agency regarding fines and cleanup costs at one of Composite's factory sites. Final EPA estimates range between $300,000 and $500,000. The Company recorded a provision for $300,000 against 2008 income.

Note 10 - Service Agreements

In 2008, the Company began selling 3-year service contracts on the "Sunpipe" product. While the product is considered to be maintenance free, an annual inspection of the refractor is required after one year to maintain operating efficiency. The Company sold 36 contracts at $3,000 each during 2008. The Company reported the proceeds as sales revenue since each service contract was associated with a unit sold.

Ratio Analysis Information

Note: Given the limited number of years of data for Composite, compute the turnover ratios and return on assets/equity ratios using the year-end balance for the related account, rather than the average of beginning and ending values. The definitions provided below are based upon year-end balances.

Liquidity Ratios

Current Ratio: Current assets/Current liabilities

Use: Like Working Capital, this is a measure used to determine the company's ability to pay its short-term debt; the ratio is useful not only to compare the company's liquidity over time, but also to compare its liquidity with that of competitors.

Use: Stricter measure of ability to pay current liabilities as it includes only assets that are quickly and easily converted to cash.

Use: Estimates how many times in a year the inventory is sold (i.e., "turned over"). The faster a company can turn its inventory, the more efficient it is. Of course, a reasonable level of inventory must be maintained to optimize sales.

Days Sales in Inventory (Number of days to sell inventory): 365/Inventory turnover

Use: A measure of how many days, on average, it takes to sell inventory.

Receivable Turnover: Sales/Ending accounts receivable

Use: Estimates how many times in a year the accounts receivable are collected. The faster a company can turn its receivables, the more efficient it is. Of course, the goal is to turn receivables quickly without foregoing credit sales.

Average Collection Period (Days to collect Accounts Receivable): 365/ Receivable turnover

Use: A measure of how many days, on average, it takes to collect accounts receivable.

Solvency Ratios

Debt to Total Assets: Total liabilities/Total assets

Use: Shows the proportion of assets financed with debt. The remainder of assets will have been proportionally financed with equity.

Debt to Equity: Total liabilities/Total equity

Use: An alternative for Debt to Total assets, this ratio shows the proportion of debt to equity.

Times Interest Earned: Earnings before interest and taxes (EBIT)/Interest expense

Use: Measures the company's ability to pay the interest on its debts; a high multiple is desirable.

Profitability

Gross Profit Margin: (Net sales - Cost of sales)/Net sales

Use: Measures the proportion of revenue available to cover operating expenses after deducting the cost of the merchandise sold.

Net Profit Margin: Net income/Net sales

Use: Measures the proportion of each dollar of sales that becomes net income.

Return on Assets: Net income/Ending total assets

Use: Measures the amount of income generated with each dollar of assets.

Total Asset Turnover: Sales/Ending total assets

Use: Measures the amount of sales revenue generated with each dollar of assets.

Return on Equity: Net income/Ending stockholders equity

Use: Measures the amount of income generated with each dollar of investment provided by shareholders.

Cash Flow

Free Cash Flow: Cash flow from operations - capital expenditures

Use: Measures the ability of the finn to sustain itself and possibly grow without outside funding.

Use: Measures the adequacy of operating cash flows to cover interest payments. A high multiple is desirable.

Student Adjustment Template (to bring Composite's Financial Statements into Conformity with GAAP)

Dear Student: Your adjustments should be in $ thousands. Rely on the relationship between cost of goods sold and sales (i.e., CGS/Sales) to estimate the cost of goods sold adjustment associated with a sales adjustment. Specifically, estimate cost based upon

Other Important Information

Utilize (copy and paste) the following template (Exhibit 2) to prepare each correcting entry:

As you move forward, identify the accounting issue and the footnote number in which the issue arises. Number your adjustments to correspond with each correcting entry and record this information in the worksheet.

Once you complete the correcting entries, a 3-step process begins. First, review the correcting entries with your professor before moving on. Second, after you gain your professor's approval, return to the Student Worksheet Template to restate the financials. Once you complete the restatement, again review the results with your professor. Finally, if all is acceptable, re-compute the necessary financial ratios. Then move on and complete steps 4 and 5 of the following case requirements.

1. A one-page business memo which includes your tentative recommendation as to whether or not your firm should buy a stake in Composite based upon your preliminary ratio analysis and other business risks. The preliminary ratio analysis is easily calculated on the Student Worksheet Template.

2. A succinct report (1-2 pages) outlining the areas of reporting concerns.

3. A revised set of financial statements as well as the recalculated financial ratios based upon your recommended correcting entries using the Student Worksheet Template.

4. A statement summarizing the materiality of the financial misstatements.

5. A final recommendation on whether or not your firm should buy a stake in Composite.

Note: Do not attempt to complete this assignment without reviewing your results with your professor. Doing so can lead to a great deal of unnecessary work.

TEACHING NOTES

The Composite Manufacturing Company Case is in fact a composite of various characters and situations encountered by a practitioner over a period of years. The facts and circumstances have been modified and supplemented to provide an integrative case appropriate for students in an advanced course in accounting. In completing the case students will utilize their knowledge of financial reporting, financial statement analysis and generally accepted accounting principles coupled with critical thinking and written communication skills. The case was class tested in a graduate Forensic Accounting and Fraud course which had a prerequisite of an undergraduate course in auditing, and would be equally appropriate in an undergraduate upper level course or a graduate course in financial reporting or financial statement analysis. The teaching notes for the case include suggested solutions to each of the case requirements as well as comments based on the class test. All solutions and teaching notes as well as the "Student Adjustment Template Solution" and "Student Worksheet Template and Solutions" are available electronically from the authors.

AUTHOR INFORMATION

John W. Kostolansky holds a Ph.D. from Columbia University and a BBA from Loyola University Chicago. His research interests include financial statement analysis, financial reporting, and effective teaching methods. Graduate courses taught include Financial Accounting for Business Decisions, Issues in Financial Reporting and Financial Statement Analysis. He is a registered Certified Public Accountant (Illinois.)

Brian B. Stanko holds a Ph.D. from the University of Kentucky, and an MBA and a BS from Eastern Illinois University. He is a registered Certified Public Accountant (Illinois.) Dr. Stanko's work experience includes five years in accounting and financial reporting and twenty years in academia. His research interests are in the areas of cash flow analysis, annual report analysis, corporate reporting and accounting education. He currently serves as the Chair of the Accounting and Business Law Department at Loyola University Chicago.

Ellen L. Landgraf holds a Ph.D. from the University of Illinois at Chicago, an MBA from Northern Illinois University and a BBA from Loyola University Chicago. She is a registered Certified Public Accountant (Illinois.) Dr. Landgrafs work experience includes positions at the IRS and in public accounting (both Big Eight and small practitioner) prior to her over thirty years in academia. Her research interests are in the areas of executive compensation, corporate governance and social responsibility, corporate disclosure and reputation and ethics and accounting.

Michael D. Pakter is a licensed Certified Public Accountant, Certified in Financial Forensics by the American Institute of Certified Public Accountants, with more than 30 years experience in financial analysis. He has a Certified Insolvency and Restructuring Advisor Certificate and a Certification in Distressed Business Valuation. He is also a Chartered Accountant and a Certified Fraud Examiner. His undergraduate academic education is in commerce, business economics, accounting and auditing. Mr. Pakter is a Managing Member of Gould & Pakter Associates, LLC.

Subject: Unaudited financial statements; Revenue recognition; GAAP; Lighting industry; Case studies

Classification: 9130: Experiment/theoretical treatment; 4120: Accounting policies & procedures; 8650: Electrical & electronics industries

Publication title: Journal of Business Case Studies

Volume: 6

Issue: 5

Pages: 1-11

Number of pages: 11

Publication year: 2010

Publication date: Sep/Oct 2010

Year: 2010

Publisher: Clute Institute for Academic Research

Place of publication: Littleton

Country of publication: United States

Publication subject: Business And Economics--Management

ISSN: 1555-3353

Source type: Scholarly Journals

Language of publication: English

Document type: Business Case, Feature

Document feature: Equations Tables References

ProQuest document ID: 756043332

Document URL: http://search.proquest.com/docview/756043332?accountid=38610

Copyright: Copyright Clute Institute for Academic Research Sep/Oct 2010

Last updated: 2013-09-06

Database: ABI/INFORM Complete

Document 15 of 100

Employee Benefit Plan Language And Sponsor Misconception

Author: Moreschi, Robert W

ProQuest document link

Abstract:

The employee benefit plan marketplace is a multi-trillion dollar industry as measured by assets under management. Previous research suggests that even sophisticated plan sponsors and participants are uncertain about the details of their plan. The variety of fee types, (wrap fees, transaction fees, participant fees, and set-up fees) and the use of industry jargon can lead to confusion and misunderstanding. This paper is a case study of an actual deferred compensation plan. We examine the business law aspects of the relationship, particularly how the complexity of the product, coupled with the contract language, could lead to plan sponsor and participant misunderstanding. [PUBLICATION ABSTRACT]

Full text:

THE PLAYERS

Assurant, Inc. (Assurant) is a New York based insurance holding company with roots in the US dating to 1977. In that year, N.V. AMEV of the Netherlands acquired Time Insurance Company and began operations under the holding company AMEV Holdings, Inc. With further acquisitions in the US, the firm changed its name in 1991 to Fortis, Inc. In 2004, Fortis, Inc. became a publicly traded company and changed its name to Assurant, Inc. The firm manages a variety of insurance portfolios encompassing health, dental, disability, credit, and warranties. (www.assurant.com).

National Trust Management Services, Inc. (NTMS) is an employee benefits plan administrator based in Warrenton, VA. Plan administrators provide a variety of services to ERISA and non-ERISA benefit plans, including recordkeeping, custodial services, audit, compliance, safe-keeping of assets, and investment advice. Founded in 1999 by Glen V. Armand, he remains the principal in charge. Mr. Armand formed NTMS after a long and successful career in the employee benefits plan administration industry. NTMS is a private firm, solely owned by Mr. Armand. (www.ntmsglobal.com)

THE INDUSTRY/BUSINESS

The employee benefit plan marketplace is massive in scope. In the US alone, thousands of firms offer nonwage benefits to millions of employees. Total Assets are in the trillions of dollars (McHenry Consulting Group). Broadly defined, there are two categories of plans: defined benefit and defined contribution. Each is a deferred compensation plan. Defined benefit plans are plans in which the employer makes all contributions and the employee is promised a stream of retirement income based on salary and years of service. Defined contribution plans are plans in which the employee and employer can make contributions, the employee directs the investments, and no promises are made as to a future income stream. Most plans fall under the Employee Retirement Income Security Act (ERISA) regulations, in which contributions receive tax-deferred status but the plans must comply with nondiscrimination guidelines. Plans subject to ERISA are referred to as "qualified plans."

Many employers, seeking to reward and keep employees, offer key employees additional deferred compensation opportunities not subject to ERISA rules (referred to as "non-qualified plans"). Like a qualified plan, investment gains in non-qualified plans are not subject to current taxation. Unlike qualified plans, employer contributions to an employee's account in a non-qualified plan are usually treated as taxable income. Also, in non-qualified plans, the plan administrator can discriminate by restricting employee eligibility and contribution limits.

THE SITUATION

The business relationship between NTMS and Assurant provided for NTMS to administer a non-ERISA benefit plan, wherein Assurant served as plan sponsor and NTMS the plan administrator. NTMS was hired in 2000 by Assurant (then named Fortis, Inc.), to provide a variety of administrative duties, to include:

* Maintenance of accounts and sub-accounts [accounts held at a non-affiliated broker-dealer]

* Provide quarterly account statements

* Process requests for investments and liquidations

* Provide account information to the plan sponsor for tax and accounting matters of the plan sponsor and plan participants

The agreement was modified and renewed in October 2006 for a three year term. The case under review stems from Assurant's action to terminate the agreement prior to the end of the third year and the resulting dispute over compensation NTMS claimed was owed to it.

The benefit plan administered by NTMS for the benefit of Assurant was a non-ERJSA plan falling under section 409(A) of the Internal Revenue Service Code (see Appendix A for an overview of the plan). As a nonERISA plan, the plan sponsor (the employer, Assurant) can discriminate in the selection of eligible employees. Typically, these plans are structured so as to only provide benefits to senior managers and directors. The employee can make contributions to their investment account. The employer also has the discretion to make contributions to the employee's account.

The contractual relationship between NTMS and Assurant was of standard format. The contract specified the responsibilities of each party. Like any such contract, it specified how the parties would interact and how they would separate. At the heart of this dispute was whether the contract allowed for the custodian, NTMS, to charge a termination fee. Assurant argued that though the language of the contract specified that the custodian, NTMS, could charge a termination fee, it was not clear how that fee would be calculated. All information and data for this case is derived from documentation of the civil proceedings in the case: US District Court for the Eastern District of Virginia, Civil No. 1:08cv928 [LOG/TCB] and from conversations with Glen Armand and counsel for NTMS.

COMMON PLAN ATTRIBUTES

Exhibit 1 below contains information about services that could be subject to a fee. Fees are charged to the plan sponsor, who can absorb them or pass them along to the plan participants (The Standard, 2007). Exhibits 2 and 3 indicate the specific fees for this Assurant plan.

ASSURANT/NTMS CONTRACT-SPECIFIC ATTRIBUTES

Participants made contributions (often via payroll deduction) to accounts administered by NTMS for the benefit of each employee. Employees were offered a menu of mutual funds into which contributions were directed per the instructions of the participant. NTMS provided custody and administration services but rendered no investment advice or fund selection criteria.

THE DISAGREEMENT

The most recent agreement was dated October 11, 2006 for an initial three year term. In the spring of 2008 Assurant (as indicated in court documents) sought to find a replacement to NTMS, effective January 1, 2009. Assurant took this action in secret from NTMS, but by accident NTMS was made aware of the impending change. NTMS inadvertently received a request for information (RFI) from Mercer, the consulting firm hired by Assurant to assist in the search. Assurant intended to notify NTMS after a replacement administrator was under contract. As it turned out, Assurant was forced by the circumstances to advise NTMS in late July 2008 that the service agreement would be terminated effective December 31, 2008.

NTMS was obviously not pleased at the turn of events, the method of notification and the termination. In deciding what option(s) they might have, NTMS looked to the service agreement as to the specific terms that applied upon the termination of the contract.

Pertinent Clauses from the Service Agreement

As regards the term and termination of the contract:

a) The term of this contract is for a period of three (3) years from the date of execution and shall automatically renew at the end of each period for an additional one (1) year period unless terminated by at least sixty (60) days' written notice to the other party prior to the Anniversary date of this Agreement. Neither NTMS nor the Plan Sponsor may terminate this Agreement, unless NTMS and the Plan Sponsor agree to in writing a shorter notice period. Such termination shall take effect as of the end of this Agreement's anniversary date falling on or after the expiration of the 60-day notice period. The Plan Sponsor shall remain liable for any accrued and unpaid compensation due NTMS.

As regards investment responsibilities and restrictions:

a) The Plan and/or Participant will pay any transaction fees or loads associated with the purchase, exchange or disposition of a mutual fund from his Account.

b) ... the Plan Sponsor and its participants agree to be bound by the terms and conditions of the related Brokerage Account Application/s and associated agreements, in all of their parts. The Brokerage Account Application and its associated agreements shall be as defined by the broker-dealer as currently in effect and the terms of which shall control over this Agreement.

As regards NTMS compensation:

a) NTMS 's compensation for performing its duties under this Agreement will be in accordance with the Core Services Fee Schedule and the Event Services Fee Schedule attached hereto as Exhibits A and B, respectively.

b) NTMS shall deduct from each respective account or sub account of the plan the Administrative Wrap Fee (AWF) as shown on Core Fee Schedule - Exhibit A. The AWF shall be proportionally deducted from the account once a year based on the greater of the average or highest balance of associated assets during the period. Any account being liquidated or transferred prior to the end of the year shall have the AWF deducted from the proceeds at liquidation.

c) Further, the Plan Sponsor affirms and agrees that upon termination of NTMS services or requested liquidation of all accounts NTMS shall have the right to deduct all outstanding fees from plan assets.

d) NTMS shall be entitled to recover the costs of collection of such past due amounts, including reasonable attorneys' fees.

NTMS typically billed plan participants some $10,000 per quarter from mutual fund trades (plan assets were approximately $100 million). As it relates to mutual fund transactions (at $20 per trade), a clause in the service fee schedule indicates some modifications to that fee:

"Excluding transactions that qualify for no transaction fee processing and One (1) mutual fund trade per account for each new payroll deduction cycle deferral limited to a maximum of twenty six (26) payroll deposits transactions per year per participant. This credit is nontransferable."

That clause was a key to the actions that followed. It was NTMS' s contention that over the approximately twenty one months the agreement was in place, NTMS routinely waived certain fees (for all participants) related to "excessive" mutual fund trades. In addition, the firm also claimed that certain wrap fees were also periodically waived. NTMS indicated that such actions on its part were a regular aspect of its business model with all clients - a good will gesture that could be reversed if a client terminated the contract. The result was that NTMS sent Assurant an invoice for over $800,000. A significant portion was due to transaction costs resulting from the receipt and reinvestment of dividends from mutual fund holdings.

As one could easily imagine, Assurant was not at all pleased with this termination invoice and so refused to pay, claiming the fees were unreasonable and not allowed by the contract. In court filings Assurant also claimed that the contract did not allow/provide for a termination fee that was based on fees that NTMS chose to waive.

NTMS provided its own audit of the transactions and wrap fees and sent that to Assurant. Assurant disputed the charges with NTMS and NTMS filed suit against Assurant for breach of contract and sought both economic and punitive compensation.

Thus, it was left to the court to determine fair and reasonable fees for NTMS' s custodial services and whether under the contract NTMS could charge a termination fee, in this case some $800,000, for previously unbilled but accrued fees. As part of the adjudication process, NTMS hired an outside auditor to analyze the billing (at NTMS 's cost). The firm, Cundiff & Associates, gave the following summary report (Exhibit 4) for the period October 1, 2006 through June 30, 2008:

POSTSCRIPT

In late autumn 2008, Assurant and NTMS reached an out of court settlement. Assurant agreed to pay the fees as determined by the independent audit. The accounts have been transferred to a new custodian effective January 2009.

TEACHING APPROACHES

A suggested approach is to let the students read the case (out of class) after the professor has presented inclass an overview of the employee benefit market, has discussed the types of fees that providers can assess a plan, and discussed the particular details of these two firms. Professors should be sure to emphasize that thorough student preparation will require conducting some research and reading beyond the case. The questions below are the students' guide to further understanding, while the references provided at the end of the case are sources for additional study. Professors may want to use the questions as the foundation for in-class discussion.

SUGGESTED QUESTIONS AND ANALYSIS

1) Describe the types of charges an employee benefit plan sponsor and participant may be subject to.

2) How might the language of the service agreement been modified to reduce potential lack of understanding of the plan sponsor/plan participants?

3) What is a customary and reasonable standard of notifying the plan sponsor/plan participant of a wrap fee charge?

4) Should NTMS have indicated on each billing statement the type and amount of charges which were accruing but not billed?

Question 1

As illustrated in "Exhibit 1: Sources of Fees" in the case, fees are broadly categorized into one-time fees and ongoing fees. One-time fees are incurred for administrative services that are needed only once. For example, the initial set-up of a plan is a single event. Other one-time charges are incurred when an existing plan is converted to a new administrator and when a plan sponsor institutes a material change in an existing plan. All three activities require the administrator/custodian to incur a time commitment to administer the necessary paperwork, plus computer system integration and compliance.

Once a plan is set up, many types of costs may be incurred on an ongoing basis. Recurring fees are divided into three categories: administration, investment, and participation. Administration fees cover a variety of activities:

* Record Keeping

* Custodial

* Enhanced platform

* Investment Consulting

* Legal/Compliance

* Audit

An example is compliance. Plans may have to submit records to a particular government agency, such as the Internal Revenue Service or the Department of Labor. Costs of the plan administrator are passed on to the plan sponsor. The sponsor may absorb the costs or pass some or all of the costs onto the plan participants.

Investment fees are a function of the management of plan assets. Mutual fund companies are a common choice to manage these assets. Asset management involves much more than merely a portfolio manager to make investment decisions. The fund company provides a number of other services, such as customer service and a web portal for participant use. In addition, like any firm, fund companies have a variety of personnel, all of whom are compensated; accountants, attorneys, sales representatives, human resource managers, etc. Investment expenses are typically grouped as:

* Mutual fund expenses

* 12b-1 fees

* Sales charges

* Asset-based fees

* Wrap fees

Normally, plan participants bear the burden of investment expenses. These charges might be part of the overall fund expenses or be charged separately.

Participation fees are charges for costs incurred when a plan participant takes a particular action, such as:

* Purchases/Redemptions

* Brokerage

* Advice

* Distribution

* Loans

Each one of these activities results in some human interaction on the part of the asset manager, plan administrator, or plan custodian. Human interaction means a cost is incurred. Plan participants normally bear these costs. Like investment expenses, charges for participation activities may be included as part of the overall expenses in a fund or may be charged separately.

How these costs are structured often adds to plan sponsor and plan participant confusion. Asset management firms might provide administration and custodial services, which can add to the level of confusion or misunderstanding. A plan sponsor and participant may be charged in a variety of ways:

* A per-use (transaction) fee [much like a commission]

* An asset-based fee [a fund company charging a given amount of basis points to manage plan assets]

* A wrap fee, usually covering all expenses [though it does not have to be all-inclusive]

In the case of NTMS, the plan sponsor and participants incurred one-time fees, transaction-based fees, and asset-based fees. The fees from the NTMS were in addition to the mutual fund expenses charged by the investment managers. Plan participants had a lengthy list of mutual funds from which they could select where to place their fund balances. This scenario is not at all unusual.

Question 2

The contract did indirectly stipulate that NTMS could bill for transactions beyond a certain amount for mutual fund trades (part of Exhibit 3). The clause reads:

Excluding transactions that qualify for no transaction fee processing and One (1) mutual fund trade per account for each new payroll deduction cycle deferral limited to a maximum of twenty six (26) payroll deposits transactions per year per participant. This credit is nontransferable.

The potential problem is that unless the plan sponsor and plan participants are aware of the actual number of trades taking place over each quarterly billing cycle, they may easily lose track of the actual cost of transacting trades in their accounts. Also, the language of the clause could be written to more clearly indicate to which mutual fund trades the mutual fund fee applies. Specifically, all transactions, even dividend distributions, are subject to inclusion under this clause. For accounts held at a mutual fund company, the cost of these transactions are bundled in the overall fund fee. But, as these accounts were held at a brokerage firm, each mutual fund trade (including receipt and reinvestment of dividends) resulted in a transaction fee. Assurant's reaction to the termination fee suggested they may not have been fully cognizant of this and were "surprised" upon receipt of a termination invoice.

As NTMS regularly chose to waive certain types of fees, having the custodian provide, at least annually, an accounting record for each account (or in the aggregate for all accounts) of the fees that were waived but accrued would potentially reduce or eliminate sponsor/participant misunderstanding.

Question 3

In the securities and investment advisory business, it is a long-standing requirement for agents to notify a customer (prior to opening an account) of wrap fees to be incurred or potentially incurred (Goldenberg and Stone). This entails information as to the size of the fee and the frequency at which it is to be applied. At least quarterly, the agent (or custodian or plan administrator) must send to each accountholder a statement that shows a variety of information about the account, including all fees and expenses charged to the account in that reporting period. It is not customary that prior to the sending of the quarterly statement and the imposition of the wrap fee that a customer would receive prior notification of the impending charges. It is sufficient and within the guidelines for the notification to be the quarterly statement on which the fees and expenses are specified. Based on conversations with NTMS and personal knowledge of the broker-dealer, quarterly statements were being sent to each accountholder and the wrap fee (if it was charged that period) was disclosed on the statement.

Question 4

Listing this information on every quarterly statement might have reduced the surprise that Assurant indicated on receipt of the termination invoice. There is a growing chorus asking for more and better disclosure of fees in employee benefit plans (AARP, 2008). Current regulations do not require complete and regular disclosure of all fees and expenses. New regulations from the Department of Labor will require, beginning in 2009, more detailed reporting of fees and compensation. The new requirement applies to ERISA plans but not to non-ERISA plans, such as the one in question between Assurant and NTMS. Statements could be modified to show the total number of transactions each period, separated into two groups: those transactions for which a charge was applied and those transactions for which the fee was waived but accrued.

WHEN TO USE THIS CASE

Depending on the emphasis of the instructor, this case will fit into several different courses. For example, a Principles of Investments course may have a chapter on mutual funds and fund fees. If the instructor chose, she could expand the standard material to include the more encompassing detail of this case. In a Portfolio Management course (often combined with investments) this case will fit neatly when the instructor chooses to focus on the more practical aspects of money management, not only the financial theory of investment management. For example, when I teach Portfolio Management, the course divides rather neatly into two components. The first component includes the standard theory of mean-variance optimization, working through the Markowitz model, CAPM, and the Arbitrage Pricing Theory. The second component is a series of exercises in managing a portfolio: equity, fixed income, cash, and alternative investments. I include administrative matters, such as fiduciary responsibilities, investment policy statements, and measuring manager performance. This "practical" portion of the course provides a good fit for this case. In a Business Law course, the instructor would have several options. The case could be the basis for a discussion of contract law. In addition, the case, coupled with the actual contractual agreement, might be used for a discussion of best practices for written communication of seemingly complex legal arrangements.

ACKNOWLEDGEMENTS

My thanks to Glen Armand of National Trust Management Services, Inc. for his valuable assistance. Any errors are, of course, the sole responsibility of the author.

Subject: Employee benefits; Fees & charges; ERISA; Third party administrators; Case studies

Location: United States--US

Company / organization: Name: Assurant Inc; NAICS: 524113; Name: National Trust Services; NAICS: 523991

Classification: 9190: United States; 4320: Legislation; 8210: Life & health insurance; 9130: Experiment/theoretical treatment

Publication title: Journal of Business Case Studies

Volume: 6

Issue: 5

Pages: 13-21

Number of pages: 9

Publication year: 2010

Publication date: Sep/Oct 2010

Year: 2010

Publisher: Clute Institute for Academic Research

Place of publication: Littleton

Country of publication: United States

Publication subject: Business And Economics--Management

ISSN: 1555-3353

Source type: Scholarly Journals

Language of publication: English

Document type: Business Case, Feature

Document feature: Tables References

ProQuest document ID: 756036494

Document URL: http://search.proquest.com/docview/756036494?accountid=38610

Copyright: Copyright Clute Institute for Academic Research Sep/Oct 2010

Last updated: 2013-09-06

Database: ABI/INFORM Complete

Document 16 of 100

A Case Study In Strategic Financial Planning In Health Service Organizations

Author: Niles, Nancy J

ProQuest document link

Abstract:

Integrating strategic planning and financial planning is the best way for health service organizations (HSOs) to ensure their budget allocations are appropriately targeted to long range solutions. In strategic financial planning, in order to ensure that there is long range financial success, annual budgets need to be analyzed from a long term organizational perspective. This paper will propose a step by step approach to strategic financial planning and their application to the healthcare industry and how the integration of these processes will result in a long term successful framework for achieving the HSO's mission and vision. Cleveland Clinic will be discussed as an example of an HSO that has successfully utilized strategic financial planning. [PUBLICATION ABSTRACT]

Full text:

INTRODUCTION

Strategic planning is the action plan for running a business over a long term period. This plan is a commitment by senior management to pursue established sets of goals that are developed to promote the company's vision and mission (Thompson, Strickland & Gamble, 2008). Financial planning is the process of analyzing the financial opportunities of the organization and selecting opportunities that will provide financial success (McLean, 2003). Integrating strategic planning and financial planning is the best way for HSOs to ensure their budget allocations are appropriately targeted to long range solutions. In strategic financial planning, in order to ensure that there is long range financial success, annual budgets need to be analyzed from a long term organizational perspective. Establishing multi year forecasting for the organization provides the financial reality that will support activities that will focus on the mission and vision of the organization. This paper will propose a step by step approach to strategic financial planning and their application to the healthcare industry and how the integration of these processes will result in a long term successful framework for achieving the HSO's mission and vision. Cleveland Clinic will be discussed as an example of a health service organization that has successfully utilized the steps in strategic financial planning.

STRATEGIC PLANNING AND FINANCIAL PLANNING PROCESSES

According to Runy (2005), the following are steps in the strategic planning goal process and the financial planning goal process:

(a) step one: establish a mission and vision statement of the organization;

(b) step two: develop a long term plan that supports the mission and vision of the organization;

(c) step three: create plans at each organizational level that integrate the mission and vision;

(d) step four: identify and evaluate the organization's external environment for new opportunities;

(e) step five: develop forecasting for market opportunities;

(f) step six: develop a plan based on capital budgets, and

(g) step seven: monitor and evaluate the results. Revise, as needed.

FINANCIAL PLANNING GOALS

(a) step one: evaluate the current performance of the organization;

(b) step two: compare the organization's performance against historical data;

(c) step three: develop financial projections;

(d) step four: assess the organization's financial status;

(e) step five: integrate the financial goals with the strategic goals to ensure compatibility, and

(f) step six: monitor and evaluate the results. Revise, as needed.

Based on Runy's step by step process of strategic and financial planning, the following is a step by step strategic financial planning process that can be successfully utilized by a healthcare organization. Each step will be discussed individually.

PROPOSED STEPS OF THE STRATEGIC FINANCIAL PLANNING PROCESS IN HSOS

(a) step one: establish the mission and vision statement of the organization. Revise, as needed;

(b) step two: create mission and vision statements at all department levels that support the organization's mission and vision;

(c) step three: assess the current performance of the organization and compare it to historical data;

(d) step four: develop a plan based on capital budgets which support the mission and vision of the organization;

(e) step five: integrate the financial goals with the strategic goals to ensure compatibility;

(f) step six: identify and evaluate the organization's external environment for new opportunities;

(g) step seven: develop financial projections based on new opportunities. Assess the risk associated with these new opportunities;

(h) step eight: monitor and evaluate results and revise as needed.

STEP BY STEP DISCUSSION

(a) step one: Establish the mission and vision statement of the organization.

In order to have successful strategic financial planning, it is important that a mission and vision statement of the organization must be developed which is the first step of the strategic planning process. Once the mission and vision statement are established, then a long range plan, step two, must be developed to support the mission and vision statements, followed by step three, that defines the responsibilities of each department to support the organization's mission and vision. However, it is important that before a long range plan is developed and departments develop supporting goals, there must be a coordination of the finance department to develop a strategic plan based on the capital reality of the organization. A strategic plan will not be successful if there is no capital to implement the plan. There are similar steps in both the strategic and financial planning steps.

According to Longest & Darr (2008), most healthcare organizations connect their mission statements to their vision statements with a core set of values. Their vision statements are less specific than the mission statement but do provide a strategic view of their direction. Table 1 provides an example of mission and vision statements of a prominent healthcare organization, Cleveland Clinic. This organization directly connects it mission and vision statements with core values. This example is typical of a mission and vision statement of a health service organization.

Once the mission and vision statements are established with the corresponding values, the organization at all levels can develop coordinated plans to achieve these organizational goals.

(b) step two: Create mission and vision statements at all department levels that support the organization's mission and vision.

The Cleveland Clinic also has mission statements developed for each of their major departments. Each department mission statement must support the organization's major mission statement. For example, the Board of Trustees has both a finance and investment committee. The Finance committee's mission is to provide assistance to the Board of Trustees in overseeing the financial strategies and policies of the Cleveland Clinic. Committee's mission is to provide oversight of the Cleveland Clinic's endowment and other invested assets, in order to ensure that the Clime's long-term investment objectives are met (http://www.mycleveland.clinic.org).

(c ) step three: Assess the current performance of the organization and compare it to historical data.

Prior to performing any type of financial planning, it is important to assess the state of the organization, particularly during this economic recession. In an HSO, performance assessment will consist of several indicators that reflect their mission and vision statement. Generic hospital performance indicators often examine number of patient visits, inpatient visits, number of admissions, number of emergency room visits, number of surgical cases and total operating revenues. Depending on the type of HSO, other factors will be assessed.

For example, the Cleveland Clinic's mission and vision statements focus on providing compassionate quality patient care while maintaining rigorous education and research for their employees and commitment to their communities. In their 2008 annual report, they indicate they have eight enterprise goals that focus on their mission and vision statement. The goals include putting patients first, safety and quality in their operations, growth in their core businesses and pursuit of new business opportunities, pursuit of research that improves patient care, academic excellence, community leadership and foster excellent working conditions. In their 2008 annual report, the Cleveland Clinic reported data from 2002-2007 on the generic performance indicators listed above as well as those indicators that reflect their mission, vision statements and core values. These performance indicators include number of residents and fellows, continuing medical education, accredited residency training programs, allied health students, grant revenue and philanthropy levels.

Also reflected in their mission and vision statement is the importance of being a socially responsible organization which develops and maintains a relationship with their community as well as enhancing their image. The Clinic reports that it is a major purchaser of goods and services in the Ohio area - spending $780 million in 2006. They also employ 3 1,000 full-time employees. From 2004-2006, they spent $500 million on new construction projects. They have developed community programs such as Neighbor to Neighbor which appoints a health educator to a targeted community to develop an interactive health program. The Clinic also established the Office of Civic Education commitment to promote education in partnership with area organizations to create innovative programs to enhance children's education. In 2006, the Cleveland Clinic contributed a record $1.2 million to the United Way (State of the Clinic, 2006).

(d) step four: Develop a plan based on capital budgets which support the mission and vision of the organization.

Capital budgets are long term budgets for purchasing assets, programs, or projects that are based on the strategic plan of the organization. It is an integral component of the strategic management process. The finance department collaborates with senior management to integrate financial planning with strategic planning to ensure the capital budget supports their mission and vision statements. According to Mclean (2003), a capital budget must assume that the asset will pay for itself either by generating revenue or receiving funding externally. If it will not pay for itself, then the proposed asset should not be pursued. Capital budgeting decisions are also contingent on the legal structure of the HSO. Although the Cleveland Clinic is a not for profit organizations, which has goals other than investor profitability, they still need to pursue a capital budget that must assess their cash flow so it can be invested back into the organization to increase or improve services to their patients. According to Sussman (2008), a capital budget is a function of operating revenues, use of external debt, balance sheets changes and projected philanthropy levels. Philanthropy to not-for- profit organization such as the Cleveland Clinic is an integral component of their cash flows which are often noted on their balance sheets or noted as non operating revenue on their income statements.

The Cleveland Clinic has always recognized the importance of philanthropy to their organization. They have recognitions societies for donors to the Cleveland Clinic who contribute as little as $ 1 00 to millions. They have 20 different funds that represent different diseases or research. All of their buildings are named after the benefactor. This type of marketing encourages other benefactors to donate to the Cleveland Clinic. Cleveland Clinic developed a campaign in 1995, which has a goal of raising 1.25 billion to focus on four areas: patient care, research, campus growth, and education. As of May 2009, $1.18 billion has been raised. In 2006, an all-time high of $370 million was donated (http://my.clevelandclinic.org). They utilize their endowments to increase their opportunities to provide patient care by building expansions, increasing the number of specialties offered, expanding geographically, etc.

Hospitals have faced scrutiny regarding their pricing of services. In 2009, a report was published in collaboration with Deloitte that exhibited a new strategic financial strategy called Value-Based" pricing, standardized pricing approach that would demonstrate to Cleveland Clinic's stakeholders that they were being transparent in their pricing strategies. They applied the pricing strategy across their 20 departments (Cleveland Clinic Transparency, 20009). The result was successful and supported their strategic initiative of value-based pricing. These are examples of both financial and strategic thinking which have resulted in strategic financial planning.

(e) step five: Integrate the financial goals with the strategic goals to ensure compatibility.

In order for health service organizations to be able to maintain excellent credit, they must maintain a long term clinical reputation which supports their credit strength. Moody Investors Services have rated the Cleveland Clinic an Aa3 rating with a positive outlook. Standards & Poors rates it AA-minus rating. They receive these positive ratings because of Cleveland Clinic's strategic planning. In the first 6 months of 2009, their operating profit margin was 7.9% compared to a 4.6% operating margin for 2008. Despite economic issues, the Cleveland Clinic recognized economic pressures and instituted budget constraints organizational wide in 2008. It also declined to fill nonessential positions and increased physician workloads. As a result, inpatient admissions were stable at 142,000 annually with overall hospital visits exceeding 3.6 million (Rhiggs, 2009). These results are very positive considering the fact that many individuals have lost their health insurance and have elected not to receive care which impacts healthcare organizations like the Cleveland Clinic, despite their reputation. Cleveland Clinic recognized this possibility and opted to assess their current financial status and how it was going to impact their long range plans for expansion and opted to restructure their debt.

(f) step six: Identify and evaluate the organization's external environment for new opportunities.

Successful integrated financial planning must include an assessment of their prospective market and demographics and its competitors (Grube, 2005). The Cleveland Clinic's leaders continually review their financial situation and external environment to ensure their strategic plan was based on the strengths of its organizational structure and its competitive environment. During its embryonic life cycle in 1921 to its current mature life cycle stage in 2009, they have developed strategies to maintain a dominant position in their industry. They have continued their integration of patient care and research to ensure they were offering cutting edge care. In 1995, the Heart Center was named the number one hospital nationally by the U.S. News and World Report annual survey and has maintained their reputation over a decade later (http://www.usnews.com).

The Cleveland Clinic was originally established in Cleveland, Ohio. As part ®f their strategic plan, they expanded their services to the surrounding suburbs. They currently operate 15 family health centers which also contain pharmacies and outpatient surgery centers in those areas. Recognizing the need to increase their exposure both nationally and internationally, based on marketing research, in 1988, they established a Cleveland Clinic health care facility in Weston and West Palm Beach, Florida; Toronto, Canada; and in 2012, in Abu Dhbai, United Arab Emirates. Cleveland Clinic in Florida has 150 physicians in 35 specialties. Cleveland Clinic Toronto established a facility for secondary and tertiary care and a wellness center. Their newest facility, Cleveland Clinic Abu Dhbai, scheduled to open in 201 1, will be a 360 bed multi specialty facility.

One of the most important components of a strategic plan is an external analysis to assess their direct competitors. The Cleveland Clinic's direct competitors are the Mayo Clinic in Minneapolis, Minnesota and Johns Hopkins Hospital in Baltimore, Maryland. A recent survey indicated that brand awareness of the Cleveland Clinic is substantially behind the Mayo Clinic so they need to continue focusing on their branding, although people's ability to recognize their name has increased from 20% in 1998 to 28% in 2006. The Cleveland Clinic has recognized that Johns Hopkins usually is ranked in the top five for many of the medical specialties. Based on an internal analysis of their strengths and weaknesses, the Cleveland Clinic has recognized that fact and has focused on four niche specialties: heart disease, urology, rheumatology and gastrointestinal disorders. They rank no. 1 in heart care and number 2 in the other three specialties. Although the Cleveland Clinic provides care in over 15 specialty areas and ranks in the top 10 nationwide for most of those specialties, they have focused on becoming one of the best healthcare systems in those four areas. In 2007, the Cleveland Clinic was reorganized by combining specialties that focus on a specific organ or disease system into integrated practices called Institutes. The reorganization occurred to further create a collaborative, patient centered care. (Facts and Figures, 2008).

(g) step seven: Develop financial projections based on new opportunities. Assess the risk associated with these new opportunities.

Market intelligence provides insight to help financial planners realize maximum opportunity for any of their products with the HSO service area. By reviewing market growth rates and market share, financial projections can be maximized (Boblitz, 2006). It is also important to note the risks associated with these proposed opportunities. Risks such as any changes in operating costs, patient revenue, and productivity changes should be assessed. Also the expected net present value should be calculated to assess these new opportunities. Based on these assumptions and calculations, the optimal decision should be selected (Mclean, R., 2003). In conjunction with step four, the Cleveland Clinic continued its external analysis to asses new market opportunities. »

Cleveland Clinic Innovations (CCI) was established to commercialize all inventions and related capabilities from throughout Cleveland Clinic. An 18-member Industrial Advisory Board provides oversight to CCI to link financial and management advice to support the commercialization of its technology. *It maximizes the research capabilities of Cleveland Clinic with more than 200 new inventions per year. Cleveland Clinic Innovations advances commercial oriented innovation and transforms promising therapies, devices and diagnostics into products by creating spin-off companies, licensing to established companies and enabling equity partnerships. Since 2001, the Cleveland Clinic has established 25 spin off companies for the sole purpose of marketing these inventions. Despite the recession, 9 patents were issued to CCI in 2009 (http ://www. clevelandclinic . org) .

CCI is an excellent example of strategic financial planning. Their mission statement has focused since 1921 on patient care and providing education and research to ensure they provide quality care. By developing the CCI to foster innovation and simultaneously increase their revenues illustrates the importance of financial and long term planning.

(h) step 8: Evaluate all steps and revise as needed.

For an organization to be truly impactful, it is necessary to have perpetual strategic planning that is synchronized with the organizational budget. If the two are developed independently, any long range successful planning may not be successful (Gee, 2007). This is also particularly true during this economic recession. Recognizing these issues, the Cleveland Clinic opted to enter the bond market in August 2008 with a $1.1 billion bond issue to restructure their existing debt. As part of this bond, they plan to utilize $500 million for new construction on their main campus in Cleveland, OH. This is an excellent example of strategic financial planning. Senior management is pursuing their strategic plan for construction of their campus while recognizing that in order to fulfill those plans, they must address the issues with their debt.

According to annual reports, their total operating revenue has increased continually. From 1998-2006, total operating revenue increased from $2 billion to $4.4 billion. Over 90% of their revenue comes from patient care. Their cash investments increased in 1998 from $1.2 billion to $2.685 billion in 2006 which indicates they are managing their funds and their debt (State of the Clinic, 2006).

CONCLUSION

A chief characteristic of successful hospitals and HSOs is the ability to develop sustainable strong financial performance over a long period of time. This type of planning is an integrated approach at all levels of the organizations to develop strategic goals in marketing, clinical outcomes, human resource management and financial performance (Gube, M, 2006).

According to Grebe (2005), solid strategic planning is essential to successful financial performance. According to rating agencies that assess healthcare organizations financial and credit status, they feel comfortable providing quality ratings to healthcare organizations that focus on the following points: (a) linking the financial and strategic plan throughout their management process; (b) market share and competitive edge; (c) measureable and successful strategy; (d) an ongoing planning process, and (e) written information to support the strategic plan. During this recession, it has become more difficult to develop accurate long term financial planning because of the increased risk of financial investments and the possibility of healthcare reform. However, the Cleveland Clinic, despite the recession, has been successful in managing their budget and their strategic plan. They have maintained positive ratings from both Moody's and Standard & Poors which have allowed them to restructure their debt while continuing to expand their facilities and their services. They have performed strategic financial planning, increased their market share and competitive edge, measured their performance systematically, continually reviewed their planning, and maintained documentation to support their activities. As a result, they are one of the best HSO's in world.

Subject: Budgets; Strategic planning; Health care industry; Financial performance; Case studies

Location: United States--US

Company / organization: Name: Cleveland Clinic; NAICS: 622110

Classification: 9130: Experiment/theoretical treatment; 8320: Health care industry; 3400: Investment analysis & personal finance; 2310: Planning; 9190: United States

Publication title: Journal of Business Case Studies

Volume: 6

Issue: 5

Pages: 23-29

Number of pages: 7

Publication year: 2010

Publication date: Sep/Oct 2010

Year: 2010

Publisher: Clute Institute for Academic Research

Place of publication: Littleton

Country of publication: United States

Publication subject: Business And Economics--Management

ISSN: 1555-3353

Source type: Scholarly Journals

Language of publication: English

Document type: Business Case, Feature

Document feature: Tables References

ProQuest document ID: 756035573

Document URL: http://search.proquest.com/docview/756035573?accountid=38610

Copyright: Copyright Clute Institute for Academic Research Sep/Oct 2010

Last updated: 2013-09-06

Database: ABI/INFORM Complete

Document 17 of 100

Classy Delicates: A Case Study

Author: Subramanian, Ram; Malaga, Ross A

ProQuest document link

Abstract:

Andy Steiner was checking the Internet for late night West Coast baseball game scores early on Saturday morning, August 3rd, 2007, when an email message popped up on his screen. It was a message from a prospective buyer for Classy Delicates, Steiner's online lingerie retailing business. Intrigued by the offer, Steiner contacted the prospective buyer who reiterated his intention and talked specific terms for the purchase. "Isn't this a coincidence," remarked Steiner to his wife, Julia. "We were just talking about the future of our business and here comes this new offer. This is the fourth offer we've had." "We should consider a sale of the business seriously," said Julia, "even though you were thinking of upgrading the site to improve traffic." "How much time do we have to examine the offers?" asked Julia to her husband. "The current buyer has made an offer to one other business and he told me that it's either the other business or us, and not both. I don't know if he is bluffing or not, but I think we have a week to decide for all four, " answered Steiner. [PUBLICATION ABSTRACT]

Full text:

INTRODUCTION

Andy Steiner was a business school professor at a university in New Jersey. Since 1996, he had specialized in teaching courses in the area of electronic commerce. When Steiner and his wife were in Maryland, Julia Steiner was unhappy at her job. The couple settled on the idea of starting a business of their own so that Julia could quit her current job. They explored various business possibilities, none of which panned out. While their search was going on, Steiner accepted a faculty job in New Jersey. Julia found a new job in New Jersey that she was happy in and pulled out of the owning a business idea. Steiner, however, continued his search for a business opportunity, except that now he focused on online businesses given his expertise in that area. He started an online store selling iPod accessories but quickly sold it, as he determined the market was too competitive. He came across an online lingerie store called Classy Délicates (www.ClassyDelicates.com). Steiner talked about his reasons for buying this business:

"Classy Délicates was an affiliate site directing users to online lingerie vendors and collecting a commission. I liked this site because lingerie vendors offered drop shipping to end users, which meant that I didn't have to cany inventory and the drop shipper took care of the details. Since I wanted to change it from an affiliate site to a retailing site, drop shipping was important to me. In addition, while the asking price was $75,000, I was able to bargain it down to $30,000 plus one and a half times the profits for the first three months, which turned out to be a measly $450 because of all the changeover expenses! I essentially paid $30,450 for a domain name and site traffic.

Steiner completed the purchase of Classy Délicates in August 2005. He immediately changed it from an affiliate site to a retail site. He contacted two leading intimate apparel vendors, Elegant Moments (Pennsylvania, USA) and DreamGirl (California, USA), who both agreed to drop ship products for Classy Délicates. Steiner redesigned the website that now featured large product images and a shopping cart system to handle customer purchases. He relaunched the site six weeks after purchasing the business.

Business was extremely slow in the first months of relaunch. Steiner reflected on this period:

"We were grossing around $200 per month in the first couple of months. We moved up to around $1,000 per month after six months and then averaged around $3,000 per month toward the end of the first year of purchase. We were getting lost in the avalanche of websites that now existed on the web. In addition, Yahoo went through a major update in January and Februaiy of 2006. During an update, sites usually get shuffled around a lot. We effectively disappeared completely from Yahoo during this period. Since this was our major source of traffic to the site, and since February - because of Valentine 's Day - is our biggest month for sales, this hurt us a lot.

To address the slow business problem, Steiner purchased pay-per-click (PPC) advertisements on Google. PPC ads appear on the top and right-hand side of the results page after a user types a query in Google (see Exhibit 1).

Merchants bid on words and phrases. When one of them was entered into Google, the ad would appear. The PPC campaign produced a negative return on investment and was soon discontinued.

Steiner then tried a second marketing approach. He used search engine optimization (SEO). SEO was a set of techniques aimed at having a site appear toward the top of the search engine results page (SERP) for a certain query. The main difference between SEO and PPC was that with PPC, the merchant pays for every click. With SEO, the clicks were free. In addition, Steiner found recent research (Sen 2005) that showed that users trusted the SEO (called organic) results and were more likely to purchase from them (Exhibit 2 describes SEO in greater detail and Exhibit 3 depicts meta tags used in organic search listings).

EXHIBIT 2: Search Engine Optimization

How Search Engines Work

A search engine is simply a database of web pages, a method for finding web pages and indexing them, and a way to search the database. Search engines rely on spiders - software that follows hyperlinks - to find new web pages to index and insure that pages, which have already been indexed, are kept up to date.

Although more complex searches are possible, most web users conduct simple searches on a key word or key phrase. Search engines return the results of a search based on a number of factors. All of the major search engines consider the relevance of the search term to sites in its database when returning search results. So a search for the word "car" would return web pages that had something to do with automobiles. The exact algorithms used to determine relevance are constantly changed and often kept secret. For example, Google's algorithm considers over 60 factors to determine relevance ("Google's Patent", n.d.).

SEO History and Current Situation

The concept of optimizing a website, so that it appears toward the top of the results when somebody searches on a particular word or term, has existed since the mid 1990's. Back then, the search engine landscape was dominated by about 6-10 companies, including Alta Vista, Excite, Lycos, and Northern Lights. At that time, search engine optimization (SEO) largely consisted of keyword stuffing; that is, adding the search term numerous times to the website. A typical trick employed was repeating the search term hundreds of times using white letters on a white background. Thus the search engines would "see" the text, but a human user would not.

The search engine market and SEO had changed dramatically over the past few years. The major shift had been the rise and dominance of Google. Google currently handles more than half of all web searches (Burns 2007). The other major search engines used in the United States are Yahoo and MSN. Combined, these three search engines are responsible for over 91% of all searches (Burns 2007).

In addition, recent research indicates that most search engine users only click on sites that appeared on the first page of the search results - basically the top ten results. Very few users click beyond the third page of search results.

The dominance of the three major search engines (and Google in particular), combined with the research on user habits, means that for any particular search term, a site must appear in the top 30 spots on at least one of the search engines or it is effectively invisible. So, for a given term; for example, "lingerie", there are only 90 spots available overall. In addition, 30 of those spots (the top ten in each search engine) are highly coveted and the top ten spots in Google are extremely important.

Practical Aspects of SEO

SEO consists of three main processes - indexing, on-site optimization, and obtaining links.

Indexing

Indexing is the processes of attracting the search engine spiders to a site, with the goal of getting indexed (and hopefully ranked well) by the search engine quickly. All of the major search engines have a site submit form where a user can submit a site for consideration. However, most SEO experts advise against this approach. It appears that the major search engines prefer "discovering" a new site. The search engines "discover" a new site when the spiders find a link to that site from other sites. So the main approach to indexing involves getting links to a site from other sites that are frequently visited by the spiders.

A typical method for getting a site indexed is the so called "Blog-Ping" approach. This technique consists of setting up a Blog on a well known Blog site. Many SEO experts prefer Blogger for this since it is owned by Google and visited often by Google's spider. Once the Blog is set up, the SEO expert begins posting short articles with a link back to the site he wants indexed. The final step is to ping the Blog. Pinging is a service that tells Blog search engines and other sites that the Blog had been updated. By using the Blog-Ping approach, sites are usually indexed very quickly (in just a few days or less).

On-Site Optimization

On-site optimization is the process of making changes to a website in order to improve its search engine rankings. Some of the main on-site factors used by the search engines in order to determine rank include title tag, meta description tag, Hl tag, bold text, and keyword density.

Meta tags are hypertext markup language (HTML) elements that describe a web page. They are not visible on the page, but are visible to the search engines. Two meta tags - title tag and description tag - are used by the search engines in two ways. First, they use the tags as one of many elements that are considered when determining search engine rankings. Second, many search engines display the title and description tags in the search listings (see Exhibit 3).

Steiner tested many different versions of the title and description tags. He noticed that small changes to the title tag made a big difference in Classy Délicates search engine ranking - particularly on Yahoo. By changing these tags Classy Délicates began to rank on the second page in Yahoo for the term "lingerie".

Hl tags are HTML elements that indicate the text is considered to be a level one header. Many search engines place importance on Hl headers and text that appears in bold on the web page. Steiner added Hl headers and bold text to the main page and each category page on the site. The headers and bold text on the main page seemed to improve the site's Yahoo ranking slightly. In addition, a number of the category pages, such as bustiers and corsets, began to rank well in Yahoo.

Keyword density is a measure of how often a certain word or phrase appears on a site. There is considerable debate among SEO practitioners as to the optimum level of keyword density. Most agree that if the keyword density is too high the search engines begin to penalize a site. However, since the search engines keep this level a secret, determining the best keyword density often requires a great deal of trial and error.

By using on-site optimization techniques, Steiner was able to achieve excellent search engine rankings for the terms "lingerie", "women's lingerie", and "sexy lingerie" in Yahoo. Classy Délicates was usually ranked on the first or second page for "lingerie". The site was usually ranked first or second in Yahoo for "women's lingerie" and "sexy lingerie".

Link Building

All of the major search engines consider back links in their ranking algorithms. A back link is a hyperlink from a site to the target site - in this case Classy Délicates. All of the major search engines also consider the relevance of the text used in the back link (called the anchor text). For example, a link to Classy Delicates that said "lingerie" would be considered relevant, but one that said "cars" would be irrelevant.

Yahoo and MSN use the number of back links in their algorithms. Google places particular importance on back links. Google does not just consider the number of links, but also the "quality" of those links. Google assigns each page in its index a Page Rank (PR). Page Rank is a logarithmic number scale from 0-10 (with 10 the best). Google places more weight on back links that came from higher Page Rank sites.

Understanding the importance of back links, Steiner began a major link building campaign. First, he embarked on link exchanges with other lingerie sites. Second, he submitted Classy Délicates to a number of web directories. Directories are just categorized lists of websites. Third, Steiner purchased links. He spent $100 per month for a package that allowed him to put links on up to 1,000 sites. These strategies, especially the links purchase, greatly improved Classy Delicates rankings on Yahoo. However, the site still did not rank well in Google.

In order to improve Classy Delicates' Google rankings, Steiner focused on higher quality links. He did this by posting comments on relevant Blogs with high Page Rank. He also submitted relevant articles to article syndication sites. Article syndication sites allow webmasters to place submitted articles on their site. So submitting to syndication sites actually provided back links from multiple sites. By focusing on higher quality back links, Classy Delicates began to rank well for "women's lingerie" on Google.

As Steiner had some expertise in SEO, he concentrated his efforts on it. By the beginning of 2006, Classy Délicates appeared in the top position for the term "women's lingerie" on Yahoo. In addition, the site usually appeared on the second page (positions 1 1-20) for the term "lingerie". The SEO strategy paid off because by June of 2007, Classy Delicates was grossing upwards of $8,000 per month.

The Classy Delicates website had monthly traffic of 35,000 to 40,000 visitors. However, Steiner was concerned at the low conversion rate (the number of site visitors who actually bought products) of less than one percent. In addition, Steiner's analytics (obtained from Google) indicated that a large number of visitors were starting, but not completing purchases. "I wonder why a visitor would take the trouble of looking at the product offerings, fill out most of the order form, and at this point change his/her mind about the purchase," remarked Steiner to his wife after looking at the analytics report in March 2007.

THE LINGERIE INDUSTRY

Lingerie was part of the apparel industry. Standard and Poor's reported U.S. apparel sales of $190.1 billion in 2006, of which women's apparel was $102 billion. U.S. per capita spending on apparel and footwear in 2006 was $1,226. The U.S. apparel industry was large, mature, and highly fragmented. Imports dominated the industry and they exceeded domestic production by a significant margin.

Lingerie accounted for $9.6 billion in revenues in 2005, an increase of 3.8 percent over 2004. Victoria's Secret, a division of the $10.67 billion (in 2007) in revenues Limited Brands, and the privately owned Fredrick's of Hollywood were the two major players in the fragmented lingerie industry.

The Internet lingerie retailing industry features many operators operating out of the U.S. as well as from Canada, the U.K. and other European countries. While Victoria's Secret and Fredrick's of Hollywood typically competed at the middle to the upper end of the industry in terms of price and branding, at the lower end there were dozens of sites that sold merchandise from the same six to eight suppliers. These suppliers (such as Elegant Moments and DreamGirl) loosely enforced pricing policies that allow for keystone markups (100% markup). While the profit margins were high, since everyone used the same suppliers it was difficult for a single vendor to differentiate.

Classy Delicates competed to some extent with the higher end lingerie retailers. However, the main competition was on the lower end, where many other retailers sold the same products as Classy Delicates. As suppliers attempted to enforce retail pricing, there was very little room to compete on pricing. Thus, most customers usually purchased on either the first site they found or the last site (after comparing prices). Therefore, it was vitally important for a lingerie website to show up as the one of the first few on a customer's web search.

Steiner reflected on his competition:

"When people think of lingerie, the names that usually come up are Victoria 's Secret and Fredrick's of Hollywood. Victoria's Secret spends a lot of money on television advertising and has tremendous name recognition. To some extent, so is the case with Fredrick's. Either because of prices or the type of products sold in these two stores, I don't believe that my customers look at Victoria's Secret or Fredrick's before buying from Classy Delicates. My competitors are mid-to low price online lingerie retailers. The trouble is that my suppliers (Elegant Moments and DreamGirl) supply to a whole bunch of online vendors and we compete aggressively with each other. We can't really compete on pricing, so the key to success is to be either the first one to show up on the customer 's search screen or at least be in the first ten or so. I need to attract customers to my website and increase the rate at which visiting customers complete the ordering process. "

BUSINESS PROCESSES

Classy Delicates required minimal operational time for Andy and Julia Steiner. Periodically, Andy Steiner had to change the product images on the website when the vendors introduced new products. He paid a site hosting fee that was a set amount plus an amount that depended on traffic. These totaled anywhere between $300-400 per month. He negotiated with Authorize.net for credit card processing for a fee of 2.25% of the transaction amount, plus transaction fees of about $0.25 per transaction. He installed a toll free phone line for customer service that saved phone messages to be answered at a later time. The fee for this was $10 per month.

Customers perused the website and placed orders. The ordering was complete when payment was made. A completed customer order automatically generated an email to the vendor. The vendor drop shipped the order directly to the customer and billed Classy Delicates on a monthly basis. Backorders posed a problem because they required follow up. Steiner spoke about the backorder issue:

"When a vendor was out of stock on a particular product, the customer's request was put on backorder. Now, officially, the vendor was required to inform me when the product was available to be shipped, but often the vendors did a poor job of it. After my customers complained to me about not hearing about backorders, I decided to take responsibility for it. Now, Classy Delicates keeps track of backorders via emails and telephone calls to vendors and we inform customers when to expect the order. We typically check with the vendors before we run specials on their items, but sometimes they are out of stock and hence, we get into the loop with the vendors and the customers."

As Andy and Julia Steiner got busy with their jobs and parenting their two young daughters, they decided to hire an assistant to manage the interaction with the vendors and the customers. Andy Steiner placed an advertisement on Craig's List for a "virtual" assistant - one who could be located anywhere but would work for Classy Delicates. Steiner hired an assistant who was paid $ 1 00 per month for this responsibility. Exhibit 4 outlines the interaction between the vendors, Classy Delicates, and the customer.

Steiner did not keep proper accounting books in the beginning and he gave the following rationale for it:

"I did not maintain proper financial records of Classy Delicates when I bought the business in August 2005. I had two reasons for this. The first was that we hardly had significant sales and I had a mental record of how much came in and the amount I paid for site hosting and other expenses. The bigger reason, though, was that I concentrated on helping improve site traffic by doing what I knew best - things such as SEO. Classy Delicates was not my full-time job; I had my academic job to attend to and Julia had just taken up a new job when we moved to New Jersey. These, along with the responsibility of raising two young daughters, took a lot of my time, !figured that I will get to the accounting part once I get more customers to visit my site. "

By June 2006, though, Steiner began keeping regular accounting records (see Exhibit 5 for a financial summary).

The Offer

During the summer of 2007, Steiner decided to test the market by putting Classy Delicates for sale. He listed Classy Delicates for sales on BizBuySell.com in July 2007 that described his business and quoted a sales price of $120,000. Steiner reflected on his move to offer the company for sale:

"I was not in any way compelled to sell Classy Delicates. My efforts at increasing site traffic was paying off and we were now making around $2,500 a month in net profit. To be honest, running the business now did not take a lot of my time. My thought was to test the market by asking for an attractive price and to see if anybody bites. Considering that I paid $30,450 for the business in 2005, a price of $120,000 means a sizeable profit. How did I choose my selling price of $120,000? I looked at various websites that talked about price multiples and other factors for valuing a web-based business. One expert suggested 10 times annual profit. I was quite certain that it would not work in the case of Classy Delicates given the nature of my business, which was selling the products of vendors in a non-exclusive arrangement. I thought a multiple of four was high enough to satisfy my requirement, and I rounded it off to $120,000. If I find a taker, perhaps I could invest the money in a new business. "

Steiner received three offers prior to the one on August 3rd. The first offer was for $65,000 while the second and third offers were in the $80,000 range. Steiner immediately rejected the first offer which he angrily remarked to Julia was an "insulting and lowball offer." One of the second offers required Steiner to essentially finance the purchase. The potential buyer was willing to pay 25 percent down at the time of purchase and the rest over a two-year period. As Steiner was considering the two $80,000 range offers, the fourth offer was made on August 3r . This was from a buyer who already had two websites (both for non lingerie businesses) running on the same web host as that of Classy Delicates. His offer was $90,000, cash down.

The Decision

Both Andy and Julia Steiner spent time going over these offers. Andy Steiner summarized their discussion and also gave his own thoughts on the offers:

"Perhaps $120,000 was too high. Even then, when both Julia and I looked at the best offer of $90,000, we were disappointed. Where was the '10 times earnings' that experts talked about? We probably can bargain with the fourth bidder knowing that he already has two sites on the same host and a third site would give him the scale necessary to increase his profits, but I don 't believe we can go higher than $95,000 or, at the most, $100,000. I argued with Julia that with the way the site traffic is increasing, if we can increase the conversion rate even marginally, we can make the $100,000 in about two years. But, as Julia pointed out, the price of $100,000 means a sizeable return on our investment of $30,450 two years ago. I have a profitable business, albeit one that does not have a defensible competitive advantage other than a favorable position on search engines. My product is not exclusive as others are selling the same thing. But, at a 100 percent margin, am I passing up a good opportunity to make a fair amount of money year after year by selling it now?

As Andy and Julia Steiner were debating the sale option, Julia reminded Andy that he had come up with an ambitious plan to make major changes to Classy Delicates. Andy's plan called from changing the site's shopping cart system to one who would charge $75 a month instead of the $300 that the current cart provider charged. Andy had received a number of quotes for switching to a new shopping cart system and redesigning the site. These quotes ranged from $5,000 - 8,000. Andy's rationale for a new cart was not just the lower monthly fee but also the fact that the new cart would give him increased control to customize the site - control that was minimal in the current form. A major risk in shifting shopping cart systems was a possible loss in search engine rankings. Andy Steiner spoke about this option:

"I feel hampered by my current shopping cart system, particularly in the check-out process. Given that I lose a lot of customers at the check-out stage, perhaps a change can help me redesign and streamline the check-out process, as well as the overall design of the site itself. It will cost me money and, more importantly, the possibility of losing my current rankings on Google and Yahoo. That worries me! "

Andy Steiner realized that he had a week to make up his mind whether to sell the business or continue running Classy Delicates. He wondered what he should do.

Subject: Retail stores; Clothing; Sale of a business; Electronic commerce; Market strategy; Search engines; Case studies

Location: United States--US

Classification: 8390: Retailing industry; 5250: Telecommunications systems & Internet communications; 9190: United States; 7000: Marketing; 9130: Experiment/theoretical treatment

Publication title: Journal of Business Case Studies

Volume: 6

Issue: 5

Pages: 31-39

Number of pages: 9

Publication year: 2010

Publication date: Sep/Oct 2010

Year: 2010

Publisher: Clute Institute for Academic Research

Place of publication: Littleton

Country of publication: United States

Publication subject: Business And Economics--Management

ISSN: 1555-3353

Source type: Scholarly Journals

Language of publication: English

Document type: Business Case, Feature

Document feature: Illustrations Tables References Diagrams

ProQuest document ID: 756035851

Document URL: http://search.proquest.com/docview/756035851?accountid=38610

Copyright: Copyright Clute Institute for Academic Research Sep/Oct 2010

Last updated: 2013-09-06

Database: ABI/INFORM Complete

Document 18 of 100

Silver City: A Case Study

Author: Mills, John R; Pippin, Sonja; Carslaw, Charles; Mason, Richard

ProQuest document link

Abstract:

The Silver City Case is designed for an advanced accounting or MBA class and provides students with the opportunity to analyze relevant information extracted from different types of business entities. These range from publicly traded corporations to non-corporate and/or non-public entities. Students are required to make a decision on the viability of a bid on a Request for Proposal (RFP) for a sports facility construction project. The primary objective is to provide a foundation for the evaluation of complex business entities. This requires the dismantling of the business structure to the point that it can be analyzed on an individual entity basis. The achievement of this objective requires students to understand the type of financial information that can be derived from each of the different entities as well as determining the reliability of such information. Furthermore, the case offers opportunities to discuss underlying guarantees that keep the business structures together. [PUBLICATION ABSTRACT]

Full text:

INTRODUCTION

Silver City is a city in the western United States that at one time was a boom town during the gold rush period. It had a population in excess of 100,000 in the 1860s and its current population has grown to over 300,000. Parts of the old central downtown area of the city have become depopulated and are in run down condition. The city has started a series of redevelopment projects in its effort to attract more people to live and work in the downtown community. One of the projects is the construction of a Silver Spurs Sports Facility. The city has put out a Request for Proposal (RFP) for the construction, operation and ownership of this sports facility. The city currently owns the land that the Silver Spurs Sports Facility will be built on but will donate the land to the winner of the proposal. The RFP was announced in April 2009. The evaluation process will commence on June 30, 2009 and the winning bid will be announced on September 1, 2009. Construction is expected to start October 1 , 2009.

The RFP has resulted in the submission of several proposals by companies with a range of ownership structures. The submissions include bidders from publicly traded corporations who have created Limited Liability Company ("LLC") subsidiaries; joint ventures and other ownership structures. Other submissions come from newly created LLCs composed of a combination of individual investors, partnerships, trusts and LLCs. All the proposers submitted financial information with a year end of December 31, 2008.

The City Council of Silver City selected a group of five senior government officials to be the Sports Facility Review Board (SFRB) ("Board"). The Board will decide on the winning proposal. In addition, the Council decided to hire a group of experts to provide advice to the Board based on their expertise in the areas of financial analysis, economic development, human resources, strategic and operational business plans, and sports complex design. You have been hired to provide the advice in the area of financial analysis.

An area of major concern to the Board is their lack of understanding of corporate financial information. Given the current weak economy, the Board wants assurance that the winner of the proposal has the financial capability to construct the project and the ability to operate the property for an extended period once it has been opened. The city has hired you to evaluate the financial suitability and stability of each of the applicants that have submitted RFPs.

EVALUATION OF AN ENTITY FOR FINANCIAL SUITABILITY

The first applicant that has been referred to you for review is Top Hill Investments, LLC. The Board has provided you with the financial data provided in Appendix A that represents the financial information provided by the Top Hill Investment group. This information and the information below has been provided by Top Hill Investments' company president, John Burch.

Top Hill Investments is a newly formed entity created solely for the Silver Spurs Sports Facility RFP. The joint venture intends to build, own and manage the facility if awarded the bid. The owners are ABC2 Corporation and Silver Nugget, LLC. As shown in Figure 1, ABC2 and Silver Nugget are each 50% owners of Top Hill Investments.

ABC2 is a wholly-owned subsidiary of ABC Corporation, a publicly-traded corporation (Nasdaq: ABC) and the owner/operator of the Stockton City Sports Arena in California. ABC2 has been created by ABC solely as a subsidiary to establish Top Hill. It does not have any significant assets or liabilities. ABC has provided its historic financial statements for the three years ending December 31, 2008 (see Tables Cl, C2, and C3).

Silver Nugget, LLC is also a newly- formed entity, formed solely in connection with Top Hill's application for the Silver Spurs Sports Facility proposal. Silver Nugget is a jointly owned company owned by three of the principal partners of BCD Construction Company (John Burch (70%), Steven Cornwall (20%) and Charles Jacobs (10%)). BCD Construction Company is a nationally-known private development company with extensive experience in the development of leading sports complexes.

Because Silver Nugget is a newly formed entity with no historical financial information, net worth statements (Table C4) and summarized tax return information (Table C5) of all of the investors in Silver Nugget have been included in the RFP. In addition to the net worth of its owners, Silver Nugget has arranged a further $150 million undrawn line of credit (hard copy of credit agreement included) from the Burch Family II Trust. Information concerning the Burch Family II Trust is provided in Table C6. This trust was specifically set up by Burch family members to fund certain investments projects. Thus, while trust income is generally not distributed, the trustee has the flexibility to distribute trust assets to Burch family members and to pledge funds for certain investment projects.

PROPOSED COST OF THE SILVER SPUR SPORTS FACILITY

Top Hill has provided estimated cost information on the proposed Silver Spurs Sports Facility as shown in Table C7. The total proposed cost is estimated to be $700 million. The cost includes $180 million for highway improvements that will provide easier access to the stadium and parking. This was one of the required improvements suggested by the City in order to have a viable bid. Top Hill also submitted together with the bid a letter of intent from First West Bank which indicates the bank would be willing to extend a five year $400 million senior security loan if the owners of Top Hill Investments make an upfront $300 million equity contribution to the project. This type of arrangement between lending institution and bidder is relatively common. Top Hill must provide $300 million in cash at the signing date of the agreement with the bank. Note that in order to be considered by the Board, they would expect the bank agreement to be in place at the time when the proposal is submitted.

Sports Facility Review Board wants advice about the financial viability of this proposal. The Board is apprehensive because the proposal from Top Hill Investments is from a newly formed corporation with no financial history. They are very impressed with the design of the proposed facility and the personalities of the proposers and they feel that the $700 million cost is a reasonable estimate. They are, however, concerned about where the funds will come from for constructing and operating the sports facility. They are particularly worried about the reliability of the financial information provided by the Silver Nugget investors. They have asked you to provide them with a financial analysis that will enable them to decide whether this bid is a viable candidate for awarding the sports facility contract and to advise them on further information they should seek before finalizing their decision.

The SFRB also notes that the financials provided were for the year ending December 31, 2008. The current year (2009) has been identified as a recession year with anticipated recovery in the third quarter of 2010. They point out that the stock market has dropped considerably and that the bankers are being more restrictive about loans. After carefully evaluating all financial information provided to you, what is your advice to Board?

POTENTIAL CASE QUESTIONS

A. Ownership Structure

Develop an overview of the different types of business entities involved in this bid. Provide a summary of the strengths and weaknesses associated with each type of business enterprise. Specifically, research the following characteristics for each of the entity involved:

* Limited liability of the entity's owner(s)

* Tax treatment of the entity's earnings

* Tax treatment of contributions to and distributions from the entity

* Restrictions regarding who can be an owner of the entity

Remember that your presentation is to the Board who has very limited private business expertise.

B. Publicly Traded Corporations

1) Prepare a financial statement analysis for the Board on ABC2's parent ABC. This should include both ratio and trend analysis.

a) Determine the financial ratios that are relevant to determine :

i. the liquidity of the companies,

ii. the solvency of the companies, and

iii. the profitability of the companies.

b) Identify the business group that should be used to make industry comparisons and identify appropriate benchmark ratios.

c) Provide an excel spreadsheet with the ratios and trends

2) Use this information to write a report providing recommendations in terms of the ABC2's and ABC's ability to fund this project.

3) What additional information should you seek to evaluate this type of entity?

4) Would your answer be different if you were told that the ABC also has a $300 million revolving bank line of credit?

C. Non-Corporate and/or Non-Public Entities

1) Identify problems that need to be addressed when dealing with the financial analysis of Silver Nugget and the net worth statements provided by its owners?

2) Cash flow statements are required to be provided with public corporations. Is it possible to prepare equivalent cash flow information from the information provided by the Silver Nugget owners?

3) If the Burch Family Trust contributes funding in the form of a loan, how should that funding be treated?

D. All Entities Combined

1) Develop a table that addresses the question of what each investor needs to contribute to the project and whether they can meet their expected input with the resources currently available.

2) Recall that the timeline of the project calls for submission of the proposals by June 30, 2009 when the evaluation process will commence. The winner will be announced by September 1 and construction is expected to start October 1 of the same year. As suggested in the text, the investors have to put guarantees in place to satisfy the Board as well as the bank. These guarantees will cover the time period from the submittal of the bid until construction starts. What nature and type of guarantee should be provided to cover this period of time? Are there any specific disclosure requirements for these guarantees?

Subject: Request for proposal; Organizational structure; Sports facilities; Redevelopment; Case studies

Location: United States--US

Classification: 9130: Experiment/theoretical treatment; 9190: United States; 2320: Organizational structure; 8307: Arts, entertainment & recreation

Publication title: Journal of Business Case Studies

Volume: 6

Issue: 5

Pages: 41-48

Number of pages: 8

Publication year: 2010

Publication date: Sep/Oct 2010

Year: 2010

Publisher: Clute Institute for Academic Research

Place of publication: Littleton

Country of publication: United States

Publication subject: Business And Economics--Management

ISSN: 1555-3353

Source type: Scholarly Journals

Language of publication: English

Document type: Business Case, Feature

Document feature: References Diagrams Tables

ProQuest document ID: 756035704

Document URL: http://search.proquest.com/docview/756035704?accountid=38610

Copyright: Copyright Clute Institute for Academic Research Sep/Oct 2010

Last updated: 2013-09-06

Database: ABI/INFORM Complete

Document 19 of 100

A Journey To Triumph: The Making Of THRICE Project Using Oracle Technology

Author: Ghani, Nor Farzana Abd; Mahamud, Ku Ruhana Ku

ProQuest document link

Abstract:

THRICE project is kicking off in February 2010, to integrate all learning systems built from the previous projects; namely, Sekolahku.net, online training solution for Malaysia's Institute for Accountancy and online training solution for Technology Park Malaysia College. All projects are owned by In-Fusion Solutions Sdn. Bhd. and are e-learning solutions, which support its core business. THRICE project will mainly leverage on the Oracle as its main technology. Integrating to new technology may not he as good as it sounds because some issues need to be considered in terms of making sure the transition process to Oracle run smoothly. Apart from that, the mobilization of staff needs to be decided in making sure THRICE project becomes a success in fulfilling the client's wish. [PUBLICATION ABSTRACT]

Full text:

INTRODUCTION

Fusionware Systems Private Limited is a joint venture between Twiceware Solutions Private Limited (India) and In-Fusion Solutions Sdn. Bhd (ISSB) of Malaysia's In-Fusion Group. It is the technology solutions wing of TWICE group of companies. TWICE group was founded in 2003 as Twiceware Solutions Private Limited, is committed to providing practical and effective solutions in areas of eLearning, Multimedia and Knowledge Services. Fusionware is set to provide education acceleration services that, in the future, would change the way education is approached and delivered the world over today. The company provides services that enable enterprise knowledge management for universities, colleges, schools and corporate organizations. Most projects undertaken by Fusionware in the earlier years were to support the TWICE group itself, as well as external projects in India, and was determined to set global footprints in the US, UK, Malaysia and Singapore.

Twiceware's strengths are in both Microsoft Office SharePoint Server 2007 (MOSS) and Oracle Service Oriented Architecture (SOA). As an education solution and services provider, ISSB's core products include courseware, enterprise resource planning (ERP) system for the education environment, educational games, Learning Content Management System, Student Information Management System, Integrated Campus Management System, Islamic Banking and Finance Program, Knowledge Information Exchange System and Portal experience.

ISSB recognizes the emergence of both MOSS and Oracle SOA as very important tools used in the development of applications today and the demand for personnel in both of these skills. Fusionware which will be the global software centre for both groups and their clients in application development using MOSS and Oracle SOA and will address the lack of such skills in Malaysia. It will also be the catalyst that will allow In-Fusion Solutions to grow beyond its core competency in the education industry to others, such as banking, telecommunication, healthcare and manufacturing.

Having successfully delivered the best education solutions to its clients, ISSB foresees the challenge to provide a complete spectrum of solutions to enhance learning experience and administration of virtual learning. The main highlight for 2010 is to integrate the management of learning content, learning activities and student data into one suite of products and, at the same time, give flexibility to future clients to customize the product according to their needs.

BACKGROUND

Fusionware Systems Private Limited is as a Joint Venture between Twiceware Solutions Private Limited (India) and In-Fusion Solutions Sdn. Bhd of Malaysia's In-Fusion Group. Founded in 2003, In-Fusion Solutions Sdn. Bhd is committed to providing practical and effective solutions in areas of eLearning, Multimedia and Knowledge Services. The joint venture between the two companies was made in March 2008 to leverage Twiceware's strength in solution development. Prasadh M.S was appointed as the Executive Director and Selvakumar Baalu as the Managing Director and CEO. Fusionware is set to provide education acceleration services that in the future would change the way education is approached and delivered world over today.

ISSB and Twiceware collaborate to provide schools with a dynamic enterprise learning management system. Learning Management System is an application that delivers, manages, tracks and reports all interactions of e-learning. Fusionware's advanced LMS automates student registration, tracks learner progress, and records test scores that indicate course completion. This online learning and management system enables trainers to assess the performance of their students.

With more than six years' of experience from Twiceware and highly skilled professionals, the company is currently collaborating with some of the world's leading organizations to solve their most complex and critical IT infrastructure, applications and business process outsourcing needs.

Technology Expertise

Fusionware continuously undertakes a comprehensive technology scan to evaluate the possible impact of new and emerging technologies on its clients' businesses. However, Fusionware considers MOSS and Oracle Fusion Middleware as their main profiles. Table 1 below provides a brief overview of Fusionware overall technical skill set:

Having chosen MOSS services as their flagship offering, the company is focused to: 1) hire additional development and consulting resources with a minimum industry Microsoft Sharepoint experience of three years, 2) ensure necessary individual certifications and renewals for all team resources, 3) obtain Microsoft enrolments and partner certifications for the organization, and 4) participate in all MOSS events and forums for networking and exposure. Currently, the company has four MOSS certified engineers to help with solution development (Exhibit 1).

Projects

Challenges faced by Fusionware as a budding software house are undeniable. For the first three months of its operation, all jobs completed were only from the group itself, Twiceware. The projects are crucial to support the backbone operation of most companies under TWICE group. Nevertheless, Fusionware believes that by embarking on a few small projects in the beginning, soon their reputation will be established locally and internationally.

Fusionware has all what it takes to fulfill the need for education of adults, top executives, young children and higher institution learners. Exhibit 2 presents a list of all projects' details granted to Fusion ware as of December 2009. Fusionware, together with In-Fusion Solutions, is collaborating on three major projects; namely, Sekolahku.NET, MIA and TPM College.

TECHNOLOGY FOR THRICE

THRICE project was an idea from Dr. Mohamad Salmi Mohd Sohod, the owner of ISSB. There are three main solutions under THRICE; namely, StudentSpace, LearnSpace and ContentSpace (Exhibits 3, 4 and 5). The three solutions will be built module-by-module to accommodate the client's needs should any customization be required. The idea is to integrate all three solutions so it can provide a complete spectrum of solutions to enhance learning experience and administration of virtual learning. Other systems also included in the THRICE product consist of the Online Tutorial System and Question Bank System.

THRICE product is using the 'Software as a Service' (SaaS) model, whereby a product that is hosted by a provider licenses an application to customers for use as a service on demand. The clients, in this case, can be the organizations and individuals. Three projects have been identified to be integrated into THRICE's suite of products. The projects are solutions that Fusionware has been concentrating on since the beginning of the joint venture with ISSB. Sekolahku.Net, scheduled to kick off in June 2010, is developed using .NET platform, MOSS 2007 and SQL 2005. MIA's and TPM College's online training solutions were completed in September 2009 and April 2009 respectively. They utilized JavaEE and Velocity Framework technologies (Exhibit 2).

The client will be able to subscribe to solutions together or by individual applications. To control the usage and billing of the services by respective clients, a billing system will be created to evaluate the subscription rates accordingly and send automatic alerts to clients when their subscription has ended. In terms of administrating the operations of THRICE, an Administration System will be put in place onto the above modules and will act as a filter or a security for the customers' data. This module typically filters out the data of different customers so that the customers could see only the data which belongs to them. Moreover, this module works in tandem with the billing module and the rest of the applications. This module is internally used by the client to maintain the users (create ids and grant access to them). The high level architecture diagram of the THRICE is shown in Exhibit 6.

The Oracle server contains the web modules and web services that are connected to all database servers. The Oracle BPEL (Business Process Execution Language) is used to define the work flow and the business execution sequence; for example, the creation of customers and customer ID, sending alerts, etc. By using a centralized Oracle server, the entire application is controlled by the customer ID; hence, the data integrity of the customer is achieved. The data is never duplicated in any of the databases. For example, the customer data never resides in any of the MySQL databases, except in the Oracle database. This eliminates data redundancy in the system, making it more responsive and cost less on the storage. All systems that require customer data will talk to the Oracle database to get the details. This concept confines the SOA standards.

THE MEN BEHIND FUSIONWARE

Current practice in Fusionware for managing its resources is to be efficient and productive as much as possible. In light of the current economic situation whereby the company needs to be small and manageable, according to designated projects, there are only around 10 employees involved with Fusionware, according to designated projects. T. Hemanth Raman plays the role as the Project Lead cum Head of Fusionware. Currently only five staff members are experts in Oracle; a team is led by Hemanth himself. The rest of the staff members are experts in .Net. Together both teams support each other according to dedicated projects. Each staff is allocated to one particular project at one time. The team's working standard operating procedure is to finish the development of the solution first and then try to concentrate on the documentation.

Project progress, milestones and man-hours spent are monitored by simple timesheets and Microsoft projects. Every staff in required to fill in a timesheet and submit it on a weekly basis. Man-hours consist of two types - non-billable and billable. Controlling the cost of man-hours of any given project is also important as it is relatively cheap to use OSS technology compared to using Oracle and MOSS technologies.

Following the trend of any software house, the majority of Fusionware's staff members are still young (below 32 years of age). Looking at the dynamicity of the industry, hence, the staff has a tendency to look for better opportunities from other IT companies, both locally and internationally. The competition of the IT companies to hire good programmers and fulfill the set of skills necessary to become fluent in certain technology is becoming obvious in the past few years. Indian IT workers are not cheap anymore and are highly demanded outside India, as well as locally.

FULFILLING CLIENTS' REQUIREMENT

Fusionware is aware of a difference of language, culture, time and distance between clients in Malaysia and the developer team in India. Nevertheless, the time and distance gaps are narrowing down as the emergence of Internet technology offers applications, such as Email, Instant Messaging and Voice over Internet Protocol (VoIP), which makes communication between them free and easy. In every project, the development of the solution starts with the proof of concept (PoC). PoC is developed first before it is presented to the clients. The development process is conducted iteratively, until the client is satisfied with the solution,

In some cases, travel is required to Malaysia to physically meet with the clients to enhance understanding of the requirements. In any project, scope creep is a common problem. Uncontrolled changes in a project's scope are unavoidable and need to be handled properly by the team. In addition, language and culture barriers also create a misunderstanding of the requirements. The team usually has a list of milestones, or a 'Term of References' document that is agreed upon by both parties to minimize scope creep. Once a project is completed, Fusionware will station help desk personnel in ISSB to handle bugs and provide other support to their clients.

SUMMARY

By January 2010, Fusionware will be considered matured enough to 'hatch' from the incubator, which means Fusionware can no longer depend on the support from TWICE group. It is a challenging year ahead for Fusionware as plans to make its presence outside of India is on the way. THRICE project will be an ultimate test for Fusionware to prove to TWICE group that they are finally ready to fly on their own after being dependent on the group's support for almost two years.

As Hemanth and his team scrutinize the plan for the THRICE project in December 2009, some issues need to be considered to ensure the smooth transition into Oracle technology - the mobilization of staff for THRICE project and, at the same time, to ensure that the client's requirements are fulfilled. Kicking off in February or March 2010, the THRICE project will be the main focus before Fusionware can start contemplating expanding themselves to Australia, UK and US in the coming years.

Microsoft Office SharePoint 2007 is a new server program that is part of the 2007 Microsoft Office system. Organizations can use MOSS to facilitate collaboration through:

1. Content management

2. Implement Business Processes & Work Flow Management

3. Document and File Sharing

4. Privileged information access by department

EXHIBIT 3 - STUDENTSPACE

STUDENTSPACE - Innovative Learning

Student Information System, STUDENTSPACE, is a Web-based self-service environment for educational establishments to manage student data. STUDENTSPACE provides capabilities for entering student test and other assessment scores, building student schedules, tracking student attendance, and managing many other studentrelated data needs in a school, college or university. STUDENTSPACE is an Integrated Software Package. It is a data warehouse of student and course information and is designed to accept progress and generate reports accurately so that any point of time any user can get the student information.

ISSB's Vision of Student Information System

* Provide better services to students, faculty, staff, prospective students, parents, etc.

* Provide meaningful, consistent, and timely data and information to end users

* Promote vision of senior management to address opportunities for change

* Update technology infrastructure for more effective and flexible delivery of new systems

* Promote efficiencies by converting paper processes to electronic form

* STUDENTSPACE applications are proven to reduce time spent on administrative tasks so you can concentrate on raising student achievement. It also facilitates networking of colleges/schools to University/Board, colleges/schools to society, colleges/schools to each other, provided they are equipped with his system.

Product Main features

The main features of STUDENTSPACE are to support the maintenance of personal and study information relating to:

* Handling enquiries from prospective students

* Handling the admissions process

* Enrolling new students and storing teaching option choices

* Handling examinations, assessments, marks and grades, and academic progression

* Maintaining records of absences and attendance in e-classroom

* Handling Student Bursary requirement

* Handling award of credit or qualifications and graduation process

EXHIBIT 4 - LEARNSPACE

LEARNSPACE - Think Freely

Learning Management System, LEARNSPACE, in essence, is a high-level, strategic solution for planning, delivering, and managing most learning events within an organization, including online, virtual classroom, and instructor-led courses. The focus of LEARNSPACE is to manage learners, keeping track of their progress and performance across all types of training activities.

LEARNSPACE goes beyond conventional training records management and reporting. The value-add for LEARNSPACE is the extensive range of complementary functionality that it offers, such as; Learner Self-Service (e.g. self-registration on instructor-led training), Training Workflow (e.g. user notification, manager approval), the Provision of On-line Learning (e.g. Computer Based Training, Read & Understand), On-line Assessment, Collaborative Learning (e.g. application sharing, discussion threads), and Training Resource Management (e.g. instructors, facilities, equipment).

LEARNSPACE is developed on Java 2 Enterprise Edition software platform and is web-based to facilitate "anytime, anyplace, any pace" access to learning content and administration.

The main features of LEARNSPACE include:

* Auto enrollment (enrolling learners in courses when required according to predefined criteria)

* Manager enrollment and approval

* Ability to create/suspend learner profiles

* Boolean definitions for prerequisites or equivalencies

* Integration with performance tracking and management systems

* Planning tools to identify skill gaps at departmental and individual level

* Support for Industry standards like SCORM 1.2 content packages and W3C standard for user interface design

* Curriculum, required and elective training requirements at an individual and organizational level

EXHIBIT 5 - CONTENTSPACE

CONTENTSPACE - Pure Creativity

The I-SYS Content Management System (CONTENTSPACE), provides primary management of the learning content used for the e-learning solution. CONTENTSPACE facilitates learning content management at a lower level of granularity, which allows organizations to more easily restructure and repurpose online content. CONTENTSPACE has emerged as the Content Management solution of choice because its state-of-the-art technology supported by professionals. CONTENTSPACE allows the creation of content by enabling good workflow processes - plan, design, develop, and integrate.

CONTENTSPACE is a comprehensive solution for managing content as it empowers users to create, publish and manage content which is richly formatted, timely, accurate and personalized. With the help of easy-to-use tools for authoring and scheduling content, creating workflows and meta-tagging, the users will get just the information they need and the content manager will have the power to present the content as and when requested.

Salient features of CONTENTSPACE

* Superior customization and content generation

* Good database connectivity to create dynamic content quickly and easily

* Manage and update the latest content in order to address rapid changes

* Seamless integration of learning content into portals for use in learning management solutions and e-learning

* Easy and flawless conversion of old content to easily usable media-rich digital content

* Ability to incorporate animation and graphics developed on latest media technology

* Ability to integrate enterprise content to ERP and CRM applications

* Sophisticated control of content access to content managers (create and maintain content) and users (view and use content)

* Ensure that content is properly reviewed and approved prior to publishing by using a multi-step, role-based workflow.

Subject: Service oriented architecture; Online instruction; Colleges & universities; Distance learning; Case studies

Location: Malaysia

Company / organization: Name: Fusionware Systems Private Ltd; NAICS: 511210; Name: Oracle Corp; NAICS: 511210; Name: Technology Park Malaysia College Sdn Bhd; NAICS: 611310

Classification: 9179: Asia & the Pacific; 6200: Training & development; 5240: Software & systems; 8306: Schools and educational services; 9130: Experiment/theoretical treatment

Publication title: Journal of Business Case Studies

Volume: 6

Issue: 5

Pages: 49-57

Number of pages: 9

Publication year: 2010

Publication date: Sep/Oct 2010

Year: 2010

Publisher: Clute Institute for Academic Research

Place of publication: Littleton

Country of publication: United States

Publication subject: Business And Economics--Management

ISSN: 1555-3353

Source type: Scholarly Journals

Language of publication: English

Document type: Business Case, Feature

Document feature: References

ProQuest document ID: 756043315

Document URL: http://search.proquest.com/docview/756043315?accountid=38610

Copyright: Copyright Clute Institute for Academic Research Sep/Oct 2010

Last updated: 2013-09-06

Database: ABI/INFORM Complete

Document 20 of 100

Valuing A B2B Website: A Case Study Of An Industrial Products Supplier

Author: Weitz, Rob; Rosenthal, David

ProQuest document link

Abstract:

In this research we examine the value of a business-to-business (B2B) website of an industrial products supplier by tracking website metrics (e.g., visitors, pages/visit, time per visit, etc.), along with the associated (non-Web-based) financial measures of sales, profit and amount of merchandise sold. We recorded this data over a 15 month period that included a significant mail promotion. Our results indicate that while the promotion dramatically increased visits to the websites, it had no positive effect on sales, profit or quantity of material sold. Generally, there was no relationship between website visits and monetary measures. [PUBLICATION ABSTRACT]

Full text:

INTRODUCTION

There has been a longstanding debate on the value of organizational investments in information technology (IT). While some have argued that investments in IT are closely linked to organizational effectiveness (Bhatt & Grover 2005, Santhanam & Hartono 2003) others have gone so far as to argue that "IT doesn't matter" (Carr 2003). With the rise of the Internet and e-commerce, a focus has turned to evaluating commercial websites. Determining the number of visitors and related metrics for a business website is relatively trivial, but assessing its business value is more complex. For business-to-consumer (B2C) websites, this valuation task is facilitated by the fact that purchases are typically made via the website. Analytics can be compiled on sales data, the effect of promotions on sales, how website design changes impact sales, etc. For business-to-business (B2B) websites without "shopping cart" functionality the task is considerably more challenging.

In this research we examine the value of a business-to-business (B2B) website of an industrial products supplier by tracking not just website metrics (e.g., visitors, pages/visit, time per visit, etc.), but the associated (nonWeb-based) financial measures of sales, profit and amount of merchandise sold. We recorded this data over a 15 month period that included a significant mail promotion; a major focus of this study is determining the impact of this promotion on the number of visits to the web and determining if these visits are correlated with increased sales.

INDUSTRIAL PRODUCTS B2B WEBSITES

van Riel, Pahud de Mortanges, & Streukens, (2005) stress the value and importance of branding and brand management for industrial brands due to a) the commoditization of many industrial products and b) the increasing importance of B2B. Perry and Bodkin (2002) among others suggest that B2B websites can be used for advertising, sales promotion, public relations and direct marketing.

While the usefulness of B2B websites is generally recognized, measuring their value still remains elusive. A principal conclusion of a Forrester Report on B2B marketing (Ramos 2007) is that, "Business-to-business (B2B) marketers collect mounds of data .... but still struggle to find effective ways to measure and demonstrate success." Some 44% of the survey respondents cited "demonstrating ROI" as the top challenge in managing their website.

COMPANY BACKGROUND

Specialty Metals, Inc. (SMI)1 is a relatively small (< $50M in annual sales) United States-based distributor of different grades of a variety of metals used in industrial manufacturing. One of their better-known products is stainless steel, an alloy whose physical properties do not degrade as easily as ordinary steel. As a result, stainless steel is used in many applications ranging from surgical equipment to cookware.

SMI's market niche is based on a number of factors:

1 . They have expert knowledge regarding which suppliers manufacture the different grades of metals, and who does so reliability.

2. They sell in small quantities.

3. They cut material to user specified sizes, with tolerances of less than .001 of an inch.

4. They ship items in stock the same or next day.

SMI's customers are generally small companies that make parts out of the metals they purchase. They generally can't buy directly from mills (the metal producers) as their orders are not large enough. These customers do not inventory the metals purchased from SMI, and typically purchase what they need for specific jobs they have in hand. One purchase may not be an accurate predictor of future purchases; that is one purchase may not signal what will be purchased in the future, or when a future purchase will occur. The individuals making the purchasing decisions may be engineers, purchasing agents or the business owners.

SMI is well-respected in its market space. Their competitors are other intermediaries providing similar services.

SMI markets their products through direct mail, advertising in trade magazines and, more recently via advertising on two industrial-products "white pages" websites. In mid-2008 SMI decided to extend their marketing reach by establishing a company Web presence. The goals of the company's website were to a) drive new sales, b) make product and contact information available and c) give/add legitimacy to brand.

Further, in addition to providing them with another opportunity for reaching out to their traditional clients, the website would enable SMI to extend their reach to many more companies in the US, Europe and Asia. The Asian market is particularly important to SMI given the shift towards manufacturing in the Pacific Rim.

Given the intricacies of SMI's products, their goal was not to allow users to enter orders over the Web. However, in addition to providing descriptions of the products and services offered by SMI, the website does allow potential customers to submit request for quotations; that is a request to be contacted. These requests are given to inside sales staff for follow up. So, as is the case for other B2B providers, there's no direct way to connect a visit with a sale as there is no "shopping cart" on the website.

There are a number of questions that would be useful for SMI to have answered. Foremost of these are the following:

* How many people visit the website?

* Is the website generating interest and does this interest yield actual sales?

* Do traditional promotions drive web traffic, and in turn drive incremental sales?

SMI commissioned a professionally produced brochure providing an overview of the company's products and services and sent it to potential customers in mid-December 2008. The list of potential customers and their addresses was purchased by SMI. The total cost of the promotion is estimated to be approximately $25K. SMI was expressly interested in determining the effect of this promotion.

ANALYSIS

We analyzed SMI website data over the period May 25, 2008 - August 29, 2009. The start date was the first full week the website was up. The end date was selected as it coincided roughly with the launch of another SMI website. (We felt this alternate site might affect the relevant data of the primary website.) The time frame includes the promotion mentioned above. A chart of weekly visits to the SMI website is provided in Figure 1.

We've divided the entire time frame into four sections. The first comprises the "initial" or "break-in" period for the website. The second, established when visits appear to stabilize at a roughly constant level, is the "pre-promotion" interval. The "promotion" period begins shortly after SMI's promotion took place and website visits dramatically increased. The final period, "post-promotion," begins when visits appear to level off again. Two points are worth noting. First, it seems clear from both the data and feedback from SMI management that this general partitioning makes sense. For example, we have website data through the present time (May 2010) and visits remain approximately at the same level as the post-promotion period so we know that the jump associated with the promotion period is not some seasonal variation. Secondly, while there is some arbitrariness about the exact cutoffs between periods, if we vary these cutoffs in any reasonable way, our overall results (to follow) don't change.

One major conclusion from the chart is that the promotion had a significant impact in terms of the number of visits to the website. This becomes perhaps more clear by viewing Figure 2 below, which breaks out the mean number of visits per week by period. The differences are statistically significant (p < .001). However, SMI provided us with sales revenue, profit, and pounds of material sold over the same time frame. We provide the mean sales revenue over each period in Figure 3. There are no figures on the vertical axis of the revenue chart, as we need to conceal SMI financial data, but the results are clear: while visits spike as a result of the promotion, there is no corresponding rise in sales revenue. (In fact, mean revenue drops.) The patterns are similar for profit and pounds of material sold.

Further, the simple linear correlation coefficient between website visits and sales revenue is effectively zero (r = -.056). The scatter diagram of revenue vs. visits is provided in Figure 4. Again, revenue numbers have been omitted."

Clearly there is no obvious relationship between the two variables. To see if visits were correlated with later sales, we lagged visits by one, two, three and four weeks, and examined each lagged variable with sales. Again, no correlation, and the scatter diagrams resemble the one above. The results are equivalent when we look at profit and visits, and pounds sold and visits. We then examined the number of inquiries generated via the website. Summary results are presented in Figure 5. We note first that there are relatively few inquiries generally (certainly as compared to the number of website visits). SMI receives approximately 125 phone inquiries per week. Unfortunately, they do not keep track of how many of these resulted from a visit to the website. Secondly, like revenue, profit and pounds sold, the number of inquiries is not related to the number of visits.

We examined two Web metrics, the number of pages viewed per visit and the time spent on the site, by period. Summary results are provided in Figures 6 and 7. Generally, visitors to the SMI website view on average about two pages and spend about a minute and a half on the site. While visits were dramatically up during the promotion period, pageviews and the time visitors spend on the website during the promotion period were the lowest of all four periods.

It would seem that the promotion prompted individuals to visit the website for a quick check, but not much more. Finally, we looked at the percentage of new visitors to the SMI website. (A new visitor is one who hasn't visited the website before, as determined by a cookie placed on the Web browser of the visitor the first time s/he visits the site.) Overall, approximately 80% of the visitors to the SMI website are new visitors. The promotion increased the percentage of new visitors by approximately 8% as compared to the pre -promotion period; this was a statistically significant difference (p < .001).

DISCUSSION, CONCLUSIONS AND FUTURE RESEARCH

Over the 15 months of our study, weekly visits to the SMI website ranged from a low of approximately 500 to peaks of around 3,000. The mail promotion had a clear and dramatic effect on visits, apparently moving them from an average of almost 600 per week prior to the promotion to a weekly average of 1 800 for the promotion period. However, the mean pages per visit and the mean time spent on the site decreased during the promotion period, as compared to the pre-promotion period. After the immediate effects of the promotion, we see an increase in the general level of visits; the post-promotion period shows average weekly visits at just over 800 - an increase of about 200 over the pre-promotion average visits. However, there is no indication that increased web traffic has resulted in increased sales. Neither sales revenue, nor profit, nor quantity of goods sold increased during the promotion period or during the post-promotion period. Further, mere appears to be no statistical correlation between these metrics and number of visitors to the website. Likewise the increased visits had no impact on the number of Web-based inquiries.

One possible explanation for these results is that, as noted previously, SMI customers typically make a purchase when they have a contract in hand. (Therefore, for example, they won't respond immediately to promotional material.) However when they do need to make a purchase, it can be argued they will more likely purchase from a company they recognize and respect. The website, and the promotion that drove the incremental visits to the website, may be valuable in contributing to the brand recognition of SMI.

There are other possible explanations for the disconnect between visits and sales - for example, poor website design. Future possible work includes an evaluation of the SMI website, surveying customers regarding their perceptions of the website, tracking the number of phone inquiries to SMI resulting from website visits, and extending our methodology to similar companies in order to validate our results.

Subject: Business to business commerce; Web sites; Web analytics; Financial performance; Metal industry; Case studies

Location: United States--US

Company / organization: Name: Specialty Metals Inc; NAICS: 331111

Classification: 9130: Experiment/theoretical treatment; 5250: Telecommunications systems & Internet communications; 2310: Planning; 8660: Metalworking industry; 9190: United States

Publication title: Journal of Business Case Studies

Volume: 6

Issue: 5

Pages: 59-64

Number of pages: 6

Publication year: 2010

Publication date: Sep/Oct 2010

Year: 2010

Publisher: Clute Institute for Academic Research

Place of publication: Littleton

Country of publication: United States

Publication subject: Business And Economics--Management

ISSN: 1555-3353

Source type: Scholarly Journals

Language of publication: English

Document type: Business Case, Feature

Document feature: References Graphs

ProQuest document ID: 756043307

Document URL: http://search.proquest.com/docview/756043307?accountid=38610

Copyright: Copyright Clute Institute for Academic Research Sep/Oct 2010

Last updated: 2013-09-06

Database: ABI/INFORM Complete

Document 21 of 100

Jagged Peak: The Case For Going Direct

Author: Hansen, Stacey; Rustogi, Hemant

ProQuest document link

Abstract:

This case explores the opportunities and challenges confronting Jagged Peak during its first decade in operation. For nearly ten years, Jagged Peak had grown at a rapid pace despite the absence of a defined competitive strategy or formal marketing plan. Today, Jagged Peak management faces strategic decisions that impact the company's future success and perhaps position the organization as a pioneer in an already saturated e-commerce solutions marketplace. The company does not have a definitive strategy for obtaining or retaining customers. The team that struggled to define their company mission and vision is faced with the challenge of identifying their value proposition and target market. A task that is typically completed during the formation of a business was being re-evaluated nearly ten years after the company's inception - to define their position in the market. [PUBLICATION ABSTRACT]

Full text:

INTRODUCTION

Jagged Peak's unique service offering as an e-commerce software and fulfillment company provided them with a distinct advantage; however, because of the company's wide breadth of services, they struggled to define their value proposition, their USP (unique selling proposition), and their market positioning throughout nearly ten years of operation. While the company had a roster of powerhouse Fortune 500 clients, the list was too short to enable Jagged Peak to continue to grow, especially considering their shaky financial situation. An economic crisis was upon them in 2008-2010, significantly impacting the retail and consumer goods industry that they served. Jagged Peak executives were faced with the difficult task to act quickly to make critical decisions that would enable them to align their services with the needs of the market. Their goal was to survive the downturn and help consumer product manufacturers affected by the crisis.

In the summer of 2008, Jagged Peak executives Daniel Furlong, Vincent Fabrizzi, and Paul Demirdjian met at the luxurious Don Cesar Resort in St. Petersburg, Florida, for a strategizing session about the company's positioning as a software firm. CEO, Paul Demirdjian, asked each person to write their vision for the company on a drawing board in the conference center. The task question seemed straightforward, but because of the complexity of the company's service offering as both a supply chain software provider and a fulfillment company, the team struggled to articulate Jagged Peak's position in the market in just a few short words. Surprisingly, each person wrote entirely different statements of their vision of the company.

Several weeks later, the team reconvened in Jagged Peak's Tampa conference room for an additional brainstorming conference. As the group reviewed the success of a freshly completed project for a global consumer brand, Chief Operating Officer, Daniel Furlong, experienced a sudden moment of clarity about the company's position. "We help compames sell direct," Furlong proclaimed. The statement was so bold that he and the other executive team members were surprised by his declaration. The company's recently completed projects all had a common theme - assisting manufacturers to establish a direct-to-consumer online- sales channel. Furlong's realization would set the executive team on a new path to position the supply chain software and fulfillment company as a leader in the direct-to-customer movement (Furlong, April 2009). However, the team needed help to take this directional guidance and develop it into a full blown strategy.

BACKGROUND

For Jagged Peak President and CEO Paul Demirdjian, the company's mission was always clear. Jagged Peak was founded based on his aspiration to better serve companies by utilizing the internet to automate all of the customer touch points in order management, from initial customer contact through order delivery.

By the 1990's, Paul Demirdjian had been involved in developing scores of software applications to facilitate process efficiencies and enhance customer service and product delivery. Demirdjian was a local Tampa Bay success story. He arrived in the U.S. from Armenia in 1982, attended the University of South Florida, and worked his way up the corporate ladder to become the CEO of Davel Communications, one of the largest payphone service providers in the US. Despite his personal and career accomplishments, he believed he was only scratching the surface of the potential that web-based technologies held.

Demirdjian's vision for Jagged Peak was inspired by his dealings with an online computer electronics retailer, in the late 1990s. After shopping online for a new laptop and waiting for nearly a month for it to arrive, he contacted the retailer's customer service call center to investigate the whereabouts of his order. The call center employee informed him that she could not locate the order or even determine if the product was in stock. Demirdjian was astounded that the retailer's web portal could not communicate with their order management system for inventory information.

This interaction prompted Demirdjian's realization that there was a growing need for an on-demand, webbased order management solution. He was determined to develop a software application that would allow companies to integrate disparate software applications to create a supply chain software platform that could be used as a single multi-channel system with one database, one administrative environment and one branded customer experience.

To realize this vision, Demirdjian founded IBIS (Internet Business Integrated Solutions) a custom web development services provider in 1999. Demirdjian believed that web sites would move away from simply being informational presentation layers to becoming transaction layers that allowed companies to more closely interact with their customers (Gasperson, 2004). Working from his home, he began building the architecture for what eventually became Jagged Peak's flagship EDGE software application.

THE MERGER

As Demirdjian's vision matured, he recognized the need for additional expertise in fulfillment to address the entire order life cycle - from customer order to delivery. Demirdjian contacted Compass Marketing Services, a nearby St. Petersburg, Florida warehousing service provider founded in 1990 who had mastered process efficiencies and best practices in fulfillment. The formation of Jagged Peak was the result of the merger of these two companies - one an emerging leader in web-based technologies; the other a stalwart, warehousing and fulfillment company.

The founders of Compass Marketing were serial entrepreneurs. Vincent Fabrizzi and Daniel Furlong had a long-standing business relationship. They had previously co-founded Paradigm Communications, one of the Southeast's largest nationally recognized advertising agencies with $60 million in revenues and an impressive list of Fortune 500 clients. Prior to co-founding Paradigm, Fabrizzi was a Vice President and partner at FKQ Advertising, a reputable Tampa Bay marketing firm. Formerly, Furlong was Vice President of Marketing for Dollar Rent-A-Car of Florida. Together, the three entrepreneurs, with a capable CFO, partnered to create a potent combination of technology, marketing, and operations knowledge- a blend of talent that would typically only be found in a Fortune 500 company. The background of these stalwarts is presented in Exhibit 1.

THE DOT-COM CRASH - WHAT'S IN A NAME?

The Internet created a budding new opportunity for retailers in the late 1990s. With the birth of the World Wide Web, investors were predicting the new trend would eliminate distributors and small space retailers by giving consumers the opportunity to purchase products online. Ventare capitalists were investing heavily in technology-based start-up companies. Unfortunately, consumers weren't yet ready to adopt this new technology and alter their buying behavior. In addition, consumer packaged goods (CPG) companies were not yet willing to disturb their relationships with traditional brick and mortar retailers by establishing a direct to consumer sales channel. While the prospect of retaining the margin lost to distributors was tempting, fear of channel conflict held back many manufacturers from exploring the new world of online retail (Bendix, Goodman, Nunes, 2001).

In the first quarter of 2001, the NASDAQ plummeted after disappointing e-commerce sales reports from the fourth quarter 2000 holiday season. As seen in Exhibit 2, investors rapidly pulled out of the technology-heavy stock market. The crash wiped out $5 trillion in market value of technology companies from March 2000 to October 2002 ("Will dotcom", 2006).

Jagged Peak's name was inspired by the NASDAQ composite index chart that "peaked" in March 2000the high point of the dot-com bubble. At a time when many high-tech firms were drying up, Jagged Peak struggled to earn the capital to build the promising new company.

GOING PUBLIC

In an attempt to both gain access to markets and to provide a fair market valuation for equity partners in Jagged Peak, the company filed as a public entity in 2005. Some Jagged Peak executives feared that public scrutiny would hinder the company's operational freedom. Despite concerns, the company required this new avenue to gain access to capital that would help them advance in the marketplace. The public offering generated $2 million from an investor firm, with a note payable at the end of 2009.

Prior to the dot-com crash, Demirdjian received a $40 million offer from a venture capitalist firm to acquire the company and its technology platform. While the offer was tempting, Demirdjian was not willing to relinquish control of the promising opportunity that he and his partners had built.

Following the dot-com crash, the decision to combine the services offered by both a software developer and a fulfillment logistics firm began to haunt Demirdjian and the Jagged Peak executive team. The arrangement was not appealing to investors. "Warehousing is not sexy to Wall Street," Demirdjian spoke of the lack of commitment from venture capitalists (Demirdjian, 2009).

Potential clients couldn't make the connection between the two vastly different industries. Rather than attempt to convince potential clients of the benefits that fulfillment services could add to their e-commerce software offering, the executives simply hid the fact that they also operated a state-of-the art 100,000 sq. ft distribution center in St. Petersburg and outsourced fulfillment to several other distribution centers in North America (Fabrizzi Interview, 2009).

An additional decision working against the company was their location. Investors were skeptical to provide funds to a technology firm that wasn't based in Silicon Valley. Tampa Bay is not known as a technology hub, hence; it was a challenge to convince investors that a superior software product could come out of Florida. (Demirdjian, 2009) Despite naysayers, CEO Paul Demirdjian holistically embraced innovation as Jagged Peak's growth strategy and was committed to remaining in Tampa Bay.

TECHNOLOGY STRATEGY

The company culture paralleled Demirdjian's tenacious, forward thinking leadership style. He and the other board members reinvested almost every dollar earned from sales revenue into R&D for enhancements of the EDGE software platform.

Technology firms traditionally have an exceedingly high burn rate while developing software applications and require a large amount of capital in the early stages of operation. Jagged Peak took a different approach. Rather than devote large sums of money to additional human capital for R&D, the company utilized downtime between large client projects to focus on enhancements of the EDGE platform. They also utilized client customized projects to enhance the software. When a client required a new module or feature enhancement, the Professional Services team would develop the solution and then build the new feature into the next version of the software application.

Supply chain software firms competing with Jagged Peak were not as fortunate to receive such a rapid return on their R&D investment. Profit Center Software invested more than $77 million in developing their platform only to go out of business in less than four years (Systemax, 2009). While their revenue continued to climb, they consistently lost money as seen in Exhibit 3.

PRODUCTS AND SERVICES

Jagged Peak was originally founded as a software company with fulfillment capabilities and eventually expanded its service offerings to provide a more complete ecommerce solution.

Software

Jagged Peak's EDGE is an enterprise-level business management software platform that lets users manage every aspect of their demand chain. It contains order management system (OMS) functionality, but also manages the entire demand side of the supply chain. In other words, the software manages the activities that take place during and after the order process. The software platform contains advanced functionality required to conduct Internetbased business and also consolidates demand that originates in any other demand channel, including electronic data exchange (EDI) and point-of-sale (POS). EDGE can apply the most complex demand management decision rules and delivers perfect orders to the appropriate systems.

Jagged Peak's ability to offer flexible business models differentiated their solutions from other providers and allowed them to add large multi-national consumer products compames to their clientele. Many large software providers required heavy capital investments of their clients for IT infrastructure, software development and ongoing maintenance fees for their appliance software models. Jagged Peak's on-demand, software-as-a-service (SaaS) model provided clients with a more flexible and affordable e-commerce business model. The cost savings was an order of magnitude often for many of Jagged Peak's clients.

In 2008, Fabrizzi looked for additional ways to differentiate Jagged Peak and create supplementary income for the firm during the economic crisis. He saw Jagged Peak's unique ability to provide affordable, off-the-shelf, web-based software solutions as a new opportunity for product marketing. Fabrizzi launched an effort to market the EDGE solutions as software products that solved a variety of business problems. The rationalization for this new strategy was that while companies weren't willing to make large capital investments in software applications but could reduce administrative costs by implementing turn-key, web-based solutions to manage business processes.

EDGE FF - friends and family private online marketplace

EDGE M3 - marketing materials management

EDGE DAM - digital asset management

EDGE PWR - product warranty registration

EDGE ROM - repair order management (reverse logistics)

EDGE B2B - business to business e-commerce

EDGE B2C - direct-to-consumer e-commerce

Fulfillment Services

In addition to software deployment, Jagged Peak also offered a flexible fulfillment business model. Clients that utilized Jagged Peak's multi-channel software could choose to utilize their own fulfillment center or one of Jagged Peak's nine third party distribution centers. While fulfillment services did not generate a large source of income for Jagged Peak, the flexibility of this option for clients provided Jagged Peak with a distinct advantage over ecommerce software providers.

Daniel Furlong's extensive knowledge in creating operational efficiencies in the fulfillment business helped the company provide exceptional value and savings to their clients. Using least-cost routing and optimized shipping carrier methods, Jagged Peak was able to offer next-day delivery to more than 80% of U.S. households with ground freight costs. The optimized carrier method helped one multi-national consumer brand to bank hundreds of thousands of dollars in freight savings while delighting their customers with next-day delivery on all orders.

Aces

Jagged Peak exploited the knowledge from their fulfillment business by creating a unique methodology that measured the components of the customer experience as they relate to order fulfillment. The innovative metrics was called ACES, for Achieving Customer Experience Superiority. The executive team realized the added benefits that the ACES model could provide to position the company as experts in the fulfillment business and utilized the knowledge to publish white papers to introduce the new methodology and illustrate how to implement the metrics using the company's EDGE software platform. Furlong and CFO Andrew Norstrud presented the new concept at the National Conference for Order Fulfillment in Las Vegas in March 2009.

The executive team had hoped that ACES would garner attention from industry analysts such as Forrester, Gartner Research and Accenture who provide research and consulting services for companies seeking ecommerce and technology platforms. However, without a significant public relations effort and investment in analyst tours, the ACES methodology would go unnoticed in the industry.

AcroBoo

In 2008, Jagged Peak created a new division, AcroBoo Commerce, to help companies sell products online through anonymous web storefronts- a solution that would minimize channel conflict for companies with traditional retail storefronts. AcroBoo created a wide variety of web stores that marketed niche-based vertical product lines of everything from hunting and sporting goods to mechanical tools to lingerie. The no-risk solution allowed manufacturers and distributors to promote their product online but not disrupt their traditional retail channel. This new service provided Jagged Peak with a new revenue stream as well as allowed them to experience first-hand the challenges that come with online retailing.

eMarketing

In promoting the line of retail web stores, Jagged Peak team uncovered several issues that came with developing an online sales channel. First, the web stores required an audience in which to market its niche products. To drive traffic to the websites, Jagged Peak implemented cost-effective search engine marketing tactics such as social networking and bookmarking and article syndication. Within days of launching the new retail websites, the stores were generating traffic and revenue.

eChannel Management

While the stores were generating revenue, they were not generating significant margins due to the highly competitive online market. Developers created an application that would help monitor competitive online product pricing. This new technology helped the team uncover another problem that manufacturers face when implementing an online sales strategy.

Many distributors and resellers were in a fierce pricing battle to win consumer sales. In addition, lowpriced grey market and counterfeit products were being marketed in the same channel as authentic items. In a weak economy, consumers benefited from low priced items but retailers were earning measly margins which affected their ability to offer quality customer service (Pereira, 2008). Ultimately, consumer brand images were suffering and manufacturers that did not have a minimum advertised pricing (MAP) policy could do nothing to stop declining margins.

As Jagged Peak experienced the challenges that online retailers experience, they realized that they had uncovered a new source of value for their clients as well as for their internal benefit. Competitive companies were emerging to offer e-marketing and pricing policy enforcement services that would help manufacturers gain control over their brand. The executive team began promoting the company's e-marketing and brand protection solutions to new clients as added value services that would lead to discussions about other Jagged Peak services.

BRANDING AND PROMOTIONAL STRATEGY

Jagged Peak was a self-funded start up, and as such, had little money for brand building. The sales and marketing budget to build brand recognition was near non-existent, as was the company's marketing presence in the marketplace. Jagged Peak was competing with technology firms with multi-million dollar sales and marketing budgets who could afford to sponsor e-commerce trade show events and invest in expensive industry analyst tours to position their company as experts in the marketplace.

Vincent Fabrizzi's dealings as a former advertising executive shaped his opinion about large advertising expenditures. "The old adage is, 'half of money spent on advertising is wasted. You just can't tell which half," said Fabrizzi. Rather than rely on flashy advertising campaigns or large investments in trade show event marketing, the executive team at Jagged Peak focused their efforts on vertical consumer goods markets.

Direct Selling

Fabrizzi utilized his relationships from past dealings in advertising to get Jagged Peak's foot in the doors of several multi-national corporations including Tag Heuer, Swatch, and Nestlé. The company offered beta programs to high-profile clients in exchange for the rights to utilize their names on testimonials and promotions to establish brand credibility with other Fortune level companies.

Jagged Peak's clientele were satisfied with the company's ability to provide affordable, rapidly deployed solutions with second-to-none support. Fabrizzi was convinced that the most dependable way to grow the company was through direct sales efforts. "I'll call up every CEO in the CPG industry and let them know that we have a solution that can allow their businesses to grow," Fabrizzi stated.

PR

Despite the company's limited marketing plan and budget, Jagged Peak garnered attention in the media. Deloitte and Touche listed Jagged Peak among America's fastest growing technology companies in 2001 and 2002. The company was also ranked third among the Florida High Tech Corridor's "Fast 50" companies in 2001.

Web Presence

By 2008, nearly 70 percent of Jagged Peak's $15 million sales revenue was generated from a single client. The executive team came to the realization that they needed to make a commitment to increase company visibility within the industry, despite budget woes. To enhance the company's presence on the web, the lean marketing team utilized the similar techniques as implemented for the AcroBoo web stores. Natural search engine marketing, public relations, and social media were economical methods to increase traffic to the corporate website for lead generation. Unfortunately, the Jagged Peak corporate site was so expansive and confusing that the company's message was lost in translation. While the 389-page website explained in great detail the intricacies of Jagged Peak's service offering, it did not convey the message that potential clients and media needed to observe. What business problems do Jagged Peak's services solve?

In mid-2009, the company made a commitment to internally update and compress the website to ensure that Jagged Peak's unique selling proposition was concise, compelling, and wouldn't be overlooked by the media, industry analysts, or potential clients. The new website would include a bold new statement about the company's new positioning to help manufacturers sell direct and provide content that would attempt to convince non-adopted companies to accept the new direct-to-customer strategy. The marketing team would create link-building blogs and articles to drive search engine traffic back to the corporate site.

The Competition

Ecommerce sales in the US grew in double digit percentages from 2000 to 2008 (Exhibit 4).

Consumer goods retailers realized that ecommerce was not a fad but a source of sales growth and customers. The explosive growth of ecommerce caught most direct marketers by surprise. From 1996 to 2001, retailers dealt with the new sales channel through minimal budgets and handed the merchandising responsibility to their IT departments. In 2004, companies started transferring ownership, along with sizable budgets, to their merchandising and marketing professionals and the ecommerce sales channel became a major revenue stream. Jagged Peak's unique combination of e-commerce software and fulfillment services began to make sense in the eyes of entrepreneurial retailers who wanted to extend their demand chain to the web. Global consumer brands like Tag Heuer and Nestlé approached Jagged Peak to assist them in implementing their ecommerce software platform.

Retailers weren't the only sector to take note of the powerful combination of services. Global delivery companies such as UPS and FedEx began to extend their offering to include supply chain solutions that could fulfill retailers need for multichannel and fulfillment services by integrating with third party software providers. Ecommerce software companies that had previously only offered web design and shopping cart functionality were investing in enhancements to their software platform and added outsourced fulfillment services (Demandware) to their solution offering. The competition had finally caught on to the web-to-ship concept and began to take advantage of the opportunities that the ecommerce channel presented. Other than Jagged Peak, no other ecommerce provider could offer a complete, flexible, and affordable ecommerce solution that covered all of the necessary components of the e-channel, including fulfillment services. Other hosted solutions providers existed that had capabilities to outsource fulfillment, but these providers required that clients relinquish control of their brand and allow the ecommerce company to sell their products in branded online web stores. Nevertheless, gaining visibility in the shadow of established outfits like ATG and GSI Commerce was a difficult task for Jagged Peak. Jagged Peak was a small fish (100 employees) competing in a very large pond of competitors with thousands of employees.

In January 2009, Forrester Research published an evaluation of the ecommerce solutions marketplace (Exhibit 5). The study provided a valuable tool for ecommerce software companies as it outlined the requirements that online retailers use when evaluating a new software platform. Among the key factors included were "improved business management tools, a need for improved system and business process integration, and a low cost-high ROI." Despite the ability to meet all of the required factors, Jagged Peak's EDGE software platform was not even mentioned in the study. The top performers in the study were ATG and IBM, whose "market presence" was rated "strong" despite the "weak" rating in cost benefit. (Walker, 2009) Failure to mention Jagged Peak was presumably due to lack of brand recognition in the market.

RETAIL EMDUSTRY FACES THE 2008-09 RECESSION

In 2008, the retail industry was battered by the turbulence of the world economy. Consumer confidence was at an all-time low and, conversely, retail unemployment was at a ten-year high (Consumer Confidence, May 2009). Nearly 148,000 U.S. retail stores shut their doors, and an additional 73,000 were expected to close in 2009 (Davis, 2009). The economic conditions produced panic amongst multi-channel consumer and luxury goods brands as they were forced to search for new ways to bridge the gaps left by store closings in their supply chain.

The executive team at Jagged Peak began taking calls from clients who were considering implementing a direct-to-customer online sales channel to circumvent their weakening retail sales channels. At the onslaught of the online retail era, companies were hesitant to go around their traditional retail channels for fear of channel conflict, however; as the economic crisis struck the retail industry, Jagged Peak's consumer brand clients were more afraid of being left behind than of causing conflict amongst their trading partners.

By the second quarter of 2009, other ecommerce solutions providers such as Digital River saw the same opportunity in assisting consumer brand manufacturers to establish a direct online sales channel. Jagged Peak may not have been innovators in the new direct-to-consumer (D2C) trend but they were certainly early adopters in the movement. The challenge would be for the company to convince the non-adopters that the D2C was a viable option to fuel growth in their business while industry research continued to indicate that either consumers or manufacturers were not yet ready to adapt to a direct-to-customer strategy (Mulpuru, 2009).

A NEW DIRECTION

In 2009, Jagged Peak was approached by a global consumer products company with a difficult challenge that would provoke the realization of the company's competitive advantage. The executive team's word-of-mouth promotional strategy was what led the client to contact Jagged Peak. The client had made a commitment in their Canadian market to open up a new online sales channel to distribute coffee products and had searched for nearly two years to find a single solution provider to set up a new distribution center, create B2B and B2C web stores, and provide order management, warehouse management, and transportation management systems. This scope of services would normally require sourcing several providers to develop the integrated software system, set up the new distribution facility, and manage the on-going maintenance and IT infrastructure. The client's target deadline was imminent when they finally approached Jagged Peak with their challenge.

Jagged Peak was able to solve the company's problem and deliver on budget and on time- within sixty days of project initiation. This was a feat unheard of in the industry. While other providers were promoting their fast, sixteen-week deployment, Jagged Peak was able to reduce the time-to-market in half. In addition, the Jagged Peak solution was a tenth of the cost of other multiple component software solutions.

Having completed this project with ease, Dan Furlong realized that they had uncovered their competitive advantage in the market. They could provide solutions faster and more affordable than any other multi-channel software and fulfillment provider in the industry. In addition the low-cost solution essentially eliminated the risk that manufacturers faced when attempting to build a multichannel ecommerce solution. This differentiation could be a catalyst to help companies establish a direct sales channel and rapidly speed their go-to-market time.

THE TASK AHEAD

Jagged Peak had accomplished what many industry analysts had purported to be impossible- to connect multiple execution points - from initial customer contact through final order disposition in real-time, with a single solution. The executive team had come to a realization about their competitive advantage in the market and decided to strategically align all functions of their business towards the same objective- to help manufacturers establish a direct online sales channel. But they still struggled with issues that could keep them from taking the lead in the industry.

Brand Recognition - will new companies trust Jagged Peak as a leader in the industry with limited exposure in the marketplace, and no clear strategic vision or direction?

Channel Conflict - will companies hesitate to circumvent their traditional retail channels to establish a direct online sales channel?

Growth - can the company establish economies of scale fast enough to service multiple clients?

Strategy - could the company align their new goals in time to take advantage of the emerging trend to sell direct?

Marketing Research - had the executive team completed enough research on the direct-to-customer channel to ensure that the strategy would be successful?

The executive team would need to respond quickly to benefit from their potential opportunity to build competitive advantage in the market place.

Subject: Electronic commerce; Direct marketing; Market strategy; Competitive advantage; Customer retention; Case studies

Location: United States--US

Company / organization: Name: Jagged Peak; NAICS: 517210, 519130, 541511, 541512, 541613

Classification: 9130: Experiment/theoretical treatment; 7000: Marketing; 8302: Software & computer services industry; 2400: Public relations; 9190: United States

Publication title: Journal of Business Case Studies

Volume: 6

Issue: 5

Pages: 65-76

Number of pages: 12

Publication year: 2010

Publication date: Sep/Oct 2010

Year: 2010

Publisher: Clute Institute for Academic Research

Place of publication: Littleton

Country of publication: United States

Publication subject: Business And Economics--Management

ISSN: 1555-3353

Source type: Scholarly Journals

Language of publication: English

Document type: Business Case, Feature

Document feature: Graphs Tables References

ProQuest document ID: 756043341

Document URL: http://search.proquest.com/docview/756043341?accountid=38610

Copyright: Copyright Clute Institute for Academic Research Sep/Oct 2010

Last updated: 2013-09-06

Database: ABI/INFORM Complete

Document 22 of 100

Corporate Entrepreneurship At GE And Intel

Author: Zimmerman, John

ProQuest document link

Abstract:

This is the first of three planned articles concerning Corporate Entrepreneurship (CE). The author is a former entrepreneur practitioner who secured an earned doctorate from Pepperdine University in 2008, and who now teaches at Zayed University in the United Arab Emirates. In this article the author explores the concept of Corporate Entrepreneurship (CE) using case study methodology to connect previous scholarly research with data collected from successful companies. The paper discusses the problem of sustaining CE as organizations mature using Hayek's Theory of Cultural Evolution as a framework. The author suggests that corporate entrepreneurship, often called intrapreneurship, while critical for sustaining competitiveness and increasing stakeholder value, often poses a dilemma for large organizations. The different processes and strategies these companies use to attempt to sustain CE are outlined together with suggestions for integrating corporate entrepreneurship into any organization's culture, strategy, and management process. Finally, recommendations are provided as to how organizational leaders can successfully integrate corporate entrepreneurship into any organization's strategy and management systems. [PUBLICATION ABSTRACT]

Full text:

INTRODUCTION

At their inception, all organizations must have engaged in some form of entrepreneurship, otherwise they would not exist. The irony is that as new ventures progress from formation to become larger entities, they often implement policies, procedures, and rules that result in bureaucratic structures that, while needed to control and manage growth, often impede the innovation and creativity vital to maintain the competitive advantage initially created by entrepreneurial activity (Ireland, Kurato, & Morris, 2006). Kenney and Mujtaba (2007) rightly connect this phenomenon to Hayek's Theory of Cultural Evolution. Hayek contends that as civilization advances from small, confined groups to more complex societies, rules and structure are spontaneously created to facilitate the complexities associated with this growth. Hayek maintained that the contradiction of this phenomenon is that this bureaucracy eventually stifles evolutionary progression, leading to the society's failure. This process is analogous to the evolution we can observe in some businesses.

For any organization to sustain success it must engage in some form of entrepreneurial activity in order to continue to effectively compete in the marketplace and continue to increase stakeholder value. Therein lies the dilemma of Corporate Entrepreneurship (CE), how can growing organizations nurture an environment for entrepreneurial activity, given that such organizations must have a certain level of policies, procedures, and processes in order to manage and control their activities. This paper attempts to compare and contrast the CE practices of two successful corporations, General Electric Company and Intel Corporation in order to understand their CE approach and its implications for dealing with the CE dilemma.

First let us define some terms. The term entrepreneurship has been employed for well over 200 years, yet there seems to be no single accepted scholarly definition of the phenomenon. For the purpose of this work we have selected one definition that appears to capture its essence. Entrepreneurship is "the process of creating value by bringing together a unique combination of resources to exploit an opportunity" (Stevenson & Jarillo-Mossi, 1986, p. 10). It is helpful to deconstruct this definition into four elements. Entrepreneurship is a process consisting of stages. Second, entrepreneurial activity has the goal of creating value. Third, entrepreneurship involves assembling resources needed to create value in some unique fashion. Finally, entrepreneurship entails the identification or creation of an opportunity. We can see that entrepreneurship is a creative process, both in the developing the opportunity and in assembling the people, capital, technology, and other resources necessary to exploit that opportunity.

CE is a phrase used to describe entrepreneurship occurring in a mid to large sized organization (Morris, Kurako, & Covin, 2008). Wolcott and Lippitz (2007) define CE as "the process by which teams within an established company conceive, foster, launch, and manage a new business that is distinct from the parent company but leverage's the parent's assets, market position, capabilities or other resources" (p. 75). CE embodies a kind of organizational renewal involving innovation and venturing, resulting in new products, processes, and technologies (Sathe, 1989). Kurako et al. (1990) propose that CE is often undertaken to solve a variety of problems such as marketplace stagnation caused by lack of innovation, perceived weakness in traditional management methods, and loss of talented and innovative employees who become frustrated with bureaucratic methods.

To summarize, Corporate Entrepreneurship consists of opportunity recognition and/or creation, formation of resources, and (hopefully) value creation (Stevenson & Jarillo-Mossi, 1986) inside an established organization that is somewhat distinct from the parent company but that leverages and utilizes its resources (Wolcott & Lippitz, 2007). We use the Stevenson & Jarillo-Mossi definition of entrepreneurship, and the Wolcott & Lippitz definition of CE as a structure to analyze CE data collected from two corporations to formulate a model of CE.

METHODOLOGY - CE CASE STUDIES

In order to examine CE, this research examines how two companies - General Electric Company and Intel Corporation attempt to practice CE. The researcher has over 1 5 years of experience with these organizations as a practitioner, and couples this practical experience with theory and scholarly research to gain insight into CE. The Corporate Entrepreneurship Climate Instrument (Hornsby, Kuratko, & Zahra, 2002), and the Entrepreneurship Intensity Questionnaire (Miller, 1983), as adapted (Morris et al.), were used as the structure for assessing each observation. Through synthesis and analysis of first-hand observations, and through secondary research, the process used by each for CE was developed. Later, this information is analyzed through the lens of Hayek's Theory of Cultural Evolution.

RESULTS - ANALYSIS OF GE AND INTEL CE

General Electric Company - Organizing and Sustaining CE

Perhaps no other organization has a history of sustained CE than does GE, many of whose innovations we take for granted today. The carbon filament incandescent light bulb (1879), the first practical x-ray technology (1920), the first commercial home television programming (1928), the first successful jet aircraft (1942), providing the basic technology for fiber optic communications (1981), magnetic-resonance guided therapy technology (1993) for medical diagnosis, leading edge technologies of today such as breakthroughs on holographic data storage that can allow up to 40 high definition movies to be stored on a single DVD (2007), are some of the many examples of GE's proven track record of innovation and CE. GE's commitment to CE can be measured by the resources deployed to innovation: a $5 Billion annual budget for research with 2,800 employees, 1,000 of whom hold PhDs, resulting in 2,537 US patents through 2008 (General Electric Company [GE], 2009). But how does a large and complex organization like GE foster the climate and culture, and manage and govern the creative activity needed to sustain CE?

The approach deployed by GE to manage CE is largely based upon its evolving organizational design and strategic processes (Ocasio & Joseph, 2005). Through the leadership of a series of chief executive officers from 1951 to 2000 (Cordiner, Borsch, Jones, and Welch), GE has established the Strategic Business Unit (SBU), supported by reporting and training, as fundamental organizational concept for CE. First implemented by Fred J. Borsch, this concept establishes relatively autonomous organizations that are free from most of the GE bureaucracy to pursue CE. Often, these SBUs report directly to the chief executive office to ensure visibility and attention. Examples of this approach can be found in the success of GE's commercial aircraft engine business, confirmed from personal observations and experience of this author. Other examples include the industrial diamond and the plastics businesses, the later providing the autonomy and freedom to innovate CEO Jack Welch attributes to his own personal success (Slater, 1999). While SBUs remained somewhat free from GE bureaucracy, they do not lack planning, strategic analysis, and oversight. A combination of strategic planning and analysis using the GE/McKinsey competitive strength and market competitiveness matrix (Ghemawat, 2002), coupled formally (under Jones), and later loosely (under Welch) with strategic reviews by the chief executive office provide a process of governance and oversight that still allowed the creativity and flexibility needed for CE to flourish. The author's personal experiences with GE's commercial aircraft engine venture provide first hand experiences that support this contention.

Intel Corporation - Sustaining a Culture of Innovation

Like GE, Intel has a storied history of innovation. As one of the first venture capital financed Silicon Valley start-up companies, Intel was founded in 1968 by Gordon Moore and Robert Noyce, financed by $10,000 from one of the first venture capitalists, Arthur Rock who organized the remaining financing by selling $2.5M in convertible debentures. The first series of memory semiconductor products were introduced soon thereafter. In 1971 Intel executed its initial public offering at $23.50 per share, raising $6.8 million. Although Intel introduced its first successful microprocessor product, the 8080 in 1974, its success was largely driven by leadership in memory technology, as evidenced by the fact that in this time period Intel had invented almost all of the successful memory technologies. The legend of innovation in microprocessor technology and products is well known, but what may be of greater interest is how Intel developed a corporate culture and management system to recognize opportunities and to craft strategies to capitalize on planned technological advances, serendipitous events, and informal alliances.

Under the founder's leadership, and later under Andrew Grove, Intel had turned its corporate culture into a powerful strategic advantage, one that valued initiative, risk taking, and confrontation of ideas. This culture became so ingrained and effective that at times it was as least as powerful as formal strategic planning processes. This set of values included important norms such as constructive confrontation, disagree and then commit, knowledge power not position power, put common sense on a pedestal, and let chaos reign and reign in chaos. In addition to open communications, a bias toward action, and others, Intel culture helped make that company not only innovate, but also implement creative CE strategies to capitalize on that innovation (Tedlow, 2006). These creative strategies included the decisions to formally partner with IBM and later form an alliance with Microsoft, deemphasize the memory business in favor of the microprocessor business, the strategy to license the X86 architecture and then abandon that strategy after the success of the 80386, the now famous Intel Inside(TM) campaign, and a highly successful venture capital organization. Unlike GE, the significant element of Intel's CE process what not organizational or procedural, but rather was often characterized by a bottoms-up driven, contentious, rebellious and chaotic nature that was actually encouraged and supported by management. At the time, successful CE strategies at Intel almost seemed to be in spite of rather than because of any formal structure or process. This obviously has been successful so far, but one can question whether it is sustainable long term, lacking an effective formal CE process.

DISCUSSION - THE CE DILEMMA

Both GE and Intel are large, complex, and thriving organizations who have significant differences in their CE processes. The development of organizations can be connected to Hayek's Theory of Cultural Evolution, where he posits that as civilizations emerge and grow their members spontaneously create rules and structures in order to foster and facilitate this growth. Hayek goes on to maintain that this structure and rules ultimately suppress new evolutionary progression that once facilitated and fostered this growth (Feldmann, 2006). A parallel can be drawn for organizations, each organization has unique culture, processes, and procedures, which can often suppress and retard CE. We can see this phenomenon illustrated in the two case studies above, and other in research. Therein lies the CE dilemma for the organization - how can a growing organization sustain CE while at the same time maintaining the procedures and rules needed for control? Several techniques and suggestions may be helpful.

CE Health Audit

As a beginning point, organizations should undertake a CE health audit. This would begin with data collection using the Entrepreneurial Intensity Instrument (EI) (Miller, 1983) and the Corporate Entrepreneurship Climate Instrument (CECI) (Hornsby et al, 2002) to conduct a comprehensive review of structures, controls, human resources management, and culture (Ireland et al., 2006).

CE Development Training

High potential individuals should receive training concerning the CE process, including an introduction to the CE, background on the company's successes and failures in CE, training on opportunity recognition/creation and creativity, commons barriers to CE, and finally an overview of how corporate entrepreneurs can launch their initiatives at the company. This training should be conducted periodically for newly promoted individuals or new hires.

Strategic Approach

We can learn from the GE process for CE. GE has incorporated the strategic business unit (SBU) process into their strategic process. This means that at least annually, or during periodic strategy review sessions where previous initiatives are reviewed with the chief executive office, new initiatives can be brought forward and evaluated using the GE/McKinsey Matrix. Those approved can be resourced and SBUs can be established to manage the implementation process. This means at each periodic strategic review an agenda needs to be in place for corporate entrepreneurs to bring their ideas. Additionally, during the annual planning cycle a budget needs to be established to fund such initiatives.

Internal Corporate Venture Capital

The midsized organization can establish an internal corporate venture capital committee. The committee would consist of senior executives from the research and development, marketing, and finance departments; and if possible any board members who may have appropriate expertise. This group would then have power to approve and fund any initiative that would add potentially value to the company. The approved initiative would be either established as a new function inside an existing division if appropriate, but the ongoing management process would be similar to that used by the venture capital community meaning periodic committee "board meetings" would be conducted for review and evaluation.

FUTURE RESEARCH

Additional quantitative research will be conducted using the survey instruments to validate or refute these case studies. The initial work in this area will be conducted in the United Arab Emirates organizations, and with several multinational corporations. Additional qualitative research will also be conducted to add to the case study data already conducted to extend and build upon this paper. The author is particularly interested in studying the approaches used by Google and Cisco Systems, and by midsized companies who are in transition to becoming larger organizations. The two approaches can then be combined in a mixed methods study to further advance CE theory.

Subject: Entrepreneurship; Intrapreneurs; Electronics industry; Case studies

Company / organization: Name: General Electric Co; NAICS: 332510, 334290, 334512, 334518; Name: Intel Corp; NAICS: 334210, 334413, 334419, 334611, 511210

Classification: 9130: Experiment/theoretical treatment; 9520: Small business; 8650: Electrical & electronics industries

Publication title: Journal of Business Case Studies

Volume: 6

Issue: 5

Pages: 77-81

Number of pages: 5

Publication year: 2010

Publication date: Sep/Oct 2010

Year: 2010

Publisher: Clute Institute for Academic Research

Place of publication: Littleton

Country of publication: United States

Publication subject: Business And Economics--Management

ISSN: 1555-3353

Source type: Scholarly Journals

Language of publication: English

Document type: Business Case, Feature

Document feature: References

ProQuest document ID: 756043398

Document URL: http://search.proquest.com/docview/756043398?accountid=38610

Copyright: Copyright Clute Institute for Academic Research Sep/Oct 2010

Last updated: 2013-09-06

Database: ABI/INFORM Complete

Document 23 of 100

A Case Of Social Entrepreneurship: Tackling Homelessness

Author: Carroll, Norman; Burke, Molly; Carroll, Mark

ProQuest document link

Abstract:

Social entrepreneurship integrates the resourcefulness of traditional entrepreneurship with the compelling drive to mitigate social ills. The focus of this study is on one social entrepreneurial organization that has changed the lives of the poor and homeless in a large urban area. The case study describes the dilemma the organization faces in deciding whether to enter into a joint venture with another non-profit social service entity. The joint venture would increase the number of at-risk people it could serve but threatens to change the unique nature of its operation and could compromise the organization's brand. [PUBLICATION ABSTRACT]

Full text:

INTRODUCTION

Erie, the CEO of The Cara Program, was in the program's new offices in Chicago facing a decision that he had to make by tomorrow. Mercy Homes Lakefront was asking the Cara Program to enter into a joint venture to maintain all of the many homes that had been vacated by foreclosure in at-risk neighborhoods in Chicago. There were many things to consider and Eric had to know by tomorrow's meeting of the Board of Directors what his recommendation was going to be. It was a difficult decision because it had the potential of changing the nature of this highly successful program serving the homeless and could alter its ability to maintain the quality controls that are the hallmark of the organization. Recognizing that any lowering of its quality standard would threaten the organization's brand, Eric pondered his decision.

THE CARA ORGANIZATION

The Cara Program was the brainchild of Thomas, an entrepreneur who had made a small fortune in the information technology field and had then used his entrepreneurial skills to develop human services programs. As Martin and Osberg (2007) stated, a social entrepreneur is "someone who targets an unfortunate but stable equilibrium that causes the neglect, marginalization, or suffering of a segment of humanity." Thomas had the thought that some homeless people, who were numerous in Chicago as in any large city, could find useful employment if someone took the time to work with them. These people seemed to be outside the usual programs available for the unemployed. They were motivated to work but faced significant challenges and thus were often seen as unemployable. Thomas did not understand in detail why people ended up homeless but he thought there must be some way to help many of them to recover from whatever situation had caused their homelessness. Dees (2001) observed that social entrepreneurship ventures "can include ...homeless shelters that start businesses to train and employ their residents. . ." and this was just what Thomas was starting to think about doing.

As in a market entrepreneurial situation, Thomas sought a way to fulfill the unmet need of this homeless population. He had earlier met Mother Teresa in India and was inspired by her devotion to the homeless and impoverished. He spoke to people in Chicago's social service agencies who had experience in dealing with the homeless and discovered that many of these people had spent time in prison which frequently barred them from future employment. Others whose lives had been damaged by a history of substance abuse were discouraged from looking for work and many came from generations of poverty that left them ill prepared for the labor market. Within that population however, there is a segment of genuinely motivated individuals, looking to change their situation but unable to do so because of the obstacles they faced.

With this information, Thomas formed a foundation to finance a social services effort to address the employment needs of this homeless population. He sincerely believed that the handicaps that these people faced could be overcome. Though these individuals lacked a healthy network of friends and family to help them redirect their lives, he believed his new foundation could offer the positive and productive support they needed to transform their futures.

Thomas knew he needed to create an organization that could not only provide support services but one which could also supply access to employment and this meant he would need to leverage his own extensive business contacts. He approached Catholic Charities of Chicago with his idea and told them his foundation would support the enterprise. The diocese agreed and in 1991 Thomas started an employment placement program for the homeless under the auspices of Catholic Charities. He named the initiative The Cara Program after the Irish name for friend. He articulated its mission "to assist motivated individuals affected by homelessness and poverty to transform their lives and achieve real, lasting success. "(Cara, 2008)

After a while the program became too large an enterprise for Thomas to manage. He would continue to support the program through his foundation, but he needed an enthusiastic young manager to head the fast growing organization. Thomas was a member of a upscale liberal Catholic parish in Chicago whose membership included many people interested in social causes. On the advice of the pastor, Thomas recruited Eric, a successful young banker who was also a member of the parish. Eric was interested to hear about this new opportunity at Cara because for some time, he had been considering changing his career to a more socially oriented one. He also had all the experience and skills that Thomas knew would be needed in expanding The Cara Program.

In 1996 the program was relocated from the Catholic Charities offices to a space in one of the parish buildings of Old St. Patrick's Church. The church is located on the near west side of Chicago's downtown and conveniently accessible to the business community. Eric took on the responsibilities of executive director at the time of the move. Since then, Cara has grown significantly. The current staff consists of 75 full-time people with 115 volunteers. African- Americans make up 55% of the full-time staff and 11% are Latinos. Most of the volunteers come from the business community. The Board of Directors is predominately male and Caucasian. Thomas remains chairman of the Board and his foundation is the major contributor to the finances of the organization.

Structure of the Organization

The Cara Program became a 501(c)(3) not-for profit corporation in 1999. It is directed by Eric who serves as President and CEO and is supported by a sixteen member board with Thomas as chairman. All the senior executives of the program bring valuable education and experience to their work:

* Eric, President and CEO for thirteen years. Ten years in the financial services industry. BA, Boston College, MBA, University of Chicago, Post Graduate Program, Harvard Business School.

* Maria, Vice President of Resource and Career Development for three years. Thirteen years of communications, budget, project and people management and strategic planning experience.

* John, Managing Director of Cleanslate for three years. Managing the rapid expansion of this social enterprise launched by Cara in 2008. Currently enrolled in Northwestern University's Kellogg School of Business Executive Management MBA program.

The Cara Program has expanded its reach in recent years, meeting all the challenges of "scaling social impact and growth" described by Bloom and Chatterji (2009). The organization now operates four separate programs: The Cara Program, Cleanslate, the Career Pathways Initiative and the Quad Communities Center for Working Families. Selecting the right staff for these four programs and placing them in the right positions has been a daunting task. After several years of effort however, and some disastrous failures, Cara finally has found the right people for the work to be done.

Still, such rapid growth has taken a toll on the Cara employees. Managing The Cara Program as well as launching three new initiatives has demanded unrelenting effort from every member of the senior leadership team and staff. It has required long days and hard work but even more importantly, it has required grappling with problems and issues never faced before and devising successful solutions. Eric pointed out "We have done a great job of adapting and changing but we are all pretty tired, maybe even a little burned out. Now we need some time to regroup."

While government, corporate, foundation and individual contributions account for the vast majority of Cara's operating revenue, Cleanslate business contracts now contribute approximately twenty percent to the annual operating budget. (Fig 1)

The operation spends over five million dollars a year on these four programs (Table 1).

As the programs have grown, both in scope and in number of participants, the board and staff recognized the need to establish additional revenue sources and Cara announced its first capital campaign in 2009. The money raised will be used for "capacity building" enabling Cara to serve its ever increasing number of clients. Though fundraising had always been a integral part of Cara activities, beginning a capital campaign to raise 10 million dollars represents a significant new challenge. "Not only is this Cara's first-ever campaign but it is being launched in a dismal economy," Eric acknowledges. "I'm told that as CEO, I should expect to spend more than fifty percent of my time on the campaign. That will be hard, but we're all neurotically productive here so we'll figure it out."

The Cara Program alone collaborates with more than 100 community social service organizations to identify and enroll individuals who will benefit from the services that Cara offers. After several years experience working with the population which the program was designed to serve, very specific admission criteria have been established to identify those individuals who are motivated to take the necessary steps to transform their lives. Candidates must complete a phone screening, attend one-on-one interviews, pass a drug test, and remain clean and sober before being accepted as "students." Cara receives more than 1 500 inquiries each year, but only one-third are accepted into the program.

Cara deliberately uses such terms as "students" or "graduates" to underscore that its participants are not "clients" or "cases" but individuals who are in a learning environment and actively seeking to develop their skills. In cooperation with the feeder community organizations, the program provides wrap around services that are effective and efficient. Realizing that the participants need bom career training and life skills development, the program offers intensive personal coaching and mentoring to all those who participate.

The Cara Program - 1991

This is the original and core program which provides support for the students who may also participate in the other programs. A carefully designed and challenging eight week curriculum develops students' basic life skills in such areas as conflict management, personal responsibility and teamwork. They are also given experientiallybased, specialized employment training in basic computer skills and customer service to help them be competitive in the workplace despite their weak job histories and poor educational background. Realizing that individuals can only "transform their lives and achieve real, lasting success" (Cara, 2008) when they find a job that pays a living wage, students are also provided job-readiness training which focuses on job search techniques, interviewing skills and professional appearance. After students secure employment, The Cara Program continues to work with them for a full year in a highly structured program of intensive support services.

Almost 60 percent of the participants are women and more than half of the participants have a previous criminal conviction. Approximately one-quarter of the students are victims of domestic violence and almost a third lack a high school diploma or GED. Almost 50 percent are in recovery from substance abuse. Only half of the students complete the challenging program. It is demanding and requires accountability. The rigor of the program distinguishes it from other similar programs but also signals to prospective employers the high level of motivation and commitment these students have to become successful and productive employees.

The Cara Program achieves its objectives by helping the students it accepts to create change in their lives by addressing the root cause of their past predicaments, whether it was homelessness, poverty, incarceration, domestic violence or addiction. It does this in a number of ways, beginning with life skills training and morning "Motivations" or pep-talks.

Life-skills training is presented in classes that are focused on transformation in self-esteem, conflict management, responsibility, team building, time management, and forgiveness. Students are expected to incorporate these concepts and lessons into their daily lives, their job searches and beyond.

Students and staff also apply these transformation concepts as they gather every morning for an invigorating program called Motivations, which might include songs, poems, or inspirational anecdotes. One question drives each morning Motivation such as "Tell us about a challenge or obstacle you have overcome that will motivate someone else." As students and staff share highly personal stories of the tragedies and triumphs in their lives, a cohesive bond is forged. Listening to the often painful experiences of their classmates and hearing their resolve to overcome these situations creates a deep sense of camaraderie. Through Motivations, students and staff become friends and mentors to each other, all invested in helping the group as a whole find success. The community is united, inspired and energized through each individual response.

Specialized employment training gives participants marketable skills, enabling them to compete successfully for entry level positions in the banking, health care, office services, manufacturing, environmental services and hospitality industries. Many students choose to participate in internships or training offered by Cara's external training partners, enabling them to learn the specific skills that the employment partners expect and demand.

Job readiness preparation integrates those aptitudes gained in life skills and employment skills training and enables students to be placed in permanent jobs. Students are considered "job-ready" only after they have completed the following steps: prepared a sample job application and résumé and had it approved; secured stable housing and childcare; completed an interview class and class homework; prepared an interview prep folder; achieved a minimum score during two mock interviews with staff or four with volunteers; had their criminal background verified and documented; had their health documented and give evidence of following physician advice; adhered to professional dress code standards and demonstrated adequate conflict management skills.

Every student who participates in The Cara Program is guaranteed a quality, permanent job after the successful completion of their program. Great effort is expended to make sure that this guarantee is met. Rather than finding "just any job" for its students, Cara works with companies that commit to offering competitive wages and reasonable benefits as well as the potential for advancement. Deliberate efforts are made to match employment to students' interests. During the past year, the industries in which Cara graduates found employment include: Food Service - 9 percent; Transportation -14 percent; Health Care - 15 percent and Facilities Management - 29 percent. (CARA, 2008)

Cara's placement staff includes "corporate account managers" who are responsible for working with the more than 125 partner companies to facilitate student placements. These companies, such as Pitney Bowes Management Services, ABM Lakeside, JP Morgan Chase and the University of Chicago, have established strong relationships with The Cara Program and regularly employ Cara graduates whom they have found to be both qualified and motivated. They have committed to paying starting wages that are significantly above the federal minimum wage, offer the potential for benefits and provide a minimum of 32 hours work per week. Currently, more than 70 percent of employed Cara participants remain on the job for at least one year indicating the placement process works well both for students and the firms employing them.

Helping students to becoming gainfully employed is one of The Cara Program's goals but employment alone does not "transform their lives to achieve real, lasting success." (Cara, 2008) Realizing that more is needed, The Cara Program provides a full year of intensive support services. Cara's Individual Development Managers (personal and professional coaches) work with participants on a wide variety of issues such as goal setting, financial management, housing and career development and advancement. Employing a strategy termed "aggressive outreach" the Individual Development Managers are intimately involved in helping participants navigate the challenges of their new jobs, and also consult with the employer to anticipate and proactively resolve any obstacles to employment success.

A financial literacy program helps participants open bank accounts, establish credit histories and even begin to save money. An incentive program that matches the participants' savings up to $1,000 encourages them to save, even as little as $20 each month. Client Support Specialists also help participants who are interested in learning about homeownership opportunities for low-income individuals. Brandon, Vice President of Program Services at The Cara Program pointed out that while the Cara program "works with individuals to help them achieve lasting success, our impact goes far beyond these individuals by themselves. ...It extends deep into the community. The core of our mission is empowering families to stop the transfer of poverty from one generation to me next." (Cara, 2008)

Cleanslate - 2005

Cleanslate is The Cara Program's social entrepreneurship enterprise. It offers internships, on-the -job training and transitional support services for Cara students who face significant obstacles to employment) Cleanslate provides neighborhood beautification services, including litter abatement, light landscaping, and snow removal to eleven Chicago neighborhoods and for many Chicago festivals and events throughout the year. It operates in the Illinois Medical District which includes two medical schools and three hospitals, Uptown, Lincoln Avenue, West Town, Bucktown, State Street, Quad Communities, Hyde Park, South Shore, Auburn Gresham and Pullman. It also provides city wide services for the Department of General Services. This initiative brought a new dimension to Cara. As Dees has explained, "(A) number of non-profits are beginning to commercialize the core programs through which they accomplish their missions; that is, they are looking for ways to make these programs rely less on donations and grants and more on fees and contracts." (1998)

Since its founding, Cleanslate has experienced incredible growth and unparalleled success. The program which began in June, 2005 with ten interns has grown dramatically and provided almost 800 transitional jobs. Currently, Cleanslate has a staff of 21 employees, 19 of whom are former Cleanslate interns. John, Managing Director of Cleanslate, explained "After just a few years in business, Cleanslate has contracts all over Chicago. It's our hope that we will continue to grow."(Cara, 2008)

Each year the business has realized more revenue, topping $1.1 million in 2008. (Table 2)

The fees collected from providing these services account for most than 20 percent of Cam's revenue and provide funding for the direct employment of Cara students. These jobs are considered transitional as the students establish a work record that makes them eligible for permanent jobs elsewhere. Since its inception, Cleanslate has provided 765 temporary jobs and these have provided a foundation for 276 permanent jobs. (Cara, 2008)

Career Pathways - 2007

As a supplement to The Cara Program's traditional services, the Career Pathways Initiative delivers job training and employment opportunities to job seekers from the Mid-South neighborhoods. Created in partnership with the University of Chicago and the City of Chicago's Department of Community Development, the service was launched in October, 2007. At its inception, The Career Pathways Initiative hoped to place at least 50 residents from Woodlawn and the surrounding communities into quality, permanent employment over the course of eighteen months. By the end of December, 2008, just fifteen months after opening, that goal had been far surpassed: 121 area residents had found quality employment and 493 had received career training through the program.

Four members of The Cara Program staff provide recruitment, training and job placement services at the Career Pathways Initiative. While their primary objective is to connect local residents to employment opportunities at the University of Chicago and the University of Chicago Medical Center, they also find opportunities through U of C vendor and supplier networks. In addition, the Career Pathways Initiative serves as a referral partner to The Cara Program, recommending to Cara motivated individuals who will benefit most from its signature life skills, job training and job placement programs.

Quad Communities - 2008

In mid 2008, The Cara Program assumed management of the Quad Communities' Center for Working Families. This center serves as a site for direct service to the community, providing career and employment counseling, education and training referrals, access to income supports, and financial counseling that includes tax assistance. The Tax Assistance program, run in cooperation with the Center for Economic Progress has already had measurable impact on the community. The Quad Communities Center for Working Families staff and volunteers helped complete a total of 1 ,25 1 2008 Tex Returns for area residents, totaling $ 1 ,909,924 in cumulative returns that could be reinvested in the community. It too serves as a referral partner for The Cara Program's core activity providing life skills, job training and placement.

A RECORD OF SUCCESS

In Illinois, 1 .4 million people live in poverty and almost three-fourths of a million live in extreme poverty, with incomes below the federal poverty line. (Heartland Alliance, 2008) The recent economic crisis has increased these figures. In Chicago, the jobless rates have climbed to alarming levels, reaching 10.7 percent in July, 2009. (Field- White, 2009)

This staggering figure indicates the significant need for The Cara Program's job training, placement and support services but at the same time, it signals increased competition for quality entry-level opportunities in the city. This increased competition for jobs is especially significant for students from The Cara Program, who already face substantial barriers to employment. As noted above, more than a quarter lack a high school diploma or GED, more than half have criminal records, almost half have a record of substance abuse and nearly all have limited or no prior work experience.

Despite these fonnidable barriers to success, The Cara Program has established itself as a highly regarded workforce development program and its social enterprise, Cleanslate, has become a preferred provider of neighborhood beautification services that restore neighborhood pride and reclaim neighborhood identity. Regularly assessing the effectiveness of its programs each quarter, Cara gathers specific data that demonstrate how very effectively it is achieving its goals: (Table 3)

These figures from the 2008 Annual Report clearly illustrate that Cara is providing its students with the skills and confidence they need to secure and sustain quality jobs, find stable housing, and become contributing members of their communities. (Cara, 2008) The personal stories of four Cara graduates give even more concrete evidence of how Cara empowers its students to lead lives of personal and professional success.

Earnest's Story

Before he came to The Cara Program, Earnest's long-term battle with substance abuse and addiction had created such a rift in his family that his marriage dissolved and his relationships with family members became strained. At one point, he was living on the streets behind McCormick Place, a convention facility on Chicago's near south side. Eventually, Ernest found his way to Olive Branch Mission which helped him in his recovery and ultimately, referred him to The Cara Program.

From the day Ernest walked into the Cara offices, Ernest worked to build his self esteem, confidence and skills. After just two short months, he secured employment at the Tribune Company, a. job that has since evolved into a decade long career. Since joining the Cara community ten years ago, Earnest has reclaimed his life on many different levels. Professionally, his career at the Tribune continues to advance. Over the years, he has moved up through several positions, from his first job as a Janitor to his current role as an Admission Specialist, where he manages an ad insert operation. This is a job with significant financial and client impact and a job that perfectly suits this detail oriented, responsive and dedicated employee.

Thanks to his career success, Earnest is now the proud owner of a three-story home in North Kenwood, which he cares for with his wife, whom he remarried when he got his life back on track. Over the past decade, Earnest has referred his sister and his cousin to The CARA program, both of whom remain at the jobs in which The Cara Program placed them several years ago. Earnest also referred Arthur, whose recovery he sponsors, and who was hired into a permanent job as a Grounds Associate with the Cleanslate program in 2008. Earnest believes in the idea that we transform our lives by aiding in the transformation of others.

JaShawn's Story

In March, 2007, JaShawn graduated from Sister House, a recovery home on the west side of Chicago, and was ready to become an advocate for women suffering from addiction and abuse. JaShawn came to The Cara Program and enthusiastically committed herself to the personal and professional skills she wanted to learn. When she became qualified for a transitional job through Cleanslate, she said "I swept those streets like they were paying me $1 million to do it." (Cara, 2008) She was thrilled to have found a meaningful channel for her energy and the companionship of others who had had similar experiences.

JaShawn watched and cheered as her fellow Cleanslate interns found permanent, quality employment. In those moments, JaShawn explained: "The Cara Program made me realize that I am the only one who can put limits on how successful I can be in my life." (Cara, 2008)

In August, 2007, JaShawn was offered a job as a receptionist for Cabrini Green Legal Aid. Although her position was part time, she was confident that it would be a good stepping stone to the career she wanted. One year later, with continued guidance from her Individual Development Manager (personal and professional coach) at The Cara Program, JaShawn was offered a promotion. She is now the Office Manager at Cabrini Green Legal Aid, working full time with benefits and even tuition reimbursement. JaShawn recently started classes in social work at Northeastern Illinois University. She credits the support services of The Cara Program for inspiring her to further her education, increase her savings and advance her career.

Cathy's Story

In January, 2007, Cleanslate hired Cathy as a Crew Chief, to lead a Cleanslate crew in the beautification of 79' Street in Auburn-Gresham. As a student of The Cara Program, Cathy was fully committed to her internship at Cleanslate, even stepping up to fill in for her Crew Chief when she was ill. When a full time position opened up, Cathy proved to be the best candidate for the job. For two and one half years, Cathy enjoyed leading her crew and earned the respect of her interns because she could identify with their experiences. Cathy excelled at her job, especially because of the time and energy she put into the coaching relationship she had with each of her interns.

Although she enjoyed working with Cleanslate, when an opportunity opened up at Cara's Career Pathways Resource Center (CPRC) on the University of Chicago campus, Cathy enthusiastically applied for the job. Her application was successful, and Cathy was soon promoted to Community Resource Specialist at CPRC. She now focuses on helping south side residents find access to employment. Cathy loves assessing job seekers' needs and helping them to identify the best opportunities for themselves available through The Cara Program and Cleanslate, as well as other community resources. Further, Cathy's successful promotion created a job opportunity for another motivated Cleanslate intern to find permanent, quality employment at Cleanslate.

Shandra's Story

When Shandra came to The Cara Program in the spring of 2008, this mother of three young children was separated from her husband and in emotional distress. The Cara community helped her to gain access to critical resources so she could move her life in a new direction. As she developed new skills and perspectives through The Cara Program's rigorous training curriculum, Shandra began counseling and started meeting with a tutor to achieve her goal of securing her GED. In early July, Shandra was very excited to gain employment the Sutton Place Hotel in downtown Chicago.

Securing this job was just the beginning of positive changes for Shandra. Throughout her year of postemployment support, she worked to improve her childcare situation, opened a savings account, purchased furniture for her new apartment, and dealt with a major credit issue. After several months of employment, Shandra faced a cutback in hours at her hotel job, and was forced to reevaluate every penny in her already tight budget. She pressed on. Through post-employment meetings with her Individual Development Manager (personal and professional coach), she worked to stretch her income and even developed a plan for regularly saving money.

Shandra recently celebrated her one-year employment anniversary at the hotel and soon after, she was promoted from her part-time position to full-time employment. Shandra is thrilled by the start of this new chapter in her life, and knows that with the stability that she gained in her year of post-employment support, she will truly excel in her new position.

MERCY HOUSING LAKEFRONT

The Cara Program, through its Cleanslate social enterprise, is now considering undertaking another new initiative. Cleanslate has been asked to offer property maintenance services in a joint venture with the not-for-profit organization Mercy Housing Lakefront. This organization is a subsidiary of Mercy Housing, a national affordable housing organization headquartered in Denver, Colorado. Mercy Housing is a not-for-profit public benefit corporation was founded in 1981 by the Sisters of Mercy of Omaha and now has a presence in 41 states, serving more than 127,000 people on any given day.

Since its start, Mercy Housing has participated in the development, financing or operation of more than 37,000 homes. About 69 percent of Mercy Housing's portfolio is rental units and the remaining 31 percent is homeownership. Mercy Housing serves families, seniors and people with special needs, particularly the formerly homeless, people with HIV/AIDS and the developmentally disabled. (Mercy Housing, 2009)

Mercy Housing Lakefront is one of Mercy Housing's newest and largest operations. It was created in 2006 when Mercy Housing Midwest merged with Lakefront Supportive Housing in Chicago. Presently, it operates more than 1,400 homes, mostly located in the Chicago area and serves more than 2,000 residents with an average income of $10,395.These organizations, which had been providing housing support services in at-risk neighborhoods in Chicago for two decades, merged with the purpose of further expanding their services (Mercy Housing Lakefront, 2009). They have created and developed a carefully conceived program that not only offers single unit occupancy housing but also provides a supportive structure of activities, where people who were formerly homeless can gain the skills and support they need to stabilize and improve their lives.

Mercy Housing Lakefront drew positive reviews in Chicago when it opened the Margot and Harold Schiff Residences, a 96-unit apartment building designed by architect Helmut Jahn. Located in the Near North neighborhood, the Schiff Residences provide permanent, affordable housing and on-site support services for formerly homeless and disabled adults. This cost effective and nationally recognized approach to preventing homelessness incorporated major design innovations and each unit has a private bath, kitchen, central air and heat as well as abundant common areas and outdoor space.

The senior leadership at Mercy Housing Lakefront includes:

* Cindy, President. Twenty-five years experience in mission-based real estate development and property operations. Extensive experience in purchasing foreclosed homes, rehabbing and repositioning them in the marketplace. Graduate of Harvard's Advanced Management Program.

* Larry, Regional Vice President for Mercy Services Corporation. Lead Trainer, Foreclosed Property Maintenance. A nationally recognized housing management expert.

Proposed Cleanslate property services program

In the City of Chicago, there has been an 86 percent increase in foreclosures since 2006 and there are currently almost 20,000 vacant foreclosed properties in the area. (EForeclosure Magazine, 2009) These vacant properties threaten the vitality of Chicago's neighborhoods because each abandoned dwelling reduces neighboring property values, attracts vandalism and crime, which then propels an exodus by residents who feel unsafe.

The Chicago Tribune recently described the impact of these foreclosures: "In the past, when banks auctioned off foreclosed homes, buyers lined up to snatch real estate at bargain prices. But given the states of the housing and credit markets, almost 99 percent of homes lost to foreclosure in 2008 went back to lenders - a total value of 1.9 billion in Chicago according to data provided by the Woodstock Institute, a think tank located in Chicago" (Chicago Tribune, 2009) As the Tribune article pointed out, banks do not have the interest or ability to serve as either landlords or realtors and so all these properties remain vacant since there are no buyers expressing interest. .

The Cara Program and Mercy Housing Lakefront are considering working together to help provide a solution to the housing crisis in Chicago, while each organization substantively increases its reach within Chicago's most affected neighborhoods. Already, the geographic areas of Cara's Cleanslate initiatives and Mercy Housing Lakefront properties significantly overlap but the joint venture would also enable each organization to expand its services to additional areas experiencing significant need.

To affect this joint venture, a new entity would be created entitled Cleanslate Property Services. Cleanslate Property Services would provide comprehensive property maintenance services to various financial institutions, lenders, developers, government agencies, and the newly formed Chicago Neighborhood Stabilization Corporation to secure and maintain abandoned or foreclosed residential homes and buildings. It would subcontract to The Cara Program's Cleanslate service for three comprehensive property maintenance services: clean-out, board-up, and ongoing maintenance. Cleanslate Property Services would also contract with other vendors on a fee-for-service basis to provide additional services as required by the property owners.

To provide this service, Cleanslate Property Service would need to hire approximately 125 at-risk individuals over a three year period for transitional and permanent jobs from the impacted areas. This would require over half million dollars a year in an annual budget of close to two million dollars. (Table 4) It has the potential to generate almost 14 million in revenue in the same three year period.

While doing this valuable work to stabilize Chicago's poorest neighborhoods, the individuals hired would also be gaining the skills and confidence that comes form successful employment. Having established a positive job history, they would then be equipped to seek other quality jobs in the future, establish themselves in stable housing, further their education, and lead personally rewarding lives.

CONCLUSION

As Eric thinks through the implications of this proposed joint venture, he sees many advantages but also sees potential problems. His biggest concern is the impact the selection of the proposed 125 new hires would have on the Cleanslate operation and the mission of The Cara Program. If the project were successful, in three years, it would significantly increase the number benefiting from Cleanslate employment opportunities. But is the Cara organization ready for this? Would Mercy Housing Lakefront have a voice in the selection and training of these new hires? Should they be subject to The Cara Program's signature life skills, employment and job readiness training and Motivation programs? If not, what would be the result?

Could this new venture dilute the mission of Cara or overwhelm Cleanslate? Maria explained: "We have to make sure that this proposal makes 'mission sense' just as much as it makes 'business sense.' Cara is a very adaptive organization, very nimble, and always sensitive to exploring new possibilities. There are really good reasons to take advantage of this opportunity created by the tsunami of foreclosures, as it has been called, but we have to be sure to look at all the issues so we make a balanced decision."

There are an abundance of issues to evaluate. In this terrible economic climate, where would The Cara Program get the seed money to fund this proposal? Could The Cara Program still maintain its commitment to respect participants' varied career interests if some Mercy students are required to work for Cleanslate Management Services? Would the joint venture take away from the Cara brand or the reputation its students have earned as top quality employees? Would working with Mercy distract the Cara and Cleanslate staff from their core businesses?

Eric wonders aloud: "We are talking about adding another business to the three ventures Cara already has undertaken in the past four years. Will this be too much too soon? For the first fourteen years, we put unlimited effort into revising and refining Cara's signature program and made it an unquestioned success. Now we are considering a fourth program and I just wonder what that could do to this overworked staff. Our people are putting in week after week of ten-hour days and then taking work home with them on weekends. Cleanslate is already growing so fast. Will it be a de-stabilizing factor if Cleanslate needs to manage another kind of program?"

There are still other factors to consider, however. How could these two organizations not join together when they share such a worthy common goal and are driven by the same commitment to prevent homelessness and to transform lives? Eric reflects on how the service areas of their organizations already overlap, about how they serve the same populations and benefit from the same governmental and philanthropic supporters. As he walked around the still-packed boxes in Cara's bright new offices, he asked "How many more people could be helped? How many more permanent jobs could be created in this period of staggering unemployment?" He ponders how many more lives would be transformed if he were to recommend that the Board consider supporting the proposed joint venture? What might he and his staff learn by working with such a successful national organization that might ultimately, help The Cara Program? And, how would he feel if they pass up this opportunity?

DISCUSSION QUESTIONS

1. The Cara Program has been tremendously successful where other social service and government agencies have failed. What accounts for this success as you consider their mission, governance structure and management strategies?

2. In its first fourteen years, the Cara Program worked hard to establish a top quality program that is recognized across the city of Chicago for its excellence and effectiveness. Since 2005, they have undertaken three new ventures. Should they now consider embarking on a fourth? Why or why not?

3. Cara's senior management describes their organization as "nimble" and their staff as "neurotically productive." Should such an innovative entrepreneurial social entity partner with a large national social service agency? What might be the challenges of this joint venture? What might be the benefits?

4. As you consider the history and operations of Cara and of Mercy Housing Lakefront, does the proposed partnership make "mission sense"? Does it make "business sense"?

5. Having seen the number of employment opportunities Cleanslate created for Cara students, the Cara staff recognizes that responding to the "tsunami of foreclosures" will provide hundreds of additional transitional and permanent jobs in this depressed economy. What will happen when the mortgage crisis is over?

6. Should Cara pursue the joint venture with Mercy Housing Lakefront? What are the reasons to go ahead with Cleanslate Property Services? What are the reasons not to? What would you recommend? Why?

Subject: Social entrepreneurship; Homeless people; Joint ventures; Nonprofit organizations; Case studies

Classification: 9130: Experiment/theoretical treatment; 2410: Social responsibility; 2310: Planning; 9540: Non-profit institutions

Publication title: Journal of Business Case Studies

Volume: 6

Issue: 5

Pages: 83-95

Number of pages: 13

Publication year: 2010

Publication date: Sep/Oct 2010

Year: 2010

Publisher: Clute Institute for Academic Research

Place of publication: Littleton

Country of publication: United States

Publication subject: Business And Economics--Management

ISSN: 1555-3353

Source type: Scholarly Journals

Language of publication: English

Document type: Business Case, Feature

Document feature: Charts Tables References

ProQuest document ID: 756036244

Document URL: http://search.proquest.com/docview/756036244?accountid=38610

Copyright: Copyright Clute Institute for Academic Research Sep/Oct 2010

Last updated: 2013-09-06

Database: ABI/INFORM Complete

Document 24 of 100

Total Insurance Inc.: Application Of ABC Management Concepts For Evaluation Of Sales Teams

Author: Sedaghat, Ali M; Sherman, A Kim; Carroll, Thomas

ProQuest document link

Abstract:

Total Insurance Inc (TII) is an instructional case to expand students' understanding of potential benefits of ABC beyond traditional manufacturing applications rather than as a technical ABC application exercise. It does not require complex calculations, yet it allows instructors to discuss why companies may adopt some ABC concepts and demonstrates the process by which they create and develop the information to build the system. Jack White was the CEO of TII, a successful independent insurer. The company acted like a broker between the insurance providers and the customers, but it is truly an agent of the insurance provider in each transaction. White, recalling an accounting course he had taken in his Executive MBA program, decided to investigate the ability of ABC analysis, as applied in that course toward evaluating customers, to gather data on cost drivers and resource use to determine the productivity of his sales teams.

Full text:

INTRODUCTION

Jack White found himself explaining to a friend at a cocktail party what he thought were the key elements of his success as the CEO of one of the most prosperous independent insurance agencies in the mid-Atlantic region of the U.S. He cited the teamwork atmosphere that the company had developed, and expressed the feeling that he had chosen excellent people to join him at Total Insurance, Inc. (TII). However, he admitted that he had trouble distinguishing which of his sales teams were contributing most to his bottom line. Like many agencies that he knew, he had developed teams within the agency to which he provided leadership and common services. Til's teams of one or two sales producers had one to five other employees and drew differently from the common resources of the firm. His conversation ended with White wondering if he could effectively answer the question of which of his teams were the most productive in terms of net profit to the organization.

He recalled managerial accounting courses he had taken and cases he had studied in his Executive MBA studies at Loyola University Maryland. He remembered how Activity Based Costing (ABC) was cited as particularly effective at identifying the costs and cost drivers that impact profitability and wondered if he could put the concept, methodologies and data together to get a better picture of the profitability of his sales teams.

THE INSURANCE INDUSTRY

Many insurance companies rely on a nationwide network of independent agencies and brokers to sell their products. Unlike the captive agents who are employees of an insurance company or telephone sales representatives, independent insurance agents and brokers are separate entities and represent an average of eight different insurance companies. (See Exhibit 1 for an overview of the commercial insurance distribution system.) This allows them to research these firms to find their clients the best combination of price, coverage, and service. The law is not clear as to whether the independent insurance agent has a fiduciary responsibility to act in the customer's interest. In fact, the word "agency" itself would indicate that the independent agent's primary attachment is to the carrier (http://www.disasterprepared.net/fiduciary.html - Accessed 6/30/09). Exhibit 1 shows the distinctions among the general types of insurance providers.

The insurance companies (also known as carriers or underwriters) are the product providers who issue policies and assume risk in exchange for premiums. The insurance industry is a global business. Worldwide premiums exceeded $3 trillion in 2006. In the United States, which accounts for about 34 percent of the world's insurance business, premiums are more than $1 trillion per year. The U.S. insurance industry employs more than two million workers, about 2.1 percent of the nation's workforce (http://www.bls.gOv/oco/cg/cgs028.htm#emply - accessed 6/29/09).

In the U.S., the insurance business is generally viewed as three distinct segments; property/casualty, life, and health. The property/casualty segment of the industry provides insurance for cars, homes, and businesses. Property/casualty insurance can be broken down into two major categories: commercial lines of insurance and personal lines. Personal lines, as the term suggests, include coverage for individuals, such as automobile and homeowners insurance. Commercial lines, which account for more than half of U.S. property/casualty insurance premiums, include many kinds of insurance designed to protect businesses. Commercial insurance performs a critical role in the world economy. Commercial insurers assume the risks inherent in the production and distribution of goods and services. This transfer of risk protects insured companies from catastrophic losses and potential financial ruin that could result from an accident, mistake, or natural disaster. The ability of commercial insurers to guarantee the stability of the U.S. and world corporations was challenged in the monetary crisis and serious recession of 2008-2009.

FINANCIAL REPORTING

Insurers in all states are required to use a special accounting system when filing annual financial reports with state regulators. This system is comprised of and named for its statutory accounting principles (SAP). SAP accounting is more conservative than generally accepted accounting principles (GAAP), as defined by the Financial Accounting Standards Board, and is designed to help ensure that insurers have sufficient capital and surplus to cover all anticipated insurance-related obligations (http://www.investopedia.eom/terms/s/sap.asp - accessed 6/29/09). The two systems differ principally in matters of timing of expenses, tax accounting, the treatment of capital gains, and accounting for surplus. Simply put, SAP recognizes liabilities earlier or at a higher value, while also recognizing assets later or at a lower value. GAAP accounting focuses on a business as a going concern, while SAP accounting treats insurers as if they were about to be liquidated. SAP accounting is defined by state law according to uniform codes established by the National Association of Insurance Commissioners. Insurance companies reporting to the Securities and Exchange Commission must also maintain and report a financial reports that meet GAAP standards.

TOTAL INSURANCE, INC

Total Insurance, Inc. (TII) was established in 1969 by Jack White. White immigrated to the United States in 1951 as an orphan. Following a stint in the United States Army, he found a job as a personal automobile policy underwriter. He later became the business manager and leading salesperson of another insurance agency before leaving to start TII. From modest beginnings, TII has become the 3rd largest privately owned commercial insurance agency in the Baltimore region (growing from $300,000 to more than $100 million in annual premium volume). With a staff of more than 90 insurance professionals, TII serves the Mid-Atlantic region and offers a full complement of insurance products: commercial property and casualty; homeowners, car and boat: surety bonds; professional liability; term, universal and whole life; and health insurance. Exhibit 2 provides some key financial measures between the TII and the industry.

The company is organized into three operating departments - commercial insurance, personal insurance and employee benefits. The commercial insurance department, which constitutes 90 percent of TIFs revenues, is divided into 18 sales teams that support 24 independent sales agents (or producers). Forty-two (42) direct support staff members are assigned to the sales teams and have generally been allocated purely on the basis of premium volume. In addition, there are 1 5 indirect support staff providing administrative, secretarial, billing, information technology and service functions to all sales teams.

THE TII PROBLEM

Although TII is one of Maryland's most successful privately held insurance agencies, it has managed to operate for the past 38 years without any formal cost accounting system. There are many common business decisions that have been difficult to address due to the lack of a cost allocation system. These issues include:

* Measuring the profitability of sales teams

* Allocating agency financial and human resources to sales teams

* Predicting and planning for future resource requirements

* Evaluating the profitability of key customers or customer segments

Jack White decided to apply Activity Based Costing (ABC) to address these issues. He was most concerned about his commercial insurance department which represented ninety percent of his agency's revenue, so he began the process of identifying what would be necessary for an ABC analysis of this part of the business.

White recognized that, typically, activity based costing (ABC) first assigns costs to the activities that are the real cause of the overhead. It then assigns the cost of those activities only to the cost objects that are actually demanding/using the activities. In his case he considered the sales team to be the cost object and he would like to apply the same principles to allocate his overall expenses to the sales teams. He recognized that this is not a typical ABC used in manufacturing firms, where the company categorizes its activities into Unit level, batch level, product level and capacity sustaining level. He thought that the cases where service companies used ABC for measuring customer profitability were closer to meeting his needs.

White decided that he needed to implement his plan by taking the following systematic steps.

1. Gather annual data by sales person and by team.

a. Sales

b. Income

c. Activities (e.g. transactions)

2. Analyze annual company expense data and determine whether expenses are fixed or variable

a. Fixed Expenses - determine an equitable allocation method

b. Variable Expenses - evaluate possible cost drivers to see which of them best predict and measure expense development

3. Develop most important cost drivers for cost allocation

a. Determine the most rational and predictive cost driver for each expense

b. Assign cost drivers to individual expense categories

c. Calculate a per unit cost for each expense category

4. Establish a financial statement that allocates costs and profits by sales team

a. Input sales data from Step 1

b. Calculate expense items by sales teams using the drivers calculated in Step 3c

5. Assess the reasonableness of the results and reassess if necessary

White was able to secure sales, income and activity data directly from the management accounting system of TII. He selected six of the teams to reduce the total analytical work load and categorized the data by sales team. Exhibit 3 summarizes some of the costs and revenues attributable to six of his teams.

From the accounting system of TII, he was able to produce an annual summary of expenses. These expenses were grouped by category. All expenses were common to a sales and service organization. Throughout the process, he attempted to use logic that was consistent with his accounting lessons. He started by evaluating Til's expenses to determine if they were fixed or variable costs, which were used in making his decisions about the most rational way to allocate these costs.

COST DRIVERS

This was one of the most important elements of the project. He evaluated numerous potential drivers that were relevant to the insurance industry. He endeavored to determine which of these potential drivers would help him allocate costs in the most rational and predictive manner. Ultimately there were only a handful of logical cost drivers (listed in the Exhibit 4). He used this list to select a cost driver for each expense category and then calculated the per-unit cost for each expense.

DEVELOPMENT OF COST DRIVERS

1. Number of Producers (Sales People): He used the number of sales people to classify certain expenses. For example, advertising expenses benefit each producer equally in their ability to win customers, therefore it was determined that advertising costs were variable based on the number of producers, even though an additional producer wouldn't increase advertising costs.

2. Number of Employees: The number of direct support employees proved to be a good measure of other expense types. For example, rent expense was best measured by the number of people assigned to each sales unit - as the number of people changes, space requirements change proportionally.

3. Premium Volume (Total Sales Dollars): Premium volume was used to measure expenses that vary in proportion to sales, for example, company insurance for "errors and omissions" is based largely on sales volume.

4. Number of Transactions (Policies Serviced): The number of transactions was an accurate cost driver for expenses linked to the processing of policies, such as courier fees, office supplies and telephone expense.

The purpose of Activity-Based Costing is to provide management a clear picture of the cost structure of their organization. There are numerous strategic decisions that will be impacted by the results of this project. With an accurate picture of the costs and the activities that drive cost, management can then develop a plan to control costs and reduce or eliminate redundancy from the system.

Underperforming sales teams will be challenged to increase output or face cost constraints. Sales people who focus on unproductive clients will be challenged and trained to pursue more profitable sales activities. Future resource allocation decisions will be aided by an accurate picture of existing resource commitments. This will help to ensure that resources are dedicated to productive, profitable areas.

As White began to see how his system might work, he designed a memorandum (Exhibit 5)to send to his sales teams when he had a good sense of whether his system would help form performance criteria that would help TII to assist the sales teams in making choices that will increase the profitability of the company.

QUESTIONS

1. How does TII compare with other companies in its industry?

2. Organizations are always looking for ways to improve their profitability, but what do you think prompted TII use ABC to evaluate team performance?

3. What additional steps should have been considered to confirm/ justify the selection of the cost drivers listed in Appendix 1

4. Apply ABC to measure the profitability of the sales teams by using the selected expenses and cost drivers from Appendix 1.

Subject: Independent insurance agents & brokers; Activity based costing; Performance evaluation; Salespeople; Case studies

Company / organization: Name: Total Insurance Inc; NAICS: 524210

Classification: 9130: Experiment/theoretical treatment; 8200: Insurance Industry; 4120: Accounting policies & procedures

Publication title: Journal of Business Case Studies

Volume: 6

Issue: 5

Pages: 97-105

Number of pages: 9

Publication year: 2010

Publication date: Sep/Oct 2010

Year: 2010

Publisher: Clute Institute for Academic Research

Place of publication: Littleton

Country of publication: United States

Publication subject: Business And Economics--Management

ISSN: 1555-3353

Source type: Scholarly Journals

Language of publication: English

Document type: Business Case, Feature

Document feature: Tables References

ProQuest document ID: 756035895

Document URL: http://search.proquest.com/docview/756035895?accountid=38610

Copyright: Copyright Clute Institute for Academic Research Sep/Oct 2010

Last updated: 2013-09-06

Database: ABI/INFORM Complete

Document 25 of 100

WHEN CHANCE TURNS TO DISASTER: PARTS A, B, AND C

Author: Armandi, Barry; Sherman, Herbert; Rowley, Daniel J

ProQuest document link

Abstract:

Derived from observation and field interviews, this two-part case describes how Professor Reynolds dealt with substituting for Professor Chance, a professor who seemed to have not been working out well with his classes. In Part A the students were complaining to Reynolds that much of their work was not being graded, and, if the work was graded, it was being graded too harshly -- at a graduate student level. Part B begins with Reynolds explaining to his students that it would be difficult for him to use Chance's grading of their work given Chance's seemingly inconsistent grading of their work. Reynolds then discussed with the Provost his new course outline and how he would handle prior course work and the Provost approved of Reynold's resolution. In Part C the Dean and Professor Reynolds decided that the students who plagiarized would be withdrawn from the course without penalty since plagiarism was inexcusable, regardless of Chance's actions.

Full text:

INSTRUCTORS' NOTES

PARTA

Dr. Reynolds walked into a bad situation. Taking over for another professor in the last four weeks of a semester in three courses, regardless of the rationale, makes it very hard on the students as well as on the faculty member in trying to find a fair and equitable way to evaluate students based upon the old instructor's criteria and any new criteria proposed by the new faculty member. Did Professor Reynolds handle this situation in an equitable manner by changing the course outline and by disregarding all of the unmarked work of students, while giving only those students who did receive grades and grades of "B" or better, extra credit? Although a very fair question, this was not the only issue that Professor Reynolds had to address.

PART ?

Professor Reynolds' noticed that two groups' term papers had been plagiarized from the textbook instructor's manual. However, Professor Reynolds should have been prepared for such a situation since it is well known that students plagiarize work and that plagiarism has plagued academia for an extended period of time. "A study by The Center for Academic Integrity found that almost 80% of college students admit to cheating at least once. According to a survey by the Psychological Record, 36% of undergraduates have admitted to plagiarizing written material. A poll conducted by U.S. News and World Reports found that 90% of students believe that cheaters are either never caught or have never been appropriately disciplined." (http://www. mustangps.org/~kingch/Cheating.htm, June 21,2006) "A study conducted by RonaldM. Aaron and Robert T. Georgia: Administrator Perceptions of Student Academic Dishonesty in Collegiate Institutions found that 257 chief student affairs officers across the country believe that colleges and universities have not addressed the cheating problem adequately. ... A national survey published in Education Week found that 54% of students admitted to plagiarizing from the internet; 74% of students admitted that at least once during committee, which shall review the case in accordance with procedures established in section 4.12 of this volume IV." (http://www.sckans.edu/policy/ docstoc/vol4_index.html)

Subject: College professors; Curricula; Plagiarism; Case studies; Academic grading

Location: United States--US

Classification: 9190: United States; 8306: Schools and educational services; 9130: Experimental/theoretical

Publication title: Journal of the International Academy for Case Studies

Volume: 16

Issue: 6

Pages: 1-2,39-42

Number of pages: 6

Publication year: 2010

Publication date: 2010

Year: 2010

Publisher: Jordan Whitney Enterprises, Inc

Place of publication: Arden

Country of publication: United States

Publication subject: Business And Economics

ISSN: 10784950

Source type: Reports

Language of publication: English

Document type: Business Case, Feature

Document feature: References

ProQuest document ID: 1401480065

Document URL: http://search.proquest.com/docview/1401480065?accountid=38610

Copyright: Copyright Jordan Whitney Enterprises, Inc 2010

Last updated: 2013-09-10

Database: ABI/INFORM Complete

Document 26 of 100

INFORMATICA DE SISTEMAS, S.A. EARNOUT NEGOTIATION

Author: Zocco, Dennis

ProQuest document link

Abstract:

Javier Portilla, a Spanish academic turned scientist/entrepreneur, received the magic phone call. Denshi Global Holdings, a publicly-traded Japanese company whose growth strategy is the acquisition of global technology companies, wants to acquire Javier's private company, Informatica de Sistemas, S.A. (IDS). The due diligence and negotiations between the two companies proceeded at a fast pace to the present impasse. Javier and Katsumi Shimura, the Denshi negotiation, disagree on the value of IDS, resulting in a "valuation gap" of euro67.5 million (¥10,987; $107.1 million USD). To resolve this issue, Katsumi has proposed an "earnout agreement" with payment by Denshi to Javier of all or a portion of the "valuation gap" based on IDS performance in the future. Denshi wants Javier to prove, through future performance based on the financial projections he presented during due diligence, that the added valuation he says exists really does exist. Javier and Katsumi are about to begin discussions to craft the elements of an earnout agreement that has value for both sides, with the added challenge of navigating the often tricky waters of cross-cultural negotiations. [PUBLICATION ABSTRACT]

Full text:

INSTRUCTORS' NOTES

Recommendations for Teaching Approaches

This financial negotiation case was written to be used in both undergraduate and graduate courses. The rigor and depth of material may be adjusted to reflect the skill and background of the student audience. 11. Is Javier justified in preferring annual performance milestones?

Uncontrollable circumstances could result in Javier missing quarterly performance goals and losing earnout payments

Catch-up provisions can address this risk

12. What is the rationale for Javier's position that missing a performance milestone by a very slight amount, e.g., a few percentage points, would result in Javier losing the entire earnout payment for that performance interval? How would you address this concern if you were Katsumi?

"All or Nothing" may violate sense of fairness in building relationship

Fairness rationale points to not losing entire earnout payment if milestones are missed by small amount

Katsumi can counter that investment community will penalize Denshi for "just missing" performance expectations

13. Is some form of cumulative, additive, or catch-up provision justified in the earnout agreement?

Creative solutions are possible that provide fairness to Javier and risk management to Denshi

Catch-up could be based on next quarter's performance or end of year

Sliding scale allows earnout payments to be related to performance on a relative basis

Minimum performance levels may be established to protect Denshi from paying for value that does not exist

14. Why is it important in an earnout agreement that the performance milestones are well-defined?

Prevents misunderstanding as to what is expected of Javier and IDS performance

All factors associated with IDS being a portfolio company that may influence Javier's ability to meet performance milestones must be identified and addressed in the agreement

Reduces the need to revisit negotiations

Reduces the chance of litigation over earnout agreement

Protects relationship going forward

Subject: Acquisitions & mergers; Business valuation; Cross border transactions; Software industry; Case studies

Location: Spain

Classification: 8302: Software & computer services industry; 2330: Acquisitions & mergers; 9175: Western Europe

Publication title: Journal of the International Academy for Case Studies

Volume: 16

Issue: 6

Pages: 43,68-70

Number of pages: 4

Publication year: 2010

Publication date: 2010

Year: 2010

Publisher: Jordan Whitney Enterprises, Inc

Place of publication: Arden

Country of publication: United States

Publication subject: Business And Economics

ISSN: 10784950

Source type: Reports

Language of publication: English

Document type: Business Case, Feature

Document feature: References

ProQuest document ID: 1401480071

Document URL: http://search.proquest.com/docview/1401480071?accountid=38610

Copyright: Copyright Jordan Whitney Enterprises, Inc 2010

Last updated: 2013-09-10

Database: ABI/INFORM Complete

Document 27 of 100

CON OR CON-STRUCTION?: THE CASE OF NYE CONTRACTING

Author: Sigmar, Lucia S

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Abstract:

Alex and Lauren Stewart, new to the Houston area, retained the services of a general contractor to make repairs to the home that they had just bought. Although they took great care in researching, specifying the work, and hiring Nye Contracting, they encountered problems from the start with the contractor, his various crews, interruptions and delays in the work schedule, and poor quality work. The last straw for the Stewarts was Nye's demand for additional money for materials to complete the job. He also threatened to place a lien on the Stewart's home until the additional money requirement was met. At this point, the Stewarts feel compelled to document their refusal to pay additional money to Nye and to hold Nye to the terms of their initial agreement, to clarify their position to his demands, to document the extent (percentage) of the work accomplished to date in order to calculate what percentage of the agreed-upon wages should be paid to date, to specify what jobs still need to be done, and to document the deterioration of their business relationship with Nye for possible legal action. Alternatively, however, the Stewarts are considering more positive communication in the hopes of convincing Nye to complete the job he agreed to perform initially and to maintain goodwill. [PUBLICATION ABSTRACT]

Full text:

(ProQuest: Text stops here in original.)

INSTRUCTORS' NOTES

Suggested Teaching Approaches

We use this case in conjunction with Lesikar, Flatley, and Rentz's Business Communications (11th edition) after classroom coverage of bad news and persuasive messages. This case enhances student understanding of the effective writing strategies in composing a complex message that is thorough and tactful, yet clear and concise. Ideally, it must also maintain goodwill between the parties involved. Writing strategies may involve using the indirect or direct approaches in writing bad news messages and the use of rational ...

Subject: Contractors; Business communications; Agreements; Case studies; Renovation & restoration

Location: United States--US

Classification: 2400: Public relations; 8370: Construction & engineering industry; 9190: United States; 9130: Experimental/theoretical

Publication title: Journal of the International Academy for Case Studies

Volume: 16

Issue: 6

Pages: 73

Number of pages: 1

Publication year: 2010

Publication date: 2010

Year: 2010

Publisher: Jordan Whitney Enterprises, Inc

Place of publication: Arden

Country of publication: United States

Publication subject: Business And Economics

ISSN: 10784950

Source type: Reports

Language of publication: English

Document type: Business Case, Feature

ProQuest document ID: 1401480145

Document URL: http://search.proquest.com/docview/1401480145?accountid=38610

Copyright: Copyright Jordan Whitney Enterprises, Inc 2010

Last updated: 2013-09-10

Database: ABI/INFORM Complete

Document 28 of 100

WE'D RATHER FIGHT THAN SWITCH: MUSIC INDUSTRY IN A TIME OF CHANGE

Author: Spotts, Harlan E

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Abstract:

Seeking to stave off innovation and squeeze as much profit from an out-moded production and distribution system, the music industry turned its collective back on their customers. They decided that they would rather "fight than switch." The music industry has been irrevocably changed by the Internet, but rather than embracing change to better satisfy their customers' needs the industry opted to continue to sell CDs. Music consumer use of the Internet and innovation has figuratively dragged the music industry into the 21st century. This case provides an overview of the changes occurring in the music industry over the last decade, allowing for the discussion of innovation's influence on distribution channels, and ethics in buyer and corporate behavior.

Full text:

It wasn't just royalties over which the artists had issues with the music labels. The complex music contracts were a constant source of irritation as the major labels sought greater control over the artists they signed to contracts. Legal disputes have raged over the seven-year rule exemption in California that allows music labels to maintain rights to artists for excessively long periods of time (Ordonez, 2001). Music labels have controlled composition clauses that effectively allow them to control creative content and the amount of content. This clause allows a music label to pay a portion (three-quarters) of the mechanical royalty rate discussed above. This clause potentially restricts the length of song as well as the number of tracks per CD (Holland, 2001b).

Work-for-Hire rules created by the major labels assigned the copyright for recorded music to the label, not the artist (Matthews, 2001). Thus, artists did not retain control over their work once it was recorded on CD. Contracts also include, what some consider particularly pernicious, recoupment clauses, where the music company "recoups" the costs of recording the CD from the artists royalty payment (Holland, 2001b). Many artists receive advances on their music production, from which they pay to record the CD. The record labels then deduct these advances from royalty payments. Clearly, contracts have been structured to the benefit of the major labels, primarily because they controlled the channel of distribution and artists had no other choice if they wanted people to hear their music outside of a small venue.

The Internet has changed the power structure of the channel. Now musicians are more likely to strike out on their own, seeing the Net as the "ultimate venue and distribution channel for their work." (Vernadukis, 1999).

One of the earliest was the artist Symbol, formerly known as Prince. More big name artists, such as Oasis and Radiohead, are exploring the opportunity provided by going independent via the Internet (Clarke, 2006). Further, larger bands are looking for different types of contracts with major labels, such as one album contracts.

The Internet also provided lesser known artists the ability to distribute their music to fans without having to go through the maj or recording labels. Garageband, an Internet music distribution site, had the goal of helping aspiring rock stars get started. Smaller bands could get advances of $10,000 to kick start their recording, with the opportunity to get additional funding if their CDs are successful (Clark, 2001).

As artists are finding new methods of distribution and make most of their earnings through live performances and merchandising they are forcing change in the industry. Artists use to earn most of their income from recorded music through the major record labels, with just one-third of their income from live performances and merchandising (Economist, 2007). This income distribution has reversed. Concert ticket sales have almost doubled to $3.1 billion between 2000 and 2006 (Economist, 2007). Naturally, the artists have devoted more time to touring and less to promoting records. The major music labels are missing out on the area of largest revenue growth, and are eager to get into the act. They have developed the 360 degree contracts that grant the major labels more rights over musician revenue streams (Butler, 2008).

Subject: Music industry; Innovations; Distribution channels; Business models; Case studies

Location: United States--US

Classification: 2310: Planning; 7400: Distribution; 9190: United States; 8307: Arts, entertainment & recreation; 9130: Experimental/theoretical

Publication title: Journal of the International Academy for Case Studies

Volume: 16

Issue: 6

Pages: 79,96-97

Number of pages: 3

Publication year: 2010

Publication date: 2010

Year: 2010

Publisher: Jordan Whitney Enterprises, Inc

Place of publication: Arden

Country of publication: United States

Publication subject: Business And Economics

ISSN: 10784950

Source type: Reports

Language of publication: English

Document type: Business Case, Feature

Document feature: References

ProQuest document ID: 1401480074

Document URL: http://search.proquest.com/docview/1401480074?accountid=38610

Copyright: Copyright Jordan Whitney Enterprises, Inc 2010

Last updated: 2013-09-10

Database: ABI/INFORM Complete

Document 29 of 100

COOPERATIVE GUATEMALA, LLC: "AN EXAMINATION OF A GUATEMALAN COOPERATIVE'S STRATEGIC DEVELOPMENT"

Author: Johnson, Nickalus; Landry, Steven P; Jalbert, Terrance

ProQuest document link

Abstract:

This case explores the establishment and growth of homogenous Cooperatives in a stunted market and some challenges facing diversification of Cooperatives in rural Guatemala. Specific concerns of this case center on the development of strategy for confronting barriers to growth facing a small fishing Cooperative in rural Guatemala, with the added challenges of both strategic and operational decisions being determined solely by the Cooperative's board of directors. The cooperative faces some significant challenges including overcoming lack of education, culturally related decision-making stigmas, and poor organizational structure. These challenges fall within the context of attempting to find competitive advantages through diversification into identified new businesses. Stemming from a search for assistance, the Cooperative eventually was assigned a US Peace Corps volunteer, the viewpoint from whom this case was developed, to assist the Cooperative in providing business administration skills, such as strategy development along with financial and operational control mechanisms, and help improve profitability. A major task of the case is to develop a framework within which the Cooperative can evaluate business opportunities it should pursue. [PUBLICATION ABSTRACT]

Full text:

CASE DESCRIPTION

The primary subject matter of this case concerns the development of strategy for confronting barriers to growth facing a small fishing Cooperative in rural Guatemala. The core issues include coming up with ways to evaluate past performance and to evaluate future options. The backdrop for these issues consists of identifying competitive advantages through diversification into identified new businesses. While this case is based on an actual, real set of circumstances, people and organizations; specific names of people, towns and the Cooperatives have been changed for proprietary reasons.

The case lends itself to student project assignments with respect to developing a strategy for "Cooperative Guatemala". Proposed solutions should follow for determining which ventures to accept with particular attention paid to the cultural implications. Furthermore, students should determine the viability of entering various markets based on incomplete information and the lack of full-time general management as identified in the case.

The case has a difficulty level appropriate for a senior course at the undergraduate level or at the graduate level. The case is designated to be taught in 1.5 class hours and is expected to require 2-3 hours of outside preparation by students.

CASE SYNOPSIS

This case explores the establishment and growth of homogenous Cooperatives in a stunted market and some challenges facing diversification of Cooperatives in rural Guatemala. Specific concerns of this case center on the development of strategy for confronting barriers to growth facing a small fishing Cooperative in rural Guatemala, with the added challenges of both strategic and operational decisions being determined solely by the Cooperative's board of directors. The cooperative faces some significant challenges including overcoming lack of education, culturally related decision-making stigmas, and poor organizational structure. These challenges fall within the context of attempting to find competitive advantages through diversification into identified new businesses. Stemming from a search for assistance, the Cooperative eventually was assigned a US Peace Corps volunteer, the viewpoint from whom this case was developed, to assist the Cooperative in providing business administration skills, such as strategy development along with financial and operational control mechanisms, and help improve profitability. A major task of the case is to develop a framework within which the Cooperative can evaluate business opportunities it should pursue.

Subject: Cooperatives; Fishing industry; Competitive advantage; Strategic management; Case studies

Location: Guatemala

Classification: 2310: Planning; 8400: Agriculture industry; 9173: Latin America; 9130: Experimental/theoretical

Publication title: Journal of the International Academy for Case Studies

Volume: 16

Issue: 6

Pages: 99

Number of pages: 1

Publication year: 2010

Publication date: 2010

Year: 2010

Publisher: Jordan Whitney Enterprises, Inc

Place of publication: Arden

Country of publication: United States

Publication subject: Business And Economics

ISSN: 10784950

Source type: Reports

Language of publication: English

Document type: Business Case, Feature

ProQuest document ID: 1401480153

Document URL: http://search.proquest.com/docview/1401480153?accountid=38610

Copyright: Copyright Jordan Whitney Enterprises, Inc 2010

Last updated: 2013-09-10

Database: ABI/INFORM Complete

Document 30 of 100

WARREN E. BUFFETT AND BERKSHIRE HATHAWAY, INC.

Author: Finkle, Todd A

ProQuest document link

Abstract:

The case discusses the history and background of one of the most successful entrepreneurs, Warren E. Buffett, and the company that he built, Berkshire Hathaway, Inc. The investment genius of Buffett who is affectionately called the "Oracle of Omaha" is examined. The progressions of Buffett's entrepreneurial endeavors are followed from his youth, college, Wall Street, investment partnership, and Berkshire Hathaway. The case discusses Buffett's keys to success, including his value system, and investment philosophy. Students are required to analyze the entrepreneurial personality of Buffett as well as perform a financial analysis on the company. Students are required to make recommendations on what Berkshire should do next in this fragile economy, which Buffett characterized as a recession. The case gives an in-depth analysis of the background, personality, and history of Warren E. Buffett. Buffett's childhood and psychological makeup are discussed as well as the various influences in his life. The case is especially interesting because it follows the path of one of the most successful entrepreneurs of all time. Students have the ability to follow the life of one of the richest people in the world. [PUBLICATION ABSTRACT]

Full text:

INSTRUCTORS' NOTES

Recommendations for Teaching Approaches

Students will find the case interesting from a number of dimensions (e.g., Buffett is the richest man in the world, yet he has a strong value system; Buffett's background, the companies Berkshire has a vested interest in, etc.). Most students will have used or eaten one of the many products associated with Berkshire Hathaway (e.g., Coke, Gillette, Dairy Queen). Instructors have the ability to integrate the entrepreneurial EPILOGUE

In late 2008, the U.S. economy was mired in a recession. Earlier in the year, Buffett stated that this will be a long and deep recession. When asked when it will end he stated that he had no idea, but it will last for at least another five months. Buffett was absolutely correct. This is indeed a long and deep recession. This is by far the worst recession since World War Π.

Buffett stated that he was not in the business of making predictions. He said that he had no idea what the market will do from day-to-day. All he was interested in was buying good companies with great management at a discount. He also stated that he invested in companies for the long term.

During one of Buffett's recent talks with university students, he was asked what some good investment opportunities were. Buffett stated that China's growth was an opportunity.

In early 2008 Buffett had $28 billion to invest. Buffett went to Europe to try and find companies to invest in or purchase. He needed to find very large companies to invest in or purchase. At the 2008 shareholder meeting, Buffett told shareholders not to expect the same types of returns as the past. He stated that you can expect a return of about 2-3% above the S&P 500.

At 78 years old, Buffett stated that he loved his job and the people he worked with. He loved going to work every day and had no plans on retiring. Buffett planned to do deals in the future just as he had in the past.

In early 2008, Berkshire began purchasing Burlington Northern Santa Fe (BNI). Berkshire has also been buying Union Pacific Railroad (UP) stock. Given the price of gasoline, railways are a much more efficient way of transporting goods rather than trucking.

Recently, Buffett also purchased more railways (UP & BNI) and stock in a diversified energy company called NRG Energy. In the summer, 2008, Berkshire sold all of its position in ConocoPhillips and then late in the year he bought a big position as oil prices went down to around $40-50 a barrel. Buffett also invested in Goldman Sachs ($5 Billion) and General Electric ($3 Billion).

In August, 2008, Buffett visited the Canadian oil sands with Bill Gates (see Crippen, 2008). He stated that the oil sands could be an investment opportunity depending on what the future demand for oil is. Buffett stated that the oil sands were the biggest possibility to fill the gap needed for oil in the world over the next 1 Ο15 years.

Subject: Diversified companies; Entrepreneurs; Success factors; Personal profiles; Case studies

Location: United States--US

People: Buffett, Warren

Company / organization: Name: Berkshire Hathaway Inc; NAICS: 335212, 442210, 445292, 511110, 511130, 524126

Classification: 9160: Biographical treatment; 9530: Diversified companies; 9190: United States; 9130: Experimental/theoretical

Publication title: Journal of the International Academy for Case Studies

Volume: 16

Issue: 6

Pages: 107,117-120

Number of pages: 5

Publication year: 2010

Publication date: 2010

Year: 2010

Publisher: Jordan Whitney Enterprises, Inc

Place of publication: Arden

Country of publication: United States

Publication subject: Business And Economics

ISSN: 10784950

Source type: Reports

Language of publication: English

Document type: Business Case, Feature

Document feature: References

ProQuest document ID: 1401480068

Document URL: http://search.proquest.com/docview/1401480068?accountid=38610

Copyright: Copyright Jordan Whitney Enterprises, Inc 2010

Last updated: 2013-09-10

Database: ABI/INFORM Complete

Document 31 of 100

TALENT MANAGEMENT AT THE ADV CORPORATION

Author: Stumpf, Stephen A

ProQuest document link

Abstract:

ADV is a $3.5 billion multinational corporation that is struggling to attract and retain professional and managerial level talent in four country markets (Germany, India, UK, and the US). The case provides retention and job openings data by country along with a discussion of talent management issues from several perspectives: the Board's views on investing in talent management, the CEO's charge for the task force, the soon-to-depart Global Head of HR's analysis of current and past talent management practices including why she is leaving, and extensive comments from your mentor detailing how ADV has attended to or ignored talent management issues in the past. Financial information is provided on the expected costs of projects and activities associated with recruiting, training, developing, and communicating the ADV talent management approach to prospective and current employees.

Full text:

Subject: Talent management; Multinational corporations; Retention; Case studies

Location: United States--US, Germany, India, United Kingdom--UK

Classification: 9179: Asia & the Pacific; 9175: Western Europe; 9510: Multinational corporations; 9190: United States; 6200: Training & development; 9130: Experimental/theoretical

Publication title: Journal of the International Academy for Case Studies

Volume: 16

Issue: 6

Pages: 121

Number of pages: 1

Publication year: 2010

Publication date: 2010

Year: 2010

Publisher: Jordan Whitney Enterprises, Inc

Place of publication: Arden

Country of publication: United States

Publication subject: Business And Economics

ISSN: 10784950

Source type: Reports

Language of publication: English

Document type: Business Case, Feature

ProQuest document ID: 1401480149

Document URL: http://search.proquest.com/docview/1401480149?accountid=38610

Copyright: Copyright Jordan Whitney Enterprises, Inc 2010

Last updated: 2013-09-10

Database: ABI/INFORM Complete

Document 32 of 100

USE OF STAFF ATTORNEYS IN DEFENDING INSURANCE CASES: CAN AN ATTORNEY SERVE TWO MASTERS?

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Abstract:

Like many states, Texas has long struggled with the question of how many clients does an attorney, who has been hired by an insurer to defend an insured, have. Courts have tended to rule that these attorneys have two clients in the insurer and the insured, yet they owe an unqualified loyalty to the insured who has been sued. The Unauthorized Practice of Law Committee has sought to end or limit this practice based on concerns that a staff attorney, whose actions can be strictly controlled by his employer, will have an irreconcilable conflict of interest and be unable to give full allegiance to the insured. In 2008 the Supreme Court of Texas reviewed a prior decision of the Court of Appeals for the Eleventh District of Texas. In American Home, the court was asked to determine if an insurance company 's use of staff attorneys to defend cases filed against their insured resulted in the insurance company practicing law. If this did constitute the practice of law it would be a violation of Texas law. The Court ruled in part that the use of staff attorneys did not constitute unauthorized practice of law on the part of the insurance corporations. This case study will discuss that decision and attempt to determine if a staff attorney can avoid being improperly influenced by their nonattorney supervisors and those supervisors' duties of maximizing profit. [PUBLICATION ABSTRACT]

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Document 33 of 100

PUBLIC FUNDS VERSUS PRIVATE ENDEAVORS: CATALOGS AND CONFLICT IN ALASKA

Author: Roberts, Wayne A

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Abstract:

Rural Alaska Community Action Program Inc launched a new catalog operation in 1993. The catalog had several purposes, one of which was to generate funds to support othersocial programs. In 1995, after two years of heavy losses and the investment of more than $600,000 of public money through Alaska State administered grant programs, controversy and uncertainty swirled about the contentious new venture. The Department of Community and Regional Affairs, the agency responsible administering the federally funded grant programs, was unsure of what to do. Besides the discomfort associated with giving taxpayer money to an organization that competed against private enterprise, they were concerned about whether the catalog operation represented a wise investment of public money. This case can be used to raise and address a number of interesting issues appropriate to classes in public administration, marketing, finance, accounting, and entrepreneurship.

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INSTRUCTORS' NOTES

1. Do you believe it made sense to forego a detailed feasibility study and instead actually put together a catalog operation, complete with products, contracts with fulfillment houses, etc.? What are the dangers of pursuing such a strategy? What are the benefits? Under what conditions does acting, rather than analysis, make sense? Under what conditions do analysis, prior to acting, make sense?

Subject: Nonprofit organizations; Catalogs; Market strategy; Government grants; Case studies

Location: United States--US

Classification: 1120: Economic policy & planning; 7000: Marketing; 9190: United States; 9540: Non-profit institutions; 9130: Experimental/theoretical

Publication title: Journal of the International Academy for Case Studies

Volume: 16

Issue: 6

Pages: 133

Number of pages: 1

Publication year: 2010

Publication date: 2010

Year: 2010

Publisher: Jordan Whitney Enterprises, Inc

Place of publication: Arden

Country of publication: United States

Publication subject: Business And Economics

ISSN: 10784950

Source type: Reports

Language of publication: English

Document type: Feature, Business Case

ProQuest document ID: 1401480154

Document URL: http://search.proquest.com/docview/1401480154?accountid=38610

Copyright: Copyright Jordan Whitney Enterprises, Inc 2010

Last updated: 2013-09-10

Database: ABI/INFORM Complete

Document 34 of 100

CJ MCLAINE'S DELI & BAKERY, LLC: A SMALL FAMILY BUSINESS CASE STUDY

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Abstract:

CJ Mclaine's Deli and Bakery, LLC, a family owned small business venture, operated in the town of Evergreen, Colorado. The Italian style deli and bakery focused primarily on its lunch business but also offered a limited breakfast menu, a dinner takeout menu, and general catering services. The business was launched in 2004 and gained significant momentum in its first year of operation. This initial success encouraged the family owners. During its second year, however, changes in the competitive environment and an economic recession created new obstacles that affected the business' sales and bottom line. Somewhat discouraged, the owners recognized that strategic alternatives had to be considered if the business was to survive. The case demonstrates the difficulty of starting a business and sustaining its growth and momentum. It highlights the vulnerability of the small business to changes in the macro environment, especially changes in economic factors, and changes related to industry and competitive forces. [PUBLICATION ABSTRACT]

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INSTRUCTORS' NOTES

Small businesses are an important part of the U.S. economy, with approximately 23 million firms in the United States classified as small businesses and over 5 0% of the private sector workforce employed by such firms (Ibrahim, et al., 2008). There is also a significant failure rate. U.S. Small Business Administration statistics indicate that of the businesses founded in a given year only 50% will remain in business four years later (Headd, 2003). This case demonstrates some of the challenges faced by one such business as it entered its third year of operation.

Document 35 of 100

CAPE CHEMICAL: CAPITAL BUDGETING ISSUES

Author: Kunz, David A; Dow, Benjamin L

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Abstract:

The case tells the story of Ann Stewart, President and primary owner of Cape Chemical. By most measures, the performance of Cape Chemical has been very good over the last three years. Double-digit sales growth has been achieved, new product lines have been added and profits have more than tripled. The growth has required the acquisition of equipment, expansion of storage capacity and increasing the size of the work force. The unexpected withdrawal of one of Cape Chemical's competitors from the region has provided the opportunity to increase its blended packaged goods sales. However, Cape Chemical's blending equipment is already operating at capacity. To take advantage of this opportunity, additional equipment must be obtained, requiring a major capital investment. It is estimated that Cape Chemical must increase its annual blending capacity by 800,000 gallons to meet expected demand for the next three years Annual capacity of 1,400,000 gallons is necessary to meet projected demand beyond the next three years. The firm has no systematic capital expenditure evaluation process. [PUBLICATION ABSTRACT]

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(ProQuest: ... denotes text stops here in original.)

INSTRUCTORS' NOTES

Case Use

The case as written includes discussion questions to aid the student in their analysis of Cape Chemical's current financial position. The case can be made more difficult by omitting the discussion ...

Subject: Capital budgeting; Chemical industry; Capital expenditures; Case studies

Location: United States--US

Classification: 8640: Chemical industry; 9190: United States; 3100: Capital & debt management; 9130: Experimental/theoretical

Publication title: Journal of the International Academy for Case Studies

Volume: 16

Issue: 6

Pages: 151

Number of pages: 1

Publication year: 2010

Publication date: 2010

Year: 2010

Publisher: Jordan Whitney Enterprises, Inc

Place of publication: Arden

Country of publication: United States

Publication subject: Business And Economics

ISSN: 10784950

Source type: Reports

Language of publication: English

Document type: Business Case, Feature

ProQuest document ID: 1401480152

Document URL: http://search.proquest.com/docview/1401480152?accountid=38610

Copyright: Copyright Jordan Whitney Enterprises, Inc 2010

Last updated: 2013-09-10

Database: ABI/INFORM Complete

Document 36 of 100

A TOC Approach To Setup Reduction To Improve Agility

Author: Villarreal, Bernardo

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Abstract:

Setup reduction has been one of the main programs to improve a firm's performance in terms of response time and flexibility. The selection and sequence of setup reduction projects takes importance in a multi-product, multi-machine environment with limited resources. This paper describes a Theory of Constraints (TOC) based approach to deal with the previous situation when the goal is to improve agility. Results of this application to a Mexican company is provided. [PUBLICATION ABSTRACT]

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1. INTRODUCTION

In order to meet the requirements for price, quality, response time and flexibility of today's competitive global market, most firms have implemented advanced technologies and philosophies such as Flexible Manufacturing Systems and Just in Time manufacturing.

Flexibility is the key characteristic of an agile supply chain. In fact, the concept of agility emerges from the development of flexible manufacturing systems (FMS). The idea of a manufacturing system being highly responsive to changes in product mix or volume was extended a wider context at the supply chain level (Nagel, et al., 1991).

Setup time reduction programs have been one of the main components of manufacturing performance improvement strategies. The prioritization of setup investment projects in a multi-product, multi-machine resourceconstrained environment is of major concern, and in particular if our objective is to become faster and more flexible to respond to customer's requirements. The most suggested approach to attack this situation is the use of Pareto analysis of total setup time in a period (Hall 1983), (Shingo 1985). Even though this insures that investment efforts are assigned to the machine with the largest setup time, it does not make sure that the systems' performance as a whole is improved.

This paper proposes a general scheme that will assist management to rank setup reduction projects with the goal of maximizing overall systems' performance measured in terms of response time reduction. The following section provides a review of the literature that deals with works related with the reduction of setup and manufacturing lead time and describes the approach considered in this paper to rank setup reduction efforts. Section 3 provides the results of the use of simulation to define a setup reduction strategy for a Mexican company that fabricates and assembles a large variety of electrical motors. Finally, several conclusions about the application of the scheme are given in the last section.

2. PREVIOUS RESEARCH

As mentioned previously, setup reduction is a key element in any improvement program. Decreasing setup time yields important benefits in productivity, response time, and flexibility. A setup reduction project will improve the overall performance of a production system provided that the machines to analyze are properly selected. Obviously, efforts should be focused on the setups that will yield the maximum gain, keeping in mind that there is a limited budget of resources. The purpose of the selection phase is to determine; which machines should be studied; what item setup must be reduced; and what sequence of setup projects should be implemented. A guideline to choose the best projects would be to seek for those machines with highest utilization, items with longest setup times and largest lot production runs (Steudel, et al 1992). Nicholas (1998) suggests to focus setup investment efforts to bottlenecks, though he does not provide a scheme or procedure. Chakravorty et al (1995) offers a general scheme based on Theory of Constraints (TOC) (Goldratt, et al 1990), and applies it to a theoretical example, assuming setup reduction projects leading to a 70% reduction in setup times. Finally, Villarreal et al (2002) provide a TOC based procedure to prioritize setup reduction efforts and apply it in the machining department of a Mexican company. All these works are developed with the purpose of improving productivity and capacity utilization. Additionally, They treat the setup reduction problem isolated from the determination of lot sizes and the requirements of investments to implement them.

Most of the literature dealing with estimating or reducing manufacturing lead time is based upon the use of queueing models. Karmarkar et al (1992), Yang et al (1993), Dobson et al (1992), and Kekre (1987) focus on the impact of lot sizing on lead time. Kekre (1987) and Yang et al (1993) consider the impact of product mix and Karmarkar, et al (1992) discusses the relevance of order release mechanisms. Yang, et al (1993) provide guidelines to prioritize setup reduction efforts, according to product setups, for a closed manufacturing cell using M/G/l queueing model. None discusses in detail how a reduction of setup time will affect the level of manufacturing lead time.

The previous works use models developed with queueing theory to treat setup reduction. Others such as Dobson et al (1992) describe the application of a GPSS simulation model of a manufacturing cell to analyze the effect of lot sizing on queueing delays and validate Q-LOTS, a general analytical model. Bard, et al (1999) use a simulation approach to estimate delays due to batching in a semiconductor facility. Finally, Atherton, et al (1995) employ simulation to estimate lot cycle times in a wafer manufacturing facility.

In this paper we are concerned with a plant that produces several items in a job shop with various work stations. Each product has a different sequence of processing, is produced in lots, and a setup is required in order to start its processing at each machine. The goal of the plant is to improve its response time to the market. In order to meet this goal, the firm is devising an improvement program of its manufacturing lead time, under a TOC scheme. A fundamental element of this program is a Setup Reduction Program in which shop floor and engineering personnel participate in the generation and implementation of projects. In this context, it is important to guide the improvement efforts, and determine and sequence those that contribute to the satisfaction of the firm's goal. The scheme must now be designed to prioritize projects according to their contribution towards the order winning factor. How to sequence the projects to improve the systems' average lead time? This aspect is treated in the following section.

3. USING SIMULATION TO DEFINE A SETUP REDUCTION STRATEGY

The purpose of the project was to improve the manufacturing lead time of the motor assembly area of Emerson de Mexico, S.A. The company assembles a high variety of electrical motors in its plant located in Apodaca, N.L., México. The plant is divided into 6 fabrication areas:

* Brackets.

* Pinions.

* Gears.

* Gearcases.

* Worm wheels.

* Shafts.

The layout and a view of the shop floor is shown in Figure No. 1.

3.1 On Time Delivery Performance

In order to measure the plant's performance in terms of delivery response, a total of 11345 orders were processed corresponding to a one year period. Of the total orders received 59% were delivered late!! Original average order manufacturing lead time was estimated at 888 minutes. A goal of about 600 minutes was estimated to obtain a "zero delay" level. A detailed analysis of the contribution of its elements resulted in the identification that the shaft assembly operation was experiencing long delays that require an important reduction. Two product families are manufactured in the shaft area. These are the output shaft and worm shaft families. Observing the lead times for both families it was found that the output shaft family was impacting the most on lead time. The work described in this document is concerned with this family.

3.2 Using Simulation to Analyze Shaft Assembly Lead Time

After considering the possibility of developing queuing models to help management to identify areas of opportunity, it was finally decided that simulation would be a more flexible tool.

The next step was to develop a simulation model of the shaft assembly operations using Promodel software. The objective of the model was to assist management to identify the machines where a reduction of setup time would impact the most total manufacturing lead time. Since it was intuitively expected that the initial efforts should be invested on bottleneck machines, a machine load analysis was carried out concluding that the Captain and Okuma presses were the bottleneck machines. It was also found out that they employed an important proportion of time, about 46.7%, carrying out setups.

It was then decided to use the simulation model to estimate the relationship of setup time reduction % and total manufacturing lead time. This relationship is shown in Figure No. 2 for the most important machines and it is represented by a piecewise linear function for each one.

The main result obtained is that the rate of manufacturing lead time reduction is decreasing for each machine. Each machine's function, consists of several linear segments with different slope, being these lower as setup time is decreased. Given this behaviour, one can take advantage of each linear segment with different slope ranking them in descendent order as illustrated in Figure No. 3. It will be considered that the manufacturing lead time reduction achieved in each linear segment is a result of the implementation of a setup reduction "effort" consisting of a set of projects.

Sequence machines according to order flow time decrease per % of setup time reduction (slope).

According to the ranking, one should initiate the strategy for reducing total manufacturing lead time with an effort (No. 1) to decrease Okuma setup time up to 30%. The next effort should be in the Captain machine decreasing setup time up to 30%, then one should focus on decreasing setup time in Okuma, and so on. At this point, each set of projects associated with each "effort" has not being identified. This will de carried out with the procedure described in the next section.

The previous reasoning is used as the basis to define a procedure to determine the setup reduction strategy for the company.

3.3 Procedure for Defining Setup Reduction Strategy

The procedure employed to define the setup reduction strategy is described as follows.

* Organize teams to identify projects for each machine.

* Identify setup time decrease impact for each project and the required investment.

* Rank the projects in ascending order according to the required investment for each machine.

* Assign projects according to rankings to each effort, until budget restriction is enforced.

* Finally, every effort, with its corresponding set of projects, is ordered accumulating the required investments. This is done until a budget limit is met or the setup reduction goal is achieved.

Table No. 1 illustrates a sample of the ranking of projects for OKUMA press. Here, three projects are shown: A 5S's program, a new tool supply system and the repair of an optical comparator. A description of their contribution to OKUMA's setup time reduction is also given along with their assignment to a particular "effort". The 5 S's program and the new tool supply system are included as part of "effort" 1 with a total investment of 1500 USdIs.

Figure No. 4 illustrates both; the sequence of "efforts" and the assignment of projects to each effort. It is worth to notice that the suggested sequence may contain "efforts" applied to different machines. The definition of the sequence is restricted by a budget constraint or a desired setup time goal.

The impact of the strategy on manufacturing lead time is described in Figure No. 5. The result of implementing it shows a decreasing rate of lead time reduction. An important conclusion reached by management was that the desired goal of 600 minutes would not be achieved by the implementation of the setup reduction program alone. It was required to identify and implement additional projects such as the reduction of production lots, the establishment of one-piece flow manufacturing and others, to be able to meet the goal.

5. CONCLUSIONS

This paper offers a procedure based upon Theory of Constraints for identifying, prioritizing , sequencing and implementing setup reduction projects in a multi-product, multi-machine environment. It is conceived to be part of an improvement program in which there is high participation of shop floor and engineering personnel. Projects are conceptually designed, selected and implemented by these personnel according to a prior ranking based upon their generation of throughput.

The procedure is applied in the shaft assembly department of a Mexican company. Simulation was a very helpful tool to craft a strategy and facilitate the understanding to everybody involved. The strategy included efforts sequenced according to their marginal contribution to order flow time reduction. The goal of 600 minutes for average order lead time could not be achieved only with setup time reduction.

Subject: Theory of constraints; Flexibility; Supply chains; Just in time; Case studies

Location: Mexico

Classification: 4120: Accounting policies & procedures; 9173: Latin America; 5160: Transportation management; 9130: Experiment/theoretical treatment

Publication title: Journal of Business Case Studies

Volume: 6

Issue: 4

Pages: 1-7

Number of pages: 7

Publication year: 2010

Publication date: Jul/Aug 2010

Year: 2010

Publisher: Clute Institute for Academic Research

Place of publication: Littleton

Country of publication: United States

Publication subject: Business And Economics--Management

ISSN: 1555-3353

Source type: Scholarly Journals

Language of publication: English

Document type: Business Case, Feature

Document feature: Illustrations Graphs Tables References

ProQuest document ID: 744080110

Document URL: http://search.proquest.com/docview/744080110?accountid=38610

Copyright: Copyright Clute Institute for Academic Research Jul/Aug 2010

Last updated: 2013-09-06

Database: ABI/INFORM Complete

Document 37 of 100

Barnes & Noble, Inc.: Maintaining A Competitive Edge In An Ever-changing Industry

Author: Hall, Wendy; Gupta, Atul

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Abstract:

On Christmas Eve in 2007, Barnes & Noble's Chief Executive Officer, Steve Riggio, sat in his Manhattan apartment overlooking the busy streets of NYC and was hoping that the last minute shoppers were making their Christmas purchases at the BSN Union Square flagship store. However, he could not help but worry about the increasing competition in the retail industry, specifically, the book industry. Riggio wondered if shoppers would even be in the stores or would they have already done their shopping on-line? If they had done their shopping on-line, would they have used Barnesandnoble.com or Amazon.com? In the midst of a struggling economy, would shoppers choose to shop at discount stores such as Costco or Target? These were just a few of the questions that Riggio was asking himself at the end of a very tough year. Riggio considered where Barnes & Noble would be in 5, 10, or even 20 years. Unfortunately, with the increasing competition, technological advances, and changes in book industiy trends, Riggio knew that the answers were not only complex; they were yet to be determined. [PUBLICATION ABSTRACT]

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More Clicks at the Bricks: How retail stores are scrambling to catch up with the shoppers empowered by the Web.

The Internet hasn ? destroyed brick-and-mortar retailing, as many once feared. But has it ever changed consumer behavior.

Headline and text from Business Week Magazine (December 17, 2007)

Barnes and Noble 4Q down, but forecast up.

Both Barnes and Noble and Borders have lost market share from aggressive discounting from online retailer Amazon.com and discounters like Target Corp. and Wal-Mart stores Inc.

Headline and text from Associated Press on-line (March 20, 2008)

BACKGROUND

Barnes & Noble, Inc. (B&N) trades on the New York Stock Exchange under the symbol "BKS" and is considered the world's largest bookseller.1 B&N currently owns B. Dalton bookstores, located mainly in large indoor shopping malls, as well as Sterling Publishing. In addition, B&N owns 74% interest in Calendar Club, L.L.C.2 B&N also sells a large amount of books and music over the internet at www.bn.com. Currently, B&N has 798 stores in operation, 85 of which operate under the B. Dalton name. B&N plans to open 35 to 40 new stores in fiscal year 2008.4 In contrast, B&N plans to gradually close underperforming B. Dalton stores. Specifically, 882 B. Dalton stores have closed since 1982, 13 of which were closed in fiscal year 2007. 5

Barnes & Noble opened the "Original" Barnes & Noble store in New York City in 1917 and the first "Superstore" in 1992.6 B&N stores are very large in size ranging from 10,000 square feet to 60,000 square feet, with most being on average of 25,000 square feet.7 Many Barnes & Noble stores include an in-store café that offers sandwiches, desserts, and Starbucks coffee products. Barnes & Noble is very much focused on community and allows each store to establish their own community events calendar, which includes events such as story time, fund raisers, book readings, book signings, and more.8

Barnes & Noble's sales consist mainly of adult trade, magazines, children's books, mass market paperback, gifts, music, and movies. On March 3, 2008, B&N opened Barnes & Noble Studio (www.bn.com/studio), an on-line multimedia site intended to lure readers, publishers, and writers.9 Mike Skagerlind, Vice President of Digital Media for B&N, said, "Our programming celebrates the diversity and creativity that surround the world of books, authors and readers in a way that is useful, entertaining, and accessible. Barnes & Noble Studio will do for the book what the cooking show did for the recipe."10 On March 24, 2008, B&N launched a new how-to website called "Quamut.com" (www.quamut.com)." Quamut.com is published by Barnes & Noble, Inc. and offers how-to information on more than 1,000 topics.12 Dan Weiss, publisher and managing director for Quamut.com said in a press release on March 24th, "Quamut.com positions Barnes & Noble as a leader in digital how-to publishing."

BOOK INDUSTRY TRENDS

Barnes & Noble is not the only company affected by changes in the book industry. Significant changes in the book industry, including the increase in audiobooks, the internet, piracy of books, music, movies, and the newly invented "e-reader", which allows consumers to read books electronically on a reading device about the size of a blackberry, are having companies within the book industry all along the supply chain taking a closer look. The Book Industry Study Group (www.bisg.org), which is considered an authoritative association within the industry, has been researching and providing the industry with a comprehensive collection of data on the trends in the book industry for over thirty years.15 In September of 2007, the BISG released its latest "Book Industry Trends 2007" book which includes data from 2005 through 201 1. The BISG projects that total consumer expenditure will increase only by 2.9% by the year 2010, down from 2007, which was projected at a 3.9% increase from 2006 (see Exhibit 1). The BISG gathers data from numerous sources, including the U.S. Census, 10-Ks/ Annual Reports, Wall Street reports, U.S. Department of Education, Retail Data, Publishers, and more.16 A time series forecasting tool is used by the BISG to project industry trends. The "Auto Regressive Integrated Moving Averages" model or the "ARIMA" uses historical data to look for patterns and project future trends.

Professors Albert Greco and Robert Wharton of Fordham University, lead researches for the BISG, discussed their predictions for the book industry during a lecture at the Library of Congress in June of 2007. Professor Wharton stated, "Overall, the industry is growing but only at a rate slightly greater than inflation. Publishers are profitable and sales are increasing, but the bar is being raised higher and higher for profit margins".19 The major categories in the book industry are Adult Trade, Juvenile Trade, Mass Market Paperback, Religious, Professional Publishing, College Textbooks, and Elhi (Elementary and High School) and College. Religious books appear to be the most successful sector and predicted to increase to S3.07B by the year 2010, which is a 50% increase from 2006. 20 Wharton and Greco attribute this increase in Religious books to "the significant number of publishers active in this field, the rise of mega churches, increased church attendance and expanded offerings on this topic at large secular bookstore chains"."' Greco and Wharton also predict the Juvenile sector to be strong based on the huge success of the final installment of the Harry Potter series. Another big title such as Harry Potter could drive sales in the Juvenile sector to $6.8B by 20 10.22 Another significant finding in the College Textbooks sector is that there is an increase in the demand for used books and electronic access to textbooks.23

One disturbing trend is the increasing amount of piracy of books, music, and movies. In 2006, the United States Trade Representative (USTR) released their annual Special 301 Report that detailed the increase of piracy worldwide.24 The Association of American Publishers (AAP) estimates that more than $600 million is lost each year due to piracy.25

Who is Reading Books?

According to the BISG's latest report, the total amount of time spent using media has increased, but the hours spent actually reading books is decreasing.26 The book industry has to compete with each person's time, and books are not a priority. Exhibit 2 shows the total estimated time and money spent by consumers on media from the year 2000 to 2010, as reported by the U.S. Census Bureau and used as the basis for the BISG's findings. Consumer books, magazines, and newspaper categories are all experiencing a decline, while electronic media, including television, is seeing an increase.

In 1992, 60.9% of adults were reading, which dropped to 56.6% in 2002.28 In addition, it appears that females are reading more than males.29 Exhibit 3 provides a breakdown of the number of male and female adults reading from 1992 to 2002. Although this data is for the years 1992 to 2002, this trend is likely to continue into the future.30 Another interesting trend to note is that adults between the years of 45 and 54 read the most, on average, followed by those between 55 and 64 years old.31 Young adults between 18 and 24 read the least, but it is suggested that the increase in technological advances and the competition for time from the internet and television is to blame.32 Finally, the U.S. Census reports that those adults making an annual income of more than $75K per year read more than those making less; in other words, the more you make, the more likely you are to read.33

The Internet Phenomenon

According to the U.S. Census Bureau the adjusted Q42007 estimates for e-commerce retail sales were reported at $36.2 billion (note: total retails sales for Q407 were $1,037.7B).35 The total e-commerce estimated sales for 2007 were $136.4 billion, which represents an increase of 19% from 2006.36 The National Retail Federation reports that on-line retails sales have gradually increased year after year. Additionally, in January 2008, a Nielsen Global On-line Survey found that 41% of items purchased on-line were books, the most popular product purchased over the Internet (second-most popular in US behind shoes, clothes, and accessories).37

Print on Demand

Print on Demand or POD is a new technology emerging in the Publishing industry where books can literally be printed on demand based on demand. However, this technology is fairly new and therefore more costly than traditional printing. For example, the cost to print a typical Hardback bestseller is approximately $3.50 per copy using traditional printing versus $5 - $8 per copy for Print on Demand.38 Nonetheless, the BISG predicts that POD will be "the Library of the future".39 This technology is beneficial to publishers because they can decrease the amount of returns from the wholesalers and it is beneficial to the retailers because it allows a more efficient use of shelf space. But POD is particularly beneficial to on-line retailers like Amazon.com where they do not have shelf space to worry about. In fact, Amazon.com has included a POD subsidiary, BookSurge, in their corporate portfolio to cut down on costs of printing.

A STRUGGLING ECONOMY

In early 2007, Wall Street and the media began rumblings that the U.S. Economy was in trouble and questioned whether or not a recession was inevitable.40 The U.S. had not experienced a recession since the aftermath of September 11, 2001 terrorist attacks and the failing dot.com industry.41 Experts attributed the troubled economy mostly to the deteriorating housing market and the increase and subsequent defaulting subprime mortgages.42 In an effort to fix the failing economy, President Bush announced on Friday January 18, 2008 his proposal for a $145M economic stimulus package designed to get consumers to spend more money43. By Monday January 21, 2008, Wall Street and foreign markets all over the world experienced the worst decline in five years, roughly 850 points in the Dow.44 This hit in the market had a ripple effect on the economy including billions of dollars of losses by the major U.S. banks, including Citigroup and Merrill Lynch45. Statistics show that consumers are spending less due to other factors such as increasing gas prices, increasing GDP (Gross Domestic Product), increased unemployment, and a general fear of the unknown46. The National Retail Federation predicts retail sales to increase only 3.5% in 2008, which is considered "the weakest pace of growth in six years."47 As of April 2008, many organizations began to publish their Annual Reports and First Quarter Results, which in many cases stated slow growth for the future and less than desirable results for the periods being reported.48 Barnes & Noble, Inc. was among one of these companies warning the investment community in a March 3, 2008 Press Release that "recessionary pressures in this uncertain economic environment will make 2008 an especially challenging retail year".49

COMPETITION

The book industry is extremely competitive. Barnes & Noble's sources of competition include other traditional bookstores (Borders, Books-A-Million), other on-line retailers (Amazon.com, Borders, Books-A-Million), independent booksellers, new technology (downloadable mp3 audiobooks and new e-readers, etc.), and other supply chains (Target, Wal-Mart, Costco, etc.). The American Booksellers Association reports that while 200 to 300 independent booksellers are closing each year, 115 new and independent bookstores opened in 2007, showing consistent growth since 2005. 50 51 In addition, alternate suppliers of books are on the rise.52 Specifically, Target, Wal-Mart, Costco, Sam's Club, drugstores, and grocery stores are stocking bestsellers at deep discounts.53

Barnes & Noble's annual 2007 store sales were reported at $4,648 million, while Borders' annual 2007 store sales were reported at $3,774 million. Books-A-Million's total Net Revenue for FY07 was $535,128, (including $26. 9M for on-line sales), which represents an increase from FY06 net revenues of $520M.

On-line sales for Barnes & Noble were reported at $476 million in 2007, while Amazon.com's 2007 revenues were reported at $14,835 million. Barnes & Noble considers Amazon.com to be their biggest competitor.54 Borders Group has an agreement with Amazon.com to operate their websites.55 Under this agreement, Amazon.com is responsible for setting prices, terms and conditions, and order processing, as well as recording the sale on their books. Therefore, Borders has not recorded internet sales in their most recent 2007 annual report. This agreement is up for renewal on a monthly basis and the company's strategic plan is to finalize their own proprietary website (http://beta.bordersstores.com), at which time the agreement with Amazon.com would be cancelled.56 Exhibit 4 summarizes in-store and on-line sales for Barnes & Noble (B&N), Borders, Books-a-Million (BAM), and Amazon.com.

Borders Group, Inc.

Borders is considered the second leading bookseller behind Barnes & Noble.58 Unlike Barnes & Noble, Borders does business internationally with superstores in Singapore, New Zealand, Australia, and Puerto Rico. Similar to B&N, Borders owns the Waldenbooks subsidiary, located mainly in large indoor shopping malls, but also includes locations in airports and outlet malls. Borders also owns 97% of Paperchase, a leading stationary store retailing in the United Kingdom. Borders operates a total of 1,143 stores including 509 domestic superstores, 32 international superstores, 490 Waldenbooks stores, and 112 Paperchase stores. Borders superstores are similar in design to Barnes & Noble superstores in that they are very large in size, averaging 24,700 square feet, and also include an in-store café featuring Seattle's Best coffee, a subsidiary of Starbucks. In an effort to upgrade its superstores, Borders opened its first "Concept" store in February 2008. 60 The concept store allows customers to do a wide variety of multimedia activities, including creating their own custom CD, making photo books, downloading music, books, and movies, and more.61 Borders believes that the Concept store is important for long-term success especially in the current competitive environment and plans to open 14 additional concept stores during fiscal year 2008.62

When Borders' President and Chief Executive, George L. Jones took over in 2006, the company was in debt.63 With increasing reports that consumer spending will decrease along with the fact that Borders was short on cash, a deal was made on April 9, 2008 with Pershing Square Capital to free up some much needed cash'64 Borders carries a large inventory of music and movies and relies on sales of these products to meet their fiscal goals'65 According to their 2007 Annual Report, Borders has suffered a loss for the past 3 years and predicts that trend to continue due to competition with other brick-and-mortar booksellers, internet retailers, and from companies that offer the downloading of media'66 On March 20, 2008, the same day as Barnes & Noble's Earnings Call, Borders announced plans to start a "Strategic Alternative Review Process"67 that would include the sale of the company. JP Morgan and Merrill Lynch have been hired to provide financial consultation during this review. Barnes & Noble Chief Financial Officer, Joseph Lombardi stated on their March 20, 2008 Earnings call that "they had not yet been approached by Borders, but that they would definitely take a good look and put it under review." ' With ecommerce and technology hard upon the heals of traditional booksellers, Borders cannot afford to not compete in this market; however, attempts to do just that failed in 2001 and led to the agreement with Amazon.com to sell Borders' products for them.69 Borders advised in their 2007 Annual Report that they were uncertain if they would make another attempt at retailing over the internet.70

Books-A-Million

Books- A-Million (BAM) started as a comer newsstand in 1917 and currently operates 208 stores in the United States, mainly the Southeastern part of the U.S. Of these stores, 184 are superstores while the remaining stores are traditional stores.71 BAM also retails through their website at www.booksamillion.com.72 In the fiscal year 2008 (February 2007 to February 2008), BAM opened nine stores, closed seven, relocated three, and converted one traditional store to a superstore format.73 BAM is focused on markets of high growth, particularly in the Southeast.74 BAM reported great results in bargain books and gifts, which includes toys and games, and reported in their most recent 2008 Annual Report, "Our investment in new fixtures in the gift departments paid off and we continue to adjust our store model to exploit the growth areas of our business."75

Books-A-Million's fiscal year ended February 2, 2008. Although Books-A-Million's net income decreased by 12.5% from FY07 to FY08 they experienced an increase in revenues by 5.1%.76 BAM attributes this decline in net income to the fact that FY07 included one more week than FY08 and in FY07, a one-time sales income of $2.3M was recorded for gift card breakages from the previous year.77 Books-A-Million's corporate portfolio includes, Bookland, "traditional" sized bookstores; Joe Muggs Newsstand, selling coffee and eats alongside a wide variety of magazines, newspapers, and periodicals; American Wholesale Book Company, a wholesale and distribution services; and Book$mart, Inc., which distributes bargain books throughout the country.78 Booksamillion.com was established in 1998 and through acquisitions of American Internet Services and NetCentral, BAM considers themselves "a value leader in book e-tailing".79 Books-A-Million does not carry an extensive inventory in music and movies (although they do sell seasonal music). Many of the Books-A-Million stores include an exclusive section called "Testaments Shoppe" that provides reference material and new writings for the Christian market.80

Amazon.com

Amazon.com was founded in 1994 by Jeffrey P. Bezos, current CEO, as an on-line bookstore, but expanded its product line and is now considered the world's largest on-line retailer.81 Amazon offers millions of products in more than just the books category. Specifically, Amazon.com offers products either through their own subsidiaries or through third party arrangements with other merchandisers in the following categories:

* Books*

* Electronics & Computers

* Toys, Kids, & Baby

* Sports & Outdoors

* Movies, Music & Games*

* Home & Garden

* Apparel, Shoes, & Jewelry

* Tools, Auto, & Industrial

* Digital Downloads

* Grocery

* Health & Beauty

*Barnes & Noble competes with Amazon.com for these products

Amazon does not separate the financial data, (revenues, profits, etc.), for their Books or Movies, Music & Games categories in their annual 10-K, so it is difficult to compare against their big competitors such as Barnes & Noble, Borders, or Books-A-Million. However, Amazon did reveal in their first quarter results that the sales of books and movies increased 28% or $2.54 billion, while their top sellers were Electronics, Toys, Baby, Consumable items, Apparel, Shoes, and Jewelry increasing 56% or $1.48 billion making up 36% of total sales.82 While the consensus within the media and the retail industry is that consumers are spending less due to the weak economy, Morningstar analyst Joseph Beaulieu told Bloomberg radio in a recent interview, "If the customer is curbing their spending, they're still continuing to spend heavily with Amazon."83

In addition to selling their own products, Amazon.com operates websites for other companies, such as Target, Sears Canada and UK, Timex, and many more.84 Consumers can access Amazon.com to buy almost anything either through Amazon or by accessing the third party's site through the Amazon.com site. Amazon offers free shipping for qualified orders over $25. Amazon's business model is to offer millions of products that are instock, at very competitive prices.85

When consumers shop for books on-line, there are a few differences and similarities between the Barnes & Noble site and the Amazon site. For example, both sites allow consumers to shop by category, such as Books/Children's Books/Baby to Preschool. Both sites then offer further options for drilling down to subcategories. Amazon.com created the idea to allow consumers a sneak peak into the book, called "Search Inside(TM)" , which is done through an arrangement with the publisher with strict rules for protecting copyright information. Barnes & Noble now offers a similar service called "See Inside", which is powered by Zinio, though it is not available for as many titles as available on Amazon.com. Another similarity between the B&N and Amazon sites are the suggestions and review features. Both companies offer customer reviews, suggestions for other types of books related to the ones being viewed, as well as data on what other customers have bought similar to the product being viewed. Exhibit 5 shows screen views of both Barnes & Noble and Amazon websites at the individual product selection level, comparing pricing and features available for the consumer by each company. On April 30, 2008, the price for Eric Carle's The Hungry Caterpillar was $17.59 ($15.83 for members) on www.bn.com and $14.95 on www.amazon.com (no membership required).

Amazon reported shipping revenues, which included membership sales from Amazon Prime and Fulfillment, of $192M, an increase of 27% from last fiscal year. Fulfillment is a service provided by Amazon where they will pick, pack and ship orders for other merchandisers.86 Sellers own their inventory at all times and shipping is available at a discounted rate or at the rates offered under the Amazon Prime membership program (details on memberships are provided later in this case).87 Amazon invests a significant amount of money into technology.88 Specifically, Amazon invested a net amount of $715M in technology, including internal software systems and new product lines.89

Competing with Technology

An increase in advanced technology has affected the way booksellers do business. Print media is in danger of being replaced by digital media and booksellers are looking for ways to compete. Professor Wharton with Fordham University and leading contributor to the BISG says, "The electronic distribution of content has become the 600-pound gorilla in the room."90 Exhibit 5 below shows the timeline of events affecting B&N and their main competitors.

Physical books and magazines have been replaced by audiobooks in CD and mp3 format as well as the newly invented e-books and e-magazines that can be downloaded and viewed on a personal electronic reading device. In 2006, annual sales of audio books were estimated at $1 billion. On November 19, 2007, Amazon.com released "Amazon Kindle" a portable, personal electronic reading device for $399, and it sold out in five and a half hours.91 Jeff Bezos, founder and CEO told the press, "The Kindle is outpacing our expectations, which is something that we are very grateful for. We are super excited by the very strong demand."92 Amazon is not the only company marketing an e-reader. To date, there are eight companies that market their version of the e-book reading device, including Sony.93

Similar to the e-book reader is the Zinio reader technology. Zinio reader is not a portable reading device, but rather a service (software package) that can be downloaded to your computer or portable reading device, like the Sony Reader, for a fee. Zinio offers textbooks, magazines, and classic book titles on their web at www.zinio.com. Magazines such as Business Week, Cosmopolitan, Readers Digest, Playboy and more have all signed up to have their magazines converted to digital format with Zinio in an effort to reach their market.95

Text messaging via cell phones has become very popular, and compames like Amazon and ShopText are creating ways for consumers to buy product via text messaging. On April 2, 2008, Amazon.com launched their TextBuylt service so that its customers could text their orders over their cell phones.96 ShopText launched its text buying service in 2005 offering a variety of products such as clothes, jewelry, perfume, CDs, movie tickets, and more, then in 2007 began to offer books with free shipping.97 Mark Kaplan, ShopText founder and Chief Marketing Officer has said that ShopText would like to partner with bookstores and publishers but as of June 2007 had not made any such partnerships.98 A ShopText customer said, "This is a system that deserves to succeed, and it probably will, considering what big, pampered kids I and my fellow boomers have become."99

MEMBERSHIP

Barnes & Noble, Borders, Books-A-Million, and Amazon.com all mention the importance of their respective membership programs. Barnes & Noble's Chief Operating Officer Mitchell Klipper, stated in the March 2008 Investor Conference Call that one of the highlights of 2007 for B&N was a record growth in new memberships and membership renewals, in fact, the figures surpassed what was forecasted by B&N.100 Barnes & Noble offers an annual membership that costs $25. Membership entitles customers to 40% off list price of current hardback B&N Bestsellers, 20% off list price of all B&N identified adult hardbacks, and 1 0% off almost everything else, including café purchases.101

Amazon Prime is a membership that costs $79 annually and provides free 2-day and discounted express shipping. Membership benefits only apply to qualified purchases defined as Amazon.com products and not third party merchandisers selling product through the Amazon.com web portal. There is no minimum purchase to get the shipping discount and members can share their membership benefits with up to four different people living at the same address. (Note: Amazon.com offers free shipping to all of its customers, regardless if they are members, for qualified orders over $25.)

In 2006, Borders offered customers their Borders Reward loyalty program which was free of charge and did not require an annual fee. A percentage of each customer's purchase was put into their membership account and offered as coupons off of Holiday purchases that year. In 2007, Borders changed the benefits of the Borders Rewards membership program by offering customers the opportunity to accrue "Borders Bucks", which accrues in $5 increments for each $150 purchase, but expires if the customer doesn't use within 30 days of qualifying. Purchases made in the in-store Seattle's Best café can be used towards the $150 accrual needed. Purchases made on-line, as of April 2008, do not count towards the accrual needed to get Borders Bucks. As a Borders Rewards member, you can also enroll free of charge into their "Borders Rewards Perks" program that offers members discounts on a number of products and services including Target, Lands End, Ann Taylor, Orbitz, and more. Borders also offers Borders Rewards members a membership program called "Borders Rewards Perks Plus" which offers even more discounts and access to special events and periodic savings; however, the cost for the Perks Plus membership is $29.95 per year. As of March 2008, Borders had 25 Million members and claim that number increases each week by an average of 140,000. 102 Borders' Public Relations Representative, Anne Roman, says that "The loyalty program is a cornerstone of our marketing and branding efforts because it is a key communications avenue for us with heavy book buyers and those who love Borders."103

Books-A-Million also offers an annual membership called the Millionaire's Club. For an annual fee of $15, members enjoy 10% off all purchases, including purchases from the in-store coffee café Joe Muggs as well as on-line at www.booksamillion.com.

Exhibit 6 below provides a brief summary of each company's membership program.

THE "THIRD PLACE"

Wikipedia.com defines the Third Place as "a term used in the concept of community building to refer to social surroundings separate from the two usual social environments of home and the workplace."104 According to USA Today, "an estimated 30 million Americans" work outside of the home and office and that number is increasing by 10% each year.105 Companies such as Starbucks have said that they consider themselves to be American's third place and to support them; they announced on April 25, 2008 their plans to roll out AT&T Wi-Fi services nationwide.106 107 Kerri Sissney, a loyal Barnes & Noble customer who visits the Lynchburg, VA B&N store on a weekly basis admits, "I'm addicted to the Chai Lattes at the café, and while I'm here I like to browse the latest in children's books; I usually can't get out of here for less than $30 dollars a pop!" If Borders' new concept store is a success, third placers could start to consider Borders a new location, since the store would have lounging chairs, a café and the ability to download music, books, movies, and more.

BARNES & NOBLE 2007 HIGHLIGHTS

On March 20, 2008, Barnes & Noble, Inc. reported their 2007 earnings results on an Earnings Call to investors. During the conference call, Chief Financial Officer, Joseph Lombardi summarized the key statistics, such as number of stores, EPS, and dividend increases. Chief Operating Officer, Mitchell Klipper summarized the 2007 highlights, which include:108

* A decrease in Gross Margin because of an intentional and strategic decision to decrease the overall price of books to their customers

* Recognition that price is not the only reason customers make purchases, but where they make them is important, especially on-line

* Disappointment in Holiday sales

* Decrease in music business

* Record comparable store sales, specifically an increase of 1.8% (comp sales are defined as revenues for a store that has been in operation for at least 12 months and compares current revenues against historical data for the current year)

* 31 new stores, indicating growth

* Record internet sales, increase by 13.4% or the highest in 5 years, attributable to a # of factors including: trust, price, selection, speed of delivery, and customer inquiry response

* Finalized their 2007 Distribution Network Optimization Strategy. Closed the Memphis, TN site, so that now 2 remaining locations provide the most efficient method, new record for inventory turnover

* Record new membership and renewal, in fact, more than forecasted

CONCLUSION

Barnes & Noble Outlook for 2008 and Beyond

Barnes & Noble has an ambitious yet cautious outlook for 2008 and beyond. B&N is concerned about the economy and how it will affect consumers buying behavior as well as how it will affect B&N' s ability to grow their business. Nonetheless, Barnes & Noble plans to open 35 to 40 new stores in fiscal year 2008, which is in line with their expansion strategy of increasing and improving their real estate portfolio.109 Additionally, Barnes & Noble will consider growing their Barnes & Noble College Booksellers division by opening a chain of University Superstores located on the campuses of major colleges and universities. B&N is hoping for another best seller similar to the Harry Potter series to boost sales, but is confident that in the absence of one, sales for 2008 will increase from 2007. One of Barnes & Noble's primary focus for the future is to increase the membership program and continue to manage expenses so that they can continue to offer lower everyday prices to all of their customers.

In addition to investments in their brick-and-mortar business, Barnes & Noble will not ignore investments in their internet business. B&N recognizes that the book industry is becoming increasingly technical and consumers are looking for more selection, faster searching, and ease of use when shopping over the internet; therefore, B&N plans to invest more money into improving and enhancing their website infrastructure and features. In addition, Barnes & Noble plans to grow their B&N Studio segment on their website to offer more features and selections for their internet customers who love books.

After the 2007 Christmas Holiday season was over, CEO Steve Riggio was still uncertain about the future of Barnes & Noble yet he had to remind himself that even in tough economic times and in an increased competitive atmosphere, Barnes & Noble managed to achieve better than expected results in FY07. But, what will Barnes & Noble's strategic plan for 2008, 2013 or 2030 be to continue their success and maintain a competitive edge? Will B&N have to think outside of the "brick-and-mortar" box and into the "click-and-mortar" space? Riggio was certain of one thing, the competition was fierce and the industry was changing, and Barnes & Noble would have to be bold to stay ahead of the game.

Subject: Performance management; Competition; Market strategy; Bookstores; Case studies

Location: United States--US

Company / organization: Name: Barnes & Noble Inc; NAICS: 451211

Classification: 7000: Marketing; 8390: Retailing industry; 9190: United States; 9130: Experiment/theoretical treatment

Publication title: Journal of Business Case Studies

Volume: 6

Issue: 4

Pages: 9-22

Number of pages: 14

Publication year: 2010

Publication date: Jul/Aug 2010

Year: 2010

Publisher: Clute Institute for Academic Research

Place of publication: Littleton

Country of publication: United States

Publication subject: Business And Economics--Management

ISSN: 1555-3353

Source type: Scholarly Journals

Language of publication: English

Document type: Business Case, Feature

Document feature: Tables References Diagrams

ProQuest document ID: 744083044

Document URL: http://search.proquest.com/docview/744083044?accountid=38610

Copyright: Copyright Clute Institute for Academic Research Jul/Aug 2010

Last updated: 2013-09-06

Database: ABI/INFORM Complete

Document 38 of 100

Using Actual Financial Accounting Information To Conduct Financial Ratio Analysis: The Case Of Motorola

Author: Collier, Henry W; Grai, Timothy; Haslitt, Steve; McGowan, Carl B

ProQuest document link

Abstract:

In this paper, we demonstrate the use of actual financial data for financial ratio analysis. We construct a financial and industry analysis for Motorola Corporation. The objective is to show students exactly how to compute ratios for an actual company. This paper demonstrates the difficulties in applying the principles of financial ratio analysis when the data are not homogeneous, as is the case in textbook examples. We use Motorola as an example because the firm has several segments, two of which account for the majority of sales and represent two industries (semi-conductor and communications) that have different characteristics. The case illustrates the complexity of financial analysis. [PUBLICATION ABSTRACT]

Full text:

INTRODUCTION

Motorola Segment Analysis

Motorola is a global manufacturer of communication products, semiconductors, and embedded electronic solutions. The company is divided into six operating segments that publicly report financial results. Financial data are provided in Appendix A. The Personal Communication Segment (PCS) designs, manufactures, and markets wireless communication products for service subscribers. Products include wireless handsets, personal 2-way radios, and messaging devices, along with the associated accessories. The Personal Communication Segment accounted for 37.8% of 2002 sales, making it the largest of Motorola's operating segments. The Global Telecommunications Segment (GTS) designs, manufactures, and markets the infrastructure communication systems purchased by telecommunication service providers. Products include electronic exchanges, telephone switches, and base station controllers for various wireless communication standards. This segment accounted for 15.8% of Motorola's sales in 2002. The Broadband Communication Segment (BCS) designs, manufactures, and markets a variety of products to support the cable and broadcast television and telephony industries in delivering high speed data, including cable modems, Internet-based telephones, set-top terminals, and digital satellite television systems. This segment accounted for 7.3% of Motorola's sales in 2002. The Commercial, Government, & Industrial Segment (CGIS) designs, manufactures, and markets integrated communication systems for commercial, government, and industrial applications, typically private 2-way wireless networks for voice and data transmissions, such as would be used by public safety authorities in a community. This segment accounted for 13% of Motorola's sales in 2002. The Semiconductor Product Segment (SPS) designs, manufactures, and markets microprocessors and related semiconductors for use in various end products, such as computers, wireless and broadband devices, automobiles, and other consumer electronic devices. Some of the semiconductors produced are used in products marketed by other Motorola segments. This segment accounted for 16.8% of Motorola's sales in 2002. The Integrated Electronic Systems Segment (IESS) designs, manufactures, and markets automotive and industrial electronic systems, single board computer systems, and energy storage products to support portable electronic devices (such as wireless handsets). This segment accounted for 7.6% of Motorola's sales in 2002.

Total Motorola sales and profitability have varied widely over the last five years, as shown in Table 1. Sales peaked at over $37B in 2000 and dropped to less than $27B in 2002. Motorola had a net loss in 2001 and 2002. Motorola's stock price has varied from a high of over $55 in February of 2000 to a low price of less than $8 in January of 2003. Despite the losses incurred recently and the variability of reported income, Motorola has continued to pay a steady dividend of $0.16 per share since 1997. This is a clear indication of the importance that Motorola attaches to the informational content associated with dividends; despite significant losses, dividends have not been reduced. The most recent data indicates that Motorola has returned to profitability, posting a $0.01 per share profit for the first quarter of 2003.

Industry Analysis

The Telecommunications Equipment Industry

The telecommunications equipment industry provides the products required to support land-based and wireless communications, both the end-consumer equipment and the infrastructure of the networks that enable the end-consumer products. Data for companies in the telecommunications industry are shown in Appendix B. Nokia is the market leader in the handset portion of this industry, followed by Motorola, Siemens and Sony-Ericsson. Ericsson leads the infrastructure portion of the equipment industry. The five largest companies are Cisco Systems, Nokia, Qualcomm, Motorola, and Ericsson (yahoo.marketguide.com).

The telecommunications equipment industry, in particular, has seen difficult operating conditions among the technology industries over the last several years. The difficult operating conditions are the result of two underlying issues. First, after a rapid build-up of wireless network infrastructure by the service providers (firms such as Verizon Wireless that provide telecommunication services to the end-consumer) in 2000, the demand for equipment by the service providers dropped some 15% in 2001 and likely dropped by even a higher percentage in 2002 (Yahoo. finance). Second, the demand for third generation (3G) wireless technologies (which includes mobile data services that can combine voice, data, email, PDA, and other features) has not evolved as quickly as expected. Wireless subscribers have chosen not to replace their handsets with the new 3G technologies in anticipation of the price of the equipment dropping (Yahoo. finance).

The telecommunication equipment industry has a beta coefficient of 2.09, explaining, in part, the difficult operating conditions in the industry as a magnification of the poor conditions in the economy as a whole (yahoo.marketguide.com). A key segment within the telecommunications industry is the wireless handset (cellular phone) segment, both because of its size and because of its visibility to end-consumers. In this wireless handset segment, Nokia is the clear market leader, with a substantial 35.8% market share in 2002 and a strong presence in the critical European market. This is important because Europe is where much of the technological innovation in the industry occurs. Motorola is in second place in this industry segment with a market share of 15.3%, less than half of Nokia's share. Third place belongs to Samsung, with a 9.8%) market share, but Samsung's strong technology and significant resources pose significant challenges to Motorola and Nokia's leadership positions. Siemens held an 8.4%o market share in 2002, while the joint venture between Sony and Ericsson held a 5.5% market share in the industry segment (Reiter, 2003).

The Semiconductor Industry

The semiconductor industry provides the semiconductor "chips", which are integral to consumer electronics, such as PC's, PDA's, audio, visual and entertainment equipment, and cellular phones. Data for companies in the semiconductor industry are shown in Appendix C. These chips are also used in commercial electronics, such as network servers, communication switch equipment, and industrial controls. Intel is the largest firm in the industry. Intel is known, in particular, for supplying the microprocessors used in PC's. The top five companies in this industry, in order of descending market capitalization, are Intel, Texas Instrument, Taiwan Semiconductor, Advanced Materials, and ST-Microelectronics (yahoo.marketguide.com).

The semiconductor industry experienced a record year in 2000 with worldwide sales of $200B. Sales experienced a significant declined in 2001, down some 30% to $140B. The decline in 2001 was attributed to weak sales in nearly every consumer electronics segment and to weak sales in commercial electronic segments, resulting in low demand for semiconductors (yahoo. finance). The year 2002 brought only a slight recovery in the semiconductor industry, with an expected worldwide sales increase likely to be only several percentage points higher than 2001 levels. November 2002 sales only increased by 1.3%, less than the 1.8% increase in October 2002. This low increase is significant because November sales have historically averaged larger increases as electronic manufacturers prepare for the holiday season (Value Line, January 17, 2003, ? 1051). The semiconductor industry has a Beta coefficient of 2.17, which, like the telecommunication equipment industry, explains, in part, the severe downturn in the industry as the entire economy took a downturn over the last several years (yahoo . marketguide .com) .

Financial Ratio Analysis

Financial ratios for Motorola, for the semiconductor industry, and for the telecommunications industry are provided in Table 2. The firms in the semiconductor industry subset represent 87% of the estimated total semiconductor industry sales of $100 billion in 2002 (Value Line, January 3, 2003, pp. 744 and pp. 770). The firm's telecommunications equipment industry represented 91% of telecommunication equipment industry sales of $277 billion in 2002 (Value Line, January 17, 2003, p 1051).

Evaluating Motorola relative to the semiconductor industry, we first note that Motorola is slightly less liquid than the average firm in the industry, with both a current ratio and a quick ratio that is lower than the industry average. Motorola's average collection period, at 61 days, is lower than the industry average of 50 days, indicating Motorola should evaluate its credit policies. Both fixed asset turnover and total asset turnover are above the semiconductor industry averages, indicating that Motorola is using its assets more efficiently than the industry average in generating sales. Motorola's debt ratio and debt-to-equity ratio indicate that Motorola is more leveraged than the average firm in the industry. This higher leverage, in part, explains Motorola's poor financial performance relative to the semiconductor industry because the leverage commits Motorola to interest payments that must be paid regardless of economic and market conditions. The ratios indicate that Motorola has a higher cost of sales than the average firm in the semiconductor industry, resulting in a lower gross profit margin and higher indirect costs, resulting in lower net profit margin performance relative to the semiconductor industry.

The situation is different when evaluating Motorola relative to the telecommunications equipment industry and, considering that the majority of Motorola's business is in this industry rather than the semiconductor industry, this is the more interesting and relevant story. Relative to the telecommunications equipment industry, Motorola has a better liquidity position, with both the current ratio and the quick ratio being higher than the industry average. Motorola collects receivables quicker than the average firm in this industry. Relative to this industry, Motorola may want to evaluate credit policies to determine if perhaps strict credit policies are negatively impacting sales. Motorola uses its total assets slightly less efficiently than the average firm in the telecommunications equipment industry and its fixed asset turnover is significantly less than the industry average, at 4.37 compared to the industry average of 6.24. Motorola is more highly leveraged than the average firm in the telecommunications industry. Motorola may want to examine its capital structure policy to ensure it has the right balance of benefit from the tax shield of increased debt relative to the bankruptcy and related financial distress costs associated with increased debt.

Several explanations are possible for the deviation from industry norms. Perhaps this is the result of a conscious choice to invest heavily in technology and automation in its manufacturing processes (as opposed to a more labor-intensive manufacturing strategy). While such fixed investments will yield significant gains in good market conditions, the investments commit the firm to fixed costs (depreciation), even in bad economic conditions. Alternatively, the poor fixed asset turnover may indicate overcapacity caused by extremely poor forecasts of future sales. Or, the poor ratio may indicate a fundamental inability or inefficiency in using the deployed assets. Motorola is slightly less leveraged, with a lower debt and debt-to-equity ratio. Keep in mind, though, that the debt ratios used in the ratio analysis above used total liabilities as a measure of debt. In contrast, capital structure analysis focuses specifically on long-term debt in calculating leverage.

Motorola has a higher gross profit margin than the average firm in the telecommunications equipment industry (32.8%> versus 29.5%>), but has a lower net margin. Motorola has a higher fixed and indirect cost structure. As an illustration of the potential fixed and indirect cost issues, consider the productivity, which for this purpose is defined as sales per employee, of Motorola relative to its chief competitor in the telecommunications equipment industry - Nokia. In 2001, Motorola generated sales of $3 1,19 IM with 111,000 employees for a productivity of $0.27M per employee. In contrast, Nokia generated sales of $27,645M with just 53,800 employees, for a productivity of $0.53M per employee - nearly double the productivity of Motorola. Clearly, Motorola has significant costs associated with its level of employment that are not being returned in sales. This is interesting because Motorola, as observed earlier, also has poor fixed asset use in addition to this effective and/or efficient use of human assets. Perhaps contributing to the poor fixed and indirect cost structure is that Motorola has elements of being a conglomerate that most of the other firms in the industry do not have. Motorola is involved in diverse business segments - telecommunications, semiconductors, automotive components, and batteries, to name a few - and must evaluate whether the administrative and infrastructure costs of managing these diverse segments are less than the benefits of having the segments under one corporate umbrella. It is not obvious that the diverse business segments within Motorola are being used synergistically to increase overall value. If there are not synergies between the business segments, Motorola shareholders should prefer that Motorola divest the segments as investors can diversify their portfolios more efficiently than Motorola can. Most of the other firms in the industry do not have to absorb the costs associated with managing such diverse business activities.

DuPont System of Financial Analysis

A DuPont analysis of Motorola, the semiconductor industry, and the telecommunications equipment industry is shown in Table 3. The story told by the DuPont analysis is similar to the story told by analyzing ratios; i.e., Motorola must focus on controlling operating costs. Relative to the semiconductor industry as a whole, Motorola has an advantage in its leverage ratio (Assets to Equity of 2.77 compared to 1.52 for the industry) and in its use of assets (Total Asset Turnover of 0.86 compared to 0.61), yet has a poorer return on equity due to its low net profit margin. While one would expect a somewhat lower net profit margin for a firm with a higher leverage ratio (the Figure 1: ROA Analysis for Motorola - 2002

firm has to pay interest to service the debt that gives the higher leverage ratio), in the Motorola case there are apparently other operational inefficiencies impacting the net profit margin because the overall return on equity is less than the industry average. A similar story, though not quite as obvious, is told by comparing Motorola to the telecommunications equipment industry averages for the DuPont analysis, where Motorola again stands out as being deficient in its ability to generate profits from its sales.

Short Term Liquidity Management

As shown in Table 4, the telecommunication equipment industry averages a current ratio of 1.52 and a quick ratio of 1.23, so Motorola's current ratio and quick ratio of 1.77 and 1.47, respectively, compares favorably to the industry. This, combined with the observation that both ratios are above one, leads to the conclusion that Motorola is in a solid short-term liquidity position. While this favorable absolute liquidity position is important, perhaps just as important to debt investors in Motorola is the trend over time in the ratios. In Motorola's case, there have been very solid improvements in its liquidity position since 1999 and 2000. Some of this improvement in liquidity comes from reductions in notes payable and the current portion of long-term debt. But a significant portion of the improvement is attributable to large increases in cash and cash equivalents. The cash and cash equivalent balance increased 97% percent during period. In addition to the cash increases seen above. Motorola has very recently taken additional steps to "further boost" its cash position by selling $325M of Nextel stock (Motorola Sells S325MofNextel Stock). This sale of 25 million of Motorola's 108 million Nextel shares was completed "to realize the price appreciation of some of its investment in the wireless communications services provider and to enhance its already strong cash position" (Motorola Completes Sale of 25 Million of Its 108 Million Shares of Nextel). After the sale, Motorola will remain one of Nextel' s largest shareholders, retaining over a 9% stake in Nextel (Motorola Sells S325M of Nextel Stock).

Capital Structure & Debt Management

From Table 5, it is evident that there has been a significant change in Motorola's capital structure over the last several years. When viewed from either a book value or market value basis, there is a significant increase in leverage. Motorola's long-term debt increased by more than 85% from 2000 to 2001, while equity dropped on both a book value and market value basis. From the data, it does not appear that Motorola has a strict or a tight target debt-equity ratio that they maintain to balance the benefits of debt (primarily, the tax savings due to interest) with the cost of debt (primarily, financial distress costs), unlike many large firms (Graham and Harvey, 2001). It is unclear whether Motorola has a strategy to minimize their weighted average cost of capital.

Some of the increase in long-term debt from 2000 to 2001 was used to replace short-term debt (Motorola 2001 Proxy Statement). However, we observed earlier that cash balances increased significantly in the same time period, indicating that some of the long-term financing was used to improve the short-term liquidity position. But these improvements in the short-term liquidity position came at the expense of an increase in operating risk. The increased leverage committed the company to increase interest payments to service the long-term debt. Interest payments increased from $529M to $844M from 2000 to 2001, increasing Motorola's losses in 2001 as economic and market conditions worsened (Motorola 2001 Proxy Statement). The significant amount of debt added in 2001 could also impact Motorola's ability to acquire long-term debt at favorable rates in the future. If funds are needed beyond what are available internally, Motorola may have no choice but to turn to the equity market, which is generally considered to be unfavorable at this point in time. The increase in long-term debt may, in part, support the free cash flow hypothesis, which asserts that bad investment decisions are often made in the presence of a large amount of free cash flow.

While we have examined Motorola's capital structure from an absolute perspective, it is worthwhile to look at the capital structure relative to the industry segment that Motorola primarily participates in - the telecommunications equipment industry. Company-wide financial structure data are shown in Table 6.

In Table 5, Motorola's debt-equity ratio, on a book value basis, is 0.69, which is higher than the industry average of 0.42, from in Table 6 and Motorola's debt-equity ratio on a market value basis is 0.47, double the industry average of 0.21. So, Motorola has not only increased its leverage, it has increased its leverage well above the industry average leverage ratio. Is this bad in the sense that the higher leverage level is detracting from firm value? We believe that this question is difficult to answer with information from publicly available sources. The appropriate amount of leverage is unique to each firm based on the firm balancing the tax benefits of increased debt against the financial distress costs associated with increased debt. However, the deviation from the industry average leverage ratio should be closely examined as, on average, other firms in similar business situations see the appropriate balance between the tax shelter benefit and distress costs at much lower levels of leverage.

SUMMARY AND CONCLUSIONS

In this paper, we demonstrate that financial ratio analysis using data for an actual company - Motorola - and industry - telecommunications and semiconductor - is complicated and is further complicated for companies that do not readily fall into a single industry. Motorola has six operating units that fall into several industries with two industries accounting for most of the sales - telecommunications and semi-conductor. The differences in the industry characteristics of these two industries complicate the financial ratio analysis of Motorola. However, a more relevant picture of the operating characteristics of Motorola is achieved by increasing the complexity of the analysis; that is, by comparing Motorola to both industries.

Subject: Financial ratios; Telecommunications industry; Profit margins; Financial accounting standards; Case studies

Location: United States--US

Company / organization: Name: Motorola Inc; NAICS: 334119, 334220, 334413, 334418, 336322

Classification: 3100: Capital & debt management; 8330: Broadcasting & telecommunications industry; 9190: United States; 9130: Experiment/theoretical treatment; 4120: Accounting policies & procedures

Publication title: Journal of Business Case Studies

Volume: 6

Issue: 4

Pages: 23-32

Number of pages: 10

Publication year: 2010

Publication date: Jul/Aug 2010

Year: 2010

Publisher: Clute Institute for Academic Research

Place of publication: Littleton

Country of publication: United States

Publication subject: Business And Economics--Management

ISSN: 1555-3353

Source type: Scholarly Journals

Language of publication: English

Document type: Business Case, Feature

Document feature: Tables Diagrams Equations References

ProQuest document ID: 744082544

Document URL: http://search.proquest.com/docview/744082544?accountid=38610

Copyright: Copyright Clute Institute for Academic Research Jul/Aug 2010

Last updated: 2013-09-06

Database: ABI/INFORM Complete

Document 39 of 100

Childcare And Entrepreneur ship: A Business Case Study

Author: Owings-Edwards, Stephanie; Herz, Paul

ProQuest document link

Abstract:

The Riverhouse Children's Center is an actual day care business. The case is an example of a small niche-business common to locales across the United States. Riverhouse is atypical of private day care centers in that it is organized as a not-for-profit institution. The case reviews the benefits and pitfalls of obtaining not-for-profit tax status for a business. The case also presents the different pricing mechanisms embedded in the fee structure of the center. Case discussion questions lead students to suggest a restructuring of the revenue side of the business. Additionally, the case reveals that there may be non-monetary motivations for entrepreneurs and highlights the challenge of working within a tight budget. [PUBLICATION ABSTRACT]

Full text:

INTRODUCTION

Lindsay Sherman opened The Riverhouse Children's Center in May of 2003. It is a childcare and preschool facility providing services for families with children from six weeks to five years old. Initially, the center was licensed to care for 12 children. This grew to 22, then 35, and today the Center cares for 45 children per day.

The Riverhouse Children's Center is located in Durango, Colorado. This is a geographically isolated town of approximately 15,000 people located in a county of about 45,000 people. In a town of this size, reputation is important; mothers talk. When women get pregnant, the word from their friends is to get their child on the wait-list at Riverhouse.

Lindsay serves as the director of the facility. She has passionate opinions about what is good for children. As we shall see, she takes home less income than she could because she runs a center based on her principles. A review of the handbook she gives to parents reveals some of her priorities. She believes in the importance of good nutrition and the value of outdoor play. The children are served a varied diet which is low in refined sugar and emphasizes organic food. As long as weather permits, the children play outside in fenced, safe areas every day. Parents are asked to provide clothing (snowsuits, raingear, swim shoes) that coaxes the maximum possible cooperation from the weather. The classrooms are full of books, puzzles, blocks, and crayons. The parent handbook specifically states, "We will not watch TV or videos at school, unless there is a very special reason... The occasion would have to be soooo special that I can't think of one."

Generally speaking, the atmosphere at Riverhouse is informal yet professional. Parents sign their children in and out rather than punching a time-clock. This is typical of the informal, trust-based environment that she has established.

Families of younger children receive a hand- written note every day detailing what their child did, what the child ate and drank, and how much the child slept. The staff will often provide additional verbal information about a child's day and general developmental progress. There is a sense that the staff cares about each child and wants him/her to be as happy as possible. It feels as if it is not entirely an impersonal business transaction. Establishing personal bonds like these is, of course, good for business. Parents will be less price sensitive, less likely to look for replacement care, if they have a good personal relationship with their child's care givers.

Children are grouped into differ-ent classes roughly according to age:

* Infants: six- weeks to one-year * Toddlers: one-year to two-years

* "Caterpillars": two-years to three-years

* "Butterflies'" three-years to four years

* Preschool children: four-years to five-years

State law defines the maximum number of children an adult supervisor can look after. Up until 3 years of age, in a non-home based childcare facility, there must be one adult for every 5 children. In the three-four year age bracket there must be one adult for every 10 children and in the four-five year age bracket there must be one adult for every twelve children. These ratios largely determine both the costs of running a day care center and the revenue a center can generate. State law also determines the maximum number of children per square foot of space that is allowed. This determines the minimum acceptable size of a facility.

Initially, The Riverhouse Children's Center was incorporated as a for-profit entity. However, in October 2004 Lindsay chose to officially change the Center's status to not-for-profit: 501(c)(3). The details and advantages of this change are reviewed later in this case study.

REVENUE

In 2005 Lindsay reported $260,233 in revenue from the Riverhouse Children's Center. Ninety-eight percent of this came from fees paid by families. Thus, the fee structure of her childcare program is tremendously important.

Demand for services that Riverhouse Children's Center provides is high. Generally speaking, each class size is close to the maximum capacity allowed by law. Table 1 shows, by age category, the current adult-to-child ratios at Riverhouse and the legal limits established by Colorado law.

In those classes which are full, Lindsay runs a wait-list. She has very egalitarian principles which are reflected in the structure of her wait-list; children are admitted on a first-come first-served basis. That is, she keeps track of the date when a child was placed on her wait-list. The family which has been waiting the longest will be the first family offered a spot when an opening arises. She has always had wait-list for at least some age categories.

Lindsay offers parents part-time schedules. As a result, although she is currently serving 43 "full-time equivalent" children, she actually sees between 55 and 60 children per week. For instance, one family may only need toddler care on Monday, Wednesdays and Fridays. Another may only need care on Tuesdays and Thursdays. Those two children, together, constitute one full-time equivalent child. A full-time child is slightly cheaper to care for than a full-time equivalent child. For the two children mentioned above, accommodated on a part-time schedule, Lindsay must bill and collect from two families rather than one, newsletters and information sheets must go to two families rather than one, space must be found for two sets of diapers rather than one, files must be kept on two children rather than one.

Lindsay realizes that offering part-time care makes it more difficult to utilize her facilities and staff to their capacity. She has considered a fee-structure which is higher for part-time care than for full-time care. However, she is concerned that such a plan would encourage "families to bring a child an extra day even if they don't need it, and I don't believe children NEED to be here full time. Three to four days per week for parents who work part-time shouldn't be discouraged."

The flat tuition rates at Riverhouse Children's Center are as follows:

* Infants: $34/day (7:45 A.M. - 4:00 P.M.)

* Toddlers: $28/day (9:00 A.M. - 3:30 P.M.)

* "Caterpillars": $26/day (9:00 A.M. - 3:30 P.M.)

* "Butterflies": $23/day (9:00 A.M. - 3:30 P.M.)

* Preschool children: $23/day (9:00 A.M. - 3:30 P.M.)

She established these rates to generate the revenue necessary to cover anticipated monthly expenses (payroll, rent, etc.). Unexpected, irregular, expenses must be paid for with revenue from other sources.

Hours before and after the stated times are billed at $2 per hour. Lindsay says she has structured her daycare fees to encourage parents to spend more time with their kids. If she charged a flat rate for ten hours of day care, then more parents would choose to leave their kids for the full ten hours. "The extra hours rate is to encourage parents to pick up their children at the end of their work day. ..It's more of a values issue for me... children learn a lot at the grocery store and running errands - they shouldn't consistently be here for extended hours if it's not necessary."

Riverhouse has had on-going problems with late and unpaid tuition. As a result, a late-fee has been instituted: "Any tuition balance not paid in full by the 10th of the month will incur a $10 late charge. Every day thereafter until the balance is paid in full there will be an additional $5 charge."

Riverhouse also charges a $30 per family registration fee. This is paid once per year. The funds generated by this fee ($1,470) offset the costs of goods, such as bedding, which need to be replenished on a regular basis. The fee is assessed at the beginning of the summer. This provides a small financial incentive for families to remain with the program through the course of the year rather than simply using Riverhouse for summer coverage and then switching to a different provider in the fall.

COSTS

Staff ratios and facility size are the primary determinants of cost for a child care center.

The facility in which Riverhouse operates was previously used as a bed and breakfast. Lindsay rents this space at an annual cost of $50,456. When she alters the facility to better suit her needs she, not the landlord, pays for the changes. In 2005 building maintenance and improvements cost her an additional $3,021. Annual utilities totaled $4,919. Her total occupancy costs were, therefore, $58,396.

Her largest expenses, though, are payroll-related. Lindsay does not pay her staff excessively.1 We know this because it takes her a significant amount of time and advertising to find a qualified staff member. Recently, a worker quit to become a waitress, explaining she could make the same salary as a waitress working only three nights per week, rather than the five days she worked at Riverhouse. Yet, Lindsay spent $162,236 on wages for her staff in 2005. Her payroll taxes totaled another $3,769. She also spent $4,884 on staff and professional development that included conferences and professional meetings. This totaled $170,849. Her own salary of $26,323 increased payroll expenses to $197,172 for 2005.

Insurance costs were non-negligible. She purchases liability insurance at an annual rate of $4,699. She also is required by the state of Colorado to purchase workers' compensation insurance through a private agency. This costs $2,469 per year. Insurance costs total $7,168.

THE BOTTOM LINE

It costs Lindsay $262,736 simply to rent the facility, pay her staff and cover taxes and insurance costs. Supplies (food, toys) cost $17,044. There are other "incidental" costs involved in running a business as well: she must have a phone, she needs to advertise for new hires, provide them with an employee handbook and run a background check on them. Altogether, these totaled another $7,759. According to the tax return filed by The Riverhouse Children's Center in 2005 her expenses, including her salary, totaled $287,539. However, in 2005 Lindsay collected only $267,196 in tuition. Without donations and grants of $26,646, about the same amount of her salary, Lindsay would essentially be running Riverhouse for a preposterous salary of about $6,000 per year.

TAX-EXEMPT STATUS

IRS Publication 557 (Tax Exempt Status for Your Organization) indicates in its text (page 22) and in its Organization Reference Chart (page 61) that children's day-care centers may qualify for tax-exempt status. In order to be recognized as a tax-exempt organization, a children's day care center must complete and file IRS form 1023 (Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code).

When converting to tax exempt status there are two important restrictions to keep in mind. The IRS states that "upon dissolution of your organization, your remaining assets must be used exclusively for exempt purposes." Thus, if Lindsay were to wish to exit from the child care business she would have to sell the center to someone else who would maintain its tax-exempt status or she would have to sell her assets (cribs, toys, furnishings, etc.) to another tax-exempt day care provider.

Both Form 1023 (used to apply for tax-exempt status) and Form 990 (the income tax form used by taxexempt organizations), require you to list the names and titles of the five highest paid employees who receive compensation of more than $50,000 per year. Thus, Lindsay can pay herself a salary of up to $50,000 without having to justify it to the IRS. If she wishes to pay herself more (and has the funds to do so), she would have to justify this higher salary by comparing her compensation to "similarly situated taxable or tax-exempt organizations" (part V, Form 1023). That is, she would have to show that child care directors with duties similar to hers, who run centers similar in size to hers, earn what she is paying herself. This would be difficult to do. According to the U.S. Department of Labor's Bureau of Labor Statistics in May of 2005, educational administrators of preschool and child care centers earned an average wage of $42,670. Moreover, seventy-five percent of all educational administrators of preschool and child care centers earn $50,660 or less.

2005 was the first full year that Riverhouse operated as a 501(c)(3). Organizing as a 501(c)(3) allows a corporation to accept tax-deductible contributions. Prior to organizing as a 501(c)(3), Riverhouse received no cash donations. In 2005, Riverhouse received $22,021 in cash grants and donations. Non-cash donations, in the form of art and other supplies and food, were valued at $4,625. Cash donations were the result of several government and private agency grants, donated funds to cover the tuition of needy families, and fundraising efforts in the form of a silent auction and other fundraising activities. The value of donated goods are also included under cash donations.

Organizing as a 501(c)(3) also allows a child care center to apply for grant funding. However, Lindsay has found that some grants are very time consuming to administer and require lengthy reports. For instance, Riverhouse contracted with the Child and Adult Care Food Program (CACFP) for only six months in 2005. The guidelines of the program would not allow water to be served with meals. Protein was not a breakfast component but grain and fruit were required. Good nutrition for the children is a fundamental concern for Lindsay and she considers these restrictions to be unhealthy. She is also opposed to waste. The guidelines of the program required that each child be served their allotted amount of milk in their individual cup. If the child did not drink that full allotment at that meal then what remained had to be thrown away.

CREATIVE SUPPLEMENTS TO THE BOTTOM LINE

Lindsay does her own payroll rather than contracting out to an accounting service. This involves much more than just writing payroll checks for her employees. She must determine how much to withhold from each employee's earnings for state and federal income taxes, Social Security, and Medicare taxes. She must pay a matching amount of Social Security and Medicare taxes on behalf of her employees. She must also pay SUTA (state unemployment tax). The federal payroll tax guidelines are described in a 68-page IRS document (Publication 15, Circular E, Employer's Tax Guide). Doing payroll is complex and detailed work. If you do it wrong there will be penalties to pay to the IRS and the state taxing authorities. As a result, many business owners choose to contract out payroll duties. However, it saves money to master the material and do it yourself.

Initially, Lindsay used the Riverhouse facility for both business purposes and residential purposes. She and her family lived in the basement for the first year and a half that Riverhouse was in operation. However, she found this was like working twenty-four hours a day, seven days a week, every week of the year. In addition, like most basements, it felt like being confined to a dungeon. She has continued to use the basement to mimmize costs, offering it as a non-wage benefit to a staff member. Note that the market value of this rent must be reported to the IRS as additional wages for the staff member.

Lindsay actively uses her family to fill-in for absent staff when needed. Her mother, sister, and mother-inlaw all participate on an as-needed basis. Lindsay herself is the first choice to fill-in for absent staff. Finding temporary replacement staff for a sick or absent worker is difficult. Having trained family willing to help out is a tremendous asset.

CONCLUSION

The Riverhouse Children's Center is a "tightly run ship." There is very little waste or money devoted to superfluous purchases. It would be difficult to suggest changes which would result in significant cost savings. However, some changes could be made to the fee structure to increase revenue. Currently, what allows Lindsay to pay herself more than $6,000 per year is the tax-exempt status of the program. Although achieving 501(c)(3) status is not easy; it is, according to Lindsay, a simpler process than obtaining a license to operate a day care center. If you are currently running a private children's day care facility, you might consider applying for tax-exempt status.

Subject: Studies; Day care centers; Entrepreneurship; Nonprofit organizations; Pricing policies; Revenue

Location: United States--US

Company / organization: Name: Riverhouse Childrens Center; NAICS: 624410

Classification: 9190: United States; 8300: Other services; 9130: Experiment/theoretical treatment; 9540: Non-profit institutions

Publication title: Journal of Business Case Studies

Volume: 6

Issue: 4

Pages: 33-41

Number of pages: 9

Publication year: 2010

Publication date: Jul/Aug 2010

Year: 2010

Publisher: Clute Institute for Academic Research

Place of publication: Littleton

Country of publication: United States

Publication subject: Business And Economics--Management

ISSN: 1555-3353

Source type: Scholarly Journals

Language of publication: English

Document type: Business Case, Case Study

Document feature: Tables Equations

ProQuest document ID: 744079973

Document URL: http://search.proquest.com/docview/744079973?accountid=38610

Copyright: Copyright Clute Institute for Academic Research Jul/Aug 2010

Last updated: 2013-09-06

Database: ABI/INFORM Complete

Document 40 of 100

Global Supply Chain Management At Printko Ink Company

Author: Abuizam, Raida

ProQuest document link

Abstract:

The Printko Ink Company case illustrates how network models can be used as an aid in spreadsheet model formulation. It also enriches students' knowledge how to use integer linear programming with binary (0-1) variables in dealing with fixed cost plant and warehouse location problems. Students completing the Printko Ink case will be able to develop a spreadsheet model that will solve for many logistic decision variables. It will help students decide where or whether to manufacture Printko Ink single product and how to get it to its customers around the world in the most economical manner. [PUBLICATION ABSTRACT]

Full text:

INTRODUCTION

Linear programming is a problem-solving approach developed to help managers make decisions. It is a powerful tool used by operations managers and other managers to obtain optimal solutions to problems that involve restrictions or limitations on their resources. These problems are referred to as constrained optimization problems. Numerous applications of linear programming can be found in today's competitive business environment. It is increasingly important to make sure that a company's limited resources are used in the most efficient way.

Linear programming is heavily used to minimize transportation and transshipment costs. Many transportation, transshipment and logistics problems fall into the category of problems known as minimum cost network flow model. All network flow problems can be represented by a collection of nodes and arcs. The nodes represent the suppliers, warehouses, or customers while the arcs represent suitable paths or routes between nodes. The transportation problem involves finding the lowest cost plan for distributing goods from multiple origins to multiple destinations that demand those goods. In the transshipment model, warehouses can be used as intermediaries to receive goods from suppliers and send them to customers.

In practice, opening a plant or a warehouse require fixed cost. Fixed cost is not a linear function; therefore, the use of binary variables (0, 1) will transform a non linear model into a linear one. This case study will help managers develop a spreadsheet model that will minimize total cost. Total cost involves production cost, shipping cost, and fixed cost. The model will also solve for which plant or warehouse to open in order to satisfy customer demand with the lowest cost possible.

Printko Ink Company: Considering Global Supply Chain Decisions Using Integer and Binary Variables in Linear Programming:

Overview:

Printko Ink, a manufacturer of printing inks, is located in Texas, USA. Roy Smith, the CEO of Printko Ink has received some information about a potential demand to his product worldwide. He called Nancy Rogers (the operation manager) and Mark Davidson (the marketing manager) to his office and requested both of them to do marketing research and collect more data regarding his interest of expanding his company globally.

After researching potential markets for Printko Ink product and studying several distributions locations, Nancy and Mark returned to Roy with some valuable information. They learned that their United States Plant Production capacity cannot meet the anticipated global demand. There is a potential market demand to their product in the United States, Canada, Brazil, Europe and Asia. Their suggested solution is to build one or more plant outside the United States. There are four potential locations in their research that deserve to be examined. Those locations are Germany, Japan, China, and Brazil. The fixed cost to operate these plants, the production capacity in tons per year, and the production cost per ton is listed in table 1.

Nancy and Mark also included in their study that there are four locations that can be used as warehouses or distribution channels. They looked into the fixed cost to build and run those warehouses along with their storage capacity and listed their findings in table 2. The four potential warehouses locations are United States, Turkey, China, and India.

Nancy and Mark reported the estimated yearly demand for their product and listed their findings in table 3.

Nancy and Mark also estimated the transportation cost from each plant to each warehouse and from each warehouse to customers in U. S dollars. Their findings are listed in tables 4, 5 respectively.

Finally Nancy and Mark provided the anticipated exchange rate in 2009. The information is listed in table 6.

Printko Ink must decide which plants and warehouses to open, and which routes from plants to warehouses and from warehouses to customers to use. All customer demands must be met. A given customer's demand can be met from more than one warehouse. Roy Smith is asking for your input to help his team to come up with the best production plan that meets all his customers' demand.

Nancy and Mark are requesting your help to do the following:

1) Draw a network diagram for Printko Ink that will help Roy graphically visualize all his options.

2) If exchange rates are expected as in table 6, develop a spreadsheet model using mixed integer linear programming to determine the minimum-cost method for meeting customers' demand.

3) Which of the plants and which of the warehouses should they open?

4) Can adding 200 tons of production capacity to the plant in China reduce total cost? Explain your findings.

5) Refer to the original input, can adding 100 tons to China's warehouse storage capacity help reducing total cost? Explain your findings.

6) Given requirement 5 input, if China can produce all your demand (i.e. 1500 tons), how does this change affect your decisions?

Teaching Notes (Solution to requirements):

Requirement 1 : Draw a network diagram for Printko Ink that will help Roy graphically visualize all his options.

Requirement 1 solution: Figure 1 presents the network diagram for Printko Ink.

Requirement 2: If exchange rates are expected as in table 6, develop a spreadsheet model using mixed integer linear programming to determine the minimum-cost method for meeting customers' demand.

Requirement 2 solution: Figure 2 illustrates the spreadsheet model input for Printko Ink, figure 3 represents requirement 2 solution, and figure 4 depicts Excel Solver parameters.

Spreadsheet model development:

The model should keep track of the following:

1. The quantity in tons that should be shipped from opened plants to opened warehouses.

2. The quantity in tons that should be shipped from opened warehouses to customers.

3. Fixed costs in US dollars of operating plants and warehouses if they kept open.

4. The production costs at the opened plants.

5. The shipping costs from opened plants to opened warehouses and from opened warehouses to customers.

6. Quantity in tons received by each opened warehouse should be equal to the quantity in tons shipped out of each opened warehouse. No storage should be kept at any warehouse.

7. Total amount shipped to final customers from opened warehouses should meet customer demands.

According to figure 3 solution, the minimum cost for this plan is $6,315,711. Figure 4 illustrates solver input for the spreadsheet model. The minimum cost plan suggested the following:

* United States plants should produce 100 tons of ink and ship it to United States warehouse.

* Japan plant should produce 500 tons and ship it to Turkey warehouse.

* China plant should produce 600 tons and ship it to China warehouse.

* Brazil Plant should produce 300 tons and ship it to United States warehouse.

* Out of the 400 tons received at the United States warehouse, 300 tons should be shipped to United States customers and 100 tons to Canada customers.

* Out of the 500 tons received at Turkey warehouse, 150 tons should be shipped to Canada customers, 150 tons to Brazil customers, and 200 tons to Europe customers.

* Out of the 600 tons received at China warehouse, 100 tons should be shipped to Europe customers and 500 tons to Asia customers.

Requirement 3: Which of the plants and which of the warehouses should they open?

Requirement 3 solution:

According to the spreadsheet solution for requrement 2, the plant in Germany and the warehouse in India should not be open.

Requirement4: Can adding 200 tons of production capacity to the plant in China reduce the total cost? Explain your findings.

Requirement 4 solution:

Figure 5 represents the spreadsheet solution for requirement 4.

According to the spreadsheet solution, the minimum cost plan is $5,042,843. Therefore, adding 200 tons to production capacity to the plant in china will reduce the cost by $1,272,868. The solution suggested closing the plant in United States and the plant in Germany along with closing the warehouse in India. The minimum cost plan for requirement 4 suggested the following:

* Japan plant should produce 500 tons and ship it to Turkey warehouse.

* Out of the 800 tons produced in China's plant, 200 tons should be shipped to Turkey warehouse and 600 tons to China warehouse.

* Brazil Plant should produce 200 tons and ship it to United States warehouse.

* United States warehouse should ship 200 tons to United States customers.

* Out of the 700 tons received by Turkey warehouse, 100 tons should be shipped to United States customers, 250 tons to Canada customers, 150 tons to Brazil customers, and 200 tons to Europe customer.

* Out of the 600 tons received by China warehouse, 100 tons should be shipped to Europe customers and 500 tons to Asia customers.

Requirement 5: Refer to the original input; can an increase of 100 tons to China's warehouse storage capacity help reducing total cost? Explain your findings.

Requirement 5 solution:

Figure 6 represents the solution to requirement 5.

According to the spreadsheet solution to requirement 5, the minimum cost plan is $6,295,71 1. Therefore, increasing China's warehouse storage capacity by 100 tons will reduce the cost by $20,000. The solution suggested closing the plant in Germany along with closing the warehouse in India. The minimum cost plan for requirement 5 suggested the following:

* United States plants should produce 100 tons of ink and ship it to United States warehouse.

* Out of the 500 tons produced at Japan's plant, 400 tons should be shipped to Turkey warehouse and 100 tons to China warehouse.

* China plant should produce 600 tons and ship it to China warehouse.

* Brazil Plant should produce 300 tons and ship it to United States warehouse.

* Out of the 400 tons received at the United States warehouse, 300 tons should be shipped to Unites States customers and 100 tons to Canada customers.

* Out of the 400 tons received at Turkey warehouse, 150 tons should be shipped to Canada customers, 150 tons to Brazil customers, and 100 tons to Europe customers.

* Out of the 700 tons received at China warehouse, 200 tons should be shipped to Europe customers and 500 tons to Asia customers.

Requirement 6: Given requirement 5 input, if China can produce all your demand (i.e. 1500 tons), how does this change affect your decisions?

Requirement 6 solution:

Figure 7 represents the solution to requirement 6.

According to the spreadsheet solution to requirement 6, the minimum cost plan is $3,208,456. If China can produce all the required demand, there is a reduction in the total cost by $3,107,255. The solution suggested closing all the plants except the plant in China along with closing the warehouse in Unites States. The minimum cost plan for requirement 6 suggested the following:

* Out of the 1500 tons produced in China's plant, 700 tons should be shipped to Turkey warehouse, 700 tons to China warehouse, and 100 tons to India warehouse.

* Out of the 700 tons received by Turkey warehouse, 300 tons should be shipped to the United States customers, 250 tons to Canada customers, and 150 tons to Brazil customers.

* Out of the 700 tons received by China warehouse, 300 tons should be shipped to Europe customers and 400 tons to Asia customers.

* India warehouse should ship 100 tons to Asia customers.

Learning Objectives:

1. To use network diagrams to represent the problem graphically. This graphic presentation will be used to develop the spreadsheet model.

2. To use binary variable (0&1) in order to take care of fixed costs. Fixed cost is not a linear function; therefore the use of binary variables will transform a non linear model into a linear one.

3. To develop a spreadsheet model to minimize total cost without the need to formulate the problem algebraically.

4. To be able to transfer all the cost into U. S dollars using the exchange rates.

Subject: Linear programming; Supply chains; Spreadsheets; Competition; International; Case studies

Classification: 2600: Management science/operations research; 9130: Experiment/theoretical treatment; 9180: International

Publication title: Journal of Business Case Studies

Volume: 6

Issue: 4

Pages: 43-51

Number of pages: 9

Publication year: 2010

Publication date: Jul/Aug 2010

Year: 2010

Publisher: Clute Institute for Academic Research

Place of publication: Littleton

Country of publication: United States

Publication subject: Business And Economics--Management

ISSN: 1555-3353

Source type: Scholarly Journals

Language of publication: English

Document type: Business Case, Feature

Document feature: Tables Diagrams Illustrations References

ProQuest document ID: 744082524

Document URL: http://search.proquest.com/docview/744082524?accountid=38610

Copyright: Copyright Clute Institute for Academic Research Jul/Aug 2010

Last updated: 2013-09-06

Database: ABI/INFORM Complete

Document 41 of 100

Case Study: Alex Charter School

Author: Johnson, Gordon; Kiani, Raj

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Abstract:

This case discusses issues associated with charter schools. Topics include accounting, statistics, and economics. The focus is on profit planning and budgeting. Students will prepare an income statement, determine a break-even point for enrollment, contribution margin, elasticity of demand to assist in decision-making about tuition, averages, and a regression equation to estimate test scores, given class size. Finally, strategic thinking is required to write a conclusion. [PUBLICATION ABSTRACT]

Full text:

INTRODUCTION

Bill Jensen was very unhappy with the quality of education his children received in public schools, so he started a private charter high school. In order to achieve his mission, he decided to become the principal of the Alex Charter School so he can reach his vision which will be one of the best private charter schools in the next five years. Bill Jensen is aware that by filling his vision, he can achieve his mission. As a school principal, he must make critical decisions following long-term strategic planning for each case as what to do, why to do it, and how to do it? As result of his effort, The Chamber of Commerce passed a resolution in support of the private school. He signed a lease for $3,500 per month rent and hired 13 teachers who he thought were the best in the public schools. Each teacher earns $60,000 per year. In addition, he hired three other employees, each earning $30,000 per year. Each student paid $4,000 per year tuition. Furthermore, additional cost for school activities is $1,000 per student.

To maximize learning, class size is limited to 15. To balance the budget, Bill had a fundraising program (organized by volunteers), including car washes and yard sales. Direct appeals to parents and homeowner associations were also part of the program. In 2009, he raised $100,000.

The main objective of the case is to maintain its quality of education. In order to achieve this, the Alex Charter School has to have financial stability. To achieve this objective, Bill Jensen should apply profit planning or budgeting techniques to determine the relationship between revenues and related expenses and also a break-even point required to manage the school in an efficient manner. Furthermore, the manager can project the budgeted income statement and statement of cash flow for the next 12 months using a profit planning concept and making sure that they are financially sound.

TOP 10 CONCEPTS

* Financial Accounting: 1 (a), 2

* Managerial Accounting: l(b&c),3,4,7

* Statistics: 1,4

* Microeconomics: 5

REQUIREMENTS

In this case, financial, statistical, and economic information are relevant and critical for the decision maker. Therefore, the following related questions are designed to provide relevant information about the case for the principal regarding school activities in 2009 and to help the principal project financial statements for the following year.

1. Define:

a. Total revenue(sales) for 2009

b. Total costs for 2009, break down the total costs into fixed and variable, and explain the fixed and variable costs behavior anyway. Then develop a cost equation model: Y=a +b(X) where Y=Total annual costs, X = Total activity driver(number of students), a= Total annual fixed costs, and b= slope of the line( variable cost per student)

c. Contribution margin per student

2. Prepare an income statement for 2009.

3. What is the break-even point (number of students) without fundraising?

4. Research into similar private schools showed:

Find the elasticity of demand. Is demand elastic?

5. A sample of contributions in dollars is: 100, 10, 20,1000, 50, 25, 10, 20

a. What is the mean?

b. What is the median?

6. A sample of private schools showed:

a. Use Excel Data Analysis to obtain a regression equation to estimate test scores, given class size.

b. Interpret the slope (regression coefficient) for this problem.

c. Estimate the test score if class size is 13.

d. Find coefficient of determination.

e. Interpret coefficient of determination for this problem.

f. Interpret the p-value for the regression coefficient. At the 5% significance level, can you reject the hypothesis that there is no relationship between class size and test score?

7. Apply strategic thinking to this case. Include recommendations for raising tuition, increasing class size, and shifting focus of fundraising to a small number of large donors.

Learning Objectives of Accounting Subjects Related to Alex Charter School Case

The accounting subjects related to this case are:

1. Cost behavior analysis

2. Cost Volume Profit (CVP) or Break-even analysis

3. Income statement determination

Following is a brief explanation for each subject.

COST BEHAVIOR ANALYSIS

Knowledge of cost behavior allows a manager to assess changes in costs that result from changes in business activity output. This allows a manager to examine the effects of choices that change activity. For example, if excess capacity exists, bids that at least cover variable costs may be totally appropriate. Knowing what costs are variable and what costs are fixed can help a manager make better bids and, ultimately, better business decisions.

Cost behavior is the way a cost changes in relation to changes in activity output. Generally, in terms of cost behavior, costs are frequently classified into fixed and variable for managerial decision-making purposes.

Fixed cost is a cost that does not change in total as output changes (i.e. total fixed cost remains constant, even if output changes); however, fixed cost decreases per unit as the output level rises and increases per unit as the activity output level falls.

Variable cost increases in total with an increase in output and decreases in total with a decrease in activity output; however, variable cost per unit remains constant per unit.

So, total costs = total fixed costs + total variable costs, which can be explained as

Total costs = (total fixed costs) + (Variable rate) *(amount of activity output), or

Y= a + b X

where Y= Total costs, a= total fixed costs, b = Variable rate, and X= amount of activity output.

Break-Even (CVP) Analysis

Cost-volume-profit (CVP) analysis estimates how changes in costs (both fixed and variable), sales volume, and price affect a company's profit.

CVP analysis allows managers to focus on selling prices, volume, costs, profits, and sales mix. Many different "what-if ' questions can be asked to assess the effect of changes in key variables on profits.

The units sold approach defines sales volume in terms of units of product and gives answers in these same terms. The unit contribution margin is needed to solve for the break-even units. The sales revenue approach defines sales volume in terms of revenues and provides answers in these same terms. The overall contribution margin ratio can be used to solve for the break-even sales dollars.

At the break-even point, all fixed costs are covered. Above the break-even point, only variable costs need to be covered. Thus, contribution margin per unit is profit per unit, provided that the unit selling price is greater than the unit variable cost (which it must be for break-even to be achieved).

Contribution margin = Sales minus total variable cost, which is the amount available to cover fixed expenses and provide for a profit.

Following is a summary of important equations:

1. Sales revenue= Price per unit X Units sold

2. Net operating income= Sales revenue - total variable cost- total fixed cost

3. Contribution margin per unit = Price per unit - Variable cost per unit

4. Break-even point in units = (Total fixed costs)/(Contribution margin per unit)

5. Break-even point in Sales dollars= (Break-even point in units)*(Price per unit)

How to prepare Income Statement

Generally, for decision-making and control purposes, management prefers to use a variable costing income statement, which is known as a contribution margin income statement. The format is as follows:

The answers to accounting and statistics questions related to Alex Charter School are:

A. Revenue for 2009 generated from students tuitions = ($4,000 tuition per year per student)*(x =195) =$780,000

where X = number of students = (13 classes) *( 15 students per class) =195

Additional revenue generated by donations =$100,000

Therefore, Total revenue=sales= $780,000+$ 100,000= $880,000.

B. Total costs for 2009= total fixed costs + total variable costs

Y = a + bX =$912,000+ ($1,000) (195)

=$912,000+195,000=1,107,000

where Total fixed costs for 2009= a = (annual rent expenses +annual salaries for 13 teachers + annual salaries for 3 employees)

= ($3,500 *12) +(13*$60,000)+ (3*$30,000)

= $42,000+$780,000+$90,000=$9 12,000

Total variable costs = (additional cost for school activities pre student) *(# of Students) = Bx = ($1,000)*(195 students) =$195,000

Generally, in terms of behavior, costs are frequently divided into two categories - variable and fixed.

Variable Costs

Variable cost behavior can be summarized as follows:

Total variable cost increases and decreases in proportion to changes in activity; however, variable cost per unit remains constant per unit.

Fixed Costs

Fixed cost behavior can be summarized as follows:

Total fixed cost is not affected by changes in activity (i.e., total fixed cost remains constant, even if activity changes); however, fixed cost decreases per unit as the activity level rises and increases per unit as the activity level falls.

C. Contribution Margin = Revenue (sales) - Total variable costs

Generally, the decision maker prefers to use the Contribution Margin Income Statement for managerial decision-making rather than the traditional income statement format used for external financial reporting.

D. Break-even point = (total fixed costs)/(contribution margin per unit)

Contribution margin per student = ($4,000 tuition per student - $1,000 additional cost for school activities per student) =$3,000.

At the break-even point, always revenue (sales) = total costs; that is, business does not make or lose money.

RECOMMENDATIONS

In case of the Alex Charter School, in order to maintain a break-even point, they must increase the student body by 109 (304 students at break-even point - 195 students as planned). To achieve this goal, they must increase the class size to 23 students per teacher or increase the tuition to $5,677 and maintain the same class size; that is, 15 students per teacher. Both options will balance the budget and it will be at the break-even point. Following are the income statements using either option:

Demand is elastic, so an increase in tuition may NOT increase total revenue.

Q4: Descriptive Statistics

Mean =1235/8 = $ 154

Median = mid point of 20 and 25 = $22.50

The large donor pushes the man up to $154, but the typical contributor, less than $30; mean much larger than median.

Q5: Regression and Correlation

1 . y = 106.3 - 0.9x, x = class size and y = test score

2. For each additional student in class, the test score decreases by 0.9 - almost one point.

3. Y =106.3 -.9(13) = 95

4. Coefficient of determination = .52

5. 53% of total variation in test score can be explained by variation in class size

6. Since the p-value for the regression coefficient is .0675 > .05, there is more than a 5% probability that you would get a slope at least this large if there were no true relationship between class size and test score. You cannot reject the hypothesis that the population parameter slope is zero.

Q6: Strategy

1. Raising tuition is unlikely to increase profits.

2. Increasing class size will lower test scores.

3. Focus on wealthy contributors.

CONCLUSIONS FOR ALEX CHARTER SCHOOL

The main objective of Alex Charter School is to provide and prepare students with a high quality of education. To achieve this objective, the School must balance its budget. The school is not currently profitable. Therefore, the decision makers for the School would need to increase the number of students more than 50%, which implies larger class sizes. However test scores will decrease if class size increases. Raising tuition will decrease total revenue due to elastic demand. The best alternative is to get large donations from wealthy contributors to balance the budget and therefore, maintain its quality of education.

Subject: Charter schools; Budgeting; Income statements; Revenue; Financial analysis; Case studies

Classification: 8306: Schools and educational services; 9130: Experiment/theoretical treatment; 3100: Capital & debt management

Publication title: Journal of Business Case Studies

Volume: 6

Issue: 4

Pages: 53-58

Number of pages: 6

Publication year: 2010

Publication date: Jul/Aug 2010

Year: 2010

Publisher: Clute Institute for Academic Research

Place of publication: Littleton

Country of publication: United States

Publication subject: Business And Economics--Management

ISSN: 1555-3353

Source type: Scholarly Journals

Language of publication: English

Document type: Business Case, Feature

Document feature: Equations

ProQuest document ID: 744083054

Document URL: http://search.proquest.com/docview/744083054?accountid=38610

Copyright: Copyright Clute Institute for Academic Research Jul/Aug 2010

Last updated: 2013-09-06

Database: ABI/INFORM Complete

Document 42 of 100

Co-Opetition Between SAP And Oracle: The Effects Of The Partnership And Competition On The Companies' Success

Author: Troesch, Erin M; Schikora, Paul F

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Abstract:

This research paper presents the secondary research findings on the similarities and differences between the strategies of SAP and Oracle, reasons why customers choose one vendor over the other, and how the competition between SAP and Oracle affects their cooperation with each other. This latter effect we refer to as co-opetition. A summary and conclusions will follow a detailed discussion of the aforementioned factors of co-opetition between SAP and Oracle. [PUBLICATION ABSTRACT]

Full text:

INTRODUCTION

The leading two companies in application software, specifically enterprise resource planning (ERP) systems, have been competing against each other for many years. These companies, SAP and Oracle, continue to battle back and forth to be considered the top enterprise applications vendor in the market. With the current economy, customers are looking for vendors that will provide them with quality, customizable and easy-to-use applications at a low, reasonable price. The competition continues to heat up as SAP and Oracle strive to provide better products and services to customers. In addition to the rivalry that many associate with these two companies, SAP offers its customers the ability to use Oracle databases to store the information needed to run an SAP application.

To investigate these current topics dealing with SAP and Oracle as ERP vendors, information was gathered through secondary research. This research consists of several journal and magazine articles in addition to on-line news releases and debates. This research paper presents the secondary research findings on the similarities and differences between the strategies of SAP and Oracle, reasons why customers choose one vendor over the other, and how the competition between SAP and Oracle affects their cooperation with each other. This latter effect we refer to as co-opetition. A summary and conclusions will follow a detailed discussion of the aforementioned factors of co-opetition between SAP and Oracle.

STRATEGIES OF SAP AND ORACLE

In the past few years, SAP and Oracle have been developing their application strategies in order to provide greater services and become more marketable to customers. SAP's large presence and rapid growth in the market suggest that it has a better strategy than Oracle (' Wailgum, 2008). Others feel that Oracle's focus on its new Fusion Applications puts its strategy above SAP's ('Bjorlin, 2008). Several other strategic moves are being heavily debated in the world of ERP systems. The following section includes why some may view SAP's ERP strategy as the best.

SAP's Strategy

SAP has transitioned to a NetWeaver platform that the company has worked on for many years in order to provide customers with greater service (Greenbaum, 2006). Besides persuading customers to use the relatively new NetWeaver platform and version 6.0 of the SAP ERP system, SAP's plan is to continue expanding into the small and mid-sized business market ("Bjorlin, 2008). SAP already has a large share of revenue coming from large businesses, but more and more small to medium-sized companies are looking for ways to improve their business capabilities and IT systems as well. These companies can benefit from implementing the SAP Business One or Business All-in-One Suite that are both part of SAP's strategy to grow.

Another part of this growth strategy is to focus on partnering with other companies instead of always acquiring them. This includes moving towards a plan of using the solutions developed by third-party companies to better support SAP applications. One major partnership has been developed with Oracle. Customers are able to use Oracle databases and services, supported by Oracle teams, along with their SAP applications (Technology Partners, 2009). Having such a strong partnership with its biggest competitor may allow SAP to appeal to new and existing customers. These customers can gain the advantage of utilizing the vendors' core competencies, SAP's ERP software and Oracle's database capabilities. After all, great customer service and support seem to be two of the greatest factors when trying to gain business in today's market.

Customers looking for service and support may find that SAP is lacking qualified professionals with the knowledge of implementing and training others to use SAP applications (2Wailgum, 2008). To rid the market of this ongoing idea that SAP lacks knowledgeable candidates for employment, Thomas Wailgum states that SAP is "bringing its message to [students at] colleges and universities and even high schools who might be interested in tech (^sup 2^2008)." Over 700 universities are taking advantage of SAP's program to make students aware of the varying jobs and careers in the ERP market and exposing them to various SAP applications. Providing such education and certification programs gives current SAP executives confidence in the long-term success of the business ("Wailgum, 2008).

Oracle's Strategy

Oracle's aggressive strategy differs from SAP's strategic plan in several ways. Researchers believe that the new Fusion Applications will make Oracle's strategy for growth in the market more compelling than any competitor's, including SAP's strategy ('Wailgum, 2008). Fusion Applications is set to be released sometime in 2010. As of now, it cannot be certain if Oracle's strategy will surpass that of SAP, but several analysts feel that Oracle's vision into the future of the market will be more appealing to customers ('Wailgum, 2008). Besides releasing new products, Oracle will continue to stick with their strategy of acquiring other companies.

Acquisitions seem to be quite common at Oracle. Its strategy is to get its hands on companies with expertise in specific industry areas (^sup 2^Bjorlin, 2008). This way Oracle can provide customers with differing applications and broader capabilities. For example, Oracle recently purchased Sun Microsystems from Microsoft. This acquisition will provide Oracle with better cloud-computing and virtualization capabilities (Chan, 2009). Cloud-computing will enhance Oracle's marketability towards customers looking for SaaS (software as a service). The ongoing plan of acquiring companies that specialize in a certain industry, such as financial services and insurance, gives Oracle the expertise and functionality to attract new users from these industries (^sup 2^Bjorlin, 2008).

In addition to competing on increased functionality, Oracle is moving towards a strategy of competing on user-friendliness (deHenry, 2006) and price (Blau, 2005). Oracle continues to look for ways to simplify its architecture and make it user friendly (deHenry, 2006). As the current economic situation affects most companies, ERP vendors' customers may want to look for applications that require less training and are easy to use. Also, those customers may be struggling financially and desire lower priced applications. Several research articles state that Oracle's cost of ownership is less than that of SAP. For example, in 2006, it was believed that "Oracle's average three-year total cost of ownership [was] 48% lower than SAP's (Westervelt & Brunelli, 2008)." However, Joshua Greenbaum states that it would be near impossible to prove how much an ERP system will cost a company to implement and maintain because each company has differing objectives and needs (2006). No two companies are similar enough to prove that Oracle is the cheapest ERP vendor. With the lack of strong evidence, it is difficult to know if Oracle's strategy of competing on price/total cost of ownership is a good idea or a deception to new customers.

Similar Strategic Moves

As previously discussed, SAP and Oracle have developed different strategies to promote growth for their ERP products. While these two vendors undoubtedly have their differences when it comes to strategic visions, they also have similarities in several key areas. The similar strategic points include enhancing their technology solutions for ERP systems, focusing on customer service and support, and partnering with each other in a professional manner. The first similarity suggests that Oracle and SAP are taking advantage of the newest technologies in marketing their business to customers. Both Oracle and SAP have recently announced that they will offer some of their ERP applications to be downloaded and used on cell phones, particularly Apple's iPhone (Kolakowski, 2009 & iPod Firmware 3.0, 2009). In this way, SAP and Oracle are keeping up with the ever-changing wants and needs of their customers by providing them with new ways of retrieving and sending information while away from the physical operations of the company.

Customer service, customer support, and application support are very important to both companies. SAP is striving to be proactive about making sure its service and support will remain strong by providing more education and certification programs (2Wailgum, 2008). Oracle is focusing on developing flexible platforms in order to improve customer service and support (Tillman & Grady, 2007). The two strategies are also similar when discussing their partnership with each other. As mentioned before, SAP enables its customers the opportunity to use Oracle databases. This alliance allows customers the advantage of running their customizable SAP application software on well-known Oracle databases (Blau, 2005). Customers get the best of both worlds and the vendors are willing to cooperate with each other. SAP and Oracle also partner with other companies in a professional manner to improve their services, applications, and public image to consumers. It seems as though most software vendors, such as SAP, Oracle, Microsoft, IBM, and others are so tightly related that it's hard to avoid working together. For example, analytics specialists Business Objects "are interested in working closer with SAP because [they] have joint clients (Blau, 2005). Companies looking to implement an ERP system for the first time should keep in mind the similarities and differences between the strategies of SAP and Oracle. The vendors' strategies may play a large role in how a company chooses the right vendor for their business needs.

REASONS TO CHOOSE A CERTAIN VENDOR

Many companies invest in ERP and other technology systems to increase business performance. A company should choose an applications vendor based on its industry-specific needs and required/desired services. Researchers have suggested ways on how to go about choosing an appropriate vendor to match the company's needs. According to R "Ray" Wang and Paul D. Hamerman at Forrester Research (Nov 2008), "a sound vendor selection process consists of four key phases." These phases are illustrated in the Figure 1 .

Figure 1 shows a recommended set of steps that a company should follow in order to choose the right vendor. The first phase is to organize, define, and develop an understanding of what the company hopes to accomplish. Narrowing the field of vendors is the second phase. The asterisk following the final point in this phase suggests that it is an optional step in the process. (The Forrester Wave is a group of reports used to help clients analyze the strong and weak points of possible vendors.) The third phase suggests that companies complete even further research on vendors, such as prices, services, and abilities to meet company needs. During the final phase, a vendor is chosen and the focus moves towards implementation.

SAP and Oracle are by far the largest vendors to consider as companies work their way through the process of choosing an ERP vendor. Together these front runners obtain over half of the ERP market share. As of 2007, Oracle recorded revenue of an estimated $7 billion while SAP recorded approximately $14 billion in revenue ("Bjorlin, 2008). While they both offer similar applications packages, customers tend to side with one or the other based on the type of industry, the size of the business, the customer's mission and vision for the future, and other numerous factors. The following section will discuss why some companies have chosen SAP over Oracle and how they went about making such an important decision.

SAP as the Best Vendor

Several companies, such as Harry & David, Joerns Healthcare, and Saladino, decided to use SAP as a result of their vendor selection processes. Harry & David chose SAP because of its capability to provide its growing company with "long-term efficiencies and visibility into its retail and wholesale businesses (SAP AG, 2009)." The mid-sized company believes that SAP, rather than Oracle, will support and fit in well with its vision to offer targeted products to certain stores. Similarly, Joerns Healthcare chose SAP because of the vendor's commitment to research and design (3Bjorlin, 2009). This commitment matched Joerns Healthcare's overall vision. Saladino, a food distribution company, chose SAP over Oracle due to a higher level of customer service and functionality it received as well as an overall lower cost.

Not only are companies choosing SAP over Oracle based on business-specific factors, but entire industries, specifically the utility and rail industries, feel that SAP is the best to suit their needs. Utilities companies have been using SAP for approximately 10 years. More companies within the industry continue to choose SAP because templates have already been developed by similar companies to ease the implementation process, and SAP's products seem to work well for other utilities companies (Saran, 2008). Improving efficiencies by combining several tasks, such as finance and customer relationship management, make SAP a strong vendor choice, but sometimes the utilities companies are finding themselves having to modify their business processes to match the systems way of doing things. Besides the utility industry, SAP has the ability to run well with railroad companies. Seeing how the ERP system works with railroads currently using SAP is one of the main reasons for others in the same industry to choose it too. In addition, SAP's capability to operate well with other products, such as databases and IBM, led Burlington Northern Santa Fe Railroad to make the decision to side with SAP over Oracle (Franke, 2007).

Most of the aforementioned companies that have chosen SAP indicate that its functionality sets it apart from the main rival, Oracle. In a 2006 debate, Joshua Greenbaum makes a case that says SAP's ability to customize applications before implementation makes it more desirable for certain industries. He also feels that Oracle lacks "deep vertical functionality, a fact acknowledged by the vertical focus of their acquisition and partnering strategy (2006)." This suggests that Oracle is being hurt by acquiring companies while SAP is able to deliver a better vision and proposal for its applications by not relying on other companies as much. While some professionals in the technology industry make strong cases for SAP, there are others who think Oracle has the upper hand when it comes to being the best vendor.

Oracle as the Best Vendor

New Age Electronics, Welch Foods, Starbucks Coffee, and Restaurant Technologies all decided that Oracle was the better vendor to choose in order to carry out and improve their businesses. These four found Oracle to be easier to use and more flexible. Current Oracle fans, such as Faun deHenry pride Oracle on being easily accessible and manageable, no matter whether the user is a fully trained executive or a common administrator (2006). Oracle's ERP system is also said to be easier to implement (deHenry, 2006). This could be the result of SAP focusing more on customizing ERP systems to customer specifications and Oracle focusing on quick deployment of its applications. Most companies tend to choose Oracle if they prefer having flexibility over customization. For example, Restaurant Technologies wanted a flexible platform to keep up with its expected growth rather than customizing applications to meet current needs (Tillman & Grady, 2007).

Oracle's user- friendliness, flexibility, and smooth implementation process may help prove the case that a positive return on investment will occur faster with Oracle than SAP. Nucleus Research reported that, out of the small and medium-sized businesses using an ERP system, 41% using SAP received positive returns while an outstanding 93% using Oracle received positive returns (Tillman & Grady, 2007). In several instances, customers and Oracle followers feel that the total cost of ownership for an Oracle ERP system is significantly less than SAP, particularly when it comes to training employees. According to Faun deHenry (2006) in making a case for Oracle, "SAP requires on average, four times more internal resources, and companies spend almost twice as much for SAP training." When going through the process of selecting the right vendor, companies may find that their cost to setup, run, and maintain an ERP system from Oracle may vary from their competitors. The cost often depends on how much you rely on the system and what it needs to accomplish for the business. Some companies might not need the advanced capabilities and extensive training for employees that other companies do. Even though there is no stated proof that Oracle costs less than SAP for everyone, several Oracle advocates suggest that Oracle's pricing is more reasonable compared to that of SAP (Westervelt & Brunelli, 2006).

A more obvious advantage that Oracle has over its competitors is its database business. Oracle has control over much of the market with this business and can now focus on developing additional applications, such as the Fusion Applications. Companies using SAP's ERP system often chose to use Oracle database applications along with it. In doing so, they get the best of both worlds. As Oracle comes out with the new Fusion Applications, those customers may find it beneficial to reevaluate their vendor selection to see if their current ERP solution is still working for them. The competition for ERP customers that exists between Oracle and SAP may have an effect on their partnership with each other. The following section will discuss how the tension between the two ERP vendors affects their ability to cooperate with each other.

COMPETITION AFFECTS COOPERATION

SAP and Oracle began promoting SAP's R/3 enterprise application suite with the relational databases of Oracle as complimentary products in 1988 (PeopleSoft, 2009). Their cooperation seemed to be going smoothly until Oracle entered the ERP market about 16 years later. Today, the two companies battle for customers in the same markets while continuing to offer products that complement each other; that is, Oracle's databases can still be used with SAP applications. When confronted in an interview about the vendors' competition affecting SAP customers who use Oracle databases, SAP's CEO, Henning Kagermann, stated that both companies "are professional enough to handle co-opetition (Blau, 2005)." Co-opetition is a term he uses in reference to the cooperation and competition that both companies face on a daily basis. Recently, the competition has heated up and Oracle has accused SAP of misusing several customer accounts and documents owned by Oracle (PeopleSoft, 2009). The current battle in the enterprise software market doesn't seem to break down the initial cooperation that began decades ago.

While there is inevitable competition between Oracle and SAP as technology partners, there is nothing to suggest that their partnership in customer support services is under crossfire. Customer service and support are key points in both vendors' strategies. Oracle's support for the databases used by SAP customers is closely linked with SAP support to provide joint customers a wide range of services to enhance the usability of the entire system. On Oracle's side, SAP expertise is required to be able to help customers because of the complex architecture of the SAP ERP system (Oracle support and sendees for SAP Customers, 2009). The knowledge of Oracle's databases must also exist in order to better confront any issues that arise in that area.

SUMMARY AND CONCLUSIONS

To get ahead in the market today, SAP's strategy is to continue pushing its NetWeaver platform, partnering with companies, and investing in more education programs. Oracle is taking a somewhat different approach by focusing on releasing its new Fusion Applications, acquiring companies, and competing on user-friendliness and price. Both vendors also keep in mind the importance of providing excellent support and a wide array of services to their customers. It is difficult to say whether SAP or Oracle has the best strategy because every company is looking for a vendor that closely matches its own vision and strategy.

Many SAP customers are happy with their vendor choice because SAP provides them with visibility, functionality, and the ability to customize applications to meet their business needs. Utility and railroad companies like the fact that SAP has committed itself to working with their specific industries. Oracle fanatics feel that Oracle provides more flexibility than other vendors, is easier to implement and use, and is known to cost less. Oracle's release of its new Fusion Applications could possibly cause some of SAP's customers to switch over to Oracle. Again, it cannot be confidently concluded that Oracle is better than SAP or vice versa because ERP customers have different needs and desires when it comes to choosing the right vendor.

Since Oracle began its partnership with SAP in 1988, the two companies have become increasingly competitive with each other. They're always looking to outdo one another, and Oracle has even sued SAP. Hopefully, both companies can remain professional in order to continue providing customers with SAP ERP systems and Oracle databases as complimentary products. Oracle and SAP must also continue to offer integrated support/service teams for their joint customers. Without a good partnership in providing these services, customers may stop choosing either vendor.

Subject: Competition; Software industry; Market strategy; Cooperation; Enterprise resource planning; Case studies

Location: United States--US

Company / organization: Name: Oracle Corp; NAICS: 511210; Name: SAP America Inc; NAICS: 511210, 541511

Classification: 8302: Software & computer services industry; 7000: Marketing; 5310: Production planning & control; 9130: Experiment/theoretical treatment; 9190: United States

Publication title: Journal of Business Case Studies

Volume: 6

Issue: 4

Pages: 59-65

Number of pages: 7

Publication year: 2010

Publication date: Jul/Aug 2010

Year: 2010

Publisher: Clute Institute for Academic Research

Place of publication: Littleton

Country of publication: United States

Publication subject: Business And Economics--Management

ISSN: 1555-3353

Source type: Scholarly Journals

Language of publication: English

Document type: Business Case, Feature

Document feature: References

ProQuest document ID: 744083081

Document URL: http://search.proquest.com/docview/744083081?accountid=38610

Copyright: Copyright Clute Institute for Academic Research Jul/Aug 2010

Last updated: 2013-09-06

Database: ABI/INFORM Complete

Document 43 of 100

Biomass Conversion To Fuels: A Challenge For Sustainable Growth In Mexico

Author: Assad, Flory Anette Dieck

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Abstract:

During an adventure into a swine farmhouse in the municipality of Montemorelos, in the State of Nuevo Leon in Mexico, it was a real discovery to find out that well processed animal excrement is a potential source of wealth for the farm owner. This academic case presents the dilemmas for the construction of biodigesters that could help decrease environmental pollution through the trade of Carbon Bonds. Energy security, technological, and environmental concerns are the cornerstones of Sustainable Growth in Mexico, applied to this specific case.1 [PUBLICATION ABSTRACT]

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INTRODUCTION

The road trip is over. Dr. Jaime Gonzalez got out of the car and proudly commented: - We finally arrived to Montemorelos, the citrus city of the state of Nuevo Leon, Mexico, get ready to taste the most delicious orange juice in the region!

It was a fieldtrip of a group of professors and friends who wanted to explore a city characterized for preserving its traditions and for being the nest of hardworking men, besides being the top producer of the best orange juice in the north of Mexico. We sat down at the well known restaurant "La Ponderosa" and enjoyed a beautiful landscape. While all of us praised the tasty orange juice, a friend of Dr. Gonzalez unexpectedly arrived to our table.

- What a great pleasure to meet you again, he said to Dr. Jaime Gonzalez, who immediately stood up from his chair and greeted his good old friend Mr. Jose Luis Tamez Tamez.

- I would like to introduce you, he said to the whole group, to a great swine cattle production leader in Montemorelos. This man, besides being an example to follow, is the President of the Swine Farms Union of Nuevo Leon, which is integrated by 1 20 swine cattle producers.

We all stood up from our chairs to welcome and invite him to chat with us for a while. This casual encounter would make our exploratory trip an unforgettable experience. Mr. Jose Luis Tamez Tamez, with a remarkable humbleness, a great sense of humor and a positive attitude, with a hard worker charm, and a generosity that characterizes Montemorelos's citizens, sat with us and gladly agreed to share his knowledge about the challenges that swine cattle producers were facing worldwide.

Our unforgettable adventure started when the owner of the Ana Margarita swine farm, that has an extension of 70 hectares (172.97 acres) located at the Montemorelos municipality, started to tell us about the ecological and sustainable projects of his farm." It was a positive impact to learn that this small city was inhabited by fully talented men with indisputable human quality, like Mr. Jose Luis Tamez Tamez, who during the course of our pleasant conversation managed to awaken an ethical consciousness in favor of the Earth within us. Nobody could have imagined that important topics such as ecological and sustainability dilemmas were so seriously discussed, in such a small city, with the same criteria as in the United Nations (UN).

A CHALLENGE TO SWINE PRODUCTION

Our group of professors was so enticed with Mr. Tamez's interesting conversation, that we invited him to stay the whole day, and kindly requested him to explain to us the strategic challenges of the swine farmhouses he represents as the leader of the Swine Farms Union of Nuevo Leon.

In a way of supporting our petition, Dr. Jaime Gonzalez commented: "- Each professor in this fieldtrip has diverse knowledge and disciplines, but we share the same mission: to discover and learn".

Mr. Tamez was touched by our great interest on the subject, and he gladly agreed to introduce us to the discovery of the problems that swine farms in Nuevo Leon were facing. And this is how his pleasant chat started:

- I think that it is an already well known fact that environmental pollution generated by animals as a consequence of intensive exploitation practices exists. Due to the production growth and the animal population increase, our biggest strategic challenge is to become a less polluting producer, said Mr. Tamez with great seriousness. The great capacity of pigs to adapt to very different climates, have made them easy to be exploited in every continent and almost in every country, with exception of those countries where, for religious and cultural reasons, their existence is forbidden (F AO, 2001).

The Food and Agriculture Organization of the United Nations (FAO), estimated that the world swine population at the beginning of this millennium was 907 millions of pigs distributed in the following way (FAO, 2001):

- Then Susana, one of the professors of the group, asked: So then, is China the highest polluting country on matters of swine exploitation?

- That's exactly right, replied Mr. Tamez. And Mexico contributes with a population of 15 million heads of swine cattle; well, to be exact, a total of 15.257 million heads in 2006, according to the last available official statistics.3 This number is still below the 19 million heads reported by Vietnam.

- Furthermore, continued Mr. Tamez explaining with great patience, the hog's fecal excretions of this swine exploitation (also known as "hog excreta") include fecal and urinary excretions, food waste and water resulting from washing the cattle plus the involuntary losses of water itself, together with other materials such as hay and sawdust used as "bedding" at the swine farmhouses. Therefore, the potential pollutants resulting from the animal exploitation have all an organic origin. This waste could have variable water content, even sometimes being totally liquid. Nevertheless, the solid fraction can be distinguished either as the total suspended solids (TSS), which is the recoverable portion obtained by filtration, or as the total dissolved solids (TDS). The sum of both fractions is called "total solids" (TS), which are precisely the ones that produce methane gas, a very polluting substance.

Mr. Tamez stopped talking, took out a FAO (1997) book from his briefcase, and told us: - In order to be precise, I would like to read this text to you out loud: "The organic character of the hog excreta allows it to get incorporated to the natural chains of nitrogen and carbon cycles, and that is the reason why, if properly used, they constitute a potential source of wealth. Generally, they are used as a fertilizer with the purpose of soil improvement. But also, they are used in integrated production systems to feed fish and ducks". - One could say, Mr. Tamez continued talking with enthusiasm, hog excreta is also becoming relevant when fattening up ruminants, either as a secondary activity of pig-breeding in the management of fecal excretions at the same farm, or as a product to be exported for intensive breeding of other cattle farms. The activity of recycling hog excreta, or recovered solids, is a good option to control the aforementioned pollution.

- I would have never imagined, Susana said. How it is possible to think that hog excreta produced by pigs could be a potential source of wealth. This is truly impressive!

- That's right, Mr. Tamez said. In general, the handling of hog excreta does not represent a real problem in Mexico, since, as I will tell you later on, there is abundant soil in need of fertilizers and the possibility of recycling the hog excreta on animal feeding, as well. Thus, we have the opportunity for pollution control.

The underlying success in the management of hog excreta consists on maintaining equilibrium with the environment they are spilled into (soil, water or animal production), which demands knowledge about the composition of the excreta and the receptor itself. Despite what has been said about the management of solidsstated Mr. Tamez with a worried expression on his face-, water (or the liquid portion of the excreta), requires particular consideration, fundamentally because its potential pollution is derived from the presence of organic material in it, which is measured in function of the solid content. Indeed, water is our biggest concern!

When Mr. Tamez saw our confused face expressions, he wisely stated: -I would like to use pig 's offal as an example. This is the name we give to the hog excreta used to feed fish. The pig 's offal requires oxygen just as fish do (02 dissolved in the water), therefore, pig's offal should be treated first before it could be used as fish food. Usually it is oxygenated with pumps. The particular characteristic of lagoons where fish are grown is that the available 02 is scarce, so it should be supplied artificially. Water from a lagoon that produces fish does not have the same amount of properties as the water from a river.

- Dissolved oxygen in the water, is an important parameter for water quality, Mr. Tamez pointed out with a convincing voice. In waters where organic material content is high, the dissolved oxygen should be measured through membrane electrodes. Waste water creates a demand for oxygen, which has to be supplied by dissolved oxygen in the receptor bodies (the lagoon where this water is poured), if not, the biological balance will be disrupted.

- I will explain it in a simpler way, said Mr. Tamez, if the organic load poured into the water is below the assimilation capacity of the receptor water, then the required aerobic conditions will remain for the normal flora and fauna; if the quantity is exceeded, then an excessive bacteria proliferation will consume all the oxygen, creating conditions for anaerobiosis. Let's remember that high quality waters should be able to support life.

- According to research papers published by FAO (1997, p. 123), continued explaining Mr. Tamez, fecal excretions and water should be considered as two independent resources, that, when mixed together, affect each other negatively: the solids reduce water quality and consequently water has to receive the required treatment in order to be reintegrated into the environment; on the other hand, fecal excretions lose their nutritious value, due to the aqueous dilution, or by other solids dragged along.

- Let's get to a conclusion, Mr. Tamez said emphatically. Undoubtedly, hog excreta can be a potential source of wealth if considered not as a waste, but as a raw material readily available all year long for recycling. Our biggest challenge towards the environment is to control water pollution, therefore the first step in order to control fecal and urinary excretions is to recover the solids, which means, to remove most of the organic matter from the water.

- Therefore, he emphasized, the need to process hog excreta could not be any clearer. But before implementing any system, some factors should be considered: the chosen system should permit an adequate cleaning process for the farm, it should facilitate the removal of feces, consume low quantities of water, need lower labor, preserve the fecal nutritious properties, make it easy to store proper amounts, suppress any offensive odor emissions, and it should eliminate all pathogens.

Farmyards are cleaned up by a sweep and drag system in 80% of swine exploitation cases around Mexico, which facilitates the recovery of solids in the hog excreta recycling process. - The crucial thing is, said Mr. Tamez in an inquisitive manner, to find a convenient, economical and practical strategy that would benefit both the environment as well as the producers.

ANA MARGARITA SWINE FARMHOUSE

The group of professors and I were impressed by the outstanding explanation of the challenges of swine cattle exploitation that Mr. Tamez was telling us about. We stopped the conversation when Dr. Jaime Gonzalez kindly asked for a new round of delicious orange juice for everybody, together with some Mexican appetizers.

We were suddenly impressed by our intrepid colleague Simon, because we all wanted to inquire even more on the debated subject matter, but before anyone said anything he popped the question we were all thinking about, and in a very polite and direct manner he asked: - Mr. Tamez, we have already understood all the general characteristics of swine exploitation, but at this point of the journey, we are now interested in getting to know your opinion about the best practical and economical strategy that would benefit your farmhouse Ana Margarita particularly as well as the swine production farms in the State of Nuevo Leon.

Staring at Simon, Mr. Tamez wisely replied: -the question that you just asked me is precisely the most important dilemma for any producer. This is exactly the dilemma that swine farms in Nuevo Leon are now facing and should solve. But let me give you a broader explanation of some other specific characteristics of swine exploitation in Nuevo Leon.

- First of all, let's talk about some of the environmental factors which swine cattle production has to fight against: temperature and humidity. The thermal capacity of pigs is limited as a consequence of their fattening tendency and their small lungs, and should be regulated in function of their age and physiological state. Pigs are in thermal equilibrium with the environment when the temperature is lower than their body's (Serres, 1997 y Rinaldo y Le Dividich 1991). Pigs' thermo-regulator is somehow defective because they lack sweat glands (pigs do not sweat), similar to reptiles, therefore they always want to be in the water or in mud - when available - in order to regulate their body temperature. The farmhouses in Nuevo Leon pollute a lot because they use large volumes of water to perform chores such as cleaning and, as just mentioned, maintaining the pigs' body temperature. As a consequence large quantities of solids, resulting from feces and food leftovers, are dragged away altogether with a considerable amount of methane gas (biogas) that could be also used for energy production.

Mr. Tamez took some photographs out of his briefcase, and continued teaching us- In order to reduce pollution at swine farmhouses, machines that separate solids are used to reduce, on a large scale, the degree of fecal matter pollution of the water; nevertheless, this is not enough.

- As we have been talking, Mr. Tamez started to recapitulate, the hog excreta can be used as a soil fertilizer for agricultural purposes, or for the growing of fish, birds, and ruminant nourishment, or as raw material in biodigesters. In our case, the hog offal is mainly used to nourish sheep and cattle. For fish nourishment, as I mentioned before, one should be more careful because the oxygen at the lagoon where fish are grown could be seriously affected.

-Let's look at the following statistics, Mr. Tamez assertively stated; a pig from our farms eats approximately 3% of its weight every day. So if a pig weighs 1 00 Kg, it gets fed with 3 Kg of balanced food. Its monogastric quality forbids it from accumulating ingested food for long periods of time so digestion occurs rapidly.4 This situation forces producers to feed pigs on a daily basis. Even though their stomachs are not relatively big, their intestines can be as large as twenty times their body size, which results in an easy adaptation to the different nourishing regimes and to the assimilation of food rich in cellulose in cases where pigs are pastured, or rich in proteins in cases where pigs are nourished with meat leftovers. (Zhou et al., 1997).

- Going back to the generation of fecal excretions at the Ana Margarita farmhouse, explained Mr. Tamez, its owner, we estimate that the average weight of a pig in a full cycle farm is 54 Kg, and it is estimated that the food that our swine cattle digests has an average of 80% digestibility (what is absorbed).

-Thus, Mr. Tamez added with technical precision, in my farmhouse, Ana Margarita, where we have 10,000 pigs, and we estimate an average weight of 54 Kg per pig, if we make some calculations, we would get the following result of feces generation per day:

- In particular, he concluded, my farmhouse Ana Margarita generates approximately 3.24 tons of feces per day, a source of potential wealth, isn't it? I have to mention that this number is only an average in order to get a rough idea about the amount of feces that are generated. In order to be more technical about the nourishment of the pigs, it is important that you know that food is accessible all the time (nourishment is available in containers and they can eat as much as they want) for the pigs 7 days after they are born until they are sold. This same procedure occurs with female milking pigs. In the case of pregnant pigs and studs, food is a bit more restrained and they are given between 2 and 3 Kg per day per animal, depending on the physical state of each.

- In 2009, there were 62 registered swine farmhouses operating in Nuevo Leon, commented Mr. Tamez, with a population of approximately 250,000 pigs. Can you imagine the amount of feces that is generated per day just in this state? Approximately 81 tons of feces per day!, expressed Mr. Tamez completely astonished.

Mr. Tamez recapitulated: - Going back to Simon's initial question, the members of our Union are farms labeled as intensive or production intensive, even though some of the farms are small, this is, they have between 800 and 1500 pigs in total.5 Those that are labeled as intensive farms are characterized by having pigs with good genetics and they are crossbred in order to obtain hybrid vigor, balanced nourishment according to the animal's production level, proper facilities for each stage, and an adequate temperature control for areas that require so. In this type of exploitation farms, our production is totally programmed, from getting the female pig pregnant until the pigs are sold. We have a vaccination calendar and external/internal parasite controls, with the main objective of doing business. The animals are always confined in small areas, there are a large number of animals which have a minimum space for each of their stages. In these exploitations we are looking for transformation of environment residuals of high biological value to feed the cattle. The most interesting thing about our strategy is the treatment of residuals at swine farmhouses for energy production (Biogas).

- We chose the construction of biodigesters, Mr. Tamez commented, because it would also help our farms to satisfy the Mexican norm on water pollutants. In the past, he said, there was no norm that established a criterion for the treatment of residual water in order to be reutilized for the public, for direct, indirect or occasional contact. In 1998 the norm NOM-003-ECOL-1997 was published, establishing the maximum permissible pollutants for treated residual waters. This norm had the objective of protecting the environment and the population's health. The official norm, not only regulates residual water outflows, but it also proposes benefits that could be obtained by designing an action plan for water cleaning. Among these benefits there are fiscal incentives consisting on reducing by 100% the investments on equipment to prevent and control the environmental pollution (Budedo, 1997), and the possible exemption of the corresponding tax payment for polluted residual waters according to the Federal Rights Law (Ley Federal de Derechos).6 The time span to fulfill the norm was 10 years, year 2007 being the deadline. But because most of the farms did not fulfill it, there was an extension until 2012.

Mr. Tamez showed us statistics stating that the applicable norm to swine cattle discharges into the water had a maximum permissible limit of 1000 coliform units (colony forming units) per 100ml.7 In 2009 we have already lowered it to 24,000 coliform units per 100ml. Working according to this norm is already crucial for operating our farms. We need an urgent improvement on this aspect! The maximum permissible limit for fecal coliform units is impossible to reach with a simple secondary treatment.8 However an increased anxiety prevails (Belausteguigoitia, 1997) because at some point in the near future, the environmental arguments could also be used as barriers to international trade.

- We greatly value pig feces, Mr. Tamez concluded, considering that its recycling process would be very successful if it resulted in the production of biogas, and estimating that feces of an adult pig can produce from 0.28 to 0.34 biogas cubic meters. This would be our best strategy that could be achieved through the construction of biodigesters. This is precisely the strategy that is currently under study in our Swine Farms Union of Nuevo Leon.

BIOGAS PRODUCTION AND ELECTRIC ENERGY GENERATION AT SWINE FARMHOUSES IN NUEVO LEON: THE BIODIGESTERS

We, the group of professors and friends, had all understood the problem so far, but our minds were rapidly searching for a solution to the dilemma of the Swine Farms Union of Nuevo Leon. This became our challenge!

After we all enjoyed a break savoring a delicious coffee, Simon firmly questioned Mr. Tamez one more time, wanting to investigate about the obstacles that blocked a practical solution for biogas production for Nuevo Leon's swine farmhouses.

- The greatest obstacle of all, replied Mr. Tamez, is the resistance to confront the environmental issue because it is considered that its solution only represents a cost and not a benefit. Besides, there is a lack of knowledge about the real costs of the diverse treatments and recycling systems. Due to the energy price increase, and as a way of reaching "sustainability" of swine production, at the Swine Farms Union of Nuevo Leon, we decided to spread the voice about the ecological and economical importance of hog excreta recycling in order to convert it in clean water, in organic fertilizers, in ruminant nourishment consumables, and as a source of biogas. This was the beginning of an important project for our farms; our target was the biogas production and electric energy generation through biodigesters.

- Building biodigesters is the core task of the aforementioned project, through which the biogas production could be stored and controlled, and the residual water could be cleaner, Mr. Tamez explained with great kindness and patience. In our farms, methane, which is 2 1 times more polluting than carbon dioxide and is produced by the solids contained in the water, is burned. Thus, biogas also known as "young methane" is caught through a burning process, which hinders the gas to go into the atmosphere causing pollution.

Professor Sandra interrupted Mr. Tamez asking him for a broader explanation of what a biodigester was because even though she knew a lot about international trade, still she didn't have deep knowledge about this concept.

- A biodigester, Mr. Tamez replied with a smile on his face, is basically a pit of variable dimensions according to the farm size and the amount of waste it generates. This pit is lined with a canvas or a liner, covering both the pit and the upper part of it, forming a balloon-like bubble that is where the generated gas is stored.

- Let me clear this up for you guys, said Mr. Tamez raising his voice, big advantages exist with the use of biodigesters, I would like to emphasize the following: low cost, easy to build, easy installation and handling, minimum maintenance (no sophisticated maintenance required), increase in profitability of swine production exploitation, maintenance of the fecal fertilizer value (half of the organic nitrogen is turned into ammonia), sedimentation as mud with small phosphate and potassium quantities (to use as fertilizers), and the reduction of the odor problem generated by the storage of feces at the farmhouse.9

- The process consists in sending or transporting the water containing all the farmhouse solids into the biodigester, crossing the whole length of the farm, Mr. Tamez continued excitedly and pleased with our real interest in his dilemma. This allows the solids to remain at the digester, and through the digestion process methane gas is generated. It is estimated that only 10% of all the incoming solids remain as mud or compost. Therefore, from each ton of solids that comes into the biodigester, only 1 00 Kg of mud will remain. Mud is extracted approximately every 8 months through some pipes that go all the way down deep into the digester, injecting hot water to remove and suck them up with a pipe or with some extraction mud bombs. In this process, the water that comes out of the digester practically does not contain solids anymore, and can be properly used for agricultural irrigation, mainly for pasture fields. At the same time, the official norm established by the National Water Commission (CONAGUA in Spanish) in relation with the maximum solid contains limits in residual waters is fulfilled.

Professor Sandra interrupted again, - Excuse me, Mr. Tamez, but the concept of a biodigester is still not quite clear for me. Would you be so kind to explain to us in a more precise detail how it works?

- Of course! Mr. Tamez replied, very pleased to have awakened so much interest on the subject. The biodigester carries out an anaerobic process immersed in water. The process called decomposition or digestion of the solids, starts when feces enter into the biodigester, similar to what happens in the stomach of an animal. It is estimated that 90% of the solids are transformed into biogas during the process (with the composition of 62% Methane (CH4), 30% C02, 7% water vapor and 1% of other gases including hydro sulfuric acid with approximately 200ppm); the other 10% is what we call mud sediment or compost which regularly is left at the bottom of the digester.10 This is the way to get a compost of the best quality which could be used for agricultural field fertilization, and in a near future, it could be also traded at an attractive price to be used in gardens because it has no odor and it represents no pollution risk. After extracting the compost or mud sediments, they could be sent directly to the fields, because the nutrients in them are ready to be assimilated by crops, together with the water." Another way of using the compost or mud sediments would be by their deposit in a dam or a dry lagoon, and wait until they get dehydrated in order to be used as fertilizers afterwards. In our case, this is an easier way to do it because this type of mud has no dangerous residuals such as heavy metals, industrial or hospital waste, since this compost or mud sediments are the product of only what the pigs eat, and their nourishment is totally balanced. There could also be a secondary lagoon at the outflow of the biodigester, in order to collect the water and send it for agricultural irrigation later.

-The most crucial moment is here! Mr. Tamez exclaimed. During the digestion process methane gas is produced, which is collected through a perforated pipe that goes inside and around the digester. Methane gas is conducted through some PVC pipelines and other type of ducts to a meter that corroborates its production volume which generates the Reduced Emissions Certificates (RECs) or Carbon Bonds resulting from the burned methane gas. Then it goes through a blowing fan to be conducted to the burner in order to avoid pollution into the atmosphere.

KYOTO PROTOCOL AND THE CARBON BONDS

When Mr. Tamez mentioned the generation of the RECs or Carbon Bonds, he was immediately interrupted by Karina, the professor with great expertise in finance, and with a questioning look said: - Would you please explain to us, Mr. Tamez, the relationship between the burning of methane gas by the biodigester made out of swine feces with the generation of Carbon Bonds?

- Sure Karina, Mr. Tamez replied, on December 11th of 1997, the industrialized countries got together at Kyoto, Japan and they were committed to execute a set of measures in order to reduce greenhouse gas emissions. These are: water vapor, carbon dioxide, methane gas, nitrogen oxide, ozone, and artificial refrigerants. Governments that signed the Kyoto Protocol agreed to reduce an average of 5% of polluting emissions between 2008 and 2012 taking as reference 1990 levels. For example, if during 1990 the pollution of these gases reached 100%, at the end of the year 2012 the percentage should be 95%. The agreement began to take effect the 16th of February of 2005. The objective of this international agreement is to limit the greenhouse gas emissions globally. Mexico, itself, signed the agreement of the United Nations Framework Convention on Climate Change (UNFCCC) the 7th of May, 1993, and ratified the Kyoto Protocol the 24th of November, 2000. Additionally, the 25th of April, 2005, the Mexican Official Federation Journal (Diario Oficial de la Federacion) announced the creation of the Mexican Climate Change Commission (Comision Intersecretarial de Cambio Climatico), constituted as the Mexican National Authority designated to write the approval letters for the projects related to the reduction of polluting emissions and the capturing of greenhouse gas emissions.

- I'm telling you all of this, Mr. Tamez said to Karina, so you know that the necessary legislative framework already exists in Mexico, so we could now venture into the so promising international Carbon Bonds market. The Kyoto Protocol establishes mechanisms where emerging markets can help industrialized countries fulfill their commitments on greenhouse gas emissions reduction. These mechanisms are: Emissions Trade and Clean Development Mechanism (CDM), which indeed represents an interesting opportunity for Mexico's participation. If we succeed in generating a CDM project that reduces greenhouse gas emissions as the biodigester does, then the methane gas emissions that we achieve to reduce can be certified, and after Reduced Emissions Certificates (RECs) are generated we can sell them to industrialized countries so they can fulfill their emission reduction goals. This way, the RECs or Carbon Bonds that we succeed to certify, can be sold in the international Carbon market either to enterprises or governments of several countries. The income that we, farmers, could get through the sale of RECs, could be used to finance the biodigester construction project, of course, once the construction had been approved as a CDM project by the United Nations (UN). It was decided to have a specific measurement unit as a trade exchange base in this emissions market, the CO2 ton was chosen as such unit, known as the "Equivalent Carbon". A Reduced Emissions Certificate (CER) is equivalent to a carbon dioxide ton that is not emitted into the atmosphere at all and that can be sold at the Carbon market to industrialized countries.

In the projects listed by the UN as those that capture gas emissions, we can find the following: recovery of methane gas from mines, landfills, and/or farms, with the purpose of burning it, or to generate electricity taking into advantage the energy produced by the burning process. In this specific area is where we, swine production farmers of Nuevo Leon, could actively participate. In practical terms, it is estimated that a Carbon Bond could be obtained for each pig per year. In my particular case, we could have 1 1 ,200 CERs as a registered base line, of course, if we have the required animal inventory.

- According to the Kyoto Protocol guidelines, Mr. Tamez insisted, the methane gas generated by the biodigester, would be property of the producer and could be used by him with the condition that all of it should be burned, that no methane residuals are left, and that everything must be transformed into carbon dioxide, having the biodigester 's wick permanently burning.

Methane gas can also be used as a heat source in heating systems for small pigs or as a fuel replacement to keep motors running at the farmhouse or at the employees' houses, or for electrical energy generation to use at the farmhouse, and/or to be sold to the Mexican Federal Electricity Commission (Comisión Federal de Electricidad or CEE).12

- If we succeed to get support from the United Nations (UN) to build the biodigesters, Mr. Tamez commented in a nostalgic manner, there would be no cost for the producers; on the contrary, they would get all the benefits from the generation and sale of Carbon Bonds, or the Reduced Emissions Certificates (RECs) (Merla 2009). The enterprise that would build the biodigester, endorsed by the UN, would recover its investment with the Carbon Bonds sale at the stock exchange market, leaving an approximate profit of 10% of their value to the swine farms. All this process would be performed by Specialized Financial Institutions, with a process that I will explain to you all a little bit later. Every swine production farmhouse, depending on its dimensions, could produce around 5,000 Carbon Bonds from which the farmhouse could get an income calculated around $150,000 USD, in a scenario where the bond would be quoted at $30 USD.13 Part of this income, as I already mentioned, would go to the swine farms.

- Going back to technicality, Mr. Tamez added, Carbon Bonds are an international mechanism aimed to reduce polluting emissions into the environment. The U. S. A is now discussing the implementation of an internal carbon market similar to the European one that could boost demand for RECs from 2012 onward.

Karina interrupted again and with an inquiring look, she approached Mr. Tamez with a unique passion for learning and posed a new question: - How many pigs should be included in order for the UN to accept an investment project for Carbon Bonds generation?

- Excellent question, Mr. Tamez replied enthusiastically. The UN does not ask for a specific number of pigs, the problem is that the registration cost of the program at the UN is the same for either 1,000 or 100,000 animals. Due to its high registration cost, in order for it to be profitable, farmhouses need to have a large number of animals. Another high cost that has to be considered is the one related to the yearly auditing process.

- It is important to point out, Mr. Tamez emphasized, that in order to generate Reduced Emissions Certificates (RECs), a greenhouse gas emissions reduction project must fulfill the procedure established by the Kyoto Protocol and by the Marrakech Agreements, which could be summarized in two: make a study for the feasibility and design of the project and present the documentation required for the Clean Development Mechanism (CDM). In order to fulfill the requirements, there are Specialized Financial Institutions such as MGM International Group (MGM Carbon Portfolio), JP Morgan, Ecosecurities and AGCERT, among others, which could offer support to the swine farms. The cost of the process in time and money is too high for only a single farmhouse; therefore, we have been thinking that several farmhouses could get together. The objective would be to have a project that could support 9 farms so that each one could build a biodigester and have a motor for electric energy generation.

- Now, Mr. Tamez concluded, if the biodigester would contribute to avoid methane gas emissions into the atmosphere, to reduce water pollution, and to generate electric energy to be used at the swine production farmhouses, could you, talented group of professors, help us understand the process of Carbon Bonds generation? How could we obtain them? How could they be traded in the Stock Market? What related experiences to this matter already exist worldwide? In what way could you give us counseling? Could you complement our technical knowledge about swine cattle with the financial approach in order to boost our entrance into the new Carbon Bonds world?

EPILOGUE

After saying goodbye to our dear friend Mr. Jose Luis Tamez and thanking him for sharing with us the dilemmas faced by the Swine Farms Union of Nuevo Leon, we left Montemorelos with an ocean full of questions in our minds. We don't know the precise mechanisms to participate in the Carbon Bonds Trade at the Stock Exchange. Technically, what are the Carbon Bonds or RECs? How are they emitted? How are RECs quoted at the Stock Exchange? How could the swine farms venture at the Stock Exchange in order to sell these RECs? What is the trading process? Are there medium and long term risks? Is there any government support for this matter? Does Mexican legislation facilitate REC emissions? Would swine cattle farms really receive a benefit in this process? Would the involvement of the swine farms in this process be worthy? Would the world be better? Would the generation of RECs in developing countries improve the world environmental protection? How are the relations among the swine farmers, the UN, RECs emitting entities, and intermediary companies such as MGM International Group (MGM Carbon Portfolio), JP Morgan, Ecosecurities and AGCERT? How are they regulated? We should do research and learn more about this subject before venturing out to offer any type of consulting and advice to the Swine Farms Union of Nuevo Leon.

On our way back to Monterrey, all of us meditated about the subject, thinking about our great adventure and everything we learned from Mr. Tamez, when Dr. Jaime Gonzalez suddenly interrupted our thoughts by saying: - Colleagues, since the Industrial Revolution and mainly due to the intensive use of fossil fuels in industrial and transportation activities, the world is facing a serious increase of greenhouse gas emissions that have damaged the atmosphere, altogether with other serious human activities such as deforestation, that have limited the atmosphere's regenerative capacity. These changes cause a gradual increase on earth temperature, the so called climate change or global warming, which at the same time triggers other environmental problems. We have just heard about a specific case where hardworking men are trying to make an effort to contribute with the heavy duty of fighting against global warming. How could we help them?

Dr. Gonzalez continued talking with great seriousness, - while I was listening the passionate narrative of my good friend Jose Luis Tamez, I remembered some words once said by Donald McGannon, who was Executive President at Westinghouse: "Leadership is action, not a position" . That is my vision of my generous friend Jose Luis Tamez. I see him as a leader looking for action. And I agree with him! Each one of us should become a role model and get involved with people, trying to inspire them as Mr. Tamez is struggling to do with the Swine Farms Union of Nuevo Leon. Let's get involved and help him.' Our support to his initiative could be a way of telling our Mother Earth that we care!

Fighting to protect the environment is also a way to find the best of ourselves. I hope that, as an interdisciplinary group of professors, we could collaborate with this Swine Farms Union of Nuevo Leon and send them a concrete proposal so they can succeed on their venture of participating in the Global Carbon Bonds Trade in favor of preserving our planet.

Subject: Swine houses; Water pollution; Biogas; Kyoto Protocol; Case studies

Location: Mexico

Classification: 9173: Latin America; 1540: Pollution control; 8400: Agriculture industry; 9130: Experiment/theoretical treatment

Publication title: Journal of Business Case Studies

Volume: 6

Issue: 4

Pages: 67-77

Number of pages: 11

Publication year: 2010

Publication date: Jul/Aug 2010

Year: 2010

Publisher: Clute Institute for Academic Research

Place of publication: Littleton

Country of publication: United States

Publication subject: Business And Economics--Management

ISSN: 1555-3353

Source type: Scholarly Journals

Language of publication: English

Document type: Business Case, Feature

Document feature: Tables References

ProQuest document ID: 744082279

Document URL: http://search.proquest.com/docview/744082279?accountid=38610

Copyright: Copyright Clute Institute for Academic Research Jul/Aug 2010

Last updated: 2013-09-06

Database: ABI/INFORM Complete

Document 44 of 100

ROMI-Driven Sales Promotions: How the Biggest Coca-Cola Bottler Outside of the U.S. Learned How to Measure the Impact of their Sales Promotions

Author: Waller, Nico Schinagl

ProQuest document link

Abstract:

As part of the arsenal of marketing, sales promotions are strategies wherein an incentive is offered to the final consumer or customer to impact sales in the short term (not to exceed three months). Also part of the family are trade promotions that have the same objective, but whose incentives are targeted to the channel of distribution or the POP owners instead of the final consumer. By this definition, one would suppose it is one of the tools of marketing that is the easiest to measure in financial terms because of its short-term nature and specific aim to impact hard metrics, such as sales vs. other campaigns, that try to impact soft metrics, such as brand consideration of purchase intent. Sadly, as the market study presented indicates, few marketing executives, well knowing the exact costs related in each promotion, bother to estimate the required resulting sales to obtain an attractive return on investment and few and far between do a post-mortem examination to quantify the real returns. As such, the objective of this paper is to present an easy methodology to evaluate, before and after, in financial terms, sales promotions of all different types and of all verticals, whether they are B2C or B2B. Also, an in-the-field assessment of the methodology will be presented inside the promotional division of FEMSA, the biggest Coca-Cola Bottler in the world (outside of the US) which performs over 300 promotions per year. The example will serve to illustrate how to implement and replicate this methodology inside of other companies, as well as give evidence of its impact. [PUBLICATION ABSTRACT]

Full text:

INTRODUCTION

In today's marketing environment in which the traditional mass media has already started its decline with the ever-increasing zapping, the penetration of DVR solutions, and the devastating reality of only a 9% result in day-after recall surveys of television spots2, new and more direct approaches are ever increasingly the focus of the marketing budget.

In this research, an old and well acquainted tool is sales promotions which target the final consumer (in a B2C environment) or customer (in a B2B environment) with an incentive to impact sales in the short term (not to exceed three months).

Trade promotions, normally targeting the final consumer or customer via the channels of distribution, in the case of B2C, the owners of the point-of-purchase, and in the case of B2B, the channel partners that promote the company's product or services, is also a well used tool to impact sales.

They are normally considered penetration strategies due to trying to sell more of the same (up-sell) or promoting a new product launch or an extension of an existing product line (cross-sell) to the existing customer base. Some, of course, also have the added benefit of attracting new customers of the mercenary type; i.e., customers with little brand loyalty and easily motivated to temporary switch brands due to a price incentive.

The incentives given normally determine the type of sales promotions, whether it is trying to increase sales via product or a financial benefit. Following is a brief description3 of the types of sales promotions:

Product Incentives: In this category, there are three main and highly-used types of sales promotions:

1. On-Pack, easily described as a promotion that puts together two different products, whether from different brands of the company or an extension of a product or service line. Two main objectives besides the desired increase of sales, are to be encountered:

* To support a product or service launch, by giving the existing customer base a chance to try out the new product or service for free, in their regular purchase

* To aid a weak product or service that is currently not obtaining the desired sales levels

2. In-Pack, also easily described as all promotions inside the package (i.e., 20% additional product for free is a well-known example). It also has secondary objectives, such as:

* To increase the frequency of use or consumption of the existing customer base

* To become a temporary bridge in an intended change or upsize of packaging

3. Volume, which, by definition, is a promotion of the same product, but divided in several packages (i.e., the two-for-one promotion is a perfect example).4

Financial Incentives: In this category, there are promotions in which the customer or consumer perceives a direct financial gain when entering the promotion:

1. Discounts have been a very traditional mechanism, especially for seasonal items; but there is a trend to minimize these kinds of promotions since they can affect the brand value of the product or service.

2. Contests in which the consumers have a chance to enter a skill-based contest after a random selection of the participants. Often, since the participants-to-be have to send in or register on-line, it is a disguised market research program.

3. Prizes, described by its true random nature, in which a consumer, just by registering its purchase and without any skill, is selected as the winner of the promotion5

Trade Promotions: As mentioned, these are directed at the owners of the point-of-purchase (B2C) or the channel members (B2B)6 and are classified as:

1. Communication in which, by a given incentive, the POP owner allows special communication marketing material to be placed in strategic locations

2. Shelf Space in which the POP owner receives, from the company, special shelf space options or designs, such as refrigerators, to be placed in high traffic zones

3. Incentives & Bonuses where special sales incentives are provided to the external sales force present at the point-of-purchase

Independently of which type, all promotions have, as the main objective, to achieve a temporary rise in sales - called the promotional lift7 - compared to the historical trend of sales, called the base line, as illustrated in Graph 1.

Any promotion that does not generate this lift is automatically called a failure; but even successful promotions - those that make the objective of creating a promotional lift - can be summed up in three levels, as shown in Graph 2.

* Level 1 : are considered promotions that gain a promotional lift during the campaign, but provoke a negative impact on sales after the promotion expires. Also called the roller-coaster effect, it is often due to the predictable nature of the reoccurring promotion, thus making the savvy customer base await the promotion to stock up on product.

* Level 2: are the promotions that meet their objective of increasing sales, and, after the promotion is over, return to historical base line levels. It is by definition a successful promotion, since it increases sales temporarily without sacrificing future income.

* Level 3: are the champions of promotions, since, not only do they obtain the desired promotional lift, but once the promotion expires, sales stay at higher than base line levels. This is normally achieved, due to the fact, that the promotion brought new customers to the table or increased the frequency of use or consumption of the existing customers8.

Market Study

To determine which sales promotion types are considered to have the most impact on sales, a market research was held, including only marketing managers and brand managers. The total size of the sample represented 112 participants that accounted and controlled yearly marketing budgets of US $462 million dollars, a signal of the senior level of management included in the survey.

As expected, over 80% of the marketing executives in the survey admitted to not being able to measure ROI metrics of all their marketing campaigns, with 67.1% admitting only to be able to measure about 10% of their yearly campaigns, although the majority (57.2%) mentioned they had all the necessary information.

METHODOLOGY

To evaluate any promotion, it is necessary to be able, in financial terms, to predict the promotional lift required to achieve an attractive ROMl, as well as to calculate the final results. In this paper, the first shall be called the "quick test" and the latter, the "post-mortem" analysis. For both, the following metrics have to be defined:

* Investment: This is the sum of all costs related, directly or indirectly, with the promotion. Not only fixed investment, but also costs of opportunity, such as price discounts or diminished profit margins are a part of this metric.

* Desired ROMI: This constitutes the rate of return determined by the company as their minimum expected return, or hurdle rate. This ROMI differs greatly from one company to the next, depending on its risk aversion. A useful rule of thumb is to set the desired ROMI at least 3.5 times the risk-free market rate.

* Required Results: These are the additional sales related to the promotion, but translated into the profits the promotion produces for the company. The required results must offset the investment as well as generate the desired ROMI.

* Average Transaction: This represents the financial sales results expressed, not in monetary terms, but in the company's stock keeping unit9.

* Profits Generated: This is the amount of the profit generated by each average transaction of the promotion (i.e., by each SKU or stock keeping unit sold).

Quick Test

In a world in which the marketing teams are staffed by highly creative, but often non-financial oriented staff, the quick test is designed to easily calculate the increase of sales or promotional lift required to achieve the desired ROMI. As shown in Table 1 , this allows the decision maker to determine the realistic or unrealistic nature of the promotion.

Once knowing the investment of the promotion, the desired ROMI, the base line sales, the average transaction, the profit margin, the duration of the promotion, as well as the number of POP in which it will be applied, the quick test allows one to determine:

1. Required Results = Investment x 1 Desired ROMI

2. Profit Generated = Average Transaction x Profit Margin

3. Required Results in Units = Required Results/Profit Generated

4. SKU per POP per Month = Required Results in units/# POP/Duration of Promotion

5. % Increase in Sales = (SKU per POP per Month/Base Line Sales) x100

Example

A company wants to invest US $30,000 in a promotion, targeting via a coupon valid in the nine existing POP establishments, and desires a minimum ROMI of 18%. The service they provide costs US $660 under a yearly contract with a profit margin of 42%. Currently the company has an average of 320 service contracts per POP and the intended duration of the promotion is two months.

1. Required Results = $30,000 x 1.18 = $35,400

2. Profit Generated = $660 x .42 = $277.20

3. Required Results in Units = $35,400/$277.20 = 127.7 SKU

4. SKU per POP per Month= 127.7/9/2 = 7. ISKU

5. % Increase in Sales = 7.1 SKU/320 SKU = 2.22%

Post Mortem

As mentioned, the quick test is to evaluate the feasibility of the promotion and to predict the required promotional lift to ensure the desired rate or return; but promotions have to be evaluated, not only before the event, but certainly after the promotion has expired, to determine the real ROMI obtained. The calculation is shown in Table 2.

Where10

* Return = Profits - Total Investment

* Obtained ROMI = Return/Total Investment

Example (Continued)

In the example, after the promotion has expired, the real sales figures allow to make the post-mortem analysis. The real sales amounted to 142 service contracts at the US $660 rate, providing a profit for the company of US $39,362.40. Thus,

* Return = $39,362.40 - $30,000 = $9,362.40

* Obtained ROMI = ($9,362.40/$30,000) x 100 = 31.2%

As shown in the example, the minimum desired ROMI was surpassed and the real rate of return resulting from the promotion is 31.2%.

CASE STUDY: FEMSA

Coca-Cola FEMSA is the largest Coca-Cola bottler in Latin America and the second largest in the world, accounting for one out of every ten Coca-Cola products sold globally. The company began operations in 1 890 with the founding of a brewery in Monterrey, Mexico. Today, over a century later, it has grown from a brewer into a complete beverage company with integrated soft drink, beer, and retail operations.

It's core business is represented by soft drinks, a division that accounts for 56% of operating profits (in the year 2006, the company reported operating revenues of US $1 1.6 billion with US $1.6 billion in operating income), and in which they have over 70 brands, including the whole Coca-Cola line. Their distribution reaches more than two million points of sale throughout Latin America and is divided in the home market segment and the on-premise segment, which includes all food and entertainment establishments.

In Mexico, the 250,000 plus top accounts, whether on-premise or home market, are attended by the channel division that manages around 300 different promotions per year. Ironically, before the intervention, no financial analysis was being made before or after each promotion; thus, there was no true knowledge of which promotion had been a success or failure.

For the Business Plan (or BP 2008), ROMI analyses were being implemented for the first time, allowing to evaluate via the quick test, the feasibility of the proposed promotion before their deployment in the field. A 40% desired ROMI was established to measure each promotional idea and a promotional lift of no more than 5% was placed as a realistic possible impact for any particular promotion (on the basis of market growth and penetration).

With these guidelines, any proposed promotional idea that looked good on paper was passed through the quick test. Promotions that needed a promotional lift of over 1 0%o of sales were immediately eliminated due to their unrealistic nature. Promotions that required a promotional lift between 5 and 10% were revised to detect if the required investment could be reduced to lower that percentage. Finally, promotional ideas that only required a below 5% promotional lift and produced the 40% desired ROMI were included in the BP 2008.

An example of a promotional campaign for the mid market segment can be seen in Table 3, considering an average transaction measured in Unit Cases of US $3.5 and a profit margin of 30%, and with the promotion having effect throughout the year, in which:

* The required results equal US $2,142,000 or Total Investment x IDesired ROMI.

* Profits Generated per SKU or CU equals US $1.05 or Average Transaction x Profit Margin.

* Required Results in Units equal 2,040,000 CU or Required Results/Profits Generated.

* Units per POP per Month result in 4.3 CU or Required Results in Units/# of POP/12 months.

* Finally, the % of Increase of Sales equals 2.3% or Units per POP per Month/Base Line Sales.

As shown in the example evaluation of the promotion, it falls in the guidelines established by the company, and, as such, was included in the BP for 2008. Of course, a post-mortem evaluation will have to be done at the end of the year to identify if the desired ROMI was met or even exceeded.

One certainty is unquestionable in that FEMSA, for the first time, will be able to say with a high level of confidence, which of the 300 different promotions executed in the fiscal year 2008 were successes and which turned out to be failures, making the creation of the Business Plan 2009 a much easier task.

Subject: Sales promotions; Distribution channels; Soft drink industry; Market research; Case studies

Location: United States--US, Mexico

Company / organization: Name: Coca-Cola Femsa SA; NAICS: 312111

Classification: 9190: United States; 7200: Advertising; 8610: Food processing industry; 9173: Latin America; 9130: Experiment/theoretical treatment

Publication title: Journal of Business Case Studies

Volume: 6

Issue: 4

Pages: 79-87

Number of pages: 9

Publication year: 2010

Publication date: Jul/Aug 2010

Year: 2010

Publisher: Clute Institute for Academic Research

Place of publication: Littleton

Country of publication: United States

Publication subject: Business And Economics--Management

ISSN: 1555-3353

Source type: Scholarly Journals

Language of publication: English

Document type: Business Case, Feature

Document feature: Graphs Charts Tables

ProQuest document ID: 744083058

Document URL: http://search.proquest.com/docview/744083058?accountid=38610

Copyright: Copyright Clute Institute for Academic Research Jul/Aug 2010

Last updated: 2013-09-06

Database: ABI/INFORM Complete