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Page 1: Crafting (Cases)

Strategy

MGlvlT 402

lnstructor:Jai Goolsarran

Centennial College

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Page 2: Crafting (Cases)

Thompson-Strickland-Gamble c Crafting and Exectr[ing Slralegr: Concepts and Cases, lTrh E(tilion

Whole Foods Market in 21XI8: Vision, 9qre Values, and Strategy

Case

0ell lnc. in 2llll8: can it 0wtake Hewlet-Packard as the worldwide Leader in personal

Gomputers?

$sulhwe{Aidines inZltls: Gulture, Valueg and 0peratinn Praatices ,- _ SCase 63

Thompson-Strickland-Gamble . Gnlingand,Ereculr:rrgSlrateg: Concepts and Cases, ISth Edition

Slarbqcks' Global Ouesr in 2lXl6: ls the BBst Yet to gome?

Thompson-Strickland-Gamble . Onling awl ExeculingSlratcgr; Conccpk and. Casa, 17th Edition

Nucor Gor0sration: Competing against Low-Cost Steel lmports

Case

Wal-Mart Storcs Inc. in2lt{18: Management's lnitiativesto Transform the Company anrtGurtail Wal-Mart Bashing

94

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Page 3: Crafting (Cases)

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Graftirg and ExecutingStralegp Goncepts aad

Gases, lTth Elmion

ICase l: llllhole Fooils I Gasa

lllE*et in 2S& Vision.

Core Values, and Stmtegy

I @ The Mccrarv-Hitt

Companies.20l0

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: :!a comDouno annual rale oI iu Dercent slnce lyyl' un6 2il percent since 2O00flfianagement's near-

'r ,: term growth objeCtives for Whole Foods lvere to.:, have 400 stores and sales of $12 billion in fiscal

1:,,, q, Vear 2010.J ,..:: r-l:..' , , Durirfg its 27-year history Whole Foods Market

,,.. .' ' trad been a leader in the natural and organic foods: movement across the United States, helping lhe

: ' industry gain acceptance among growing numbersl ' , ,-of consumers concerned about the food they ate-

LTh" cornpany sought tg^.ojfgr-the highest quaiity,, : least processed, most flq]-q{$ and naturally pre-

Ju,'.ir. served foods available..fohn Mackey. the company's',, ,; ,, i-of6uqaer ana CEbi, believed thai whole ioodr'

"' i rapid grou'th and market success had much to dorvith its having "remained a uniquely mission-driven

i company-highly selective about-rvlrat-rve sell, ded-,i,t*-E icated to our iore valueqandffitifrirquality stan-

dards and committed to ft taffiag riculture."[- Mackeyt r.ision uEs-6r Mrole Foods to

become an international brand syronymous not justrvith natural and organic foods but also x,ith beingthe best food retailer in every cqgrmunity in rvhichWhote Foods stores *,"r" lo.at"dlhe rvanted WholeFoods lvtarket to set the stanGd for excellencein food retailinfl'(Mackey's philosophy rvas that

,/,-... . . 1/-':r "' -:

Copyright €i 200S by i\rrhur A. Thompson. .{ll rights reseo-ed.

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CASE Wfu.,#3.e F*ods &&aeE<e€

sEa 2##8: Vasi*ca, WFE-\/

Eie3.ea€s) ald Scra'tegy

, Arthur A. Thompsont,,, TI* Univeriiqr ofAlabama l

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. rr. . ffiF;unded ip,, 1 ggil| Whole Foods Market' wqlyed,,'.. ffinoma.localtup erlrctfornatural andffitr' 'El', fciods in:Austin; Texas,jnto the world's largest

, .,.,'ieriil chain of nitural'and d;ffiriil foods supermar-:i:,r ks1s.:I'ha'compariy had 2007Gles of $6.6 billion

marketing high-quality natrual and organic foods tomore and more customers in more'and more com-munities rvould over time gradually transform thediets of individuals in a mannerthat would help themlive longer. heqt$ie,r* more pleasurable lives. But as

the companyt@fftVt ole Foods, Whole Peopte;Wlrole Planet" implied. its core mission extendedrvell beyond food retailing-:,see Exhibit l. At itsWeb site, the company proclaimed that its deepestpurpose as an organization was helping support thehealth, rvell-being, and healing of both people-customers, team members, and business organiza-tions in general *and the planet.l

TFIE-FJATURAL Ah$D

as "natural" or organic-about $62 billion in 2007-represented about 7.3 percent of the roughly 5850billion in total U.S. grocery store sales. Naturulfoodsare defined as l'oods that are mlnipglly processed:largely or completely free of ah'iflElal ingredients,preservatives, and other non-nanrally occurringchemicals; and as near to their rvhole, nahlral stateas possible. lllre U.S. Department of Agriculture'sFood and Safety Inspection Sen ice defines natumlfood as "a product containing no artificial ingredi-ent or added color and that is minimally processed."While sales of natural foods products had increasedat double-digit rates in the 1990s, grorvth had slorvedto the 7-9 percent range since 2000.

Page 4: Crafting (Cases)

Ilompsor.Sticlland-{irmhle:

Gralting rnd Frecuting

Strategp Concrlls and

Casas, l?lh Editaon

Gese l: UUhola Foods

Markot in 8l0& Visiotr,

Core Yalues, and Strategy

Case I Whote Foods Market in ?008: Vision. Core Values. and Strategy

Exhihit 1 Whole Foods Market's Motio: Whole Foods, Whole People, Whole Planet

Source; Company overview posted at J\i.r.:ti:,ii:.ii*iiii:ii:i:ilii-i.:jiiiii {accessed March 21, 2008), and 200? 10-K [eport, p.5.

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Whole FoodsWe obtain our producls locally and from ali oGr rhe world, often from smatl; uniqueiy dedicated food artisans. Wa ',strive to offer the highest quality, least processed, most flavorful and naturalty preserved bods.We believe lhat foodin its purest state-unadultelite!-by artificial addilives, flyeeteners, colorings and preservatives-is the best lasting,a nd most nu tritious fooclEva-lable)

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w" ,"r*lt tf" Uest peoge w9 9rn to ulcome part of our team. We empower tnem to mati" ;"ny of "rarional-i

,. , .' i

. ..decisions, creating a respectful worlqlace where team members are treated fairty and are highly motirrated to jwrce€d.We look for team members who are passionate about food, but also well-rounded human beings who can play a criticalrole in helping build our Comparry into a prolitable and beneficial part of every community in wnicn we opente.. .;: . , , . :.. r.,i ....':::...... ..:. ... ..1

, ,,,,:.,:, ,: ,, ,:,,,We believe companies, like individualg must assume lheir share of respbnsibilig for our plinet. We active[r SUpport :

organic farming on a global basis becausa we believe it is the best met-hod for piomoting'sustainable agricirnuie .

and'protecting the environment and farm workers. On a local basis, we are actively invotveO in our com-rnunities by, ;

supportlng food banrc, sponsoring heighborhood events, and contributing at least 5 percent of our after:tax profitJ. ,.

in the form.of cash or products to not-for-prollt organizations- . ., . . ., ; .,1 ..,-.. : .,,. , .. f. 1r',,.,

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l"{ 'd{ ,"nOrganic foods were a special dubset of the narural

foods category; to be labeled as offiic, fqqdChad{q"be grorvn o-rd pro""ss"dnv-ighgrl-th-e ,se offfiifi$sj*'o n tlb i oti

"r, horm on es, ffi {ff p [e^prical s'l*i fi

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feffiEers.'preservatives, #bi*ffi tiu*r, o. g"#"fiS'en gii-eerin g. Organic fooilf incl uded fresh fnrG-andvegetables, meats, and processed foods that lrad beenproduced using any or all of the follorving:

(USDA) officially established labeling standards for Iorganic products, overriding both the patclrwork ofhinconsistent state regulations for rvhat coriliiEilabeledas oryanic and the different rules of some 43 agenciesfor certi$ing oryanic products. The nerv USDA regu-lations established fourcategories of food rvith oryanicingredients, rvith varying lqvels of organic purity:

l. 100 percenl organic prcdacts: Such productsrvere tsually rvhole foods, such as fresh fruitsand vegetables, grorvn by organic methods-rvhich meant that the product had been grotvnu,ithout the use of synthetic pesticides orsewlys,e-based fertilizers; had not been subjected io irra-diation; and had not been genetically modified orinjected rvith bioengineered organisms, _erorvthhormones. or antibiotics. Products that rvere 100

Dercent orsanic could carrv the ereen USDALrgani c ."ii n c ati o# ffi "frH.i a*o

-u'," merchan t

could document that the food product had beenorganically grorvn (usually by a certified organicproducer).

Organie pruducts: Such products. often pro-cessed. had to have at least 95 percent organicallycertified ingredients. These could also carry thegreen USDA organic certification seal.

lutade *'ith otganic ingrcdients: Such productshad to have at least 70 percentoryatic ingrediens;they eould be labeled"made with organic ingredi-ents" but could not display the USDA seal.

. Agriculrural mauagement pragices, $tgt pro-moted a healthy and renervabte e.@ifiiift.'These

, t practices could include no genetically engineered

l,.1 c1n^,' seeds or crops, petroleum-based fertilizers, fer-' t ) filizers made from se$age sludge. synthetic pes-ticides, herbicides, or fungicides.

. Livestock management practices that involvedorganically grorvn feed fresh air and outdooraccess for the animals, and no use of antibioticsor growth hormones.

. Food processing practices that protected theintegriry of the organic product and did notinvolve the use of radiation, genetically modi-fied organisms, or synthetic preservatives.

In 1990, passage of the Organic Food Production Actstarted the process of establishing national standardsfor oryanically grorvn products in the United States.a movement that included farmers, food activists.

t lf

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"l;-H.ti, conventional food producers. and consuner grcups." ) "' ; In October 2002. the U.S. Department of Agricutrure

Page 5: Crafting (Cases)

I nonrpsm-SrricUaad-tiasrble: I

Cralling afid Erecuting

Strategf Cqncepls and

Casag tTth Edition

I

Gasel:WhoteFoods I Case

Markcl in 200S: Uision,

Co,e Vallres, aDd SlrategX

@ The McGral-Hill

Comparues, 2010

Part 2 Cases in Crafting and fxecuting Strategy

d. All other prcducts rvith oryanic ingrcdients:Products with less than 70 percent organicingredients could not use the rvord orgaric onthe front of a package. but organic ingredientscould be listed among other ingredients in a lessprominent part ofthe package.

An official rvith the National Or-ranic Program,commenting on the appropriateness and need forthe nerv USDA regulations, sai4 "For the first time,rvhen consumE{stpg"the rvord org-anic on a package,it rvill have ctrlsi[ffiHt meaning."2 The nerv labelingprogram rras notlnGnded as ihealth or safety pro-gram (organic products have not been shown to be

more nufitious than conventionally grorvn products,according to the American Dietetic Association), butrather as a nra*eting solution. An organic label hadlong been a selling point for shoppers \vanting to avoidpesticides or to support environmentally friendlyagricultural practices. Horvever. the nerv regulationsrequired documentation on the part of growerc. pro-cessors, ei{porters, importers, shippens, and merchantsto verify that they were certified to grorv. process, orlundle organic products carrying the USDA's organicseal. In 2003, Whole Foods was desiErated as the

first national "Certified Organic" grocer by QualityAssurance lnternational, a federally recognized inde-pendent third-party certifi cation oryanization.

According to the Organic Consumers Associa-tion. sales of organic foods in the United States hit.$17 billion in 2006. up 22 percent from $13.8 billionin 2005. When natural foods and beverages (definednarrorvly as those rvith no artificial ingredients) werelumped in rvith organic foods and beverages, ttre U.S.

retail sales total camilto $28.2 billion in 2006, upfrom $23.0 billion in 2005. Natural and organic foodsand beverages were projected to reach nearly $33 bil-lion in 2008. Organic food sales rvere said to repre-sent about 3 percent of total U.S. retail sales of foodand beverages. About 3l percent of orerall organicsales in 2006 rvere tluough mainstream supermarkets/grocery stores. and 24 percent rvere thrcugh the lead'ing natural food supermarket chains such as WholeFoods. Wild Oats, and Trader Joe's. Another 22 per-

cent of all organic sales rvere through independent,small natural grocery store chains. Organic foods and

beverages rvere arailable in nearly every food cate-gory in 2008 and rvere available'in over 75 percent ofU.S. retail food stores. Most observers believed that

organic products had staying power in the market-place as opposed to being a passing fad.

lvlajor food processing companies like Kraft,General Mills, Groupe Danone (the parent of DannonYogurt), Dean Foods, and Kellogg had all purchasedorganic food producers in an effort to capitalize ongrorving consumer interest in purchasing organicfoods. I{einz had introduced an organic ketchup andbought a 19 percent stake in Hain Celestial Group,one of the largest organic and natural foods produc-ers. Campbell Soup had introduced.organic tomatojuice. Starbucks, Green Mountain Coffee, and sev-eral other premium coffee marketers rvere market-ing organically grorvn coffees; Coca-Colat Odrvaliajuices rvere organic; Del Monte and Hunt's were mar-keting organic canned tomatoes; and Tyson Foodsand several other chicken producers had introducedorganic chicken products. Producers of organicallygtorvn beefrvere selling all they could produce, andsales were expected to grow 30 percent annuallythrough 2008.

Organic farmland in thq United States totaled4.1 miltion acres (about 1.7 million aoes of croplandand 2.4 million acres of rangeland and pasnre.l in2005. up from 2.1 million acres in 2001.3 There rvere8,400 certified organic farms in 2005. and perhapsanother 9,000 small farmers grorving organic prod-ucts. All 50 states had some certified organic farmland'rvith California- North Dakota, Montana. lvlinnesotaWisconsin. Texas. and ldaho havjns the larsest amountof certified oryanic oH&@ffihit only ibout I per-

cent of U.S. fqrmland rvas certified oryanic in 2005,farmers rvere 6ecoming increasingly,i9lg:esled in andattracted to organic farming. chiet$tiffifse of thesubstantially higher prices they-could get for oryani-cally grorvn fruits, vegetables, and meats.

ffiEMILIh.gc GF GMGA$qilCFOSDSAccording to the USDA. 2000 was the first year intvhich more organic food rvas sold in conventionalU.S. supermarkets than in the nation's l4.5p0lpaturalfoods stores. Since ?00?, most mainstr#8tfi'tuper-markets had been expanding their sffins of nitu-ral and organic products, u,hich ranged fronr freshproduce to wines, cereals. pastas. cheeses. yogurts,

Page 6: Crafting (Cases)

IhonEon-Suickland-0amhter

Clalting aad Execrning

StralesF CoocepB IrdGases. ITth Editioo

vinegars, potato chips, beef, chicken, and cannedand frozen fruits and vegetables. Fresh produce rvasthe rnost popular organic product*leffuce, broc-coli, cauliflower. ceiery carrots, and apples were thebiggest sellers. Meat, dairy bread, and snack foodswere among the fastest-grorving organic product cat-egories. Most supermarket chains stocked a selsctionof natural and organic food items, and the num-ber and variety of items they carried was grorving.Leading supermarket chains like Wal-Mart, KrogeqPublix, Safervay, and Supervah.r/Save-a-Lot had cre-ated special "organic and health food" sections fornonperishable items in most of their stores. Kroger,Publlr, and several other chains also had specialsections for fresh oryanic fruits and vegetables intheir produce cases in most of their stores in 2007.Safervay, Publit, and Kroger rvere stocking organicbeef and chicken in a number of their stores, rvhileWhole Foods rvas struggling tb.{nd organic beef andchicken suppliers big enough to s\ply all its stores.Two chains-upscale Harris Teeterin the southeast-ern United States and Whole Foods.Market*had

-EEq*leir orvn private-label brands of organics.

@i9*J#ows the leading supermarket retailers inTffirTfmerica in 2006. Whole Foods Market rvasranked 24th in ?006, up from 26th in 2004.

Most industry observers expected that, asdemand for organic foods increased conyentionalsupermarke8 tvould continue to expand thqir offer-ings and selection. Supermarkets lvere afhacted tomerchandising organic foods for several ieasons:Consurner demand for organic foods rvas; grorv-ing at close to 20 percent annually, and mount-ing consumer enthusiasm for oryanic productsallorved retailers to command attractively high profitmargins on organic products. In contrast, retail salesofgeneral food products rvere grorving slorvly (in panbecause more and more consumemi were eating outrather than cooking at home).and Rriffiometitionamong rivf' supermarket chains rvas

-@{(rvhich

4grn43# profi t margins on merygrocery items).Seleral factors had cbthbiffild to transform

orgon/,r foods retailing. onc*I'-nicl#;'1f,*.,, in,o tt .fastestgrowing segment of U.SlFood sales:

rifi;' Healthier eating paftelns on the part of a popu-

lace that rvas becoming better educated aboutfoods. nutrition, and good eating habits. Amongthose most interested in organic products rvere

Case l: llYhola Foorls

Msrket inal0& VisiorL

Core Values, and Slratsgy

Case t Whole Foods Market in 2008: Msion, Core Values. and Strategy

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aging, affiuent people concemed about healthand better-for-you foods-

. lncreasing consumer concerns over the purityand safety offood due to the presence ofpes-ticide residues, grorvth hormoues, artificialingredienG, chemicals, and genetically engi-neered,inqredients: ..i )P.,r ..*?iT,i-rlii"';T rr"*t1,-#il"Ioirn"rr, *.ndamong people of many ages and e-thnic groups.

. Grorving belief that organic farming had positiveenvironrnental effects, particularly in contibut-ing to healthier soil and water conditions and tosustainable agricultural practices (rvhich rvas con-firmed by a series of studies done at the Univer-sity of Michigan and the Universiry of lllinois).{

A 2005 survey commissioned by Whole Foodsfound that 65 percent of U.S. consumers had riedorganic foods and beverages, up from 54 percentin both 2003 aud 2004:.27 percent ofrespondenrsindicated they consumed more organic foods andbeverages than they did one year before.s Ten per-cent consumed organic foods several times perrveek, up from just 7 percenr in 2004. The top lhreereasons rvhy consumers were buying organic foodsand beverages lvere avoidance of pesticides (70.3percent), freshness (68.3 percent), and health andnutrition (67.1 percent);,55 percent reported buy-ing organic to avoid genetically modified foods.Also. many respondents agreed that organic foodsand beverages rvere better for their health (52.8 per-cent) and better for the environment (52.4 perceng.The categories of organic foods and beveragespurchased most frequently by those participat-ing in Whole Foods' survey rvere fresh fruits andvegetables (73 percent), nondairy beverages (32percent), bread or baked goods (32 percent), dairyitems (24.6 percent), packaged goods such as soupor pasta (22.2 percent), meat (22.2 percent), snackfoods (22.1 percent), frozen foods (16.6 percent).prepared and ready-to-eat meals (12.2 percent;, andbaby food (3.2 percent).

The higher prices of organic products rvere theprimary barrier for most consumers in trying or usingorganic products-75 percent of those participatingin the 2005 Whole Foods survey believed organicsu,ere too expensive. Other reasons for not consun-ing more organics rvere availability (46. i percent)and loyalty to non-oryatric brands (36.? percent).

Page 7: Crafting (Cases)

I ftoorpson-suicrhnd-Ganbh I

Crafting and Frecuting

Strstegp Goncepts and

Cases lTth Edilion

Gase t:Whote Foorh I Cr,"Market in 2ff1& VisionCom Values ard StrarelU

Part 2 Cases in Crafting and Executing Strategy

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aSales revenue numbers i*clude all store items in Wal-Mart Discount Stores and Supercenters, not just those relaled to tood andgroceries. Sales of grocery candy, tobacco, and health and beauty aids represented aboul 38 petcent ol total sales al Wal-Mart DisctuntSlores and Supercenters.Wal-Marl.s market share percentage is based on grocery- and supennarkel-item sales ol 579,8 billion(38 percenr of 5209.9 billion).b Sales dala lor itoger {vuhose supermarftet braods also include C,ty Market, King Sooper, Ralph's, and 11 smaller chains} includerevenues from all companfowned relail oullels fluel cenlers. drugstores, apperel, and iewetry] that are nol supermarket-related.cThe sales revenue figure for Costco includes all items sold at Cost@ sto€s; sales ol only grocery ltems (food, sundries, tresh produce,gasoline, and pharmary) were 536.6 biltion; the markel share percentage is based on lhat S365 bitlion.d Sales revenue oumbers include all slore items sold al Sam's Glub, not l'ust those related to lood and groceriesi lood and sund.iesaccounted tor 01 percent of sales (about $25.7 billion),The market share percenlage is based on estimated lood and grocery-relaledsales of S25.7 billion.eSales data lor Supervalu includes 1.368 supermarkets {including 1,124 ol whidl wete recently acquired lrom Albertson's), 301 corporale-owned Save-A-Lols, 867 lac-ensed Sarre-A-Lols, anar 3l lhensed Cub Foods stores.t Loblaw is a Canadian chain; sales and maftet shares are based only on Loblaw store sales in lhe Uilited Slales.s Ahold USA , lhe U.S. drvision ol Netherlands.based Ahold, includes 386 Stop & Shops. 192 Giant Foods {Landover, Maryland), 126 GiantFoods (Carlisle, Pennsylvania), and'l 23 Tops Marlets.h Delhaize includes 1,171 Food Uon stores, 158 Hannaford Bros. slores, 108 Sweetbay and Kash'n Kany stores, 68 Hanrey's stores,22 Bloom units, and 17 Bottom Dollarstores.Sources:Wal-Mart:s 2007 lG.K reporl andTop 75 North American Food Belailers.' ;i'+:rr.::ri:r.i::ii.:'..f,1;:-.!:i-:]iiri (accessed March 20,2008).

WhiOLE FCODS MIAHKET

Whole Foods Market lvas founded in Austin, Texas,rvhen John Mackey, the current CEO, and hvo othertocal natural foods grocerc in Austin decided thenatural foods industry rvas ready for a supermarketformat. The original Whole Foods Market opened inI98!yl!& staffof only 19. It rvas an immediate suc-ffirme, there rvere ferver than half a dozennatural foods superrnarkets in the United States. By1991, the company had l0 stores. revenues of $92.5million, and net income of $1.6 million. WholeFoods became a public company in 1992, with itsstock trading on the NASDAQ; Whole Foods stock

Exhihit 2 Leading North American Supermarket Chains, 20o6

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was added to the Standard & Poor's Mid-Cap 400Index in May 2002 and to the NASDAQ-I0O Indexin Decernber 2002.

F**a -EFaE:=sa!{qt! -L- Ei):r*iire+

In 1997, rvhen Whole Foods developed the "Wholefs,qdq;$gl&pk-Whole Planet" slogan, JohnFfteEi1r&ftnrnas a go-gener rvith a "cowboy lvayof doing &ings," said:

This slogan taps into perhaps the deepesr pulposeof Vfhole Foods Market. Itl a purpose rve selclomtalk about because it seems pretentious. but a pur-pose nevertheless felt by many of our team members

Page 8: Crafting (Cases)

thompson-Sti*hnd-Sanble;

Cnfiing and Execrtiog

SlrategF Soncepts and

Cases, l7th Edition

and by many of our customers (and hopefully rnanyof our shareholders too). Our deepest purpose asan organization is hclping support the health, well-being, and healing of both people (customers andTeam Membcrs) and of the planet (sustainable agri-culture, oryanic production and eDvironmental sen-sitivity). When I peel arvay thc onion of my pcrsonalconsciousness dorvn to its core in trying to under-stand rvhat has driven me to create and grorv thiscompany, I come to my desire to promote the generalrvell-being of everyone on earth as well as the eaflhitself. This is my personal greater purposc rvith thecompany and the slogan perfectly reflects it.

Complementing the slogan were five core valuesagemeat and company per-

n the company's 2003 annualE-y said:

Our core values reflect the sense of collective fateamong our stakeholders and are the soul ofour com-pany. Our Team Members. shareholders. vendors.community and cnvironment must flourish togetherthrough their affiliation rvith us or we are not suc-ceeding as a business. It is leadership's role to bal-ance the needs and desires ofall our stakeholdcrs andincrease the produetivity ofWholc Foods Markct. Bygrorving the collective pie. rve create larycr slices forall of our shareholdcrs.

Exhibit S Whote Foods Market's Core Values

Gasa l: Whole Foods

Itllarket in 20[ts: VisionCore Values. and Slrategy

Case I Whole Foods Market in 2008: Vision, Core Values, and Strategy

Sa'*inEiis $ta'ategi+Since going public in 1991, V/hole Foods'grolvthstrategy had been to expand via a combination of j)opening its orsn De\y stores and acquiring small, l/o\tmer-rnanaged chains that had capable person- |nel and were located in desirable markets-the'cogp@t significant acquisitions are showni(Gxhibit 4.}}t since the retailers of natural andS__.-----flo-i$trrTl-oods were mostly one-store oper,itions andsmall, regional chains having stores in the 5,000-to 20,000-square-foot range, attractive acquisitioncandidates rvere hard to find. From 2002 to 2006,Whole Foods'matagemeflt decided to drive growthby openiag l0 to 15 decidedly bigger stores in nret-ropolitan areas each year-stores that ranged from40.000 tq"* f."t to * *,

ihestandard supermarkets operated by Kroger. Safervay,Publix, and other chains.

ThelVild Oats MarketAcquisition In2007,Whole Foods moved to purchase struggling Wild OatsMarkets-Whole Foods' biggest competitor in natu-ral and orgonic foods*for $700 million. Wld Oasoperated 109 stores in 23 states under the Wild OasMarket, Henry's Farmer's Market, and Sun Harvest

Our CoreValuesThe following lisr ol core values eflects what is truly important to us as an organization. These arei not vatues thatchange from time to time, situation to siluation or person lo person, but rather they are the underpinning ol our,company culture. Many people feel Whole Foods is an exciting company of which to be a part and a very specialplace to worK These core values are the primary reasons tor this feeling, and they transcend our slze and our :

growlh rate, By mainlaining these core mlues, regardless ol how large a company \{hole Foods becomes, we canpreserve what has ahmS'truertspecial aboul our company. These core values are the soul of our company.

SeltingtheHighestGualityNaturalandOrganicProductsAvailable :, :,, .:,I Passion for Foo&-We appreciate and celebrate lhe difference nalural and organic products can make in the

quality of one's life.. Qualrty Standards-We have high slandards and our goal is to sell the highest quatity products wa possibly can.

We define quality by evaluating the ingredients, freshness, safety, laste, nulrltive value and appearance of all ofthe products we carry. We are buying agents for our cuslomers and not the selling agents for the manufaclurers.

Satisfuing and Delighting Our Customers '\.. : : : j

. Our Gustomers-They are our most important slakeholders in our buiiness and the lifeblood of our business.Only by satisfying our customers lirst do we have the opportunig io satisfy the needs oi our other stakeholders.

. Extraordinary Gustomer Service-We go to extraordinary lengths to satisfy and delight our customers. We wantto meet or exceed their expectations on every shopping trip We know that by doing so we turn customers into .

' advocates for our business. Advocates do more than shop with us,.lhey ialk about Whole Foods to their friendsand olhers. We want to sen e our customers competently, efficiently, knowledgeably and with ftair.

(continued')

sonn

Page 9: Crafting (Cases)

I lturqson-stichland-Gamtm I

ftafthg and Erecuting

Strategp Conccpts and

Gases, l}th Edidon

c{

Exhihit 3 (Continued)

8asel:!fltrolefoods I C."uMarket inAt@ Vislon.

Core llalues, and Slmtegy

Part 2 Cases in Crafting and Executing Strategy

@ The li,lcGmw-Hill

Companies, ?010

. Education-We can generute grgal9r, qppreciation and loyalty from all of our stakeholders by educaling themi about natural and organic foods, health, nutrition and the anvirc,nment : : :

' : '1.".'. ':.':'r. ' I l:ri ''i,.'

". .'i'... .:1...:1 : 1. .. Meaningful Valu+We offer value to our customers by providin$ them with high quality products, extraordinaryservice and a cbmpetitive price.We are constantly chaltenged to improve the value proposilion to our

' . 'n"iir iniovation-,-Wi *u;'r"t*i';xparirnenti.:Frilndly iompetirion *itiin ti," company'tretp"'r" to continrally': improve our stores. W6, constantly innovale and raisa oui retail standards and are noi afriia to try new ideas and

,::::: 66pqgpl5;:.....,::.:..:.,,- -...'r::..:..ri.:.. .....,.:i.:...i..,,r,., ....t.. ,. . ,, .,,,,. . .,

:rir'.tnvitinEsibreenvkodrtrents...Wecreatdstore'envimnmlnlstliatar"i*iting;ndiun,anO'ietiectrne' ,',, , i,'; communities they serve. We want our stores to become comrnunity megting places where our customers mebt

1 1.',:',1..1ti-...".,..: ..1, ..."., . ". -

. : .: a .

, ; .' gmiiowerhs Work fnviirinmentSjOur success iS dependent upon' titelcolJective energy and intetligence oi.':,:,:.

, , 6tl of our.Team Members. We strive to create a work environment where motlvated Team Members can llourish :,:,.., dndsucceedlolheirhighestpolential.Weappreciateeffortandrewardresults. :: : .. :.::., : : . i

'., ,, setf-Responlioiritv*ir" raie responsibitity ior oui own Cuccess ano failures. We cetebrate iuccess *o :

' , ' . , sse failures'as opportunities for growth. We recognize that we are responsible for our own happiness and ,' .. ,,

success.. Self-Directedfeamiifte firndamental wor[ unit'oi'ttretompany is the:selfdirected feam. Tearns meet,, i ,

regularly to discuss issues. solve problems and appreciate each others'contributions. Every Team Member.belongs.tolaTeam,, :..,r.....',. :.,.... .:...: ..:...:::,.... r r................

:. Open & Timely lnformatioir:We belierre knoMedge is power and we support our Team Members' right toaccess inlormation ihat:impacts thelr iobs. Our books are open to ourTeam Members, including our annualindMdual compensation report. We also recognize everyone's right to be listened to and heard regardless oIlheir point of view. .,,,

:

.. lncremental Progres*Our company continually improves through unleashing the collective creativity andintetligence of all of ourTeam Members. We recognize that everyone has a conlribution to mdke. We keepgetting better at what we do.

. Shared Fate-We recognize there is a community of interest among alt of our stakeholders. There are :

no entitlements; we share together in our collective late. To that end we have a salary cap that limits thecompensation (wages ptus prolit indentive bonuses) oi any Team Member to iourteen times the average totaicompensation ol all fulHimeTeam Members in the company. -i.r".'......r.. ... I I -:i,i!'.. " ',, '

creitingWeiltnffrroughProfitJ&Grovvth:,,.,,.,', , ,, ,t, ,,' ",. , ,,,'., ; ., , . , ,,- ,

. Stewardship-Weare stewards of our shareholders' investments and we take that responsibility very seriously.We are-.committ6-d lo increasing long-lerm shareholder value. , ' :

. Protib:;We Oam our profits every day lhrough voluntary exchange with'our ciistomers. We recognize that'profits' are essential to creating capital for growth, prosperig, opportunity, job satisfaction and job security.:,,CaringAboutOurCommunities&OurEnvironmentl '::::: " -:r::'':i '' : :: 1: : :

. Sustainable Agrieulture-We support organic farmers, growers and the environment'through our commitmentto sustainable agriculture and by expanding the market for organic produc{s. . .

' Wis€ Environmental Practices-We rcspect our environment and recycld, reuse, and reduce our waste ,

t whereveirandwheneverwecan. , t : : I ,'..'.",''';1'. t.i'r':'.'.... Commrinity Citiienship-We recognize our responsibitity to be active participants in our local communities.

We give a minimum of 5o/o of our profits every year to a wide vafiety of communily and non-profit organizations., ln addition; y/e pay ourTeam Members to give of iheir time lo community and service organizations. :

. Integrity inlAll Business Oeating$-Our trade partners are our allies in serving our stakeholders. We'treat, : them with respect, fairness and iniegrity al all times and expect the same in return., : :, , . '

'''"." : 1 '1:"''

:: :I: -

Page 10: Crafting (Cases)

Ilompson-Strkllaad-Samtle:

Cratting and ExeEutirg

Strategp Concepts and

Cases. lTah Edhion

Case l: Wrsle Foods

Marlcet in 2fl1& Visio*,

Core Ualues, and Strategy

Case I Whole Foods Market in 2008; Vision, Core Values. and Strategy

Exhibit 4 Major Acquisitions by Whote Foods Market, t 992-2002

c-9

1992 j Bread & Circusr: ' : :. ,' ,,'r : Northeastern

....,.-.r . . ;1, :..;,.t . : ...., I ;:.,.., i, i -,..., Un.tgd States,: t,,

. . . . .... . ... : .. ..:' .. r..1 ,..

1gg3 .: Mrs. Goochtr'r : : ,:: iiir :. .. r southem califomia1 995 ' Fresh Fields MarketS, ,:, . East Coast and

.-: :,,,..-...':r,.. :';,, Chhagoafga1997, MerchantofVino,,,: .. Detroitarea

6'

,,7

22,': . , for549,000additional shares:.i,:,. : :

. . 6 , Approximatety,'t 'million shares of, ,i, 1 ,,:

' , . : ..,., cornmOnsl0ck::.. 1,,:'',;.. , ,;,,.,,;.; ,,.,",:,'.

2 . 200,000 shares of common stock: ,: .l

. 4,.,. ..,::, S24.5millionincashi,.,,,:,,:,.,.,-r;,.1;, r:,..

: 3 , : , 525.7 million in cash,.plus aisumption '

:. .: 1, ., ol trtail liabillties.l..'. .,,,,, ,. , .', ..:-,,;,. r.

3 ;. Apprcximalely$35 milliori ip cash,1, ,:7 . :, , S20 million in cash plus 239,000 shares

.: .....' ofcommoristock :,,,,,,,,,,,...,, :.,....:. :.,.

74 (after sale ' $565 million ptui'fne'a*iuiiiption of S1SZol 35 stores) rnillion in debfi howwer, Whole Foods:''

received approximately 5166 miilion forlhe 35 stores that were subsequendy .

sold (out ol the total ol 109 stores thatwere acquired) .,

$20 mitlion plus $6.2 million in comrionStOCk,,:,.:r. .:,'' :.,:,:.,; ., . , .l: ii I ::r' .'

:. i.::.:.r:j,]._r, ..

2,970,596 shards oi'commonltoci,,',,,4.8 million shares of stock plui options ,

1997 Bread of Life . '

1999 ,r Nature's Heartkind2OO0'' Food4Thought'':

2007 Wild Oats Natural. : Markelplace .

Soutn floriOaBoston area

Sonoma Coun$, CA

..,, :,,-

United States andCanada

: ";. :,. , (Natural Abilities,'Inc.).i.; r .:,,Ogl Hanyb Farmeis Market ,i Atlanta:2004: Fresh & Wild. : i

.., r,, ' . .. ... Greal Britain

brands aud had total annual sales of about $1.2 bi[-lion. The Federal Trade Commission (FTC) opposedthe acquisition on grounds that the competition in theorganic foods retailing segm€nt would be rveakened:horvever, a U.S. district court found that tlre FTC'sposition iacked merit. When the district court's rul-ing was upheld on appeal, Whole Foods rvas legallycleared to complets its acquisition of Wild Oats in lateAugust 2007. Acquiring Wild Oas gave Whole Foodsenfiry into 15 nerv metropolitan markeb and 5 nervstates. Wtole Foods then quickly sold 35 Henryt andSun Harvest stores in California and Texas previouslyacquired by Wild Oats, along rvith a California distri-bution center. to Los Angeles food retailer Smart &Final, realizing almost $166 million from the sale andreducing its net purchase price for Wild Oats Marketto about $534 million (rvhich included the assump-tion of $137 million in Wild Oats'debt). In addition,Whole Foods immediately closed nine Wild Oasstores that did not fit with its brand strategy or realestate straregy and began planning to relocate sevensmaller Wild Oas stores to existing or soon-to-be-opened Wrole Foods loeations.

Whole Foods' CEO John Mackey. believedthat the addition of the Wild Oats stores rvould give

Whole Foods additiona[ bargaini4gpgyer rvith suppiiers.-boosr the oreraii@'iffiis. and allorv general and adminisirativeexpenses for the combined conrpanies to be reducedsignificantly. Moreover. rvhile Wild Oats stores lvereolder and smaller than Whole Foods stores (the aver-age Wild Oats store rvas 24.100 square feet versus a

Whole Foods average of 34,000 square feet), man-agement believed that over time it s,ould be able toboost customer Eaffic and sales per square foot atthe former Wild Oats stores to levels in line rvithtltose at Whole Foods stores. Three months after theclose of the acquisition. sales at Wild Oats storesrvere said to be "rapidly irnproving" due to expandedproduct offerings and price cuts on more tban 1,000items.o During 2008, Whole Foods planned to spendclose to $45 million renovating Wild Oats stores andrebranding them as Whole Foods stores.

Et*r* ,$!e*s friiii t,si*stl$EE

Whole Foods'stores had an open format and gen-erated average annual sales of about $32 million.The cornpany's "sweet spot" for most markets it hadentered since 2000 rvas a store fooprint behveen

Page 11: Crafting (Cases)

Ihompon-Sricklarri-8m!le:Gralling aad EracuingStratagy Goncepts ardCaseE lrth Edition

Casa l: lilrhole Fotds

Market io 200& Visioa

Coro Values, and Stnlegr

c-t0 Part 2

45,000 and 60,000 squlre2008, it had 8? storcs that lvere 40,000 square feetor larger-the biggest lvas a 99,800-square-footstore in London. The l00-plus stores that companyhad opened since 2000 averaged 48,000 square feet,

and l8 Whole Foods stores were over 60.000 square

feet. Whole Foods had the hvo largest supermarket

stores in Nerv York City, a 58.000-square-foot store

on Columbus Circle in Manhattan aad a 71,000-

square-foot store in the Borvery. Mtole Foods had

a 74,500-square-foot store in Columbus, Ohio; a

flagship 78,000-square-foot store in Austin, Texas;

a 77,000-square-foot store in Pasadena, California;and hvo ?5,000-square-foot stores in the suburbs ofAtlanla. Georgia. It rvas the company's practice each

year not only to open new stores but also to relo-cate some of its smaller stores to larger sites rvithimproved visibility and parking. In early 2008, the

company had 89 stores averaging 51,500 square feetin varying stages of development 13 of &ese rvere

over 65,000 square feet (the nelv stores of supermar-ket chains like Safervay and Kroger averaged around55,000 square feet), and 15 rvere in nerv geographic

marlcets. Exhibit 5 provides store-related statistics.In 2008, Wrole Foods had stores in 36 states.

Whole Foods favored store locations in tire upscale

areas of urban metopolitan centes, frequently onpremier real estate sites. Most stores ryere in high-traffic shopping locations; some rvere freestanding,some were in stip centersr and some rvere in high-density mired-use projects. Whole Foods had itsorvn internally developed model to analyze potential

markets according to education levels, populationdensiry, and income rxithin certain drive times. Afterpicking a targetfiCtopolitan area. the company's site

consultant did a comprehensive site srudy and devel-oped sales projections; potential sites had to pass cer-tain flrnancial hurdles. Nerv stores opened 12 to 24months after a lease was signed.

The cash investment needed to get a nerv WholeFoods Market site ready for openin*e varied rvith the

rnetropolitan area, store size, amomt of rvork per-

formed by the landlord and the complesity of site

development issues-the average capital cost was

$15.1 million in 200?.? In addition to the capitalcost ofa new store. it took about $850.000 to stock a

store rvith inventory a portion ofrvhich rvas financedby vendors. Pre-opening expenses (includin,e rent)averaged 52.6 million for the 2l nerv stores openedand relocated in fiscal 2007.

1991

1992

1993:. -'t ..1994

1gg5'

1996 ',

1997 '.:19e8 ,

lggg .

20002oo! :.

2A022003;

1,:', 2004, , ':

; 200!,:., ,...r:2006::i:

'2007":' , '

: . :.25:.,.,, , .. 42

_,

.:.. : .i49'""

, ' 61 ,''' " .. ,, 6s '

', l' .:..r:

, . , 75 .' ,

. ;:... ,.:: r ,,, . - " 87. I

,.',. " ., _ 117 .

I. ., . ."-126,l. .". . t. .. . , ... . '. 135'. ... .- : l: r : :- '".'. 'r'1.:: :

,t. -':, :.'. 145 , .,

..,,': .'.. .1.:.........

' ..,-''' ,, ''"":_': 175

.,t., '','. 'tt , 186-, : .': .:.' ,. 2Z6 .

cases in craftins r". *"y"#*"n, $i{-GJ -4yfeet. AII tol4 in early L FfA*X*t Lgg;e

Wrile product and brand selections varied fromstore to store (because stores rvere different sizes andhad different qlientele), Wrole Foods'product lineincluded some 30,000 natuftil,"6fganiE;andgql!{metfood protuet*arrd rig{&Qg" iP. Is,*. Fresh produce*fruits and vegetables, includ-

ing seasonal, exotic, and specialty products likecactus pears, cippolini onions, and Japaneseeggplant.

. Meat and poultry-natrural and organic meats,house-made sausages, turkey. and chicken prod-ucts from animals raised on rvholesome grains.pashreland, and well rvater (and grorul lvithoutthe use of by-products, hormones, or steroids).

. Fresh seafood--a selection of fresh fish; sluimp;oysters; clams: mussels; homemade marinades;and exotic iterns like octopus, sushi, and blacktip shark. A portion of the fresh fish selectionsat the seafood station came from the company's

:

Exhihit 5 Number of Stores in theWhole Foods Markets Chain,1991-2007, and Selected StoreOperating Statistics, 2000-2007

lcontinuedl

Page 12: Crafting (Cases)

I lhompson-strickhnd-0amtte: I

Cralting and Erecufng

Strategy Concegts and

CeseE'l7llr Edilion

CasE t:YVhole Foods I C"..Market inAlt!& VisiooCore Values. ard Shtegy

$3,864,950s482,061

' 14.9%...':

5,145,261

31,566

' 34.2"/a

j' 9.3%

s4,701,289s536,986

,.,',.. .... , :'::. 12.80/o,.,.

's,B1g,B4g

j 33,200

:r :.1 35.10/a

.: : ,,9!9ro

I gIe tvtcGrarv-xitt

Cilnpanies.2t)10

s5,607,376,., s593,439,

:.,'l:: :.. .r...-.r-.-..: 'r 11.070 '.

6,376,817':

, , s4,za+'

,, :.'3{rgyo,,

;.::,', "' ::':::.: g.6a/o.:l

s6"591,773

s-qto,zoo

.-..,,.': ',: :'. ' 7.1To

''.:9,312,'l07

I ' gg,z4o

Case t Wrole Foods Market in 2@B: Vision, Core Values, and Strategy

Exhihit 5 (Continued)

Store sales (000s).:; i1.., .,. ::

Average weekly salesr ,,' .

Comparable store sales . ,

grOWthr.:: ,,.i,. ,,:,. '

Total square footage ofall stoies, end of year ' , "Average store size, end ,'of year, in square leetr ,:t: ,:.

Gross margin, atl-store I , :

avefaqe: .,. : " i'." : :-r:'' :

-" I i''_"'1"':" ' 'Store contributioni. '';', .'

all-store averaget, 1,,...,,.,.,,,

34.8%

8.9olo

'Delined as average aonual sales increases at slores open a fult year o. more; r€prcsents the rate at which sates at existing stores areincreasing annually on average,

fDelined as gross profn minus direct slore expenses. where gross pront equals store revenuos less cost of goods sold.SOurcesl lnformalion posled at ,."irnii.;yir.r:,iisi,i:iin;ri,.ii.Li;r: {accessed March 14, 2008), and lhe companyb 2007 10-K report.

Pigeon Cove and Select Fish seafobd processiogsubsidiaries. Seafood items coming from distantsupply sources were flown in to stores to ensurema,{imum freshness.

A selection ofdaily baked goods*breads. cakes,pies, cookies, ba-eels, muffins, and scoiles.

Prepared foods-soups, canned and packagedgoods, oven-ready mealsi rotisserie meats.hearth-fired pizza, pastas, pates, salad bars. asandrvich station, and a selection of entrees andside foods prepared daily.

Fine-qualiry cheeses, olives (up to 40 rarietiesin some storcs)! chocolates, and confections.

Frozen foods, juices, yogurt and dairy products.smoothies, and bottled waters.

A nide selection of dried fruits. nuts, and spices(eitl'rer prepackaged or dispensed from bins).

Beer and wines-the selection o[ domesticand imported rvines varied from store to store.Organic rvines rvere among those available.

Coffees and teas-the company's Allegro cof-fee subsidiary supplied all stores rvith specialryand organic coffees. and several of the neuerstores had in-store coffee-roasting equipmentthat allor.ved customers to order any of 20 vari-eties to be roasted tvhile they shopped. The teaselections included environmentally correct.

premium exotic teas from remote forests. Moststorcs had a coffee and tea bar rvhere shopperscould eqioy freshly brerved drinks.

A body care and nutrition departrnent contain-ing a rvide selection of natural and organic bodycare products and coslneties, along rvith assortedvitamin supplements, homeopathic remedies,yoga supplies, and aromatherapy products-allitems entailed the use of non-animal testingmethods and contained no artificial ingredients.

Natural and organic pet foods (including thecompany's orvn private-label line), treats. toys.and pest control remedies.

Crocery and household products-canned a$dpackaged goods, pastas. soaps, cleaning prod-ucts. and other conrcntional household iterns thathelped make Whole Foods'larger stores a one-stop grocery shopping destination rvhere peoplecould get everything on theirshopping list.

A floral department u,ith sophisticated florverbouquets and a selection of plants for inside andoutside the home.

A'365 EverydayValue" line and a "365 OrganicEveryday Value" line of private-label productsthat *,ere less expensive than comparable namebrands, as rvell as a family of privateJabel prod-ucts rvith consistent logos and packaging for

l@il

c-lr

Page 13: Crafting (Cases)

i norEsonsricuand-Gamble: I

Crftiltg and F.recuting

SrategF Concspt3 snd

Cases, tld: Edition

Casel:WholeFoods i Crr.Market in ?{10& Vision

Coru ValuE& Bod Slralegy

@IhE McGE\./-Hill

Companies,20l0

c-I2

organic

Part 2 Cases in Crafting and Fiecuting Strategy

specific departrnents-examples included"Whole Kitchen" forprepackaged fresh and fro-zen grocery iterns; "Wrole Treat" for cookies,candies, and frozen desserts; "Whole Pantry"for herbs, spices, and condiments; atrd "WholeCatch" for prepackaged fresh and frozen sea-

food items.

Educational products (information on alterna-tive health care) and books relating to ltealing,cookery diet, and lifestyle. [n some stores, therewere cooking classes and nutrition sessions.

Whole Foods

Whole Foods' tlree-story shorvcase UnionSquare store in Manhattan carried locally madeNerv York offerings, seasonal items from the nearbyGreenmarket farmer's market, and numerous exoticand gourmet items. A 28-foot international sectionfeatured such items as Lebanese fig jam, preservedlemons from Morocco, lndian eurries, Thai rice,shrffed grape leaves from Greece, and goulash fromHungary. The prepared foods section had a GrillingStation rvhere shoppers could get grilled-to-orderdishes such as srvordfish in red pepper Romescosauce and steak rvith a mushroom demi-glace.

One of Whole Foods Market's foremost com-mitrnents to its customeni was to sell foods thatmet strict standards and that rvere of high quality interms of nukition. freshness, appearance. and taste.Whole Foods guaranteed I00 percent satisfactionon all items purchased and rvent to great lengths tolive up to its core value of satisfying and delightingcustomers. Buyers personally visited the facilitiesof many of the company's suppliers and uere verypicky about the items they close and the ingredientsthey contained. For the benefit of prospective foodsuppliers, the company maintained a list of ingre-dients it considered unacceptable in food products.

orvs the company's quality standards.

ause the costs of grorving and mar-6 foods ran 25 to 75 percent more than

conventionally grorvn items. prices at Mrole Foodsrvere higher than at conventional supermartriets. Forthe most part. Whole Foods sold premium productsat premium iirices. Price-sensitive consumers andsome media critics had dubbed Whole Foods as

"Whole Paycheck." Some of the exotic items sold atWhole Foods had eye-popping price tags*for exam-ple, Graffiti eggplants gro\vn in Holland lvere $4 perponnd. lobster mushrooms from Oregon rvere $25per pound, and a thr-ee-ounce can of organic pearljasmine tea uras Sl4.e The earth-friendly detergents.toilet papers. and other household items that WholeFoods merclrandised frequently rvere priced higherthan the name brands of comparable products foundin traditional supermarkets. However, as one analystnoted. "lfpeople believe that the food is healthier andthey are doing something good for themselves. theyare rvilling to invest a bit.more. particularly as theyget older. It's not a flad."lo Another grocery indus-try analyst noted that rvhile Whole Foods served agrorving niche, it had managed to attract a nerv kindof customer. one rvho rvas rvilling to pay a premium

accountedof67

percent of Wholehigher than the 40-50 percent that perishables rep-resented at conventional supermarkets. The acqui-sition of the tkee 75,000-plus-square-foot Harry'sMarket sllperstores in Atlanta, rvhere 75 percentof sales rvere perishables, had provided the com-pany rvith personnel having valuable intellectualcapital in creatively merchandising all major per-ishables categories. Mauagement believed that thecompanyt emphasis on fresh fruits and vegetabies,batriery goods, meats, seafood and other perish-ables differentiated Whole Foods stores from othersupermarkets and attracted a broader customer base.

According to John Mackey:

First-timc visitors to Whole Foods Market are oftenarved by ourperishablcs. We devote rnorc spacc to freshfruits and vegetables, including an extensive selectionof organics. than most of our competitors. Our meatand poultry products arc natural-no artificial ingre-diens. minimal proppssing, and raised rvithout the use

of artificial grorwh hormones. antibiotics or animalby-produets in their feed. Our seafood is eithcr wild-caught or sourced from aquaculture farms rvhere envi-ronmcfltal concerns are a priority. Also. our seafoodis never treated rvith chlorine or other chemicals, as iscommon practice in the food retailing industry. Witheach nerv store or renovation. rve challenge ourselvesto create more entcrtaining, theatrical. and scintillat-ingly appctizing prcpared foods areas. We bake daily,usiag rvhole grains antl unbleached, unbromated flourand featurc Europcan-style loavcs. pastrics. cookiesand cakcs as rvcll as gluten-free bakcd goods for thoscallergic to rvhsat. We also offer many vegctarian and

vegan products for our customers sceking to avoid 3llanimal products. Our cheeses arc free of artificial fla-vors, colors. and synthetic preservatives. and rve offeran outstanding variety of both organic checscs and

cheeses marle using traditiooal methods.s

Page 14: Crafting (Cases)

[ ftompson-svicklanrl-Grmttu I

Gratting and Exacrting

slraleBF concepts and

Coses 17th Edition

Case t: Wlole Foods I c*.Market in 2tX!& Uision,

Core Values. ard Strategy

I.-'-***--_l @Compnies,fl)10

Case 1 Whole Foods Market in 2008: Vlsion, Core Values. and Strategy C-I3

Exhihit G Whole Foods Market's Product Quality Standards and Customer Commitments

, Our business is to sell the llghest quality foods we can find at the most competltive piices possible: We evaluate. , ,:r.:;' qualitt in terins 6f nutrition, freshness; appeamnce, and laste; our search foi quality is a niuer-ending process,l,. , ,,,

l, i , lryg reature iooOs that are free bf artificial'preservatives, colors;'tta*o,sr,rbeteners;rana r,vaag*"t"d hts.:,',::i,. ,:

,,rl, we'areiiasllgiiatei'auoir!,uieattasllngrooo,notn"pre'a e-C1'"tr"riil;i,h';,ilisi 'ri;,t].i.,.i,t,''..:t,1,,1...,:

,f..wegroulde,f.ood:andnrf,io'O*ip-"[Ji"th"tuupporthealth;;dwetfbeing;,1.11,..i,:.,,,-,.- ..r.,,.11r11q..,;q1,,-,

: ' WhotE roousivrarrett ouality:Stanoaros ieam malntain" an "*t*n=irr'tist'ot,uhaccepr"lr* "si"o't;ii.:i:.-Ho*l*r,,.]r' ' ffeating a product with no unacceptabte ingredients does not guarantee that Whole fooCs Uirtrit wilt sbll it. Our ,i, -,:

; buyers are passicinate abbut seeking out ttie freshest, most healthful; minimallll processed pioducts available ,' .,' .' . ,r:

[As of 2008;!he1e.,werq 81'chemicals on lA/hole Foods'list of unacceptable'ingreOiehts,.includihg,aitificial colorsl ".',artificial flavors;'aspartaine; bleached flour; cyclainates, loie gras, hydrogeirated fati, irradiated foods, nitrates and:, r

nitrites; saccharin, sofiic acid, sucralose, and sulfites {sutfur dioxidi}.J -

SourcejThe quali$ standards section ol v;r:i,;.*'ir*i;i+,rdu:,:iiiili.::f r: (accessed March 24, 2{!08).

to dabble in health food without being totally com-mitted to vegetarianism or an organic lifestyle.l I

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Whole Foods Market did not have a standard

selection of personal care items and natural cosmet-ics (as rvell as a makeup station), salad bars, sit-dorvndining .treas, gounnet food sections rvith items fromaround the rvorld, and ever-changing selections andmerchandise displays. Many stores had recipe cardsat the end of key aisles. A ferv stores offered valetparking, home delivery and massages. Managementbelieved that the extensiye and attractive displaysof fresh produce, seafoo4 meats and house-madesausages (up to 40 varieties), baked goods, and pre-pared foods in its lalger stores appealed to a broadercustomer base and were responsible for the fact thatWlple Foods stores iarger than 30,000 square feetwere generally better performers tlun smaller stores.

Whole Foods' 78.000'square-foot flagship Aus-tin store rvas a top central Texas tourist destinationand a dorvntorvn Austin landmark it had an intimatevillage-style layout; six mini restaurants rvithin thestore; a rau' food and juice bar; more than 600 vari-eties of cheese and 40 varieties of olives: a selec-tion of 1,800 wines: a Candy Island with handmadelollipops and popcorn balls; a hot nut bar rvith anin-house nut roaster: a rvorld foods section; a rqlk-i* beer cooler rvith 800 selectionq i4 pastry chefsmaking a variety of items; a narurat lrome sectionrvith organic cotton apparel and household linens: anextensive meat deparfnent rvith an in-house smokerand 50 oven-ready items prepared by in-house chefs:and a theaterlike seafood department rvith nrorethan 150 fresh seafood items and on-the-spot shucking. cooking. smoking, slicing and frying to order.

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Maoagernelt ht"Whole-Foods rvanted customers tovierv c-ompany stores as a "third place" (besides homeand office) *,here people could gather, learn, audinteract while at the same tirne enjoying an intrigu-ing food-shopping and eating e.rperience. Stores hada colorful dicoq and products rvere attractively mer-chandised (see Exhibit 7). According to one indus-try analyst, Whole Foods had "put together the idealmodel for the foodie rvho's a prenriurn gourmet andthe oatural foods buyer. When you rvalk into a WholeFoods store, you're ovenvlrclmed by a desire to lookat everything you see."l1

Most stores featured hand-stacked produce. in-store chefs working in open kitchens. scratch bakeries.prepared-foods stations. European-style charcuteriedepartmeRts, "Whole Body''departnents t'ith a rvide

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ttrI Tbonpson-strickland-Gamlle: I Case 1: Whole Foods I csse

Cralting and Executing Market in 20lE: Visiou

Strategp Concepts and Core Values. ard Strategy

Cases, lTth tdition

C-I.l Part 2 Cases in Crafting and Executing Strategy

txhibit 7 Scenes from Whole Foods Stores

@ The McGrarv-Hill

Companies. 2010

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Stratogp Gorccpts ardCasrs, lllh Edltion

Casel:lMrotaFoods I Cr.uMarker inzlto& VisioilCora Volues. and Strategy

The Cohunbus Circle store in Manhattan had a248-seat caf6 rvhere shoppers could edoy resrauxant-quality prepared foods while rela.xing in a comfortablecommunity setting; a Jamba Juice smoothie stationthat served fushly blended+o-order fruit smoothiesand juices; a full-service sushi bar by Genji Exprcsswhere customers sat on bar stools enjoying fresh-cutsusli wrapped in oganic searveed; a rvalk-in grcen-house shorvcasing &esh-cut and exotic florvers; a lvineshop rvith more than 700 varieties of wine from bothlarge and small vineyards and family estates; and achocolate enrobing station in the bakery where cus-tomers could requestjust about anythiry covered inchocolate. The two-story store in Pasadena, Califor-nia ffiole Foods' largest store west of the RoclryMountainsi, had a wine and tapas lounge; a seafoodbar; an ttalian raftoria; 1.200 selections of rvine; freshdoughnuts made hourly; a 6,000-square-foot producedepartrnent that featured more than 500 items daily;and free rvireless Intemet access. Tbe tkee-story99,800*quare-foot store in London had 55 in-storechefs; 13 dining venues (including a tapqs bar, a cham-pagne and oyster bar, a pub, and a sushi and dim sumeatery) that accommodated 350 diners; a self-servicebulk foods center with 100 selections; and a l2-meterdisplay of fresh seafood (many of the seafood selec-tions rvere hook-andJine cauglrt off the shores of theUnited Kingdom).

Whole Foods got veryhigdising experts and customersfrom the bright colors of the producT?Eflays, tothe qualiry of the foods and customer service. tothe rvide aisles and cleanliness. Management rvas

continually experimenting rvith nerv merchandisingconcepts to keep stores fresh and exciting for cus-tomers. According to a Whole Foods regioaal rnan-ager. "We take the best ideas from each of our storesand try to incorporate them in all our other stores.We're constantly making our storcs better."li WholeFoods'merchandising skills *'ere said to be a primebctor in its success in luring shoppers back timend again*Whole Foods stores had annual salesrveraging more than $800 per square foot of space

(about double the sales per square foot of Krogerand Safervay).

To further a sense of community and interac-tion rvith customers, stores typically included cus-tomer comment boards and "Take Action" centers

for customers who rvanted information on such top-ics as sustainable agriculture, organics. overfishing

I on**,Gr*-rr,Corpanies.2010

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problems and the sustainability of seafood supplies,the environment, and similar issues. The Torontostore had biographies of farmers suspended from theceiling on placards and a board calling attention toWhole Foods' "Sustainable Seafood Policy" bungabove the seafood station. ln 2008, Whole Foodsbegan introducing signage and brochwes in all itsstores informing shoppers of the company's Five-StepAnimal Welfare Rating Program, rvhich laid outa set of "animal compassionate" standards expectedof Wrole Foods' meat and poultry suppliers: thesestandards focused on humane living conditions forthe animals and specified permissible and prohib-ited production and handling techniques &om parentstock tluough slaughter.

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iflg-EndgEf 'ff Af e]ofaTCtrrereghnrvideprograms.marketing efforts for individual stores, and a nationalbrand-arvareness initiative focused primarily onnational in-store marketins Drosratns. Stores speat_._most of their marketins Urr-an"tJon in-siffiTi=oon"o- ;a;,oeuCt samplings. Store personnel rvere encouraged toextend company efforts to encourage the adoptionof a natural and organic lifestyle by going out intothe community and conducting a proactive publicrelations campaign. Each store also had a sepamtebudget for making contributions to philanthropicactivities and community outreach programs.

Since one of its core values was to satisff anddelight customers (see Exhibit3), Wrole FoodsMarket emporvered team menrbers to do rvhateverit took to meet or exceed cusiomer expectations onevery shopping trip. Competent, knorvledgeable,and friendly service rvas a hallmark of shopping ata Whole Foods Market. The airn lvas to turn highlysatisfied customers into advocates for Vfhole Foodsrvho talked to close friends and acquaintances abouttheir positive experiences shopping at Whole Foods.

Case I Whole Foods Market in 2008: Vision, Core Values, and Strategy

Whole Foods spent about 0.5 percent of its revenues.,-J

on acvenrsmg, a mucn smauer p_gge4Bgilm$_qog:--nl@ng instead torelyorirnarity On ivord:of-mouth recommendations andiesnm"fri.;Fffi *...t"*ers.nrer"rporatelnar]Gi-'

Customers could get personain every department of the store. Whenasked rvhere an itern rvas located, team

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c-I6 Pa* 2 Cases in Crafting and Executing Sirategy

often took them to the spot, making conversationalong the rvay and offering to answer any questions.Team members were quite knorvledgeable and enthu-siastic about the products in their particular depart-ment and tried to take advantage of opportunities toinform and educate customers about natural foods,organics, healthy eating, and food-related environ-mental issues. They took pride in helping custom-ers navigate the extensive variery to malce the bestchoices. Meat deparEnent personnel provided cus-tomers with custom cuts. cooking instructions, andpersonal recommendations.

.t*ss $per*trs*sWhole Foods employed a team approach to storeopemtions. Depending on store size and trafficvolume, Whole Foods stores employed betrveen85 and 600 team members, r.vho.ivere organized intoas many as 13 teanrs. each led by a team leader. Eachteam rvithin a store rvas responsible for a differentproduct category or aspect ofstore operations, suchas customer service. prepared foods, produce, andcustomer checkout stations. Teams were empoweredto make many decisions at the store level pertain-ing to merchandising, departmental operations, andefforB to please custome$.

Whole Foods'comrnitment to team-based man-agement of store operations stemmed from the con-viction that the company's long-term success lvasadvanced by having happy employees actively help-ing to create happy customers. The team approach,complemented by a strong emphasis on empoweringemployees, rvas seen=qs promoting a strong corpo-raJe culture and coirtributing to a rvork environmentrvhere motivated team members could flourish, builda career, and reach their highest potential. WholeFoods' top management believed that empoweredteams helped harness the collective eneryy and intel-ligence of team members to operate their depart-ments effectively and efficiently-thereby enablingWhole Foods to manage its stores better than rivalsupermarket chains managed their stores- Manage-ment also believed that team members rvere furthermotivated and inspired by the compaay's strategicvision*many team members felt good about theirjobs and had a greater sense of purpose becausetlrc rvork they did contributed to better diets andeating habits on the part ol Whole Foods shoppersand to the overall rvell-being of society at large.

I arnurrcr*-*u,Corpanies. ?)10

Indee{ many job candidates lvere drarvn to inter-vierv at Whole Foods because they identified rviththe companys mission of selling natural and organicfoods, advancing the cause oflong-term sustainableagricultural practices, and promoting a cleanerenvironment-a mission that rvas captured andreflected in tlte company's motto of "Whole Foods,Wrole People, Whole Planet."

A team member at Whole Foods'store inAustin,Texas. said, "I really feel like we're a part of mak-ing the rvorld a better place. When I joined the com-pany 17 years ago, rve only had four stores. I havealways loved*as a customer and nory as a TeamMember-the camaraderie. support for others. andprogressive aEnosphere at Whole Foods Market."laAccording to the company's vice president of humanresources. "Team members rvho love to take initia-tive, rvhile enjoying rvorking as part of a team andbeing rervarded through shared fate, thrive here."

Top executives at Whole Foods rvere acutelyarvare that the company's decentralized teamapproach to store operations--rvhere many person-nel. merchandisiug, and operating decisions weremade by teams at the individual store level-madeit critical to have an effective store team leader. Thestore team leader worked rvith one or more associatestore team leaders, as rvell as rvith all the departmentteam leaders, to operate the store as efficiently andprofitably as possible. Team leaders screened candi-dates for job openings on their team. but a trvo-thirdsmajority of the team had to approve a nerv hire-andthat approval came only after a 30-day trial for tlrecandidate. StLre team leaders rvere paid a salaryplru a bonus based on the store's economic valueadded (EVA) contribution; they rvere also eligible toreceive stock options.ls Twice yearly, teanr membersrvere asked to complete a confidential, third-partyadministered team leader survey that provided themrvith an opportunity to give team leaders construc-tive feedback. Store team leaders reported directly toone of I I regional presidents.

Starting in 2002, team members across thecompany were encouraged to actively contributeideas about the benefits they rvould like the com-pany to.offer. The suggestions rvere compiled, putinto a choice of packages, and the choices submittedto team members for a vote- The benefits ptan thatrvas adopted for2003 through 2006 rvas approved by83 percent of the 79 percent of the team membersparticipating in the benefirs vote. Under the adopted

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Case I Whole Foods Market in 2008: Vision. Core Values. and Strategy c-r?

plan, team members could select their orvn benefits and it stops a lot of people from becoming yourpaekage. The resulting health insurance plan that the lover-"16 When rvorkers at a Whole Foods Market incompany put in place in January 2003 involved the Madison, Wisconsin! voted to unionize in 2002, Johncompany paying 100 percent of the premium for full- Mackey spent over nine months going to all of thetime employees and tlre establishment of company- company's stores to speak rvith store employees per-funded "personal wellness accounts," rvhich team sonally, listen to rvhat'*as on 0reir minds, and gathermembers could use to pay the higher deductibles; suggestions for improving working conditions.any unused balances in a team member's account Unionization efforts had never made any headway atcould roll over and accumulate for future expenses. Whole Foods, and the company was widely regardedA second companyrvide benefits vote rvas held in as very progressive and genuinely committed to cre-fiscal 2006 to determine the benefits program that ating a positive, satisSing work environment.rvould be in place from 2007 through 2009. One Whole Foods had made Forlune's "100 Bestoutcomeof thesecondvote, inrvhichapproximately Companies to Work For" list for ll consecutive77 percent of eligible team members participated, years (1998-2008); it ivas one of only 14 compa-rvas that the company again provided health care at nies to make the list every year since its inceptionno cost to eligible fuIl-time employees (defined as and rvas the only national supermarket chain tothose rvho rvorked 30 or more hours per rveek and ever make the list (although Wegmans, a regionalhad rvorked a minimum of 800 hours); the cost of supermarket chain. rvas the top-ranked company ondependent health care premiums rvas shared behveen Fortune\ 2005 tist and rvas the third-ranked com-the company and the team member, with the percent- pany in both 2007 and 2008). In scoring companies,age paid by the team member declining as years of Fortute placed trvo-thirds rveiglrt on responses to aservice rvith the company increased. Other key ben- 57-question survey of 400 randomly selected employ-efits included paid time off, a 20 percent discount oo ees and one-third on Fofirrre's orvn evaluation of a

all purchases at Whole Foods, ddntal and eye care cornpanyi demographic makeup, pay and benefits,plans, life insurance and disability insurance plans. and culture.and an emergency assistance plan.

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&afting and Exeuuting

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Every year, management gave team members anopportmity to complete a morale survey coveringjob satisfaction. opporamiry and empolverrnent, pay,

training, and benefits. In 2004, the overall participa-tio$ rate rvas 63 percent (versus 7l percent in 2003).Of the team members responding in 2004, 86 per-cent said they almost ahvays or frequently enjoyedtheir job (the same porcentage as in 2003). and82 percent said they atmost ahvays or frequently feltemporvered to do their best rvork at Whole Foods

Market (up slightly from 8l percent in 2003). Com-mon responses to the question "what is the best thingabout rvorking at Whole Foods Market?" includedcorvorkers. custonters, fl exibility, rvork environment,grot th and learning opportrrnities. the productsWhole Foods sol4 benefits. the team concept, andthe culture of emporverment.

Whole Foods Market had 54,000 employees in2008, of rvhom approximately 85 percent rvere full-time. None \\€re represented by unions. althoughthere had been a couple of unionization attempls.John Mackey rvas vietuved as fiercely anti-union and

had once said: "The union is like having lierpes. Itdoesn't kill you, but it's unpleasant and inconvenient

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Whole Foods strived to create a "shared-fate con-sciousness" on the part of team members by unit-ing the self-interests of team men:bers with thoseof shareholders. One way management reinforcedthis concept rvas through a gain-sharing programthat rervarded a store's team menrbers according totheir store's contribution to operating profit (storesales less cost of goods sold less store operatingexpenses)-gain-sharing distributions added 5 to 7

percent to team member wages. The company alsoencouraged stock orvnership on the part of team

members through three other programs:

l. A rcam nrcmber stock olttiott plan. All full-timeand part-time team members rvere eligible for a

grant ofstock options each year based on teammember performance and length of serviceto the company. In 2007, options to purchase1.7 million shares rvere granted to 13,400 teammembers.

7. A team nrcmber stock purchase plan- Throughpayroll deductions, team members could pruchase

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@tl Thomp*n-suicklad-Gan*t* I Casel:IttroleFoods I Cr..CraltiBc ard Er3curing Market in 2lXl& Wsiott

S[dsBF Concepts and Core Vlluos, tnd Strategl

Cases. Uth Edition

c-r8 Part 2 Cases in Crafting and Executing Strategy

a restricted number of shares at 95 percent of themarket price on the purchase date. Approximately2,000 tearn members participated in this plan infiscal 2007.

3. A team ntentber a1lfi) plan. Whole Foods Mar-ket stock was one of the investrnent options inthe 401(k) plan.

All the teams at each store rvere continuouslyevaluated on msasures relating lo sales, operations,and morale; the results rvere made available to teammembers and to headquarters personnel.lT Teamscompeted not only against the goals they had setfor themselves but also against other teams at theirstores or in their region-competition among teamslvas encouraged. ln addition, stores rvent throughtwo revierv processes-a storc tour and a "customersnapshot." Each store rvas toured periodically andsubjected to a rigorous evaluation by a group of40 personnel from another region; the group includedregion heads, store team leaders, associate team lead-ers. and leaders from two operating teams. Customersnapshots involved a surprise inspection by a head-quarters official or regional president rvho rated thestore on 300 items; each store had I0 surprise inspec-tions annually, rvith the results distributed to everystore and included in the rervard system. Rervardsrvere team-based and tied to performance metrics.

Wrole Foods had a salary cap that limited thecompensation (rva,ees plus profit incentive bonuses)of any team member to 19 times the average totalcompensation of all full-time team members in thecompany-a policy mandated in the companyi corevalues (see Exhibit 3J. The salary cap rvas raisedfrom 14 to !9 times the average total compensationin 200i-ii trad been I times in 2003; thelncreasesstemmed from the need to attract and retain keyexecutives. For example, if the average total com-pensation rvas $50,000, then a cap of 19 times theaverag€ meant that an executive could not be paidmore than $950.000. All team members had access tothe companyi financial books, including an annualcompe*sation report listing the gross pay of eachteam member and company executive. Cofounderand CEO John Mackey had recently reduced hisannual salary to Sl, rvith future compensation fromhis personal stock options going to Wlrole Foods'l\\,o not-for-profi t foundations.

The company promoted from rvithin as muchas possible. rvi& team members often moving up to

assume positions at stores soon to be opened or atstores in other regions.

The Use of Economic Value Added toMeasure Performance In 1999, Whole Foodsadopted an economic value added (EVA) managementand incentive system. EVA is defined as net operatingprofits after ta,res minus a charge for the cost of capi-tal necessary to genexate that profit. At Whole Foods,EVA at the store level rvas based on store contribu-tion (store revenues minus cost of goods sold minusstore operating expenses) relative to store investnentover and above a rveighted average cost ofcapital of9 percent-average store contribution percentages for2000-2007 are shorvn in Exhibit 5. Senior executivesmanaged the companyrvith the goal ofrzrprurr)rgEVAat the store level and companyrvide; they believed thatan EVA-based bonus system rvas the best furancialframervork for team members to use in helping makedecisions that created sustainable shareholder value.The teams in all stores rvere challenged to find ways toboost store contribution and EVA-the team memberbonuses paid on EVA improvernentaveraged 6percentin 2003.

In 2007, more than 750 senior executives.regional managersi, store team leaders. and assistantstore team leaders throughout the company were onEVA-based incentive compensation plans. The pri-mary measure for payout rvas EVA improvement.The company's overall EVA climbed from a negative$30.4 million in fiscal 2001 to 52.6 million in fiscal2003. $15.6 million in fiscal 2004, $25.8 million in2005, and $64.4 million in 2006, but then droppedsharply to $353 million in 2007.

In addition. management used EVA calculationsto determine rvhether the sales and profit projec-tions for new stores would yield a positive and largeenough EVA to justi$r the investment. EVA calcula-tions uere also used to guide decisions on store clos-ings and to evaluate nerv acquisitions.

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Whole Foods' buyers purchased most of the itemsretailed in the company's stores from local. regional.and national rvholesale suppliers and vendors. Muclrof the buying responsibiliry rvas located at the regionaland national levels in order to put the company in abetter position to negotiate volume discounts rvithmajor vendors and distributors. Whole Foods Mar-ket rvas the largest account for many suppliers of

I @ Tne rus8nw-xnCuqanies,2010

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Ihompsoo-SEfo tlil&Gamtte:Cralling and fxcutingStrateg$ ConcipG snd

8ases. lTth Editioo

natural and oganic foods. United Natural Foodsrvas the company's biggest supplier, accounting fiorabout 24 percent of Whole Foods' total purchases infiscal 2007; United was the company's primary sup-plier of dry grocery and frozen food products. How-ever, regional and store rnanagers had discretionaryauthority to source from local organic farmers andsuppliers that meet the companyt quality standards.In 2007*2008, the company's buyers began to placestronger emphasis on buying directly from producersand manufacturers.

Whole Foods orvned trvo produce procurementcenters that faciiitated the procurement and distri-bution of the majority of the produce Whole Foodssold. However, rvhere feasible, local store persoanelsourced produce items from local organic farmers aspart of tlre company's commitment to promote andsupport organic farming methods. Tivo subsidiaries,the Pigeon Cove seafood processing facility in Mas-sachusetts and the Select Fish seafood processingfacility on the West Coast, supplied a portion of thecompany's seafood requirements. A regional seafooddistribution facility bad recently been establishedin Atlanta.

The company operated nine regional distibu-tion centers to supply its stores. Nine regional bakehouses and five commissary kitchens supplied areastores rvith various prepared foods. A central coffee-roasting operation supplied stores rvith the compa-ny's Allegro brand of coffees.

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Whole Foods demonstrated its social conscience andcomnrunity citizenship in a variety of rvays:

. By donating at least 5 percent of its after-taxprofits in cash or products to nonprofit or edu-cational organizations. ln fiseal 2007. WholeFoods made charitable donations of just under$15 million, equal to about 8 percent of after-ta.r profits in fiscal 2007.

. Whole Foods'Green Mission Task Force pro-moted environmentaliy sound practices for ereryaspect of store and facility operations- In early2008, Mrole Foods began using all-nanral-fiberpackaging at its salad and food bars. As of EarthDay 2008 (April 22), Whole Foods ended the 115e

of disposable plastic bags at the checkout lanes

Gase l: Whole Foods

Madtet in 26& VisionSore Urlues and Strat*gy

Gase I Whole Foods Market in 2009: Msion, Core Values. and Strategy

of all its stores, chiefly because such bags didnot break dorvn in landfills. Company officialssaid the move lvould eliminate use of I00 mil-lion plastic bags annually-in *reir place, cus-tomers rvere offered reusable paper bags madeof 100 pereent recycled paper (at a cost of l0cents each) and an opportunity to purchase styl-ish long-life canvas bags for 99 cents (80 per-cent ofthe content ofthe canvas bags came fromrecycled plastic bottles).

The company was in the process of convertingits distribution fleet vehicles to biodiesel fuel.The company purchased renetvable eneryy cred-its to offset I00 percent of the electricity used inall of its locations (retail and nonretail) in NorthAmerica. In both 2006 and 2007, $flhole Foodsrvon a Green Porver Partnership arvard from theU.S. Environmental Protection Agency for sup-porting tlre development of renervable energy.

Whole Foods creared the not-for-profit AaimalCompassion Foundation in January 2005, whichstrived to help producers adopt and improvetheirpractices for raisilg farm animats naturallyand humanely.

In October2005. Whole Foods had established anot-for-profit Whole Planet Foundation that rvascharged rvith combating poverty and promot-ing self-suffieiency in third-rvorld countries thatsupplied Whole Foods rvith some of the prod-ucts it sold-

Whole Foods participated in a Whole Tradeprogram that committed the company to payingsmall-scale producers (chiefly in impoverished,lorv-rva-ee countries where living standards rverelow) a price for their producrs thar more thancovered the producer's costs; the goal was tomalie sure that the producers of products meet-ing Whole Foods'quality standards could ahvaysafford to create. harvest or grow their productso that they did not have to abandon their lvorkor jeopardize the rvell-being of their farnily tomake ends meet. The commitment to payingsuch producers a premium price rvas vierved asan investment in such producers and their com-munities, a way for producers to be able to putmoney back into their operations. enable themto invest in training and education for theirrvorkers. and have sufficient take-home pay tohelp support a better life. Whole Foods' goal

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was to have more than 50 percent of its prod-ucts imported from developing nations meet itsWhole Trade qualificatiors rvithin l0 years. In2007, the Whole Trade Guarantee label was fea-tured on more thar 400 items at Whole Foods'stores. Whole Foods donated I percent of theretail sale of each Whole Trade product sold tothe Whole Planet Foundation.

In 2007, Whole Foods established a Local Pro-ducer Loan Program that arvarded lorv-interestloans to small-scale food producers and grorvers.

So far, Whole Foods had committed $10 millionto its microlending program to help aspiring localproducers of organic and narural agriculturalcrops! body care products, and artisan foods (such

as nut butters, ice creanq granolas, and cheeses)to grorv and flourish. Loan recipients had to meetWhole Foods Market's quality standards, use thefunds for expansion, and have a viable businessplan. Loan amounts rvere behveen $1,000 and

$100,000 rvith flr,xed interest rates that rangedbetrveen 5 and 9 percent in 2007.

Team members at every Whole Foods store wereheavily involved in such community citizenshipactivities as sponsoring blood donation drives,preparing meals fbr seniors and the homeless.holding fund-raisers to help the disadvantaged.grorving vegetables for a domestic violenceshelter, participating in housing renovation proj-ects, and rvorking as deliverypeople for Mealson Wheels.

. Individual Whole Foods stores held "5oZ Days"(or "Cornmunity Giving Days"), donating 5percent ofthat day's net store sales to a local orregional nonprofi t or educational organization.

In an effort to "rvalk the talk" about its commifnentto its core values and "Whole Foods, Whole People,Whole Plarret" motto, Whole Foods had gatheredinformation about key issues that could affect peo-ple's health and rvell*being-the genetic engineer-ing'of food supplies, food irradiation practices. andthe organic standards process-and disseminatedthat information via in-store brochures, presenta-tions to groups. and postings on the company's Website. Further. the company had developed positionstatements on sustainable seafood practices (seeExhibitS), the merits of organic farming, and rviseeuvironmental practices. Whole Foods regularlypublicized its position statements in its stores andon its Web site, along with the company's commit-ment to selling only those meats that had been raisedrvithout the use of grorvth hormones. antibiotics, andanimal by-products

Mackey's Ethics Are Called into QuestionBusl)less Etlu'cs named Whole Foods Market to itslist of the "100 Best Corporate Citizens" in 2004,2006, and 2007. Horvever, during 2007, CEO JohnMackey was the center of attention in nvo ethics-related incidene. The first involved a discoverythat. over a seven-year period Mackey had typedout rnorc than 1.100 entries on Yahoo Finances

j'

Exhihit I Whole Eoods' Position on Seafood Sustainability

The simple fact is our oceans are soon to be in trouble, Our world's lish slocks are disappearing lrom our seas becausethey have been overfished or harvested using damaging tishing pradices. To keep our lavorite seafood plentiful for ustoenjoyandlokeepitaroundforfuturegenerations,wemustactnow. ' ."-: "., ., l

ls i shopper, you have the power to-turn the tide. When you purchase'seefood from fisheries 0sing ocean-Iriendly melhods, you reward their actions and encourage other fisheries to operate responsibly;:, . :

At Whole Foods Market, we dernonstrate our long-terrn comrnitmenl to seaiood preservation by: . t , ,1 ; , , .

. Supporting fishing practices that ensure the ecological health of the ocean and the ibundance of marine life.

. Parlnering with groups who encourage responsible practices and provide lhe publicwith accurate informationaboutiheissue. " . .:.:.,,'.....

. ;;;il;;;I*n weli-managed seafood facitity and proiessing'plinr, ekleon'Cove seiiooo, rocateo inGlouceste[Massachusetts i ,, .,..;..',:1':'::...,11:'., ' ".'

. Helping educate our cuslomers on the importance of practiies that'can mike arUiiteCnce noW'rno Win into lhefuture.l :,. i..: i '1''::': .:.. 'i.:.:i ,',.r . i- '.

,

. Promoting and setling the products of welt+nanaged fisheries:

Page 22: Crafting (Cases)

I lhomCs0n-Suicklan6-sambte: I Caset:WholeFoods I Cu"u

Cralring and Erecuting Merket in AB& Vision.

Stral?py ConcEpts ard Cora Valueg ood Suaregy

Gases. lTth Edition

message board touting his company's stock andoccasionally making uncomplinrentary rcmarksabout rival Wild Oats Markets. Mackey! postingsstopped several months prior to Whole Foods'offerto buy Wild Oats Market. ln making his postings,Mackey used the alias Rahodeb-a variation ofhis rvife's name, Deborah. The llrall Struet Jannalreported tlrat in January 2005 Rahodeb posted thatno one rvould buy Wild Oats at its current price of$8 per share and that Whole Foods had nothing togain by buying Wild Oats because Wild Oats'storesrvere too small.ls A lferp York Tintes article reportedthat. on March28,2006 Rahodeb rwote, "OA[S haslost their rvay and no loRger has a sense of missionor even a wcll-thought-out theory of the business.They lack a viable business model that they can rep-licate. They are floundering.around hoping to finda viabla strBtegy that may stop their erosion. Prob-tem is they lack the tinre and the capital corv."le TheNan,Tbrk Times article quoted Mac\ey as saying. "lposted on Yahoo! under a pseudonym because I hadfun doing it. I never intended any of those postingsto be identified rvith me." Mackeyt postings, rvhichcame to light in June-July 2007 and spurred callsfor his resignation on grounds that he breached hisfiduciary responsibility, rvere first discovered by theFederal Trade Cornmission (FTC) in Whole Foods'documents that the FTC obtained in the course ofchallenging the Wiid Oats acquisition, According toMackey, the viervs he expressed in his Rahodeb post-ings sometimes represenled his personal be[efs andsometimes rvere different because he rvould occa-sionally play the role of devil's advocate. He saidno proprietary infornration about Whole Foods rvas

disclosed.2O l.rr the days follorving thE media reportsof the postings, Mackey expressed remorse for hispostings, apologized for his behavior. rnd askedstakeholders to forgive him forexercising badjudg-ment. Nonetheless. certain Mackey poslings werecited in court documents filed by the FTC as rea-sons rvhy Whole Foods' acquisition of Wild Oatsshould be blocked. On July 17, 2007, the Securitiesand Exchange Commission (SEC) announced thatit lrad begun an investigation of the postin*es- Thatsame day, Wltole Foods announced that the compa-ny's board of directors had formed a special com-mittee to investigate the postings a*d retained legalcounsel to advise it during the investigation. WholeFoods said it rvould cooperate fully rvith the SECirquiry.

| @The irc6€rv-H;tt

&mpanies,2tll0

c-2r

In October 2007, Whole Foods announced thatthe special committee had completed its investiga-tion of Mackey's rnessage board postings and thatthe board of directors affirmed its support of CEOJohn Mackey; the company indicated that the spe-cial committeet findings would be turned over tothe SEC and that the company rvould have no fur-ttrer comment pending the SEC investigation.zl AsofAprit 2008. there had been no public announce-ment regarding the SEC's investigation of Mackeyipostings.

A second confoversy-stirring incident involveda Mackey-authored blog entitled "Whole Foods.Wild Oats and the FTC" that was posted on thecompanyt Wbb site on June 19, 2007. Mackey, whoobjected strenuously to the grourds on rvhich theFTC rvas trying to block Whole Foods'acquisitiouof Wild Oats, authored the blog, rvhich rvas dedi-cated to posting Updates aod information regardingthe FTC proceedings and to making the case forrvhy the companyt acquisition ofWild Oats Marketshould be allorved to go fonvard. Mackey explainedthe basis for the blog:

Ivty blog posting provides a detailed look into WholeFoods Market! dccision-making proccss regard-ing thc merger, as rvcll as our companyb experienceinteracting rvith the FTC staffassigned to this merger.I provide explanations of horv I think the FTC. to date.has neglccted to do its homervork appropriateln espe-

cially givcn tlre statements made regarding prices.quality, and service levels in its complaint. I also pro-vidc a glimpse into the bullying tactics u.red againstWhole Foods Market by this ta.rpayer-funded agency.

Finally. I provide ans\lers in my FAQ section to manyof the questions that rarious Tcam Members harefieldcd from both thc media and company stakehold-ers- As previously announced rve set an intention as

a company to bc as transparcnt as possiblc through-out this lcgal process. and this blog entry is my firstdctailed effort at transparency.

The blo-e posting by Mackey included the follorvingheadings:

. Vy'hy Whole Foods Market Wants to Buy WildOats.

. Whole Foods Market's Objections to the FTC'sInvestigation.

. What the FTC Is Claiming in Its Objectionsto the Meryer.

' FAQs.

Case 1 Whole Foods Market in 2O0E: Vision. Core Vatues. and Strategy

Page 23: Crafting (Cases)

m*,o*lt;,,*,*,o I

Grclling and F.recuting

$rategy Golcapts and

CEss$ 17dt Edilion

Cass 1: lMrole Foods I c"ruMarket inZn& Visios.

Core Valuas. and Slrategy

II @Ihe McGravl-Hill

Companies, ?010

f'-r', Part 2 Cases in Crafting and Executing Strategy

Critics of the Mackey blog posting said it wasinappropriate for a CEO to publicly air the com-paRy's position, to take issue rvith the FTC, and tomake the company's case for why the acquisitionshould be allorved to proceed. At the least, some crit-ics opined the blog should be toned down. Whenthe SEC announced on July 17,2007, that it rvouldinvestigate John Mackey's financial message boardpostings, Mackey put a hold on further blog postingsregarding the FTC's actions to try to block the WildOas acquisition.

B$Ee*ie Fms#s Iu*arkct'* F*saasrcia!

F*rf*rma;**eSince becoming a public company in 1991, WholeFoods Market had been profitable every year exceptone-2000, rvhich involved a net loss of $8.5 mil-lion. That loss stemmed from a decision to divest anutritional supplement business and losses in trvoaffiliated dot-com enterprises (Gaiam.com andWholePeople.com) in rvhich Whole Foods orvned a

minority interest. The company's net income rose ata compound average rate of 17.6 percent from fiscal2003 through fiscal 2007 despite a falloff in 2007net income to $182.7 million from $203.8 million in2006. Wlrole Foods paid its first quarterly dividendin January 2004: since then, dividends had beenincreased several times. The company began payinga quarterly dividend of $0.20 as of the first quarterof fiscal 2008: this dividend level resulted in cashoutlays of about $28 miltion quarterly.

Whole Foods' bqsiness generated cash florvsfrom operations"of S410.8 million in fiscal 2005,$4i2.7 million in fiscal 2006, and $398.6 million infiscal 2007. For the most part, the company's capi-tal expendinres rvent into funding the developmentor acquisition of nerv stores and the acquisition o[property and equipment for existing stores. Capitalexpenditures totaled $324.1 million in fiscal 2005,S340.2 million in fiscal 2006. and S529.7 millionin fiscal 2007. of rvhich $207.8 million. 5208.6million, and $389.3 million, respectively, rvas fornew storc development and $l16.3 million, S13l.6million. and 5140.3 million, respectively, rvas forrernodeling and other additions. During fiscal 2008.Whole Foods expected capital expenditures to be inthe range of $575 to $625 million. of rvhich 65 to 70percent rvas related to nelv store openings in 2008and beyond and approximately 7 to 8 percent related

to remodeling the acquired Wild Oats stores. To aidin financing the Wild Oats acquisition and continuefast-paced opening of nerv stores, Wrole Foods hadtaken on long-term debt of more than $700 millionand negotiated a 5250 million line of credit with itsbanks. Exhibits 9, 10, and ll present the company'srecent statements of operations and consolidatedbalance sheeg.

Lexc- &rsn*i m g *ex*E*pati:EEEt$i!tr liii?irtE ra "F *i4'+sii irrijiti 3:e ii{}zi k ti +-siL?a{d4

In 2008, the souring U.S. economy hit Whole Foodsrather hard. Sales increases at Whole Foods storesopen at least a year rose a meager and unexpectedlylorv 0.8 percent in 2008 versus a robust 8.2 percentin 2007: however. much of the sluggish sales grolvthrvas at the former Wild Oats stores rather than atstores that Whole Foods had opened--comparablestore sales grorvth rvas 5 percent at Wrole Foodsstores (but this rvas still welLbelorv the 10.9 percentavemge annual sales grorvth increases that WholeFoods had realized in the 2003-2007 period). Dur-ing the JulpSepternber 2008 period, sales at the 55Wild Oats stores that remained open (45 had beenrebranded as Whole Foods stores) rvere $159.3 mil-lion and sales at these stores had grorvn at 4.6 per-cent during September 2008.

On July 29, 2008, the United States Court ofAppeals for the District of Columbia reversed thelorver court o,rder allowing Whole Foods' acquisi-tion ofWild Oats to go fonvard and directed the U.S.District Court to reopen the proceedings for furtherevidentiary hearings. Separately, the Federal TradeCommission had reopened its administrative actionchallenging Whole Foods acquisition of Wild Oats.The administrative case rvas scheduled to go to trialin February 2009. Whole Foods rvas vigorously con-testing the FTC! administrative case.

In August 2008, Whole Foods announced thatplanned nerv store openings for 2009 vould bereduced. While it rvas unclear horv much flexibil-ity Whole Foods had to back our of signed leasesor revise the lease terms for the 70 nerv stores thathad been scheduled to open in 2009 and 2010, it hadso far been able to terminate dre leases for 13 of itsplanned new store openings at a cost of $5.5 million.In addition, Whole Foods announced that quarterlydividend payrnents rvould be suspended indefi-nitely. The company had cash of about $30 million

Page 24: Crafting (Cases)

I lhomgson-srictland*Gadk I

Gralting and hacutingStralegy Concepts and

Gases, ITlh Edition

expenses

Caselrlllholefiods I Cr"uMar&er in 2ll0& V"rsion

Core Vplre& and Sttategy

I

$5,607,376'. ....'

1,...:- .'

3,647,7341,959,642

1,421,968

537,674

181,244

I oneu*rrv-ttittComFnnies, Al0

Case 1 Whole Foods Market in 2008r Vision. Core Values. and Strategy

Exhibit 3 Whole Foods Market, Statement of Operations, FiscalYears 2003-2007($ in thousands, except per share data)

c-23

Sabgir"i:':.rril r.l'li..':i: ".'' :r: :"'"i'-:

Cost of goods sold and occipancy,costs-:..-',.','.r.: . . :.

. GrossProfit,' . :'' : : ".

:

Direct store expenses : ' :

Storecontribution,'. ,: : -,

$6,591,773

. "... t... . '

4,295,1702.296,603

.'!,/..'!1.'F2s, 585,374

217,743

s4,701,289''. r.. .. ti I

3,05211ry

1,&9,105

,,1,223,473425,63ar58,864

S3,864;950r..,'... -.,.ll. ;.

2;523,816:1,341,134

sb6,o4o

355,094,. 119,800

$3,148,593,:l:.:.. :t::.. .....i..

2,070,3341,078,259, 7s4,42i'

283,837r 100,693Gen6ral and'administrative

Pre-openinifand'relocation costs,Operating incofi",, , :: . ::lnterest expense; net : , r..

.

lnveshnentand otheiincome 'l 'ilncome before income taxei. i ,

Provision for income taxes :, ' . .,

Basic eamings per share '

Weighted average shares' : '

outstanding 1 :

Diluted earnings per share

Weighted average sharesoulstanding, diluted basis

Dividends declared per share

' 70,190

' zg7,4sl' ' (4,209)" 11,924304,567121,827

sl82,740$1.30

140,088

s1.29141,936

s0.87

37,421 .

319,009:

(32)

20,796 ,

339,713

.13.s,88qs203,828

s1.46139,328

s1.41

145,082

s2.45

I .. 37,035' 229,793

':: {2|22319,623

237,133

100,782

s136,351

s'l.05130,090

s0.99139,950

s0.47

, 1,1'.:, ,l.l

,:, 18,648 ,

216,e6. r "(7,249), i. ,: ,.6,456 ..

215,853 i..

86,341

s129,s12sl.06

122,648...

s0.99135,454'

$0.30,I

:,, ll tS,ZSS

: 167,379

:'l'(8,114): 5,593

164.858

,:..., 65,943

s98,915

r, i. $0.84118,070

.'.i,....$0.79

130,660

Source.'Whole Foods Markel,2007 1G.K report. p.25.

and about $100 million available on existing linesof credit as of November 2008; in recent qua(ers,Whole Foods'capilal expenditures for store expan-sion lrad exceeded iu cash florvs from operations.pushing total debt to $929 million. To bolster itsfinancial position and provided needed funding foropening additional stores and revamping former WildOals stores, Whole Foods had recently arranged tosell $425 million of preferred stock to private equityinvestors, rvhich equatBd to an orvnership interest of17 percent in the event the private equity investorsexercised rights to convert their preferred stoclc intocofirmoD stock.

COruBPHTITORS

The Food retailing business rvas intensely competi-tive. The degree of competition Whole Foods facedvaried from locality to locality. and to some extentfrom store location to slore location rvithin a given

locale. Competitors included local, regional, andnational supermarkets. along rvith specialty grocerystores and health and natural foods stores. Mostsupermarkets offered at least a limited selection ofnarural and organic foods, and some had chosen toexpand their offerings aggressively. Whole Foods'executives had said it rvas to the conrpanys benefitfor conventional superrnarkets to offer natural andorganic foods for two reasons: first, it helped fulfillthe company's mission of improving the health andrvell-being of people and the planet and, secon{ ithelped create nerv custorners for Whole Foods byproviding a gate$,ay experience. They conterdedthat as more people lvere exposed to nanrral andorganic producB, they rvere more likely to becomeWhole Foods customers because Whole Foods rvas

the category leader for narural and organic products,offered the laryest selection at competitive prices,and provided the most informed customer seryice.

Whole Foods Markett hvo biggest competitorsin the natural foods and organics segment of the food

Page 25: Crafting (Cases)

I nmpson-suicuand-6an&h I

Crafting and ErccutingStsatagp Coaceps aaiCssEs, lTth Edition

Casel;WholsFoods I cr"uMa*el in200&Vision.

Core Values, snd Sr"le$y

lr**,*.,**----lCompanies.20l0

c-2.1

Exhihit 10

Part 2 Cases in Crafting and Executing Strategy

Whote Foods Market, Consolidated Balance Sheet, FiscalYears 2006-2002($ in thousands)

Short-terminvestments.''.''..r,:.,'.,. ... .,'..,'', ' ': -.:.,1 '.. : .. 119a.847.",

Proceedsreceivablefromstoredjvestitures; ::.: i6s,o54: ,'.,,.. ' ... I -,,t,,'Accounlsrgceivablg ,. ..: .:;..':: .:.:, l: '.' " 105,209.,'.',:i:.::'r'.::r',"'l 62,137.,':,t..'-.

Prepaidexpensesand'othercunentassets,:. ' - : 6Q.8gg.;.,.,',,...,:,.r,:'l g3,gd4...i,.,Total cunentaii;sets,i r,: ,,,,:r;.ilr,',...,',

,. l',::' ' .66?,180, ..,.,i ,',,,, r,, ,@.., ,....,.

Propertyandequipmenh'nef of accumulateddepreciation :. 1 :.:; ' , ','',::;:,.....,, I ,r.,',,, 1, ..:.;andamottization, 'r. .. : .: ,., : ' t'1,666,S59 ', ': .,", : t. ' 1.296,133 .', :

lntangibleassets,netofaccumulatedamortization, I 97,683t,, , , : B4,16T';'Defenedincometaxes. . .. ,::r. I 104,877 .. i ' ..: Zg,41Z': '

otherassets ,., , i',. r..." zl,17g ": s,zos].,

-

Total assets ., .i , , . : S3,2iS,128 , , ,.- $2,042;996 ,

. " l r '.Liabilities and Shareholders' EquityCurrentliabilities: .: : ,:l., ,,., , ,

Cunentinstallmentsoflong.termdebt:':i.

Assets

Cunent assets:

vu!l9.|llttorq|[l|v||lgu|lvllg.tElltluEUl,.-.,:

and capilal lease obligations S 24,781 , S : 49Accountspayable. '. 225,728.,.. 1 , :tat,e57,Accrued payroll, bonus, and olher benefils due team

members- 1S1,290., ..,,,., . 158.014Dividendspayablq,, , ., 25,060. . .:othercunenitiabiiities ,, ,,',.. ,.

' szEssT . ', -. . igqrgsoTotal cunent liabititieJ. ' , ,80"516. . , ., --S0r,i?0

Othertong-lerraliabiiities' , 1.. , .. .' ', '. . ,, elrrsg,, ,'. . ' uu

Long-termdebtandc5pitai teaseobiigations, less .: ,...ii,r: t.,,",: .; :.i,..,:cunent'installments 736,087,., ' 8,606Deferredrenttiabitig ': '.' ", ' . , '. '''' tsz,ssz'. ;.,. -t , rzo,oa; "'

Tolal liabilities . ' . 1,754,3?4,.,,.,, ..,.' OgA,gsg"r"".."':r.',,1-.;.: '.'::.-:': . .... '' "-::'-'r::.: .

Shareholders'equity:Commonstock,noparvaIue,..1....;..::.]j...:....'300,000sharesauthorized:143,787.and142,198shares.......:..,,issued;139,240and139,607sharesoutstandingin2007 .' .'. ':-..:':-:i.': ri':-: :;.:,:::''..,r.::. :.and 2006, respectively ' , 'l;234845: : ,.,: :: .: r :r : 1,147,872

Total shareholders'equityr:. ,.: ..,' . ,: :. .. : : .. . 1,458.804.:::r'i;:r: :..:. 1.404,14gCommitmenlsandcontingencies,'. , ,.... . ::.','"',,: j':

Totat tiabilitiesandshareholders'equity : ' j- : S3,213J281,..r:: ii':l::, ' 92,942,996

ano ZUUO, fespecuvery. . . ' 'l'Zgiluzl5::..:1 :.:r'-: j r.j..: , 1,147,872:Commonstockintreasuryitcosl::':'- , (199,96i),.,r .,., (99,364)Accumulated other comprehensirre income 15,772' .. , :: ' : 6,g7sRetainedeamings , , ,,,14,1??,,,1: .,,,1l.,:,- s49,a6q

Source:Whole Foods Market, 2007 lO-K report. p.4't.

Page 26: Crafting (Cases)

lhonpson-Strickland-Grmtlc

Cnfting and Execuing

Stntegrp Concaps and

Gases, lTth Edition

txhihit 1I

Casa 1: Vtlhole tosds I e*.Marlct in 2lE8:VisionCore Values. and Strategq

-I | @ The McGny.,-uitt

$qropanies, 2{1,0

Case I Whole Foods Market in 2008: Vision, Core Values, and Strategy

Whole Foods Market, Selected Cash Flow Data, FiscalYears 2008-2007($ in thousands)

l€D

c-25

N:! cash prgyid3d by oeeyting. actruilies , .

' Caih flows from invesling activities . . , 'DeVelopment iosts or new store locations," '

' Ottreiproperty,'ptant and equipment expendituresPurchase 6f availabte-tor-sale sEcurities

Sale of availabie.for-sale securitiesi Payment for purchase of

'aiquired entities, net ol cash

acquired , '

:,,lOthef item:: '.i. i'-r:..:.:-. I ' .. :::: .

: rrrJ,caSn rieo ln invbsringiactivities'

i"i""t Rair"from financinj actititiis'ii ' I '

Dividends'paid,'.,',lssuance of iommon stock : '

Purchase oftreasurystock t,

.' .

Excess tax benefit related to exe#ise of team member' stock oPtionS i '

Proceeds lorm longterm bonowingPayrnents on long-term debt and capital lease obligations, Net cash provided by {used in) financing activities

Other cash flow dataCash and cash equirralents at beginning of year

Cash and cash equivalenls at end ol year

' Net change in cash and cash equivalents

lnterestpaid .:':.:Federal and state income laxes paid

s 398,603

(389,349) ',

(140,333). '

1277,2831 '

475,625(596,236,.

: 32,59jt. ,

$(894,981) , "

S 1Se,Z+21, ,.54.383

'' {9e.e97)l12,839 ,

,

717,QOO

(e3,3s4

s494,126 :

s 2,?52

{2.2s2].4,561

152,626

, s 4'10,819

(207,792)

(116,318)

;... -':. -..:. r

(208,s88i. ... t: 't:.(131,614)., :: ,:.-,:..,,. .:.,.:(555,095).. -; ';. -

362,209 . .. ,. , .

, (s6;19n:! l

s(569,255) tl

..... ,..',::..';.:..s{358,075):.::

: ::222,030 .

. (ee;e64)",52,008 '

: ., -, , l :'.

(s,680) -

$(18e,681I

$ 308,524

2,252 ' '

(s06,?72)

607

70,226''

. , 1,969

s(322.242)

.' $ (54,683).

.- 85,816

t, ', a'.'

T' ,

'=rl

(5,e33)

s 25,200.

' ' s 194,747

308,524't'l3,7TI

1,063

74,746

'includes cash outlays for a sPecial one-lime dMdend ot S.0O per share that was paid iust prior to a 2-lor-1 slock sptit in eady 2006.Source.'Whole Foods Ma*el, 2007 10-K repon, p.44.

retailing industry rvere Wild Oats Markets (until its2007 acquisition by Whole Foods) and Fresh Market.Another competitor rvith some overlap in productsand shopping ambience rvas Trader Joe's. Supervalu/Save-a-Lot, the sixth largest supermarket chain inNorth Arnerica (see Exhibit 2), had begun an initia-tive to launch a chain of smail natural and organicfoods stores called Sunflorver Markets.

i::rirrirlrEFS-

i,ii-E E t ii.t t*fr ES t':i't &i'!,i *E

Prior to being acquired by Whole Foods in August2007, Wild Oats Market ranked second behind WholeFoods in the natural foods and organics segmentand rvas Whole Foods'big-eest and closest competi-tor in terms of merchandise mix, product offerings,store arnbience, and target clientele. The company's

109 stores in 23 states and British Columbia Can-ada. operated under four names (Wild Oats NaturalMarketplace. Henry's Farmer's Market Sun Harvest.and Capers Community Markets) and generatedcombined sales of about $1.? billion. Mike Gillilanda cofounder of Wild Oats and its original CEO, hadgone on an aggressive acquisition steak during theIate 1990s to expand Wild Oats'geographic co\€rage.But Gillilandi acquisition binge piled up extensivedebt and dropped the company into a money-los-ing position u,ith too many stores, a dozen differentstore names, a dozen different rvays of operating, andinconsistent product selection and customer servicefrom one location to another.

When Perry Odak, formerly the CEO of Ben &Jerry's Homemade until it rvas acquired by Unileverin 2000, joined the company in 2001. he sheamlined

Page 27: Crafting (Cases)

I lhompson-sricktrul-Gamtle: I Caset:Vltholehods i C".,Craftirg and B<rcuting ll/larftet hAxt&Vision,Slrate$E Concepts and Core VEIBBS, and StrolagyCases, lTli Edition

Part 2 Cases in Crafting and Executing Strategy

operations, closed 28 unprofitable stores, cut prices,trimrned store staffing by l00employees, and launcheda nelv, smaller prototype store with a heavier empha-sis on fresh food. Merchandising and marketing wererevamped. The strategy tvas to drarv in more "cross-over" shoppers with lorver-priced produce, meat, andseafood and raise the average customer purchaseat checkout above the current $19 level. Mren thisstrategy produced only mixed resuhs? Odak over thenext several years tried a series of different strategicinitiatives-accelerating nerv store openings, remodel-ing a numberofexisting stores, changing store layouts,expanding fresh produce selections, offering more pri-vatelabel products, making efficiency improvementsin distribution and store operatiom, and tinkering rviththe product mix and product selection. But none ofOdakt initiatives delivered the hoped-for improve-ments in profit margins and company profitability.although sales did grorv from $969 million in 2003to Sl.2 billion in 2006-2007. Wild OaB recorded anet loss of $43.9 million in 2001, net income of $5.1million in 2002, net income of $1.6 million in 2003,a net loss of 540.0 million ia 2004, net income of $3.2million in 2005, and a net loss of $ 16.6 million h 2006.

While both Whole Foods and Wild Oats hadstores in some of the same urban areas, for the mostpart theirstores were not in the same neighborlroods.Wild OaS'latest stores rvere 22,000 to 24,000 squarefeet and fearured a grocery-store layout (in rvhichproduce, dairy meat. seafood, and baked goods rverearound the perimeters of the store). an expandedproduce section at the front of the store, a deli, a

sushi bar. ajuice andjava bar, a reduced selection ofcanned and packaged irems. and store-rvithin-a-storesections for.qupplements and specialty personal careproducts.

firec.?ls *S+i,,fu*t€ I LrSiin ai?::*,!!:riir?'

Fresh Market, headquartered in Greensboro, NorthCarolina, rvas a family-orvned 77-store chain oper-ating in 17 states in the Southeast and the Midwest.Founded by Ray Berry. a former vice president rvithSouthland Corporation rvho had responsibility oversome 3,600 ?-Eleven stores, the first Fresh Marketstore opened in 1982 in Greensboro. Berryb conceptlras to develop a small neighborhood store rvith the feeland anuosphere of an open European-style market thatrvas service-oriented and focused on perishable goods

I tri.***'-nn -_lCompanies. Z)10

(particularly fresh produce and meats and seafood dis-played in glass-front refrigerated cases). All Fuxhresand display pieces rvere purchased use{ as the storervas financed entirely rvith the family's savings. Afterthe Greensboro store, rvhich had lorv-level lightingand classical music playing in the background, provedto be a hit rvith customers, Berry began to open similarstores in other locales. During the 1982-2000 perio{Fresh Market's sales revenues grety at a Z5-2 percentcompound rate, reaching $193 million in 2000; rev-enues were an estimated $350 million in 200?. Thecompiuly had almost 7,000 employees in early 2008.Management planned to open 15-20 nerv storcs annu-ally. Expansion lvas funded by internal cash florvs andbank debr Financial data rvere not available becausethe company rvas privately orvned, but Fresh Marketiprofitability was believed to be above rhe industryaveElge.

Fresh Market's product line included meats;seafood; 300 fresh produce items (iucluding a grorv-ing organic selection): fresh-baked goods; preparedfoods;40 varieties ofcoffeeq; a selection ofgroceryand dairy items; bulk products; cheeses; deli items(including rotisserie meats. sandrviches, wraps,and signature soups); rvine and beer; and floral andgift items. Fresh Market stores rvere typically inthe 18,000- to 22.000*quare-feet range and rverelocated in neighborbood shopping areas near edu-cated high-income residents. Nerver stores had anopen-air design that evoked "old-rvorld Europeancharm, artful sophistication, old-fashioned retailsentiment. an--d- a rvarm and friendly atmosphere."Warm lights.'tlassical background music, and terra-cotta-colored tiles made Fresh Market stores a cozierplace to shop than a typical supermarket.

Aside from store ambience, Fresh Market differ-entiated itselffronr natural foods stores and traditionalsuperrnarkets rvith rvhat management considered assuperlative service; attractive fresh produce displays;appealing fresh rneat and seafood selections: and"upscale grocery bou{iqtre" items suclr as pick-and-pack spices. goumtet coffees, chocolates, lrard-to-get H&H bagels from Nerv York City. Ferrarat NervYork cheesecakq fresh Orsini parmesatr cheese. andAcqua della Madonna bottled rvater: and an extendedselection of olive oiis. mustards, bulk products (gm-nolas, nuts, beans, dried fruis. spices, and snaclcmixes), lvine, and beer. Stores also stocked a sn:allassortrnent of floralitems and gifts (cookbooks, gift

Page 28: Crafting (Cases)

I lLompon-suictrtaod-6arr6le: I

Cralting rnd Executing

Suaregp Concepls and

Gasos, ITtlr Hition

Case l:llYhotaFoods I Cr..Madtet in 2m& YisioaGore Valoes, and Strategy

cards, baskets! cutting boards, and gift baskets) and abare lineup ofgeneral grocery products. The productline emphasized variety. flreshness, and quality. Eachdepartment had at least one employee in the area con-stantly to help shoppers-the idea rvas to force inter-action behveen storc employees and shoppers. Fromtime to time, stores had cooking classes, wine tast-ings, and food sampling events. Fresh Market spon-sored an annual frrnd-raiser for ttre Juvenile DiabetesResearch Foundation called the Root Beer Float.

Stores had 7$-100 employees, resulting in laborcosts about double those of supermarket chains. AIIfull-time employees rvere eligible immediately uponhire to enroll in a medical, dental, and life insur-ance plan. After 90 days, eligible full+ime employ-ees were offered additional benefits that includeddomestic partner medical and dental coverage, short-and long-term disabiliry insurance, holiday bonuses.employee discounts, and a 401(K) plan rvith 50 per-cetrt company matching of employee contributions.Immediately upon hire, all part-time employeeswere eligible to enroll for medical, dental, and lifeinsurance.

Trag5*r .i*e'sBased in Pasadena. California. Trader Joe's rvas

a specialry supermarket chain rvith more than 315stores in 22 states (Arizona, California, Connecticut, Delarvare, Georgia. Illinois, Indiana, MarylandMassachusetts, Michigan, Missouri, Nevada, NervJersey, North Carolina, Nelv Me,xico, Nerv York,Ohio. Oregon. Pennsylvania, Virginia, Washington,and Wisconsin). Management described the compa-nyt mission and business as follorvs:

AtTrader Joci. our mission is to bring our customcrsthe best food and beverage values and the informationto makc informed buying decisions. Therc are morethan 2.000 unique groccry items in our label. all athoncst everyday lol priccs. We rvork hard at buyingthings right: Our buyers travel the rvorld scarchingfor nerv items and rvc rvork rvith a variety of supplicrstvho make intcrcsting products for us. many of therncxclusive to Tradcr Joe's. All our privatc label prod-ucts have their orvn "angle." i.e.. vegetarian. Koshcr.organic orjust plain decadent. and all havc minimallyprocessed ingredients.

Customers tell us, "l never knerv food shop-ping could be so much fun!" Some evcn call us"Thc homc of cheap thrillsl" We like to bc part of

I @lhE tutcGrarv-Hitl

Cornpanies.20l0

our neighborhoods and get to knotv our customers.And rvhere else do you shop that even the CEQ DanBane. rvears a loud Harvaiian shirt?

Our tasting panel tastes cvery product beforc rve

buy it. If tve don't like it, rve don't buy it- If cusrom-ers don't like it. they can bring it back for a ne.hasslercfund.

We stick to thc business we knorv: good foodat the best priccs! Whenevcr possible rve buy directfrom our suppiiers, in large volume. We bargainhard and manage our costs carefully. We pay incash. and on time, so our suppliers like to do busi-ness rvith us.

Trader Joet Crerv Members are friendly, knorvl-cdgeable and happy to see their customers. They tasteour items too, so they can discuss them rvith theircustomcrs. AII our stores regularly cook up nerv andinteresting products for our customers to samplc.s

Plans called for ongoing development and info-duction of nerq dne-of-a-kind food items at valueprices, and continued expansion of store locationsacross the country.

Prices and product offerings varied somewhatby region and state. Customers could choose froma variety ofbaked goods, organic foods, fresh fruitsand vegetables. imported and domestic cheeses,gourmet chocolates and candies, coffees. fresh sal-ads, meatless entrdes and other vegan products,lorv-fat and lorv-carbohydrate foods. frozen fish andseafoo( heat-and-serve entrees, packaged meats,juices, rvine and beer, snack foods, energy bars, vita-mins, nuts and tail mixes, and rvhatever other exoticitems the companyt buyers had come upon. About10-15 nerv. seasonal. or one-time-buy items rvereintroduced each rveek. Products that rveren't sellingu,ell rvere dropped. Trader Joe's lrad recently rvorkedrvith its vendors to remove genetically modifiedingredients from all of its private-label products. lthad also discontinued sale of duck meat because oFthe cruel conditions under rvhich ducks rvere gro\\,n.

Stores rvere open, rvith u,ide aisles, appealingdisplays. cedar plank u'alls, a nautical decor, and crervmembers rvearing colorful Harvaiian shirts. Becauseof its combination of lorv prices, an emporiumJikeatmosphere, intriguing selections, and friendly ser-vice, customers vierved shopping at Trader Joe's as

an enjoyable experience. The company rvas able tokeep the prices of its unique products attractivelylow (relative to those at Wlrole Foods, Fresh ivlar-ket. and Wld Oats; partly because its buyers were

Case I Whole Foods Market in 2008: Vision, Core Values, and Strategy

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I lborrpson-suicklaod-sadk I

Crafting ard Frecuting

StrategF ConEeFrs and

crses, ITth Edition

Casal:WhoteFoods I Cr"uMa*et inZXE:Uision.

Gore Ualues, and Strategy

I ar**c,**** ---lCompanies, mt0

Fre*I: & E*$y f**rgrcfuxr'fu**dfili n :i:r rr- +.6tEnitl *tts f -=j

In 2007. a nerv chain, Fresh & Easy NeighborhoodMarket- emerged as a competitor in the natural andorganic se,cm6nt of the retail grocery industry. Fresh& Easy rvas a nelvly estab'lished subsidiary of Brit-ish supermarket giant Tesco, the rvorldi third largestretailer (sales of f51.86 billion for fiscal year endingFebruary 23, 2008, equivalent to about S95 billion).Tesco did extensive research on 60 American fami-lies and had numerous focus groups in Californiaprovide conuxents on store prototypes trefore open-ing its first 2l stores in Phoenix. follorved quicklyby an additional 38 stores in Las Vegas, San Diego.and Los Angeles. Some of the stores tvere located inlorv-income central-city nei ghborhoods, rvhile othersrvere adjacent to nredium- and upper-income residen-tial areas. Tescot ambitious growth strategy calledfor opening Fresh & Easy locations at the rate of 3perrveek with 200 stores open by February 2009 andas many as 500 stores by 201 I. The company opened

Part 2 Cases in Crahing and Executing Strategy

ahvays on the lookout for exotic items they could Sunflower Farmers Market stores ranged frombuy at a discount (all products had to pass a taste test 25,000 to 27.000 squar€ feet and had a rvarehouse-and a cost test) and partly because most items nere like afmosphere, lvith no customer service e,\ceptsold under the Trader Joe's label. for eheckout personnel. Stores stocked about 5.0{i0

different items, a number of rvhich were one-of-a-

sgi$r$sdu$r Fsc'aarere flbjiartue€s +'#il::il1'iJ#lT:1':J1il#,i"#,:fiY:Sungorver Markets, out to establish a discount niche minimally processed food items. Pallets of goods

in organic and natural foods, entered rh" *r;k;;;; l|!t_t t?::d wherever there rvas floor space avail-

2003 with four srores-rrvo in Phoenix, on" in erl"- ill:: -Ef"l ttore stocked fresh produce, meats and

qnerque, and one io n.nu"J1e;ig}gdilril.o-fi- :-u-nfT-1-"_"ttals, nuEition bars, health drinks, pas-

pany, basea in Boulder, cotorado, had 14 ";;'i; 3)Iti:i *eals, trail mixes, coffee,,nuts, candy,

Ariiona, colorado, Nevada, and Nerv tutu*i"Jona'" 1111dt::I",:t"t' breads, vitamins, supplements, nat-

distribution center in phoenix. sunflorver,s ;;;;; ural remedies, medications, soaps, shampoos, and

borrorved frorn concepts emptoyed uy r*a"rlo]ir 3::lt:j::e stores had food bars with live chefs-

and small farmer's-market-r5rpe stores. Thr ";;;;: ,u:*.tY-bad a rveekly sales flyer, and wednes-

ny's mission statemont aesiriuea i,r rour-pror-i"a :j]tl:::^ltomoted as "Double Ad Day" because

,uot,gi,approach: r'-"=-- llfutfrJ':[".T..11],-',i XfiI."1,1:,"ffi'H!:l

' We }Vill Ahvays Offer the Best Quality Food on V/ednesday); shoppers could thus find virtuallyat the Lorvest Prices in Torvn. "Better-than- hvice the amount of items on sale tluoughout thesupermarket quality at better-than-supermarket store on Wednesdays. Stores also served the com-prices" is our motto. munify by organizing activities, lectures, and events

. We Keep Our Overhead Lorv. No fancy fix- that emphasized the value of good nutrition and atures or high rent. No corporate headquarters healthy lifestyle.. . . just regular people, like yo4 looking for thebest deals rve can find.

. We Buy Big. We source directly, we pay ourvendors quickly, and rve buy almost everythitrgby the pallet or truckload. That buying powermeans big savings for you!

' We Keep tt Simple. We don't charge our vendors"slotting allowances" or shelf space fees. Justhonest-to-gogdnes'$' negotiating for the lorvestpossibld price and rve pass the savings or to you.

The company's tagline rvas "serious Food . . .

Silly Prices." According to founding partner MarkOilliland "The Iast thing rve want to be is anotheruanna-be Whole Foodsl'Cilliland rvas formerly thefounder and president of Wild Oats but rvas florcedout when his aggressive expansion strategy put WildOats in a financial bind. Gilliland's ambitions forSunflower \vere to have 50 locations in 2013 andbecome a company with annual sales of $500 mil-Iion. In late 2007, Sunflorver raised $30 million inequity financing from PCG Capital Parrners to fundits store expansion initiative: plans called for open-ing about eight nerv locations annually.

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I ftornpscn-Suictland--$emlle I

Crafting and Etecuting

Slrateg$ ConceFrs and

Case5. tlrh Edirion

CasEtWholeFoods lC*"Market in 2m&Visiott.

Co.e Value, and Strategy

an 820.000-square-foot disu'ibution center (bigenough to supply about 400 stores) in a Los Angelessuburb that was used both to create and package pre-parcd foods and to supply area stores; a warehousefor northern California was being planned for rvhenstore expansion moved northrvard.

The Fresh & Easy concept called for stores to bein readily accessible neighborhood locations: haveabout 10,000 square feet of shopping space (abourthe size of an average Waigreenl); stock around3,500 items (versus about 60,000 at a typical super-rnarket); and convey a theme of fresh, wholesome,and easy-to-prepare foods in a convenient and pleas-ant setting. Product offerings ranged from gourmetitems to everyday staples and included natural andorganic foods: fruis and vegetables; meats, fish. andpoultry; and a selection of prepared foods and grab-and-go products-all intended to convey a themeof fresh, rvholesome, and easy to prepare. About 45percent of the products on the shelves rvere house-branded Fresh & Easy items-one of the biggest-selling private-label items rvas a $1..99 bottle ofFresh & Easy "Big Kahuna" Australian rvine (anidea said to be an imitation of Trader Joe's "Tivo-Buck Chuck" wine offering).!{ Other key fearures ofFresh & Easy stores included:

. Low prices (around 2O-25 percent belorv tr-aditional supermarkets and on a par rvith the pricesat'fi/al-Mart Supercenters).

. Locally sourced and mostly packaged freslr pro-duce rvith expiration dates.

. Wide aisles and simple store layouts.

. Lorv shelves that allorved shoppers to see allacross the store.

. All self-checkout.

. Energy-efficient store designs, lighting, andequipment (and the 820.000-square-foot distri-bution ceilter ltad the largest solar panel roof inCalifornia).

. Most Fresh & Easy brand products, particularlyprepared [oods, rvere packaged so shopperscould see rvhat rvas inside.

. A taste-before-you-buy policy rvhere shopperslvere encoura-sed to take almost any product tothe "Kitchen Table" area of the store. rvhere a

staffperson rvould open it or cook it and doleout samples.

I @*p tvtcGrarv-gnt

Conpanies, ?0'|0

c-29

Holever, in April 2008, top executives at Fresh& Easy announced that the company rvould put athree-month hold on fi.rther nerv store openings "tokick the tires, smooth out any rwinkles and makesome improvernents customers have asked for."lsManagement had already corrected a problem ofstores &equently running out of certain items andresponded to unexpectedly high demand for pre-pared foods by adding more than 100 nerv selec-tions. A ftyer campaign backed by the United Foodand Commercial Workers Union (which representedworkers at competing supermarket chains) had castdoubts about the freshness and safety of the meatand produce sold at Fresh & Easy stores (rvhere thervorkforce rvas nonunionFthe flyers directed read-ers to a union-produced Web site lvith links to nervsarticles detailing instances in Europe where Tescosupermarkets lvere found to be selling old or expiredfood products.

But there rvas also thought to be a more fun-damental strategic issue about whether the Fresh& Easy concept of offering a limited selection oforganic and narural foods at relatively cheap pricesrvas really rvorking. One anaiyst estimated'thatlveekly sales at Fresh & Easy stores had only beenabout $170.000 instead of the projected $200,000.36A research report by another analyst rvas consider-ably more dorvnbeat, suggesting that rveekly salescould be averaging as linle as $60,000.17 Skepticsof the Fresh & Easy format believed that health-conscious food shoppers could find a far rvider andmore appealing selection at Whole Foods stores(and to a lesser extent at Trader Joe's), and theshopping ambience rvas far superior at both WholeFoods and Trader Joe's. lnexpensive packaged foodsrvere commonplace at supermarkets and full-rangesuperstores.

Horvever. bullish obserrrers sarv the Fresh &Easy concept of trying to meld qualiry, lorv price, andconvenience as a promising opportunity that couldfill a big hole in the U.S. market. One very bullishretail analyst had gone out on a limb and projectedthat Fresh & Easy could have 5.000 U.S. stores andannual sales of $60 billion by 2020. making it oneof the top l0 U.S. grocers.ls And Tesco rvas lvidelyvierved as a formidable retailer rvith ample resourcesto fine-tune Fresh & Easyt business conceptand strategy and to eventually generate a return onits $700-millionAlus investment in Fresh & Easy.

Case I Whole Foods Market ia 2OO8: Vision, Core Values. and Strategy

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I nrnpsar-Srn:*land-sanrth I

Cralting and hecstin!SratsgF ConEepE rildcases. tTrh Etlition

Case 1: Illhale Foorts I Cu""Madtet in 2fi18; VisionCore Yalues. and Stratagy

@Ihe Mc6arv-Hill

Cenpanies, 2010

I

Part 2 Cases io Crafting and Executing Strategy

In commenting on the Fresh & Easy venture in theUnited States, Tesco CEO Sir Terry Leahy sai("Clearly, it is high risk. tf it fails iti embarrassitrg. . . .lf it succeeds then it's transformationali'2e In April2008, Leahy announced that rvhile Tesco expectedto report losses of about $200 million in 2008 on itslaunch of Fresh & Easy stores in Arizona, Califor-nia, and Nevada because ofstart-up expenses, salesrvere "ahead of budget" and &e best-performingstores lvere e.xceeding $20 in sales per square footper lveek-a rypical nelv _qrocery store in the UnitedStates rvas said to average $9 to $10 in sales persquare foot during the first year of operations.3o Heindicated that the company planned to have 200 Fresh& Easy stores open in the United Srates by mid-2009and rvould begin releasing sales numbers for Fresh &Easy stores in September 2008.

E rr.rsp**msstt g**+;ars$ a** rte**tE;F**;i &s.***raIn 2005, there tvere approximately 14,000 small.independent retailers of natural and organic foods,vitamins/supplements, and beauty and personal careproducts. Most rvere single-store, onner-managede[terprises serving small to medium-sized commu-nities and particular neighborhoods in metropolitanareas. Combined sales of the 14.000 independentsrvere in the $18 billion range in 2007. Tivo othervitamin/supplement chains, General Nutrition and

Endnotes

Vitamin World, dominated the vitamin/zupplementsegment rvith about 7,500 store locations; vitamin/supplemeut chains lvere an alternative source formany of the products that Whole Foods stocked inthe vitamin/supplement section of its stores. Most ofthe independent stores had less ttran 2.500 square feetofretail sales space and generated revenues of lessthan $l million annually, but there rvere roughly 850nahral foods and organic retailers rvith stJre sizesexceeding 6,000 square feet and sales ofbehveen $ Imillion and $5 million annually.

Product lines and range ofselection at the storesof independent natural and health foods retailersvaried from narrorv to moderately broa( depend-ing on a storet market focus and the shopper trafficit rvas able to generate. Inventories at stores underI.000 square feet could run as linle as $10,000,rvhile those at stores of 6.000 square feet or moreoften ranged from 3400.000 to $1,200.000. Manyof the independents had some sort of deli or bev-erage bar, and some even had a small dine-in arearvith a limited health foo6 menu. Revenues andcustomer traffic at most independent stores tveretrending uprvard, reflecting grorving buyer interestin nalural and organic products. Most independentretailers had average annual sales per square foot ofstorc space of $200 (for stores under 2,000 squarefeet) to as much as $470 (for stores greater than6.000 square feet)-Whole Foods'average wBS over5850 per square foot in 2007 (excluding the nervlyacquired Wild Oats stores).ir

I Thg carggrs sg-clion OJ -.jivr.rri,lr.ri;:.,::i::.:iiirr+i:.r:;-.:,,i (aCCgSSgdMarch 26, i'008).e As quoled in Eliaabeth Lee, "Natiooal Stafldards Now Deline OrganicFood." At anla Jouma! aN constitution, oclober 21 , 2002-3 Eco,nomic Sesearch Service, U,S. Oepanm€nt of Agricutture, data at1r,;1.; 1- ; 1,..:i;1i 1.i:i.r (aCCeSSed March 25. 2008)," lnlofmation posled il r;r"rr.i+*riri;.,::ti:rii;:,.r:rir; (aCCgSSed March 25,2008).scompany press release, November 18, ZO0S.6John Mackey's le[er to ]he shareholdgrs in the companys 2007annual reporl, November 2007.7 Company press release. February 19. 2009, p. 4.u Leller lo Shareholders. 2003 annuat report.e Prices ciled in'Ealing Too Fast at t/Vhoie Foods,'gusrhesswee&October A4. 2005, p.94.r0 Hotlie Shaw. "Retail-S'aw1, Whote Foods Opens in Canada,* rvaliona,Post May1,2002,p.FPg.rr See Karin Schill Rives. -fexas-Based Whole FooG Markel Makes-Cflanges to Cary N.C., Grocery Slorei Nsu6 and Obsert€r, March 7,2002.

rrAs quoted in Marityn Much,'Whole Foods Markets: Austin, TexasGreen Grocer Relishes Atlpical Sales,' ,nyeslors gusiness Dai,ilySeptember 10,2002.{3As quoted in nVhole Foods Market to Open in Atbuquerque. N.M.."Santa Fe NeI.v Mexican, Seplember 10, A0OZ.r{ Company press release, January 21, 2003.ts EVA at the slore level rrras based on store contribution (store rev-enues minus cosl ol goods sold minus stoie operaling expenses) rela-tive lo store ifiveBlrrent over and above lhe cost ol capitai.t6As quoted in John K Witson, "Going lryhoE xog wtin Wfrob fooos,,Bankrale.corn, posied December 23. 1 999. Mackiy made lhe stat+ment in 1991 lvhen ellorts were being made to unilnize the company,sstore in Berkeley, Calitomia.t? tnlormation conlained in John B. Wells and Travis Hagtock,'Whole Foods Martet, lnc.," Haryard Business School clse study9-705476.ra David Kesmodel and John. R. Witke, -l rhole Foods ls Hof, Wtd Oatsa Dud-So Said Rahodeh," WarrSlreetJournal, Jul)/ 12.2007, :,i:,;,,..- .::,--. .,.:.: -.....,'-il^:.. it=1 r--...i-,.!.i, j..r.. :,:,.:-r':iii !.' tt-.iti ra I r r.,, i;?:3::f,:ii:l-J j-i.). jii:iii (aCCgSSedApril7,2008).

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ij.l:

TtomgsorSthUrnd-GE obkCrafing and Eracurino

Slrallgf CooBepts snd

Casas. tTrh Edition

Gasa t: Whote Foods

ilarket in 2llk Vision,

Core Values. and Srrtcgy

Gasa

Case I Whole Foods Market in 2008: Msion. Core Values, and Strategy c-3r

reAndew Martirl nUhole Foorls ExeculiE Used Alias," lrervl6rk rrneS,SXt 12, 2007, xtrr,,.,illlirilrs.cr!fl/!!$?if?,r i ?/Lu,cirri!$si l?i*rd::.il,.riii(accessed April 7, 2008),a tbld.?1 Company press rcleasa, October S, 2007. Accoding to a Juty 13.2007, posling on a Eusinessweer( message board, .*vi'r.ilrusin?ss.

:,.dqrlLc,ofi:,.r.'trueralrrkrla*+giritiir/t a.?hi:,+si?Q.:; j0TJithc. :i!.ri;ts.. joir.hiiui (accessed Apdl 7, 2008).z lnloamatloo postgd itt.,r,.*t,irr.Jrrjre*.ccu (accessed Decernber l,2005).aThig seclion ls based on hlormalion posted al ry.*i.;.:iufiiicr.irrsrtr.!rg..s.ccrn and in Joe Lewandowski."NaluElg Slores FGsheoThelr

SlralegieC' Natu6, fuods Merdwtd*r:January 1, !Qe4, i.;rrrr.returslicccsr;i+i.)lrirndise;.:orr taccgssed NovembBr 19. AtXl4),2t Mattherv Boyle,'Tasco Needs a Flesh Slart h the U.S.,, FrrruoaD_ecgmber 4. 2007, rvrrt.c;i,ttt)'!il,:r.ccrr, (aCCASSed Apfil 7. 2OO8),s As quolod in Bruce Horovill 'Erilish lmrasion Hits docery StorssiUSJ4 fodaX Apdl 7,2006, p.82.stbid.etHd.2t lbid.ae As quoted in "Fresh, Bst Far from Easy: EcoDorTrrb0 June Zi. ZOO7,eirarr..carcrrrsi.rl'nr (aCCgSsed Aprll 7, 2008).sConpany press releasa Aptil iS. 2009.3r Natu/E,t Ws Merchilld,iset, June 2004, p. 27.

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ttlI lhompson-strickland-Gamble: I Gase6:Delltnc.inXXl& I Case

Cralting and Etecrning gan ir ouerlake

Strale0$ GonceFls aEd llewlel-Packard as&e

Gases, l?th Edhioo Wortdwide Leaderin

Petsrnal Computers?

I O nre uc€ar"-xitl

Cowanies. ?010

ffie&$ Saae. ssa 2#m8: ilaffi Ec EAS E

ffivertaE<e E{ew Eeee- E} aeEcatrd

as tfue ErYoetsdv*rade E eader inFers,ssae$. tcampeecetrs F

.,, , ' . g rritte+, at:th" age'of 19, Michael biU in "st

a,,,,,' fr{ $1,000 of his own monef aod founded Dell'

.1' ' I Computer'with a simple' r'ision and business,,:,: concept-that personal computers (PCs) could be:

,; . I built to order and sold directly to customers. Michael1, , ' Dell believed his approach io the PC'business hadl, : ', trvo advantages: ( I ) blpassing distributors and retail, i' dealers eliminated thi martrups of resellers. and .

r (2) building to brder greatly reduced the coss and

,,,,.,,' ' risks associated rvith carrying lug. stocks of parts,

;,. components. and finished goods. Behveen 1986.l,,i , and 1993, the company rvorked to refine its stat-,,'i egy, build an adequate infrastructure, and establish,, ', market credibility against better-knorvn rivals. [n,: the mid-to-late 1990s, Dell's strategy started to click .

.., to-order business model and strategy had provided, the company rvith the most effrcient procurementl

,,rr manufacturing, and distribution capabilities in the

i.i global PC industry and given Dell a substantial cost

.,i. and profit margin advantage over rival PC vendors.

. ., During 2004-2005, Dell overtook Hervlett-',, Packard (HP) to become the global rnarket leader

", in PCs. But Dellt global leadership proved short-

, lived; HP. energized by a nerv CEO rvho engineered

,, a revitalized stretegy. dramatically closed the gap ont., Dell in 2006 and regained the global market share,,l ' '

lead by a fairly *'ide margin iu 2O07-rvinning an

, ,' 18.8 percent global share versus Dellt 14.9 percent.

, -i tn the United States, Dell also struggled to fend off, a resurgent HP during 200G2007. Whereas Dell

; Copyright '.* 30g$ hy.{rthur A. Thompsor *nd John E. 6ambtc. All dghrsi' rcscnr:d"

had a commanding s:.e' pl*e;t' sharei'afrPd'dalesin the United Statis in 2005, cdmfortatg'aUeaC'otHP ( 19.5 percent) and far outdistancing Apple;Acer,Toshiha, Catervay, and Lenovo/IBlvt;,, Defllsl-U.S,share had slipped to 28.0 percent by the'edd of 2007;white HP's iharu tuos up to 23.9 percbnl Exhibit Ishows the shifting donestic and global:'sales,rand

market share ranliings in PCs during 199&2007.Since the late I990s, Dell had also been driv-

ing for industry leadership in servers:, ln,the mid-to-tate 1990s, a big fractipn of the servers sold rvereproprietary machines running on custoiniZed U:rixoperating systems and carrying price tags. iangingfrom $30,000 to $1 million or morei; But|a'seis-mic shifi in sener technology. coupled'ivith,giolv-ing cost-consciousness on the part of sefrer'users,produced a radical shift arvay 916fi1 vs61s costly.proprietary, Unix-based servers during. 1999-2004to lorv-cost x86 machines that rvere bastid'ori:'stan-dardized components and technology, ran on:bitherWindorvs or Linux operating systems. arid carriedprice tags belorv $10,000. Servers rvith these,char-icteristics fit Detl's smtegy and capabilities, per-fectly. and the company seized on the oppoitunityto use its considerable resources and capabilities inmaking lorv-cost, standard-technologll PCs to go

after the market for [orv- and mid-range x86 serv-ers in a big *,ay. During 2004*2007. Dell reigned irs

the number one domestic seller of 186 seners forWindou's and Linux (based on unit volume);'rvithjust over a 30 percent market share (up from about3-4 percent in the rnid-1990s). Dell ranked numbertrvo in the torld in x86 server shipments during this

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CasEs, ulh Edilion Worldwide leader in

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Case 6 Dell lnc. in 2008: Can lt Overtake Hewlett-Packard as the Worldwide Leader in PersonalComputers?

I ftonpso*-Suicrbnd-Garrble: I GaseS:Delllne.in2Gt& I C*uCnfting and Exocsting Can it grenake

Ssategs Concepts and Hewlau-Pac.kard as the

same period, with market shares in the 24-26 per-cent rangei lvhich put it in position to contend lvithHP for global market leadership.

ln addition, Dell rvas making market inroadsin other product categories. Its sales ofdata storagedevices had grorvn to nearly $2.5 billion annually,aided by a strategic alliance rvith EMC. a leaderin data storage. In 2001-2002, Dell began sellinglol-cost, data-routing srvitches-a product cate-gory rvhere Cisco Systems lvas the dominant globalleader. Starting in 2003, Dell began marketing Dell-branded printers and printer cartridges, productcategories that provided global leader HP rvith the

lion's share of its profits; as of 2008. Dell's sales ofprinters and printer supplies rvas believed to exceed

$3 billion. Also in 2003, Dell began selling flat-screen LCD TVs and retail-store systems, includ-ing electronic cash registers! specialized sofi:tvare,

services, and peripherals required to link retail-storecheckout laues to corporate information systems.

Dell's MP3 player, the Dell DJ, was number twobehind the Apple iPod. Dell added plasma scr€enTVs to its TV product line in 2004. Since the late

I990s, Dell had been rnarketing CD and DVDdrives, printers, scanners. modems, monitors, digitalcamerasi, memory cards, data storage devices, and

speakers made by a variety of manufacturers.So far. Dell's foray into nerv products and busi-

nesses had in most cases. proved to be profitable*for a time. Dell sold handheld PC devices, an MP3player (called the Dell DJ) that competed againstthe Apple iPo4 and big-screen TVs, but these prod-ucts lvere abandoned rvhen profits proved elusive.According to Michael Dell, "We believe that all ourbusinesses should make money. [f a business doesn'trnake money, if you can't figure out trorv to makemoney in that business. you shouldn't be in thatbusiness."l Dell products rvere sold in more than170 countries, but sales in 60 countries accountedfor about 95 percent oftotal revenues.

GGT'd PANJY BACKG HG U fl{ E

At age 12. Michael Dell rvas running a mail orderstamp-trading business, complete rvith a nalionalcatalog, and grossing $2,000 a month. At l6 he rvas

seliing subscriptions to the Housron Post, and at 17

he bought his first BIVIW rvith mor:ey he had earned.

He enrolled at the University of Texas in 1983 as a

[ @Ihe trtc0arv-Hitl

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premed student (his parents rvanted him to becomea doctor), but he soon became immersed in comput-ers and started selling PC components out of hiscollege dormitory room. He bought random-accessmemory (RAM) chips and disk drives for IBM PCsat cost from IBM dealers, who at the time often hadexcess supplies on hand because they were requiredto order large mon&ly quotas from IBM. Dell resoldthe components through newspaper ads (and laterthrough ads in national computer magazines) at

10-15 percent belorv the regular retail price.By Aprit I984. sales rvere running about $80,000

per month. Dell decided to drop out of college andform a company, PCs Ltd., to sell both PC compo-nents and PCs under the brand name PCs Limited.He obtained his PCs by buying retailers' surplusstocks at cost, then porvering them up with graphicscards, hard disks, and memory before reselling them.His shategy was to sell directly to end users; byeliminating the retail markup, Dell's new companywas able to sell IBM clones (machines that copiedthe functioning of IBM PCs using the same or simi-lar components) about 40 percent belorv the priceof IBMs best-selling PCs. The discounting stmt€gywas successful. atracting price-conscious buyersand generating rapid revenue gro\th. By 1985, thecompany rvas assembling its orvn PC designs rvith a

ferv people rvorking on sit-foot tables. The companyhad 40 employees, and Michael Dell rvorked I8-hourdays, often sleeping on a cot in his office. By the endof fiscal 1986, sales had reached $33 milljon.

During the next several years, horveveq PCs Lim-ited rvas hampered by growing pains-specifically, a

lack of money, people, and resources. Michael Dellsought to refine the company's b*siness model; add

needed production capacity; and build a bigger,deeper management staff and corporate infrastruc-ture'while at the sarne time keeping costs lorv. Thecompany lvas renamed Dell Computer in 1987, andthe first international offices rvere opened that sarne

year. In 1988. Dell added a sales force to serve largecustomers, began selling to government agencies,

and became a public company-raising $34.2 mil-lion in its first offering of common stock. Sales tolarge customen quickly became the dominant partof Dellt business. By 1990. Dell Computer hadsales of $388 million, a market share of 2-3 percent,and an R&D staffolmore than 150 people. MichaelDell's vision nas for Dell Computer to become oneof the top tluee PC companies.

Page 36: Crafting (Cases)

I noo4sotr-srri"uanrl-6usle I Case&Detllnc.in208: I crruCralting and Erecuting Can h (harraka

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Grsas, l7lft fdition Worldwide Leader inPersonal Compsters?

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Thinlcing its direct sales business rvould notgrow fast enough. in 1990-93. the company begandistributing its computer products through SoftWarehouse Superstores (norv CompUSA), Staples(a leading office products chain), Wal-Mart, Sam'sClub, and Price Club (rvhich merged with Costco inI993). Dell aiso sold PCs through Best Buy stores in16 states and through Xerox in 19 Latin Americancountries. But rvhen the company learned horv thinits margins rvere in selling through such distributionchannels, it realized it had made a mistake and rvith-drew from selling to retailers and other intermediar-ies in 1994 to refocus on dircct sales. At the time,sales tluough retailers accounted for only about? percent of Dell's revenues-

In 1993, further problems emerged: Dell report-edly lost $38 million in risky foreign-currency hedg-ing, qualify difficulties arose lvith certain PC linesmade by tlie companyt coutract manufacturers,profit margins declined, and buyers were turned offby the company's laptop PC models. To get laptopsales back on mck the company took a charge ofS40 million tolwite offits laptop line and suspendedsales of laptops until it could get redesigned modelsinto the marketplace.

Because of higher costs and unacceptably lorvprofit margins in selling to individuals and house-holds. Dell did not pursue the consumer marketaggressively until sales to individuals at the compa-ny's Internet site took offin I996 and 1997. It becameclear that PC-savvy individuals, rvho rvere buyrngtheir second and third computers. rvanted power-ful computers rvith multiple features: did not needmuclr technic*l supporq and lilced the convenienceof buying direct-fr.om Dell, ordering a PC config-ured exactly to their liking, and having it deliveredto &eir door rvithin a matter of days. In early 1997.Dell created an internal sales and marketing groupdedicated to serving the individual consumer seg-ment and introduced a product line designed espe-cialiy for home and personal use.

By late 1997. Dell had become a lorv-cost leaderamong PC vendors by wringing greater and greaterefficiency out of its direct sales and build-to-orderbusiness model. Since then, the company had con-tinued driving hard to reduce its costs by closelypartnering rvith key suppliers to drive costs out ofits supply chain and by incorporating e-cornmercetechnology and use of the lnternet into its everydaybusiness practices. Throughout 2002-2007, Dell nas

rvidely regarded as the lorvest-cost producer amongall the leading vendors of PCs and servers rvorld-wide. Ivloreover, its products rvere highly regarded; in2007. Dell products received more than 400 arvardsrelating to design, quality, and innovation-this rvas&e largest number of product arvards for a singleyear in the companyb history.

In its 2008 fiscal year, Dell posted revenues of$61.1 billion and profits of nearly $3.0 billion. Itranked number 34 on Fortrrne's liit of the 500 larg-est U.S. corporations for ?007. In 2008, Dell hadapproximately 88,200 employees rvorldwide, upfrom 16.000 at year-end 1997: more than 66 percentof Dell's employees rvere located in counries outsidethe United States. and this percentage rvas grorving.The company's headquarters and main office com-plex was in Round Rock, Texas (an Austin suburb).Its name had been changed from Dell Computer toDell Inc. in 2003 to reflect the company's growingbusiness base outside of PCs. Exhibits 2 and 3 pro-vide information about Dell's financial performanceand geographic operations. .

$#Ea*E:a** **iE

In the company's early days Michael Dell hung aroundmostly rvith the company's engineers. He rvas so shythat some employees thought he rvas stuck up becausehe never talked to them. But people rvho rvorked rvithhim closely described him as a likable young manrvho rvas slorv to lvarnl up to strangers.2 He lvas atenible publlc speaker and wasn't good at runningmeetings. But Lee Walker, a 5l -year-old venture cap-italist brought in by Michael Dell to provide much-needed managerial and financial experience duringthe companyt oryanization-building years. becameMichael Dell's mentor, built up his confidence. andrvas instrumental in rurning him into a polishedexecutive.s Walker served asihe con',pany's presidentand chief operating officer from 1986 to 1990; he hada fatherly image. knerv everyone by name, and playeda key role in implementing lvlichael Dellb marketingideas. Under Walker's hrtelage. Miehael Dell becameintimately familiar rvith all parts of the business.overcame his shyr:ess. learned to contol his ego,and turned into a chadsmatic leader rvith an instinctfor motivating people and rvinning their loyalty andrespect.

When Walker had to leave the company in 1990for health reasons, Dell turned to Morton Meyerson.

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fonner CEO and-president of Electronic Data Sys-tems. for advice and guidance on holv to transformDell Computer from a fast-grorving medium-sizedcompary into a billion-dollar enterprise. Thoughsometimes giver to displays of impatience, MichaelDell usually spoke in a quiet, reflective manner andcrune across as a person with marurity and seasonedjudgment far beyond his age. His prorvess rvas basedmore ofl an astute combinarion of technical knorvl-edge and n'tarketing know-horv than on being a tech-nological rvizaril In 1992, at the age of 27. MichaelDell becanre the yor:ngest CEO ever to head a Fortune500 company: he was a biltionaire at the age of 31.

By the late 1990s, Michael Dell had becorne oneof the most respected executives in the PC industry.Journalists lrad described him as "the quintessential

American entrepreneur?' and "the most innovativeguy for marketing coruputersJ' He rvas a much-sought-after speaker at indusrry and company con-ferences. His viervs and opinions about the futureof PCs, the Internet, and e-commerce practices car-ried considerable rveigirt both in the PC industryand among executives rvorldwide. Once pudgy andbespectacled. in early 2008, 43-year-old MichaelDell rvas physically fit, considered good-looking,rvore contact lenses, ate only health foods, andlived in a three-story 33.000-square-foot home on a60-acre estate in Austin, Texas. rvith his rvife andfourchildren. In 2008, he orvned about l0 percent ofDell's common stock. rvorth about $4.3 billion.

Michael Dell rvas considered a very accessibleCEO and a role model for young executives because

Page 39: Crafting (Cases)

ilt.:r

Case 6 Dell lnc. in 2008: Can li. Overtake Hewlett Packard as the Worldwide Leader in Personal Computers?

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he had done rvhat many of them were trying to do. Hedelegated authority to subordinates. believing thatthe best resulB came from "hrning loose talentedpoople who can be relied upon to do what they'resupposed to do." Business associates viewed MichaelDell as an aggressive personality! an exkemely com-petitive risk taker rvho had always played close to theedge. He spent about 30 percent ofhis time travelingto compaoy operations and meeting rvith customers,In a typical year, he rvould make trvo or three trips toEurope and irvo trips to Asia.

In mid-2004, Michael Dell, who had been thecompany's first and only CEO, ransferred his title ofCEO to Kevin Rollins, the company's president andchief operating officer. Dell remained as chairmanof the board. Dell and Rollins had run the companyfor the past seven years under a shared leadershipstructure. The changes rvere primarily ones of title,not of roles or responsibilities. But rvhen the com-pany's perfbrmance stalled in 2006, Kevin Rollinslvas relieved ofhis responsibilities and Michael Dellreassumed the title of CEO (and continped in the roleof chairman of the company's board of directors).

DE[-L'S STffiATEGY AINDBLJSINESS MODEL

In orchestrating Dell Inc.'s rise to global prominence,company executives had come to believe stronglythat four tenets were the key to delivering superiorcustomer valu€:d

l. Selling direct to customers is the most efficientrvay to market tlre company's products because itelirninates rvholesale and retail dealers that irnpedeDell's understanding ofcustomer needs and expec-

tations and that add rurnecessa4, time and cost.

2. Allorving customers to purchase custom-builtproducts and custom-tailored services is themost effective way to meet customer needs.

3. A high$ efficient supply chain and manufaerur-ing organiz*tion, grounded in the use ofstandard-ized technologies and selling direct, paves thervay for a lorv-cost structure rvhere cost savings

can be passed along to customers in the form ofIorver prices.

4. Dell can deliver added value to customers by{l) researching ail the technological options.

C.I2I

(2) trying to determine rvhich ones are "opti-mal" in the sense of delivering the best com-bination of performance and efficiency, and(3) being accountable to customers for helpingthem obtain the highest return on their invest-ment in IT products and services. in almost allcases, non-proprietary standardized technolo-gies deliver tlre best value to customers.

With top management holding firmly to thesetenets, Dell's stntegy during the 2002-2007 periodhad seven core elements: (l) making build-to-ordermanufacturing progressively more cost-efficient,(2) parfrrering closely rvith suppliers to squeeze costsavings out ofthe supply chain. (3) using direct salestechnigues to gain customers, (4) expanding intoadditional products and services to capture a biggershare ofcustorners' IT speading, (5) providing goodcustomer service and techuical support, (6) keepingR&D and engineering activities focused squarely onbetter meeting the needs of customers, and (7) usingstandardized technologies in all product offerings.

The business model on which the strategyrvas predicated rvas straightfonvard: Continuouslysearch for lvays to reduce costs-the company'slatest initiative lvas to reduce costs by $3 billion in2008. Use the company's strong capabilities in sup-ply chain rnanagement, lopv-cost manufacturing, anddirect sales to gro\y sales and market share in boththe PC and server segments and expand into productcategories rvhere Dell could provide added val_ue toits custome$ in the form of lorver prices. The stan-dard pattern for entering nerv product categories wasto identi$ an [T product with good margins: figureout horv to build it (or else have it built by others)cheaply enough to be able to significantly under-price competitive products; nrarket the new productto Dellb steadily grorving customer base; and watchthe market share points, incremental revenues, andincremental profits pile up.

**ss=E$f isi*r,ct **E sn=Er= $r$*r'F,**s*$*t*'iteylxE

Dell built the vast majority of its computers, rvork-stations, and servers to orden only a small fractionrvas produced for inventory and shipped to rvhole-sale or retail partnen. Dell custorners could ordercustom-equipped servers and rvorkstations accord-ing to the needs of their applications. Desktop and

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@, I thonpson-strirklaml.Grmble I Gasa6:0elllnc.in200& | C*,Gralting and Erecuting Can it (hsnaka

Strategp GoncepG and HBwlaf+ackard as the

Ceses, lTth Edition Worldwidr Leadar in

Personal Computers?

c-l!2 Part 2 Cases in Crafting and &ecuting Strategy

laptop customers ordered rvhatever configurationof microprocessor speed. random-access memory,hard disk capacity. CD or DVD drives, faVmodem/wireless capabilities, graphics cards. monitor size,speakers, and other aecessories they preferred. Theorders were directed to the nearest factory. ln 2008,Dell had assembly plants in Austin, Texas; Nash-viile, Tennessee; Winston-Salem, North Carolina;Limerick, Ireland: Xamen. China; Penang, Malay-sia: Hortolindia, Brazil; Chennai, India; and Lodz,Poiand. In March 2008, the eompany announced thatits desktop assembly plant in Austin, Texas, rvouldbe closed. The Winston-Salem plant was Dell's larg-est rvhen it opened in 2005 and had the capacity toassemble 15,000 to 20.000 deslcops per day-it couldturn out a new PC wery five seconds. Dell shippedabout 140,000 produc8 daily-about I every second.PCs, rvorkstations, and servers lvere assembled at alllocations: assembly of lorver-volume products wasconcentrated in a more limited number of locations.All plants used much the same production systemsand procedures. Typically, a plant had the capabil-ity to build and deliver a customert order in tkee tofive business days: horvever. the Wnston-Salem plantcould in most cases deliver orders to customers on theeastern coast of the United States in one to ttuee busi-uess days. Dell believed in building its assembly plantsclose to customem because the labor costs to assemblea PC rvere about $10 rvhereas the logistics costs tomove parts and ship a finished PC rvele about $40.s

Ongoing Improvements in Assembly Effi-ciency Until 1997, Dell operated its assemblylines in traditional fasfiion. with each rvorker per-forming a gingle operaiion. An order form accompa-nied each metal chassis across the production floor;drives, chips, and ancillary items were installed tomatch customer specifications. As a partly assem-bled PC arrived at a nerv rvorkstation, the operator.standing beside a tall steel rack rvith drarvers futl ofcomponents. rvas instructed rvhat to do by little redand green lights flashing beside the drarvers. Whenthe operator rvas finislred, the component drarv-ers \\€re artcmatically replenished from the otherside and the PC chassis glided dorvn the line to thenext u.orkstation. Horvever. Dell had reorganizedits plarts in 1997, shifting to "cell manufacturing"techniques rvhereby a team ofrvorkers operating at agroup rvorkstation (or cell) assembled an entire PCaccording to customer specifications. The shift to

cell manufacruring reduced Dell's assembly times by75 percent and doubled productivity per square footof assembly space. Assembled computers rvere firsttested aod then loaded rvith the desired sofhvare,shippe( and typically delivered five to slx businessdays after the order rvas placed.

Later, the cell manufacturing approach lvasgradually abandoned in favor of an even more effi-cient assemblyJine approach that allowed rvorkersto tum out close to 800 desktop PCs per hour onthree assembly lines that took half &e floor spaceof the cell manufachring process, rvhere productionhad run about I20 unim per hour. Here the gains inassembly efficiency rvere achieved pa*ly by rede-signing the PCs to permit easier and faster assem-bly, partly by making innovations in the assemblyprocess, and partly by reducing (by 50 percent) thenumber of times a cornputer rvas touched by rvork*ers during assembly and shipping. In 2005, it tookabout 66 minutes to assemble and test a PC. More-over, just-in-time inventory practices that left palletsofparts sitting around eveqAvhere had been nveakedto just-in-the-nick-of-time delivery by suppliers ofthe exact parts needed every couple ofhours: double-decker conveyor belts moved parts and componentsto designated assembly points. Nervly assembled PCsrvere routed on conveyors to shipping, rvhere theyrvere boxed and shipped to customers the same day.

Dell's nerv 750,000-square-foot plant in Winston-Salem featured a production layout lhat allorved com-puters to be tested as its components and softrvarervere installed This "instantaneous build and test"operation peimitted team members to identify andcorrect any problems on the spot rather than rvaitinguntil the PC rvas fully assembled. Workers at all Dellplants competed rvith one another to come up rvithmore efficient assembly methods. Cost-saving assem-bly innovations pioneered in one Dell plant rverequickly implemented uorldrvide.

Dells latest cost-saving initiative uas to movearvay from I 00 percent confi gureto-customer-orderassembly to a mixhre of fixed configurations (forcomponents that rarely varied from order to order)and flexible configurations (for conrponents thatlvere subject to strong and varying eustomer prefer-ences-like hard drive size, screen displays. amountof memory graphics cards. type of microprocessor.and version of Windorvs operating system).

Dell rvas regarded as a rvorld-class manufacfur-ing innovator and a pioneer in horv to mass-produce

@ the McGmw-Hill

Companios. 2(}l0

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I ftorqmn-.sricltand-GamblE: I

Cralting and Erecuting

stralsgrF coacelB rnd

Cases, 17dr Edition

I

Case6:0ell lnE.inZ!08: I Case

Can il 0vsrtake

llewlett-Pac*ard as the

Worldwide !esder inPe$onal Gomputers?

a customized product-its methods were routinelystudied in business schools lvorldwide. Several ofDell's PC rivals*most notably Hervlett-Packard-had given up otr trying to produce their orvn PCs as

cheaply as Dell and shifted to outsourcing &eir PCsfrom contract manufhcturers rvho specialized in PC

assembly and often assembled a variety ofPC brands.Dell management believed that its in-house rnanufac-turing delivered about a 6 percent cost advantage ver-sus outsourcing- Deil"s build+o-order strategy meantthat the company had oniy a tiny stock of finishedgoods inventories in-house and that, unlike competi-tors using the traditionat value chain model, it didnot have to rvait for resellers to clear out their owninventories before it could push neiv models into themarlretplace-resellers typically operated rvith 30 to60 days inventory of prebuilt models (see Exhibit 4).Equally important was the fact that customers rvhobought from Dell got the satisfaction of having their

f I @flre ttilcGraw-Hill

Conpanies,20l0

computers customized to their particulu liking andpocketbook.

Quality Control All assembly plants had thecapability to run testing and quality control processes

on components, parts, and subassemblies obtainedfrom suppliers, as well as on the finished productsDell assembled. Supptiers rvere uged to participate ina quality certification progmrn that committed themto achieving defined quatrty specifications. Qualitycontrol activities were undertaken at various stages inthe assembly process. In addition, Dell's quality con'trol program included testing of completed unis afferassembly, ongoing production reiiability audits, failuretracking for early identification ofproduction and com-porert problems associated rvith nerv models strippedto customers, and information obtained frorn custom-ers tluoug} service and technical support programs. Allof the companyb plants had been certified as meeting

Exhibit 4 Comparative Value Chain Models of PC Vendors

l@t

Case 6 Dell tnc. in 2008: Can lt Overtake Hewlett-Packard as the Worldwide Leader in Personal Computers? c-t2l

ffiffi

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I lhorEson-Stricktaod-0antte: I

Cralting and EreculinB

$tntegp Concegr and

Cases, lnh Edilion

I

Dase & Dell lnc. in !tt$: I Case

Gan it (hortake

llewlatt-Pachard as tho

ItYorldwirte leader inPersonal Comprers?

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ComDanias.20l0

c-u4 Part 2 Cases in Crafting and F-recuting Strategy

ISO 9001:2000 standards. But rvhile Delll quality con-Eol program \ws f[st-rate, it rvas not perfect; in fiscalyear 2008, Dell incurred special rviurauty cost charyesof S307 million to service or replace certain desktopmodels ttrat included a vendor part ttrat failed to per-form to qpecifications.

Partnerships rvith Suppliers Michael Dellbelieved that it made much better sense for the com-pany to partner rvith reputable suppliers of PC partsand components than to integrate baclovard and getinto parts and components manufacturing on itsorvn. I{e explained rvhy:

If you've got a raee rvith 20 players all vying to makethe fastest graphics chip in the worl{ do you tvant tobc the trvenfy-first horse, or do you lvant to cvaluate

the field of20 and pick the best one?6

Dell management evaluated the various makersof each componenL picked the best one or two as

supplien; and then stuck with them as long as theymaintained their leadership in technology, perfor-mance. quality, and cost. Management believedthat long-term partnerships with reputable suppli-ers had at least five advantages. First. using name-brand processors, disk drives, modems, spealiers,and multimedia components enhanced the qualityand performance of Dell's PCs. Because of varyingperformance among different brands of components,the brand of the componeuts rvas quite irnpofiant tocustomers concerned about performance and reli-ability. Seeond because Dell parurered rvith suppli-ers for the long terrn and because it committed topurchase a specified percentage of its requirementsfrom each supplier, Dell rvas assured of getting thevolunre of eompiShenrc it needed on a timely basis

even rvhen overall market demand for a particularcomponent temporarily exceeded tlrc overall mar-ket supply. Third Delli long-run commitment toits suppliers made it feasible for suppliers to locatetheir plants or distribution centers rvithin a ferv milesof Dell assembly plants, putting them in position tonrake deliveries daily or every ferv hours, as needed.Dell supplied data on inventories and replenishmentneeds to its suppliers at least once a day-hourlyin the case of components being delivered severaltimes daily from nearby sources.

Fourth, long-term supply partnerships facilitatedhaving some of the suppliert engineers assignedto Dells product design teams and being treated aspart of Dell- When nerv products rvere launche4

suppliers'engineers lvere stationed in Dell's plants; ifearly buyers called with a problem related to desi_sn.

further assembly and shipments \vere halted whilethe supplier's engineers and Dell personnel correctedthe flarv on the spot"7 Fifth, long-term parfirershipsenlisted greater cooperation on the part of suppli-ers to seek oew ways to drive costs out of the sup-ply chain. Dell openly shared its daily productionschedules, sales forecasts, and nerv model introduc-tion plans rvith vendors. Dell also did a three*yearplan with.each of its key suppliers and worked rvithsuppliers to minimize the number of different stock-keeping units of parts and components in its prod-ucts and to identiff rvays to drive costs down.

Commitment to Just-in-Time InventoryPractices Dell's just-in-time inventory emphasisyielded major cost advantages and shortened the timeit took for Dell to get new generations of its computermodels into the marketplace. Nerv advances rverecoming so fast in certain computer parts and com-ponents (particularly microprocessors, disk drives,and rvireless devices) that any given item in inven-tory was obsolete in a matter of months, sometimesquicker. Moreover, rapid-fire reductions in the pricesof componenls rvere not unusual*for example. Intelregularly cut the prices on its older chips rvhen itintroduced nerver chips, and it introduced nerv chipgenerations about every three months. In 2003-2004,component costs declined an average of 0.5 percentrveekly. s Michael Delt explained the competitiveand economic advantages of minimal componentinventories: *

lf I'r'e got I I days of invcntory rrnd my competi-tor has 80 and Intel comes out tvith a nerv chip. thatmeans I'm going to get to market 69 days sooner. lnths computer industry, inventory can be a prctty mas-sive risk because ifthe cost of materials is going dorvn50 percent a year and you havc trro or threc months ofinvcntory vcrsus I I days. you've got a big cost disad-l,antaga And you're vulnerable to product transitions,rvhen you can gct stuck rvith obsolete inventory- 9

For a growing number of parts and components,Deli's close partnership with suppliers lvas allo*'-ing it to operate with no more than trvo hours ofinventory.

In fiscal year 1995. Delt averaged an inven-tory turn cycle of32 days. By rhe end offisccl 1997(January 1997). the average rvas down to 13 days. Infiscal 1998. Dell's inventory averaged 7 days. rvhich

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Case 6 Dell lnc. in 2008: Can lt Overtake Hewlett-Packard as the Worldwide Leader in PersonalComputers?

Ihompso*Stsiclland-Ganble:

Cralting and B(sculinB

StrategF CoBcelts aIdCases. ITlh Editlqn

Case 6: Dell loe. in 2IIl&Can it 0rertrkellewlett-Packard as treWorldwidc leader inPelsonal G!ilputars?

eompared very favorably rvith a l4-day average atGatervay, a 23-day average at then indusury leaderCompaq, and the estimated indusryrvide average ofover 50 days. In fiscal years 1999 and 2000, Delioperated lvith an average of 6 days' supply of pro-duction materials in inventory; the average droppedto 5 days'supply in fiscal year 2001,4 days'sup-ply in 2002, and 2.7 to 4 days'supply in fiscal years

2003-2007.

*e$ie IrErst€ SsrEes $'aratcgya*t,$ *+;iartaealrcg 8$'f *r'tsWith thousands of phone, fax, and Internet ordersdaily and ongoing field sales florce contact rvith cus-tomers, the company kept its finger on the marketpulse, quickiy detecting shifts in sales trends, desi-en

problems, and quality glitches. If the company gotmore than a ferv of the same complaints, the infor-mation rvas relayed immediately to'design engineersrvho checked out the problem. When design flarvsor components defects rvere found, the factory rvas

notified and the problem correeted rvithin a fervdays. Management believed Dellt ability to respondquickly gave it a significant advantage over PC mak-ers that operated on the basis of large productionruns ofvariously configured and equipped PCs andsold them through retail channels. Dell sarv its directsales approach as a totally customerdriven system.rvith the flexibility to transition quickly to nelv gen-erations of components and PC models.

Web Site Strategy Dell's Web site u,as one ofthe rvorld's highest volume Internet conrmerce sites.rvith nearly 500 million unique visitors, rvell overI billion visits, and close to l0 billion page reguestsannually. Dell began lnternet sales at its Web site in1995, almost overnigltt aclilevin-e sales of $l milliona day. Sales at its Web site reached 55 million dailyin 1998. $35 million daily in 2000. and $60 million a

day in 2004. By early 2003. over50 percent of Dell'ssales rvere Web-enatlled*and the percentage trendeduprvard through 2007. The revenues generated at theWeb site tvere greater than those generated at Yahoo,

Coogle. eBay, and Amazon combined. l0

At the cornpany's Vy'eb site, prospective buy-ers could revierv Dell's entire product line in detail,configure and price customized PCs, place orders.and track orders from marrufacruring through ship-ping. The closing rate on sales at Dell s V/eb site rvas

20 perceot higher than that on sales inquiries receivedvia telephone. Management believed that enhancing',,0.,v,"+.*sii.,:or,.l to shrink Uansactiotr and order ful-fillment times, increase accuracy, and provide morepersonalized content resulted in a higher degree of"e-loyalgi" than traditional attributes like price andproduct selection.

Dell's Customer-Based Sales and Market-ing Focus Whereas many technology companiesorganized their sales and marketing efforts aroundproduct lines, Dell rvas organized around custornergroups. Dell had placed manageffi in charge of devel-oping sales and service programs appropriate to ttreneeds and expectations of each customer group. Untilthe early 1990s, Dell operated with sales and serviceprograms aimed at just nvo market segments-high-volume corporate and governmental buyers and lorv-volume business and individual buyen. But as sales

took off in l99J-1997, these segments rvere subdi-vided into finer, more homogeneous categories thatby 2000 included global enterprise accounts. large andmidsize companies (over 400 employees), small com-panies (under 400 employees), health care businesses(over 400 employees), federal govefirment agencies,state and local government agencies. educational insti-tutions, and individual con$rners. Many of these cus-tomer segments lvere furthbr subdivided-for instance,in education, there rvere separate sales and marketingprograms for K*12 schools; higher education institu-tions; and personal-use purchases by faculty, staff, andstudents.

Dell had a field sales force that called on largebusiness and institutional customers throughout thervorld. Dell's largest global enterprise accounts rvereassigned their orvn dedicated sales force-for exam-ple. Dell had a sales force of I50 people dedicatedto meeting the needs of Oeneral Electrici facilitiesand persomel scattered across the rvorld. Individu-als and small businesses could place orders by tele-phone or at Dell's Web site. Dell had call centers inthe United States. Canada. Europe. and Asia r,vith

toll-free lines; customers could talk with a salesrepresentative about specific models. get informa-tion fa.red or mailed to them, place an order, andpay by credit card. The Asian and European calicenters u,ere equipped rvith technology that routedcalls from a particular country to a particular callcenter. Thus, for example, a customer calling fromLisbon, Portugal, was automatically directed to

i]j:

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Itrmpsur-scichlard-Oor*U: I

Crafting and Execu{in0

Strslegf Comepts and

Cases. 17th Edition

Sase&0elllnc.inan& I c."uCan it oYedake

[ewlett-Packa]d ss lho

Woildwi{e leader in

P€rsonel Conputers?

@ Tte i&Gral-HillCornpsnies, All0

@il I

c-lt6 Part 2 Cases ln Crafting and Executing Strategy

a Portuguese-speaking sales rep at the call center inMontpelier. France.

Holever, in some countries Dells sell-direct-to-customers strategy put it at a disadvantage inappealing to small business customers and indi-vidual consumers, since most of these customersrvere reluctant to place orders by phone or over theInternet. Rivals in Japan and China who marketedPCs through retailers and other resellers were out-selling Dell in the small business and household seg-ments. According to an executive at Lenovo. one ofDell's biggest rivals in China. "It takes flvo years ofa person's savings to buy a PC in China. And rvhen

hvo years of savings is at stake, the whole familyIvatrts to come out to a store to touch and u-y themachine." ll To address the reluctance of householdsto buy direct from Dell. the head of Dell's consumerPC sales group in Japan installed 34 kiosks in lead-ing elecronics stores around Japan, allorving shop-pers to test Dell computers, ask guestions of staff,and place orders---{lose to half the sales werc topeople rvho did not know about Dell prior to visitingthe kiosk. The kiosks proved quite popular and rvere

instrumental in boosting Dell's share of PC sales toconsumers in Japan.

Inspired by the success of kiosks in Japan, in2002 Dell began installing Dell Direct Store kiosksin a variety of U.S. retail settings as a hands-oncomplement to Internet and phone sales. The kioskstores shorvcased Dellk newest notebook and desk*top computers, plasma and LCD TVs, printers,and music players. The kiosks did not carry inven-tory but customers could talk face-to-face rvith a

knorvledgeable D,-ellir:sales representative, inspectDell's products-'and order them on the lnternetrvhile at the kiosk. The kiosks rvere considered a

success in getting consumers to try Dell products.More kiosks were added and by December 2005.Dell had 145 Dell Direct Store kiosks in 20 states,rvithin reach of more than 50 percent of the U.S.population.

Supplementing the Direct Sales Strategyrvith Sales at the Retail Stores of SeleetPartners In fiscal2006, Deli's share of PC sales

to U.S. households dropped to 25.6 percent from29.3 percent the prior year. In 2007, its share ofihe home or consumer market in &e United Statesdropped even more precipitously, to 18.9 percent (see

Erhibit 5). Sales to households rveakened in otherpa*s of the rvorld market as rvell. The declines tvere

partly due (1) to Hervlett-Packard's aggressive andsuccessful efforts (mainly, lorver pricing and betterfeature sets) to gain market share at Dell's expenseand (2) to surging U.S. sales of Applet PC models(see Exhibit l), buoyed chiefly by consumer infatu-ation with Applel iPod models and its nerv iPhone.Dell management responded to the unexpectedand unprecedented falloff in sales to householdsby backing off on its almost I00 percent commit-ment to selling direct and forging partnerships withsuch retailers as Wal-Mart, Staples, and Best Buyto begin offering select Dell PCs in retail stores.Similar initiatives to begin selling through retail-ers were taken in other parts of &e world market.In Latin America, Dell forged retailing partnershipswith Wal-Mart and Pontofrio. Deil's retailing part-ners in Europe, the Middle East, andAfrica includedCarphone Warehouse, Carrefour. Tesco, and DSGi.In China, Japan, and other parts of the Asia-Pacificregion, Dell began selling its PCs at the stores ofGome (the Ieading consumer electronics retailerin China), Suning, Hontu. IiliMart, Courts, Croma,Officervorks (104 stores in Australia),.and Bic Cam-era. By mid-2008. Dell had its products available ir12,000 retail stores rvorldrvide and planned to grorythis number considerably.

So far, Dell management rvas pleased rvith theinitial results of its shift to using retail stores as a\vay to supplement online and telephone sales toconsumers and small businesses.

;":.E;tE esrcig* i;t€* flrl*'** Frs*'**-tsIn recent years, Dell had expanded its product offer-ings to include data storage hardlvare, srvitches.handheld PCs, printers, and printer cartridges. andsoftrvare products in an effort to diversifo its revenuestream and use its competitire capabilities in PCsand servers to pursue grorvth oppornrnities. IvlichaelDell explained rvhy Detl had decided to expand intoproducts and services that complemented its sales ofPCs and servers:

We tend to look at rvhat is the nexr big opportunityall thc time. We can't take on too many of these atoncc, bccause fu kind of ovcrloads the system. Butrvc believe fundamentally that if you think about thervhole market, itt about an 5800 billion market, allarcas of tcchnology orer time go through a processof ttandardization or commoditization. And \ye tryto look at thosc. anticipate rvhat's happening anddevelop strategics that rviil allorv us to get into those

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Grafting and Erecuting

srrategy concrpB and

Casas, lTth Edition

CaseS:Delllnc.in2{t0& I Cr..Car it (hsnake

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I @ Tne McGm,,r+;tt

Companies. 2010

Case 6 Dell lnc. in 2008: Can lt Overtake Hewlett-Packard as the Woddwide Leader in Personal Computers? c-I27

Exhihit 5 Trends in Dell's Market Shares in PCs and x86 Servers, 199,rt-2007

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markets. ln the server market in 1995 we had a 2 per-

ccnt market sharc. today lve have over a 30 percent

share. rve're number I in the U.S. Horv did that hap-pen? Well. first of all it happcned because we startedto have a high marliet share for desktops and notc-books. Then customers sai4 oh yes. we knorv Dcll.thosc arc the guys s,ho havc really good desktopsand notebooks. So they have servers. yes. tve'll tcst

those. rve'll tcst them around thc periphery. maybe

not in thc most critical applications at first. but uc'lltest them here. ffhen they discoverl thesc are reallygood and Dell provides great support . . . and I thinkto some cxtent lvc've benefited from the lact that ourcompetitors have underestimated the importancc ofvalue. and the porvcr of thc relationship and thc scr-vicc that $,e can crcate rvith the customer.

AncL also, as a product tends to standardize therc's

not an climination of the rcquiremeni for custom ser-

vices. thcre\ a reduction of it. So by offering some scr-

viccs. but not tlre scn'iccs afthe traditional proprictarycomputcr company. rvg've been able to incrcasc ourshare. And in fact. rvhat tcnds to happen is customersembrace thc standards. because they knorv that's goingto save them costs. Lct mc girc you an examplc ...

about a ycar ago tve entered into the data nehvorkingmarket. So rve havc Ethernet srvitches. layer2 srvitches.

So if you har,c PCs tnd seners. you need switches:crcry PC attaches to a srvitch. every server attaches to

a srvitch. lt's a pretty €asy sale. stvitches go along rvithcomputer systems. We looked at this market and rvere

ablc to come up rvith products that are priccd about

27: timcs less than the markct leader today, Cisco, and

as a result the business has grorvn very. very quickly.Wc shipped I.8 million srvitch pors in a period ofabout a ycar. rvhen most people rvould have said that's

not going to t'ork and come up rvith all kinds of rca-

sons rvhy rve can't succeed. 1l

As Delli sales of data-routing srvitches accelerated in2001-2002 and Dell management mulled over rvhetlwrto expand into other nehvorking products and Internetgear, Cisco elected to discontinue supplying issrvitchesto Dell for resale as of October 2002. Delt's familyof PorveConnect snitches-€imple commodity-likeproducts generally referred to as layer 2 switches in the

indusny-rvere about 75 percent cheaper than thosemade by Cisco as of 2005.

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I norpson-srhlhrd-Grmble: I Case6:Detllnc.in2008; I c.r*Cratting aod &ecuting Can it 0vertake

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Companies.20l0

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c-l28

Senior Dell executives saw extemal storagedevices as a growth opportunity because the com-pany's corporate and instifutional customers lveremaking increasing use of high-speed data storageand retrieval devices. Dell's PorverVault line of stor-age products had data proteation and recovery fea-tures that made it easy for customers to add and

manage storage and simplify consolidation. ThePorverVault products used standardized technologyand components (rvhich were considerably cheaperthan customized ones), allorving Dell to underpricerivals and drive down storage costs for its customersby about 50 percent. Dell's competitors in storagedevices included Hewlett-Packard and IBM.

Some observers saw Delli 2003 entry into*re printer market as a calculaled effort to go afterHervlett-Packardb biggest and most profitable busi-ness segment and believed the Dell offensive rvas

deliberately timed to throrv a rvrench into HPs effortsto resolve the many challenges of successfully merg-ing iu operations rvith those of Compaq. One of the

reasons Dell had entered the market for servers back in1995 rvas that Compaq Computer, then its biggest rivalin PCs. had been using its lucrative profits on servetsales to subsidize charging lorver prices on Compaqcomputers and thus be more price-competitive against

Dell's PCs-at the time Compaq uas losing money onits desktop and notebook PC business. According toMichael Dell:

Compaq had this cnorrnous profit pool that they rvere

using to fight against us in the desLtop and notebookbusiness. That rvas not an acceptablc situation. Ourproduct teams knerv that the scrvers weren't that

complicatcd or.gxpensive to produce, and customersrvere being cliCrgcd unfair priccs. 13

Dell management believed that in 200S-2002 HPrvas doing much the same thing in printers andprinter products, rvhere it lrad a dominant marketshare rvorldrvide and generated about 75 percentof its operating profits. Dell believed tlrat HP rvas

using its big margins on printer products to subsi-dize selling its PCs at prices comparable to Dell's.even though Dell had costs that rvere about 8 per-

cent lorver than HP's. HP's PC operations rvere

either in the red or barely in the black during mostof 200S-2003, rvhile Dell consistently lrad profitmargins of 8 percent or more on PCs. Delt manage-ment belier.ed the companyi entry into the printer

Worldwide Leader in

Poi$oIal Comptlters?

Part 2 Cases in Crafting and Executing Strategy

market rvould add value for its customers. MichaelDell explained:

life think 1ve can drive dorvn the entire cost oforvn-ing and using printing products. If you look at anyothcr market Dell has gone into. rve have been able tosignificantly save moncy for customers. We kno,v rve

can do that in printers: rve have looked at the zupplychain all the rvay through its various cycles and rve

knorv there are inefficiencies there. I think the priceofthe totai offering rvhen rve includc the printer andthe supplies . . . can come dorvn quite considerably. l{

When Dell announced it had contracted rvithLexmark to make printers and printer and toner car-tridges for sale under the Dell label beginning in?003, HP immediately discontinued supplying FIPprinters to Dell for resale at Dell's Web site. Dellhad been selling Lexmark printers for two years and,

since 2000, had resold about 4 million printers madeby such vendors as HB Lexmark. and other vendorsto its customers. Lexmark designed and made criti-cal parts for its printers bu-q r.rsed offshore contractmanufacturers forassembly. Cross profit margins onprinters (sales minus cost of goods sold) rvere said tobe in single digits in 2002*2004. but the gross mar-gins on printer supplies rvere in the 50-60 percentrange-brand-name ink cartridges for printers typi-cally ran S25 to $35. As of fall 2005, Dell had soldmore than l0 million printers and had an estimated20 percent of the market for color netrvork lasers andcolor inkjet printers in the United States. ls

Dell e.xeeutives believed the company's entryand market sirccess in printer products had put addedcompetitive pressure on Hervlett-Packard in theprinter market and rvas partly responsible for HP'sshare of the printer marltet rvorldrvide slipping fromjust under 50 percent to around 46 percent in 2004.To frrther keep the pricing pressure on HP in 2003,Dell had priced its storage and nehvorking productsbelow comparable HP products.

Exhibit 6 shorvs a breakdorvn of Dell's sales byproduct category. Exhibit 7 shorvs Dell's average rev-enues per unit sold for fiscal years 1998-2008. Thedeclines u,ere driven by steadily falling costs for com-ponents, Dell's ability to improve produetivitv andtake costs out of its value chain. and Dell's strategy ofpassing along cost savings to its cusiomers and try-ing to deliver more ralue to customers than its rivalsdid. Horverer. the tiny increases in average revenues

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Exhihit 0 Dell's Revenues by Product Category 2006-2008

c-l29

$21.61. , . 38.7o/o.

1a4. , -

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.-. .. ...' ,,:,. .....,,,,]

.8.3,,.r14.9.,5.4', , 9.8':4.?,.. . . 7.5.,

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M;-,y ;i*rctJ (aptop rcs ano:workstations)''.' . ..Soltware and peripherats (printers,monilors, TVs; proiectors, ink,' ,

and toner cartridges). , ,r :

Servers and netrvorking hardware

Consulting and enhanced servicesStorageproducts i r : l

Totals -:.

$19.6

17.4

9.9

6.5

5.3

2.4

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28.5

16.2

10.6

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$2,6002,2542,0501,700

1,640

1,590

1,560

1,500

1,510

1,540

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Exhihit I Trend in Dell's ApproximateAverage Revenue per Unit Sold,Fiscal Years 1998-2008

expenses (see Exhibit 2) made it infeasible for Dellto cut prices and still preserve its operating profitmargins. Top executives opted to maintain prices tokeep the company's already lorver operating profitrnaryins from going dorvn any further (see Exhibit 2);this left Dell vulnerable to HP's strategic offensiveto regain sales and market share-an offensive thatfeatured prices for HP producs that rvere more inline with rvhat Dell was charging.

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Service became a feature of Dell\ strategy in 1986nhen the company began providing a year's freeon-site service with nrost of its PCs after userscomplained about having to ship their PCs backto Austin fior repairs. Dell began offering PC buy-ers the option of buying contracts for on-site repairsen'ices for a defined period (usually one to fouryears). Dell contracted rvith local service provid-ers to handle customer requests for repairs: on-siteservice rvas provided on a four-hour basis to largecustomers and on a next-day basis to small custon:-ers. Dell generally contracted rvith third-party pro-viders to make the necessary on-site service calls.Customers notified Dell rvhen they lrad problems:such notices triggered trvo electronic dispatches-one to ship replacernent parts from Dell's factory to

Source: Company linancial records and company postings alrq rn r.,..ili: | :.,:: ;:r : (aCCgSSed May 3, 2008).

per unit in the past trvo fiscal years reflected slorvingdeclines in components prices, a shift in the PC sales

mix arvay fronr desktops to laptops (which carriedhigher price tags and thus yielded greater average

revenues per unit sold). and Dell's more resuainedpricing (to protect its operating and net profit mar-gins from further erosion]. In fiscal 200?-2008,unlike prior years, Dell had difiiculty in lorveringunit costs; out-of-proportion increases in operating

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Slratagp Goncepts aad

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Woddwide Leader inPersonal Conputers?

c-r3rl Part 2 Cases in Crafting and Erecuting Strategy

the customer, and one to notify the contract serviceprovider to prepare to make the needed repairs assoon as the parts arrived. 16 Bad parts rvere ietrnmedso that Dell could determine what lvent wrong andhow to prevent such problems from happening again(problems relating to faulty components or flarledcomponents design lvere promptly passed along tothe relevant supplier for correction). [fbusiness orinstitutional customers preferred to work rvith theirown service provider, Dell supplied the provider ofchoice tvith training and spare parts needed to ser-vice the customers' equipment.

Later. Dell began offering contracts for Com-pleteCare accidental damage service. In 2006, Dellbegan using an online diagnostics tool called Dell-Connect to houbleshoot and resolve problems rvitha customer's computer rvhile the customer tvitsi con-nected to Dell's V/eb site. ln 2007, Dell launched acorporate blog called Direct2Dell, a customer ideaengine called ldeaStorm, and several online corn-munity forums for the purpose of bener lisren-ing to and engaging with customers. Delli onlinetraining programs featured more than 1,200 coursesfor consumer, business, and IT professionals. Over50 percent of Dell's technical support and customerservice activities rvere conducted via the lnternet.Customers could also request technical support viaa toll-free phone number and e-mail: Dell receivedmore than I million phone calls and 500,000 to600,000 e-mail messages annually requesting ser-vice and support.

Dell had 25 customer service centers rvorldrvidein 2008 that rvere primarily engaged in handling tech-nical suppo*, requesls for repairs, and other issuesand inquirie_s. In amo:ve to trim rising technical sup-port and customer service costs in 2C0zf-2005, Dellopted to move a large portion of its support sen icesto countries lvhere labor costs tvere lorv. But accord-ing to Dell's president of global services and chiefinformation officer. *We did it lvay too quickly-*edidn't move process management disciplines rvithit as effectively as rve should have. and rve rvoundup maki_ng some mistakes rvith the services experi-ence."17 The outcome lvas a sharp rise in customerconrplaints, especially among small business andindividual customers rvho rvere most afected-anumber of irritated Dell customers went so faras to post their horror stories at Web sites likeIhateDell.net. and the resulting media publicity tar-nished Dell's reputation for customer service among

these buyers. To correct the service problems, Dellhad moved many of ir service centers back to coun-triesrvhere big numbers ofits customers rvere located.Service processes were standardized worldwide, andbest practices from all over the rvorld rvere builtinto the standards. Dell's goal \vas to reach 90 per-cent customer satisfaction-rvhere customers ratedtheir service experience rvith Deli as ,.top notih,' or"very satisfisd'1*4e quickly as possible. In early2008, Dell's customer satisfaction ratings rvere at92 percent for Asia, at 90 percent in the Europe/Middle EasVAfrica region, and in the 80 percentrange for the Americas (these ratings included allservices for small, medium, and larye customers). 18

Premier Pages Dell had developed customizedpassword-protect€d Web sites called premier pages

for more than 50.000 corporate. governmental, andinstirutional customers rvorldrvide. These premierPages gave customers' personnel online access toinformation about all Dell products and configura-tions the company had purchased or that rvere cur-rently authorized for purcha'se. Employees could usePremier Pages to (l) obtain customer.rspecific pric-ing for rvhatever machines and options the employeervanted to consider, (2) place an order online thatrvould be routed electronically to higher-level manag-ers for approval and then on to Dell for assembly anddelivery, and (3) seek advanced help desk support.Customers could also search and sort all invoicesand obtain purchase histories. These features elimi-nated paper invoices, cut ordering time, and reducedthe internal lAbor customers needed to staff corpo-rate purchasing and accounting functions. Customeruse of Premier Pages had boosted the productivityof Dell salespeople assigned to these accounts by50 percent. Dell rvas providing Premier page servieeto additional customers annually and adding morefeatures to further improve functionality.

Product Design Services One of Dell's latestservices for large custorners rvas making special-purpose products for such customers as Intemetsearch providers. social netrvorking sites. and bigvideo content sites that might need 10.000 or moreunits to accomrnodate its requirements. Such cus-tomers did not rvant to pay for a generall:urposeproduct tvith components or performance leatuies itdid not need. So Dell created a group that had thecapability to pror.ide a big user rvith thousands ofunits of a product stripped of unnecessary features

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thomgson-Suickland-tamblE:

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case 6 Dell lnc' in 2008: Can lt overtake Hewlett-Packard as the worldwide Leader in personat Computers?

and equipped with whateverprccessor, memory! anddisk drive suited the customer's needs. Dell person-nel rvould visit with the customer, ascertain th"

"u"_tomer's needs and preferences, provide a prototypervithin three tveeks for evaluation and testing, makeany additional changes rvithin another two rvieks forfirrthertesting and evaluation. and then be in volumeproduction by the thousands of units withio anothertluee or four weeks*altogether about a nine-rveekdesi gn-to-production/delivery cycle.

Value-Added Services for Customers withLarge IT Operations Dell kept ctose track ofthe purchases of its large global customersr coun-try by country and department by department_andcustomers themselves found this purchase informa-tion valuable. Dell's sales and support personnelused their knorvledge about'a particular customer"sneeds to help that customer plan pC purchases, toconfigure the customer's pC netrvork, and to pro-vide value-added services. For example, for its largecustomers Dell loaded softrvare and placed ID tagson nervly ordered PCs at the factory thereby elimi*nating the need for the customer.s IT personnel tounpack the PC, deliver it to an employee's desk,hook it up, place asset tags on the pC, and load theneeded softrvare-a process that could take severalhours and cost $200-$300. le While Dell charged anextra $15 or $20 for the softrvare-loading andasset-tagging services, the savings to customers rvere stillconsiderable-one large customer repoSled savingsof $500.000 annually from this service.20

In 2007 and early 2008. Dell spent about52 billion to make a series of sofirvare-reiated acqui-sitions that gave it an altogether nerv vatue-addedcapability:

1. Everdream Corporation-Everdream i\?s aleading provider of Softrvare as a Service (SaaS)solutions. rvith operations in California andNorth Carolina. ll:is acquisition enabled Dellto extend its capabiliti€s to use the lnternet toremotely manage global delivery of softrvaresolutions from servers. storage devices. andprinters to desktop PCs. laptops, and other end-user devices. Dell managernent believed thatrernote-service management of sofnriare prod-ucts rvould help business customers of alt sizessimplifi their IT infrastructure-a value-addedoutcome that Dell was aggressively pursuing.Terms of the acquisition tere not disclosed.

2- SilverBackTechnologies inc.-Sitverback was aprivately orvned Massachusetts-based companythat had a delivery platform to remotety man*age and monitor SaaS products. Such a platformrvas essential to Dell's shategy of simplifyingcustomers' IT infrastructures by providing theiipersonnel rvith desirable software applicitionson an as-needed basis via the Internet. Terms ofthe acquisition lvere nol disclosed.

3. Messageone Inc.-Acquired for $155 million,Message0ne was aIt industy Ieader in SaaS-enabled continuous e-mail service, e-mai!archiving, and disaster recovery of e-nraiimessages. The Messageone acquisition furtherenhanced Dell's strategy to use SaaS applicationsand remote softrvare management tools to deliverconfigure-to-order [T services to commercialcustomers over the Internet.

4. Equallogic-This company, acquired for $1.4billion, rvas a leading provider of high-perfor-mance storage area ne$fork (SAN) solutionsthat made storing and processing data easier andcheaper Equallogic's technological capabilitiesallorved Dell to offer its customers a secure datastorage solution that used the customer's exist-ing IT infrastmcrure. could be installed in min-utes. managed itself,.and rvas easily expanded asneeds increased.

5. ASAP Softtvar+-ASAE acquired at a cost of$340 million_. rvas a leading softrvare solutionsand Iieensing services provider, with expertisein soffrvare licensing and the management of ITassets. The ASAP acquisition expanded DelltIineup of softrvare offerings from 200 to 2,000.

6. The Netrvorked Storage Company-NetrporkedStorage rvas a Ieading IT consulting group thatspecialized in transitioning customers to proven,simplified cost-efficient data storage soiutions.Dell managernent sarv this acquisition as animportant element in its strategy to build thecapability to offer Dell customers simple, cost_effective rvays to manage their IT infrastruchrres.fbrms of the acquisition rvere not disclosed.

Dell management salv all slr acquisitions as greatlystrengthening the company's capabilities to providean altogether nerv value-added service to

"uitomerswith sizable IT operations, all of rvhom rvere find-ing the tasks of managing and maintaining an ITinfrastructure fo be increasingly compte.x and costly.

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C-I32 Part 2 Cases in Craftiog and Executing Strategy

Executives at Dell believed that having greater capa-bilify than rivals to offer commercial customers sim-ple. cost-effective \vays to manage their IT operationsrvould give Dell added competitiveness in marketingits lineup of product offerings to commercial enter-prises worldwide. While Dell already was the salesleader in PCs sold to corporations and businessesin North America and Europe, extending its tead inthese regions and grorving sales and market share inthe remaining parts of the rvorld could make a mate*rial contribution not only to grorving Dell's overallbusiness but also to overtaldng Hewlett-Packard asthe global leader in PCs.

Enhanced Services and Support for LargeEnterpriSes Corporate customers paid Dell feesto provide on*site service and help rvith migrating tonelv information technologies. Service revenues hadclimbed from Sl.7 billion in 2002 to about $5.3 bil-lion in fiscal ?008. This portion ofDell's business rvas

split benveen rvhat Michael Dell called close-to-the-box services and management/professional services.Dell estimated that close-to-the-box support servicesforDell products represented about a S50billion mar-ket as of 2005. rvhereas the market for managemenUprofessional services (IT life-cycle services, deploy-ment of nerv technology, and solutions for greater ITproductivity) in 2005 rvas about $90 billion. The mar-ket for IT consulting and services rvas forecast to bein the $850-$900 billion range in 201l. For the mostpart. [Tconsulting services rvere becoming more stan-dardized, driven primarily by grorving hardware andsofhvare standardization, reduction in on-site servicerequirements (partly because of online diagnosticand support tools. groiving ease of repair and mainte-nance-. increased 6ustomer knorvledge, and increasedremote management capabilities), and declines in theskills and knolv-ho"v that rvere required to performservice lasks on standardized equipment and instailnew, more standardized systems.

Dell's strategy in enhanced services. Iike itsstrategy in hardrvare products, lvas to bring down thecost oflT-related services for its large enterprise cus-tomers and free custot'tlers from "overpriced relation-ships" rr,ith such vendors as iBIvI. Stm Microsyslems.and Hervlett-Packard tlrat fypically charged premiumprices (5250 per hour) and realized hefty profits fortheir efforts-rr According to Michael Dell,. custom-ers rvho bought the services being provided by Dell

@ Tlte McGrarv-Hill

Cornpanies,20l0

saved 40 to 50 percent over what they rvould havepaid other providers of IT services.

TIre caliber of technical support and customerservice that Dell provided to its large enterprise cus-torners rvas highly regarded (despite the problernssometimes experienced by small businesses andindividuals). tn a 2005 survey of IT execurives byC/O magazine, Dell rvas rated number one amongleading vendors for providing "impeccable customerservice" to large enterprises.

Providing Online Shoppers lyith Cus-tomer Reviervs of Dell Products Users ofDell products wera encouraged to provide Dell rvitha revierv of their experiences rvith the products theyhad purchased. As part ofthe revierv process, cus-tomers rvere asked to provide a rating of the prod-uct using a S-point scale that ran from I (poor) to5 (excellent). Shoppers brorvsing through Dell'sproduct offerings could vierv the average customerrating score for each product directly on the screenrvhere the product details rvere displayed and couldclick on an adjacent link to iead the accompanyingreviervs. In 2008. about 50,000 cusromer reviervsof Dell products rvere posted and available forinspection.

Listening to Customers In addition to usingits sales and support mechanisnrs to stay close to cus-tomers. Dell periodically held regional forums thargave senior Dell personnel oppornrnities to listen tothe company's biggest and rnost influential customersand discuss tlfeir emerging needs and expectations.The meetirrg agenda frequently included a presen-tation by Michael Dell. plus presenrations by Dell'ssenior technoiogists on the direction of the latesttechnological developments and u,hat the florv oftechnology really meant for customers. presentationson rvhat nerv and upgraded products Dell rvas plan-ning to introduce. and breakout sessions on topics ofcurrent interest.

In February 2007. DeU began inviting cusrom-ers to post their ideas for improving its productsand services at a section of its Web site calledIdeaStorm- As ofApril 2008. cusronrers had postedmore than 8.900 ideas. 45 of rvhiclr had been imple-mented. Michael Dell believed that the Internet andthe speed rvith rvhieh people rvorldrvide rvere ableto connect to the Internet via a grorving nunrber of

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Hewlct-Packard as the

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Case 6 Dell lnc. in 2008: Can lt Overtake Hewlett-Packard as the Wodddde Leader in Personal Computers? c-r33

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devices had forever redefined what it means to listento customers:

Listening used to mean aommissioning a customersuney. Norv it means engaging dircctly rvith custom-crs and critics and using those relationships to crcatea smarter business. Thpping into the ideas of our cus-tomers is like having an open source R&D lab. r

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Dell's R&D focus rvas to track and test nerv develop-ments in components and sofhvare, ascertain rvhichones rvould prove most useful and cost-effective forcustomers. and then design them into Dell products-Management's philosophy rvas that it rvas Deli's jobon behalf of its customers to sort out all the nerv tech-nology coming into the marketplace'and design prod-ucts having the feahrres, options, and solutions thatrvere the most relevant for customers. studies con-ducted by Dell s R&D personnel indicated that. overtime, products incorporating standardized technologydelivered about hvice the performance per dollar ofcost as products based on proprietary technology.

At the University of Buffalo, for example, Dellhad installed a 5.6 teraflop cluster ofabout 2.000 Dellservers containing 4,000 microprocessors that con-stituted one of the most porverful superconiputers inthe rvorld and gave researchers the computing powerneeded to help decode the human genome. The clus-ter of servers. rvhich rvere the same as those Dell soldto many other custonrers, had been installed in about60 days at a cost of a ferv million dollars-far less

than the cost of another vendor's supercomputer thatused proprietary teclutology. Energy giant AmeradaHess Corporation (norv knotvn as Hess Corpora-tion), attracted by Detl's use of standardized andupgradable parts and components, installed a clusterof several hundred Dell rvorkstations and allocatedabout 5300.000 a year to upgrade and maintain it;the cluster replaced an IBM supercomputer that cost$1.5 million a year to lease arrd operate.

Dell's R&D unit also studied and implementedrvays to control quality and to strearnline the assem-bly process. ln 2008. Dell had a portfolio of 1,954U.S. patents and another ?.196 patent applications

were pending. Dell's R&D group includedabout 4.000 engineers. and its annual budget forresearch. developmett. and engineering rvas in theS430-$500 million range before jumping to morethan 5600 million in fiscal 2008 (see Exhibit 2).

Sc$eec' EEcme*ts eF $*E$'s

Btssl**ss "€trcEegyDell's strategy had three other elements that comple-mented its core strategy: eatry into the white-boxsegment of the PC industry, advertising, and con-tinuous pursuit of cost reduction initiatives.

Dell's Entry into the White-Box PCSegment ln 2002, Dell announced it u'ouldbegin rnaking so-called rvhite-box (i.e., unbranded)PCs for resale under the private labels of retailers.PC dealers that !;upplied *,hite-box PCs to smallbusinesses and price+onscious individuals under thedealer's orvn brand name accounted for about one-third oftotal PC sales and about 50 percent ofsales tosmall businesses. According to one industry analyst,"Increasingly, Dell's biggest competitor these daysisn't big brand-name companies like IBM or HP: it'srvhite-box vendors." Delli thinking in entering thervhite-box PC se-cment rvas that it rvas cheaper toreach many small businedses through the rvhite-boxdealers that already served them *ran by using itsorvn sales force and support groups to sell and ser-vice businesses rvith ferver than 100 employees. Dellbelieved that its lorv-cost supply chain and assemblycapabilities rvould allorv it to build generic machinescheaper than rvhite-box resellers could buy cornpo-nents and assemble a customized machine. Manage-ment forecast that Dell rvould achieve $380 millionin sales of rvhite-box PCs in 2003 and rvould gen-erate profit margins equal to those on Dell-brandedPCs. Some industry analysts rvere skeptical of Dell'smove into rvhite-box PCs because they e.xpectedrvhite-box dealers to be reluctant to buy their PCsfrom a company that had a history of taking their cli-ents. Others believed this rvas a test effort by Dell todevelop the capabilities to take on rvhite-box dealersin Asia and especially in China. rvhere thE sellers ofgeneric PCs rr,ere particularly strong.

Advertising Michael Dell rvas a firm believerin the porver ofadvertising and frequently espoused

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rrtI n0nlson-ssiclland-Grmll$ | Gase&oellhc,in2frt8: I Case

Crahing and Btecuting Can it 0vertslreSlrstegp Concepts and llswlefi-Packasd ss theCases, tllh Edition llYorldwide Leader in

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C-13,t Part 2 Cases in Crafting and F.\ecuiing Strategy

its importance in the company's s&ategy. He insistedthat the company's ads be communicative and force-fuI, not soft and firzzy. The company regularly hadprominent ads describing its products and prices insuch leading computer publications as PC Magasineand PC World, as well as in U&{ Toda1,, the YfallStrcet Jownaf, and other business publications. Fromtime to time, the company ran ads onTV to promoteits products to consumers and small businesses. Cat-alogs ofabout 25-30 pages describing Delli latestdesktop and laptop PCs, along with its printers andother offerings, lvere periodically mailed to consum-ers rvho had bought Dell products. Other marketinginitiatives included printing newspaper inserts andsending nervsletters and promotional pieces to cus-tomers via the Intemet.

Continuous Pursuit of Cost-ReductionInitiatives Michael Dell had long been anardent advocate of relentless efforts to improve effi*ciency and keeps costs as low as feasible. But dur-ing Kevin Rollins's tenure as CEO, Dell's cost edgeover rivals had narrorve4 and the companyt profitmargins had slipped as rvell (paaly because fierceprice competition rvas driving dorvn the prices ofmany products that Dell sold faster than Dell rvas

able to lorver its cosis per unit)-Exhibit 7 shorvs thedorvnrvard trend in the average revenue Dell receivedfrom each urrit sold. When he reassumed his role as

CEO in 2007, Michael Dell announced that tighterconfols over operating expenses rvould be imple-mented immediately and that management rvouldbegin an in-depth exploration of rvays for improv-ing Delli cost-competitiveness, organizing opera-tions more. gfficiently,'and boosting profitability andcash flows. In May 2007, Dell aunounced an initia-tive to reduce the global rvorkforce headcount byl0 percent, or 8.800 people. By March 2008, a net of3,200 jobs had been eliminated. Horvever. the com-pany had actually hired 2,100 more people to stafffrontline operations and customer-facin g activi ties;the net reduction of 3,200 people was achieved bycutting 5.300 personnel engaged in performin-e rvhatDell called non-frontline activities. The result rvas

to increase the number of Dell employees engagedin frontline and customer-facing activities frorn54 percent to 57 percent.

In March 2008. Dell executives announced thatover the next three years the company rvould seek to

@ the McGaur-Hill

Corpanies, 2010

achieve annualized savings of $3 billion via produc-tivity improvements and cost-reduction efforts acrossall the company's value chain*-design. supply chainlogistics. materials, manufacruring, and other operat-ing activities. Management reaffirmed its commit-ment to reducing the global employee headcount by8.800 and achieving the related labor+ost savings.At the same time, Dell also put programs in place toreignite the company's revenue grorvth in five focusareas: global consumer products, sales to Iarge enter-prise customers, laptop computers, sales to small andmedium enterprises, and sales in emerging countries.

TF{E INFGffiTMATICNTEC$.{NOLOGYIVIAHKETPLACT lhJ 2OO8

Analysts expected tlrc rvorldrvide IT industry togrow from $1.2 trillion in 2007 to $1.5 trillion in2010, a compound grorvth rate of about 7.7 percent.Of that projected 2010 total, about $560 billion rvaserpected to be for hardrvare (PCs, servers, storagedevices, networking equipment, and printers andperipherals); $327 billion forsoftrvare: and $613 bil-lion for services. From 1980 to 2000, lT spendinghad grorvn at an avemge annual rate of 12 percent;thereafter. it had flatlened-to a 1 percent decline in2001, a 2.3 percent decline in 200?, a single-digitincrease in 2_Q03*then rose more briskly at ratesin the 5-10 percent range in 2004, 2005, 2006 and2007. The slosdorvn in IT spending in 2001-2007compared to earlier years reflected a combina-tion of factors: sluggish economic grorvth in manycountries in 2001-2003: overinvestment in IT in the199)-1999 periodl declining unit prices for nrany 1Tproducts (especially PCs and servers); and a grorv-ing preference for lorver-priced standard-componenthardrvare that rvas good enough to perform a varietyof functions usiug off-the-shelf Windorvs or Linuxoperating systems (as opposed to relying on propri-etary hardrvare and custonrized Unix softlvarei. Theselling points that appealed most to [T customersrvere standardization, flexibility. modularity. sim-pliciry, economy of use, and value.

There rvere several driving forces contribut-ing to increased global spending for information

Page 53: Crafting (Cases)

Case 6 Dell lnc. in 2008: Can lt Overtake Hewlett-Packard as the Worldwide Leader in PersonalComputers? c-r35

I lhompson-Suicftkcd-Ganrtlu I

Cralting a*d Fxecuting

Srategp Conceps and

Casss, lTth Efition

Casef:DElllnE.inIXE: I Cu",Can it lhEilahalle$rlet-Packard as tha

livorldwide [.rd!r in

Parconal Computers?

techno.l-ogy products ard services starting in2004. " One rvas the explosion of digital informa-tion and content. According to Forrester Research,the world's data doubled approxirnately every threeyears, a phenomenon that rvas expected to producemore than a sixfold increase in data benveen 2003and 20 10, A second force rvas the rapid expansion ofsearch engine activiry, e-mail, text messages, socialnetrvorking Web sites like My Space and Facebook,blogs. and online video and images; these fed theworldrvide demand for digital devices to create,store, share, and print the mushrooming volume ofdigital information and content. The third force rvasthe rapidly grorving demand for information tech-nology products and services in emerging marketsaround the rvorld-like Brazil, Russia, China,India,and several other countries in Southeast Asia andEastern Europe-rvhere over half of the rvorld'spopulation resided. At the same time, several othercomplicating factors were at rvoqk. Much of thegrowing volume of content lacked autbenticationand proper secudty, plus the conten! rvas increas-ingly global and mobile. And consumer expecta-tions rvere changing-people rvanted instantaneousaccess to content regardless of what kind of devicethey rvere using or rvhere they happened to be, andtheir tolerance for complexity was lorv. AII of theseaspects of the global IT markeplace created hugeopporrunities for [T providers and huge challengesfor [T users.

Exhibit 8 shorvs actual and projected PC salesfor 1980-2012 as compiled by industry researcherInternational Data Corporation (IDC). Accordingto Gartrrer Research, the billionth PC rvas shippedsometime in july 2002; of tire billion PCs sol4 anestimated 550 million were still in use. ForresterResearch estimated that the numbers of PCs in uservorldrvide ,,vould exceed I billion by the end of2008(up from 575 million in 2004) and rvould approaclr1.3 billion by 201I and 2.0 billion by 2016. With arvorld population of more than 6 billion, most indus-try participants believed there rvas ample opportunityfor further grorvth in the PC market. Crorvth poten-tial for PCs rvas particularly strong in Russia, China.India, several other Asian countries. and portions ofLatin Arnerica (especially Brazil and Mexico). At thesame time, furecasters expected full global buildoutof the lnternet to continue, rvhich rvould require theinstallation of millions of servers.

I onuu,err*+,uCorpanies, a}I(l

Erhihit I Worldwide Shipments of PCs,Actual and Forecast, 1980-2012fin millions)

1980, .., i, :: :::1985

1990 . . ::

1995

2000:"'2001.

20CI2

,1:,,,,2004 ,,,,,,,.,',,,,,,:,2005

2006.2AO7

2008- , ,,2009'20't0'201 1'2012'

.::.. 'l

,.- 11

. '2458

' 13g

,. .133138't53

1TT

206

235

269

s023S5

368

398

426

'Foreca5l.

.Source.' lntemational Data Corporation.

F'{ OW D E I.I.'S' STRATfi GY

:i:rl:i'v:r .

PUT COFdPET$TIVE

PHESSUME GN RIVALS

When the personal computer industry first beganto take shape in the early 1980s, the foundingcompanies manufactured many of the componentsthemselves*disk drives, memory chips, graphicschips, microprocessors, motherboards. and sofrrvare.Subscribing to a philosophy that mandated in-housedeveloprnent of key components, they built expertisein a variety of PC-related technologies and createdorganizational units to produce components as rvellas handle final assembly. While certain noncriticalitems rvere typically outsourced" if a computer makerwas not at least partially vertically integrated and didnot produce sorne components for its PCs, then itwas not taken seriously as a manufacturer. But as theindustry grerv, technology advanced quickly in somany directions on so many parts and components

Page 54: Crafting (Cases)

rrtI Ttompsor-Suicklanrl-Gamtle I Case&oelllnc.inADS: I Cese

GrattingaadEracuting CanitOuerlake

Sraegy: Conceptrand llewlat-Packard as theCases, l?th Edition Worldwide Lsader in

Porsonal EomputErs?

c-136 Part 2 Cases in Crafting and Executing Strategy

that the e8rly personal computer manufacfurers couldnot keep pace as experts on aii fronts. There rvere toomany technologies and manufacturing intricacies tomaster for a vertically integrated manufacturer tokeep its products on the cutting edge.

As a consequence! companies emerged thatspecialized in making particular components. Spe-cialists could marshal enough R&D capability andresources to either lead the technological develop-ments in their area of specialization or else quicldymatch the advances made by their competitors.Moreover, specialist firms could mass-produce thecomponent and supply it to several computer man-ufacturcrs far cheaper than any one manufacturercould fund the needed component R&D and thenmake only lvhatever smaller vclume of componentsit needed for assembling its orvn brand of PCs. Thus,in the early 1990s, such computermakers as CompaqComputel IBM, Hervlett-Packar{ Sony, Toshiba.and Fujitsu-Siemens began to abandon vertical inte-gration in favor of a strategy of outsourcing mostcomponents from specialists and concenmting onefficient assembly and marketing their brand of com-puters. They adopted the build-to.stock value clpinmodel shorvn in the top section of Exhibit 4. It fea-tured arm's-length kansactions betlveen specialistsuppliers, manufacturer/assemblers, distributon andretailers. and end users. However. a ferv others, rnostnotably Dell and Gatervay. employed a shorter valuechain model, selling directly to custome$ and elimi-nating the time and costs associated rvith distribut-ing tluou-uh independent reselters. Building to orderavoided ( I ) having to keep many differently equippedrnodels on retailers' shglves to fill buyer requests forone or anotlrer configuration of options and compo-nents. and (2) having to clear out slorv-sellin,s modelsat a discount before introducing nerv generations ofPCs*for instance. Helvlett-Packard's retail dealershad an average of43 days ofHP products in stockas of October 2004. Direct sales eliminated retailercosts and markups; retail dealer margins rvere rypi-cally in the range of 4-i0 percent.

Because of Dell's success in using its businessmodel and strategy to become the lon'-cost leader.most other PC makers had tried to emulate variousaspects of Delli strategy, but rvith only limited suc-cess. Nearly all vendors were trying to cut days,ofinventory out of their supply chains and reduce theircosls ofgoods sold and operating expenses to levelsthat rvould make them more cost-competitive $,ith

@Ihe McGm'rHill

Companies, Sll0

Dell. In an effiort to cut their assembly costs, severalothers (inciuding HP) had begun outsourcing assem'bly to contract manrfacturers and refocusing theirinternal efforts on product design and marketing.Virtua[y all PC vendors rvere trying to minimize theamount of finished goods in dealer/disributor inven-tories and shorten the time it took to replenish dealerstocks. Collaboration rvith contract manufacturersrvas increasing to develop the capabilities to buildand deliver PCs equipped to customer specificationsrvithin 7 to 14 days. but these efforts were hamperedby the use of Asia-based contract manufachrrers*delivering built+o-order PCs to North Anrerican andEuropean customers rvithin a trvo-week time framerequired the use of costly air freight from assemblyplants in Asia.

While most PC vendors rvould have liked toadopt Delli sell-direct strategy for at least someof their sales, they confronted big channel conflictproblems: if they started to push direct sales hard.they rvould ahnost certainly alienate the independentdealers on rvhom they depended for the bulk of theirsales and service to customers. Dealers sarv seli-direct efficrts on the part of a manufacturer rvhose

brand they represented as a move to cannibalizetheir business and to compete against them. How-ever. Dell's success in gaining large enterprise cus-tomers rvith its direct sales force had forced grorvingnumbers of PC vendors to supplement the efforts oftheir independent dealers rvith direct sales and ser-vice efforts of their orvn. During 2003-2007. severalof Dells rivals rvere selling l5 to 25 percent of theirproducts direft.

fi{E\4f LTTT.PACKAHD:DELL'S EE*XEF ffi$V;qL $N

PCS ANE x86 SEffiVEffiS

In one of the most contentious and controversialacquisitions in U.S. history Hervlett-Packard share-holders in early 2002 voted by a narrorv n'rargin toapprove the companyt acquisition of Compaq Corn-puter. the lvorld's second largest full-service globalcomputing company (behind IBM). rvith 2001 rev-enues of 533.6 billion and a net loss of 5785 mil-lion. Compaq had passed IBM to become the rvorldleader in PCs in 1995 and remained in fint place

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Case 6 Dell lnc. in 2OO8: Can lt Overtake Hewlett-Packard as the Worldwide Leader in Personal Computers?

I lhorryson-SuiaoaEil.Gadte: I

Crafting and Erecuting

Stratlgp Corcepts and

Gsses, 17lh Edilion

Gase&Delllnc.in2lX)& | Cn.u

Can it 0uer$ke

Hewlett-Packad as the

tllorldwide trader inPersonal Compulers?

until it was overtaken by Dell in late 1999. Compaqhad acquired Tandem Computer in 1997 and DigitalEquipment Corporation in 1998 to give it capabili-ties, products, and service offerings that allowed it tocompete in every sector of the computer industry-PCs, servers, workstations, mainframes, peripher-als, and such services as business and e-comrnercesolutions, hardrvare and software support, systemsintegration, and technology consulting.ll In 2000,Compaq spent $370 million to acquire certain assets

of lnacom Corporation that management believedrvould help Compaq reduce inventories, speed cycletime, and enhance its capabilities to do business withcustomers via the Interqet. Nonetlreless, at the timeof its acquisition by HP, Compaq rvas stmggling tocompete successfully in all of the many product andservice arenas where it operated.

Carly Fiorinar rvho became HP's CEO in 1999,explained rvhy t!9 acquisition of Compaq rvas stra-tegically sound: r)

With Compaq. rve become No. I in Windorvs. No. I

in Linux and No. I in Unix ... With Compaq, rve

become the No. I player in storage. and thc leaderin the fastest grorving segmcnt of the storage mar-ket-storage area nenvorks. With Compaq. rve dou-ble our service and support capacity in the area ofmission-critical infrastructure design, outsourcingand support. . . . Let's talk about PCs. . . . Compaq has

been able to improve their turns in that business from23 tums of inventory per year to 62-100 pcrccntimprovemcnt ycar over year-and they are comingclose to doing as rvell as Dcll docs. They've reducedoperating expenses by Sl30 million, improved grossmargins by thrce points. reduced channel inventoryby morc than 5800 rnillion. They ship about 70 per-

ccnt of their commcrcial volume through their dircctchannel. comparable to Dell. We ryill combine oursuccessful retail PC busincss model rvith their com-nrercial business model and achievc much moretogethcr than n'e could alone. With Compaq. rvc rvilldoublc the sizc of our sales force to 15.000 strong.We rvill build our R&D budget to more than S.t bil-lion a year. and add important capabilities to HPLabs. WE rvill become the No. I player in a rvholehost of countries around the rvorld-HP operates inmore thsn 160 countries. nith rvell over 60 perccntef 611 psvcnues coming from outside the U.S. Thenerv HP rvill bc thc No. I player in the coasumer andsmall- and medium-busincss ssgments. . . . Wc havcestimated cost synergies of S2.5 billion by 200.1. . . . Itis a rarc opportunity rvhen a technology company canadr.ancq its market position substantially and reduce

I o*reucGew-HittCompanies.2{ll0

its cost srructurc substantially at the same time. Audthis is possible because Compaq and HP are in thcsame busincsses, pursuing the same strategies, in thesame markets,'with complementary capabitities.

However, goiilg into 2005 the jury was still outon whether HP's acquisition of Compaq rvas the suc-cess that Carly Fiorina had claimed it would be. Thecompany's only real bright spot rvas its $24 billioncrown jervel printer business, which still reigaed as

the unchallenged rvorld leader. But the rest of HP'sbusinesses (PCs, servers, storage devices, digilalcameras, calculators, and IT services) were under-achievers. Its PC and server businesses lvere strug-gling, Iosing money in most quarters and barelybreaking even in others-and HP rvas defirritely los-ing ground to Dell in PCs and lorv-priced servers. Inservers, HP rvas being squeezed on the lorv end byDell's lorv prices and on the high end by shong com-petition from IBM. According to most obseners,IBM overshadorved HP in corporate computing-high-end servers and IT services. HP had been ableto grolv revenues in data storage and technical sup-port services, but profit margins and total operatingprofits rvere declining. While HP had successfullycut annual operating costs by $3.5 billion-beatingthe $2.5 billion target set at the time of the Compaqacquisition, the company had missed its earningsforecasts in 7 ofthe past 20 quarters-

With HPi stock price stuck in the $18-$23price range, impatient investors in 2004 beganclamoring for the company to break itself up andcreate hvo separate companies, one for its printerbusiness and one for all the rest of the businesses.While FIP's board of directors had looked at break-ing the company into snraller pieces, Carly Fiorinauas steadfastly opposed, arguing that HPt broadproduct/business lineup paid off in the form ofadded sales and lorver costs. But in February 2005.shortly after HP released disappointing financialsfor 2004 (the company's eamings per share totalof $1.16 in 2004 rvas substantially belorv the earn-ings per share total of $ 1.80 reported in 2000), CarlyFiorina resi-uned her post as HP's CEO amid mount*ing differences benveen herselfand menrbers of HP sboard ofdirectors about *,hat actions rvere needed torevive HP's earnings.

Mark Hur_d president and CEO of NCR (for-merly National Cash Resister Systems), rvas broughtin to replace Fiorina, effective April l, 2005; Hurd hadbeen *t NCR for 25 years in a variely of management

Page 56: Crafting (Cases)

c-t38 Part 2 Cases in Crafting and Executing Strategy

positions and rvas regarded as a no-nonsense ex€cutivervho underpromised and overdelivered on results.26Hurd immediately sought to bolster HP's competi-tiveness and financial perfomrance by bringing innelv managers and attacking bloated costs. In his firstseven months as CEQ the resuits were encouraging.IIP posted revenues of 586.7 billion and net proflrts

of $2.4 billion for the fiscal year ending October 31,2005. FIP had the number one ranking rvorldrvide forserver shipments (a position it had held for i4 consecu-tive quarters) and disk storage systems, plus it rvas thervorld leader in server revenues for Unix, Windows,and Linux systems. During the first seven months thatHurd rvas HPt CEq the companyi stock price roseabout 25 percent.

With Hurd at the helm, Hewlett-Packard contin-ued to gain traction in the marketplace in the nextnvo fiscal years. For example. HPi sales of laptopcomputers increased 47 percent iu fiscal 2007 andits PC business in China nearly doubled, makingChina HP's third biggest rnarket for PCs. The com-pany posted revenues of $91.7 billion in fiscal 2006ard $104.3 billion in fiscal 2007. Earnings climbedfrom $2.4 billion in 2005 to $6.2 billion in 2006(equal to a diluted earnings per share of$2.18) andto $7.3 billion in 2007 (equal to a diluted earning pershare of $2.68). By late fall 2007. HP's stock pricewas more than double rvhat it bad been during CarlyFiorina's last days as CEO. The company's 2007share of the estimated S1.2 trillion global iT mar-ket rras almost 9 percent. lt rvas the global leader inboth PCs and x86 servers running on Windorvs andLinux operating systerns. About 67 percent of HP'ssales rvere outside thelUnited States. In fuIay 2008,HP announced thal it rvas expecting fiscal 2008 rev-enues of about $l14 billion and a diluted earningsper share in the range of $3.30 to 53.34. Exhibit 9

shorvs the performance of Hervlett-Packard's fourmajor business groups for fiseal years 2001*2007.

HP's strategy in PCs and servers differed fromDell's in trvo important respects:

1. Although HP had a direct sales force that soiddirect to large enterprises and select other cus-tomers. a very sizable share of HP's sales of PCsrvere made through distributors, retailers. andother channels. These included:

. Retailers that sold HP products to the pub-lic through their orvn physical or Intemetstores.

@ the McGnrv-Hill

Companies, ?010

. Resellers that sold HP products and ser-vices. freguently rvith their orvn value-addedproducts or seryices, to targeted customergroups.

. Distribution partrrers that supplied HP prod-ucts to smaller resellers rvith rvhich HP hadno direct relationships.

. [ndependent distributors that sold HP prod-ucts into geographic areas or customersegments in rvhich HP had little or nopresence.

. Independent softrvare vendors that oftenassisted H? in selling HP computers, sery-ers, and other products/services to theirsoftrvare clients.

. Systems integrators that helped Iarge enter-prises design and implement custom ITsolutions and often recomrnended that theseenterprises purchase HP products whensuch products lvere needed to put a custom-ized IT solution in place.

Much of HP's global rnarket clout in PCs andservers came from having the world's biggestand most diverse netrvork of distribution part*ners. The percentage of PCs and servers soldby its direct sales force and by its various chan-nel parb€rs varied substantially by geographicregion and country. partly because customerbuying patterns and different regional marketconditions made it useful for HP to tailor itssales, maflieting. and distribution accordingly.

2. While in-house personnel designed the compa-nyt PCs and x86 serversr the vast nrajority rvereassembled by contract manufacturers located invarious parts of the rvorld. Big-volume ordersfrorn large enterprise customers rvere assembledto each customer's particular specilications. Theremaining units rvere assembled and shipped toHP's retaii and distribution partners: these rvereconfigured in a variety of uays (different micro-processor speeds, hard drive sizes, display sizes,memory size. and so on) that HP and its resell-ers thought rvould be attractive to customersand then assembled in lar,ge productions runs tomaximize manufacturing efficiencies.

During 2005-2007, after replacing a number oftlP's senior executives. Mark Hurd engineered severalstrategic moves to sbengthen HP's courpetitiveness

I nompmn-srickland-Gamate: I

CratliBo and trecutinBSIr3togF Coneepb and

Casss, l?th Edilion

I

Case&Delllnc.inZlXt& I Gase

Gan it Orrrtakellewletl-Pachard as tho

tlYoddwide Leader inPe13ouol Compulers?

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Crahing ald Execuliog

StrategF Conrepls arrd

Cases, ITth Edition

I case6:0El!lnc.in20{E I cr."Csn it {h6rtak.Hewlett-Packord as the

Worldwida leader ia

Personal Computars?

::.,, s!a,je!':: I ,.;.' 4,315

I onemoaw-ninCornpanies, Z0l0

Case 6 Dell lnc. in 2ffi8; Can lt Overtake Hewlett-Packard as the Worldwide Leader in Personal Computers? C-139

Exhihit I Performance of Hewlett-Packard's Four Major Business Groups, Fiscat Years2001-2007 ($ in billions)

:iNet revenuer:::. i.'Openting income

$21;094 .'. '2,977

t, ,,

,'j , S16-d4G:. ,. ': :,.. , 11829

' ,,. ',- ., j

. i $15,617:1,507

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1r s15.536

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,r. $13,r/8:; , ' l'263....,...,..:

s1 2,3s71,362

s12,3261.369

' s12,8021,617

$36,4091,939

Net revenue : l

' Operaling income '

2005 , :

Netrevenue:., ,

Operating income

2004:..: .. .

, Net rbvdnde . :....

Operating income .

Net revenue .

Operating income (loss)

2002"Net revenue

Operating income (loss)

2001'Net revenue

Operating income (loss)

$26,7863,978

szs,lss

.:, 3"113

i, :: 1,,

$24,1993,847

'--,''s22,569

s,596

$20,3583,365

s19,6022,103

$29,1691,152

$26,741657

824,622

210

s21,21022

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(6s6)

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(s7e)

2007

'Besults tor 2001 and 2002 rcpresent the combined results of bolh HP and Compaq Computer.Source.'Company 10-K reporls 2003, 2004, and 2Cl0?.

and ability to deliver better financial performance toslureholders:. Top executives charged each HP business rvith

identiffing and irnplementing opportunities toboost efficiency and lower costs per unit. Everyaspect of the companyi supply chain and internalcost structue rvas scrutinized for nays to become

more emcient and reduce costs. The costs of each

value chain component*&om real estate to pro-curement to IT to marketing-rvere examined sothat n:arragers could knotv cossby business group.

rcgion, country site. product. and employee; these

levels of cost analysis rvere then used to scrutinizehorv each expense supported HPb stategy andrvhether there \yere opportunities for cost savin-es.

Corporate overheads rrrere trimrned negotiations

rvith suppliers rvere conducted to be sure that HPlvas gettitg the best terms and best prices on itspurchases! steps were talien to trirn HP's rvork-hrce by about 15.000 people \yorldwide, the

organizational structure was sfeamlined resultingin three layers of management being removeq andthe companyis very complicated IT operationswere simplified and tlre expenses reduced-theobjective rvas to en-sineer HP's IT architecture andoperations to be the rvorldb best showcase for thecompany! technology. In 2008, HP began tim-ming the number of sites rvorldrvide at rvhich itconducted activities by 25 percent. The resultingin:provements in operating expenses paved the\\,ay for IIP to price its products more cornpeti-tively against those of Dell and other rivals.

:iiii: i

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Ihomgroo-Sricldao&. Gamble:

Ctahing and Executing

Strategy Coacepts and

Cases,17ft Etrrtior

Casa & DEll lnc. in mkCan il Overtake

Hawlett-Faclard as theWorldrilide leader in

Personal Computers?

c-110 Part 2 Cases in Crafting and Executtng Strategy

. Company personnel began working moreclosely rvith large enterprise customers to findways to simpli$ their experience with informa-tion technology.

. A number of new products and services rvereintroduced.

. HP spent close to $7 billion to acquire morethan a dozen softrvare, technology, and servicecompanies that management believed rvouldadd significant capabilities and rechnology toHP's portfolio and help fuel revenue growth.

' The company prepared to capitalize on three biggrorvth opportunities that top management sawemergin-e over the next fourorfiveyears: ( I ) next-generation data center architecture; (2) grorvingconsumer interest in ahvays-ready, ahvays*onmobile computing; and (3) digital printing. MarkHurd believed that HP had important strengths inall three of these high-growth market arenas butneeded to be more adept in getting new productsinto the markeplace. He directed company per-sonnel to develop a better "go-to-markot" modeland to ant the sales force rvith the tools neededto "get quotes and proposals in front of custom-ers as fast as anybody on the planet." IIP added1.000 people to its sales force in 2007 to expandits coverage of key accounts and geographic mar-kets; an additional 1,000 salespeople rvere addedthrough acquisitions.

Soon after becoming CEO in 2005, Mark Hurdconcluded tlut HP needed to beef up its IT servicesbusiness in order to go head-to-head against IBM.the unquestioned--rvotldrvide leader in IT services:iBM had 2007 rlvenues ofabout $54 billion and anestimated J.? percent global share of a 5748 billionmarket. Hurd took a major step in that direction inMay ?008. nraking his first really big strategic moveas HP's CEO by cutting a deal to aequire ElectronicData Systems (EDS) for a cash price of $13.25 bil-lion. According to Gartner (one of the rvorld's lead-ing technology research firms). EDS had IT servicerevenues of $22.1 billion in 2007, equal to a globalshare of 3.0 percent-ahead of HP rvith revenues of$17.3 billion and a 2.3 percent share (see Exhibit l0for the sales and marlcet shares of the rvorld's top sixlT service pror.iders). While a combined HP/EDSuould have IT service revenues of more than S49 bil-Iion and market share of 5.3 percent-sufiicient fora strong second place in the global market-industry

Exhibit I0 Estimated Sales and MarketShares of the World'sSix Leading Providers oflnformation TechnologyServices,2007

IBM. .

Electronic Data ,.

Systems (EDSi:

Accenture, , i.'FUjrISU, . :

Hera,l,lett-Pdikard .',.

Computer SciencesCorp. (CSC) ,.All others: -.,.. ,. ,.. , ,.

Totals,.''.'

s 54.'l 7.2%

22J .,, I ,,-. 3.0

tS.$,.. : , 2.818.6 ' 2.517.31 :. '.

r'.':' 2.3

16.3

599.0s748.0

,2'1"80.0

100.0%

'Gartnefs 517.3 billion number lor HP's 2@7 revenues in lTservices exceeds lhe 5'16.6 bitlion reported by HP in irs 200710-K repor: and shown in Exhibit 9. ,Source: Gartne[ as reporled in Justin Scheck and Ben Worlhen,.Hewletl-PackardTakes Aim at lBM," Walt StreetJournal May i4,2008, p.81.

observers were not enamored rvith the ability of HP/EDS to compete rvith IBM for hi,sh-end high-proflrtbuyers of IT services. IBM! profit margin in ITservices rvas almost double EDSi 6 percent profitmargin. partly because IBM catered to the aeeds ofhigh-end custbmers and partly because IBM hadabout 74,000 employees in India, rvhere rvages forIT professionals were considerably lorver*only27,000 of EDSt 140.000 employees rvere in lndia.

EDS, founded in 1962. rvas best knorvn for itscapabilities in nrnning clients' main*arne systems!operating help desks to support personal computerusers, developing and running business softrvarefor its clients. and handling zuch autonrated IT pro-cesses as billing and payments for clients.2T [nconfast, HP's IT senice business revolved aroundmanaging infrastructure-such as back-office serversystems-for its large enterprises. There rvas relativelylittle overlap betneen the customer bases of the fivocompanies. HP executives believed there nas plentyof opportunity to cut costs at EDS and that there vvereclear revenue-boosting opportunities. such as expand-ing sales of managed printing services. Even so, Hp!shareholders were unenthusiastic about the EDS

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Itom son-Srickland-Gamble:

Croting and Erearning

Stntegp ConcepE and

Cases. t?ti Edilion

Cose 6: Dell lnc. in 2l!(&83n il 0verlako

Hewler-Pacftad as the

Worldwide Leaderin

Parsoaal tomputers?

Case 6 Dell lnc. in 2008: Can lt Overtake Hewlett-Packard as the Worldwide Leader in Personal Computers? c-r4t

acquisition-HP's stock price fell more than $10 pershare in the trvo days follorving nervs of the acquisi-tion but recovercd $2.50 of the drop rvithin a week.

DE[.L'S FI.JTUME

PROSPECTS

ln a February 2003 article in Brsriress 2.0. MichaelDell sai( "The best rvay to describe us nor. is as abroad computer systems and services company. Wehave a pretty simple system. The most importantthing is to satisfy our customers. The second mostimportant thing is to be profitable. tfrve don'r do thefirst one rvell, the second one lvon't happen."18 Forthe most part, Michael Dell rvas not particularly con-cerned about the efforts ofcompetitors to copy manyaspects of Dell's build+o-order, sell-direct strateglr.He explained rvhy on at least hvo occasions:

The competition started copying us scven years ago.That's rvhen rve were a Sl billioa business. . . . Andthey hmen't made much progress to be honest tvithyou. The learning curve for them is difficult. It's liksgoing from baseball to soccel 1e

I think a lot of people havc analyzed our businessmodcl. a lot of people have u,ritten about it and tricdto understand it. This is an lS)/r-ycar procBss... .

It comes from many. many cycles of leaming .. .

Itt vcry very difercnt tlnn designing products tobe built to stock. . . . Our rvhole company is oricntcdaround a very different rvay of operating. . . . I don't.for any second believe that they are not trying rocatch up. But it is also safc to assume that Dcll is notstaying in the same place. Jo

On other occasioils, Michael Dell spoke aboutthe size of the conrpany's future opportunities:

When technologies begin to standardize or commod-itize. the game starts to change. Markets open up robe volume markcts and this is very much rvhsre Dellhas made its mark-fir.st in thc PC markct in deshtopsand notcbooks and then in thc scrver market and thcstorage markct and sen'ices and data act*orking. Wecontinue to cxpand the array ofproducts that rve scll.the array oflscrvices and ofcoursq expand on a gco-graphic basis. The way 1\,e think about it is that thercare all ofthese rarious technologies out there. . -. Whatrve have been able to do is build a business systcm thattakes those technological ingredients. translarcs thcminto products and services and gets them to the cus-tomer more efficientl-v than any company around.3l

Therc are enorrnous opportunities for us to grorvacross multiple dimensions in terms ofproducts. withservcrs, storagc, printing and services represcnting a

huge realrn of expansion for us. Thereb geographicexpansion and market sharc expansion back in thecore business. The primary focus for us is pickingthose opportunities, seizing on them, and makingsure we have the talent and thc leadership *erorvinginside ths company to support all that growth Andthere! also a netrvork effect here. As rve grorv ourproduet lines and enter nerv markets. rve see a fasterability to gain share in nerv markets vcrsus onesrve'vc previously eotered. 3l

A great portion of our grorvth rvill come from keymarkets outside the U.S. We have about I0 perccntmarket share ourside the United States, so there'sdefinitely room to grow. We'll grorv in the enterpriservith servcrs, storage. and services. Our grorvth rvillcome from ncv arcas like printing. And. quite frankly.those are really enough. Therc are other things that Icould mcntion. other things rve do. but those oppor-tunities I mcntioned can drive us to S80 billion andbeyond. sJ

That Dell had ample grorvth opportunities rvasindisputable-in 200?, it only had a minuscule2 percent share of the $1.2 trillion global market forIT products and services. Exhibit I I shorvs Dell'sprincipal competitors in epch of the industry\ majorproduct categories and its estimated 2007 marketshares in each category.

In 2008. despite near-term prospects ofsluggisheconomic grorvth in the United States and perhapselservhere, Michael Dell remained enthusiastic aboutthe unrivaled opportunity for the company's busi-ness given that the number of people online globally(via PCs. cell phones. and other devices rvith lnter-net connectivity) rvas e.rpected to increase from justover I billion in 2008 to over 2 billion by 201l:

The rvorld is rvitnessing the most e,rciting and prom-ising pcriod for technotogry ever secn. Wc call it the"Connected Era." The second billion people com-ing onlinc. many from the rvorldk fast grorvin-e andemerging econonries. expect a diffcrcnt tcchnologyexperience to thc first. The lntemet has unleashedbillions of nerv conversations and made it possiblefor peoplc to conncct in nerv rvays. The emerEenceof this connccted era is aryuably the most iaflluentialsingle trend renrodcling the rvorld today. x

In May 2008, the latest sales and market sharedata indicated that Dell might be closing the gapon Hervlett-Packard and on the verge of mounting

Page 60: Crafting (Cases)

c-r{t Part 2 Cases in Crafting and Executing Strategy

Erhihit I I Dell's Principal Competitors and Dell's Estimated Market Shares by ProductCategory 2007

I nompsoo-suickland-Gaobh I

Crahing and Ex*cntrirrg

Strdtegs ConEepts and

Ceses.l?lh Ediliorr

I

Sase&Delllnc.inZ{llE I Case

8sn it 0veilake

Hewlett-Psckard as heU9orldwida Leader iaPelsonal Computers?

. Hewlett-Packard (makerol bothCompaq and HP brands); :

Lenovo, Apple, Acer, Toshiba, ' '

Sony, Fujitsu-Siemens .

{in Europe and Japan) :

Hewlett-Packard, lBM. Sun' Microsystems, Fujilsu :

Hewtett-Packard, lBM, EMC,Hitachi. i.:.. . .;; .. ., . l

Cisco Systems, Broadcom, . .. .j ..

': Enterasys, Nortel, 3Com,Airespace, Proxim.,, , :

Hewlett-Packard, Lgxmark, Canon;'Epson . r,. l

Accenturb, IBM; Hewiett-Packard,Fujitsu, EDS, many olhers

$375 billion: .

,,,.... .1, ]:'

560 billion, ',-. -t ...'1

S48 billion ,.

,:. -:: ', : . :-.: .-,'. .

:S65 billion '

-sso biiiidn' ' 'l

S748 billion i .

I r"*,i**r*Companies. 2010

*15"/o

:

-11oi/o

-5%

-20/;,

'..j

*5o16

<1i';

Servers, , , , ,,, ,, ,; .

. :. : 1'

Daia storage devices-

ttetwtlrNng switches :,

and related equipment,: . ., : 1,::i- :.: .. .. .-.

Printers and piinter '.cartridges , ..,. : :: r i:.. .

Services' .:. . i. .- r, .

Source: Compited by lhe case aulhors lrom a rrariety of sources, including lnternational Data Corporalion. -!,.:i:.+ri..i:*i:,, andThe Watl Sl:,eelJoumat, May 14, 2008. p.81. l

txhihit I2 Worldwide Unit Sales and Market Shares of Top Five PC Manufacturers, First

Quarter 2008 versus Fourth Qua*er 2007

1

2a

45

Hewlett-Packard

Dell ,. - , :. ,.. ..Acbf . ...

Lencivo ,l. hTpshiba--". .

AllOthers

13,251,000

10,913,000

6,9'14,000,

4,8.14,00o

3,069,000

30,537,000'69,498,000

11,291 ,0008,971 ,000 ...

4,164,000s3,980,0002,544,000''

29,674,000, :

60,624,000r.

19.'t o/o

15.7oio

9.9016

6.9%

4.40h

43.9o,L

100.0or/o

18.6%

14.8%

6.9%6.6%

4.?"/o

48.904

100.0%

17.4o/o

21-8"/o

66.0%2'.1 .oo/"

20.67o

2,9orto

14.6%

'Figures lor Acer include shipments of Gateway, which was acguired by Ac€r in 20O7.

Source: lnlemational Data Corporation. as per posling at ,rr,',''i.i:li;.:;'.:r:: (accgssed May 12' 2008)'

another run at beiilg the global leader in PC sales.

Exiribit 12 shorvs the sales and market shares of thervorld's top fire PC vendors in the flrst quarter of2008 as compared to the fourth quarter of 2007.Moreover, Dell's senior executiv€s believed that thqiraggressive moves to reduce costs n'ould help restoreprofit maryins, given that there seemed to be some

modest relief from having to conrend rvith erodingaverage revenues per unit sold (see Exhibit 7).

Honever. by late Fall 2008. Dell's prospectsfor overtaking HP rvere looking more bleak. Globalrecessionary forces had caused a significant slorv-dorvn in global IT spending during 2008 and evenlarger cutbacks uere being forecast for at least the

Page 61: Crafting (Cases)

Case 6 Dell lnc. in 2008: Can lt Overtake Hewlett-Packard as the Worldwide Leader in Personal Computers? c-143

Ihomgsoa-Slrickland-Ganble:

Gralting and Erecuting

$ralagf Concrpls {ndCases, t7th Edilion

Sasa 6: llell lnc. in IXI&Can it 0sarlake

Hewlett-Packard Es lhelllloddwidE Leader inPersonol Compulcrs?

first half of 2009 in light of the global financial cri-sis that emerged in Fall 2008. Still, HP reported a5 percent increase in revenues for iu 2008 fourthquarter ending October 3l (excluding the effect ofits reeent acquisition of EDS) versus the year ear-lier 2007 fourth quarter and a 2008 fourth quarterearnings increase of 4 pereent; moreover HP wasforecasting that fiscal 2009 revenues rvould be in theS127.5 to $130 billion range, up frorn $l18.4 billionin 2008. Dellt saies revenues in the third quarter of2008 were 3 percent belorv those in the 2007 thirdquarter on unit-shipment grorvth of 3 percent; Dell'sthird quarter 2008 net profits were dorvn 5 percent.

The {'thll Strcet Joantal reported in September2008 that Dell rvas trying to sell its worldwide net-work of computer factories in an effort to reduceproduction costs; the apparent plan rvas to enter intoagreements rvith contract manufacfurers to produceits PCs. While Dell had for many years been theindustry leader in lean manufacturing approachesand cost-efficient build+o-order production methodsand rvas still the lorv-cost leader in producing desk-top PCs. it had fallen behind contract n:anufactur-ers in producing notebook PCs colt efficiently*andtirere rvas a pronounced shift among individualconsumers to purchase laptop PCs instead of desk-tops. Laptop PCs rvere more complex and labor-intensive to assemble than rvere desktops. To helpcontain the assembly costs of laptops, Dell hadalready begun having Asian conhact manufacturers

Endnotes

partiatty assemble its laptops; these partly assembledlaptop units rvere then shipped to Dell's orvn plantsrvhere assembly rvas completed. Because each lap-top lvas produced at two factories, Dell refened toits assembly of laptops as & "two-tlvo" system. Butthe two-touch system tv;Is more costly than simplyhaving a contract manufacturer in Asia perform theentire assembly. Hence. Delll interest in abandon-ing in-house production altogether and shifting toI 00 percent outsourcing.

As of late November 2008, Dell had found nobuyers for its planls. But the company had nonethe-Iess begun outsourcing the full assembly of sornelaptop models to contract manufacturers (such as

Tairvan's Foxconn Group) to eliminate the extra costsof the hvo-touch system, and it had made significantprogress in cuning operating expenses elservhere-operating expenses rvere l2.l percent of revenuesin the 2008 third quarter verslx 12.8 percent in the2007 third quarter. There rvere some other positives.In the 2008 third quarter, Dell's Global Consumerbusiness posted a l0 percent revenue gain on a32 percent increase in unit slripments-Dell's rev-enue grorvth $as double the industry average andthe profitabiliry of this business rvas the highest in1.3 quarters. Dell consumer products rvon 4l arvardsin the 2008 third quarter-the Inspiron Mini 9 note-book nas selected as one'of Tinte lvtagazinei 'oBestInventions of 2008" and as one of CNET's "10 MostCutting Edge Products of 2008."

I As quoted in'Dell Puls Happy Cuslomers First," Nr&r(ei WeekliDecember 16,2002.z"Michael DelL On Managirg Growth," MrS WeeI6 September 5,

1988, p. 1.3'The Educatioa ol Michael D€11," Bus,nessweelr, March 22, t933, p.86.{ Dell's 2005 10-K report, pp. 1-2.s Flema*s by Kevin Rolliits ln a speech aa Peking University, Nouem-

ber2, 2005, and posled at 'i,ri!.ii::i:.r:::)iii.6 As quoled in Joan Magretta, "The PowEr of Virtual lr{egration: Afilnterview wlh Dell Computer's Michael Dell," H€nrardBusr?ress AeviervMarch-April 1S98, F.74.' lbid., p.75.I Speech by Michael Dell at Universily ol Toronto, SeptembEr 21, 2004,

'rj'!:r.,; l ii i:.. i:r:-., {accessed Decgmber'l 5, 2004).e tbid., p zo.

r0 Remarks by Michaet Detl, Gather Symposium. Orlaftdo, FL,Oclober 20, 20O5. .r';r,,t. ririi.rsri.rr Ouoted in Neel Chorvdhury'Dell Cracks Chinai Fcrtune, Jufie 21,1999, p. 121.laBemarks by Mkhael Dell, Garher Fall Symposium, Ortando, Fl-October 9, 2002,,..:r,i,..,.i:ril.,i:i:i.

13 Bemarks by Michael Dell al the University ol Toronlq Seplember 21.flgQ.rl. L :p,;;.ir,11ii"1 ji::.ra Ouoled in the fioanfia, i?mes Globat News Wire, Oaober 10. 2002.rs Flernarks by Michael Dell, Gartner Symposlun. Orlandq FL,OCtOber 20, 2005, .,.jr:,,!._liiti..ir rti.r€ Kevin Bollins, "Using lntormallon lo Speed Execution," Harvard Busi-ness Eeyierv, March-April 1998, p.81.

'? As quoted in Don Tennant, "Oell Exec Addresses Servl'ce Woes inRun-up to fT-as.a-Servke Launch," Cafiputeftvarld, Marcn 17, 2008,:r':r.ji.:;r:rr::r-iiilirii:iii.i:tri: (aCCgSSed May 12, ?OOBi.rs tbid.te Magretla, The Power of Virtual lnleg.ation,'p. 7920 "Michael Dell Rocks," Forrune May 1 1, 1998, p. 612r Orroted in Kalhryn Jones, "The Dell Wayi Susiness 2.0, February2003.4conpany press rel€ase, April 6,2008.a Much oi this paragraph was devEloped by lhe case authors lrominlormation in Hentett-Packard's 2007 annual report.2{'Can Compaq Catch Up?" Susinessweer( May 3, 1999. p. 163.?5 Company press release and speech posted at :rrr;.i.irii .i:i :::,accessed December 11, 2004.

Slr!

Page 62: Crafting (Cases)

Itoopso*Srhlhr&8.rrDlsCtafting and ErcoutfugStrtlrgt:ConelnE and

Bss!& Irlh Edltion

Cacr 6: 0ell lnc. io AIEGan it lhartrktHrwtct-Prckrrd rsrhrWorliryida tradcr in

Parsonal Gonpurers?

Part 2 Cases in Crafting and F;ecuting Strategy

@Ilciile8r.tr{ilCorryu*as.El0.

c-ld4

s loulse Lee and PBter Bunowq lttrtrat's Dogging DBIIB Stod(i Brrsr:,_essw6ek, Sepilember 5, 2005, p. 90.2'Ju$in Schech and B6n Worthen, "HEtvlett pad€rd Tak$ Alm ellBM." wailsraat Jounat,May 14,2008, p.81.a 8usfiress e.4 Fetruary ZfXjS, rvs.,r.busiltr$!3.;:sni.nComrentg made lo stidents at lhe Unirrectty ol NdthCaro&1e and,eporled in he Pare&r, rvetr4' E oasenE; NovBmbgr 16, 1999.sRemarls by Mi&ael DeU, Ganner Fall Syfiposlum. Orlando, FL,Octobsr 9, 2m2. rrt.a.c;gi!.rcrr.

tr Hemarks by Micheel Delt, MtT Sloan School ot ManagiErnen! Setrtet$sr 28, 2002, *.sw.de ll.ccil.s Remad6 by Mhhael Detl, Univercity ot 6ronlo, Sept€rbs 21,20O1, ir+t.<isii.cr:n:.sRemafis by Mhhad DeH. Garlner Symposium. Orlando FL Oaober20. 2005, **'w.ieil.rorr.s Rema,ks by Midtael Detl lo reporte]s h Dubai, compafiy pr€ss6lsa5q April6.20llB

Page 63: Crafting (Cases)

I thorupson-Sricttand-liamblc: i

Gnlting ard Execuino

Slrategp Conceps and

Goses, tl$r Edition

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Airlines in 2[E: Cullure.

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every quarter of

falloffs in airline tiaf-frc due to lt had contended sudiess-

safety and maintenance. and mounting customer dis.satisfaction rvith airline service. :, i.'; . :r,:,,

Once regarded as little more than a, scrippyunderdog with quirlcy practices that flew mainly to"secondary" airports (rather ;han high-traffic aii-ports like Chicago's O'pare, Dallas-Fort,.Worth,Atlanta's Hartsfield and Nerv York's LaGuaidia andKennedy airports), Southu'est had proved it rvas'amajor competitive force in the U.S. airline-indus-try. It lrad the lowest operating cost strucrure in thedomestic airline industry and consistentlv offeredthe lorvest and simplest-faftft5ot only rvas it themarket share leader in t5ffiilof passengers'carriedbut is market share rvas climbing at a time lvhenpassenger g other major U.S. airlines,rvasstagnant-r

tu'fi;-

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- ,', -....-,:',,,Colryright 13 2m$ by'rlrthur r\. Thompson and John E, Gamble;All' ..:

rightsrcscn'url, ....'..'

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The Universir.v ofAlabama '

,,,., ..,. . t,.'.,'.' . -t I ,l.i ' ,

HIn 2008, more people'rvere flying Southwest Air-ffi lines than any other US. ,airline. and SouthrvestHnoa the enviable aiffitr?J of,bsing.'the onlymajoi US. air carrier6ai rvas

"O6"t"t#fty profii

able, After losing"more than S35-Eiilion during2001;2005, U.S. commercial airlines earned a com-bined $3.lbillion in 2006 and $5.0 billion in 2007;but shffi higher costs fol jet fuel in 2008 rvereexpected to result in another monqy;loping year formost major U.S. airlines. rvith theffifabYA exceptionof Southrvest. In August 2008, analysts t ere project-ing combined ?008 tosses of $5 to $8 billion for theU.S. airliue induetrvas a rvhole. dependins on rvhathappened to .@ff'prices and jet fuel irices forthe rernainder of the year. Horvever. the US. airlineindustry's profit outlook brightened considerablyu,hen crude oil priggs dr#Blred belorv $100 per bar-rel in September, pi!,ifipnn! revised $08 profit pro-jections for the industry sorp\vheife,.near breakevenpoint*the difference betrveef'buying jet filel rvhencrude oil u'as S$7r;fer barrel (as it s,as in portionsof July 2008) versus rvhen crude oil nas $100 pefbarrel (as in a portion of September 2008) .qY*tfl',1to a fuel cost savings industry-rvi@pf Sl5 blimi-.

The U.S. airline industry had iil* money in 14

of the 28 years from l9S0,througlr 2007, rvith com-bined annual losses *@ffi**ombined annualprofits by S15 billion. Yet in July 2008, Southrvestreported record quarterly revenues. its 69th consecri-tive quarter of profitability. rising passenger trafficon its fLights, and a record load factor (percentageof available seats sold). The company had reporteda profit €very year since 1973. During 1990-1994,rvhen the airline industry had five straight money-losing years, Eid "ff

120.000 employees, and lost acumulative $t3rbillion, Southrvest earned a profit

w,ot916o' c-401

Page 64: Crafting (Cases)

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E RtS 3 6tR 5 Ur E El6 ffi Ele g'frlE+ i I d- o- o-l of ut- n-l aa- 6- trl-l 6- - tr I - q- <rl-l @-

o, lo, co t*l(o (o colto.. r- I..llO F l- co col(o# l= *6-16 d-l+ . 19 | t lto

c-r02

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I nonpson-SutNana-Gamlle I

Crallio[ and Ereculing

Stsale!i$ Concepts ardCases tTt r Edition

I

Casszlsouftweli I Gase

Airliaes in d)0& Gullure,

Vakas, and 0perating

Praclice!

I rO ThE ucGnrv-Hitt

Crnsanies. ?010

c-l03

du; t-;,!- $^1,;,iexecUtlves from other carriers. He particularly iought , , /,ort peopl-e who tvere innovative, lvouldn't 511'ffi-ft-smdG' Tr*'rr

doing things differeqtly or unconventional$Gd rvere

, motivated by the challenge ofbuilding an airline from*{cratch. Muse rvanted his executive team to be rvilling

fo thinh like mavericks and not be lulled into institut-ing practices at Southwest that rvere largely imilativeof &ose at other airlines. According to Rollin King,"It was our one opporunity to do it right. . . . We allunderstood that this lvas our ooportunity to decide

noru to do it orr**@*nl-Ioiffi)*vas, and stili is,we do rvhatever we hFi66-lo'!-et the job done.'r

Case 23 Southwest Aidines in 2008: Culture. Values. and Operating Practices

Over the yEAts, King had heard many Texas busi-:&:qai v:*r inessmen E;ri,F-IoUL"obout the length of time it tookto drive behveen the tlrree cities and lhe expense offlying the airlines currently serving these cities. Hisbusiness concept for the airline rvas simple: atmctpassengers by flying convenient schedules. get pas-

sengers to their destination on time, make sure theyhave a good experience, and charge fares;gqtgetitivervith travel by automobile. Kefleip5 slggticbl thatKing's business idea rvas UaUI{ dtg into the pos-

sibilities during the qp4![erv rveeks and concludeda new airline rvas ferisfulEf he agreed to handle the

necessary legal rvoilEd alsp to,invest $10,000 ofhis own funds in the venture.o-6 db*^

In 196?, KeUeherTiiEt-pape$ to incorporate the

nerv airline and submitted an application to the Texas

Aeronautics Commission for the nsw company tobegin serving Dallas, Houston. and San eirtqlp..ie;t rival airiines in Texas pulled every striffief

SqUTH T'SurdL

STRU iro GAIN , t, /FOOTT-{OLDc/.o-f,'':A P'JIAHKET

could to block the nel airli$$.op*c:T::t''g InJune lg7l,southrvestiniriateditsfirstflightsrvith

operations, precipitating a cUntqg[0s four-year ;;;; ,hr;;;;; inctuded 6 round-trips behveenparade of le-eal and regulatory proceedings' Herb DaltasandsanAntonioand t2round-tripsbehveenKelleher, tq*,*ir#lt,ol tJX-,t:Tt*I-: !:h:]l Housron and Da*as. The introductory sio one-lvay

{{^*,, ,^*_ ffiHltlrffiTJJ:,j:xJr;:*.ff:Tiffil: faresto ny the Gordenrriangre, rveu berorv the $2?

*;; q\\4Ln ruling from u.s. Suprenre court. Kelleher recalled and $28 fares clraryed by rivals' atffacted disappoint-"*.' r-d --=:e u]ll'^l;"--lll:::::_*J-:';^::",'L:11:: 1::':": ingty smafi numbers of passengers-some days the

r :: *ft-'

:".TtT: 11"-::l1$#,"i'it'ly_::T:_:", totat for au ls flights would be ress than z50 people. , - l-'/ra- d-tr inra:qe me' there was no Bggt to our compehtors'

Southrvest's financial resources rvere shetc'hed so &-o {a'''' l"sal assertions' Thev rvere tiT{{P_i::_':l::lh:l:

thin that the company'utrehi i;rr ror r"raraGilntr,'superior ffi"*8Ti:.!1*er

to P*,"-:3?,j" *i on Lamar Muset personai-credit card. The companyrvould collifbt before \Ye ever got into business. I

,, i. As-! .-#ffiffi; ffi"#;a . shorv that Southrvesr rvas short of ground equipmenl and most of rvhat it

:F',7 n'lrc'l AiIIT*y.1, going to sun'ive and rvas going into |iil'ff':11i3i1'ffi!ffili::;X'i1#,-*operation-'" il,.,^^ ...^- L- ..^Lr i- G:ph";; i*,irr, og4ffililices ar

In January 1971, Lamar Muse rvas brought in personnel got on t

as the cEo ro get operatiols u1d1.waffi,1gg11 L"t"Tllll;Xi1}}l-"::*:1!Uffi*ff:{* o""k an tggrerye.and selflorllient airline-?6t81'ff ffho - aud^ enthusiasm remained rrigh; conrpany personnel

knerv the tut:lr,E,X#11*-'uho had &e entrepre- /{ffi;;;d ;-ao ottirua"r and adeptness at getting

l;Hl;5fffi-[..j':l[}-,:ilfnb,:fl :',,|il;ff,',r*a;;;,,",ou,",,rvereavaiiabrethe major carriers. Through private investors and an To try to gain market visibility and dntm up more

initial public offering of stock in June 1971, Muse passcngErs' southrvest decide{it had to do more than

raised $? million in nerv capital to purchase planes just run3gls-in the media: {ua-1 cc',o . - ^ r t - .

and equipment and provide cash for start-up. Boeing . Southrvest decided to have its flight hostesselh.- Py !ti:agreed to supply tluee nerv 737s from its inventory dress in colorful hot pants and rvhite lutee-high Lct'r'

discourting its price from 35 million to $4 million boots rvith high heels. Recruiting ads for South*

and financing 90 percent of the S 12 million deal4f ;- rvest's first group of hostesses rvere headlined

. ', Because the airline industry rvas in the throrilof -' 'Attention. Raquel Welch: You can have a job

*l lb a stump in the early l9?0s, Muie rvas able toF*it a if you measure up." Tivo thousand applicants

talenteilseniorstaffthatincludedanumberofveteran responded and those selected for interviervs

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Pa* 2 Cases in Crafting and Executing Strategy

were asked to come dressed in hot pan$ to sholvoff their lees-the eomDanv-,rvanted to hireIong-legged ieauties *itlr rfffi,llHghpersonali-ties. More than 30 of SoutfiffiIs first gradu-ating class of 40 flight attendants consisted ofyoung women rvho had been cheerleaders ormajoreftes in high school and thus had experi-ence performing in front of people rvhile skimp-ily dressed.

t I second attention-getting$qtio]nfwas to givepassengers free alcoholic t'e?erh'S during day-time flights. Most passen-gers on these flightsrvere business travelers. Management's thinkingrvas that many passengers did not drinlc duringthe daytime and that with most flights being lessthan an hour's duration it rvould be cheaper tosimply give the drinks arvay rather than collectthe money.

. Taking a cue from being based at Dallas's LoveFiel{ Southrvest began using the tag line "NorvThere's Somebody Else Up There Who LovesYou." The routes behveen Houston, Dallas,and San Antonio became knorvn as the LoveTriangle. Southrvest's planes were referred to as

l- ! r Love Birds, drinks became Love Potions, p€-e- fu nuts were called Love Bites. drink.orpon, fiere

Iove Stamps, and tickets rvere printed on LoveMachines. The "Love" campaign set the tone forSouthrvest's approach to its customers and com-pany efforts to malie flying Southwest an enjoy-able. fun, and differentiating experience- (Later,rvhen the company rvent public. it chose LUV as

its stock-hading symbol. ). tn order to -add'iirore flights rvithout buying

more pllrnes, the head of Southrvest's groundoperations came up rvith a plan for ground erervs

to off-load passengers and baggage, refuel the

. plane. clean the cabin and restock the galley, on-ioad passengers and baggage, do the necessarypreflight cheek and papenrork and push a*'ayfrom the gate in l0 minutes. The lO-minuteturu became one of Southrvest's signanrresduring the 1970s and I980s. ([n later years. as

passenger volunre grerv and many flights rvere

filled to capaciry. the turnaround time graduallyexpanded to 25 minutes-because it took moretime to unload and load a full plane rvith l25passengers, as cornpared to a half-full plane rvithjust 60-65 passengers. Even so. the ?5-minute

@ The MsGnui-Hill

Conpanies.20l0

average turnaror:nd time at Southrvest in 2002was still shorter than the 40- to 60-minute turn-around times typical at other major airlines.)In late November 1971, Lamar Muse came uprvith the idea of offering a $10 fare to passengers

on the Friday-night Houston-Dallas flight. Withno advertising, the I l2-seat flight sold out Thisled Muse to realize that Southrvest lvas servingtrvo quite distinct types of travelers in the GoldenTriangle market: (l) business travelers rvho rveremore time-sensitive than price-sensitive andrvanted rveekday flights at times suitable for con-ducting business and (2) price-sensitive leisuretravelers who rvanted lorver fares and had more

WXMtitV about rvhen to fly.s He came up wittr6-trf6-tier on-peak and o$peak pricing strueturein which all seats on rveekday fiights departingbefore 7:00 p.m. rvere priced at $26 and all seatson other flighs lvere priced at $13. Passengertraffic increased si gnificantly-and systemrvideon-peak and oflpeak pricing soon became stan-dard across the rvhole airline industry.

In 1972, the company decided io move its flightsin Houston from the newly opened HoustonIntercontinental Airport (rvhere it rvas losingmoney and rvhere it took 45 minutes to get todowntorvn) to the abandoned Houston HobbyAirport located much closer to dorvntourn Hous-ton. Despite being the only carrier to fly intoHouston Hobby. the results rvere speclgqglar-business travelers that flerv to HousfrGffitlyfrom Dallas and SanAntonio found the HoustonHobby location far more convenient and passen-ger traffic doubled almost immediately.

In early 1973. in an attempt to fill enrpty seatson its San Antonie-Dallas flights, Southtvestcut its regular $26 fare to $13 for all seats, alldays, and all times. When Braniff International.at that time one of Southrvest's major rivals,announced Sl3 fares of its orvn, Southrvestretaliated with a trvo-page ad rm in the Dal-tAs newspapers. headlined "Nobody Is Goingto Shoot Southwest Airlines Out of the Sky fora Lousy $13" and containing copy saying Bra-niff was tr-ving to run Southrvest out of busi-ness. The ad announced that Southrvest rvouldnot onty match Braniffi Sl3 fare but that itrvould also give passengers the choice of buy-ing a regular-priced ticket for $26 and receiving

I rnonpson-SrricHond-Gadtu I

Crafting and Erecuting

Strategp Conceps and

Crsls. r7th Edilion

Gase2*southwar, I gr.u

Airlines in 2fi1& Cultura,

Yalues. and Opcraring

Praclice!

C-10,1

Vat" t'*e

+;t;

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Eares. ITdt Edilion

Case 23: SouthrYrst

Airlines in 208: GulureValues, ard 0perating

Pradic;s

1 .,rCu"" 23 Southwest Airlines in 2008: Culture. Vatues, and Operating Practices C{05

V\'tt(-t )ra compfmentary fifth of Chivas Regal scotch, 123,000 possengen flew from Harlingen Airport inCrorffi-Royal Canadian lvhiskey. or Smimoff the Rio Grande Valley to Houston. Dallas, or Sanvodka (or, fornondrinkers, a leather ice bucket). Antonio: in the I I months following Southrvest's ini-Over 75 percent of Southrvest's Dallas*Houston tial flights,325,000 passengers flErv to the same threepassengers opted for the $26 fare, although the cities.percentage dropped as the hvo-month promo- /lt( Believing that Braniff and Texas lnternational

I f tion rvore on and corporate controllers began rvered_gliber:llqlyengagingintacticstoharassSouth-

, A.n"*:'l insisting that eompany employees use the $13 rvest's operations. Southrvest convinced the U.S. gov-6i{-fne local and national media plckqd- up e*nruni to irivestigate rvhat it considered predaiorythe story of Southrvest's offer. proclbfffnp'dre tactics by its ehief rivals. In February 1975, Braniffbattle as a David-versus-Goliat-E struggle in - and lbxas International were indicted by a federalrvhich the upstart Southr,vest did not stand much grand jury for conspiring to put Southrvest out ofof a chance against the much larger and rvell- business-a violation of the Sherman Antitmst Act.established Braniff; qasgggts sentiment in The two airlines pleaded "no contest" to the charges,Texas swung to Southw6lt's siiid @ o signed cease-and-desist agreements, and rvere fined

- .' vest reported its first-ever amrual proflrt in 1973.soumwest renorted its first-ever amrual nroflrt in 1973. a modest $100'000 each'

When Congress passed the Airline DeregulationAct in 1978, Southrvest applied to the Civil Aero-

Al]CmE LEGAL AND nautics Board (norv the Federal AviationAgency) to

ffi E G rr

'ArG HV * uE o u E s

*^1 " ll"'ff ih1ff&T,,lfJl ?liffi $,:HJ::;oficials and airlines operating out of Dallas-Fort

During the resr of the 1970s, southrvest found itsetf worth (DFw) o*''H:ffi*i|]':l*,||:oassengerk' ,'r . :,-r i- ^*^+L-- -^..-r or regar and regura_ fft#,fir:*ff*T?"X$"H:"#ffi nfi.u,emDroreo rn anorner ,"r"*";i'i:-J;i'#":Hil: traffic tq.b.e sipLfud ?$fl{'from DFW. The oppo-

*r-ur,ri*'d;; i"r"il;toutnrvestt retusal to nents solicited the aid of Fort worth coJ

move irs flighs rrorn Dauas Love Field. locatsd lnYl*1.9,:.:'L".lYj:*:I^*l-Y-t House

r0 minutes rrim dorvntown. our to the nervry opened :i[:'ffi[:'}ii$]:J?,",ij}i fi}ii:?,1trrl""JDallas*Fort worth Regional_A,irnort. w.trictr. ryls ;;j;";;r;;;ffi. d;#;;;ame to beiu mrnutes ffom oownlorvn uaras. Locar omlcrals and maneuvering ensued' what emerged c

rvere furious because trrey ,vere c;;i;g ; i;;; knon'n as the wright Amendment of 1979: no airline

rrom southrvesr's flights in and out orDFtu to herp ;TllJi:"J:?l"ilT:Hiilig,iliHf::::,f?;Iservice the debt on the bonds issued to finance theconstrudion of DFW. southrvest's posirion rvas Hill;'H*r*r,:":ffi-r:r;i:.T::llTjithat it rvas not required to reove because it had not I::.:i:.::.:^:r-*agreed to do so nor had it been ordered to do so by Southwest could not advertise' publish schedules or

the Texas Aeronautics commission-moreove( the fares' or check baggage for travel from Dallass Love

company's headquarters rvere located at Love Field. Field to any city it served outside Texas' Louisiana-' r "'r." ':-:*:*,1",:: ;-;:':-:**^,-' -::- ' '-'-' Arkansas. Gklahoma. and Nerv lvlexico'The courts eventually ruled that Southrvest's opera-

- tions could remain at Love Field. , h* qu{qT\dt ttw4l A second battle e_!!!ed rvhen rival airlines pro- ii*;* Ba'EEE*'s t# $ier:;iv:* $al**# '-: 0 ' y'

tested Southwest's apt-iication to begin serving s"u- * E:1I=ysis:y F;ls*r**lis,,f/.-;-;.4{rg?6€!SE$t:i4.r!Ga:+x-r...*ll^*)6-, eral snraller cities in Texas: their protest was based ":

on arguments that tlrcse markets ivere already rvell The legal, regulatory and competitive battles that,r.r"i and that Southu,est's entry rvould reiult in Southuest fought in its early years produced a strongcostly overcapacity. Southrvest countered that ils lou' esprit de corps among Southrvest personnel and afares rvould allorv more people to fly and grorv the drive to survive and prosper despite the odds. Withmarket. Again. Southu'est prevailed and its viervs newspaper and TV stories reporting Soutlrrvest's dif-about lorv fares expanding the market proved accu- ficulties regularly. employees unre fully arvare thatrate. In the year before Soutlrrvest initiated service, the airline's existence lvas constantly on tlre lir:e.

tlSr

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Had the company been forced to move from LoveFiel{ it rvould most likely have gone under, an out-come that employees, Southrvest's rivals, and localgovemment officials understood rvell. According toSouthrvest's president. Colleen Barrett. the obstaclesthrown in Southwest's path by competitors and localofficials rvere instrumental in building Herb Kelle-her's passion for Southrvest Airlines aud ingraining a

combative, can-do spirit into the corporate culture:

They rvould put trvelvc to fifteen larvyers on a caseand on our side there rvas Herb. They almost rvorehim to the ground. But the more arrogant they rvere,the more determined Herb got that this airline rvasgoing to go into the air*and stay there.

The rvarrior menulity, the very fight to survive.is truly rvhat crcatcd our culture.6

@ Ihe tricGrarv-Hill

Companies. Al0

since 1973*in an industry nored for its vulnerabil-ity to economic cycles and feast-or-famine proflrt-ability. During 1990-1994, rvhen rhe airline industryhad five straight money-losing years, laid off 120,000empiqrees. and lost a cumulative S13 billion, South-rvest earned a profit every quarter ofevery year.

Exhibit 3 provides a five-year sunlmary of South-rvest's financial and operating performance. Exhibits4 and 5 provide industry-ivide data on airline travelfor 1995-2008.

E-{EHB KELLEF{FR:COFOLjNDER CIF

SCUTE.$WEST AI\DLONGTituir cEoHerb Kelleher majored in philosophy at WesleyanUniversity in Middletorvn. Connecticut, graduatingrvith honors. He earned his larv degree at Nerv YorkUniversiry, again graduating rvith hopors and alsoserving as a member of the law revieu,. After gradu-ation, he clerked for a Nerv Jersey Supreme Courtjustice for nvo years and then joined a larv firm inNervark. Upon marrying a rvoman from Texas andbecoming enamored rvith Texas, he moved to SanAntonio-. rvhere he became a successfiil larvyerand came to represent Rollin King's small aviationcompany.

When Ke-lleher took on the role of Southrvest'sCEO in 1981,'he made a poirrt of visiting rvith main-tenance personnel to check on horv rvell the planes*ere running and talkiug rvith the flight artendants.Kelleher did not do much managing from his office.preferring instead to be out among the troops as muchas he could. His style was to listen and observe and toofffler encouragement. Kelleher attended most gradu-ation ceremonies of flight attendant classes, and heoften appeared to help load bags on Black Wednes-day, the busy travel day before Thanksgiving. Heknerv the names of thousands of Southrvest employ-ees and rv*s held in the highest regard by Southrvestemployees. Wherr he attended a Southrvest employeefunction. he rvas srvarmed like a celebrify.

Kelleher had an affiniry for bold-print Harvaiianshirts, oured a tricked-out motorcycle, aad made nosecret of his love for smoking cigarettes and drinkingWild TLrkey whiskey. He loved ro make jokes and

I Thomgson-Srhlbad..6aohle I

Crafting and Erecuting

Stralegy Coarepts aad

Cases. tTth Edilion

GaseZlsouthwesl I cu..Airlines io 20& Gulture.

Yoluas, and 0pemingPraclicEs

Th{E START OF T'HE F{EMB

KEL[.Eh{EH EMA

When Lamar Muse resigned in 1978. Southrvest'sboard wanted Herb Kelleher to take overas chairmanand CEO. But Kelleher eqjoyed practicing law andwhile he agreed to become chairman of the boar{he insisted.that someone else be CEO. Southnest'sboard appointed Horvard Putram, a group vicepresident of marketing services at United Airlines,as Southrvest's president and CEO in July 1978.Putnam asked Kelleher to become more invoh,ed inSouthrvestb day-today operations, and over the nextthree years, Kelleher got to know many of the com-pauy's personnel arrd iobserve them in action. Put-narn announced hii resignation in the fatl of l98lto beconre president and chief operatin_e officer atBraniff International. This time. Southrvestl boardsucceeded in persuading Kelleher to take on theadditional duties of CEO and president.

When Kelleher took over in 1981. Southrvest had27 planes. 5270 million in revenues. 2,100 empioy-ees. and 14 destination cities. Over the next 26 years,Southrvest Airlines prospered racking up many indus-try firsts and expanding into more geographic areas-see Exhibit 2. In 2008. Southrvest rvas the Iaryest U.S.conrmereial airline in terms of passengers flown andthe sixtb largest in terms of revenues. It had 2007revenues of $9.9 billion annually and 34,000 employ-ees. and its 527 jers flerv 3.400 flights to 64 eities in32 states. Southrvest had been profitable every year

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Itonqson-Suickland-Sarntte:

Gafting and BtecuingStrategy Corceps and

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Caso 2& Southwest

Airliaes in 2lll8: Culure,Values, and 0peratingPractices

Case 23 Southwest AirJines in 2008: Culture. Values, and Operating Practices

EXhihit 2 Malestones at Southwest Airlines, tgBS-2OOz

c{07

1S83

1984 1

1985,t';,.. . ..,. .,1

| .. :l l. ..11

1 386

1988: ,

1990

1992... :t'-

19S3

1 994

'1995

1996

Th19e ad<litignal Boeing 737s are purchased; Southwest flies more than 9.5 miltion passengers.

Southwest is ranked first in customer satr'sEction 'among lhe U.S. airlines for the fourlh straighi year. r . ,,

lervice bqqins to Sllouis and Chicago Midway airporE. Southwesinames'thd'Ronato tvt"ion.to ti,. ..HoUse as its ptimary charity*lhe tie-in was theresult of an effort by a Southwesl pilot who lost,r, .'i.i;i, ,ra daughter lo leukernia and who believed lhat Ronald McDonald Houses were a worthy way to,, ,. , .':.demonstratesouthwest'scommunityspiril . ..':,. 1.. . ...,,,. ,'i.. ...,Southwestfliesmorethanl3millionpassengers.. t

, , , l t .,' . ,. .," , , ,', ,,t

Southwest becomes the first U.S. airline to win lhe Tn'ple Ciown (best on-time record, fiwesi i"po*s'oi.mishandled baggagq and fewest complainls per 100p00 passengers) for a single monlh, , . ,, , .: . ,

Revenues reach 51 bitlion; Southwest was the only major U.S. airline to record both an operating pront l

andanetprofit. . . i:,,i ,, ,-, '

Southwest wins its first annualTriple Crown for best on-time record, best UaggagJ nindtinj, and teweitrcuslomer complaints; lor the second year running, Southwest was the only maior U.S. airline ls 19966l:r :

bothanoperatingprolitandanetprofit. : i:,::, j,i.,:.,:,, , ,',:Souihwest begins operations on the East Coast and wins its second annual trifte Crowni revenues , , ,,exceed 52 biltion and profits exceed $100 million. For the third consecutive year, Southwest is the only :, .

maiorU.S.airlinetorecordbolhanoperatingprofitandanetprofit. r ,.r ,,.,.,: .,., :: i : ', -r,iSoulhwest leads the industry by introducing ticketless travel in lour cities; Soulhwest wins iiS ftriiA mpfe

Ticketless travel becomes available systemwide; Southwest wins fourth consdcutive'Iiipte Ciown. : rl

Service to Flodda begins; Southwest wins fifth consecutive Triple Crown. Southwest and its employeescontribute almost $740,000 to help support Bonald McDonald Houses, including 534,000 in cashdonations from the company and S302,500 in free air travel lor families staying at Ronald McDonald

::$:: ffi',:ff"J:ily":,1'*[":il,more rhan 50 mirion peopre ry sourhwesr.Southwest is named by Fortune as the best company to work for in America,

:

Service is added to lhree more cilies. .

The number of passengers on Southwest flights exceeds 60 million. and revenues surpass the$5 billion mark; the company records ils 28th consecutive year of profitability and gth consecutive year ofincreased protits. Southwest becomes the 4th largest U.S. airline in lerms of passengers canied.Southwest is prolitable for the 30th consecutive year and the only U.S. airline to report a profit for 2001:a record &1.5 miltion passengers fly Southwest.Soulhwest ranks second among companies across all industry groupsr and lirst in the airliile industry onfurlune's 2002 list of America's most admired companies.Southwest becomes the 2nd largest U.S. airline in lerms of passengers canied. .r, r . . r :. ,

A record 96.3 million passengers fly Southwest. , ,

Southwest becomes the largest U.S. airline in terms of passengers carried and is profitable br the 35lhconsecutive year. Southwest Aitlines is named lo EusinessWeelCs lirst ever"Customer Service Champs'list and is voted "Overall Best Airline" in the United States by Frost & Sullivan's CEO Leadership Forum.

1997

1998

1999

2000

2005

2006

2007

2001

2002

. +G +\La.engage in franks and corporate antics. promptingsome people to refer to him as the 'tlorvn prince"of the airline indusqy. He once appeared at a com-pany gathering dressed in an Elvis costume and hadarm-rwestled a South Carolina company executive ata public event in Dallas for rights to use "Just PlaneSmart" as an advertising slogan.T Kelleher rvas uell-knorvn irrside and outside ths company for his com-bativeness, particularly rvhen it came to lreating back

competitorsdplpne occasion. he reportedly told agroup of yglbhi-ehrployees. "lfsomeone says they're

,uoing_to smack us in the fac+-knock them out,stonff them out. boot them in the ditch, cover themover, and move on to the next thing. That's the South-rvest spirit at rvork.'ts On another oicasion, he said. "Ilove battles. I think it's part of rhe Irish in me. lti likeufiat Patton said. 'War is hell and I love it so.'That'shorv I feel. I've never

-eotten tired of fighting."e

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Airliues in 2m& Cullure,

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@ Ihe MrGrarv-Hill

Companies. Zll0

Part 2 Cases in Crafting and E(ecuting Strategy

txhihit 3 Summary of Southwest Airlines' Financial and Operating Performance,2003-2007

Financial Data (S in millionsiexcept per'share'data)Operatingrevenues.t..,., .

Operalingexpensei , t

,

operatingincomer l..tl',. ,,, t

Other expenses (income) net . ,, : :

lnccima before taxes :, , i, .'Provision for income taxeC ,

' ' ',. .

NetlnCOmeir ,' :',' .,' : , ,,1 .., , ...,

lrlet income persharq bas'rc ,

Nei inCome per Shaie, diluted .' .

Cash dividends per common shareTotal assets at period-end ,. , , . ,, ,. ... ,

Long-term obligations at perio6endStockholders' equity at period-end

Operating Data :

Flevenue passengerscanied '. .

Flevenue passenger miles (RPMs)(000s)

Available seat miles (ASMs) (000s)

Load factor'Average length of passenger haul'

(miles)

Average airuraft stage length (miles)

tfips IownAveragepassengerfare ::

Passenger revenue yield per RPM

Operaling.revenueyield perASM , '

Operating expenses per ASMFuel costs per galton (average)

Fuel consumed, in gallons {millions)Full-time equivalent employees atyear-end

Size of fleet at year-endf

, ,. ' $9,861'' : 9,970

, ',',',.l 791

','.','--(3!2!l- 1,059,

'.'',.. , 4't3,'..:, S 645,:' S0.85.,.,, , .84

; 50.018

. , S16,772

' s2,oso$6,941

88,713,472

101,9'10,809

72,318,812

99,635,96772.6

.: 815

629

i,rso,osss106.60

13.080

I 9.90c9.100

sl.70

.: : 11489

34.378

$9,0868,15?

934144

790

,, 291

$ 499

s0.63.61

s0.018

s13,460s1,s67$6,449

83.814,82396,276,90767,691,289

92,663,02373.1

808

oez

1,092,331s104.40

12.980

9.81o

8.80as1.531,389

32,664

481

s7,5846,85q

725(54):

T7S

295,

9-194,s0.61 '

.60s0.018

s14,003s1,394s6,675

77,693.87588,379,90060,223,100

85,172,79570.7Tt5

6071.!028,639

" s93.68

12.0908.9008.056

s1.031,287

31,729

445

s6,5306,'r26

40165

339124

$5,937r5:5s8,

379

t22s)604232

520

s_319s0.27

. :.27$0.018

$11,137,

$1i700s5,527

I

70,902,rI381,066,03853,418,3s3

76,861,29669.5753

576981,591

s88.5711.760

8.50a7.970

s0.831,A01

31,01 'l

417

s 372

s0.48

:..46s0.018

s9,693s1,332ss,029

65,673,945

74,719,340

47,943,066

.71,790,425

66.8

730

' 558

949,882

s87.4211.97a

8.27a7.74a

s0.721,143

32,447

388

t& )i

'Bevenue passenger miles divided by available seat miles.

tlncludes leased aircrattSourDe.' 2007 lO.K report.

While Southwest was deliberately combativeand fl3rnlggurt in some aspeets o[ its operations,rvhen it came to the financial side of the businessKelleher insisted on ftscal conservatism, a sEongbalance sheet, comparatively lolv levels of debt, and

4;#,,4zeatqris attention to bottom-line profitabiliry. WhileSEii-ti.uin-* strongly in being prepared for adversity,Kelleher lrad an aversion to Southrvest personnelspending time drarving up all kinds of formal strate-gic plans; he once said "Reality is chaotic; planning

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Ihompson-$lricltand..0mhle:

Cnfiing aod Exuculing

stralcas concspls aIdCases. t?rh Editiot

Case 2X Soulhwest

Airlines ia 21tr& Culture.

Values, and 0gerating

PraBtices

Gase 23 Southwest Airlines in 20OBr Culture. Values, and Operating Practices

Exhihit 4 Selected Operating and Financial Data for Major U.S. Airline Garriers, 199$-FirstQuarter 2008

Passengirs (in mitiitins;''' : rr:''

Fiignis (in thousands): :: " ' ': :

Revenue passenger miles 1in : :

billions)' ' :

Availabld seat mites (in billicns)' : 807.1 987.9 1,016.4 ' 1,006.3

Load hctor' : - : 67.0 72.3 77.5'. 79.2

Passenger revenues (in millions) " S69,470 S93,622 S93,500 ' $1 01 ,419

Average domestic fare (4lh quarler) S 288 S 340 $ 315 S 918Operating profit (loss) (in mlllions) S 5,852 S 6,999 $ 427' S 7,514'

Net prolit (loss) (in millions) S 2,283 S 2,486 ($ 5,782)' S 3,'t26

Fuelcost(inmitlions) :: S9,696 S16,447 S33,15O $38,548Totaf employees :' '. 546,987 679,967 562,467 545.695

666.2 738.3 . 744.2 ::: i; 799.a , : :'t81.1

9,035.0 11,558-0 . '11.2M.0: , 11,365.0 2,529.7

692.8 7?g;,.6 ' 796.8 "' 829.0 '190.3

i r,,: 1,b3i.6...,,, Z.qi.i

:..,, ,, 79.9 . ' 77.2.'' $107i01J :.' 525,527

-'S '33J'.,, n.a.'' S 9,210 ': n.a'

':t s 4,gg8. ":l' ' nla.: s 41,580 $12,824

,' ' SSO,gOT n.a:

559.0

8,062.0603-4

Sources: AirTransport Associalion, 2008 Economic Report, p.T: Air Transport Association, 2005 Economic Repofi, p. 7: and U.S.

Department ol Transporlation, Bureau of Transporiation Stalislics, aidine tralRc data press releases, \rarious years.

is ordered and togicat. Th, **iJ[["s ni]-fJt#'that goes on in most strategiE pliilnlng p]oG$escreBtes a mental straitjacket that becomes disablingin an industry rvhere things change radically fromone day to the next." Kelleher u'anted Southrvest

managers to think ahead have contingency plans,

and be ready to act s,hen it appeared that the futureheld signifieant risks or rvhen nerv conditions sud-denly appeared and demanded prompt responses.

Kelleher ivas a strong believer in the principlethat employees-not customers-came first:

You have to treat your employces like your custom-ers. When you treat them right, thcn thcy rvill treat

your outside customcrs right. That has bcen a veryporverful compctitive weapon for us. You'vc got totake the time to listcn to people's ideas. If you just tellsomebody no. that's an act of pouer and in my opin- -L!*6eion. an abuse of porver. You don't \Yant to cortllEqiq -'people in their thinking,lo

Another indication of the importance that Kelleher /placed on ernployees was the message he had pen:redv'3in 1990 that ivaiprominently displayed in ttre166$of Southrvesti headquarters in Dallas:

The people of Southrvest Airlines arc "the cre-ators" of rvhat rve have becomc-and of rvlrat rve

rvill bc.

Exhihit 5 Operating Revenues of Selected U.S. Airlines, 2000-2007 ($ in billions)

American

United,DellaContinental

Norlhwest

US Airways

SouthwestAmerica West

s22.920.1

19.2

14.2

't2.5

11.7

9.9

s22.51S.3

17.513,1

12.6

11.6

,',

s20.617.3

16.5

1 1.1

12.3

7.27.63.4

sI8.615.7

15.2

9.9

11.3

7.1

6.5

2.5

s17.413.414.9

7.310.1

6.8.5.9 '

2.2'

s15.913.9

12.4

7.49.26.9

5.5

2.0

s15.6 518.1

16.1 19.3't3..2 15.3 '

8.2 9.4

9.6 11.0

8.3 9.2

5.6 5.7

2.0 2-3

'Merged \reith US Aiuays in 2O05; revenues included in US Aimays lo12006 and2007.Souries: Bureau olTransporlatron Slatistics, Air Canier Financiat Re@rts, Schedule P-12 and company annual reporls for 2007.

-:E

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I fiompsoo-suicktand-Garrtle: I

Cralting and Executing

Slrateg$ Concepts atdGases. ITth Edition

Casa 23: Southwtsr I c".uAirlirras in 20(k Gultun,

Values. and 0perating

Pnctises

@Ihe McGaw-Hill

Cornpanies. 2tll0

Lh1

c{t0 Part 2 Cases in Crafting and Executing Strategy

Our people transformed an idca into a legend.That lcgend rvill continue to gro\v only so long as

it is nourishcd*by our peoglci indomitable spirit.bouodlcss cncrgy, immcfiSf !*oodivill, and buraingdcsire to excel.

Our thanks-and our love-to the people ofSouthrvest Airlines for creating a marvelous familyand a wondrous airline.

ln June 2001. Herb Kelleher stepped doryn as

CEO but continued on in his role as chairman ofSouthrvestl board of directors and the head of theboard's executive committee; as chairman, he playeda lead role in Southrvesti sbategy, expansion to nervcities and'aircraft scheduling, and governmental andindustry affairs. tn May 2008, after more tban 40 yearsof leadership at Southwest. Kelleher retired as chair-man of the board ftut he rvas scheduled to remain a

full-time Southrvest employee until July 2013).

NE\fld EiTECUTIVELEADEHSF{[P ATSGUTEdWilST: 2001-2S08In June 2001. Southrvest Airlines, responding toanxious investor concerns about the company's lead-enffiuccession plans, began an ordeily transferof porver and responsibilities from Herb Kelleher.age 70, to nvo of his most trusted protdges.(an-E$!,

@54. Southrvest's general counsel anAEn-e ofKelleher's most trusted prot6ges. succeeded Kelleheras South Another of Kelleher's trustedprot€gds.Colleen Southrvestt executivevice president-cust,onrers and self-described keeperof Southrvest's pgp-14lly corporate culture. becamepresident and chief operating officer.

{i!:!sf..+ fIj+rri!e:/" i:-d,*{ 'iigIHii ! -rjiRsir!.i{E{}!,U+ Y",sif'HSJ; tilEj, -{tiJ i *{$ji,Is*cD^4 .!i"

James Parlier's alisciifion u'ith Herb Ketleher rventback 23 y"ors. toGffii en they rvere colleaguesat l(elleher's old larv firm. Parker moved over toSouthrvest from the law firm in February 1986. Park-er's profile inside the company as Southrvest's vicepresident and general counsel had been relativelylorv, but he rvas Southrvest's chief labor negotiatorand muclt of the credit for Southrvest's good rela-tions rvith employee unions belonged to Parker. Prior

to his appointnent as CEO, Parker had been a mem-ber of the company's executive planning committee:his experiences ranged from properties aqdltacilities,to technical services to the companyt anlf,f,tE3ffiivendors and partrers. Parker and Kelleher rvere saidto thinli much 1!p, and Parker was regarded as hav-ing a good sense ofJrugror, although he did not haveascolorfu landfl ff.f Sofr?ffi -nersonolitvasKelleher.parker was seen *Ei8n&t-T$&rieht;r,-oru kind ofperson rvho liad a st.ongJffiP SlbJuthrvest's cultureand market niche and rvho could be niee or tough.depending on the situation. When his appointrnentwas announced Parker said: f ,hit *1"

There is going to be ao change of course insofar"asSouthrvest is coneerned. We have a very ex!ffiEdleadership team. We've all rvorNed together for a longtime. There rvill be evduliqlfary changcs in South-rvest, just as there have ahmys bccn in our history.Wc're going to s{ay true to our busincss model ofbeing a low-cost. lorv-fare airline.ll

Parker retired unexpectedly. for personal reasons, inJuly 2004, stepping doryp qsEEO and vice chairman ofthe board and also rgffiffihom the conrpany's boardof directors. He was succeeded by Gary C. Kelly.

fi . E E***E **n**ffii***u'upiFsaE #r3.:if -'44!$g $ ::ii iliif i,{i ? L_&3#u:!sa! k&$V [ tuGBg!

Colleen Barrett began rvorking as Herb Kelleherslegal secretary in 1967 and had been with Southrvestsince 1978. As executive vice president-€ustomers,Barrett had a higtr profile omong Southwest employ-ees and spent most of her time on culture building.rnorale building, and customer service; her goal rvasto ensure tbat employees felt good about rvhat theyrvere doing and felt emporvered to sene the cause ofSouthu'est Airlines. 11 Slre and Kelleher rvere regardedas Southrvest's guidins liclilh and some anaivsrs saidshe rvas essentiotty nffiffias the company's chiefopemting officer pri6 to hir formal appointrnentas president- Much of the credit for the companyistrong record of customer service and is strong-culture rvork climate belonged to Barrett. \

Barett had been the driving force behind lining, ,w

the halhvays at Southrvestt headquarters rvith photoiofcompany events and trying to create a family atmo-sphere at the company. Believing it rvas importantto make employees feel cared about and irnportant.Barrett had put together a nefivork ofcontacts across

,:rlr ^iy"iq0

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IhoEpson-Sttictlod-Earnlh:

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Stale0F Concests and

Cases, lTth Edhion

the cornpany to help her stay in touch with tvhat washappening rvith employees and their families. Whenneftvork members learned about ev€nts that rverervorthy of acknorvledgment. the rvord quickly got toBarrett*the information rvent into a database andan appropriate greeting card or gift was sent. Barretthad a remarkable ability to give gifu that rvere indi-vidualized and connected her to the recipient.13

Barrett rvas the first rvoman appointed as presi-dent and chief operating officer of a major U.S. air-line. In October 2001, .Forrrure included Barrett onis list of the 50 most porverful rvomen in Americanbusiness (she rvas ranked number 20). Barrett retiredas Southrvest's president in July 2008 but rvas sched-uled to remain as a full+ime Southrvest employeeuntil20l3.

$*r"g *. H*EEy: S*a;thru*sE's $$$.r.-,sliririsi, {4.q6sint4:Y

{-e.}a*ry*!-i $*$}[iL

Gary Kelly rvas appointed vice chairman of theboard of directors and CEO of Souihrvest effectiveJuly 15, 2004. Prior to that time, Kelly rvas executivevice president and chief financial officer from 2001to 2004, and vice president-finance and chief finan-cial officer from 1989 to 2001. Hejoined Southrvestin 1986 as its controller. tn 2008, effective with theretirement ofKelleherand Barrett. Kelly assumed thetitles of chairman of the boar4 CEO. and president.

When he ',vas named CEO in 2004. HerbKelleher said:

Cary Kelly is one ofour brightest stars. rvell respectedthroughout the industry and rvcll knorvn. over morethan a decade, to the media. analyst. and inves-tor conrmunities lor his excellcncc. As part of ourBoardi succession planning. rve had alrcady focusedon Cary as Jim Parker's successor. and that processlras simply been accelcrated by Jimi personal dcci-sion to retire. UnderGaryk leadership, Southrvcst hasachieved the strongest balance sheet in the Americanairline industry: thc best fucl hedging posirion in ourindustry: and trcmcndous progress in tcchnology.l{

During his tenure as CEO. Kelly had rvorked rvithother top-level Southu.est executives to sharpen andfine-tune Southrrest's strategy in a nurnber of areas.continued to expand operations (adding both moreflights and initiating sen'ice to new airports). andstrived to maintain the companyi lorv-cost advan-tage over its domestic rivals.

Gase 23: $outhwest

Airlincs in 2lll8: Gulture.

Ualues. and 0peradng

Praclicrs

Case 23 Southwest Airlines in 2OO8: Culture, Values, and Operating practices c-fit

Kelly sarv four factors as keys to Southwest'srecipe for success:

. Hire great people, treat'em like family.

. Care for our Customers warmly and personally,like they're guests in our home.

. Keep fares and operating costs lower than any-body else by being safe, efficient, and opera-tionally excellent.

. Stay prepared for bad times rvith a strong balancesheet, lots of cash, and a stout fuel hedge.15

To help Southrvest be a standout performer on thesefour key success factors, Kelly had established fivestrategic objectives;

. Be the best place to rvork.

. Be the safest. most efficient, and most reliableairline in the rvorld.

. OfferCustomers a convenient flight schedule rvithlots of flights to lots ofplaces they want to go.

. Offer Customers the best overall havelexperience.

. Do all of these things in a rvay that main[ainsa lorv cost structure and the abiliry to offer lowfares.l6

SOUTF{fuVEST,AI H LI N ES'

STMATEGY

From day one, Southrvest had pursued a lorv.cost/lorv-price/no-frills strategy. Its signarure low faresmade air travel affordable to a rvide segment of theU.S. population-giving substance to the compa-ny's tag line "The Freedom to Fly." It employed arelatively simple fare structure featuring lorv, unre-stricted. unlimited everyday coach fares, as rvellas even lou,er fares available on a restricted basis.All of Southrvest's different fare options could eas-ily be perused at the company's Web site, and thecompanyi restrictions on tickets were more lenientthan those of its rivals. In 2008. ils highest oDe-wayunrestricted rvalkup fare rvas $399 (a fare chargedfor is longest nights): substantially loter fares rvereavailable for short- and medium-distance flights.Many flights had some seats available at deeplydiscounted fares, provided they rvere purchasedvia the companyt Web site. In November 2007,

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I rtorEsor-suickland-Sar&la: I

Grdltin0 and ErecfiingSrategp Concepu and

Casos. lTth Edilion

case2Ssouthwesr i cr..Airlires in ?lIE Culture,

Value+ and 0pera!inB

Practicas

@ The McGrav*Hill

Ccmpanigs.28 l0

-.::t*,,ii!,j

lil;.i:'.i:

j:il,

.,:;!

iii

c-{t2 Part 2 Cases in Crafting and Executing Strategy

Southrvest introduced a nelv Business Select fare toattact economy-minded business travelers; Busi-ness Select customers had early boarding privileges.received extra Repid Rewards (frequent-flyer cred-is), and a free cocktail. In 2008, rvhen rival airlinesinstituted a series of add-on fees-including a fuelsurcharge for each flight. fres for checking bags.

fees for processing frequent-flyer travel alvards, fees

for buying a ticket in person at the airport. and fees

for in-flight beverages-in order to cover skyrocket-ing costs for jet fuel (rvhich had climbed from about

l5 percent ofoperating expenses in 2000 to 40 per-cent of operating expenses in mid-2008), Southrvestchose to forgo i Ia carte pricing and stuck rvith an

all-inclusive fare price.From time to time, Southrvest ran special fare

promotions. To celebrate its 30th anniversary in 2001,Southrest aunounced special S30 one-way fares to30 destinations &om 35 cities fora four-month trav€lperiod; its car rental and hotel partners participatedin the promotion, offering $3O-per-day rentals, S30-

off discounts. and $30-per-day hotel rooms at some

locatious. The 30-year celebration also included dec-orations in gate areas, prize givearvays, and employ-ees playing games in the gate areas so that customerscould share in the "Southlvest Spirit."

Southlvest rvas a shrervd practitioner of the con-cept of price elasticity, proving in one market afteranother that the revenue gains from increased ticketsales and the volume ofpassengertraffic rvould morethan compensate for the revenue erosion associatedrvith lorv fares. When Southrvest entered the Floridamarket u,ith an introductory $l7 fare fromTampa toFort Lauderdale. the mrmber of annual passengers

flying the -Tampa-Fort Lauderdale route jumped

50 percent. to more than 330.000. In Manchester. NervHampshire. passenger counts rvent from l.l millionin 1997. the year prior to Southrvesti entry, to 3.5

nrillion in 2000 and average one-'rvay fares droppedfrom just over $300 to $129. Southrvest's success

in stimulating higher passenger traffic at airportsacross the United States via lorv fares and frequentflights had been dubbed the "southwest effect" bypersonnel at the U.S. Deparunent of Transportation.Exhibit 6 shorvs the cities and airports Southuestsened in mid-2008; Southrvest.had sizable marketshares at &e five airpor* rvhere its passenger countsrvere highest: Oakland (65 percent). Baitimore (55 per-eent). Las Vegas (38 percent). Phoenix (31 percent),and Chicago Midrvay (18 percent).

Unlike the hub-and-spoke route systems of rivalairlines (where operations were concentrated at a lim-ited number of hub cities and most destinations lvereserved via connections through the hub), Southrvest'sroute system had been carefully designed to concen-trate on flights behveen pairs ofcities 150 to 700 milesapart rvhere there was enough passenger traflrc thatSouthuest could offer a sizable number of daily fl ights.As a general rule, Southrvest did not initiate service toan airport unless it envisioned the potential for orig-inating at least I flights a day there and sarv oppor-nrnities to add more flights over time-in Denver,for example, Southwest had boosted the number ofdaily deparnres from 13 in January 2006 (the monthin rvhich service to and from Denver was initiated)to 79 in May 2008. Southrvest's point-to-point routesystem minimized connections.. delays. and total triptime-its enrphasis on nonstop flights benveen about410 pain of cities in 2008 allolved about 75 percent ofSouthrvestl passengers to fly nonstop to their destina-tion. While a rnajority of Southrvest's flights involvedactual in-air flight times of less than 90 minutes. inrecent years the company had added a significantnumber ofnonstop flights to more distant destinationsat those airports x,here its classic lorv lares could gen-erate profitable amounls of passenger raffic.

Southrvestt frequent-flyer prograrn! Rapid Re-rvards. rvas based on trips florvn rather than mileage.Rapid Rervards customers receirad one credit for eachone-\\,ay trip or trvo credits for each round-trip florvnand could also earn credis by using the services ofSouthrvest's car"rental, hotel, and credit card partners.There u,ere nvo types of travel arvards: (l) one freeround-trip after the accumulation of l6 credits lvithin24 months and (2) a companion pass for travelersrvho accumulated 100 credits rvithin a l2-monthperiod-the companion pass was for unlimited freeround-trip travel. provided the Rapid Rervards mem-ber purchased a ticket or used a free alrard ticket andttre companion Rapid Rervards nrember flerv on thesame flight. Arvard tickets $,ere automatically gener-ated rvhen earned. valid for l2 months after issuance,and subject to a limited number of blacliout datesaround major holidays. Rapid Rewards menrbers rvhoflerv 32 quali$ing flights rvithin a l2-nronth periodreceived priority boarding privileges for a year. In2007. Southuest customers redeemed approximately2.8 million au'ard tickets and flights on companionpasses. accounting for about 6.2 percent ofthe pas-sengers on Southu,est flights.

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I honpson-sticklarrd-Gamtt* I

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Sases' tlrh [dition

Case8:Southwest I crr.Airlines in flIE: GulEre,

Yalues. and 0perrtingPraaices

I @ Tne rvlcG.a.r.itilt

Companies. ?010

l@h

Case 23 Southwest Aidines in 2008: Culture, Values. and Operating Practices

Exhibit E Airports and Cities Served'by Southwest Airlines, May 2008

c*il3

LasVegas. Chicago Midway . ,

, Phoenix' :.. _': " .,,.Baltimore/lrA/ashlngton

Oakland .

. Hauslon Hobby, ,

Dallas ([ove Field] .

Los Angeles : : .. .,. .,

Orlando ,: ., . ,, ,

SanDiego , ''

24o.,..

A5,,..198

166

134145, ,,'140

12?. .

112108

," 55,,. ..:.,. 47: I ::'

:.: . 43.,'. .

38. "'21 .

29, 16 r,. 19,',, 37 .,,, t

19

21.

29242613

17

14

11

14

10

r Albany' Albuquerque

Amarillo

Austin ' .

Birmingham

Boise

Buffalo

Burbank

Cleveland

Columbus,0HCorpus Christi

. Denver

Detroit Metro

El Pasq;1 :

Fort Lauderdalb

Fort Myers/Naples'Harlingen/South Padre lsland

Hartford/Springfield

lndianapolis

Long lsland/lslipJackson, MS

Jacksonville

Kansas CityLittle Bock '.

Louiwille.'Lubbock, i

Manchester, NH .,Midland/Odessa -

New Orteans

Norfolk

Oklahoma City0mahaOntariq CA

Orange Counry CA

Philadelphia

Pittsburgh

Portland 0BProvidence

Baleigh-Durham

Reno/fahoe .., .:Sacramento ....,. l

St. Lou'B

Salt Lake City

San Antonio : .-San JoseSeattleSpokane

Tampa

TucsonL.IUts Washington, DC (Dulles)

West Palm Beach

Source.' Soulhwest Aitli*es,

*aa-pt*r**r Se*'wis* *fi si SaEst#$$#e'

SeEEefs*'*s*st

Southrvest's approach to delivering good customerservice and creating customer satisfaction waspredicated on presenting a happy face to passengers.

displaying a fun-loving attitude. and doing things ina manner calculated to malie sure passengers had

a positive flying experience. The company made a

special effort to employ gate personnel rvho enjoyedinteracting rvith customers, had good interpersonalskills, and displayed cheery outgoing personalities.A nunrber ofSouthrvesti gate personnel let their s,itand sense of humor shon'by sometimes entertainingthose in the gate area with trivia questions or contests

such as *Who has the biggest hole in their sock?"

Apart from greeting passengers corning onto planesand assisting them in finding open seats and stow-ing baggage, flight auendants were encouraged to be

engaging. converse andjoke rvith passengers, and go

about their task in s,ays that made passengers smile.On some flights, attendants sang announcements topassengers on takeoff and landing. On one flightrvhile passenBers were boarding, an attendant rvithbunny ears popped out ofan overhead bin exclaim-ing "Surprise!" The repertoires used to amuse pas-

sengers varied from fliglrt crerv to fli-eht crerv.

Both Herb Kelleher and Colleen Barrett had made

a point of sending eongratulatory notes to employeesrvlrcn the company received letters from custom-ers complimeniing particular Southsest employees;complaint letters rvere see[ as learning opportunities

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C*ll{ Part 2 Cases in Crafting and Executing Strategy

for employees and reasons to considermaking adjust-ments. Barrett provided the follorving policy guide-lines to employees regarding holv far to go in tryingto please customers:

No Employce rvill ever be punished for using goodjudgment and good old common sense rvhen tryingto accommodate a Customer*no matter rvhat ourrules arc.l7

When you empolver People to make a positivedifference cvery day, you allorv them to decide- Mostguidelines are written to be broken as long as theEmployee is leaning torvard the Customer. We fol-lorv the Colden Rule and try to do the right thing andthink about our Customer.ls

Southwest executives believed that conveying afriendly. fun-loving spirit to customers rvas the keyto competitive advantage. As one Southrvest man-ager put it, "Our fares can be matched: our airplanesand routes can be copied. But rve pride ourselveson our customer service."le The company's missionstatement, revised in 2008. highlighted its customerservice comrnitment:

The mission of SouthrvestAirlines is dedicarion to thchighest quality of Customer Service delivered rvith a

sense of rvarmth. friendliness, individual pride. andCompany Spirit.

In 2007. Southwest did an "extreme gate makeover"to improve the airport experience of customers. Themakeover included adding (l) a business-focusedarea rvith padded seats. tables rvith power outlets,power stations rvith stools, and a flahscreen firvith neu,s programming and (2) a family-focusedarea rvith smaller tablbs and chairs, power stationsfor clrargingelectfrcal devices, and kii-friendly pro-gramming on o flat screen TV

l;tmrks;'it* iT -+] \: si Fr'* llt ttt} exSouthuest was continually on the lookout for novelrvays to tell its story make its distinctive personacome alive. and strike a chord ia the minds of airtrarelers. Many of its print ads and billboards u'eredeliberately unconventional and attention-getting soas to create and reinforce the company's maverick.fun-loving, and combative image. Some previouscampaigns had included such tag lines as "?'/re Lor\,-Fare Airline" and "Tlre All-Tirne On-Time Airline":others touted the company's Triple Crorvn arvards.

II o tne Mccow-xitl

ConPanies.20l0

One of the companyl billboard campaigrrs promotedthe frequency of the company's flights rvith suchphrases as "Austin Auften," "Phoenix Phrequently."and "L.A. A.S.A.P." Each holiday season since 1985Southrvest had run a "Christmas card" ad on TV fea-turing children and their families from the RonaldMcDonald Houses and Southrvest employees. Freshadvertising campaigns rvere launched periodically-Exhibit 7 shorvs four representative ads.

ln 2002, Soutlnvest began changing the look ofits planes, updating its somervhat drab gold/orangeired scherne to a much fresher and brighter canyonblue/red/gold/orange scheme-see Exhibit 8.

#em*a' Str*tcg'g *5*egecslEe

Southrvest's suategy included several other elements:

. Grudual expansiott into netv geographic markets*Southwest generally added one or two newcities to its route schedule annually, preferringto saturate the market for daily flights ro the cit-iesiairports it currently berved before enteringnerv markets. In selecting nerv cities. Southrvestlooked for city pairs that could generare substan-tial amouuts of both business and leisure traftic.Management believed that haviug numerousflights flying the same routes appealed to busi-ness travelers looking for convenient flighttimes and the ability to carch anorher flight ifthey unexpectedly ran late.

. Adding flighls in arcas *tterc riyals y'ete cril-ting backserlice-Wl'len rivals cut back flighrsto cities that Southrvest served Southrrcst oftenmoved in rvith more flights of its orvn. believ-ing its lou,er fares rvould attract more passen-gers. When Midrvay Airlines ceased operationsin November 1990, Southrvest moved in over-night and quickly institured fli_ehts to ChicagoiMidrvay Airport. Southnest rvas a first-mover inadding flights on routes rvhere rivals had cut theirofferings follorving the September I l, 2001, ter-rorist attacks. When American Airlines closedits hubs in Nashville and San Jose, Southn'estimmediately increased the number of its flightsinto and out of both locations. When US Ainvaystrimmed its flight schedule for philadelphia andPitlsburgh. Southrvest promptly boosted irsflights into and out of those airports, Southrvestinitiated sen'ice to Denver rvhen United. beset

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Exhihit 7 Four Sarnples of Southwest's Ads

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parts inventories, simplify the training of main-tenance and repair personnel, improve ttre pro-ficiency and speed rvith which maintenanceroutines could be done. and simplifo the task ofscheduling planes for particular fl ights. Further-more. as the launch custbmer for Boeing's 737-300, 737-500, and 737*700 models. Southrvestacquired its new aircraft at favorable prices.See Exhibit 9 for statistics on Southrvestt air-craFr fleet.

Southrvest rvas the first major airline to intro-duce ticketless travel (eliminating the need toprint and process paper tickets) and also theFirst to allorv customers to make reservationsand purc[ase tickets at the company's Web site(thus byphssing the need to pay cornmissions totravel agents for handling the ticketing process

and reducing staffrng requirements at South-rvest's reservation centers). Selling a ticket onits Web site cost Southrvest roughly S1, versus

S3-$4 for a ticket booked through its orvn inter-nal reservation systern and as much as $15 fortickets lor business travelers purchased tluotrghtravel agents and professional business travelpaflners. Ticketless travel accounted flor morethan 95 percent ofall sales in 2007, and nearly74 percent ofSouthrvesti revenues \vere gener-ated through sales at irs Web site.

The company de-emphasized flights to congestedairports. stressing instead serving airports nearmajor metropolitan areas and in mediunr-sizedcities. This helped produce better-than-averageon-time performance and reduce the fuel costs

c{16

Old ColorScheme(plane without winglets)

n ith financial difficulties, cut back operationsat its big Denver hub.

, Curtailitrg fiights on nrurginally ptofitubleroules whete numerous seats o-ften went n{illedand shiftirtg planes to toutes with good gmlntth

opporltmities-tr4anagement was aftracted tothis strategy element because it enabled South-west to grorv revenues and profits rvithout har.ing to add so many nerv planes to its fleet.

. Prtrrrg sttottg enrphasis on sa.fery*, high-qaali4'ilruiiltenance, and rcliable operutiotts.

Southrvest management believed the company'slorv-fare srategy, coupled rvith frequent flightsand friendly service, delivered "more value for less

money'" to customers rather than "less value for less

money." Kelleher said "Everybody values a verygood service proSidedr'at a very reasonabte price."30

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Southrvest management fulIy understood that lor.v

fares necessitated zealous pursuit of lorv operatingcosts and had over the years, instiruted a numberof practices to keep its costs belorv those of rival

]"t"ff. *r,oany operated only one type of aircraft-the Boeing 737-to mininrize the size of spare

Part 2 Cases in Crafting and Executing Strategy

Ixhibit I Southwest's New Look and Aircraft Equipped with Winglets

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Itonpsoo-Sthtlaod-Gambtel

Gralting and Exocuring

Slrategy Concepts and

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Ixhibit I Southwest's Aircraft Fleet as ofMay 2008

CasE2l SoutwestAirliras in 2Gl8: Culure,

Values, and 0perating

Practicos

Case 23 Southwest Aidines in 2008: Culture. Values, and Operating practices

Boeing 737-300Boeing 737--500;

Boeing 737-700

Average age of aircraft lleet --close io 9 years i' .1

Average aircraft trip length-{3l miles and an averageduration of t hour and 51 minutes

Average aircraft utilization in 2008-:-7 llighti per dayand about 13 hours of tlight iime.

.

Fleet iizF1990: 106, 1995; 224,2AAO:344, 2008: 527Firm orders for new aircraft-ZQ08: 29, 2009:20, 2010:

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'ln each case, SoulhwEst was Boeing's lau.ch customer forthis model.

associated rvith planes sitting in line on crorvdedtaxirvays or circling airports waiting for clear-ance to land; in addition, it allorved the com-pany to avoid paying the higher landing fees andterminal gate costs at such high+raffic airportsas Atlanta's Hartsfield International. Chicago'sO'Hare, and Dallas-Fort Worth (DFW) wherelanding slots rvere controlled and rationed tothose airlines rvilling to pay the high fees. lnseveral cases, Southwest was able to compet€on the perimeters of several big metropolitanareas by flying into nearby airparts with less

congested air space. For example. Southrvestdrerv some Boston-area passengers arvay fromBostonl Logan International by initiating ser-vice into nearby Providence, Rhode Island andManchester, Nerv Hampshire. Southrvest's pref-erence for less congested airports also helpedminimize total travel time for passengers*driving to the airport. parking. ticketing, board-ing. and flight time.

. Southrvest's point-to-point scheduling of flightslvas more cost-efficient than the hub-and-spokesystems used by rival airlines. Hub-and-spokesystems involved passengers on many differ-ent fiights coming in from spoke locations (orperhaps another hub) to a central airport or hub*'ithin a short span of time and then connecting

to an outgoing flight to their destination (a spokelocation or another hub). Most flights arrivedand departed a hub across a hvo-hour rvindorv,creating big peak-valley swings in airport per-sonnel rvorktoads and gate utilization-airportpersonnel and gate areas were very busy whenhub operations were in full su'ing and then rvereunderutilized in the interval awaiting the nextround of inbound/outbound flights. In contrast.Southrvestt point-to-point routes permittedscheduling aircraft so as to minimize the timeaircraft were at the gate, currently approximately25 minutes, thereby reducing the number of air-craft and gate facilities that would othenvise berequired. Furthermore, with a relatively evenflorv of incoming/outgoing flighs and gate traf-fic, Southrvest could staffits terminal operationsto handle a fairly steady rvorkload across a day.rvhereas hub-'and-spoke operators had to stafftheir operations to serve three or four daily pealrperiods.

. To economize on the amount of time it took ter-minal personnel to check passengers in and tosimplify the rvhole task of making reservations,Southrvest dispensed rvith the practice of assign-ing each passenger a reserved seet, lnstea{ formany years, passengers rvere given color-codedplastic cards with thd letters A, B, or C Mrenthey ehecked in at the boarding gate. Passen,eersthen boarded in groups, according to the color/Ietter on their card sitting in rvhatever seat rvas

open rvhen they got on the plane-a proceduredescribed by some as a'tattle call." Passengersrvho rvere particular about rvhere they sat had toarrive at tha gate early to get boarding cards andthen had to make sure to be up front u,lren it rvastheir group's turn to board. ln 2002, Southrvestabandoned the use of plastic cards and beganprinting a big. bold A. B, or C on the boardingpass rvhen the passenger checked in at the ticketcounter; passengers then boarded in groupsaccording to the lerter on their boarding pass.in 2007-2008. in order to significantly reducethe time that passengers spent standing in linervaiting for their group to board Southrvestintroduced an enharced boarding method thatautomatically assigned each passenger a spe-cific number rvithin tlre passenger's boardinggroup at the time of checlc-in; passengers thenboarded the aircraft in that numerical order. All

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c{18 Part 2 Cases in Crafting and Executing Strategy

passengers could check in online up to 24 hoursbefore departure time and print out a boardingpass, thus bypassing counter checlpin (unlessthey wished to check baggage).

. Southrvest flight attendants were responsible forcleaning up trash left by deplaning passengersand otherwise getting the plane presentable forpassengers to board for the next flight. (Untilrecently, other carriers had cleaning cretvs comeon board to perform this function; however.recurring losses at many airlines in 2001-2005forced stringent cost-cutting measuresr prompt-ing most all airlines to cut out the use of clean-ing crervs and copy Southrvesti practice.)

. Southrvest did not have a flrst-class section inany of is planes and had no fancy clubs for itsfrequent flyers to relax in at terminals. No mealshad ever been served on Southrvest flights: pas-sengers rvere offered beverages and snack (apractice that made reprovisioning planes simpleand quick). During 2001-2005, virrually allairlines discontinued meal service on domesticflights (except for first-class passengers) as away to cut expenses; a few of Southrvesti rivalshad begun charging passengers $2 for coffee, softdrinks. and bottled rvater served during flights.

. Southwest oflered passengers no baggage trans-fer services to other carriers-passengers rvithchecked baggage rvho rvere connecting to othercarriers to reach their destination lvere respon-sible for picking up their luggage at Southrvest!baggage claim and then

-eetting it to the check-infacilities of the connecting carrier. (Southwestonly booked tickgts involving its orvn fli_shts:customers connecting to flights on other carri-ers had to book such tickets either through travelaqents or the connecting airline.) Starting in2008, Southwest's airline rivals be_san charging$25 to $50 for a second checked bag. and a feu'had instituted fees for the first checked bag.

. In mid-2001 Southrvest implemented use of nervsoftrvare that significantly decreased the timerequired to generate optimal crerv schedules andhelp improve on-time performance.

. Starting in 200t, Southrvest began convertingfrorn cloth to leafterseatst the team of Southxastemployees that investigated the economics of theconversion concluded that an allleather interiorrvould be more durable and essier to maintain.more than justiling the higher initial coss.

@ The McGrai'r-Hill

Companies, 2010

Southrvest rvas a first-mover among major U.S.airlines in employing fuel hedging and derivativecontracts to counteract rising prices for crude oiland jet fuel. Since 1998. the company's aggres-sive fuel hedging stategy had produced fuel sav-ings of about $3.5 billion over rvhar it rvould havespent had it paid the industry's average price forjet fuel. These savings had been a huge contribu-tor to the companyt ongoing profitability; forexample, in the second qua*er of 2008, South-rvest realized 55l I million in favorable cash ser-tlements from derivative contracts and reportednet earnings of $321 million. (By comparison,Delta had hedged 49 percent of irs fuel require-ments and realized gains of $313 million on itsfuel hedge contracts in the 2008 second quarter.)Southwest had derivative contacts for approxi-rnately 80 percent of its third-quarter 2008estimated fuel consumption at an average crude-equivalent price of approximately $61 per barrel(compared to approximately 90 percent at approx-imately $51 per barrel for third-quarter 2007):crude oil prices rvere in the $l lG-$130 range inJuly-August 2008, but fell to the $9G-$95 rangein September 2008. Moreover, Soutl*vest hadderivative contracts in place for approximately80 percent of is estimated fuel consumption for*re fourth quarter of 2008 at an average crude-equivalent price of approximately $58 per barrel;approximately 70 percent in 2009 at an averagecrude+quivalent price of $66 per barrel; approx-imately 4p percent in 2010 at an average crude-equivalenl price of approximately $81 pir barrel:and over 20 percent in 20 I I and 20 l? at an aver-age crude-equivaleut price of approximately $77and $76 per barrel. respectively.

To enhance the performance and efficiency ofits aircraft fleet. Southrvest had recently addedvertical rvinglets on the rving tips of most allits planes and had begun orderin_s nerv planesequipped rvith rvinglets (see Exhibit B). Theservinglets reduced lift drag. allorved aircraft toclimb more steeply and reach higher flight lev-els quicker, improved cruising performance.helped extend engine life and reduce mainte-nance costs. and reduced fuel burn. ln 2007,Southrvest partnered rvith Naverus. an aviationconsulting firm. to deveiop nerv flight systemsand procedures that rvoutd result in its planesbeing able to reduce fuet consumption. lorver

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Sralting and Execuring

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emissions, and curtail noise rvifle simulta-reously taking better advantage of the high-performance characteristics of its aircraft.

. [n 2007*2008, Southrvest began investing intechnology and sofirvare to replace its ticketlesssystem and iA back-office accounting, payroll,and human resource information systems, so asto enhance data florv, operational efficiency, andcustomer service capabiliry.

Sou&west's operating costs were consistently thelowest of the major U.S. airline carriers*see Exhibit10. Exhibit l l shorvs a detailed breakdown of South-west's operating costs for the period 1995-2007.

SOLjTHWHST'SPECPLE MAISAGEMEI\ITPRACTI CES AN D CU [.T1",' H EWhereas the litany at many companies.rvas that cus-tomers come first, at Southwest the operative prin-ciple rvas that "employees come first and customerscome second." The high strategic priority placed onemployees reflected management's belief that deliv-ering superior service required employees who notonly rvere passionate about theirjobs but also knervthe company rvas genuinely concerned for theirrvell-being and committed to providing them rvithjob security. Southrvests thesis rvas simple: Keepemployees happy*then they rvill keep customershappy. (The company changed the personnel depart-rnent's name to the People Department in 1989.)

ln Southrvest's 2000 annu*l report. senior man-ag€ment e,rplained rvhy employees lvere the compa-ny's greatest asset:

Our people are lvaffnt caring and compassionate andrvilling to do rvhatever it takes to bring the Freedomto Fly to thcir fellorv Americans. Thcy take pride indoing rvell for themselvcs by doing good for othcrs.They have built a unique and porverful culture thatdcmonstratcs that the only rvay to accompiish ourmission to make air travel affordablc for others. rvhileensuring ample profitability. job security, and plenti-ful Profit.sharing for oursclves. is to kecp our costslorv and Customcr Service quality high.

At Southrvcst, our People arc our grcatest assets.rvhich is rvhy rve devote so much tirne and energy tohiring great People rvith rvinning attitudes. Because11,s arc rvell knorvn as an cxcellent placc to rvork

Case 2& Southwesl

Airlines in 2lB Culturs.

Ualuas, and 0pera{ngPractices

case 23 southwest Arlines in 20oB: culture. Values, and operating practices c{r9

rvith great career opportunities and a secure firture,Iots of People 1va$t to rvork for Southrvest. . . . Oncehirecl rye provide a nurturing and supportive rvorkenvironment that gives our Employees the freedomto be creative. havc fun, and make a positivc diffcr-cnce. Although rve offer competitive compcnsationpackages, it's our Employees' sense of orvnership.pride in team accomplishments. and eahanced jobsatisfaction that keep our Culture and SouthrvcstSpirit alivc and rvhy rve continue to produce rvinningseasons.

CEO Gary Kelly echoed the views of his predeces-sors: "Our People are our single greatest strengtlland our most enduring long term competitiveadvantage."2l

*e*rar*uEsrg, S*rc**[*9, a** !*irexgSouthwest hired employees for attinrde and trainedfor skills. Kelleher explained:

We can train people to do things whcre skills arc con-cerned. But there is one capability rve do not haveand that is to change a pcrson's attitude. So rve preferan unskilled person rvith a good attitude ... [ro] ahighly skilled pcrson rvith a bad attitude.x

Management believed that delivering superiorservice came from haviqg employees rvho treatedcustomers rvarmly and courteously; the companylvanted employees rvho genuinely believed tlratcustomers rvere importanl not employees rvho hadmerety been hained to act like customers wereimportant. The belief at Southrvest rvas that superior.hospitable service and a fun-loving spirit florvedfrom the heart and soul of emplcyees who them-selves rvere fun-loving and spirited rvho liked theirjobs and the company they rvorked for, and rvhorvere also confident and emporvered to do their jobsas they sa$, fit (rather than being governed by strictrules and procedures).

Southrvest recruited employees by means ofnervspaper ads. career fairs, and Internet job iist-ings; a number of candidates applied because ofSouthrvesti repiltation as one of the best compa-nies to rvork for in America and because they rvereimpressed by their experiences as a customer onSouthrvest flighs. Recruirnent ads rvere designedto capture the attention of people thouglrt to pos-sess Southrvest's "personaliry profile." For instance,one ad shorved Herb Kelleher impersonating ElvisPresley and had the foiiolving headline: "Worl< In A

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Thompson .Stichtaoi-Eamble: I

Cralting aad Execuling

SfategF Concepts and

Csses, tTth Edition

ICaso 23: Soutiwest I Case

Airlines in dll& Culture,

llaluer and Openting

Praclices

@, I

C-122 Part 2 Cases in Crafting and Executing Strategy

Exhibit I I Trends in Southwest Airline's Operating Expenses per Average Seat Mile,1995-2007

I @ Ihe McGew-Hill

Companies,20l0

3.270 3.18c 3.1 0O 2.89e,, , 2.846 r, 2.816,, 2.400

2-31 . '1.58 1.30

peoples' emotions and responding in a genuinely car-ing, empathetic manner. Southrvest rvanted employ-ees to deliver the kind of service that shorved theytruly enjoyed meeting people, bein-e around passen-gers, and doing their job, as opposed to deliveringthe kind of service that came across as being forcedor taught. According to Kelleher. "We are inter-ested in people rvho externalize. rvho focus on otherpeople, rvho are motivated to help other people. Weare not interested in navel gazers.'!5 Southrvest rvas

draryn to candidates rvho not only presented a "rvhis-tle rvhile you rvork" attitude but also appeared likelyto exercise initiative, rvork harmoniously rvith fellorvemployees, and be community-spirited.

Southwest did not use personaliry tests to screenjob applicanls, nor did it ask applicants rvhat theyrvould or should do in certain hypothetical situa-tions. Rather, the hiring staff at Southrvest analyzedeach job category to determine the specific behav-iors. knorvledge. and motivations that job holdersneeded and then tried to find candidates rvith thedesired traitsra process called targeted selection. Atrait common to all job categories was teamlvork: a

trait deemed critical for pilots ard flight attendants*as judgment. In exploring an applicanti aptitudefor teamrvork. interviervers often aslied applicants totell them about a time in a prior job u,hen they s,ent

Salaries, wage6, bonuiEq, :., 3,22o, ' 3.29$and.benefitS.r. .,'..,-::,...,'r ::.,i:.. ... . .... ...

Fuel andoil I : r'Maintenance materials' and'

repairs ,.,,.,. ,,,..,, ,. , ',..

Aircraftrentals' : ; . ,

2.55

0.62 0.51

0.16,, 0.170.s6 0.53

0 .52 0.60

0.19 0.25

0.53 0.s3

'1.16 1.11

0.60 0.57..0.25 A.27

0.52 0.50

1.18: 1.34.. 1.01

0.61: : Q.gg. :Q.gQ

029 0.33 ,. 0.470.48 0.44 . O.M

0.47 : . 0.4:t1.71, , 1.72

7-73a 7.47a

Landing fees and otherrentals ..:r.:..'.'''.r.:.

Depreciation , ' '

OtherexpenleS,, ., t,.,

Tolal . r,.:,

0.5Q ,, 0.55 0.56

1.43',','. 1.41 1.37

8.800 8.056 7.700

0.53 0.52 0.49..1 .44 1 ,55 'l ,65,7.606 7.41e 7.54d,

, 0.56',r- 1.43'9.10e

Note: Figures in this exhibit differ lmm lhose for Soulhwest in Exhibit I because lhe 6osl ftgures in Exhibil I are based on cost perpas-senget retanue rnile, whereas the cost figiures in this exhibit are based on costs pet availabte seat mile, Costs per revenue passengetmile represent the costs per tickeled passenger per mile tlown, whereas costs per available seal mile are the cosls per seat pet milellawn {inespedive o{ whether the seat was occupied gr nat).

Source:Company ISK reports and annual reports.

Place Where Elvis Has Been Spotted." The body ofthe ad read:

Thc qualifications? It helps to bc outgoing. Maybe even

a bit off ccntcr. And be prepared to stay for a u,hilc.After all. rvc havc the lorvest employee turnover rate inthe industry. Ifthis sounds good to you.just phone ourjoblinc or sentl your resume. Attention Elvis.l'1

Colleen Barreff elaborated on what the companylooked for in screeningcandidates forjob openings:

Wc hire People to live the Southrvest Way [seeExhibit l2l. They must possess a Warrior Spirit, lcadrvith a Servant! Hcart. and have a Fun-LUVing atti-tude. We hirc Pcople rvho fi_eht lo rvin. rvork harcl are

dedicated. and havc a passion for Customer Service.Wc rvon't hire Peoplc if something about their behar-ior rvon't be a Cultural fit. We hirc the best- Whenour nerv hires rvalk throu_eh the door. our mcssagc tothem isyou are starting thc flight ofyourlife.s{

Alljob applications were processed through the Peo-ple and Leadership Development Department.

Screening Candidates In hiring for jobs thatinvolved personal contact rvith passengers, the coilr-pany looked for people-oriented applicants rvhorvere exfoverted and had a good sense of humor. lttried to identiff candidates rvith a knack for reading

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Airtints in208: CulBre.

Values. and 0perating

Prac{ces

out of theb rvay to help a corvorker or to explain howthey had handled conflict lvith a corvorker. Anotherfrequent question was "What was your most embar-rassing rnoment?" The thesis here rvas that havingapplicana talk about their past behaviors providedgood clues about their future behaviors.

To test for unselfisltfless, Southwest interview-ingteams typically gave a group of potential employ-ees ample time to prepare five-minute presentations

about themselves; during the presentations in an

informal conversational seuing. intervielvers rvatched

the audience to see rvho was absorbed in polishingtheir presentations and rvho rvas listening attentively.enjoying the stories being tol( and applauding theefforts of the presenters. Those lvho rvere emotion-ally engaged in hearing the presenters and givingencouragement tvere deemed more apt to be teamplayers than those rvho rvere focused on lookinggood themselves. All applicants for fliglt attendantpositions were put through such a presentation exer-cise before an intervierv panel consisting of custom-ers, experienced flight atteudants, and members ofthe People Deparhnent. Flight attendant candidates

who got through the group preseirtation interviervs

then had to complete a three-on-one intervierv con-ducted by a recruiter, a supervisor from the hiringsection ofthe People Departrnent. and a Southrvest

flight attendant; follorving this intervierv. the three-per:ion panel tried to reach a consensus on rvhether

to recommend or drop the candidate.

In 2007, Southrvest received 329,200 r6sum6s

and hired 4.200 nerv employees.

l9.i!&'i11;: aaE-qi:

Apart from the FAA-mandated raining for ce*ainemployees. training sctivities at Southrvest $'ere

designed and conducted by Southwest's Universityfor People. The cunicr.rlum included courses for nerv

recruits. employees, and managers. Learning rrasvierved as a never-ending process for all company per-

sonnel: tlrc e.xpectation u'as that each employee should

be an "interrtional learner," looking to grorv and develop

not just from occasional classes tatrien at Southrvest's

festive University for People learning center but also

from their everyday on-the1'ob experiences.

Southrvest's University lor People conducted

courses on safety, communications, stress manage-

ment. career developmeut, performance appraisal,

decision making, leadership, corporate culture, and

I I @ &e tvtscnrv-nitt

Cornpanies,2010

employee relations. Leadership courses for managers

empbasized a management style based on coaching,empowering, and encouraging, rather than supervis-ing or enforcing rules and regulations. One of the

keystone course offerings for managers rvas Lead-

ership Southrvest Style, rvhich made extensive use

of the Myers-Briggs personality assessment to helpmanagers understand the "lvhy'' behind colorkers'behaviors and to learn how to build trust, empathize,resolve conflicts. and do a betterjob ofcommunicat-ing. From time to time supervisors and executivesattended courses on corporate culture, intended tohelp instill, iugrain. and nurhre such culhral themes

as teamrvork. trust, harmony, and diversity. AIIemployees rvho came into contact lvith customers,including pilots. received customer care Eaining.

Orientation for nerv employees included videoson Southrvest's history an overview of the airlineindustry and the competitive challenges that South-rvest faced. and an introduction to Southtvest's cultureand management practices. The culrure introductiortincluded a video called f/re Sottf/rlves/ S/rry'le thatfeatured hundreds of Southrvest emPloyees rap-ping about the fun they had on their jobs. (At nianySouthwest gatherings, it rvas common for a groupof employees to do the Southrvest Shuffle, rvith theremaining ettendees chee;ing and clapping.) Therewere also exercises that demonstrated the role ofcreativity and teamrvork and a scavenger hunt inrvhich new hires rvere given a time line lvith spe-

cific dates in Southrvest's history and asked to fill inthe missing details by vierving the memorabilia.dec-orating the corridors of the Dallas headquarters and

getting information from people rvorking in variousoffices. Mueh of the indoctrination of new employ*ees into the company's culnrre rvas done by corvork-ers and the employee's supervisor. Southrvest madeactive use of a one-year probationary employmentperiod to help ensure that nerv employees fit in rvithits culture and adequately embraced the company'sculrural values.

The OnBoarding Program for Nervly fliredEmployees Southrvest had an employee orienta-tion program called OnBoarding designed to providenerv hires rvith information and assistance from thetime they were selected until the end of their firstyear. During their first 30 days at Southrvest, newemployees could access an interactive online tool-OnBoarding Online Orientation-to learn about the

company-

Case 23 Southwest Aidines in 2008: Culture, Values, and Operating Practices

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Airlines io 2lB: Gulture,

llalues, and 0perating

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Frgagt*gEeEg

Part 2 Cases in Crafting and Executing Strategy

Approximately 80 to 90 percent of Southrvesttsupervisory positions were filled internally, reflect-ing managementt belief that peopte who had "beenthere and done that" rvould be more likely to appre-ciate and understand the demands that people underthem rvere experiencing and also be more likelyto enjoy the respect of their peers and higher-levelmanagers. Employees could either apply for super-visory positions or be recommended by their presentsupervisor. Nerv appointees for lorv-level manage-ment positions attended a threeday class calledLeading with integrity, aimed at developing lead-ership and communication skills. Employees beingconsidered for managerial positions of large opera-tions (deemed "Up and Coming Leaders") receivedtraining in every depar*neat of the company over osix-month period in rvhich they continued to performtheir current job. At the end of the six-month periodcandidates rvere provided rvith 360-degree feedbackfrom department lreads, peers. and subordinates;representatives of the People Department analyzedthe feedback in deciding on the specific assignmentof each candidate-16

fl {a ii-f. :,: €: ;,1 ii * E.i *r sL: :ii-j rii! rii # iii =i 4ii iE *i 3t

Southrvest s pay scales te*ded to be above the indus-try average-sometimes eveo at or near the top ofthe industry. and the company offered good benefitpackages relative to other airlines. In 2008, rnedianhourly pay at Southrvest rvas in the neighborhood of$31 for flight attendalts, S40 for aircraft mechan-ics and service tEchnid*rans. $24 for customer servicerepresentatives and baggage handlers, $20 for cargoand freight agents, S95 for flight engineers and copi-lots, and $135 for commercial pilots.27 Pay scalesfor the company's 6,800 ramp agents. operationsagents! provision agents, and freight agents-all ofrvhom were represented by the Transport WorkersUnion-rvere said to be the highest in U.S. airlineindustry.r8 Southrvest rvas also an inaustry leader intotal compensation of pilots and flight attendants.

Southwest introduced a profit-sharing plan forsenior employees in 1973, the first such plan in theairline industry. By the mid-1990s the plan had beenextended to cover most Southwest employees. As of2008, Southrvest had stock option programs for vari-ous enrployee groups. a 401(k) employee savingsplans that included company-matching contributions,

and a profit-sharing plan covering virrually allemployees that consisted of a money purchasedefined contribution plan and an employee stockpurchase plan. Company contributions to employee410(k) andprofit-sharing plans totaled $241.5 millionin 2000, $264 million in 2005, $301 miltion in 2006,and $279 million in 2007; in recent years, thesepayments had represented 8 to 12 percent of basepay. Employees participating in stock purchases viapayroll deduction bought 677,000 shares in 1998,686,000 shares in 2000, 1.5 million shares in 2005,and I.3 million shares in 2007 at prices equal to90 percent of the market value at flre end of eachmonthly purchase period. Southwest employeesorvned about l0 percent of Southrvest's outstandingshares and held options to buy some 28.5 millionadditional shares.

$sx*g *'H** Retetr gxils

About 80 percent of Southrvest's 34,300 ernployeesbelonged to a union, making it one ofthe most highlyunionized U.S- airlines. The Teamsters, Union repre-sented Southrvest's airline mechanics, stock clerks,and aircraft cleaners; the Transport Workers Unionrepresented fl ight attendants; Local 555 of the Trans-port Workers Union represented baggage handlers,ground crews. and provisioning employees: and thelnternational Association of Machinists representedthe customer service and reservation employees.There rvas one in-house union*the Soutlrrvest Air-line Pilots Association that represented the compa-ny's 5.400 pil6ts. Despire having sometimes spiriieddisagreements over particular issues, Southrvest andthe unions representing its employee groups hadharmonious and non-adversarial relationships forthe most part-the company had experienced onlyone brief strike by machinists in the early 1980s.

Management encouraged union members andnegotiators to research their pressing issues andto conduct employee surveys before each contractnegotiation. Southrvesti contracts rvith the urrionsrepresenting its employees were relatively free ofrestrictive rvork rules and narrorv job classificationsthat might impede rvorker producriviry. All of thecontracts alloued any qualified employee to performany firnction-thus. pilots, ticket agents. and gatepersonnel could help load and unload baggage rvhenneeded and flight attendants could pick up rrash andmalie flight cabins more pr€sentable for passengersboarding the next flight.

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I easoz3:Southwest I cu"u

Airlinss in Z!08: Cul$raValueq snd 0peraingPraclicos

In 2000-2001, the company had contentiousnegotiations with Local 555 of the Transport Wbrk-ers Union (representing about 5,300 Southrvestemployees) over a new wage and benefits package;the previous contract had become open for renego-tiation in December 1999 and a tentative agreementreached at the end of 2000 rvas rejected by 64 per-cent of the union members rvho voted. A memo fromKelleher toTWU representatives sai4 "The cost andstrucilrre of the TWU 555 negotiating committee'sproposal rvould seriously undermine the competitivestrength of Soutlrrvest Airlines; endanger our abilityto grow; threaten the vatue of our employees'profit-sharing: require us to contract out work in order toremain competitive; and threaten our 29-year historyofjob security for our employees." In a union nervs-letter in early 2001 , the president of the TWU sai("We asked for a decent living wage and benefits tosupport our farnilies, and were told of horv unnor-thy and horv greedy we lvere." The ongoing disputeresulted in informational picket lines in March 2001at several Southrvest locations, the. first picket-ing since 1980. Later in 2001, rvith the help of theNational Mediation Boar4 Southu'est and the TWUreached an agreement covering Southrvest's ramp.operations, and provisioning employees.

Priorto the September I l, 2001, terrorist attacks,Southrvest's pilots nere somervhat restive about theirbase pay relative to pilots at other U.S. airlines. Themaximum pay for Southrvest's 3.700-plus pilots

ftefore profit-sharing bonuses) rvas $ 148,000, versusma{mums of $290,000 for Uniteds pilots, $262,000for Deltai pilots, $206,000 forAmericani pilots. andS199,000 for Continental's pilots.le Moreover. someveteran Southu,est employees rvere grumbling aboutstaffshortages in certain locations (to hold dorvn laborcosts) and cracks in the company's close-knit familyculture due to the influt of so many nerv employeesover the past several years. A number of employeesrvho lrad accepted lorver pay because of Southrvest'surderdog slalus were said to feelentitled to "big ah-line" pay norv that Southlvest had emerged as a majorU.S. carrier.'u HorveveL rvhen airline baffic droppedprecipitously follorving 9/l I. airlines rvon big rvageand salary concessions from unions representingpilots and other airline *,orkers; moreover, about Iin 5 airline jobs*some l?0,000 in al}-rvere elim-inated. In 2006, a senior Boeing 737 pilot at DeltaAir Lines rvorking a normal 65-hour month made$116,200 annually, dorvn 26 percent from pre-9/llrvages. A conrparable pilot at United Airlines earned

I o ne tlrcnur-Hin

Companies. 2010

c{25

$102,200, dorvn 34 porcent from before 9/ll and atAmerican Airlines, such a pilot made $122,500, 18percent less than the days before 9/ll. As of 2006*2007, Southwest pilots rvere quite rvell paid comparedto their counterparts at most other airlines, earningabout 45 percent more than pilots at United Airlinesand l8 percent more than pilots at American Airlines.In 2007-2008, Southrvest and iS pilots'union werein the process ofnegotiating a netv agreemenl

In 2004 and 2007, in au attempt to contain ris-ing labor costs, Southrvest offered voluntary buyoutpackages to approximately 8,700 flight attendans,ramp rvorkers, customer service employees, andthose in reservations, operations, and freight who hadreached a specific pay scale; the buyout consisted ofa$25$00 payment and medical and dental benefits fora specified period. About 1,000 employees acceptedthe 2004 buyout offer. In some cases: the employ-ees rvho accepted the buyout rvere not replaced; incases rvhere replacements rvere neede4 Southrvestrvas able to hire nerv employees for lesser pay thanthe departing employees rvere earning (because onlyemployees rvho rvere at or near the top of their paygrade**due to good job performance and length ofsen ice x,ith the company-rvere offered buyouts).

TEr* s's*-ts3f *f f F**i*g'Southu,est Airlines had never laid offor furloughedany of its employees since the company began oper-ations in 1971. The no-layoff policy lvas seen as

integral to horv the company treated is employeesand to nranagemeni efforts to sustain and nurture theculture. According to Kelleher:

Nothing kills your companyb culture likc layoffs.Nobody has evcr bccn furloughed here. and that isunpreccdented in the airlinc industry. h's becn a hugestrength o[ ours. Iti certainly helped negotiate ourunion contracts. . .. We could have furloughed atvarious times and been morc profitable. but I ahvaysthought that n'as shortsighted You rvant to shorv yourpeoplc you ralue them and you're not going to hurtthem just to get a little more mgney in thc short term.Not furloughing people breeds loyalty. lt breeds asense of sccurity. lt brcecls a scnse of trust.ll

Southu,est had built up considerable goodrvill rvithits employees and unions over the years by avoid-ing layoffs. Both senior managemert aud Southrvestemployees regarded tlre trro recent buyout offers as

a better approach to rvorkforce reduction than invol-untary layoffs.

Case 23 Southwest Airlines in 2008: Culture, Values. and Operating Practices

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Case8:southwest lCaseAirlines inZB: Culture,

Yatues. and 0perating

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@ Ihe Mt6rare-Hill

Companies.20l0

Part 2 Cases in Crafting and Executing Strategy

Sp*e'aciioxt I{!*lt EeuE

In 2007, Southrvest management launched an inter-nal initiative called Operation Kick Thil, a mul-tiyear call to action for employees to focus evenmore attention on providing high-quality customerservice. maintaining low costs, and nurruring &eSouthwest culture. One component of OperationKick Tail involved singling out employees for spe-cial recognition rvhen they did something to make a

positive difference in a customer's travel exp€rienceor in the life of a coworker.

CEO Gary Kelly sarv this aspect of OperatiouKick Tail as s way to foster the employee attihrdesand commitment needed to fulfill Southrvest's prom-ise of "Positively Outrageous Customer Service": heexplained:

One of Southrvest's rituals is finding and develop-ing People rvho arc "built to serve." That allorvs us

to provide a pcrsonal. rvarm level of sen'ice that isunmatchEd in the airline industry.

irrle;a *gem *att $ t1i+ic

At Southrvest. management strived to do things in amanner that would make Southrvest employees proudof the company they rvorked for- Managers wereexpected to spend at least one-third of their time outof the office. rvalliing around tlre facilities under tlteirsupervision, observing firstlrand rvhat was going on,listening to employees. and being responsive to theirconcerns. A former director of people developnrentat Southrvest told of a conversation he had rvith oneof Southrvest's ternrinal managers:

While I rvas out in the field visiting one of our sta-tions. one of our managers mentioned to me that he

rvanted to put up a suggestion bo.r. I respondcd bysaying that. "Sure-rvhy don't you put up a sugges-tion box riglrt here on this uall and then admit youare a failurc as a manager?" Our theory is. if youhave to put up a box so people ean rvrite dorvn thcirideas and toss thcm in. it mcans you are not doingrvhat you are supposed to be doing. You are supposedto be setting your peoplc up to be rvinners. To do that.you should be there listening to them and availableto thcm in person. not ,i,ia a suggestion bo.r. For themost part. I think rve have a vcry good sense of thisat Southrvest. I think that nrost people employed hereknon, that they can call any one ofour vice presidentson thc tclephone and get hcard almost immediately.

The suggestion box gives managers an out; itrelinquishes their rcsponsibil.ity to be accessible totheirpcople, and that's whcn rve lravc gottcn in troublcat Southrvest-rvhen rve can no longcr be responsiveto our flight attendants or customer service agcnts,rvhen thcy can't gain access to somebody rvho cangive them resources and ansrvers.sl

Company executives werc very approachable,insisting on being called by their first names. At nervemployee orientations, people were told, *We donot call the company chairman and CEO Mr. Kelly;we call him Gary." Managers and executives hadan open-door policy, actively listening to ernployeeconcerns, opinions, and suggestions for reducingcosts and irnproving efficiency.

Employee-led initiatives were cortmon. South-west's pilots had been instrumental in developingnelv protocols for takeoffs and landings that con-served fuel. Another frontline employee had sug-

_eested not putting the company logos on trash bags,saving an estimated 3250,000 annually. Rather thanbuy 800 computers for a nerv reservations center inAlbuquerque, company employees determined thatthey could buy the parts and assemble the cornputersthemselves for half the price of nerv ones, saving thecornpany Sl million. It rvas Southrvest clerks rvhocame up u,ith the idea of doing arvay rvith paper tick-ets and shifting to e-tickets.

There rvere only four layers of managementbenveen a frontline supervisor and the CEO. South-rvest's employees enjoyed substantial authority anddecision-malilng power. According to Kelleher:

Wc've triccl to creat€ an cnvironmcnt rvhere pcoplcare able to, in effect. bypass o.en the fairly lcanslructures that te have so that thcy don't have to con-vene a mccting of the sages in order to gct somcthingdone. ln many cilscs. tlrcy can just go ahead and do iton their orvn. They can take individual responsibilityior it and knorv they rvill not be crucified if it doesn'trvork out. Our leanness requires pcople to be com-lortable in making their orvn decisions and undertak-ing their orvn efforts.33

Frorn time to time. there nere candid meetingsof frontline employees and managers rvhere oper-ating problems and issues among uorkers anddepartments rvere acknorvledge( openly discussed,and resolved.'* lnformat problem avoidance andrapid problem resolution lvere seen as managerialvirtues.

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$* ttt!'r u'r *.*u's C *ri+ Biai il*sTrvo core values*LUV and fun-permeated thervork environment at Southrvest. LUV rvas mucitmore than the company's ticker symbol and a recur-ring thenre in Southrvestt advertising campaigns.Over the years, LUV grerv into Southrvest's codervord for treating individuals-fellow employees andcustomers-rvith dignity and respect and demon-skating a caring. loving attihrde. LUV and red heartscommonly appeared on banners and posters at com-pany facilities, as reminders of the compassion thatwas expected torvard customers and other employ-ees. Practicing the Golden Rule. internally andexternally, rvas expected of all employees. Employ-ees rvho stnrggled to live up to these expectationswere subjected to considerable peer pressure andusually rvere asked to seek employment elservhere ifthey did not soon leave on their orvn volition.

.Frlr at Southrvest lvas exactly rvhat the rvordimplies. Throughout the company, fun appeared inthe form of the generally entertaining behavior ofemployees in performing their jobs, the ongoingpranlss and jokes, and frequent cdmpany-sponsoredparties and celebrations (rvhich typically includedthe Southrrcst Shuffle). On holidays, employeesrvere encouraged to dress in costumes. There rvere

cbarity benefit games, chili cook-offs. Halloweenparties, nerv Ronald McDonald House dedications.and other special events of one kind or another atone location or another almost every rveek. Accord-ing to one manager, "We're kind ofa bi_e family here.and family members have fun together-"

Case 23: Southwest

Airlines in 2fi8: Culturg,

Vatues. and 0pentingPractices

case 23 southwest Airlines in 2008: culture, Values. and operating practices

s EriJgESEei rs " iiiEgtr gEEE?s

Southrvest executives believed that the companytgrorvth was primarily a function of the rate at rvhichit could hire and fain people to flrt hto its culture, tomirror the Southrvest Spirit, and to consistently dis-play the traits that comprised the Southrvest Way (seeExhibit l2). CEO Gary Kelly said, "Some things arSouthwest won't change. lVe rvill continue to expectour people to live what rve describe as the 'South-rvest Way,' rvhich is to have a Warrior Spirit, Ser-vant's Heart. and Fun-Loving Attitude. Those threethings have defined our culture for 36 years."3s

The Culture Committee Sourhrvest formed aCulture Commirtee in 1990 to promote "PositivelyOutrageous Service" and devise tributes, contests.and celebrations intended to nurhrre and perpetu-ate the Southrvest Spirit. The committee, chaired byColleen Barrett until mid-2008. rvas composed ofI00 employees rvho had dernonstrated their com-miunent to Southrvest's mission and values and zealin exhibiting the Southrvest Spirit. Members camefrom a cross-section of deparxnents and locationsand functioned as cultural ambassadors, missionar-ies. and storytellers during their two*year term.

The Culture Comminee had four all-day meet-ings annually; ad hoc subcommittees formed through-out the year met more frequently. Over the years, thecommittee had sponsored and suppo*ed hundreds ofways to promote and ingrain the Southtvest Spirit-exampies included promoting the use of red heartsand LU!__1o embody the spirit of caring, serving

Exhiltit I I Personat Traits, Attitudes, and Behaviors That Southwest Wanted Employeesto Possess and Display

. Workfusgd:1::.. 1,1 ,.,;,,

. Desire to be the best r

. Be courageous .. Display a sense ol urgency

. Persevere

. lnnovate . .' ' ":. I

.: Follow the Golden Rule

. Adhere to the Easic Principles'

. Treat others with respect

. Put others first

. Be egalilarian

. Demonstrate proaclive CustomerService . :l

. Embrace the SWA Family : :

. : Hirve FUN ..1_.

. Don't take yourself too seriously .. Maintain perspeclive (balance)

. Celebrate successes

. Enjoyyourwork

. Be a passionate team player

s

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c-l?8 Part 2 Cases in Crafting and Executing Strategy

pizza or ice cream to employees, or remodeling anemployee break roorn. Kellehsr indicated, "We're notbig on committees at Southrvest, but of the commit-tees rve do havq the Culture Committee is the mostimportant."36

Efforts to Nurture and Sustain the South-lvest Culture Apart from the efforts of the Cul-rure Committee, Southrvest rnanagement had soughtto reinforce the company's core values and culturevia an annual Heroes of the Heart Arvard. a mentor-ing program called CoHearts, an event called Day inthe Field during s,hich employees spent time work-ing in another area of the companyl operations, aprogram called Helping Hands that gathered volun-teers from around the system to rvork trvo rveekendshifts at other Southrvest facilities that rvere tempo-rarily shorthanded or experiencing healy rvorkloads,and periodic meetings called Culnrre Exchange tocelebrate the Southrvest Spirit aud company mile-stones. Alnrost every event at Southrvest rvas vid-eotaped. rvhich provided footage for creating suchmultipurpose videos as Keepin'the Spiit l/ive thatcould be shorvn at company events all over the sys-tem and used in training courses. The concepts ofLUV and fun rvere spotlighted ia all of the compa-ny's training manuals and videos.

Southrvest's monthly nervsletter. LUY Lines,often spotlighted the experiences and deeds ofpar-ticular employees. repriuted letters of praise fromcustorners. and reported company celebrations ofmilestones. A quarterly nervs video, As the Plane?irrrrs. rvas sent to all facilities to keep employeesup to date on companl happenings, provide clips ofspecial evqn-ls, and-share messages from customers.employees, and executives. The company had pub-lished a book for employees describing "outrageous"acts of serv'ice. Sometimes irnportant informationrvas circulated to employees in "fun" packages suclras Cracker Jack boxes-

E;t; i:t I il:.,c n c S.t *: # ;t*.:*ii.,iF:i* --'i"

lvlanagenrent rvas convinced the company's strategy,culture, esprit de corps. and people managementpractices fiostered high labor productivity and con-tributed to Southtvest having very }ow labor costscompared to other airlines (as shorvn in Exhibit10). When a Southrvest flight pulled up to the gate,ground crews, gate personnel. and flight attendantshustled to perform all the tasks requisire ro hrrn the

plane quickly-employees took pride in doing theirpart to achieve good on-time performance. South-rvest's turnaround times rvere in the 25- to 30-minuterange. versus an industry average of around 45 min-utes. In 2007, Southwest's labor productivity com-pared favorably rvith the U.S. airline average:.

@Ihe Mc6mrv-Hill

Comganies.20l0

Passengersenplaned pet

,

employee,Z007 .

Employees per. .

plane, 2007 ,

*.;+&q * f! s*n *^ill-. *o-+3 iirEEEr iijF'ffiE Eiii!.,8E;i

Under Herb Kelleher, instituting practices and support systems that promoted operating excellence hadbecome a tradition and a sotrce of company pride.Much time and effort over the years frad gone intofinding the most effective ways to do aircraft main-tenance. to operate safely. to rnake baggage handlingmore efficient and baggage rransfers more accurate,and to improve the percenta-se of on-time arrivalsand deparrures. Believing that air travelers rveremore likely to fly Southrvesr if its fli,ehts u.ere reli-able and on time. Southrvest's managers constantlymonitored on-time arrivals and departures. makinginquiries whefi many flights ran behind and search-ing for ways to improve on-tinre performance. Oneinitiative to help minimize rveather and operationaldelays involved the development of a state-of-rhe-art flight dispatch system. CEO Gary Kelly hadfollorved Kelleher's lead in pushing for operationalexcellence- One of Kelly's s8ategic objectives rvasfor Southu,est "to be the safest, most efficient. andmost reliable airline in tle rvortd." Soutbwest man-agers and employees in all positions and rank trereproactive in offering suggestio*s for improvingSouthrvesti practices and procedures; those rvithmerit rvere quickly implenrented. Southrvest rvasconsidered to have one of the most competent andtlrorough aircraft maintenance progran$ in the cout-mercial airline ir:dusfry and going into 2008. rvasrvidely regarded as the best operator among U.S. air-lines. Its recent record vis-ir-vis rival airlines on fourimportant measures of operating performance rvascommendable-see Exhibit 13.

| ftompsorsuicklond-Gambie: I

Grahing ard Executirrg

Strategp Conccpls and

Cases. lTth Edirion

Case23:Southwesr I cu"uAirlines in 21tr8: Culture,

Values, and 0perating

Practices

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=.,

ii:i1:4.:

Thompson-Slriclland-Gamble:

Crofting and Executinp

Slrsteis GoFEeFrs and

Gases, lTth Edilion

Case f3: Southwes

Airlioes in 2tE8; CulUm.

Vahes. md 0perarhg

Practices

@ the Mc0ral-Hitl

Companies. ?0'10

Case 23 Southwest Aidines in 2008: Culture, Values. and Operating Practices

txhihit I3 Comparative Statistics on On-Time Flights, Mishandled Baggage, Oversales,and Passenger Complaints for Seven Major U.S. Airlines, 2000 throughQuarter I of 2008

c{29

American Airlines

Continenlal Air Unespiua air Lines

Northwest Airlines: ,

Soulhwest Airlines

United Air Lines

US Airways . .

American Airlines

Continental Air Lines

Delta Air UnesNorthwest Airtines

Southwest Airlines

United Air Lines

US Airways

American Airlines

Continental Air Lines

Delta Air Unes

Northwest Airlines

Soulhwest Airlines

United Alr Unes

US Airways

75.goh76.7.

79.3' .

80.7. ,

't8.7 :

71.6' .

72.7 .

5-44.4.11

3.644.98

4.1'46.71

4.57

0.59

0.50

0.44

0.121.701.61

0.s0

2.772.2i1.60

2.17

0.41

5.071.63

78.0 o,'"

78.776.479.379.979.876.0

4.583.306.21

3.583.464.009.73

a.723.01

1.06

1-74a.74o.421.01

1.01

0.890.91

0.834.170.870.99

75.60h74.8

76.275.1

80.3

75.778.9

4.91

3.85

4.75

3.11

s.663.89

5.59

1.16

2.60

2.68

1.00

1.8'l

0.88

1.07

1.22

0.85

0.93

0.69

0.18

1.19'1.?2

: 72.40/o

73.5.,,; 76.6 ':,

71.480.7:73.0, ,,,

69.7, ,

66.9 9'o

74:1

75,7;:,: :

71.'l r t,78.5 {h69.1, '. ,

,5-3

5.82,3.78

e81,?.974.41 :

4.76

3.86

0.98

1.57

1.80

1.15

1.68

0.89

2.01

1.30

1.03

2.14

0.92

0.32

1.61

1.94

6.40

s.0e5.263.805.#4.837.17

1.06

1.93

3r';71.25

1.25

0.401.68

1.44

0.75

1.50

1.13

0,192.O0

2.6s

American Airlines

Continental Air Lines

Delta Air Unes

Northwest Airlines

Soulhwest Airlines

United Air Lines

US Airways

Source: Otlice ol Aviation Entorcement and Proceedings, Air Travel gonsumer Beport, various years.

I:,1:a;ti:il

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1!oapsoa-Suicklanrl-Gardle:

Etafting and E<ecuting

Strategy Goncapu and

Cises, lrth Edition

Case23: Soudnrest

Airlines in ll(ts: CutturA

Values, and 0pemtin[Pnctices

Part 2 Cases in Crafting and Executing Strategy

The First Significant Blemish on South-lYest's Safety Record While no Sourhtvestplane had ever crashed and there had never been apassenger fatality, there ryas an incident in 2005 inwhich a Southrvest plane landing in a snolv stornrvith a strong tailwind at Chicagot Midrvay atrportlvas unable to stop before ovemrnning a shorter-than-usual runway, rollin-s onto a highrvay, crashinginto a car, killing one of the occupants, and injur-ing 22 of the passengers on the plane. A NationalTraffic Safety Board investigation concluded that"the pilotl failure to use available reverse &rust ina timely manner to safely slorv or stop the airplaneafter landing" was the probable cause.

Belated Aircraft Inspections Further Tar-nish Southryest's Reputation In early 2008,various media reported that Southwest Airlines overa period of several montts in 2006 and 2007 hadknorvingly failed to conduct required iuspectionsfor early detection of fuselage fatigue crackingon 46 of its older Boeing 737-300 jets. The com-pany had voluntarily notified the Federal AviationAdministration (FAA) about the lapse in checks forfuselage cracks but eontinued to fly the planes untilthe rvork rvas done-about eight days. The belatedinspections revealed tiny cracks in the bodies of sixplanes, rvith the laqgest measuring four inches; noneimpaired flight safery- According to Gary Kelly,"Southrvest Airlines discovered the missed inspec-tion area. disclosed it to the FAA. and promptly re-inspected all potentially affected aircraft in March2007. The FAA approved our actions and considrered the matter closed as of April 2007." Nonethe-less, on March 12;2008, shortly afrer the reports inthe media surfaced about Southlvest fiot meetinginspection deadlines, Souihrvest canceled 4 percentof is fliglrts and grounded 44 of its Boeing 737-300s until it verified that the aircraft had undergonerequired inspections. Kelly then initiated an internalrevieu, of the company's maintenance practices; theim,estigation raised concerns about the companytaircraft maintenance procedures, prompting South-u,est to put three employees on leave. The FAA

Eadnotes

subsequently fined Southwest $10.2 million' forits transgressions. In au effort to help restore cus-tomer confidence. Kelly publicly apologized for thecompany's wrongdoing, promised that it would notoccur again, and reasserted the company's commit-ment to safety; he said:

From our inception. Southrvest Airlines has main-tained a rigorous Culture of Safety-and has main-tained that samc dedication for more than 37 ycars.It is and ahvays has been our number one priority toensure safety-

We've got a 37-year history of very safe opera-tions, one of the safest operations in the world. andrvcle safer today than rve've ever been.

In the days following the pubiic revelation ofSouthrvest's maintenance lapse and the tarnishingof its reputation, an industry-nide audit by the FAA'revealed similar failures to conduct timeiy inspec-tions for early signs of firselage fatigue at five otherairlines-American, Continental. Delta, Unite{ andNortlrrvest. An air travel snafu ensued, rvith morethan 1,000 flights subsequently being canceleddue to FAA-mandated grounding of the affectedaircraft rvlrile the overdue safety inspections rvereperformed. Further public scrutiny, including a con-gressional investigation, turned up documents indi-cating that ilt some c:]ses planes flerv for 30 monthsafter &e inspection deadlines had passed. Moreover.high-level FAA officials rvere apparently arvare ofthe failure of Southrvest and other airlines to per-form the inspections for fuselage skin cracking at thescheduled times and chose not to strictly enforce theinspection diadlines-according to some comrnen-tators. because of allegedly cozy relationships rvithpersonnel at Southrvest and the other affected air-Iines. Disgruntled FAA safety supervisors in chargeof monitoriug the inspections conducted by airlinecarriers testified before Cougress that senior FAAofficials frequently ignored their reports thar certainroutine safety inspections rvere not being conductedin accordance rvith prescribed FAA procedures.Shortly thereafter. the FAA issued more stringentprocedures to ensure that aircraft safety inspectionsrvere properly conducted.

I Kevin and Jackie Freiberg, NUIS! Soufnvesl Nrttnes, Ca4 Recipe,orBus,hess aad fursonal Success (New yortq Broadway Books,19S8), p.15.2bid., pp. 16-18.s Kalrira Brooker, The Chairma'l of the Boad Looks Back," forrrrreMay 28, 2001, p.86.

r Freiberg and Freiberg, NUfSl, p.41.5 tbid., p, 3r.5 tbid., pp. zs-zz.7 rbid., pp.246-4?.8 As quoted in the Dallas Morri?g lven4s, March 20, 2001.e Broot€r, "The Chairman ol the Boad Looks Bact<," p. &1.

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Cases. lTth Edhion

roAs quoted ln ibid., p.72,It As quoted ln Seaflre 7?mes, March 20, 2OOl, p. G3.Ir Speech al Texas Christian University, SeptembEr 13, 2007; ..o,:*.iirrr::rrrris:,.-:njir (aCCeSSed Seplembef S, 2008).t3 Freiberg and F eiberg, fVUfSr, p. 163.r{Company press release, July I5,2004.rsspeech lo Greater Boston Chamberof Commerce, Ap.it 2g, 2OOB,ii ;..,.::.sif uiiiu*ni.;i,,,: {accessed Seplenber 5. 2008),t0speech to BusinessToday lntemalional Conlerence, Noveriber A0,2007,,,^r,,',+,sr rii?r,i.' :'..+rir: (accessed Septembet 8, A00g).rTAs cned in Freibe.g and fteherg, ,vUTSt p. e8B.t0Golleen BaneB, speech. Janoary n,,2OA7,,,r..!,.ii.i,:;r;iirr!.:ii.ulrii(accessed on Seplember 5.2008).rs Brenda Paik Sungo, t{ow Fun Flies at Soilthwest Airlanes," person-nel JournalT+, no.6 (June 1995), p.70.a Statemenl made in a 1993 Hanrard Business Schoot video andquoled in Roger Hallowelt,'Sourhw8st Ai.lines: A Case Sludy Link.ing Employee Needs Sarslaction and OrganizatioRat Capabitities toCompetilive Advantage,' Humai Sesou rce Managemmt 95, no. 4{Ivinter.|396}, p.517.al Statemenl posted in the Careers Seclioll, 'r,,,.',.sr,,ri:!rir*:i.:ri*(accessed Seplember 8, 2008).

Gase ZI Southwest

Airlines ia Zffi; Cultura,

Values, and 0perating

Placlicss

case 23 southwest Airlines in 2008: culture, Values. and operating practices

@lheMcGnw*lillConponies, 2010

c-t3l

2 As quoled in James Ca$pbell Quick. traftirts an OrgBnleauonalStruclure: Herbb Hand at SouthwestAartines," Organieatianal Wam-,bs 21 . no. 2 (Autumn 1992), p. 51.Bsouthwest, advertisemgnl. "Work in a Place Where Etvis Has Beengpotled." and Surco, "How Fun Flies at Souihwest Airlines,'pp. 6{-65,2o Speech to the Paso Oel Norle Group in Et Paso, TBxas, Janinry 22,?-007,,'j'.'."-,- ",,' i *i sl. i:: {.,r; : (accessed September 5, 2008}.25 Ouick. 'rcralling an Organizalional Structure," p. 52.

l Sunoo, "How Fun Flies at Southwest Aidines,'p. 74.27 Based on pay scale data hr Soulhwest Aidiies, x.t,r.slr.sc;,iei*"i (acce$sed Seplembgr 8. 2008).

aTerry Maxon,'southwest Aklines Begins ContraclTalks with GrourdWotkers," Darras Momlng News, tanuary 23, 2008. .sr:t .risijlrrri-ryii.*r:r {accessed Sgpternb€r 8. 2008}.!! Shawn Tully, 'Fom Bad to Worse,' &durrq October 1 S, 2001 , p. 1 24 .w Melanae Trotlman, Tmid Crippled Bivals, Southu,est Tries to Spaead

lls wings,' war street Joumal, oclober 11, 2001, p. A10.3r Brooker, The Chairman ol thg Board Looks Back,"p.72.32 Freiberg anct Freiberg, NUfSI p, 273.33 tbid., p- 76.il Hallowll,'southwest Airlines: A Case Sludy," p.524.35 Speech lo Business Today lnlemational Conlerence.-Freiberg and Freiberg, MISI p. 165.

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e-r.flr.

Iio nTso!-Sln'clla nd-Eamble:

Cralting and Executinq

Strategp Concepts and

Cases, lSrh Edidon

StErtucks' Global guesl in

2005: ls tic Eest Yat to

Come?

Scerfuare$<s' Gl*be1 Qeaesc ssa

2#ffi6: Hs e$ae BcsE Yet tc$ Ccsme ?

Amit J- ShahF ro stb u rg State Uniuersit-v

Thomas F. Har,vkFrostb utg State Unhterciry

Sn early 2006, Horvard Schultz. Starbricks'founder,

[{ chairman of the board. and global strategist.Acould look rvith satislaction on the company'sphenomenal grorvth and market success. Since 1987.Starbucks had transformed itself from a modestnine-store operation in the Pacific Northrvest intoa porverhouse multinational enterprise rvith 10.241

store locations. including some ?,900 stores in 30

foreign countries (see Exhibit I ). During Starbucks'early years rvhen coffee l\ras a S0-cent morninghabit at local diners and fast-food establishments,skeptics had ridiculed the notion of 53 coffee as ayuppie fad. But the popularity of Starbucks' Italian-style coffees, espresso beverages. teas. pastries. andconfections had made Starbucks one of the greatretailing stories of recent history and the rvorld\biggest special$"coffee chain. In 2003, Starbucksmade the Fortune 500. prompting Schultz to remark."lt s,ould be arrogant to sit here and say that 1 0 years

ago lve thought u,e rvould be on the Forhrne 500. Butrve dreamed from day one and rve dreamed big."l

Having positioned Starbucks as the dominantretailer. roaster. and brand of specialry coffees and

coffee drinlis in North America and sparvned the crea-tion of the specialty coffee industry management'slong-terrn objective \vas nolv to establish Starbuckas the most recognized and rcspected brand in tlre

rrorld. Nerv stores rvere being opened at the rate

of roughly 32 per week in 2005, and management

Cop,vright',1 :006 hy ..\mit J. Shah. i\rrhurA.'[rornpson and 1]omusF. llurvli

c-d68

Arthur A. ThompsonTlte Uniuersity af Alabama

'

expected to have 15,000 Starbucks stores open rvorld-u,ide going into 2006. Believing that the scope ofStarbucks' long-term opporhrnity had been under-estimated Schultz had recently increased the targetednumber of stores from 25.000 to 30,000 rvorldrvideby 2013. at least half of rvhich were to be outside theUnited States.r He noted that Starbucks had only anoverall 7 percent share of the coffee-drinking marketin the United States and perhaps a I percent shareinternationally- According ro Schultz. "That stillleaves lots ofroom for grorvth. Internationally. rve arestill in our infancy.'a'Althouglr coffee consunrptionrvorldrvide rvas stagnanl coffee rvas still the second,most-consumed beverage irr the rvorld trailir:g onlywater-r

i

Starbucks reported revenues in fiscal 2005 of$6.4 billion. up 205 percent from 52.l billion in fiscal2000; after+a:< profits in 2005 rvere $494.5 million,an increase of 423 percent from the company's fiscal2000 net earnings of 594.6 million.

COMPAfiUY BACKGROUruE

Starbuclcs got its -sldfi1il t s7i\hen rhree academ-ics. E n g I ish teacheTTe$Bll-divin. h i story re acherZev Siegel, and rvriter Cordon Borvlier-all coftbeaficionados-opened Starbucks Coffee. Tea, andSpice in touristy Pikes Place Market in Seattle. Thethree partners shared a love for fine coffees and ex-otic teas and believed they could build a clientelein Seattle that rvould appreciate the best coffees and

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Ihongsoa-$trickland-Samllel

Crafling rnd B(eclttiloStrategp Coneepts and

Cases, 15lh Edilion

StartuDhs' Clobal ouest iR

2fl15: ls the Best Yet to

Como?

@The McGraur-Hill

Companies.2qlT

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Case 29 Starbucks' Global Quest in 2006: ts the Best yet to Come? C-|69

Exhibit I Number of starbucks store Locations worrdwide, lg87-2oos

Licensed Locations of Starbucks Stores, 2005

Source:2005 l&K 'epo(.

teas. rnuch like rvhat had already emeryed in the San

Francisco Bay area. They each invested $1,350 andborrorved auother $5,000 from a bank to open thePikes Place store. The inspiration and mentor for theStarbucks venture in Seattle rvas a Dutch imrnigrantnamed Alfred Peet, lvho had opened Peeti CoffeeandTea, in Berkeley. California. in 1966. Peet's storespecialized in importing fine coffees and teas and

os,u beans the European way toflavors- Customers were encour-

dark-roastingbring out the

itstulr

aged to learn horv to grind the beans and make theirorvn Feshly brerved coFee at home. Baldrvin, Siegel.and Bonker n'ere rvell acquainted with Peet's exper-tise. having visited his store on numerous occasionsand listened to him erpound on quality coffees andthe importance of proper bean-roasting techniques.

:iiii

ie

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Ihocpson-SbicHaod-{iaurtle:

Gmfting and Erecuting

Strategy: CoacepE and

Cases, lSlh Edition

Starbuclts' Gtobal lluesn inAn& k the Sest Yet loCone?

Part 2 Cases in Crafting and Executing Strategy

The Pikes Place store feanrred modest, hand-built. classic nautical fixtures. One rvall \vas devotedto whole-bean coffbes, rvhile another had shelvesof coffee products. The store did not offer fresh-brerved coffee by the cup, but tasting samples weresometimes available. Initially, Siegel rvas the onlypaid employee. He wore a grocerts apron. scoopedout beans for customers, extolled the virtues offine, dark-roasted coffees, and funciioned as thepartnership's retail expert. The other tlvo partnerskept their day jobs but came by at lunch or afterrvork to help out. During the sta*-up period, Baldrvinkept the books and developed a growing knorvledgeof coffee; Borvker served as the "magic. mysteryand romance man."J The store was an immediatesuccess. rvith sales exceeding expectations, partlybecause of interest stirred by a favorable articlein the Seattle Times. For most of the first year,Starbucks ordered its coffee-bean supplies fromPeet's, but then the partners purchased a usedroaster from Holland, set up roasting oporations ina nearby ramshackle building, and developed theirorvn blends and flavors.

By the --ffi6i0ithe company had four Star-bucks stores in the Seattle area and had been profit-able every year since opening its doors. But then ZevSiegel experienced burnout and left the companyto pursue other interests. Jerry Baldrvin took overday+o-day management of the company and func-tioned as chief executive officer; Gordon Borvker re-mained involved as an owner but devoted most of histime to his advertising and design firm. a rveekly nes,s-paper he had founde{ and a microbrewery that he rvaslaunching knorvn as th,e Redhook Ale Bre*ery.

Iloward Schultz Entersthe Pictureln 198 I , Horvard Schultz, vice president and generalmanager of U.S. operations for a Srvedish makerof stylish kitchen equiprnent and coffeemakers,decided to pay Starbucks a visit-he rvas curiousabout rvlty Starbucks rvas selling so many of hiscompanyi products. The morning after his arrival inSeattle. he rvas escorted to the Pikes Piace store byLinda Grossman. the retail merchandising managerfor Starbucks. A solo violinisr x'as playing Mozart atthe door (his violin case open for donations). Schultzrvas immediately taken by the porverful and pleasing

aroma of the coffees. the rvall displaying coffeebeans, and the rorvs of coffeemakers on the shelves.As he talked rvitl'r the clerk behind tbe counter, theclerk scooped out some Sumatran coffee beans.ground them. put the grounds in a cone filter, peuls4hot rvater over the cone, and shortly handed Schultza porcelain mug filled rvith freshly brewed coffee.After only taking three sips of the brerv. Schultz rvashooked. He began asking the clerk and Grossmanquestions about the company, about coffees fromdifferent parts of the rvorld, and about the differentrvays of roasting coffee.

A bit later, he rvas introduced to Jerry Baldwinand Gordon Bowker, rvhose offices overlooked thecom-panyi coffee-roasting operation. Scbultz rvasstruck by their knorvledge about.coffee, their eom-mitment to providing customers rvi& quality coffees.and their passion for educating customers about themerits of dark-roasted coffees. Baldrvin told Schultz,

.'- tne companycoffees and put

them through a meticulous dark-roasting process tobring out their full flavors. Baldrvin explained thatthe cheap robusta coffees used in supermarket blendsburned rvhen subjected to dark roasting. He also notedthat the makers ofsupermarket blends preferred light-er roasts: rvhich allorved higher yields (the longer acoffee rvas roaste4 the more rveight it lost).

Schultz rvas also struck by the business phi-losophy of the nvo partners. It rvas clear that Star-buck stood ngtjust for good coffee but also for thedarl,i-roasted Havor profi les tl'rat the founders rvere pas-sionate about. Topqual ity, fresh-roasted rvlr o le-beancoffee s,as the conrpany's differentiating feature anda bedrock value. [t u,as also clear to Schultz that Star-bucks rvas strongly committed to educating its cus-tomers to appreciate the qualities of fine coffees. Thecompany depended mainly on rvord of mouth to getmore people into its stores, then built custonrer loyaltycup by cup as buyers gained a sense ofdiscovery ande.xcitement about the taste of fine coffee.

On his trip back to NervYork the next day, HorvardSchultz could not stop thinking about Starbucks andrvhat it *,ould be like to be a part of the Starbucksenterprise. Schultz recalled. "There rvas somethingmagic about it. apassion and authenticity I had neverexperienced in business."T The appeal of living intlre Seattle area ryas another stroug plus. By the timelre landed at Kennedy Airport, he knerv in his heart

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he rvanted to go to work for Starbucks. At the firstopportunity, Schultz asked Baldwin rvhether therewas any way he could fit into Starbucks. While Schultzand Baldwin had established an easy, comfortablepersonal rapport, it still took a year: numerousmeetings at which Schultz presented his ideas. and alot of convincing to get Baldrvin, Bowket and theirsilent partner from San Francisco to agree to hire

, ,him. Schultz pursued a job at Starbucks far morepnoL *flvigorously than Starbucks pursued hiring Schultz.

Th-eTe*wf some nervousness about bringing in anoutsider, especially a high-porvered New Yorker rvhohad not grolvn up rvith the values of the company.Nonetheless, Schultz continued to press his ideasabout the ffemendous poterrtial of expanding theStarbucks enterprise outside Seattle and exposingpeople all over America to Starbucks coffee. Heargued that there had to be more than just the fen,thousand coffee lovers in Seattle rvho tvould enjoythe companyl products.

At a meeting rvith t@-Qree olvners in SanFrancisco in the spring qftqg2,"Xehultz once againpresented his ideai *iuiffiffir opening Starbu-cksstores across the United States and Canada- Hethought the meeting rvent well and flerv back toNerv York, believing a job offer rvas in the bag.Holever, the next day Jerry Baldrvin called Schultzand indicated that the olvners had decided againsthiring him because geographic expansion $,as toorislry and they did not shap.Sphultf's vision forStarbucks. Scnutu rvas d8f#ornffi#, seeing hisdreams of being a part ofSiiiEGG' furure go upin smoke. Still, he believed so deeply in Starbucks'potential that he decided to make a last-ditch appeal;he called Baldrvin back the next day and made an

impassione-d reasoned case folyvhy tfgf,egision rvas

a nristake. Baldrvin agreed to4e""SfrSJ# The nextmoming Baldrvin called Schultz anil told hirn thejob of heading marketing and overseeing the retailstores rvas iris, In September 1982, Horvard Schultztook over his nerv responsibilities at Starbucks.

Starbucks and Howard Scluiltz:The 1982*1985 PeriodIn his 6rst ferv months at Starbucks, Horvard Schultzspent most of his rvaking hours in the four Seattlestores-rvorking behind the counlers, tasting dif-ferent kinds of coffee, talking rvirlr customers.gefting to knorv store personnel, and learning the

Case 29 Starbucks' Global Quest in 2006: ls the Best yet to Come? c-{7t

retail aspects of the coffee business. By December,Jerry Baldrvin concluded that Schultz rvas ready forthe final part of his taining, that of actually roastingthe coffee. Schultz spent a week getting an educationabout the colors of different coffee beans, listeningfor the telltale second pop of the beans during r _l ^-the roasting process, leaming to taste the subtle Cir,*h re

differences among Baldrvin and Borvkert variousroasts, and familiarizing himself with the. roastingtechn(ues for different Eeans. -*& " ",t

loSchultz made a point of aiclimA[rig himself

to the informal dress code at Starbucks, gainingcredibility and building tnrst with colleagues, andmaking the transition from the high-energy. coat-and-tie style of Nerv York to the more casual, lorv-key ambience of the Pacific Northrvest (see Exhibit2 for a rundorvn on Horvard Schultz's background).Schultz made real headrvay in gaining the acceptanceand respect of company persounel *,hile rvorkingat the Pikes Place store one day during the busyCtxistrras season that first year. The store rvas packedand Schultz rvas behind the counter ringing up salesof coffee rvhen someone shouted that a shopperhad just headed out the door rvith some stu$-:-twoexpensive coffeemakers it turned out_. one in eachhand. Without thinking, Schultz leaped over thecounterand chased the thiefup the cobblestone streetoutside the store, yelling. t'Drop that sfuffI Drop it!"The thief rvas startled enough to drop both piecesand run arvay. Florvard picked up the merchandiseand refurned to the store, holding the coffeemakersup like trophies. Everyone applauded. Wlren Schulureturned to his office later that afternoon, his staffirad strung up a banner that read: "Make my day."8

Schultz rvas overflorving rvith ideas for the com-pany. Early on, he noticed that first-time customerssometimes felt uneasy in the stores because of theirlack of knou,ledge about fine coffees and becausestore employees sometimes came across as a littlearrogant or superior to coffee novices. Schultzn'orked *,ith store employees on customer-friendlysales skills and developed brochures that madeit easy flor customers to learn about fine coffees.Horvever. Sclrultzi biggest inspiration and visionfor Starbucks' future came during the spring of 1983rvhen the company sent him to Milan, Italy, to attendan international house*,ares show. While walkingfrom his hotel to the convention center, he spottedan espresso bar and lvent inside to look around.The cashier beside the door nodded and smiled. The

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Exhibit 2 Biographical Sketch of Hovuard Schultz

Source.' Howard Schultz and Dori Jones Yang , Pour Your Heart Jnlo ,t (New York Hypedon, 1 997).

barista behind the countergreCIted Howard cheerfullyand moved gracefully to pull a shot of espresso forone customer and handcraft a foarny cappuccino foranother. all the rvhile;conversing merrily witll those

standing at the counter. Schulu thought the barista'sperformance was "great theater." Just dorvn tlte rvayon a side street, he entered in an even more crorvdedespresso bar rvhere the barista, rvhom ire sunnisedto be the o\yner. was greeting customers by name:people rvere laughing and talking in an atmospherethat plainly rvas comfortable and familiar. In flie nextferv blocks. he sarv trvo more espresso bars. Thatafternoon, rvhen the trade shor.v concluded for theday, Schultz rvalked the streets of Milan to explorenrore espresso bars. Some u,ere srylish and upscale:others attracted a blue-collar clientele. Most lrad fervchairs, and it rvas common for ltalian opera to beplaying in the background. What struck Schultz rvas

horv popular and vibrant the ltalian coffee bars rvere.

l:l'dwtY"9

Energy levels rvere typically high, and they seemedto function as3n integral cornmuniry gatirering place.Each one had its orvn unique character, but they allhad a barista rvho performed rvith flair and maintaineda camaraderie rvith the customers.

Schultz remained in Milan for a tveek, explor-ing coffee bars and learning as much as he couldabout the Italian passion for coffee drinks. Schulurvas particularly struck by the fact that there rvere1,500 coffee bars in Milan, a city about the size ofPhiladelphia. and a total of 200,000 in all of ltaly. Inone bar. he heard a customer order a caffe Iatte anddecided to try one himself--the barista made a shotof espresso, steamed a frothy pitcherofmilk. pouredthe hvo together in a cup, and put a dollop of foamotr the top. Schultz liked it immediately, concludingthat lattes should be a feature iten: on any cof.fee barmenu even though none of the coffee experrs he hadtalked to had ever mentioned them.

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shocked at the results, concluding that employeesuo longer trusted him. In the months that follorve{he began to spend more of his energy on Peet's

operation in San Francisco.It took Horvard Schultz nearly a year to con-

vince Jerry Baldrvin to let him test an esFresso bar.Baldrvin relented rvhen Starbucks opened its sixthstore in $prilf98j. It rvas the first store designedto sell Uffe##trnd it rvas the first store locatedin dorvnidifrTeaftle. Schulu asked for a 1,500-square-foot space to set up a full-scale Italian-styleespresso bar. but Jerry agreed to allocating only300 square feet in a corner of the nerv store. As adeliberate experiment to see ivhat would happen, thestore opened rvith no fanfare. By closing time onthe first day, some 400 customers had been servedrvell above the 25O-customer average of Starbucks'besrperforming . stores. Within hvo months thestore was serving 800 customers per day. The trvobaristas could not keep up rvith orders during theearly-morning hours, resulting in lines outside thedoor onto the sidervalk. Most of the business lvas atthe espresso counter. rvhile sales at the regular retailcounter lvere only adequate.

Schultz rvas elated at the test results. expectingthat Jerry's doubts about entering the beverageside of the business rvould be dispelled and that he

rvould gain approval to iursue the oppornrnity totalte Starbucl$ to a nerv level. Every day he rventinto Baldrvin's office to show him the sales figuresand customer counts at the ne$, dorvntorvn store.But Baldrvin was not comfortable rvith the successof the ne$' store. believing that it felt rvrong andthat espresso drinks rvere a distraction from thecore business of marketing fine arabica coffees atretail. Baldrvin rebelled at the thought that peoplervould see Starbucks as a place to get a quick cupof coffee to go. He adamantly told Schultz, "We'recoffee roasters. I don't rvant to be in the restauraltbusiness . . . Besides, we're too deeply in debt toconsider pursuing this idea."e While he didnl denythat the experiment rvas succeeding, he didn't rvantto go fonvard rvith introducing beverages in otherStarbucks stores. Schultz's efforts to persuadeBaldrvin to change his mind continued to meetstrong resistance. alttrough to avoid a total impasseBaldu,in finally did agree to let Schultz put espressomachines in the back of possibly one or trvo otherStarbucks stores.

'@

Case 29 Starbucks' Global Quest in 2006: ls the Best yet to Come?

Schultz's 1983 rip to Milan produced a rev-elation: The Starbuclcs stores in Seattle completelymissed the point. There was much more to the coffeebusiness than just selling beans and getting peopleto appreciate grinding their orvn beans and brewingfine coffee in their homes. What Starbucks neededto do rvas serve fresh-brewed coffee. espressos, andcappuccinos in its stores (in addition to beans andcoffee equipment) and try to create an Americanversion of the ltalian coffee bar culture. Going toStarbucks should be an experience! a special treat.a place to meet friends and visit. Re-ereating the au-thentic ltalian coffee bar culture in the United Statescould be Starbucks' differentiating factor.

Schnltz Become, ffi';61r0On Horvard Schultz's return from Italy, he sharedhis revelation and ideas for modiffing the format ofStarbucks'stores rvith Jerry Baldrvin and GordonBorvker. But instead of rvinning their approval fortrying out some of his ideas. Schultz encounteredstrong resistance. They argued that Starbucks rvas a

retailer, not a restaurant or coffee bar. They fearedthat serving drinks would put them in the beveragebusiness and diminish the integrity of Starbucks'mission as a purveyor of fine coffees. They pointedout that Starbucks had been profitable every yearand there rvas no reason to rock the boat in asmall, private company like Starbucks. But a rnorspressing reason not to pursue Schultz's coffee barconcept emerged shortly-Baldrvin and Borvkerrvere excited by an opporruniry to purchase PeetiCoffee and Tea. The acquisition rvas hnalized inearly 1984, and to fund it Starbucks had to takeon considerable debt. leaving little in the rvay offinancial Sexibility to support Schultz's ideas forentering the beverage part ofthe coffee business orexpanding the number of Starbucks stores. For mostof 1984. Starbucks n'tanagers rvere dividing theirtime betueen operations in Seattle and the Peet'senterprise in San Francisco. Schultz found himselfin San Francisco every other rveek supervising themarketing and operations of the five Peet stores.Starbucl<s enrployees began to feel neglected and inone quarter, did not receite their usual bonus dueto tight financial conditions. Employee discontentescalated to the point rvhere a union election rvas

called. The union rvon by tlrree votes. Baldrvin rvas

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Over the next several months, SchulE madeup his mind to leave Starbucks and start his orvncompany. His plan was to open sspresso bars in high-traffic dorvntorvn locations, serve espresso drinksand coffee by the cup, and try to emulate the friendly,energetic atrnospherc he had encountered in ltalianespresso bars. Baldrvin and Bowker. knowing horvfrushated Schultz had become, supported his effortsto go out on his orvn and agreed to let him stay in hiscurrent job and office untii definitive plans were inplace. Schultz left Starbucks in late 1985.

Schultz's Il Giornale YenfireWith the aid of a larvyer friend rvho helped companiesraise venture capital and go public, Horvard Schultebegan seeking out investors for the kind of com-pany he had in mind. Ironically, Jerry Baldrvincommitted to investing S 150,000 ofstarbucks'moneyin Schultz's coffee bar enterprise, thus becomingSchultz's first investor. Baldrvin accepted Schultz'sinvitation to be a director of the nerv eompany. andGordon Bolvker agreed to be a part-time consultantfor six months. Borvker, pumped up about the nervventure. urged Schultz to talie pains to make surethat everything about the nerv stores*the name. thepresentation, the care taken in preparing the coffee-be calculated to elevate customer expectations andlead tllem to expect something better than competitorsoffered. Borvker proposed that the nerv company benamed Il Giornale Coffee Company (pronouncedil jor NAHL ee), a suggestion that Schultz accepted.ln December 1985, Borvker and Schulu made a tripto Italy. rvhere they rdsited some 500 espresso barsin Milan and Vercii:a- observing local habits, takingnotes about decor and menus, snapping photo,Eraphs,and videotaping baristas in action.

About S400,000 in seed capital was raised bythe end ofJanuary 1986. enough to rent an office,irire a couple of key employees, develop a storcdesign. and open the first store. But it took until theend of 1986 to raise the remaining $l-25 millionneeded to launch at least eight espresso bars andprove that Schultz's strategy and business modelsere viable. Schuitz made presentations to 242potential investors, 217 of s,hom said no. Many rvhoheard Schultz's lrour-long presentation salv coffeeas a commodiry business and thought tlrat Schultz'sespresso bar concept lacked any basis for sustainablecompetitive advantage (*o patent on dark roast. no

advantage in purchasing coffee beans, no rvays to barthe entry of imitative competitors). Some noted thatcoffee couldn't be turned into a grorvth business-consumption of co$ee had been declining sincethe mid-1960s. Others rvere skeptical that peoplervould pay $1.50 or more for a cup of coffee, and thecompany's unpronounceable name turned some off.Being rejected by so many of the potential investorshe approached rvas disheartening (some rvho lis-tened to SchulU's presentation didn't even bother tocall him back: others refused to rake his calls).Nonetheless, Schultz maintained an upbeat aftitudeand displayed passion and enthusiasm in making hispitch. He ended up raising $1.65 million from about30 investors; most of the money came from ninepeople, five of rvhom became directors.

The first II Giornale store opened in Aprii 1986.It had 700 square feet and rvas located near the en-trance of Seattle's tallest building. The decor u,asItalian, and there rvere ltalian rvords on the menu.Italian opera music played in the background. Thebaristas rvore rvhite shirts and borv ties. All ser-vice rvas stand-up*there lvere no chairs. Nationaland international papers rvere hung on rods on thervatl. By closing time on the fust day, 300 custom-ers had been sened-mostly in the morning hours.But rvhile the core idea rvorked well. it soon becameapparent that several aspects of the format were notappropriate for Seattle. Some customers objected tothe incessant opera music. others rvanted a place tosit dorvn. and many did not understand the ltalianrvords on the,.menu. These "mistakes" were quicklyfixe4 but an bff[ort rvas made not to compromise thesgle and elegance of the store. Within six months.the store rvas serving more than 1.000 customersa day. Regular customers had learned hou, to pro-nounce the companyt name, Because most custom-ers lvere in a burry it becarne apparent that speedyservice lvas essential.

Six months after opening the first store. Schultzopened a second store in another dorvtlto\l.n build-ing. A third store rvas opened in Vancouver, BritishColurnbia- in April 1987. Vancouver was chosen totest the transferabiliry of the company's businessconcept outside Seattle. Schultz's goal rvas to open50 stores in five years. and he needed to dispel hisinvestors' doubts about geographic expansion earlyon to achieve his grorvth objective. By mid-1987.saies at the three steres were running at a rate equalto S 1.5 million annually-

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Il Giornale Acquires Starbucks

El4atql"]gEl.lrrry Baldwin and Gordon Borvkerdecided to sell the rvhole Starbucks operation inSeattle-the stores, the roasting plant, and theStarbucks name. Bowker wanted to cash out his cof-fee business invesfnent to concentrate on his otlrereoterprises; Baldwin, who rvas tired of commutingbehveen Seattle and San Francisco and u,restlingwith the troubles created by the two parts of thecompany, elected to concentrate on the Peett opera-tion. As he recalls, "My lvife and I had a 30-secondconversation and decided to keep Peet's. It rvas theoriginal and it rvas better,"ro

SchulU knerv immediately that he had to buyStarbucks; his board of directors agreed. Schultzand his nervly hired finance and accounting man-ager drerv up a set of financial projections for thecombined operations and a financing package thatincluded a stock offering to Il Giornale's originalinvestors and a line ofcredit rvith local banks. Whitea rival plan to acquire Starbucks was put togetherby another Il Giomale investor, Schultz's proposalprevailed-and rvithin rveeks Schulu had raised the$3.8 million needed to buy Starbucks. The acquisi-tion was completed in August 1987. The new nameof the combined compE-nre:TffiSarbucks Corpo-ration. HStarbucks president

STARBUCKS AS APRIVATE COffiFAISY:I 987-3. 992The follorving Monday morning-. Horvard Schultz re-turned to the Starbucks offices at the roasting plant.greeted all the familiar faces, and accepted their con-gratulations. Then he called the staff togetlrcr for ameeting on the roasting plant floor:

AII my life I have rvanted to be pax of a company anda -croup

of people n lto share a common vision . . . I'mhere today because I lore this corrrpany. I love rvhat itrepresenls. .. I knorv you-rc concerned. .. I promiseyou I rvill not let you dorvn. I promise you I rvill norleave anlonc behind . . . [n fir'e years. I tvant you tolook back at this day and say "I was there rvhen itstafled. I lrelped build this company into somer.hinggrelt."tr

c-475

Schultz told the group that his vision was forStarbucks to become a national compa[y rvith val-ues and guiding principles that employees could beproud of. He indicated that he wanted to includepeople in the decision-making process and that hewould be open and honest rvith them.

Schule believed that building a company thatvalued and respected its people, inspired them, andshared the fruits of success rvith those who contrib-uted to the company's long-term value tvas essen-tial, not just an intriguing option. His aspiration wasfor Starbucks to become the rvorld's most respectedbrand narne in coffee and for the company to be ad-mired for its corporate responsibility. In the next fervdays and rveeks, Schultz came to see that the unityand morale at Starbucks had deteriorated badly in the20 months he had been at Il Giornale. Some employ-ees rvere rynical and felt unappreciated. There rvas afeeling that prior management had abandoned themand a rvariness about lvhat the nerv regime rvouldbring. SchulE decided to make building a nery re-lationship of mutual respect behveen employees andmanagement a priority.

The nerv Starbucks had a total ofnine stores. ThebusinessplanSchultzhadf, -re:-En'tEil-rn-FE3todled

for the new compary to open 125 stores in the nextfive years-ls the first ygar, 20 the secon{ 25 thethir{ 30 the fourth, and 35 the fifth. Revenues wereprojected to reach $60 million in I992. But the com-pany lacked experienced management. Schultz hadnever led a growth effort of such magnitude and wasjust learning rvhat thejob of CEO rvas all about hav-ing been the president of a small company for barelyhvo years. Dave Olsen. a Seattle coffee bar ownerSchultz had recruited to direct store operarions at IlCiornale, rvas still leaming the ropes in managing a

multistore operation. Ron Larvrence. the company'scontroller, had rvorked as a control]er for several or-ganizations. Other Starbucks employees had only theexperience of managing or being a part of a six-storeorganization. Wren Starbucks'key roaster and cof-fee buyer resigned Schultz put Dave Olsen in clrargeof buying and roasting coffee. Larvrence Maltz, rvhohad 20 years'experience in business and eight years'e,tperience as president of a profitable public bever-age company, lvas hired as executive vice presidentand charged rvith heading operations, finance. andhurnan resources.

In the next several months. a number of changesrvere instituted. To symbolize the merging of the two

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companies and the trvo cultures, a new logo rvascreated that melded the designs of the Srarbucks logoand the Il Giornale logo. The Starbucks stores rvereequipped rvith espresso machines and remodeled tolookmore ltalian than Oldriforldaautical. Il Giornalegreen replaced the traditional Starbucks brorvn. Theresult lvas a nelv type of store-a cross between aretail coffee-bean store and an espresso barlcafd thathas nou, become Starbucks' signarure.

By December 1987, the mood of the employeesat Starbucks had turned upbeat. They rvere buyinginto the changes that Schultz rvas making and beganto Eust management. Nerv stores were on the vergeofopening in Vancouver and Chicago. One Starbucksstore empioyee, Daryl Moore, lvho had startedrvorking at Starbuck in l98l and rvho had votedagainst unionization in 1985, began to question theneed for a union rvith his fellorv employees. Over thenext ferv weeks, Moore began a move to decerti$the union. He carried a decertification letter aroundto Starbucks' stores securing the signatures of em-ployees rvho no longer rvished to be represented bythe union. He got a majority of store employees tosign the letter and presented it to the National LaborRelations Boar4 rvhich then decertified the unionrepresenting store employees. Later, in 1992, theunion representing Starbucks' roasting plant andrvarehouse employees was also decertified.

Market Expansiort Outsidethe Pacific NorthwestStarbucks'entry into Chicago proved far more trou-blesome than n:anagement anticipated. The firstChicago store o-!6ned in October 198? and threemore stores rvere opened over tbe next six months.Custonrer counts at tlre stores rvere substantiallybelorv expectations. Chicagoans did not rake to dark-roasted coffee as fast as Schultz had anticipated. Thefirst dou'nto$.n store opened onto the street rathertl'ran into the lobby of the building u,here it rvaslocated; in the rvinter rnotrths. customers rvere hesi-tart to go out in the rvind and cold to acquire a cup ofcoffee. It rvas more expensive to supply fresh coffeeto the Chicago stores out of the Seattle warehorrse(ilre company solved the problem of freshness andquality assurance by putting freshly roasted beans inspecial Flavorlock bags that used vacuum packag.ing techniques with a one-way valve to allorvcarbondioxide to escape tvithout allorving air and moisturein). Rents rvere higher in Chicago than in Seattle,

and so were lvage rates. The result rvas il squeezeon store profit margins. Cradually. customer countsimproved, but Starbucks lost money on its Chicagostores until, in 1990, prices rvere raised to reflecthigher rens and labor costs. more experienced storemanagers rvere hired. and a critical mass of custom-ers caught on to the taste of Starbucks products.

Portland, Oregon, lvas the next market Starbucksentered, and Portland coffee drinkers took to itsproducts quickly. By 1991, the Chicago srores hadbecome profltable and the company rvas ready forits next big market entry. Management decidedon California because of its host of neighborhoodcenters and the receptiveness of Californians to higlr-quality, innovative food- Los Angeles rvas chosen asthe first California market to enter. L.A. rvas selectedprincipally because of its status as a trendsetterand its cultural ties to the rest of the country. L.A.consurners embraced Starbucks quickly, and the ZosAngeles lirres named Starbucks as the best coffee inAmerica even before the first area store opened. Theentry into San Francisco pfoved more troublesomebecause San Francisco had an ordi.nance againstconverting stores to restaurant-rclated uses in certainprime urban neighborhoods: Starbucks could sellbeverages and pastries to customers at stand-upcounters but could not offer seating in stores that hadformerly been used for general retailing. Horvever.the city council was soon convinced by cafd orvnersand real estate brokers to change the code. Still.Starbucks faced strong competition from Peet's andlocal espresso bars in the San Francisco market"

Starbucks' store expansion targets proved easierto meet than Schultz had originally anticipate-d. andhe upped the numbers to keep challenging the or-ganization. Starbucks opened l5 nes, stores in fiscal1988,20 in 1989, 30 in 1990, 32 in 199t. and 53 in199Z-producing a rotal of l6l stores. significantiyabove tlre 1987 objective of 125 stores-

From the outset. the strategy was to open onlycompany-otvned stores; franchising r.r,as avoided soas to keep the company in full control of the qualityof its products and the character and location of isstores. But company orvnership of ail stores requiredStarbucks to raise netv venture capital to cover thecost of new store expansion. In 1988, the companyraised $3.9 million: in 1990, venture capiralistsprovided an additional SI3.5 million; and in 1991,another round ofventure capital financing generatedSl5 million. Starbucks rvas able to raise the neededfunds despite posting losses of $3i0,000 in 1987.

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$764,000 in 1988, and $1.2 million in 1989. Whilethe losses wer€ Eoubling to Sta$ucks' board ofdirectors and investors, SchulE's business plan hadforecast losses during the early years ofexpansion.At a particularly tense board meeting rvhere directorssharply qu€stioned Schultz about the lack of profit-ability, SchulE said:

Look, rve're going to keep losing money until tve cando three things. We have to attract a manageme nt r€amrvell beyond our expansion needs. We have to build arvorld-chss roasting facility. And rve necd a compu-ter information system sophisticated enough to keeptrack ofsales in hundreds and hundreds ofstores.tl

Schule argued for patience as the company in-vested in the infrastructure to support continuedgrowth rvell into the 1990s. He contended that hiringexperienced executives ahead of the grorvth curve.building facilities far beyond current needs, and in-stalling support systems laid a srong forrndation forrapid, profiAble grorvth on down the road. His argu-ments carried the day rvith the board and rvith in-vestorst especially since revenues lvere grorving byapproximately 80 percent annually and customer trafficat the stores was meeting or exceeding expectations.

Starbucks became profitable in 1990; profitshad i*creased every year since I 990 except for fiscalyear 2000 (because of $58.8 million in investmentlvrite-offs in four dot-com enterprises)- Exhibit 3

provides a financial and operating summary for2000-2005. Exhibit 4 shorvs the performance oflthecompany's stock price. The stock had split 2-for-lfive times. In September 2005, Starbucks' board ofdirectors approved the repurchase of up to 5 millioushares of common stock; a total of 35.7 millionshares bad been repurchased since the companyrvent public.

HOWARD SCH[."[LTZ'SSTRATEGY TO IWAKESTARBUCKS A GREATPLACE TO UUORK

Horvard Schultz deeply believed that Starbucks'suc-cess lvas heavily dependent on customers luving a

very positive experience in its stores. This meanthaving store employees *,ho rvere knorvledgeableabout the company's products. rvho paid attention to

Case 29 Starbuck! Global Quest in 2006: ls the Best Yet to Come?

detail in preparing the company's espresso drinks,who eagerly communicated the companyt passionfor coffee, and rvho possessed the skills and per-sonality to deliver consistent, pleasing customerservice. Many of the baristas rvere in their 20s andrvorked part-time, going to college on the side orpursuing other career activities. The challenge toStarbucks, in Schultz's view, rvas how to attract, mo-tivate, and reward store employees in a manner thatrvould make Starbucks a company that people rvouldrvant to work'for and that rvould generate enthusias-tic commitrnent and higher levels of customer ser-vice. Moreover, Schultz wanted to send all Starbucksemployees a message that would cement the trustthat had been building between nranagement and thecompany's rvorldorce.

One of the requests that employees had made tothe prior owners of Starbucks rvas to extend healthcare benefits to part-time rvorkers. Their requesthad been tumed dorvn, but Schultz believed thatexpanding health care coverage to include part-timers rvas the ri-eht thing to do. His father hadrecently passed arvay with cancer and he knerv fromhis orvn experience of having grorvn up in a ftirnilythat struggled to make ends meet how difficult it rvas

to cope rvith rising medical costs. in 1988. Schultzwent to the board of directors with his plan to expandthe company's health cEue coverage to include part-tinrers rvho rvorked at least 20 hours per rveek. He sarv

the proposal not as a generous gesture but as a corestrategy to win employee loyalty and commitmentto the company's mission. Board members resistedbecause the company rvas *nprofitable aud the addedcosts of the exiended coverage *,ould only rvorsenthe company's bottom line. But Schulu arguedpassionately that it was the right thing to do andrvouldn't be as expensive as it seemed. ble observedthat if the nerv benefit reduced turnover, rvhich he

believed rvas likely, then it s,ould reduce the costs ofhiring and training-rvhich equaled about $3,000 pernerv hire; he firther pointed out that it cost SI,500a year to provide an employee rvith full benefits.Part-timers. he argued rvere vital to Starbucks.constiruting hvo-thirds of the company's rvorkforce.Many rvere baristas rvho knerv the favorite drinks ofregular customers; if the barista left. that connectionrvith the customer rvas broken. Moreover, nranypart-time employees rvere called upon to open thestores early sometimes at 5:30 or 6:00 a.m.; othershad to rvork until closing, usually 9:00 p.m. or later.Providing these employees u,ith health care benefits,

Ei

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c{78 Part 2 Cases in Crafting and Executing Strategy

he argued, rvould signal that the company honoredtheir value and contribution.

The board approved Scliultz's plan, and part-timers rvorking 20 or mere hours rvere offered thesame health cov€rage as full-time employees startingiu late 1988. Starbucks paid 75 percent of an employ-ee's health care premium; the empioyee paid 25 per-cent. Over the years, Starbucks extended its healthcoverage to include prevenfive care, crisis counseling,dental care, eye care, mental health, and chemical de-pendency. Coverage rvas also offered for unmarried

@ The McGrarv-Hill

Comuanies.2007

parhers in a commined relationship. Since mostStarbuclis' employees were young and compara-tively healthy, the company had been able to providebroader coverag€ rvhile keeping monthly paymentsrelatively lorv. The value of Starbucks'health care pro-gram struck home rvhen one of the company's storemanagers and a former barista rvalked into Schultz'soffice and told him he had AIDS:

I had knoln he rvas gay but had no iriea he rvas sick.His disease had entered a nerv phase, he explained.and he rvouldn't be able to rvork any lonser. We sat

"t

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I lhompson-Srricltand-0ambter I

Craftiag aBd Er6Euting

Strategp Concepts and

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Sbrbucks'Global0uesrin I Case

2006: [s lhs Best Yel loCome?

E"v#i&ii:3 Financial and Operating Summary for Starbucks Corporation,FiscalYears 2000-2005 (dollars in 00Os)

179,8520;,,,,.,,,110;202 .

$rii:280;219rr

Sijii:,78i794,i',iiil $* 9458a::

iii $5;aQli .riii3i3i?,sll

$1,366,355 ' i 51,148,399

Cti nent ilabiliiies:l;,rrir

G1;7{2i4s6:

\Continued)

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Starbucks' Global {Iuest in

2006: ls tfts SEst Yet to

Come?

@ The McGaw-Hill

Cm6pani€s, 2007

Case 29 Starbuck's Gtobal Quest in 2006: ls the Best Yet to Come?

Exhibit 3 Continued

c{79

. ....,... .. ..,,.....ri;.;.::;.:.::::1 j-1 ::r:jrii,.:j it,:!..it,-::. ,. .. I

;'rr- iritga,slrts,,Et1r1'.,1 jtiif1f.r1',$+1151r'..,'"..,u".i;:...ii..

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r""",,: ri:i::i:'t: ':r'::":"':'l:"i':':"'""""""''.'::

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lThe company! tiscal year ends on the Sunday closest to September 30. All fiscal years presenled include 52 weeks, excepl fiscal 20M,which includes 53 weeks.:ln fiscal 2000, the company wrote oti most of its inveslment in ,our ill-fated dot-com businesses. ln fiscal 2001, lhe company wrole olf anadditional S29 million in lnternet-related investments.lon October 10, 2001, the company sotd 30.000 of its shares ol Starbucks Coflee Japan Ltd. at approximalely S495 per share, nei ofrelated costs. which resulled in a gain ol S13.4 million.{Earnings per share data tor fiscal years presenled above have been restated lo rellect the 2-!or-1 stock splils in liscal 2006 and 2001.sworking capital deiicit as of October 2, 2OO5, was primarily due to lower invesiments lrorn the sale of securities to fund common slockrepurchases and increased cunenl iiabilities lrom short-term borrowings under lh€ revolving credit facilily,clncludes only Starbucks company-operated retail stores open 13 months or longer. Comparable Store Sales percentage for tiscal 2004excludes lhe extla sales week.TStore openings are reporled nel ol closures.Elnternational slore informalion has been adiusled for lhe liscal 2005 acquisilions of licensed operaaions i* Germany, southern China, andChile by reclassilying hislorical inforrnalion lrom liceased store to company-operaled stores.eunited Slates slores open at liscal 2003 year end included 43 SBC and 21 Tonefazioile ltalia Company-operated stores and 74 SBCfranchised stores.

Saurce: 1O.K reporls lor 2005, 2004, 2003. 2002, and 2000. Notes renect e005 1G.K reporl.

together und cried. l'or I could not {i$d mciuringlulwords to console hinr. I couldn't compose nryself. Ilruggcd him.

At rhtt point. Starbucks had no provision foremployees rvith AIDS. We had a policy decision.

Because of' Jim. rve dccided to oller lrealth-carecovenlge to all cmployces rvlto have ternrinal illnesses.paying medlcal costs ia full from the time tlrcy are notable to rvork until they are covered by govemr:rentprograms. usually trvcnty-ninc months.

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I

Starbucks'Global lluest in I Case

An& b $e Sest Yct to

Come?

@Tlte McGarv-llill

Corpa{es.2007

Spl its : v

nade in October 1991, jusr afrer the end of thecompanyt fiscal year in September; each partnerlvas granted stock options rvprth l2 percent of basepay. Each October since then, Starbucks has grantedemployees options equal to 14 percent ofbase pay,arvarded at the stock price at the start of the fiscalyear (October I ). When the Bean Stock program lvaspresented to employees, Starbucks dropped the termemplol,ee and began referring to all of its people as

parlfiers because everyonet including part-timersrvorking at least 20 hours per rveelq rvas eligible forstock options after six months. At the end of fiscalyear ?004, Starbucks'employee stock option planincluded 38.4 million shares in outstanding options;nerv options for about 9 million shares were beinggranted annually.15

Starbucks Stock Purchase Planfor EmployeesIn 1995, Starbucks implemented an employee stockpurchase plan. Eligible employees could contributeup to l0 percent of their base eamings to quar-terlypurchases of the company s comnrcn stock at 85percent of the going stock price. As of fiscal 2005,about 14.8 million shares had been issued sinceinception of the plan. and nerv shares rvere beingpurchased at a rate close to I million shares annuallyby some 18,800 active ernployee parricipants (outof almost 55,100 employees rvho nere eligible to

Part 2 Cases in Crafting and Executing Strategy

Exbibit.l The Performance of Starbucks' Stock, 1992-2005

Source.' ,:1.r.-=-i*:rr-c:;ji"i:?-i:i::..,j-..clj.ij: (acressed December 28, 2005).

After his visit to me. I spoke with Jim ofien andvisited him at the hospice. Within a year he was gone.

I received a letter from his family aftenvard. tellingme horv much they appreciated our benelit plan.rs

In 1994 Horvard Schultz rvas invited to theWhite House. He met one-on-one rvith PresidentBill Clinton to brief him on the Starbucks' healtltcare program.

The Creation of an EnryloyeeStock Optiott PlanBy 1991 the company's profitability had improved tothe point rvhere Schultz could pursue a stock optionplan for all employeeSi a program he believed rvouldhave a posifive."'long-term effect on the success ofStarbucks.r{ Schultz lvanted to turn all Starbucksen'rployees into partners, give them a chance toshare in the success of the company, and make clearthe connection betueen their contributions and thecompany's market value- Even though Starbuckswas still a prirate company, the plan that emergedcalled for granting stock options to all full+imeand part-time employees in proportion to iheir basepay. The plan. dubbed Bean Stock, was presentedto the board in May 1991. Though board membersrvere concerned that increasing the number ofshares might unduly dilute the value of the sharesof investors rvho had put up hard cash, the planreceived unanimous approval. The first grant $'as

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Starbuclts'Global 0u8!t in I Base

2906: ls the Btst Yslto

Come?

I Gr Ttre tr,tc6orv-Hirt

CompariDs.2007

rvorltforce of over I15.000 People rvorldwide, learntheir concerns, and measure job satisfaction. In the

latest sample survey of 1,400 employees. 79 percent

rated Sta$ucks' rvorkplace envtoffnent favorablyrelative to other companies they were familiar with,72 percent reported beiug satisfied rvith their presentjob, 16 percent rvere neutal, and 12 percent weredissatisfied. But &e 2002 survey revealed that manyemployees vierved the benefits pacloge as only"average," prompting the company to increase itsmatch of 401(k) contributions for those rvho had beenrvith the company more than three yeors and to have

these contributions vest immediately.Exhibit 5 contains a summary of Starbucks'

fringe benefit program. Starbucks rvas named byFortwrcmagazine as one ofthe "l00 Best Componiesto Work For" in 1998. 1 999, 2000, 2002, 2003, 2004,and 2005. ln 2005, Starbucks rvas rariked llth. up

from 34th in 2004. In October 2005, Starbuckshad approximately 1 15,000 employees rvorldrvide.of rvhich 97,500 rvere in the United States. It had

91,200 employees in its U.S. company-owned stores.

Employees at l0 stores in Canada rvere represented

by a union.

Stat'bttcks' Corporate Yahtes &ndBushrcss PrinciplesDuring the early building years, Howard Schultaand other Starbucks' senior executires worked to

instill some key values and guiding principles into

Case 29 Starbucks' Global Quest in 2006: ls ttre Eesi Yet to Come?

participate).t6 During fiscal 2004, the U.K. Share

Incentive PIan. a nerv employee stock purchase

plan rvas introduce4 discontinuing the original planestablished in 2002. As offiscal 2005, 1 0,732 shares

had been issued.r?

The'lVorkplac e E nv iro nrue ntStarbucks' managernent believed the company's pay

scales (around $9*$12 per hour) and fringe benefitpackage allorved it to attract motivated people rvithabove-average skilis and good rvork habig. Storeemployees were paid several dollars above the hourlyminimum wage. Whereas most national retailersand fast-food chains had turnover rates for store

employees ranging from 150 to 400 percent a year,

the turnover rates for Starbucks baristas ran about 65percent. Starbucks' turnover for store managers was

about 25 percent, compared to about 50 percent forother chain retailers. Starbucks executives believedthat efforts to make the conrpany an attractive. caringplace to rvork rvere responsible for its relativelylow turnover rates. One Starbucks store managercommented "Morale is very high in my store among

the staff. I've rvorked for a lot of companies, but I'venever seen this level of respect. It's a company that'svery true to its rvorkers, and it shorvs. Our customersahvays comment that rve're happy and having fun. Infact, a lot of people ask if they can rvorli here."r3

Starbucks' management used annual "ParlnerView" surveys to solicit feedback from the company's

f,rr;/rilrir 5 Elements of Starbucks' Fringe Benefit Program

riaj:l

::iilSij:

Source: Compiled by lhe case researchers lrom company documenls and olher soutoes'

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Slsrtucks' Globsl 0uesl in

2lI)6: ls the Best Yet to

Come?

Part 2 Cases in Crafting and Executing Strategy

the Starbucks culrure. The cornerstone value in theeffort "to build a company lvith soul" was that the____company wo@ the perfectcup of coffee-it rvould continue buyrng the bestbeans and roasting them to perfection. SchulUremained steadfastly opposed to franchising; hervanted the company to-tfi5-lel6iE5fr alrtyof its products and build a culture common to allstores. He was adamant about not selling artificially{lavored co[e--e, beq4; : *ffiltrtiry-5e*#ffiffihemical s." tf a customer rvantedhazelnut-ffavored coffee, Starbucks rvould addhazelnut syrup to the drinL, rather than adding hazel-nut flavoring to the beans during roasting. Runningflavored beans through the -srinders would result inchemical residues being left behind to alter the ffavorof beans ground aftenvard; plus, the bhemical smellgiven offby artificially flavored beans rvas absorbedby other beans in the store. Furthermore, Schultzdidn't rvant the company to pursue supermarket salesbecause it rvould mean pouring Starbucks'beans intoclear plastic bins rvhere they could get stale, thuscompro-mising *re company's legacy of fresh, darlc-roasted fu ll-fl avored coffee.

Sta:bucks' management was also emphaticabout the importance of employees paying attentionto rvhat pleased customers. Employees rvere trainedto go out of their rvay*even to take heroic measuresif necessary-to make sure customers rvere fullysatisfied. The theme rvas "Just say yes" to customerrequests. Further employees rvere encouraged tospeak their minds without fear of retribution fromupper management--?Senior executives rvanted em-ployees to be struiight tvith them, verbalizing rvhatStarbucks rvas doing right, rvhat it rvas doing wrong,and rvhat cltanges rvere needed. Matagernent wantedemployees to be involved in and contribute to theprocess of making Starbucks a better company.

A values-and-principles crisis arose at Starbucksin 1989 rvhen customers started requesting nonfat(skim) milk in making cappuccinos and lattes. How-ard Schullz, rvho read ail customer comments cards,and Dave Olsen. head of coffee quality, conductedtaste tests of lattes and cappuccinos made u'ithnonfat mitk and concluded they rvere not as good as

those made rvith u,hole milk. Horvard Behar, recenttyhired as head of retail store operations, indicatedthat management's opinions didn't matter; whatmattered rvas giving customers rvhat they rvanted.

Schultz sai{ "We rvill never offer nonfat milk. It'snot rvho tve are." Behar, horvever. stuck to his guns,rnaintaining that use of nonfat milk should at least betested-othenvise, it appeared as if all the statementsmanagement had made about the importance ofreally and truly pleasing customers rvere a sham.A fierce internal debate ensued. One dogmaticdefender of the quality and taste of Starbucks'coffeeproducts bunonhoied Beharou$ide liis of6ceand toldhim that using nonfat milk amounted to "bastardizing"the company's products. Numerous store managersmaintained that offering hvo kinds of milk rvasoperationally impractical. Schultz found himself in aquandary torn between the company's commitrrrentto quality and its goal of pleasing customers. Then.one day after visiting one of the stores in a residentialneighborhood and watching a customer leave to go toa competitor's store because Starbuclcs did not makelattes rvith nonfat milk, Schultz authorized Behar tobegin testing.te Within six months. all 30 stores rvereoffering drinks made rvith nonfat milk. Currently,about lralf the lattes and cappuccinos Starbucks sellsare made rvith nonfat milk.

Schultz's approach to offering employees goodcompensation and a comprelrensive benefits packagervas driven by his belief that sharing the company'ssuccess rvith the people rvho made it happen helpedeveryone think and act iike an o$.ner. build positivelong-term relationships with customers, and do thingsefficiently. He had vivid recollection of his fathertemployment -experience*bouncing from one lorv-paying job tti another. rvorking for employers rvhooffered feu, or no ber:efits and rvho conducted theirbusiness rvith no respect for the contributions of thervorkforce-and he had no intention of Starbucksbeing that type of company. He vou,ed that he rvouldnever let Starbucks enrployees suffer a similar fate.saying:

iVIy tathor rvorked hard all his lite and he had liuleto shorv for il He s,as a beaten man. This is not theAmerican dream. The rvorker on our plant floor iscontrihuting great virlue to the company: if he or shehas lorv self-rvorrh. rhar will have an effect on rhecompany.l'

The company's employee benefits program tvaspredicated on the belief that better benefits atractgood people and keep them longer. Schultzi ratio-nale, based on his father's experience of -uoing fromone lorv-rvage. no-benefitsjob to another, rvas that if

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Itonpton-SEictland-Santle:

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Gases. l5th Erlirion

Starburks' Slobsl Ouest in

2004 ls fte SestYel io

Como?

Case 29 Starbucks' Global Quest in 2006: ls ffie Best Yet to Come?

STATEMETUT

Gr!.-6" ["**"#

|,"'"*;[email protected]

llrnl" d.f { *f^ ,

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geographic expansion stategy that targeted areasthat not only had favorable demographic profiles butalso could be serviccd and supported by the com-pany's operations infrastructure. For each targetedregion. Starbucks selected a large city to serve as ahub; teams of professionals rvere located in hub ciries to support the goal of opening 20 or more storesin the hub in the first tivo years. Once stores blan-keted the lrub, then additional stores rvere opened insmaller, surrounding spoke areas in the region. Tooversee tlre expansion process, Starbucks createdzone vice presidents to direct the development ofeach region and to implant the Starbucks culture inthe nervly opened stores. All of the nerv zone viceprcsidents Starbucks recruited came s,ith extensiveoperating and marketing experience in chain storeretailing.

Skrbucks' smtegy in major metropolitan cit-ies rvas to blanket the area rvith stores, even if somestores cannibalized another store's business.:r Whilea nerv store might drarv 30 percent of the business ofan existing store trvo or so biocks arvay, managementbelieved its "Starbucks everyrvhere" approach cutdorvn on delivery and management costs, shortenedcustomer lines at individual stores, and increasedfoot traffic for all the stores in an area.

In 2002, new stores generated an average of$1.2rnillion in first-year revenues. compared to 5700,000in 1995 and only S427,000 in 1990. The steady in*creoses in nerv-store revenues rvere due partly togrorving populariry of premium coffee drinks and

vou treat vour emplovees rvell, thev in turn *iil* STARETFCKS' STOREtreatcustomersrverr' f{ ExpJirusloru STRATEGY

$TARB[jCKS' M[SS[OAE i h tgsz and lee3 starbucks developed a tlrree-year

ln early I 990. the senior executive team at Starbuckswent to an off-site re$eat to debate the company'svalues and beliefs and draft a mission statement.Schultz wanted the mission statement to convey astrong sense oforganizational purpose and to articu-late the company's fundamental beliefs and guidingprinciples. The draft rvas submiffed to all employeesfor revierv and several changes were made based onemployee cornments. The resulting mission state-ment, which remained unchanged in 2005, is shorvnin Exhibit 6.

Following adoption of the mission statement.Starbucks' management implemented a "MissionRevierv" to solicit and gather employee opinions as

to rvhether the company rvas living up to its statedmission. Employees rvere urged to report their con-cerns to ttre company's Mission Revierv team ifthey thought particular management decisions werenot suppor{ive of the companyi mission statement.Comment cards rvere given to each nervly hiredemployee and rvere kept awilable in conrmon areas

rvith otheremployee forms- Employees had the optionof signing the comment cards or not- Hundreds ofcards were submitted to the Mission Revierv teameach year. The company promised that a relevantmanagerwould respond to all signed cards rvithin hvorveeks. Horvard Schultz revierved all the comments,signed and unsigned.

Exhibit 5 Starbucks' Mission Statement

j,l,

i,.+

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20{E: ls &e EestY?t to

Ccme?

@ Ihe McGmrv-Hill

Companies,2{}07

c*484 Part 2 Cases in Crafting and Executing Skategy

partly to Starbucks'growing reputation. In more andmore iRstances, Starbucks' reputation reached newmarkets even before stores opened. Moreover, exist-ing stores continued to post sales gains in the rangeof 2-10 percent annually. In 2005, Starbucks postedsame-store sales increases averaging 8 percent (referback to Exhibit 3 ), the l4th consecurive year rhe com-pany had achieved sales growth of5 percent or greaterat existing stores. Starbucks' revenues had climbedan average of20 percent annually since 1992.

One of Starbucks' core competencies rvasidenti$ring good retailing sites for its new stores.The company was regarded as having the bestreal estate team in the coffee bar industry and a

sophisticated system for identiSing not only themost attractive individual city blocks but, also theexact store location that rvas best; it also workedhard at building good relationships with local realestate representatives in areas rvhere it was openingmultiple store locations. The company's site locationtrack record tvirs so good that, as of 1997, it hadclosed only 2 of the I.500 sites it had opened; itstrack record in finding successful store locationswas still intact as of 2005 (although specific figuresrvere not available).

In markets outside the

I nte rnatio nal E xp an sio n

United States

expansloncompany

-opeifie*iiffi*ffiffiStrybueks-'used* r"ldeef!ffi6r/licensee to helpit recruit talented individuals. set up supplierrelationships. locate suitable store sites. and caterto local market conditions. Starbucks looked forpartners/licensees that had strong retaillrestaurantexperience. had values and a corporate culfurecompatible rvith Starbucks', $,ere committed to goodcustomer service. possessed talented managementand strong financial resources! and had demonstratedbrand-building skills.

Starbuck had created a ne\y subsidiary Star-bucks Coffee lnternational, to orchestrate overseasexpansion and begin to build the Starbucks brandname globally via licensees. (Refer back to Exhibit Ifor the number of licensed international stores in

each country.) Starbucks' management expected tohave a total of 10.000 stores in 60 countries by theend of 2005. As of August ?005, Starbucks was lo-cated in 34 countries. with 1,049 company-operatedstores and l,734licensed locations outside the UnitedStates. The company's fust store in France bpenedin early 2004 in Paris. China was exFected to beStarbucks'biggest market outside the United Statesin the years to come. Thus far. Starbucks'productswere proving to be a rnuch bigger hit rvith consum-ers in Asia than in Europe. In 2003, the StarbucksCoffee International division rvas only marginallyprohtable, rvith pretax eamings of only S3.B millionon sales of $603 million. Horvever, the profitabilirypicture improved in 2004, with pretat profirs risingto $5 I .7 miliion on sales of $803 million. And it dideven better in fiscal 2005, rvith prete\ earnings of$86.4 million on sales of $1.03 billion.

So far. Starbucks had avoided

Iicensed operations in Germany and Chile (where ithad been a 20 percent equiry partner), and it boost-ed its orvnership of stores in southern China from20 percent to 5l percent.

In klay 2005, Starbueks announced the firststep into expanding its consumer products channelin the South Pacific region by launching the salesof its Frappudcino line in Japan and Tairvan. Thecombined ready+o-drink markets in these countriesrepresented more than Sl0 billion in annual sales.:lIvlarketing of Frappuccino products also began inSouth Korea through agreements tvith leading lo-cal distributors; the ready-to-drink coffee segmenrin South Korea represented $320 million in annualconsumer sales.lt

Employee Tra*tiltg andRecogttitionTo accomrnodate its strategy of rapid store expan-sion, Starbueks put in systems to recruit. hire, andtrain baristas and store managers. Starbucks' vicepresident for human resources used some simpleguidelines in screening candidates for nerv posi-tions. "Vy'e rvant passionate people rvho love coffee. . . lVe're lookin,e for a diverse u,orkforce. rvhiclr

refiuI$tflEnd capable.local company qlth*!a.,{ipgkiro*E owi@develop and

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2005: li rhq Ecst Yet to

Come?

reflects our community. We tvant people who enjoyrvhat they're doing and for lvhom rvork is an exten-sion of themselves."l4

Every parher/barista hired for a retail job in aStarbucks store received at least 24 hours trainingin his or her first hvo to four rveeks. The topicsincluded classes on coffee history, drinli preparation,coffee knorvledge (four hours), customer service(four hours), and retail skills, plus a four-hourrvorkshop titled'*Brerving the Perfect Cup." Baristasspent considerable time learning about beveragepreparation-grinding beans, steaming milh learn-ing topullperfect ( I 8- to23-second) shots ofespresso.memorizing the recipes of all the different drinks,practicing making the different drinks, and learninghorv to customize drinks to customer specifications-There rvere sessions on operating the cash register,cleaning the milk rvand on the espresso machine.explaining the ltalian drink names to unknorvingcustomers, selling home espresso machines, makingeye contact rvith customers, and taking personalresponsibility for the cleanliness of the store.Everyone was drilled in the Star Skills. tlueeguidelines for on-the-job interpersonal relations:(l) maintain and enhance self-esteern, (2) Iisten andacknorvledge, and (3) ask for help. And there rvererules to be memorized: Milk must be steamed to atleast 150 degrees Fahrenheit but never more than170 degrees; every espresso shot not pulled rvithin23 seconds must be tossed; never let coffee sit inthe pot more than 20 minutes; ahvays compensatedissatisfied customers rvith a Starbuck coupon thatentitles ttrem to a free drink.

In response to feedback tluough 2003 Parr-ner Vierv Survey, Starbucks expanded its trainingand career developnrent oferings by adding thefollorving::s

Colfee lulasters PrCIg,anr.' A sel of courses inrvhich partners deepen their coffee knorvledgeand expertise. More than 7.000 pilrrners havetaken advanta-ee of this training eitirer partiallyor t'ully.

Senant Leadership {'Yorkshop: A rvorkshopthar emphasizes trust. collaboration, people de-velopmenl and cthics. Approximarcly 6,200pa.rtncrs attended this rvorkshop.

Carcer Pou'er and Cor.eer Pou,er forCoaches {'lrorl*hop: A rvorkshop designeclto provide psrtners and their managers rvith anopportunity to re{lect oD their personal valucs.

Case 29 Starbucks' Globat Quest in 2006: ls the Best yet to Come?

carcer dreams, and development through coach-ing and l'eedback. More than ?00 partners inSeatle attended the rvorkshop.

Management trainees attended classes for 8 to12 rveeks. Their haining covered not only the cof-fee knowledge and information imparted to baristasbut also the details ofstore operations, practices andprocedures as set forth in the company's operatingmanual, information systems, and the basics of man-aging people. Starbucks'trainers rvere all store man-agers and district managers rvith on-site experience.Among their major objectives lvere to ingrain thecompany's values, principles, and culture and to passon their lmorvledge about eoffee and their passionabout Starbucks.

When Starbucks opened stores in a nel market.it launched a major recruiting effo*. Eight to l0rveeks before opening a store, the company placedads to hire baristas and begin their training. lt senta Star team of experienced managers and baristasfrom existing stores to the area to lead the store-opening effiort and to conduct one-on-one trainingfollorving the company's formal classes and basicorientation sessions at the Starbucks Coffee Schoolin San Francisco.

To recognize tite partner contributions, Star-bucks had created 19 different arvards programsranging from frequent arvards to high-level casharvards. Some of the high-level arvards includedManager of &e Quarter for store manager leader*ship. Green Apron Awards for outstanditrg customerservice. and Green Bean Awards for exceptionalsuppo{ for companyi environmental mission.

Real Estate, Store Desigrt, StorePlannhtg, and C anstructionStarting in 1991. Starbucks created its orvn in-houseteam ofarchitects and designers to ensure that eachstore rvould convey the right image and character.Stores had to be custom-desiened because the com-pany clitltrT-buy real estate and build its orvn free-

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'. each space rvas leased in an existing struciiire,making each store differ in size and shape. Moststores ranged in size from 1.000 to I.500 square feetand nere located in office buildings. dorvntorvn andsuburban retail centers. airport terminals, universitycampus areas. and busy neighborhood shopping

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areas convenient for pedestrian foot traffic and/ordrivers. Only a select fetv were in suburban malls.

Over the years, Starbucks had experimentedwith a broad range of store formats. Special seatingareas were added to help make Starbucks a desir-able gathering place where customers could meetand chat or simply enjoy a peaceful interlude in theirday. Flagship stores in high-traffic, high-visibilitylocations had lireplaces. leather chairs, nelvspapers,couches, and lots of arnbience. The company alsoexperimented rvith drive-through windows in loca-tions rvhere speed and convenience wers importantto custorners and with kiosks in supermarkets, build-ing lobbies, and other public places.

A "siores of the futrue" project team rvas formedin 1995 to raise Starbucks'store design to a still hi-eherlevel and come up with the next generation of Star-bucks stores. The vision of rvhat a Starbucks storeshould be like included such concepts as an authen-tic coffee experience &at conveyed the artistry of es-presso making. a place to ttrink and inragine. a spot'where people could gather and talk over a great cupof coffee, a comforting refuge that provided a senseof communify, a third place for people to congregatebeyond work or the home. a place that rvelcomes peo-ple and rervards them for coming, and a layout thatcould accommodate both fast service and quiet mo-ments. TIrc team researched the art and literature ofcoffee throughout the ages. studied cofee-growingand coffeemaking techniques. and looked at horvStarbucks' stores had already evolved in terms of de-sign. logos, colors, and mood. The team came up rvithfour store designs--one for each of the four stagesof coffeemaliing: grot:ying, roastir:g. brerving, andaroma-each rvith its orvn color combinations, light-ing scheme. and component materials. Wthin each ofthe four basic store templates. Starbucks could varythe materials and details to adapt to different storesizes and settings (doryntoivn buildings. college cam-puses. neighborhood shopping areas). In late 1996,Starbucks began opening netv stores based on one offour forma8 and color schernes, But as ttre numberof stores increased rapidly in 2000-2003, greaterstore diversity and layout quickly became necessary.Exhibit 7 shorvs the diverse nature of Starbucks stores.

To better control average store opening costs,the company centralized buying, developed stand-ard contracts and fi,ted fees for certain items, andconsolidated rvork under tlrose contractors rvhodisplayed good cost control practices. The retail

operations group outlined exactly the minimumamount of equipment each core store needed so &atstandard items cor.rld be ordered in volume fromvendors at 20 to 30 percent discounts, then deliveredjust-in-time to tle store site either from companyrvarehouses or the vendor. Modular designs for displaycases \vere developed. And the rvhole store layout rvasdeveloped on a computer, rvith software that allolvedthe costs to be estimated as the design evolved. Allthis cut store opening costs significantly and reducedstore development time from ?4 to I8 rveelcs.

In AUguULSlO2* .qtarbrcks_-teamed_ rjtr*-wirJr,AMobile

a second lane or espresso rvhile they caught up one-mail, listened to di,eital music, put the fiuishingtouches on a presentation, or accessed their corporateintranet. Since theAugust 2002 introduction ofWi-Fiat Starbucks. rvireless Intemet service had been addedat over 1,700 more stores. Internal research shorvedthat tlre average connection lasted approximately45 minutes and that more than 90 percent of accessesrvere during the off-peak store hours.

During the earlystart-upyears. Starbucks avoideddebt and financed nelv stores entirely rvith equitycapital. But as the company's profitabiliry improvedand its balance sheetStrengthened Schultz's oppo-sition to debt as a'legitimate financing vehiclesoftened. ln 1996 the compauy completed its sec-ond debt offering, netting $16l niillion from thesale of convertible debentures for use in its capitalconstruction program. This debt rvas successfullyconverted into common stock in 1997. Over thenext eight years. strong internal cash ffoue allorvedStarbucks to finance virtually all of its store ex-pansion rvitlr internal funds; in 2005, tlre company hadless than 53 million in long-term debt on its balancesheet despite having $ 1.8 billion in net investment infacilities and equiprnent, but it did have long-termliabilities of $193.6 miilion associared rvith leaseobligations at its stores.

Store AmbienceStarbucks management vierved each store as abillboard for the cornpany and as a contributor to

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Case 29 Starbucks'Global Quest In 2006: ls the Best yet to Come?

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building the company's brand and image. Each detailwas scrutinized to enhance tbe mood and ambienceof the store. to make sure everything signaled "best-of-class" and reflected the personality of the com-munity and the neighborhood The thesis wils"Everything matters." The company lvent to greatIengths to make sure the store fixtures, the merchandisedisplays. ttre colors, the artrvorh the banners. the music.and tlre aromas all blended to create a consistent,inviting, stimulating environment that evoked theromance of coffee, that signaled the company's passionfor coffeq and that rerwrded customers rvith ceremony,stories, and surprise. Starbucks was recognized forits sensitivity to neighborhood conservation rvith&e Scenic fuirerica's award for excellent design and"sensitive reuse of spaces rvittrin cities."

To fy to keep the coffee aromas in the storespure, Starbucks banned smoking and asked employ-ees to refrain from rvearing perfumes or colognes.Prepared foods rvere kept covered so that customersrvould smell coffee only. Colorful banners and post-ers in tune lvith seasons and holidays kept the lookof Starbucks stores fresh- Company designers cameup rvith artrvork for commuter mugs and T:shirts indifferent cities that rvere in keeping rvith each city'spersonality (peach-shaped coffee mugs for Atlanta,pictures of Paul Revere for Boston and the Statue ofLiberty for Nerv York). To make sure that Starbucks'stores measured up to standards. the company used"mystery shopperst' rvho posed as customers andrated each location on a number of criteria.

TFIE PROEI,CT LINEAT STARETJCKS

Starbucks stores offered a choice of regular ordecaffeinated coffee bevera-ees, a special 'toffeeof the day," and an assortment of made-to-orderItalian-sryle hot and cold espresso drinks. ln addition,customers could choose from a rvide selection offresh-roasted rvhole-bean coffees (rvhich could beground or not on the premises for take-home indistinctire packages), fresh pastries, juices, hot andiced teas, coffeemaking equipment, coffee mugs andother accessories. and music CDs. From time to time,stores ran specialpromotions touting the compapy'tspecial Christmas Blend coffee, shade-grorvq.doffeefrom Mexico. organically gro\$t coffees, aod'various

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rare and exotic coffees from across the world. In2003. Starbucks began offering customers a choiceof using its exclusive Silk soymilk specifically de-signed to accentuate is handcrafted beverages usingespresso roast coffee andTazo chai tEas: the organic,kosher soymilk appealed to some customeis as asubstitute for milk or skim milk in various coffeeand tea beverages.

The companyi retail sales mix in 2005 rvas77 percent beverages, 15 percent lood items,4 per-cent rvhole-bean coffees; and 4 percent coffeemak-ing equipment and accessories.:6 The product mix ineach store varied depeoding on the size and locationofeach outlet. Largerstores carried a greatervarietyof whole coffee beans, gourmet food items, teas, cof-fee mugs, coffee grinders, coffeemaliing equipment.filters, storage containers, and other aecessories.Smaller stores and kiosks rypicatly sold a full line ofcoffee beverages, a limited selection of rvhole-beancoffees, and a ferv hardrvare items.

The idea for selling music CDs (rvhich, in somecases, lvere speciat-compil6'ti6frSTat had been puttogether for Starbucks to use as store backgroundmusic) originated rvith a Starbucks store managerrvho had rvorked in the music industry and selectedthe nerv "tape of the month" Starbucks played asbackground in its stores. He had gotten complimensfrom customers rvanting to buy the music they heardand suggested to senior executives that there rvasa market for dre eompany's music tapes. Researehthrough nvo years of comment cards turned up hun-dreds asking,Starbucks to sell the music it playedin its stores.'The Starbucks CDs proved a signifi-cant seller and addition to the product line: some ofthe CDs rvere specifically collections designed totie in rvith nerv blends of coffee that company u,aspromoting. Starbucks had also coproduced a RayCharles CD Genits Laves Compa4ri rvhich becanrea multiplatinum album tvith significant sales komStarbucks stores.

In 2000, Starbucks acquired Hear Music, a SanFrancisco-based company, to give it added capabi-lify in enhancing irs music CD offerings. In 2OO+.Starbucks infoduced Hear Music rnedia bars. aservice that offered custorn CD burning at selectStarbucks stores, and it opened several StarbucksHear ivlusic Coffeehouses-a first-of-its-kind cof-fee and music establishment rvhere customers couldenjoy a frcshlybretrcd cup ofcoffee rvhile dorvnloadingn:usic from the company's 200.000-plus song library

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and if they rvished have the dorvnloaded songsburned onto a CD for purchase.

In 2005, in an average week. an estimated 30million-plus cutomers patonized Starbucks, upfrom about 5 million in 1998. U.S. stores did abouthalf of their business by ll:00 a.m. Loyal custom-ers patronized a Starbucks store 15 to 20 times amonth, spending periraps $50-$75 monthly. Somecustomers rvere Starbucks fanatics, coming in daily.Baristas became familiar rvith regular customers.learningtheirnames and theirfavoritedrinks. ChristineNagy, a field director for Oracle Corporation in PaloAlto, California. told a Woll Sfieet Journcl reporter,"For me, it's a daily necessity or I start getting with-drawals."lT Her standard order rvas a custom drink:a decafgrande nonfat no-rvhip no-foam extra-cocoamocha; rvhen the barisra sarv her come through thedoor, she told the reporter, "They just say 'We needa Christine here.' " Since the inception of StrrbucksCards in 2001, 52 million Starbucks customers hadpurchased the reloadable cards that allorved them topay for their purchases rvith a quick swipe at the casl'rregister and also to earn and redeem rervards- Theuse of Starbucks Cards was a grorving means of pay-ment in Starbucks stores. In fiscal 2004, the companyreached approximately $1 biliion in total life-to-dateactivations and reloads on Starbucks cards. Due toits success in the United States the Starbucks Cardrvas being launched internationally, with the initialrollouts starting in Japan and 6reece.

In the fall of 2003, Starbucks. in partnershiprvith Bank One, introduced the Duetto Visa cardrvhich added Visa card functionality to the reload-able Starbucks Cards. By charging purchases to theVisa account of their Duetto card anyrvhere Visacredit cards were accepted, cardholders earned I per-centback in Duetto Dollars. automatically loaded ontheir Starbucks card account after each billing rycle.Duetto Dollars could be used to purchase beverages.food and store merchandise at any Starbucks loca-tion- The Duetto card rvas an example of the ongo-ing effort by Starbucks' ntanagement to introducenew products and experiences for customers thatbelonged exclusively to Starbucks: senior executivesdrummed tlre importance of ahvays being open to re-i nventin-e the Starbucks experience.

So far, Starbucks had spent very little moneyon advertising, preferring instead to build the brandcup-by+up rvilh customers via rvord of mouth andthe appeal of its storefronts. The company spent a

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total of $87.7 million on advertising in fiscal 2005,up from $49.6 million in fiscal 2003.

Joint Ventures and AcquisitionsIn 1994. afier months of meetings and experi-mentation. PepsiCo and Starbucks entered into ajointventure to create new coffee-related products for massdistribution through Pepsi channels, including coldcoffee drinks in a bonle orcan. Horvard Schultzsarv thisas a major paradigm shift rvith the potential to causeStarbucks' business to evolve in heretofore unima-ginable directions; he thought it rvas time to look forways to move Starbucks out into more mainstreammarkets. Cold coffee products had historically metrvith poor market reception, except in Japan, rvherethere was an $8 billion market for readytodrinkcoffee-based beverages. Nonetheless, Schultz rvas

hoping the partners rvould hit upon a nerv productto exploit a good-tasting coffee extract that had beendeveloped by Starbucks' recently appointed directorof research and development. The joint venture's firstnew product, Mazagran. a iightly flavored carbonatedcoffee &ink. rvas a failure: a madret test in southernCalifornia shorved that some people liked it andsome hated it. While people were rvilling to try it thefirst time. partly because the Strrbucks name rvas onthe label, iepeat sales proha disappointing. Despitethe clash of cultures and the different motivationsof PepsiCo and Starbucks, the partnership held to-gether because ofthe good rvorking relationship thatevolved betrveen Horvard Schule and Pepsii seniorexecutives. Then Schule, at a meeting to discuss thefurure of Mazagran, suggested. "Why not developa bottled version of Frappuccino?":8 Snrbucks hadcome up rvith Frappuccino in the sunrmer of 1995,and the cold coffee drinli had proved to be a big hot-rveather seller: Pepsi executives rvere enthusiastic.After rnonths of experimentation, tlre joint venhrreproduct research team came up rvith a shelf-stableversion of Frappaccino that tasted quite good. It rvas

tested in West Coast supermarkets in the summer of1996; sales ran l0 times projections, rvith 70 percentbeing repeat business. Sales ofFrappuccino reached$125 million in 1997 and achieved national super-market penetration of80 percent^ Starbucks' manage-ment believed that the market for Frappuccino rvouldultimately exceed $ i billion.

ln October 1995 Starbucks partnered rvith Drey-er's Grand lce Cream to supply cofee extract for

Case 29 Starbucks' Global Quest in 2006: ls the Best yet to Come?

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prices in Starbucks'retail stores. Flavor selections insupermarkets lvere more limited than those at Star-bucks stores. Going into 2006. Starbucks coffeesrvere available in some 31,300 grocery and rvare-house clubs (such as Samt and Costco) with 30,000in the United States and 1,300 in the inteniationalmarkets. Revenues from this category comprised24 percent ofspecialty revenues in fiscal 2005.

Starbucks executives recognized tltat supermar-ket distribution entailed several risks, especially inexposing Starbucks to fust-time customers. Star-bucks had built its reputation around the unique re-tail experience in its stores where all beverages rvereproperly prepared-it had no control over how cus-tomers rvould perceive Starbucks rvhen they encoun-tered it in grocery aisles. A second risk concernedcoFee preparation at home. Rigorous quality controland skilled baristas ensured that store-purchasedbeverages rvould measuro up. but consumers usingpoor equipment or inappropriate brerving methodscould easily conctude that Starbucks packaged cof-fees did not iive up to their reputation.

Starbuc}s had also entered into a l.imited numberof licensing agreements for store locations in areasrvhere it did not have ability to locate its own out-Iets. The company had an agreement rvith MarriottHost international that allorved Host to operate Star-bucks retail stores in airport locations, and it had anagreement rvith Aramark Food and Services to putStarbucks stores on university campuses and otherIocations operated by Aramark. Starbucks received a

Iicense fee aqd a royalty on sales at these locationsand supplied the coffee for resale in the licensed lo-cations. AII licensed stores had to follorv Starbucks'detailed operating procedures, and all managers andemployees rvho rvorked in these stores received thesame training given to Starbucks managers and storeemployees. As of 2005, there rvere 2.435 licensed orfranchised stores in the United States and 1,806 li-censed stores in other countries. Licensing revenuesincreased from $241 million in fiscal 2001 to $673million in fiscal 2005: domestic stores accounted for$515 million ofthe revenues from licensing in 2005.

Starbucks had a speciatty sales group that pro-vided its coffee products to restaurants, airlines. ho-tels. universities. hospitals, business offices. coufitryclubs, and select retailers. One of the early users ofStarbucks coffee was Horizon Airlines. a regionalcarrier based in Seattle. In 1995, Starbucks enteredinto negotiations rvith United Airlines to serve Star-bucks coffee on all United flights. There rvas muclrinternal debate at Starbucks about rvhether such

?art? Cases in Crafting and Executing Strategy

a new line of coffee ice cream made and distributedby Dreyer's under the Starbucls brand. The nervline, featuring such flavors as Dark Roast ExpressoSrvirl, JavaChip, Vanilla MochaChip, Biscotti Bliss,and Caffe Almond Fudge, hit supermarket shelvesin April 1996, and by July 1996 Starbucks' cofFee-flavored ice cream was the top-selling superpremiumbrand in the coffee segment. [n 1997, trvo nerv lorv-fat flavors were added to complernent the original sixflavors, along rvith trvo flavors ofice cream bars; allrvere rvell received in the marketplace.

The partnerships rvith Pepsi and Dreyer's pro-duced about S20 million in revenues for Starbucksin fiscal 2005 (equal to about 2 percent oftotal spe-cialty sales).

In 2004, Starbucks teamed rvith Jim BeamBrands to invent a Starbucks Coffee Liqueur thatrvould be sold in bars, liquor stores, and restaurants;projections rvere for systemrvide gross sales of over$8 million annually. Launched in February 2005,Starbucks Co$ee Liqueur rvas the top-selling nervspirit product through August 2005, according toNielsen. [n October 2005, again collaborating rvithJim Beam Brands, Starbucks introduced StarbucksCream Liqueur, a blend of cream. 'spirits, and a

hint of Starbucks coffee. With 22 million cordialconsum€rs in the U.S. market, the cream liqueurcategory rvas nearly three times the size of coffeeliqueur category. Both Starbueks Coffee Liqueurand Starbucks Crearn Liqueur rvere packaged in a750-milliliter boffle priced at $22.99.

In April 2005, Starbucks purchased Ethos Waterfor $8 million in cash. The acquisition rvas made toexpand the line ofteferages in Starbucks'stores intlre United"states.

Licensed Sfores &ndSpecialty SalesStarbucks had a licensing agreement rvith KraftFoods to market and distribute Starbucks u,hole-beanand ground coffees in grocery and mass-merchandisechannels across the United States. Kraft managed alldistribution, marketing, advertising. and promotionsand paid a royalty to Starbucks based on a percent-age of net sales. The coffee &at Starbucks sold in su-permarkets featured distinctive. elegant packaging,prominent positions in grocery aisles, and the samepremium quality as &at it sold in its stores. Productfreshness was guaranteed by Starbucks' Flavorlockpackaging, and the price per pound paralleled the

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a move made sense for Starbucks and the possibl€damage to the integriry of the Starbucks brand ifthe quality of the coffee seryed did not measure up(since there rvas different cofeemaking equipmenton different planes). [t took seven months of negotia-tions for Starbucks and United to arrive at a mumallyagreeable lvay to handle quality control on United'svarious types of planes.

In recent years, the specialty sales group hadrvon the coffee accounts at Hyatt, Hilton, Sheraton,Radisson, and Westin hotels, resulting in packets ofStarbucks coffee being in each room rvith coffee-mal*ing equipment. Starbucks had entered intoan agreement with Wells Fargo to provide coffeeservice at sorne of the bank's locations in California.A 1997 agreement rvith U.S. Office Products gaveStarbucks an entrde to proviile its coffee to rvorkersin 1.5 million business offices. [n addition, Starbuckssupplied an exclusive coffee blend to Nordstrom'sfor sale only in Nords8om stores, operated coffeebars in Barnes & Noble bookstores, and. mostrecently, had begun coffee bar operations in Chaptersbookstores (Chapters rvas aToronto book retailer thathad sites tlroughout Canada) and Borders bookstoresthat had cafes. Starbucks also had an alliance rvithSYSCO Corporation to service the majoriry of irsfood-service and restaurant accounts. In fiscal 2005.Starbucks rvas supplying its coffees to 15,500 food-service accounts lvorldrvide, producing fiscal 200irevenues of 5304 million, up from $179 millionitt 2001.

Other Starbucks initiatives included a 24-hourStarbucks Hear Music digital music channel avail-able to all XM satellite radio subscribers and theavailability of rvireless broadband Internet servicein company-orvned stores in the United States andCanada. Collectively, these other initiatives accoun-ted for 3 percent ofspecialty revenue in fiscal 2005.

Starbucks experimented rvith a mail order cata-log and rvith online sales at its Web site, but it dis*continued those operations in 2003 rvhen sales felloff (chiefly because of the grorving availability ofStarbucks coffees in supermarkets arid the compa-ny's expanding nunrber of store locations).

Ir srenB[JcKS C0FFEE

ry PURC!{ASING STRATEGY

Starbucks personnel traveled regularly to coffee-producing countries-Colombia. Sumatra. Yemen,

Case 29 Starbucks' Globat Quest in 2006: ls the Best yet io Come? c-{9t

Antigua, Indonesia, Guatemala, Nerv Guinea. CostaRica. Sularvesi. Papua" Kenya. Ethiopia, Java. andMexico-building relationships with grorvers and ex-porters, checking on agricultural conditions and cropyields, and searching out varieties and sources thatrvould meet Starbucks' exaeting standards of qual-ity and ffavor. The coffee-purchasing group. work-ing with personnel in roasting operations, tested nervvarieties and blends ofbeans from different sources.

Coffee lvas grown in 70 tropical countries andrvas the second-most-traded commodity in the rvorldafter petroleum. The global value of the 2000*2001coffee bean crop was about $5.6 billion. By WorldBank estimates_. some 25 mitlion small farmersmade their living grorving coffee. Commodity-gradecoffee, rvhich consisted of robusta and commercialquality arabica beans, was Eaded in a highly com-petitive market as an undifferentiated product. Cof-fee prices uere subject to considerable volatilitydue to rveather. economic and political conditions inthe grorving countries, netv agreements establishingexport quotas, and periodic efforts to bolster pricesby restricting coffee supplies. Starbucks used fixed-price purchase commitments to limit its exposure tofluctuating coffee prices in upcoming periods and.on occasion, purchased coffee futures contracts toprovide price protection., ln years past tirere hadbeen times rvhen unexpected jumps in coffee priceshad put a squeeze on Starbucks' margins. forcingan increase in the prices ofthe beverages and beanssold at retail.

Starbucks sourced approximately 50 percent ofits beans from Latin America, 35 percent frorn thePaciflc R[m. and l5 percent from East Africa. Sourc-ing from multiple geographic areas not only allorvedStarbucks to offer a greater range ofcoffee varieties tocustomers but also spread the compar:y's risks regard-ing rveather, price volatility, and changing economicand political conditions in coffee-grolving countries.

During 2002, a global oversupply of more than2 billion pounds drove the prices of commoditycoffees to historic lorvs of S0.40*$0.50 per pound.The specialty coffee market. rvhich represented aboutI0 percent ofrvorldn ide production, consistedprima-rily of high-quality arabica beans. Prices for specialtycoffees rvere determined by the qualiry and fl avorofthebeans and rvere almost ahvays higher than prevailingprices for commodity-grade coffee beans. Starbuckspurchased only high-quality arabica coffee beans.paying an average of 51.20 per pound in 2004. Itspurchases represenled about I percent ofthe rvorldicoffee bean crop. The company's green coffee costs

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reachsd a historic lo'w in 2002 and had graduaUyincreased since then. Given the price volatility risk.the company entered into fixed-price purchase com-mitrnents in order to secure an adequate supply ofqualify green coffee. As of October 2005, tire com-pany had over $375 miliion in fixed-price purchasecommitments, rvhich along rvith existing inventoryrvas expected to provide an adequate supply ofgreencoffee through fiscal 2006.r

Believing that the continued grorvth and successof its business depended on gaining access to ade-quate supplies of high-quality coffees year-in andyear-out, Starbucks had been a leader in promotingenvironmental and social stervardship in coffee-origincountries. Starbucks'coffee sourcing strategy tvas tocontribute to the sustainability of coffee growers andhelp conserve the environment. In sourcing greencoffee beans, Startucks rvas increasingly dealingdirectly rvith farmers and cooperatives. and its policywas to pay prices high enough to ensure that smallcoffee grorvers. most of rvhom lived on the edge ofpoverty. rvere able to cover their production costsand provide for their families. About 40 percent ofStarbucks purchases rvere made under three-to five-year contracts. rvhich management believed enabledthe company to purchose its future coffee beanrequirements at predicuble prices over multiple cropyears. Coffee purchases negotiated tkough long-termcontacts increased from 3 percent in 2001 to 36percent in 2002. Farmers rvho met important quality,envirorunental. social, and economic criteria, rvhichStarbucks had developed with the support of Conser-vation Internationali Center for EnvironmentalLeadership in Business. sere rervarded with financialincentives.and p*ifened supplier status. In fiscal2004. the company opened its Farmer SupportCenter in Costa Rica to support existing and potentialStarbucks coffee suppliers and their communities.

Starbucks had $375 million in fixed-price pur-chase commitments in October 2005 but was notplanning to increase this commitrnent in the near fu-ture due to a significant jump in the prices of greencoffee beans (in some cases the going prices for greenbeans u'ere above the fixed purchase prices). The highcomnrodity prices forcoffee beans made farmers Iesswiliing to enter into fixed-price arrangements.

Fair Trade Certified CaffeeA grorving number of smail coffee *qrorvers \teremembers of democratically run cooperatives thatrvere registered rvith the Fair Trade Labeling Organi-

zatious Intemational; these growers could sell theirbeans directly to importers. roaste$. and retailers atfavorable guaranteed "Fair Trade" prices. The ideabehind guaranteed prices for Fair Trade coffees rvasto boost earnings for small coffee grorvers enoughto allorv them to afford basic health care, education,and home improvements. Starbucks marketed FairTrade Certified coffee at most of irs retail stores andthrough other locations that sold Starbucks coffees.In October 2005, Starbucks inkoduced Cafe EstimaBlend FairTrade Certified Coffee as the coffee of therveek to support Fair Trade Month 2005. Srarbucksexpected to purchase l0 million pounds of FairTradeCertified coffee in 2005, and it planned to purchase12 million pounds in 2006.

Enviro nment&l B e st Practic esSince 1998. Starbucks had partnered with Conser-vation lnternational to promote coffee cu]tivationmethods that protected biodiversiry and maintaineda healthy environment. A grorving percentage ofthe coffees that Starbucks purchased rvere grown"organically" without the use of pesticides, herbi-cides. or chemical fertilizers: organic cultivationmethods resulted in clean groundrvater and helpedprotect against degrading of local ecosystems, manyof rvhich rvere fragile or in areas rvhere biodiversityrvas under severe threat. Anotherenvironmental con-servation practice involved groiving organic coffeeunder a natural canopy of shade trees interspersedrvith fruit trees and other crops; this not only allorvedfarmers to gbt higher crop yields from small acre-ages but also helped protect a-sainst soil erosion onmountainsides.

COF'FEE ROASfiNAGOPERATIONS

Starbucks considere d the roasting of its coffee beansto be somethin_e of an art form" entailing uial-and-error testing of different combinations of tinre andtemperature to get the most out of each lype of beanand blend. Recipes tvere put together by the coffeedepartment, once all the components had been tested.Computerized roasters guaranteed consistency. Eachbatch rvas roasted in a pouerful gas oven for 12 toI5 minutes. Highly trained and experienced roastingpersonnel monitored the process. using boflr smelland hearing, to lrelp check rvhen the beans rvere

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Ihonrpssnl9t ickland-Ger*le:

Cralting and EreelingStrategp Concepts and

Caseq 15& Edition

Stafturhs' Olobal 0uest in

200& ls lhe Besl Yetto

Cone?

@ Ihe lvlcGrar.r-Hill

Coopanies, 2007

Case 29 Starbucks'Global Quest in 2006: ts the Best yet to Come?

perfectly done---'coffee beans make a popping sound CARE. A second major philanthropic effort in-rvhen ready. Starbucks' siandards lvere so exacting volved providing financial support to communitythat roasters tested the color of tite beans in a blood- literacy organizatious. b1995-*:fgbUgk-hffi;cell analyzer and discarded the entire batch if thecell analyzer and dlscarded the entire barch if the a g lglg_ tgj$nf_gJ-9-.lhs_co*ditions-"of*rrerkersreading}vasn,tontarget.Afterroastinsandcoo}'in9.ffiffi-ligG$e',s!eusxe'--:-''9.*".-'g"the coffee rvas immediately vacuum-sealed in bags --oi'ionarfrT'6iTif-gr;vers'anffioiffi-'finaiiiatrvith one-rvay valves that let out gases naturally pro. -assistEiiicd'fiif aEfiCfiltiifiifimiirijvement bioiiprojects. Induced by fresh-roasted beans without letting oxygen *-. -.199?; Sur.tticks fonned an alfiarin*-one-rvay valve technology extended &e shelf tifE*of packaged Starbucks coffee to 26 rveeks. As a mat-ter ofpolicy, horvever, Starbucks removed coffees onits shelves after three months, an( in the case of cof-fee used to prepare beverages in stores, the shelfiifervas timited to seven days after the bag was opened.

At the end of fiscal 2005. Starbucks had roasr-ing plants in Kent. Washington; York, Pennsylvania;Minden, Nevada; and the Netherlands. ln additionto roasting capability. the Kent, York Minden. andNetherlands plants also had additional space forrvarehousing and shipping coffees. The roastingplants and disribution facilities in Kentsupplied storesrvest of the Mississippi and in theAsia-Pacific region.The nervly constructed Minden plant and distributioncenter lvas used to supply stores in the Mountain l$fest

and Midwest- The roasting and distribution facility inYorli, rvhich could be expanded to I million squarefeet. supplied stores mainly east of the Mississippi.The 94.000-square-foot facility in the Netherlandssupplied stores in Europe and the Middle East.

p poor, small-scale

w*fiisf-year grant'of$?5B0UTBnt to fund a nelv processing faeility and

STAREI.ICKS' CORPORATESOCflAil. RESPOruSIBILITYSTRATEGY

Horvard Schultz\ effort to "build a company rvitlrsoul" included broad-based initiatives to contributepositively to the communities in rvhich Starbuckshad stores and to the environment. The guidingtheme of Starbucks' social responsibility strategyrvas "Giving back to our comrnunities is the u,ay rvedo business." The Starbucks Foundation lvas set upin 1997 to orchestrate the company's philanthropicactivities. Since l99l Starbucks had been a majorcontributor to CARE. a rvorldrvide relief and de-velopment organization that sponsored health.education, and hunranitarian aid programs in almostall of the third lvorld countries rvhere Starbuckspurchased its coffee supplies. Stores featured CAREin promotions and had organized concerts to benefit

set up a loan program for a producer cooperative.Starbucks had an Environmental Committee

that looked for rvays to reduce, reuse, and recyclelvaste, as well as contribute to local communiqr en-vironmental efforts. There was also a Green StoreTask Force that looked at how Starbucks storescould conserve on \vater and energy usage and gen-erate Iess solid u'aste. Customers rvho brought theirowfi mugs to stores rvere given a lO-cent discount ofbeverage purchases (in 2002, customers used com-muter mugs in making purchases about 12.7 milliontimes). Coffee grounds, rvhich rvere a big portion ofthe waste stream in stores, rvere packaged and givento cusiomers. parks, schools and plant nurseries asa soil amendment. Cornfany personnel purchasedpaper products rvith high levels ofrecycled conrentand unbleached fiber to help Starbucks minimizeits environmental fooprint. Stores participated inEarth Day activities each year rvith in-store promo-tions and volunteer efforts to educate employees andcustomers about the impacts their actions had on theenvironment. Suppliers rvere encouraged to providethe most energy-efficient products rvithin their cat-egory and eliminate excessive packaging; Starbuckshad recently instituted a Code of Conduct for sup-pliers ofnoncoffee products that addressed standardsfor social responsibility, including labor and humanriehts. No genetically modified ingredients rvereused in any food or beverage products that Starbucksserved rvith the exception ofmilk. (U.S. labelin! re-quirements do not require milk producers to discloseihe use of hormones aimed at increasing the nrilkproduction of dairy herds.)

ir.l

ii-

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Ei_

alcharitable projects of one kind or 4[otlrcr. donat*

gbenrefi rs. Eriiiil oteda i\E;;n a orua ged to recomrn indffi-d{ p$Elr grants from the Starbuclis Foundationto benefit local community literacy organizations.

"Ce

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Cralting and Erecuting

StratsgF Concepts and

Cases. l5th Edition

I

Starbucks'Global 0uest in I Case

zlD& ls the Eest Yet to

Ccme?

I I O Trra ruccar;-ttltt

Companies,2fi1?

coffee segment had expande4 as interesteq educated,upscale consumeni became increasingly inclined toupgrade to premiurn coffees lvith more robustflavors. Whereas retail sates of specialty coffeesamounted to only $45 million in 1969, by 1994 retailsales of specialty coffees had inueased to $2 billion,much of rvhich stemmed from sales in coffee bars orthe shops of coffee bean retailers (like Peet's). Theincrease rvas attributed to rvider consumer awarenessof and appreciation for fine coffee, the emergenceof coffee bars featuring a blossoming number ofpremium coffee beverages, and the adoption of ahealthier lifestyle that prompted some consumers toreplace alcohol rvith coffee. Coffee's image changedfrom one ofjust a breakfast or after-dinner beverageto a drink that could be enjoyed at any time in thecompany of others. Many coffee drintrrers took to theidea ofcoffee bars rvhere they could enjoy a high-caliber coffee beverage and sit back and relax rvithfriends or business associates.

Some industry experts expected the gourmetcoffee rnarket in the United States rvould be saturatedby 2005. But the international market rvas muchmore rvide open as of early 2004. The United States,Germany. and Japan rvere the three biggest coffee-consuming countries.

COMPETITORS

Starbucks' pTmary competitors rvere restaurants,specialty coffee shops. doughnut shops, supermar-kets. convenience stores. and others that sold hot cof-fee and specialty coffee drinks. ln 2003, there rverean estimated 14.000 specialty coffee outlets in theUnited States, s,ith some observers predicting therervould as many as l8,000localions selling specialtycoffee drinks by 2015.

Starbucks'success was prompting a nurnber ofambitious rivals to scale up their expansion plans.Still. no other specialty coffee rival had as manyas 400 stores. but there were at least 20 small localand regional chains that aspired to compete againstStarbucks in their local market arenas. most notablyCaribou Coffee (337 stores in 14 states and theDistrict of Columbia), Tuiiyt Coffee (98 stores in4 states). Gloria Jean's (280 nrall locations in 35states and several foreign countries), Nerv WorldCoffee (30 locations), Brerv HaHa (13 locarions inDelauare and Pennsylvania). Bad Ass Coffee (about60 locations in l8 states. Japan. and South Korea),

Part2 Cases in Crafting and Executing Strategy

Exhibit B Starbucks' EnvironmentalMission Statement

On the Fourth of July weekend in 1997. threeStarbucks employees rvere murdered in the com-panyt store in the Ceorgetorvn area of Washington,D.C.; Starbucks offered a $100.000 rervard forinformation leading to the arrest of the murderer(s).The company announced it rvould reopen the store inearly 1998 and donate all future net proceeds of the

store to a Starbucks Memorial Fund that rvould makeannual grants to local groups rvorking to reduceviolence and aid the victims of violent crimes.In 2005, Starbucks made a $5 million, five-yearcommitment to long-term relief and recovery effortsfor victims of Hurricane Katrina and committed $5million to support edr.pational programs in China.

Starbucks felt-so deeply about its responsibilitiestlrat it even developed an environmental missionstatement to expand on its corporate mission state-ment (see Exhibit 8). In 2002. Starbucks also beganissuing an annual Corporate Social ResponsibilityReport (the reports for recent years can be vieued in

TFIE SPECIALTY COFF'EEIruEUSTRY

Wriie the market for traditional commercial gradecoffees had stagnated since the I970s, the specialty

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I thocrpson-suicxan*.car$h I

Cralting snd heculingStralegF Concsers Eod

Gases" lSlh Edilion

I

Starbueks'Globat 0uesl in I Case

2fl15: ls rh. BestYet to

Come?

Second Cup Coffee (the largest chain based inCanada), and Qwikyt (tndia). Caribou Coffee rventpublic in late 2005, rvith a stock offering that raisedabout $68 million. McDonald's had begun openingMcCaf€s. While it had been anticipated in the late1990s that local and regional chains rvould merge inefforts to get bigger and better position themselvesas an alternative to Starbucks, such consolidationhad not occurred as of 2003. But numerous retailentrepreneurs had picked up on the grorving popu-larity of specialty coffees and opened coffee bars inhigh-pedestrian-traffic locations to serve espresso,cappuccino, latte, and other coffee drinks. Growingnumbers of restaurants tvere upgrading the quality ofthe coffee they served

Starbucks also faced competition from nationrvide coffee manufachrrers-:-such as Kraft GeneralFoods (the parent of Ma.trvell House), Procter &Gamble (the marketer of Folger's and Millstonebrands), and Nestl6-that distributed their coffeesthroughsupermarkets. Both General FoodsandProcter& Camble had introduced premium blends of theirMaxrvell House and Folgers coffees on supermarketshelves. pricing them several dollars below Star-bucks' offerings. But Starbucks' most importantcompetitors in supermarkets were the increasing

Endnotes

I- I oruu*.c*r-*tr, 'Cunpanies,Z!07

c-{95

numbers of rival brands of specialty coffees*GreenMountain, Allegro, Peaberry, Brothers, and dozensof other brands. Because many consumers lvereaccustomed to purchasing their coffee supplies at

supermarkets, it rvas easy for them to choose whateverspecialty coffee brand or brands were featured in theirlocal supermarkets over Starbucks-

FUTIJRE CHALLENGES

In fiscal 2006. Starbucks planned to open 1,800 nervstores globally. Top management believed that itcould grorv revenues by about 20 percent annuallyand net earnings by 2G-25 percent annually forthe next three to five years. Horvard Schultz andCEO Jim Donald vierved China as a huge marketopportunity. along rvith Brazil, Indiq Brid Russia.Horvard Schultz believed that, to sustain its grorvthand make Starbucks one of the rvorld's preeminentglobal brands, the company had to challenge thestatus quo, be innovative, take risks, and adapt itsvision of who it rvas. rvhat it di4 and rvhere it rvas

headed. If the challenge lvas met successfully, inall likelihood the company's best years lay on thestrategic road ahead.

Case 29 Starbucks'Global Quest in 2006: ls the Best Yet to Come?

tAs quoted in Gora Daniels, "Mr. Colleei furlunq April 14, 2003,p.139.t2004 annual report, lelter to shareholders.12002 annual teport, leiler lo shareholders..lbid.sHova:d Schullz and Dori Jones Yang, PoutYow Hearl lnlo ,t (New

York: Hyperion, 1997), p.33.Glbirt-, p.34,;]bid., p.36.lAs told in ibid.. p,48.tlbid., pp.61-52.loAs quoled in Jenniler Beese, "Statbucks: lnside the Cotlee Cull,"Forrune. December 9. 1996, P. 193.

'rschultz and \eng, PovrYaur Heart lnlo ,r, pp. 101-2.r:lbid.. p. 142.t3lxid., p. r29.riAs related in ibid.. pp. 131-36.ie2004 annual report, P.36.

r6lbi(,-

'?2005 Starbucks 10-K .eport, p. 67.

'!Ben van Houlen. "Employee Perks: Starbuci{s CotleEb EmployeeBenefil Plan,' Reslalrail Eusiness, May t 5, 1 9S7, p. 85.reAs relaled in Schuttr and \Ang. tuurYour Heaft ln16 fl, p. 168.pAs quoled in lng.id Abramovitch, "Miracles of Markelir€i Suctess40, no.3. p- 26.3!Daniels, "Mr. Colfee,'p. 140.ccompany press releasse, May 31, 2005, and October 25, 20053€ompany press release, Oclobgr 25, 2005.:{KatE Rourds, "Staftucks Collee: lncenl/;ve 167, no.7,9.22.$CSR aanual Gporl, Starbucks, nscal 2004.sFiscal 2005 annual reporl, p. 14.:rDavid Bank,'Starbucks Faces Growing Compelalion: lts O,lIm Slores,"The Wall Strcet Journal, January 21, 1997. p. 81.:aAs relaled in SchulE and Yang , Pour \bw Heart l/l,lo lL p. 224 .;,$arbocks 2005 lorm 10-K report, p.6.

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Ilrmryson-Sric klend-Grmtl e:

Crafting and Erecuting

Slfirtegf Corcrpts and

Casei, tTth Editioo

Case tll ltlucot

Sorporatioa: Gompelirg

agaiost [ow-Cost Steel

lt!Forls

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Arthur A. ThornpsonThe Universiqr sgAlabrma

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ffi n the 1950s and early 1960s, Nuclear Corporationffi ofAmerica rvas involved in the nuclear instrumentE! and elecronics business. After suffering tluoughseveral money-tosing years and facing banliruptcyin 196a; the company's board of directors opted fornerv leadership and appointed F. Kenneth Iversonas president and CEO. Shortly thereafter, Iversonconcluded that the best rvay to put the compafly onsound footing lvas to exit the nuclear instrumentand electronics business and rebuild the companyaround its profitable South Carolina-based Vulcraftsubsidiary which rvas in the steel joist business-Iverson had been the head ofVulcraft prior to beingnamed president. Iverson moved the companylheadquarters from Phoenix, Arizona, to Charlotte,North Carolina, in 1966 and proceeded to expandthe joist business rvith nerv operations in Texas andAlabama, Then, in 1968, management decided tointegrate. backrvard into steelmaking, pqgtlyTbecause

of the benefits of supplying its orvn #9frequire-ments and partly becausg lverson sarv opportunitiesto capitalize on nervly emerging technologies to pro-duce steel more cheaply. The company adopted thename Nucor Corporation in 1972, and lverson initi-ated a long+erm strategy to grorv Nucor into a majorplayelilr the U.S. steel industry.'

@r@Nucor had become the seventh larE-est iiEEf company in America: u'itL revenues of$758 miilion, sixjoist plants. and fourstate-of-the-artsteel nrills that used elecsic arc fi.rnaces to producenetv steel products fronr recycled scrap steel. Nucor

in the country.l A series of artictes in the lVarr I'or*er,reldieilEow Nucor, a relatively small American steelcompany, had built an enterprise tbat led the, ivholeworld into a nelv'era of making:steel rvith recycledscrap steel. NBC did a business documentary thatused Nucor to make the point that American manur,facturers could be successful in eompeting againstlorv+ost foreign manufacturers . :,,, .

At the turn of the century, Nucor rvas the seCondlargest steel producer in the United States and charg-ing to overtake longtime leader U.S. Steel. Nucorisales in 2000 exceeded I I million tons, and revenuesrrere nearly &1.8 billion:'Several years thereafter,Nucor surpassed U.S. Steel as the largest steelmakerin No*h America. btrt Nucor fell back into secondplace in 2006 rvhen a global steel company in Europernade a series of acquisitious in the United States tocreate a U.S.$ased subsidiary (Mittal SteeL USA)rvith greater production capacity than Nucor. (Horv.ever, Nucorshipped more tons of steel to customers

revenues of $14.8 billion, and net profits ofS 1.8 billion. It rvas the most profitable steel producerin North America in both 2005 and 2006; The_rpg,L"-.

in 2005 than did Mittal Steel.) At &e end o

uctron having the capaciry

FroAuceff fril[on tons of steel annually, 2006

pany lvar regarded as the lorv-cost steel producer inffiffi-a ;-steel Droducers in the

competitively successful manufacfuring companies copyri-qht io ?00? by rtrthur..l. Thompson .,\tt riglrrs n.scrvxl.&*,.t' **--_,w !84

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I nompscrr-sricklaod-Grmllo: I

Crahing and Erecutiag

StrategF ConcEpts and

Cases. l?rh Edirion

Case lll l{ucor I Cuuu

Corporatiou: Gompeting

against Low-Cost Steel

lmpons

Part 2 Cases in Crafting and Executing Strotegy

t-

c-r94

Exhibit I Nucor's Growth in the Steet Business, 19Z0-2006

:'1970i.,

"1975,,'

1990 ,

1985. ,

1990'1ggs., l

2000, ,

2001 :,

2002r.,2003 ,

20O4.',:

2005 I l2006,,:

207,000.,.,.387,000

1,is9,0001,902,0003,648.0007,943,000

1'1,189,000

12,237,000.',

13,442,000:17,473,000'l9,1O9,ooor

20,465,000,22,118,000

$2453'14

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595621

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' $50.8121.5

482.4

758.51 ,481.63,462.0

4,756.543e3.74,801.76,265.8

11,376.8

E,7A1.O14,751.3

s2.211.7

76.1

106.2

111.2

432.3

478.3't79.4

230.1

66.9

1,731.3

2.016-4

2,593-8

s1030DO

5635624816

1S

495

104

129

@The McGnrv-Hill

Companies, 2010

$1.17.6.

45.1

58.575.1

274.5

3i o.e :

113.0

162.1,

62,81,121.5':

1.310.3'1,757.7"

sorrce.' company rccords posled at i.ri!{+.iiiii:ii.:+iii (acclsscd octobcr 3, 3{J06. and January 31. 1007t.

every year since 1966-a truly remarkable accom-plishment in a mature and cyclical industry whereit rvas common for companies to post losses rvhendemand for steel sagged. Going into 2007, Nucor hadpaid a dividend for 135 consecutive quarters. Exhibit Iprovides highlighs ofNucor's grorfih since 1970.

N3UCOH [f'J 2G07

Ken Iverson, the architect of Nucori climb fromobscurity to promineqce in the steel industry, wasregarded by-.-1nany*as i "modet company president."Under Iverson, rvho served as CEO until late 1998,Nucor rvas known for its aggressive pursuit of inno-vation and technical excellence, rigorous qualitysystems, strong emphasis on employee relations andworkforce productivity, cost-conscious corporate cul-ture, and ability to achieve lorv costs per ton produced.The company had a streamlined oryanizational struc-ture, incentive-based compensation systems, and steelmills that lvere among the most modern and efficientin the United States. Iverson proved himself as a mas-ter in crafting and executine a lorv-cost leadershlp_

.stratggLand f,e made o poiJof-iliEifrE-siffiiFpracticed rvhat he preached when it came to holdingdotm costs. The offrces of executives and divisiongeneral managers rvere simply furnished. There rvere

no company planes and no company cars, and execu-tives rvere not provided rvith company-paid countryclub memberships. reserved parking spaces, execu-tive dining facilities, or other perks. To save moneyon his orvn business expenses and set an example forother Nucor managers. Iverson flelv coach class andtook the subrvay rvhen he rvas in NervYork City.

When lverson left the company in 1998 fol-lorving disagreements rvith the board of directors.he rvas succee-ded briefly by John Correnti and thenDave Aycockiboth of rvhom had rvorlied in variousroles under lverson for a number ofyears. In 2000.Daniel R. DiMicco, rvho had joined Nucor in 1982and risen up tlrough the ranks to executive vicepresident. uas named president and CEO. UnderDiMicco. Nucor continued to pursue a rapid-grorvthstrategy, expanding capacity via both acquisitionand neu, plant construction and boosting tons soldfrom I 1.2 million in 2000 to 22.1 million in 2006.Exhibit 2 provides a summary of Nucor's financialand operating performance for 2000*2006.

Fi'*Sas*E !"5ms

Over the years. Nucor had expanded progressivelyinto the manufacture of a rvider and rvider range ofsteel products. enabling it in 2006 to offer steel usersone of the broadest producr lineups in the industry.

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I nompson+u,:*trnd-Gamhle: I Case 1o: l{ucorCraltingondExaeuing Co.poralion:Compeling

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Cases l?th Edition lmpons

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Case 1O Nucor Corporation: Competing against Low-Cost Steel lmports C-195

txhihit 2 Seven-Year Financial and Operating Summary, Nucor Corporation, 2000-2000($ in millions, except per share data and sates per employee)

FortheYear :r, . r. r : - .. .. .lNet,sa1es,,, ,, ,,,.,, ,',.,, , . .,. :

Cosls, rixpenses and othen

Markeiing, administrative,' ' and other expenses ,

:'lnteiest'exfense (incixne); net

Other income

:..i::. -:.. .. .r.... ....::.:i.1:

$12,701.0 $1't,376.9 S6,26s.8,'l :.i:i:-,..: .,: it.,i..i j1:t:r,

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s 0.92s $

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s 33r-s $

375-1

1,159

s 4,071.6

1,255.7

2,815.9

2,'136.6

3.2

$ 2,855.77,138.8

923.6

4,279.e

3'40.2

11,300

9,128.9

4'15.0

?2-480.9

-0,59q)9,645.6

1,731 .3 :

609.8

5,SS6.5

165.4

24.6

24.4

lu.6l6,199.0

, es.s4.1'

,... ('a)

: 151.5

4,263.0' 493.5

, 182.6

:.,,,, r :,4,$a3 3,914.3 3,929.2

1.121.5 S 62.8

s3.54 S 0.20

3.51 0.20

0.235 S 0.20

9.9o/o 1.0"/'o

38.7o/o 2.74/o

285.9 S 215.4

383.3 364.1

1.107 637

"175.6 1s0.714.3 ::.,6.57S.5 103.1. I a-':

__(29.9). '. (20.2):

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. 230.Jr 179:4. 68-0 ee-+

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s 243.6

307.1

s28

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823.8

s 162.1 $ 113.0 $ 310.9': ..:. i. : . . ..: . :..'i .:l.r

,: .11,.,,

$ '0.52 S 'O.SZ S '0.95

0.s2 , 0-97 0.95

$ o.'19 s 0.17 s 0.1st:

?.60/" 6.596

5.2% 14.2Vo

s 26't.1 I 415.4

289.1 259.4

531 619

sl,3i3.7 S1,379.5484.2 558.1

88S.5 821.5

,..:: ..:;

, .' Total ., , 12,057:5' Eamings tieiore income taxes '2;69g.8.,

,',' Provision for income taxes : 996.i '

i Netdamings t" iS-frE;F:'

''s s.73' 5.68

s 0.90.,: . ,

t 1.9"/e

38.6"/o

s 338.4363.91,U3

...,..s 4,675.0

1,450.0

3,225.O

.. :.".2,251-2

. 3.2

s 2;s56.47,885.0

922.34,826.0

301.211,900

Net earnings pbr share:.:.....BASIC ,.:,,,,Diluted- ,, . , , .

Dividends declared per share

Percentage of net earnings tonet sales '

Fletum on average equityCapital arpendituresDepreciation

Sales per employee (000s) '

AtYear EndCunent assets

Cunent liabilities

Working capital :

Cash provided by operalingactivities

burent ratio

Property, plant and equipment

Total assets

Long-term debt

Stockholders'equityShares outstanding (000s)

Employees

s 3,174.9 S1,620.7

1,06s.8 629.6

2349.2 991.0

1,024.8 493.8

3.0 2.6

$ 2,818.3 S2,81Zl6,133.2 4,492.4

923.6 903.6

3,456.0 2,342.1

319.0 314.4

10,600 9,900

497.?. 495.1 820.8

2.4 2.8 2.5

s2,932.'l 52,365.7 $2,329.44,381.'t 3,7593 3,710.9

894.6 450.5 460.5

2,323.0 Z,eOt.S 2,131.0312.8 311.2 310.4

9,800 8,400 7,900

Sourcej2005 and 200S 10-K reports and eompany press release, January 25, 2007.

Steel products lvere considered commodities. Whilesome steelmakers had plants where production qual-iry rvas sometimes incoasistent or on occasionsfailed to meet customer-specified metallurgicalcharacteristics, most steel plants turned out productso f comparabl e metal lurgical qualiry--one producert

reinforcing bar r,i,as essentially the same as anotherproducert reinforcing bar. a particllar grade ofsheetsteel made at one plant uas essentially identical tothe same grade of sheet steel made at another plant.

:.t.i

The

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c-I96 Part 2 Cases in Crafting and hecuting Strategy

price ofeach particular steel product being driven by%oemano-suDDlv condrttons tor that Droduct.

,e*,dF3i*i- ls*e'+'"**'- *+" *'-**6-M-

Steel Products Nucor's first venhrre into steelin the late 1960s. via its Vulcraft division, rvas prin-cipally one of fabricating steel joists and joist girdersfrom steel that lvas purchased from various steel-makers; the joists and girders rvere sold mainly toconstruction conFactors. Vulcraft expanded into thefabrication of steel declcing in 1977, most of rvhichrvas also sold to construction-related customers, Vul-craft's joist, girder, and decking products were used

mainly for roof and floor support systems in retailstores, shopping centers, warehouses, manufactur-ing facilities, schools, churches, hospitals, and, to alesser extent, multistory buildings and apartments,

In 1979, Nucor beean fabricating cold finishedsteel products]Fise consisted mainlv of cold drawn

turned groun4 and polished steel bars or rods ofvarious shapes-rounds, hexagons, flats, channels.and squares-and rvere made of carbon, alloy, andleaded steels as per customer specifications or end-use requirements. Cold finished steel of one qlpe oranotber rvas used in tens of thousands of products,including anchor bolts, farm machinery ceiling fanmotors, garage door openers, air conditioner com-pressors. and lalvn molvers. Nucorsold cold finished

and electri

"supplied rnanufacturers buying steel products in rela-tively small quantities. The total market for cold fin-ished products in the U4ited States rvas an estimated2 million tons aunuirlly. In 2006. Nucor Cold Finishy$rhelargestproduieffi

-unileusnries. *-itri"o AffiJt th;ffiffibo; 1 i p;;-c-e-ntTl-tfTffid finish facilities (in Nebraska, SouthCarolina, Utah, ar:d Wisconsin) had annual capacityof 490,000 tons. Nucor Cold Finish obtained virnr-ally all of the steel needed to produce cold finishedbars from Nucor's bar mi[s.

Nrc6?5- line of steel products also included

*-*tetal building systems, light-gauge steel framing,and steel fasteners (bolts. nuts, rvashers, screivsrand bolt assemblies). These rvere produced by thecompany's building system and fasteners divisions.Nucor Building Systems began operations in 1987and had fourmanufacturing facilities (Indiana, SouthCarolina, Te.ras. and Utah) in 2007; its uall and roof

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systems were mainly used for industrial and com-mercial buildings. including distribution centers.automobite dealerships, retail centers, aircraft han-gars, churches, office buildings, rvarehouses, andmanufacturing facilities. Complete metal buildingpackages could be customized and combined withother materials such as glass, woo{ and masonry toproduce a cost-effective, aesthetically sound build-ing of up to I million square feet. The buildingsrvere sold through a builder distribution netrvorkNucor Building Systems obtained a significant por-tion of its steel requirements from Nucori bar andsheet mills.

The fastener division. Iocated in Indiana,began operations in 1986 rvith the construction of a$25 million plant. At the time, imported steel fas-teners accounted for 90 percent of the U.S. marketbecause U.S. manufacturers rvere not competitive on

Steelmaking In 1968 Nucor got into basicsteelmaking, building a mill in Darlington, SouthCarolina. to manufacture steel bars. The Dariin-etonmill rvas one of the first plants of major size in theUnited States to use electric arc fi.rnace technologyto melt scrap steel and cast molten metal into variousshapes. Electric arc fiirnace technology rvas particu-larly appealing,."because the labor and capital require-ments to melf steel scrap and produce crude steelrvere far lorver than those at conventional integratedsteel mills, rvhere rarv steel rvas produced using cokeovens. basic oxygen blast firrnaces, ingot casters,and multiple types of finishing facilities to makecrude steel from iron ore. coke, limestone. oxygen!scrap steelt and other ingredients. By 1981. Nucorhad four bar mills making carbcn and alloy steelsin bars, angles, and light structural slrapes; in 2006,Nucor had l0 such plants rvith a toral annual capac-ity of approximately 7.7 million tons. The productsof bar mills rvere rvidely used in metal buildings,farm equipment, automotive products, furnifure, andrecreational equipment: many types of constructionrequired the use ofsteel reinforcing rods, or rebar.

ln the late 1980s. Nucor entered into the pro-duction of sheet steel at a nervly constructed plantin Crarvfordsville. Indiana. Flat-rolled sheet steel

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was used in the production of motor vehicles. appli-ances. steel pipes and htbes, and other durablegoods. The Crarvfordsville plant was the first in theworld to employ a revolutionary thin-slab castingprocess that substantially reduced the capital invest-ment and costs to produce flat-rolled sheet steel.Thin-slab casting machines had a funnel-shapedmold to squeeze molten steel down to a ttricknessof 1.5-2.0 inches, compared to the typical 8- to10-inch-thick slabs produced by conventional casters.It rvas much cheaper to tlren build arid operate facilitiesto roll thin-gauge sheet steel from 1.5- to Z-inch-thickslabs than from 8- to lO-inch-thick slabs. The Crarv-fordsville plant's costs uere said to be $50 to $75 perton below the costs oftraditional sheet steel plants.a highly significant cost advantage in a commod-ity market where the going price at the time rvas

$400 per ton. ForDes magazine described Nucor'spioneering use of thin-slab casting as the most suilstantial technological/ industrial innovation in thepast 50 years.2 By 1996, nvo additional sheet steelmills that employed thin-slab casting technologrywere constructed and a fourth mill rvas acquired in2002, giving Nucor the capacity to produce 10.8 mil-iion tons ofsheet steel products annually as of2006.

Also in the late 1980s. Nucor added rvide-flangesteel beams, pilings, and heavy strucrurat steelproducts to its lineup of product offerings. Struc-tural steel products were used in buildin-es. bridges.overpasses! and similar such projects rvhere strongrveight-bearing support rvas needed. Customersincluded construction companies, steel fabricators.manufacturers, and steel service senters. To gaineiltry to thE strucfural steel segment. in 1988 Nucorentered into a joint ventute rvilh Yamato-Kogyo. one

of Japan's major producers of rvide-flange beams.to build a nerv struchual steel nrill in Arkansas; a

second rnill rvas built on the same site in the 1990s

that made the Nucor-Yamato venture in Arkansasthe largesr structural beam facility in the WesternHemisphere. In 1999, Nucor began production at athird strucrural steel mill in South Carolina. All threemills used a special continuous casting method thatwas quite cost-effective. As of 2006, Nueor h*d thecapacity to make 3.7 million tons of structural steelproducts annually.

Starting in 2000, Nucor began producing steelplate ofvarious thicknesses and lengths that rvas soldto manufacfurers of heavy equipment. ships, barges,rail cars. refinery tanks. pressure vessels, pipes and

Case l0: Nucor

Gorporation: Compeling

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Case l0 Nucor Corporation: Competing against Low-Cost Steel lmports c-I97

tubes, and similar products. Steel plate was made atmills in Alabarna and North Carolina that had com-bined capacity of about 2.8 million tons.

Exhibit 3 shows Nucor's sales by product cat-egory for 1990-2006. The breadth ofits product linemade Nucor the most diversified steel producer inNorthAmerica. The company had market leadershipin several product categories-it rvas the largest U.S.producer of steel bars, structural steel, steel joist,steel deck, and cold-rolled bars. Nucor had an over-all rnarket share of shipmene to U.S.-based steelcustomers (including imports) ofabout 17 percent inboth 2005 and 2006.

S?rat*Sy

rvould strengthen Nucort customer base, geographiccoverage, and lineuSi of product offerings. Beginningin the late 1990s, Nucor management concluded thatgrorvth-minded companies like Nucor might u,ell bebetter off purchasing existlng plant capacity ratherthan building new capacity, provided the acquiredplants could be bought at bargain prices, economi-cally retrofitted rvith nerv equipmEnt if need be, andthen operated at costs comparable to (or even belorv)those of newly constructed state-of-the-art plants. Atthe rime. the steel industry rvorldrvide had far moreproduction capacity than rvas needed to meet mar-ket demand, forcing many companies to operate inthe red. Nucor had not made any acquisitions sinceabout 1990, and a team offive people rvas assembled

in 1998 to explore acquisition possibilities.For almost three years, no acquisitions \vere

made. But then the economic recession that hit Asiaand Europe in the late 1990s reached the UnitedStates in fuli force in 2000-2001. The September I l.2001, terrorist attacks further rveakened steel pur-chases by such major steel-consuming industriesas construction. automobiles. and farm equipment.Manv steel companies in the United States and other

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Starting in 2000, Nucor embarked on a fougpgglgrowthltrategy that involved neru ac{[!!fffi, new

rvas to make acquisitions that

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29 steel companies in the United States, includingBethlehem Steel Corporation and LTV Corporation,the nation's third and fourth largest steel producers,r€spectively, filed for bantrcruptcy protection. Bank-rupt steel companies accounted for about 25 percentof U.S. capacity. Tlte Econontisf noted that of the14 steel cornpanies tracked by Standard & Poor's,onla$ucor rvas indisputabiy heaithy. Some experts

eer inouslry sproduction capacity might be forced to close beforeconditions improved; about 47,000 jobs in the U.S.steel industry had vanished sisce 1997.

Z0-year lows in 1998. Globally, the industry hadabout I billion tons of annual capacity, but punydemand had kept production levels in the 750 to800 million tons per year range during 1998-2000.

that steel companies in six countries (Canada, SoutlrKorea, Tairvan, Italy, Belgium, and South Africa)had illegally dumped stainless steel in the UnitedStates, and the governments of Belgium, Italy, and

South Africa further facilitated the dumping by giv-ing their steel producers unfair subsidies that at leastpartially made up for the revenues lost by sellingat belorv-market prices. Congress and the Clintonadministration opted to not impose tarifs or quotason imported steel, rvhich helped precipitate the num-ber ofbankruptcy filings. Horvever, the Bush admin-istration rvas more receptivnrto protectins the U.S.

steel industry from the &_ffiffidiif foreignsteel comparries. [n October 2001, the U.S. Interna-tional Trade Commission (lTC) ruled that increased

1Fof up to 30 percent

Case lG ilusorCorporatiott: Competing

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lmports

Case 1O Nucor Corporation: Competing against Low-Cost Steel lmports c-199

on imports of selected steel products to help providerelief from Asian and Ewopean companies dumpingsteel in the United States at ultralorv prices.

market conditions rvere for

-.r*---\' (h. ?99J<l{ucor paid $ll5 million to acquire

-s[Fstantially all of the assets of Auburn SteelCgrypany's 400,000+on steel Ear-Sffi[G-Auburn, NervYork. This acquisition gave Nucorexpanded market pr€sence in the Northeastand rvas seen as a good source of supply for a

new Vulcraft joist plant being coustructed inChemung, NewYork.

. ln November 2001-. Nucor announced the acqui-sition of ITEC Steel [nc. for a purchase priceof 59 miIIi6i.-ITEIIGITId annual revenuesof $10 million and produced load-bearing light-gauge steel framing for the residential and com-mercial market at facilities inTexas and Georgia.Nucor rvas impressed rvith lTEC's dedication tocontinuous improvement and intended to grorvITEC's business via geographic and product lineexpansion. ITEC Steel s name was changed toNucon Steel Commercial Corporation in 2002.

. ln July 2002, Nucor paid $120 million toourchase Trico Steel Comoanv. rvhich had a

2.2-million+on sheet steel mill in Decahrr,Alabama- Trico Steel rvas a joint venhre ofLTV (which orvned a 50 percent interest), andtrvo leading international steel companies-Sumitomo Metal Industries and British Steel.The joint venfure partners had built the mill in1997 at a cost of $465 million, but Trico rvas inChapter I I bankruptcy proceedings at the time ofthe acquisition and the mill rvas shut dorvn. TIteTrico mill's capability to make thin sheet steelivith a superior surface quality added competi-tive strength to Nucori strategy to gain sales andmarket share in the flat-rolled sheet segment. ByOctober 2002, nvo months ahead of schedule.Nucor had restarted operations at the Decaturmill and rvas shipping products to customem.

. ln December 200r, Nucor paid $615 millionto purchase substantially all of the assets of

Even

'Company proceeded to make a series

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I no4son-Suctlan&Grsrbl* I

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c-?00 Part 2 Cases in Crafting and Executing Strategy

Birmingharn Steel eomoration. which includedfour-bar mills in Alabama, Illinois. Washington,and Mississippi. The four plans had capacityof appmximately 2 million tons annually. Thepurchase price also included approximately$120 million in inventory and receivables, theassets of Port Everglade Steel Corporation, theassets of Klean Steel, Birmingham Steel's orvn-ership interest in Richmond Steel Recycling,and a mill in Mernphis, Tennessee* that rvas notcurrently in operation. Top executives believedthat the Birmingham Steel acquisition rvouldbroaden Nucor's customer base and build profit-able market share in bar steel products.

In August 2004, Nucor acquired a cold-rollingmill in Decahr, Alabama, from WorthingtonIndustrieffi is ffiiii6i--i6fi'mill]firEiffi opened in 1998, rvas located adja-cent to the previously acquired Trico mill andgave Nucor added ability to service the needsofsheet steel buyers located in the southeasternUnited States.

In June 2004, Nucor paid a cash price of$80 million to acquire a plate mill orvned byBgtain-baspa Corus Steel that u*as located inTrncaoosa, AEEfiil:TEmuscaloosa mill. rvhichcurrentty lud capacity of 700.000 tons thatNucormanagement believed rvas expandable to I milliontons, was the first U.S. mill to employ a specialtechnologqy that enabled high-quality rvide steelplate to be produced from coiled steel plate. Themill produced coiled steel plate and plate prod-ucts that $,ere cut to customer-specified lengths.Nucor intended to offer these niche products to itscommodity pliiie and coiled sheet customers.

In February 2005, Nucor completed the purchaseof Fort Horvard Steeli operations in Oatri Creek.Wisconsin: the Oak Creek facility producedcold finished bars ir: size ranges up to six-inchrounds and had approximately 140,000 tonsofannual capaciry.

In June 2005, Nucor purchased Marion SteelCompany located in Marion, Ohio. for a cashprice of$l l0 million. Marion operated a barmillrvith annual capaciry of about 400,000 tons; theMarion location rvas in proximity to 60 percentof the steel consumption in tlre United States.

h May 2006, Nucor acquired Connecticut SteelCorporation for $43 million in cash. Connecticut

Steel's bar products mill in Wallingford had annualcapacity to make 300.000 tons of rvire rod andrebar and approximately 85,000 tons of rvire meslrfabrication and stuchral mesh fabrication, prod-ucts that complemented Nucor's present lineupof steel bar products provided to constructioncustomers.

. In late 2006, Nucor purchased Verco Manufac-turing Company for approximately $ 1 80 million:Verco produced steel floor and roof deckingat one location in Arizona and trvo locationsin California. The Verco acguisition furthersolidified Vulcraft's market leading position insteel decking, giving it total annual capacity of530,000 tons.

. ln January 2007. Nucor announced plans toacquire all of the shares of Canada-based Har-ris Steel for a total cash purchase price ofabout$1.07 billion. Harris Steel had 2005 sales ofCdn$1.0 billion and eamings of Cdn$64 mil-lion. The cornpany's operations consisted of(l) Harris Rebar, which was involved in the fab-rication and placing ofconcrete reinforcing steeland the design and installation of concrete post-tensioning systems: (2) Laurel Steel, rvhich man-ufactured and disributed rvire and rvire products.rvelded wire mesh, and cold finished bar; and(3) Fisher & Ludion, rvhich manufacnued anddistributed heavy indushial steel grating, alumi-num grating, and expanded metal. ln Canada.Harris Steel had 24 reinforcing steel fabricatingplants. tw$ steel srating distribution centers. andone cold finished bar and rvire processing plant:in the United States, it had l0 reinforcing steelfabricating plants. hvo steel grating manufacrur-ing plants, and three steel grating manufacturingplaats. Harris had customers throughout Canadaand the United States and employed about 3,000people. For the past three years. Harris had pur-chased a big percentage of its steel requirementsfrom Nucor. Nucor planned to opemte HarrisSteel as an independent subsidiary.

rvide had lgrproved markedly. Prices in thJUnitedstates $,ere about )U percent higher than in 2000 andNucor's sales and earnings rvere at all-time highs(see Exhibits I and 3). Butrnade steel into the U.S.

ine of

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I ftompson-Stricklaod-Grmtlu I Case t& Nuccr I Cnru

Cralting and Executing Corporation Competing

Slralegp Coocspts and Egainst Low-Con Steel

Gases. lTth Editioa lrnports

U.S. international Trade Commission extended rheantidumping and countervailing duty orders and sus-pension agreement covering imports of hot-rolledsteel from Brazil, Japan, and the Russian Federationfor au additional five years.

\\ ffru Commercialization of Nerv Technolo-ll gies and New Plant Construetion The-

second element of Nucor's grourth strtegy was to

be firstto-market rvith nerv steelmaking technolo-gies. Nucor management made a conscious effiort tofocus on the introduction of disruptive techoologies(those that rvould give Nucor a commandirg mar-ket advantage and thus be disruptive to the effortsof competitors in matching Nucor's cost cornpeti-tiveness and/or product qualiry) and leapfrog tech-nologies (those that would allorv Nucor to overtakecompetitors in terms of product qualiry, cost per ton,or market share).

One of Nucor's biggest and most recent suc-cesses in pioneering new technology had been atits Crarvfordsville facilities, where Nucor had thervorld's first installation of direct strip casting ofcarbon sheet steel-a process called Castrip- Afterseveral years of testing and process refinement at

lo Castrip technology inthe United States and Brazil. Tbe process. rvhich hadproved to be quite difficult to bring to commercialreality, rvas a major technological breakthrough forproducing flat-rolle{ carbon. and stainless steelsin very thin gauges; it involved far ferver process

steps to cast met8l at or very near customer-desiredthicknesses and shapes. Tlre Castrip process drasti-cally reduced capital outlays for equipment and pro-duced savings on operating expenses as rvell-majorexpense savings included ability to use lorver qualityscrap steel and requiring 90 percent Iess energy toprocess liquid metal into hot-rolled steel sheets. Abig environmental benefit of the Castrip process wascutting greenhouse gas emissions by up to 80 per-cent. Nucor's Castrip facility at Crarvfordsville hadthe capacity to produce 500.000 tons annually andemployed 55 people. In 2006, Nucor rvas buildingits second Castrip faciliry on the site of the Nucor-Yamato beam mill in Arkansas.

I @'ltleMcGnr.r-Hitl

&mpanies.2010

c-201

ln 2006, Nucor announced that it rvould con-struct a new facility to produce metal buildingssystems in Brigham City, Utah. The new plant,Nucor's fourth building systems plant, rvasto have capacity of45,000 tons, employ over 200people. and cost about $27 million; operationswere expected to begin in the flrst quarter of2008. The new plant gave Nucor national rnar-ket reach in building systems products and totaiannual capacity of more than 190.000 tons.

In 2006, Nucor announced plans to consfuct astate-of-the-art steel mill in Memphis, Tennes-see. to produce special quality steel bars; themill rvas expected to cost $230 million, employmore than 200 people, and have annual capacityof 850,000 tons. Management believed the millrvould not only give Nucor one of the industryimost diverse lineups of special quality steel barproducts but also provide a significantly. bet-ter cost structure compared to both foreign anddomestic competitors in the special quality steel

slate-of-the-art facilities in the most economical fash-ion possible and then made it standard company prac-tice to invest ag-eressively in plant modemization andefficiency improvements as technology advanced and

neiv cost*saving opportunities enreryed. Nucor man-agement made a point olstaying on top of the latestadvanees in steelmalcing around the rvorld diligentlysearching for emerging cost-effective technologiesit could adopt or adapt in its facilities. Executives atNucor had a io.nssterrdire LoJnEli&$tElrffiitrre Uistiecirnolow

Case lO Nucor Corporation: Competing against Low-Gost Steel tmports

[onstruction offered the opportunity io

Castrip process lvas

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**- Nucor management also stressed continualimprovement in product quality and cost at each oneof its production facilities. Many Nucor locations rvereISO 9000 and ISO 14001 certified. The company had

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Ihorpmn-Suicktand-Gamtle:

Grafting and Erecuting

Srralegs Goncopls and

Caser llrh Editiol

Case llL ilucorCorporation: Gompatin g

agaiosl Low-Cosr Sreel

Impofts

c-202 Part 2 Cases in Crafting and Executing Strategy

corporatetation that plant-level managers would be aggressivein implementing methods to improve product qualityand keep costs per ton lorv relative to rival plants.

The company's latest initiative involved invest-ments to upgrade and fully modemize the operationsof is production faeilities. Examples included a three-year bar mill modernization program and the additionolvacuum degassers to its four sheet steel mills. Add-ing the vacuum degassers not only improved Nucor\ability to produce some of the highestquality sheetsteel available but also resulted in expanded capacity atlorv incremental cost. Nucor's capital expenditures fornerv technology, plant improvemeots, and equipmentupgrades totaled MlS million in 2000. $261 millionin 2001. $244 million in 2002. $215 million in 2003.$286 million in 2004, $331 million in 2005, and$338 million in 2006. Capital expenditures for 2007u,ere projected to be $930 mittion: the big increaseover 2006 capiral spending rvas intended to ensure thatNucorplants rvere kept in state-of-the-art condition andglobally competitive on cosl Top executives expectedthat allof Nucor's plans rvould have ISO 14001 certi-fied Environmental Management Systems in plaee bythe end of2007.

Global Grorvth via Joint Ventures Thefourth component ofNucor's strategy rvas to growglobally rvit[ jointventures and the licensing of nervteclurologies. Nucor had recently entered into a jointvennrre rvith Companhia Vale do Rio Doce (CVRD)to conskuct and operate an environmentally friendlypig iron project in northern Brazil. Production beganin the fourth quarter of 2005- The joint veflture atthe Brazilian plant involved using fast-gro*,ingeucalyptus trees as fue1.3 Eucalyptus trees reached a

mature height of 70 feet in seven years and imme-diately began to grorv back rvhen harvested the firsttrvo times, after rvhich they had to be replanted. Theproject appealed to Nucor because it counteractedglobal rvarming. As eucalyptus trees gro$,. they takein carbon dioxide from the atmosphere and seques-ter it in their biomass: some goes back into the soilas leaves and *vigs fall to the groun-d rvith tire

remainder being stored in the wood of the bee. Whileburning the eucalyptus lvood to create the char-coal fuel on which this project depended resultedin the release of some of the stored carbon dioxideto the atrnosphere and still more rvas released rvhenthe charcoal rvas combined rvith iron ore in a miniblast furnace to create pig iron, some of the carbondioxide rvas locked up in the pig iron. But the neteffect on any global warming due to the release ofcarbon dioxide rvas ovenvhelmingly positive, giventhat about 500,000 to*s of pig iron were beingproduced and that over ?00,000 acres. or about312 square miles, of eucalyptus forest rvere beingrestored or protected. In the overall scheme, the pro-duction of pig iron at the Brazilian plant removedabout 2,400 pounds of carbon dioxide from the atmo-sphere for every ton of pig iron produced; this com-pared quite favorably rvith the conventional methodof producing pig iron, .rvhich increased the carbondioxide in the atmosphere by 4,180 pounds for everyton ofpig iron produced.

Nucor had recently pqrtnered rvith the NoTinto Group, Misubishi Corporation. and Chinesesteelmaker Shougang Coqporation to pioneer RioTinto's Hlsmelt technology at a new plant located inKrvinana, $y'estern Australia. The Hlsmelt plant con-verted iron ore to liquid rnetal or pig iron and rvasboth a replacement for rraditional blast furnace tech-nology and a hot metal source {ior electric arc fir-naces. Rio Tinto had been developing the Hlsmelttechnology for I0 years and believed that it had tlrepotential to rgvolutionize iron making and providelorv-cost, high-qualiry iron for making steel. Nucorhad a 25 percent orvnership in the venture and had ajoint global marketing agreement rvith Rio Tinto tolicense the technology to other interested steel com-panies. The Australian plant represented the rvorld'sfirst cornmercial application of the Hlsn:elt technol-ogy. Production started in January 2006; the planthad a capacity of over 800,000 metric tons and rvasexpandable to 1.5 nrillior metric tons at an attrac-tive capital cost per incremental ton. Nucor viervedthe Australian plant as a future royalty stream andrarv rnaterial souce- The technology had also beenlicensed to a Chinese steelmaker that planned toconstnrct an 800.000-ton steel plant in China usingthe Hlsmelt process for its iron source.

Nucor's third principal international projectinitiative to

a progmm called BESTmarking airned at being theindustrywi de ffitEffi ffi "Effity

o f produc-tion and efticiency measures. Managers at all Nucorpiants rvere accountable for demonstrating that &eiroperations rvere competitive on both product

involved a rarv materialsrvasaJready

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I lhonqson-Su:chland-Grmbler I Gase it trlusor

CraftingandExecuting Garporation:Gompeting

SrrateBE ConDepls and rgainsl tow-tost Slesl

Cases.l,th Edition lmporls

I cur.

the largest purchaser of smap steel in NorthAmerica,and the companyls rapid grorvth smtegy made it vul-nerable to rising prices fur scrap steel. In an efilort tocutail its dependence on scrap steel as a raw materialinput, Nucor acquired an idled direct reduced ironplant in Louisiana in September 2004, relocated itsoperation to Trinidad (an island offthe coast of SouthAmerica near Venezuela), and expanded the proj-ect to a capacity of 1.8 million metric tons. Nucorrvas currently purchasing 6 to 7 million tons of ironannual$ to use in making higher-quality grades ofsheet steel: integrating backrvard into supplying 25 to30 percent of its orvn iron requirements held promiseof raw material savings and less reliance on ouBideiron suppliers. The Trinidad site rvas chosen becauseit had a long-term and very cost-attactive supply ofnaturai gas, along rvith favorable logistics for receiv-ing iron ore and shipping direct reduced iron toNucor's sheet steel mills in the United Suates. Pro-duction began in January 2007.

Nucor rvas looking for other opportunities glob-ally. But so far. Nucor's stmtegy to participate inforeign steel markets was via joint ventures involv-ing pioneering use of nerv steelmaking technolo-gies. The company did not currently have any plansto build and operate its orvn steel mills outside theUnited States-its only company-operated foreignfacility rvas the one in Trinidad.

#tses*a'igt*t*

Nucor had 49 facilities in I7 states and rvas the larg-est recycler of scrap steel in North America. Thecompany recycled over 23 million tons of scrap in2005 and over 2l million tons in 2006. At Nucoristeel mills, scrap steel and other metals lvere meltedin electric arc furnaces and poured into eontinuouscasting systems- Sophisticated rolling mills con-verted the billets, blooms. and slabs produced byvarious casting equipment into rebar, angles. rounds,channels, flats. slreet, beams, plate, and other fin-ished steel products. Nucor's steel mill operationsrvere highly automated, t-voically requiring ferveroperatir:g employees per ton produced than the millsof rival companies. High rvorker productiviry at allNucor steel mills resulted in labor costs equal toabout 8 percent of revenues in 2005*2006-a con-siderably lorver percentage than the labor costs atthe integrated mills of conrpanies using union taborand conventional blast furnace technolo-ey. Nucort

t- I @nemcgorv-nntCollpanies, ml0

value chain (anchored in using electric arc furnacetechnology to recycle scrap steel) involved far ferverproduction steps, far less capital investment, andconsiderably less labor than the value chains of com-panies rvith integrated steel mills that made crudesteel from iron ore.

. Nlcor's nvo lig :ost components at its steelptanrc were scraP srvere driven by market demand-supply conditionsand could fluctuate significantly-see Exhibit 4.Nucor implemented a rarv material surcharge in 2004to cope rvith sharply increasing scrap steel prices in2004 and help protect operating profit margins. Totalenergy costs increased by approximately $7 per tonfrom 2004 to 2005 as natural gas prices increasedby approximately 3l percent and electricity pricesincreased by approximately l9 percent; energy costsrose another $l per ton in 2006. Due to the effi-ciency of Nucorl steel mills, horvever. energy costsremained less than l0 percent of revenues in 2004,2005, and 2006. In 2006. Nucor hedged a portion ofits exposure to natural gas prices out into 2007 andalso entered into conkacts rvith natural gas suppliersto purchase nahrral gas in amounts needed to operate

txhihit 4 Nucor's Costs for Scrap Steeland Scrap Substitute, 2005-2006

Case 10 Nucor Corporation: Competing against Low-Cost Steel lmports

2000

2001

2002200320042005

Quarter 1

Quarter 2Quarter 3Quarter4

2006

Quarler 1

Ouarter2Quarter 3

Quarter4

$120

101,

110

137

238

27224621724A

,l

237

247257243'

Source.'Nucois 10-K Ieporls and inlormation posted at i.,,rtr.ii:.:;i;i..ri:r-! (accessed October 25. 2006, and January 31, 2007).

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Ihompsirn-Stdcklaod-Gamhh:

Cratting ad Exocuting

$rotegp Concepts and

Gases, trth Ediriou

Gase lG llucorCorporation Competing

aBainst low-Cost Steel

lm!orls

Part 2 Cases in Crafting and Executing Strategy

i* direct reduced iron facility inTrinidad from 2006through 2028.

Nucor plants rvere linked electronically to eachother's production schedules, and each plant strivedto operate in a just-in-time inventory mode. Virtu-ally all tons produced rvere shipped out very quicklyto customers; consequently, finished goods invento-ries at Nucor plants rvere relatively small-

.$ rgamiaaEi e*s esr fli ftie*ag*r* eert

F*lrIo-srlsthF

Nucor had a simple. streamlined organization struc-ture to allorv employees to innovate and make quickdecisions. The company rvas highly decenualizedwith most day-to-day operating decisions made bydivision or plant-level general managers and theirstaff. The three building systems plants and the fourcold-rolled products planrs rvere headed by a groupmanager, but othenvise each plant operated indepen-dently as a profit center and rvas headed by a gen-eral manager. rvho in most cases also had the title ofvice president. The group manager or plant generalmanager had control of the day+o-day decisions thataffected the group or planti profitability.

The organizational structure at a f5pical planthad three management layers:

. General Manager

. Department Manager

. Supervisor/Professional

. Hourly Employee

Group managers gpd plant manageffi reportedto one offour execritive vice presidents at corporateheadquarters. Nucor's corporate staff u,as exception-ally small. consisting of only 66 people in 2006.the philosophy being that corporate headquartersshould consist of a small cadre of Executives rvhorvould guide a decentralized operation rvhere liberalauthority was delegated to nranagers in the field.Each plant had a sales manager who rvas responsiblefor selling the products made at that particular plant;such staff functions as engine.ering, accounting,and personnel management lvore performed at thegroup/plant level. There rvas a minimum of paper-rvork and bureaucratie systems. Each group/plantwas expected to earn about a 25 percent return ontotal assets before corporate expenses, taxes, inter-est. or profit sharing. As long as plant managers met

their profit targets, they rvere allowed to operate rvithminimal restrictions and interference &om corporateheadquarters. There was a very friendly spirit ofcompetition from one plant to the next to see rvhichfacility could be the best performer, but since all ofthe vice presidents and general managers shared thesame bonus systems, they functioned pretty muchas a team despite operating their facilities individu-ally. Top executives did not hesitate to replace groupor plant managers rvho consistently struggled toachieve profitability and operating rargets.

s*$CIr$if e se* fr * *rp * *ssti* r; Fraatie* sNueor rvas a nonunion "pay for performance" com-pany rvith an incentiveffi ihatrervarded goal-oriented individuals and did not puta maximum on rvhat they could earn. All employeesrvere covered under one offour basic compeosationplans. each,fgatudng*incentives related to meeting-ffiisnecrnc soils ano tarEBl\l. Praduction htcpntiye _fuir*Production line

jobs rvere rated on degree of .responsibilityrequired and assigned a base wage comparableto the uages paid by other manufacturing plantsin the area rvhere a Nucor plant rvas located.But in addition to their base rvage, operatingand maintenance employees \vere paid weeklybonuses

rvork

Ail operating and maintenance employees rveremembers"of a production team that includedthe team's production supervisor, and the ton-nage produced by each rvork team lvas nlea-sured for each rvork shift and then totaled forall shifs during a given rveek. If a productionteamt rveekly output beat the rveekly standardteam members (including the team's productionsupervisor) earned a specified percentage bonusfor each ton produced above the standard-production bonuses were paid *,eekly (ratherthanquarterly or annually) so that rvorkers and super-visors rvould be rervarded immediately for theirefforts. Tbe standard rate was calculated basedon rhe ci-pa-bilffi;TTTEE

"q"rp*."r .*pr"v"o

(r),pically at the tirne plant operations began).and no bonus rvas paid if the equioment lvasnot oers a big incentive to keep a plant.s equipment in

numberof thei

Page 135: Crafting (Cases)

Ihonpsoa-Stickland-Gamtle:

Crafting and ErecutingSlrategF eoBcepts and

Gases. lTth Edition

good working eonditionF\Lqgor's philosonhv

J{g! I-g5pgtqHg*qrr{.l[e_bsnus Eiffiiimei

plants were seldom raised unless a plant under-tvent significant modernization or important nelvpieces of equipment were installed that greatlyboosted labor productivity. It was common forproduction inceutive bonuses to run from 50 to150 percent of an employee's base pay, therebypushing theircompensation levels up well abovethose at other nearby manufacturing plants,Worker efforts to exceed the standard and get abonus involved not so much rvorking harder aspracticing good teamwork and close collabora-tion in resolving problems and figuring out howbest to exceed the production standards.

2. D e n a r tl w t *! a! aE e L!!:cg,t t iyq, flSn-Depart-ment managers earned annual incentive bonusesbased primarily on the percentage of net incometo dollars of assets employed for their division.These bonuses could be as much.as 80 percentofa department managerb base pay.

3. Prcfessional and ClericolBonrrsPlan-Abonusbased on a dlvlstons net tncome return on assetsrvas paid to employees that rvere not on the pro-duction rvorker or department manager plan.

4. S-g,r!g: O"fi_r_"t;J fg#/J#*ifu.-Nucor's seniorofficers did not have employment contracts anddid not participate in any pension or retirementplans. Their base salaries $€re set at approxi-mately 90 percent of the median base salary forcomparable positions in other manufacturingcompanies rvith conrparable assets, sales, andcapital. The remainder of their compensationrvas based on Nucor! annual overall percent*age of net incorne to stockholder's equity (i.e.,return on equiry. or ROE) and rvas paid out incash and stock. Once Nucor-s ROE reached a

threshold of not less than 3 percent or more than7 percent (as determined annually by the com-pensation committee of the board of directors).senior officers earned a bonus equal to 20 per-cent of their base salary. lf Nucor's annual ROEexceeded 20 percent, senior officers earned abonus equal to the 225 percent oftheir base sal-ary. Officers could earn an additional bonus ofup to 75 percent of their base salary based on acomparison ofNucor's net sales grorvtlr rvith the

Gase 10: Nucor

Corpontior: Gompeting

agaimt low-Cos Steol

lmlons

Case I O Nucor Corporation: Competing agaiqst Low-Cost Steel tmports c-205

net sales growth of members of a steel industrypeer group. There rvas also a long-term incen-tive plan that provided for stock awards andstock options; this incentive covered a three-year performance period and was linked toNucor's return on average invested capital rela-tive to &at of other steel industry competitors.The structue of these officer incentives rvassuch that Nucor officers could find their bonuscompensation swinging rvidely-from close tozero (in years like 2003 rvhen industry condi-tions rvere bad and Nucor's performance rvassubpar) to 400 percent (or more) of their basesalaries (rvhen Nucort performauce rvas excel-lent, as had been the case in ?004-2006).

Nucormanagement had designed the company'sincentive plans for employees so that bonus calcula-tions involved no discretion on the part ofa planVdivision manager or top executives.'lhis rvas doneto eliminate any concenrs on the part of rvorkers thatmanagers or executives might shorv favoritism or oth-envise be unfair in calculating or arvarding bonuses.Based on labor costs equal to about 8 percent ofrevenues, a typical Nucor employee earned closE to$91.300 in 2005 in base pay and bonuses. (The aver-age in 2000-2002. rvhen the sreel marliet rvas in thedoldrums, rvas about S60,000 per employee.f Totalrvorker compensation at Nucor could run double theaverage earned by workers at other manufacturingcompanies in the states rvhere Nucori plants rverelocated- At Nucor's nerv $450 million plant inHertford County, North Carolina, lvhere jobs rverescarce and poverty lvas common. Nucor employeesearned three times the local avernge manufacturingrvage. Nucormanagement philosophy rvas that u,orlc-ers ought to be exceilently compensated because theproduction jobs rvere strenuous and the rvork envi-ronment in a steel mill rvas relatively dangerous.

Employee turnoverin Nucor rnills rvas extremelyiou': absenteeism and tardiness rvere minimal. Eachemployee rvas allorved four days of absences andcould also miss work for jury duty, military leave,or the death of close relatives. After this, a day'sabsence cost a wod(er the entire performance bonuspay for that rveek. and being more than a half-horrrlate to rvork on a given day resulted in no bonuspayment for the day. When job vacancies did occur,Nucor rvas t'looded tvith applications: plant person-nel screened job candidates very carefully. seekingpeople with initiative and a sFong rvork ethic.

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@' I

c-206 Pan2 Cases in Crafting and Executing Strategy

EmBlop*e fiel*aee*s aei:s! B{Etste*r?

**s*xsscsEmployee relations at Nucor rvere based on fourclear-cut principles:

1. Management is obligated to manage Nucor insuch a rvay that employees rvill have the oppor-tunity to earn according to their productivity.

2. Employees should be able to feel confident (hat

if they do theirjobs properly. they rvill have a jobtomorrow.

3. Employees have the right to be treated fairly andmust believe that they rvill be.

4. Employees must have an avenue of appeal rvhen

they believe they are being ueated unfairly.

The hallmarks of Nucor's human resourcesstrategy rvere its incentive pay plan for productionexceeding the standard and thejob securiry providedto production rvorkers--despite being in an industryrvith strong dorvn rycles. Nucor had made it a prac-tice not to lay offrvorkers.

Nucor took an egalitarian approach to providingfringe benefits to its employees; employees had thesame insurance programs, vacation schedules, andholidays as upper Ievel management. Horvever, cer-tain benefits lvere not available to Nucor's officers.The fringe benefit package at Nucor included:. PrcJit slrarirg-Each year, Nucor allocated

I0 percent of is operating profits to profit-sharing bonuses for all employees (except seniorofficers). Depending on company performance.the bonuses could run anyrvhere frorn I percentto over 20 per-cent-of pay. Tilenty percent of thebonus arfrouut was paid to employees in the fol-lorving March as a cash bonus, and the remaining80 percent rvas put into a trust for each employee.rvith each employee's share being proportional tohis or her earnings as a percent oftotal earningsby all uorkers covered by the plan. An employ-eet share of the profits became vested after onefull year of employment. Employees receiveda quarterly statement of their balance in profitsharing.

, 401(k) plan-Both officers and employees par-ticipated in a 401(k) plan, in rvhich the companyrnatched from 5 percent to 25 percent of eachemployee's first 7 percent of contributions; theamount of the match lvas based on horv rri,ell thecompany rvas doing.

. Medical and dental plan--:fhe company had aflexible and comprehensive health benefit pro-gram for officers and employees that includedrvellness and health care spending accounts.

. Tttition rcintbursenrcnt*Nucor reimbursed upto $2.750 of an employee's approved educa-tional expenses each year and up to $1,250 ofaspouse's educational expenses.

. Entployee stock purchase p/all*Nucor had amonthly stock investment plan for employeeswhereby Nucor added I0 percent to the amountan employee confibuted torvard the purchase ofNucor shares; Nucor paid the commission on allshare purchases.

. Ser:r ice au'ar ds-After each five years of servicervith the company, Nucor employees received aservice award consisting of five shares ofNucorstock.

. Scholarchrps-Nucor provided the children ofemployees (except senior officers) up to $2,750worth of scholarship funding each year to beused at accredited acadertic institutions.

. Other benqlits-Long+erm disability, life insur-ance. vacation. In 2004,2005, and 2006 Nucorpaid each enrployee (excluding officers) a spe-cial year-end bonus of 52,000; this rvas in addi-tion to record profit-sharing bonuses and 401 (k)matching contributions of 5272.6 million in2006. S206.0 mitlion in 2005, and $172.3 mil-lion in ?004 (r'ersus only $8.9 million in 2003).The extra $2.000 bonuses resulted in addi-tional profit-sharing costs of approximatelyS23.8 million in 2006, 522.6nrillion in 2005. and$21.0 million in 2004.

Most of the changes Nucor made in rvork proce-dures and in equipment came fronr employees. Theprevailing vierv at Nucor rvas that the employeesknerv the problems of their jobs better than anyoneelse and rvere thus in the best position to identiffrvays to improve horv things tvere done. Most plant-level managers spent considerable time in the plant,talking and meeting rvith frontline employees andlistening carefully to suggestions. Pronrising ideasand suggestions u,ere typically acted on quicklyand implemented-management rvas rvilling to talce

risks to try rvorker suggestions for doing things bettera:rd to accept the occasional failure rvhen the resultsrvere disappointing. Teamrvork, a vibrant team spirit.and a close worker-management partnership rveremuch in evidence at Nucor plants.

Itompson-Slicklrrd-8amhh: I

Crafting and Erecuting

Strrtegy Gonccpts and

Casas. lTlh Edition

Gasel@t{ucor I c"",Corporation: Coopeting

against [ow-8ost Steet

lmports

@ IheMcGnvr-Hill

Companies. 2010

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Itompsoo-Stricklaod-Gamth;

Crafiing and &ecutingStrategf Conqepls and

Cgses. lTrh Editiar

Cose 1O Nucor

Corpoaion: Gonpeting

against Low-Cost Steel

lnports

Gase l0 Nucor Corporation: Competing against Low-Cost Steel lmports C-20?

Nucorplants did not use job descriptions, Man- pay-for-perforrnance incentive system and to beginagement believed job descriptions caused more instilling the egalitarian Nucor culftre and ideaproblems than they solved, given the teamrvork aEno- sharing. Top priority rvas given to looking for rvayssphereandtheclosecollaborationamoDgrvorkgroup to boost plant production using fewer people andmembers. The company sarv formai performance rvithout making substantial capital iuvesEnents; theappraisal systems as added papenvork and a rvaste of take-home pay of workers at nervly-acquired plantstime. If a Nucor employee was not performing rvell, typically went up dramatically. At tho Auburn Steelthe problem rvas dealt rvith directly by supervisory plant, acquired in 2001, it took Nucor about sixpersonnel and the Peer pressure of work group mem- months to convince rvorkers that they rvould be bet-bers (rvhose bonuses rvere adversely affected). ter off under Nucor's pay system; during that time,

Employees rvere kept informed about company Nucor paid people under the old Auburn Steel sys-and division performance. Charts shorving the divi- tem but posted rvhat they rvould have earned undersion's results in return on assets and bonus payoff Nucor'ssystem.Pretfysoon,rvorkerswereconvincedwere posted in prominent places in &e plant. lvlost to make the changeover-one rvorker sarv his payall employees were quite arvare of the level of pmfis climb from 553,000 in the year prior to the acquisi-in their plant or division. Nucor had a formal griev- rion_.1!g$i2[Q[]n 2001 and ro $92.000 in 2005.sance procedure, but grievances rvere ferv and far { \behveln. The corporaG office sent all nervs releases 1 Ngw Employees )Each plant/division had a

to each division, ivhere they rvere posted on bulletin '-'e5nsul" reipo-nsftne-for providing new employees

boards. Each employee received i copy of Nucor! rvith general advice about becoming a Nucor team-

annual report; it rvas company practice for the cover mate and serving as a resource for inquiries about

of the annual report to consisi of the names of all horv things lvere done at Nucor. horv to navigate the

Nucor employees. division and company, and horv to resolve issues

All of these practices had crebted an egalitarian that might come up. Nucor provided new employees

cutture and a highly motivated workforce that grerv rvith a personalized plan that set folth who rvould

out of former CfO rc.o lverson's radical inslsht give them feedback about horv rvell they rvere doingthat employees, even hourly clock punch"o, ,uJdd and rvhen and horv this feedback rvould be given;

put forth ixtraordinary effbrt and Le exceptionally from time to time. nelv ernployees met rvith the plant

productiveiftheyrue.i.ichtyrervardedtreated.uitir manager for feedbaclc and coaching. In addition,

r.spect, and given real porver to do theirjobs as best thers rvas a new employee orientation session that

they sarv fit.5 There rvere countless stories of occa- provided a hands'on look at the plant/division oper-

sions rvhen managers and rvorkers had gone beyond ations; new employees also participated in product

the cali of dury io expedite equipmeni repairs (in group meetings to provide exPosue to broader busi-

many instan"", "r"n

biorving tireir rveekends to go ness and technical issues. Each year. Nucor brought

help personnel at other Nucoi plants solve a crisii;: all rec-ent college hires to the Charlotte headguarters

the'cimpany's rvorkforce ruos i,nourn for displayin! for a forum intended to give the new hires a chance

unusual passion and company Ioyalty even .vhen oJ to .nefrvork and provide senior management rvith

personal financial stake rvas involved. As one Nucor guidance on horv best to leverage their talent.

rvorker put it, "At Nucor, we're not 'you guys'and'us guys.'It's all of us guys. Wherever theb.ottleneck Ff E.*t*;; *m* if1t:f*imtiU*is.rvegothere,andeveryonervorksonit."6 '---' --'# - ---- ----#

It rvas standard procedure for a team of Nucor The commodify narure of steel products meant thatvetefims. including people rvho lvorked on the plant the prices a cornpany could command rvere drivenfloor, to visit with their counterparts as part of the by market demand-supply conditions that changedprocess of screening candidates for acquisition.T more or less continualiy. es a consequence, Nuclr'sOne of the purposes of sucit visits rvas to explain average sales prices per ton varied considerablythe Nucor compensation system and culture face-to- from quarterto quarter-see Exhibit 5. Nucor'spric-face. gauge reactions. and judge rvhether the plant ing strategy lvas lo quote the same price and salesrvoutd fit into "the Nucor rvay of doing things" if it terms to all customers, rvith the customer paying alluas acquired. Shortly after making an acquisition, shipping chatges. Its prices lvere customarily theNucor nanagement moved srviftly to institute its lo*,est or close to the lorvest in the U.S. market for

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I n*pon+ri.ftand-Gsmbh: I

Gratting and Executing

STtaESF Concepts and

Cases 17th Edition

Case l(} l{ucor I c"""Goryontior Competing

sg8inst low-Cost Sleel

lmports

@ The McGrarv-Hill

Companies, ?0l0

by Product Category

c-208

Exhihit 5

Part 2 Cases in Grafting and Executing Strategy

Nucor's Average Sales Prices (per ton) for Steel Products,2005-2006

. ?00S,,,,iI,Qtrl,

" . Qtr2:',,],: Otrg' 'Otr4'2006 . ':

Qtil 'Qtr2'j' ":'i ::. ... . . .:'l:

". _ QtrS',' , Qtr4' '

: $675 :: 609

szs,.. s83

.l,;.. -..:.l: t...:

' 594:625673 ,

.:... ,.. t:.. 624

$605i .: $763574 t.'' 708561 ., . 625

634 684

$1,102.

1,084

1,056

1,A77

1 ,1041,092'

1,122.'

1,175

$1,012.1,067 '

t 1,003'

'

1:otn i

1 ,010 ''t,033

1.067.998 ,

6119 6981 ::.

, ., : ]

667 , 7127A3 746..,t.:. .. .;727. 732

s5.14

499496542

.':

543567601

576

$1,02097293s

' g3l

s6636211

:szi630

938

.r: 930

946r 1.031

'63r. 654

702., 683

Source: Company records posted at ;+*r".i,r,rrr.;cr;: (accessed Octoher 23, 2006, and January 31, 2007).

steel. Nucor's status as a low-cost producer rvith reli-ably low prices had resulted in numerous customersentering into noncancelable 6- to l2-month con-tracts to purchase steel mill products from Nucor.These contracts contained a pricing formula tied torarv material cosB (rvith the cost of scrap steel beingthe primary driver of price adjustrnents during thecontact period). tn 2005-2006, about 45 percent ofNucor's steel mill production rvas committed to con-tract customers. All of Nucor's steel mills planned topursue profitable contract business in the future.

Nucor had recently begun developing its plantsites rvith the expectation of having several customercompanies co-locate ngarby to save shipping costson their steel purchases. tn order to gain the advan-tage of lorv sNpping costs, two tube manufacturers,hvo steel service centers, and a cold-rolling facilityhad located adjacent to Nucor's Arkansas plant. Fourconrpanies irad announced plans to locate close to anerv Nucor plant iu North Carolina.

Approximately 92 percent of the production ofNucor's steel mills nas sold to outside customers in2005-2006: the balance uas used internally by Nucor'sVulcraft. Cold Finish, Building Systems, and Fasten-ers divisions. Sleel joists and joist girder sales lvereobtained by competitive bidding. Vulcraft suppliedprice quotes to con&actors on a significant percent-age of the domestic buildings that had steel joists andjoist girders as part of their support systems- Nucor'spricing for steel joiss, girders. and decking included

delivery to the job site. Vulcraft maintained a fleet oftrucks to ensure and control ou-time delivery; freightcosts for deliveries rvere less than I0 percent of rer,-enues in 200t2006. In 2005. Vulcraft had a 40 per-cent share of the U.S. market for of steel joists. Steeldeck rvas specified in the majority of buildings usingsteel joists and joist girders. In 2005 arrd 2006.Vulcraft supplied more than 30 percent oftotal domes-tic sales of steel deck; the 2006Verco acquisition gaveNucor the capability to substantially increase its salesand market share of steel deck in 2007.

.r"

COE\$PETBfiCN$ iEN THESTHTL INDUSTHY

The global marketplace for steel rvas considered tobe relatively mature and highly cyclical as a resull ofongoing ups and dorvns in the rvorld economy or theeconomies of particular countries. In general. com-petition rvithin the steel industry. both in the UnitedStates and globally, was intense and e.xpected toremain so- Numerous steel companies had declaredbankruptcy during the past 10 years. either ceasingproduction altogether or more usually continuing tooperate after being acquired and undergoing restruc-turing to become more cost-competitive.

Worldrvide demand had grorvn by about 6 per-cent annually since 2000 (rvell above the l.l percent

Page 139: Crafting (Cases)

Ihomps on-Slricllanrl-Gamble:

Srafting rnd ErecutingSlralegp Concepts and

Gases, 17tt Edition

Csse'l& trlucor

Corporation: Conpetin g

against Lorrl-Cost Steel

lfipons

Case 10 Nucor Corpomtion: Competing against Low-Cost Steet lmports

Exhibit $ Estimated Worldwide Production of Crude Steel, with Compound AverageGrowih Bates, t 975-2005

1975

1980 .

'tsgs'

19901 995

2000200120a2.2003 ,

2004 .

200s

n.a.

n.a,

s2s0415.

470

385

270330

465,790

770

710790792849828934937996

1,068

1,176

1,247

1975-'1980

1S80-'t9851 S85-199019S0-1995

1995-20002000-2005

, 2.2Yo,t..

,0'1 ,,,,:.1.4: . :

-0.5 . r.

1.4 ,'.6.0, .

n.a. = notavailable

Source.'lnlernational lron and Steel lnslitute, Waild Steel in Figues,2O06, i..,i.,.. r:ri {accessed November 5, 2006i.

Exhiltit 7 Estimated Consuinption of Steel Products, by Geographic Region, 2000-2005.fin millions of tons)

European Union (25 countries)

Other European countries, Bussia, and UkraineNorlh AmericaCentral and South America

AlricaMiddle East

Asia

Australia,NewZealand : , ' '

r Worldtotal ..., ,.'.', .t....,,.',.-. . :.

177.6

60.8

161.6

31.0

17.0

?1.7353.0

7.4

830.2

174.6

64.1

145.6

31.8

18.4

25.5382.7

6.9

849.6

173.2

63.0

145.S

30.4

20.3

27.9

432.8

7.9901.5

71.8

143.5

30.421.0

33.3496.2

__9.3980.6'

185.2

75-6

164.2

36.0

?2.6

33.7

546.7

8.t1,472.9

176.8

80.1

149.7

35.8

24.7

38.2602.8

.r: ' 8.7

1,116.8

grorvth rate from 1975 to 2000), but there had beenperiods oF both strong and 'uveak demand during2000-2006 (see Exhibit 6). Prices for steel productslvere near record levels tluoughout most of 2004*?006, driven by strong global demand for steel prod-ucts (see Exhibit 7). Worldrvide sales ofsteel producls\l,ere in the $770 to S790 billion range in 2004-2005:prior to 2004, global sales had never exceeded$500 billion in any one year. accordin*s to data com-piled by the International lron and Steel Instirute..

Nonetheless. steehnaking capaciry rvorldrvidestill exceeded global demand in 2005-2005. Manyforeign steelmakers, looking to operate their plantsas close to capacity as possible or seeking to takeadvantage of flavorable foreign currency fluctua-tions, had begun exporting steel products to the U.S.market, rvhere strong demand and tight domesticsuppiies lrad pushed steel prices to highly profitablelevels. According to U.S. Departmenr of Commercedata, steel imports into the United States rose by

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Itmrysor.Sricldond-Gamhle:

Grahing and Execufng

Stralegy Goncepts and

Cases, l?th Edirion

Gase ll} Nucor

Gorporatioa Competiog

agairH Lorv-Co$ Slestlmporrs

c-1t0 Part 2 Cases in Crafting and Executing Strategy

over 70 percent betrveen November 2005 and Sep-tember 2006 and were expected to reach a recordlevel of over45 million tons in 2006 (see Exhibit 8);companies in China, Russia, Korea, Turkey, Taiwan,Japan, India, Australia, and Brazil \vere particularlyaggressive in exporting their production to the U.S.market.' Steel imports frorn China, for example,jumped from 139,300 tons in November 2005 toa monthly average of over 575,000 tons in July,August, and September 2006. Steel imports fromTaiwan rose from 48,400 tons in November 2005to nearly 265,000 tons in September 2006. Steelirnports from Russia were 121.300 tons in Novem-ber 2005 and 517,000 tons in August 2006. Steelimports from Korea rvere about 115,700 tons inNovember 2005 and over 260,000 tons in Septem-ber 2006; imports from Australia tere 60,000 tonsin November ?005 and 162.000 rons in September2006. In 2005, foreign steelmakers captured a22.8 percent share of the U.S. market for steelproducts (based on tons); foreign steelmakers rvereexpected to achieve close to a 30 percent share oftheU.S. market in 2006. Many non-U.S. steel prcduc-ers rvere owned and/or subsidized by their govern-ments, a condition that often meant their productionand sales decisions rvere driven by political and eco-nomic policy considerations rather than by prevail-ing market conditions. Steel supplies in the UnitedStates iand other counkies) rvere also subject to

shifting foreign exchange rates, rvith more importspouring in rvhen the local curency rvas strong andmore exports florving out rvhen the local currercywas rveak-

ln February 2007, Nucor CEO Dan DiMiccoapplauded the announcement that the U.Sr gov-ernment had requested World Trade OrganizationOV-fO) dispute settlement consultations rvith Chinaregarding claims that China rvas violating WTO rulesby providing subsidies to Cliinese steel exporters.r0Under the WTO dispute settlement procedures, areguest for consultations rvas the first step in resolv-ing the U.S. claim that the Chinese government wasviolating WTO rules. If a WTO panel found thatChila rvas indeed breaking WTO rules, it couldorder China to provide compensation to the UnitedStates by allorving the United States to impose highertariffs on Chinese goods or take similar measures.Under US. countervailing duty larv, if a U.S. Depart-ment of Commerce investigation confirrned that for-eign plants exporting steel to the United States rverebeing subsidized by their govgrnment and if the U.S.Intemational Trade Commission determined that thesubsidized imports had injured the domestic steelindusbry, then the United States could apply counter-vailing duties to offset the subsidies. While the U.S.govemment had not previously applied countervail-ing duties when authorized to do so, the CommerceDepartment was currently considering rvhether to

Exhihit I ttre U.S. Market for Steel Products, 1995-2005 (in millions of tons)

1995

199619971998 102.41999. , 106.22000 ' 109.1

2001"' :. 9g-g

2002 , " 100.02003 ' 106.02004 ' '' 111.42005' " 105.0

7.1

5.06.0

5.5

5.46.5

6.1

6.0

8.2

7.9

9.4

97.5100.9

105.9

24.429.2"3'1.2 ',41.5 '

95.7 '3g.or' '

......:30.1. 'g2,7'. " '

23-1 : . ::

g5.g t" '

32.i: "::.: l'

114.8

125.0

131.0

138.4136.5

140.5

1A.9126.7

120.9139.31

127.7

'Apparent U.S. consumption equals tolal shipmenls mint s exports ptus imports.sourEej American lfon and steel lnstitute, as reporled in slandard & Poors lnduslry surueys.

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tho mpmn-Sticlland-$arable:

Craftirg and Execuling

SrarDgE Corcepe aod

Gases, lTlh Edition

change this practice. DiMicco saw rhe U.S. govern-ment's request for WTO settlemeflt consultations asonly a first step toward leveling the playing field forU,S. steel producers: he said:

This request does not cover the vast majority ofthemassive domestic subsidies China provides to itssteel industry and other manufacturers. Nor does itaddrcss China's gross manipulation of its currency,tvhich provides Chinese exports rvith a huge advan-tage in international trade. Free trade is possiblc only. if everyone follotvs the rules-and China hasn't,l I

Exlribit 8 shorvs steel production, steel exports,and steel imports for the U.S. market for 1995-2005.Exhibit 9 shorvs the vaiue of steel mill shipments byU. S. -based steelmakers for 2004-2005, broken dorvnby product category. Exhibit l0 shorvs data for the top20 countries rvorldrvide as concerns total steel pro-duction, steel exports. and steel imports; Exhibit I Ishorvs the 20 largest steel companies worldrvide asof2005.

STEE$- PRODI.,IETICF\{Steel rvas produced by either integrated steel facili-ties or minimills that employed electic arc furnaces.Integrated mills used blast furnaces to produce Imtmetal typically from iron ore pellets, limestone.scrap steel, oxygen! assorted other metals. and coke.(Coke rvas produced by firing coal in large coke

Gase 1& Nucor

Corporatioo: CoraFBtirlg

rsaiust Low-Cdsl Sleel

lmportg

Case lO Nucor Corporation: Competing against Low-Cost Steel lmports c-1It

ovens and rvas the major fuel used in blast furnacesto produce hot metal.) Hot metal from the blast fur-nace process rvas then run through the basic oxygenprocess to produce liquid steel. To make flat-rolledsteel products, liquid steel rvas either fed into a con-tinuous caster machine and cast into slabs or elsecooled in slab form for later procexing. Slabs rverefirrther shaped or rolled at a plate mill or hot stripmill. In making certain sheet steel products. the hotstrip mill process rvas follorved by various finishingprocesses! including pickling, cold-rolling. anneal-ing, tempering, or galvanizing. These various pro-cess€s for converting raw steel into finished steelproducts rvere often distinct steps undertaken at dif-ferent times and in different on-site or off-site facilities rather than being done in a continuous processin a single plant facility-an integrated mill rvasthus one that had multiple facilities at a single plantsite and could theiefore not only produce crude (orrarv) steel but also run the crude steel through vari-ous facilities and flmishing processes to make hot-rolled and cold-rolled sheet steel products, steel barsand beams, stainless steel. steel rvire and nails. steelpipes and tubes. and other finished steel products.The steel produced by integrated mills tended to bepurer than steet produced by electric arc furnacessince less scrap was used in the production process.(Scrap steel often contained nonferrous elementsthat could adversely affect metallurgical properties.)Some steel customers required purer steel productsfor their applications.

Exhibii I Dollar Value of Shipments of Steel Milt Products by U.S.-Based Steelmakers,by Produet Category 200+2005 ($ in billions)

Steel ingot and semiiinished shapes

Hot-rolled sheet and strip, including tin mill products

Hot-rolled bars and shapes, plales, structural shapes, and pilings

Steel pipe and tube

Cold-rolted sheet steel and strip

Cold finished steel bars and steet shapesSteel wire .

All other steel mill products

Total :

$4.9 :. S5.725.2 r : 24.814.9 17.1

9.5. ,.:. . 10.912.2. : '13.5

2,0 : . 2.1

2.3 , , 2.31.3 1.3

872.7' -, S7e.3

Sorrrc': U.S. Depanrnentof Commtrce."Cum'nt Indusrrial Rcpons. Slcsl tvlill Producls.f,firsr"-,y',!:$.,j{i:.r!}.lrrJ.iit:.i (accessctlNorcmbrr l.2$06).

L

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I nompson-srhtland-Ganrlb: I

Cralting ard Execudng

Strategy ConcepE and

Cases, lllh EditiDn

Case l0: l{ucor I c"",Gorporalion: Comp8ting

agaiflst Low-Cosl Steel

lEports

@ Ihe McGryr-Hill

Corpanies.20l0

c-212 Part 2 Cases in Crafting and Executing Strategy

Ixhihit I0 Top 20 Countries: Totalsteet Production, Steel Exports, and Steel tmports,2004-2005 fin millions of tons)

1234567I9

't0

11

12

13

14't5

16

't7

18

19

20

, China.". r. . ..,,,, .,,,,,,''.,,, : : -],,:,,, .

Japan- ., : :j .

United States

: ,. Bussia , ,l: i South Korea ,: :

j Germany.: .

Ukraine,-, i ,

lndia , , .

Brazil .

llaly, :..-i. .,,,_, ., Tu*ey. ,. ,., ,t

.. ,, , France., , ....'. .. ,

Taiwan, China: ,

Spain,, ,,l

Canada ., .. ,. ,

United Kingdom

Belgium

South Africalran

,; Japan

I Flussia. ,. , ,

- Ukraine' i l

GermanY :

Belgium .', ..t.. '

Ghina

.. France

South Korea

, ltaly, : .,

. Turkey . ..Brazil '. . .

: Taiwan, ChinaNetherlands .

United Kingdom

United States

SpainAustriaMexico

lndiaCanada

Chinai,:,-.:,,- .r,,,:, . .: : :.:.,, I, 36.6unitedstites i:.1r:. : :: .. 36.4Germany , , .'. '. ".'.i z1.gItaly' ' l:,....,,

..t 21.4Saulh Korea ,.. . .' ' 1g,s

. r.::, :1 :.: :

France ::,,, ....1 .; . . tg.ZBelgium, :: . :.,r..: . 16.4Taiwan,Ghina.. : ,,,,.. 15.1

Spain.:.. ... ..:',.i::: .: ,, 13.0

Thailand'. :.:,: ,:i, :. 12,2:Canada.,;"'.:., ,,-. . 10.2:-.

United Kingdorn:,, . .; :: 9.6 :

Turkey .. ., :. . . . ,. -" : 9.0ilfan:'...'. ,.;,.:.. , : ..: . .... 8.7Malaysia,:r.,.' .. 8.3Netherlands , 7,2Hong Kong . 6.9Mexico

- 6,4

Vielnam :: , 6.0United Arab Emirates 5-l

. 385.0, 124.0. . ,

104.6:..,;,

72.8.: ,

52.7,.;.

. 49.0 ,

. 42.5 :

,. .: 42.O.:,.,

.: 34.8 .

. , 32.3

. 23.1.'.-,- 21.5 :..

,: 20.5,,,..19.5 -

, 17.9' : -

16.9 .

14.5

11.0't0.5

10.4

38.3 . -

33.5i. i

31.1 .'

30.1 : '

25.9u.220.616.514.7. . :

14.5:.13.2 ,.. .

10.4 .

oo...:8,6,. ,

8.0.7..1

6.46.1

6.1

6.0

Minimills used an electric arc firrnace to meltsteel scrap or scrap substitutes into molten metalsdrich rvas then cast into crude steel slabs, billetsor blooms in a continuous casting process: as wastlte case at integrated grills, the crude steel was thenrun through- variOus facilities and finishing pro-cesses to make hot-rolled and cold-rolled sheet steelproduets. steel bars and beams, stainless steel, steelrvire and nails. steel pipes and tubes. and other fin-ished steel producs. Minimiils could accommodateshort production runs and had relatively fast prod-uct change-over time. Minimills typically rvere ableto produce a narrotver range of steel products thanintegrated producers, and their products tended to bemore commodity-like. The electric arc technologyemployed by minirnills offered trvo primary com-petitive advantages: eapital investment requirementsthat u'ere 75 percent lorver than those of integratedmills, and a smaller workforce (lvhich translated intolorver labor costs per ton shipped)-

GLCIBAL STEEI-IEIDUSTHY TRENDSOver the past five decades. changes in steelmak-ing technology had revolutionized the rvorld's steelindustry. Up uutil the 1960, steel was produced inlarye-scale plants using capital-intensive basic oxy-gefi blast furnace technology and open hearth fur-nace technology rvhere steel rvas made from scratchusiug iron ore. coke. scrap steel, limestone. and otherrarv materials*suclr companies were refemed to asintegrated producers because the value chains at suchplants involved a number of production steps andprocesses to convert tle rarv materials into finishedsteel products. But starting in the 1960s. the advent ofelectric arc fumace technology spurred netv start-upcompanies to enter the steelmaking business. Thesenerv companies, called minimills because theirplantsproduced steel on a much smaller scale than did the

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Ihomp:on-Sur'cklanl-Grm[le: I Case ll] Nucor I C"r.Grafting and Erecuting Corporalion: Compering

SuateBFColtcBprsand againstLow-GosSteelGases tTlh Edilion lmports

--ffi@Qompanier. Z0l0

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' ., , , : : , .: :- . .,'-,, ';..', 33.3 ,, ,

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, , 15.1i

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13.3

10.2

12.5

12.5

Case i0 Nucor Corporation: Competing against Low-Cost Steel lmports

., 1. ,..',

,;. .

,2.,,': ..3.' ::.:... ,

4,,9,, :

6,7,.8,.;' :

9 '.r

10.. '

1't: .::'.: .

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18

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,., :: 89.4 .,..i,:,

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,: 1.. 35.3: .,.t,l sg.e ', -''

"-.. 32.9.. .,

25.0.:.: .

.,., ?1.1 ,.,,r.,

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::.i. 18.2.:: . '' 17J,. :

.: 15.3.15.1r

: 15.0.,, 14.9

14.8

14313.1

12,6

,. Mittal Steel' (Netherlirnds),

, Arcelorl (Luxembourg),1,, ;

NipponSteel(Japan), : ;,POSCO (Soulh Kore6),, r,-

JFE (Japan) . ,, 'r;Baosteel (China) . ,: :,

USSteel (USA), ;,, i'i ,

Nucor(USA) ,. :: .:, ,, ,, r

Corus Groupt (Great Britain)Fliva (ltaly): j .: : :

, ThyssenKruppte"**rl.' Tangshan (China)-r : :,r ' :':

' Evraz(Bussia) :" .' .

Gerdau (Brazll) r' ' ,' ' , '

Severstal (Russia), r ."Sumitomo (Japan) , ,

SAIL(lndia) r , '

Wuhan (Ghina) , l

Anshan iCirinal'. ' :

Magnitogorsk {Russia}

'Mitlal Sleel and Arcelor merged in 2006.tcorus Group was acquired by Tata Ste6l (lndia) in 2006;Tata Steel was the world's 56th largest poducer ol sleel in 2005.

Source.'lnternational lron and Steel lnslitute, World Sleet in Figures, 2A06, !:J!er!.:-..=i;rr.',r*i.r'r-i (accessed November 6, 2006).

integrated mills. used lorv-cost electric arc furnacesto melt scrap steel and cast the molten metal directlyinto a variefy of steel products at costs substantiallybelorv those ofintegrated steel producers.

fuitially, minimills were able to only make lorv-end steel products (such as reinforcing rods andsteel bars) using electdc arc furnace technology.But rvhen thin-slab casting technology came on thescene in the 1980s. minimills were able to competein the market for flat-rolled carbon sheet and stripproducts; these products sold at substantially higherprices per ton and thus trere attractive market seg-ments for minirnill companies. Carbon sheet andstrip steel products accounted ficr about 50-60 per-cent of total steel production and represented thelast big market category corfolled by the producersemploying basic oxygen furnace and blast furnacetechnologies. Thin-slab casting technology, which

lrad been developed by SIvIS Schloemann-SienragAG of Cermany, rvas pioneered in the United Statesby Nucor at its plants in Indiana and elselvhere.Other minimill companies in the United States andother countries were quick to adopt thin*lab castingtechnology because the lorv capital costs of thin-slabcasting fhcilities, often coupled rvith the lower laborcosts per ton, gave minimill companies a cost andpricing advantage over integrated steel producers,enabling them to grab a grolving share of the globalmarket for flat-rolled sheet steel and other carbonsteel products. Many inte-Erated producers ilsosrvitched to thin-slab casting as a defensive measureto protect their profit margins and market shares.

By 2005. electric arc furnace technology rvas

being used to produce about 33 percent ofthe rvorldbsteel; basic oxygen furnace technology rvas used toproduce about 65 percent of the all steel products.

Exhibit l1 Top 20 Steel Companies Worldwide, Based on Crude Sieel Production, 2008

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I tompson-Sricttao&.Gamble: I

Craftin0 snd Erectning

Strategp Gonceps and

Gases. lTth Edition

Case ll} Nucor I c"ruCorporation: Competing

against lsw-Cot Steal

lmpoas

@Ihe McGarv-Hilt

Compar{es.28l0

c-2t4 Part 2 Cases in Crafting and Executing Strategy

Limited supplies of scrap steel and upward-trendingprices for scrap steel rvere said to be the main factorsconstraining greater use of electric arc technologyacross the lvorld. Open hearth technology had largelybeen abandoned as of 2005 and was used only atplants in Russia, the Ukraine, lndia, and a few otherEastern European counries. In 2003-2006, about90 percent of the rvorldi production of steel involvedthe use of continuous*castirg technology.

meryerbetrveen toubled British Steel and KouinklijkeHoogovens, a rvell-regarded steel company based inthe Netherlands.

Jinan Iron and Steel and Lairvu Steel, the 6thand 7th largest steel producers in China and &e 23rdand 24th largest producers in the rvorl4 merged inOctober 2006 to form a company with total salesof almost 23 million tons in 2005; the merged com-pany was named Shandong lron and Steel. Industryobservers believed the Jinan-Lairvu merger tvas anattempt by Chinese steelmakers to better competervith Arcelor Mittal and other foreign rivals.

In the United States, United States Steel, head-quartered in Pittsburgh. had acquired National Steelin 2003, giving it steelmaking capabiliry of 26.8 mil-lion tons annually as of 2006. In 2006, U.S. Steel had12 steelmaking facilities in the United States, one inSlovalcia, and tlvo in Serbia. U.S. Steel had a labor-cost disadvantage lemus Nucorand Mittal Steel USA(the U.S.-based operations of Arcelor Minal), partlydue to the lorver productivity of its unionized rvork-force and partly due to its pension costs. While MiualSteel USA also had a union rvorkforce. it had recentlydorvnsized the labor force at some of its plants byclose to 75 percent and norv operated many of its U.S.plants ,rvitlr a very lean rvorkforce in a manner aliin toNucor. Arcelor Mittalt recent acquisitions of InlandSteel and [nternational Steel Group in the UnitedStates had transformed Mittal Steel USA into NorthAmerica! Iargest steel producer, with operations inl2 states and annual rarv steel production capabilityof about 31 mi$ion tons. Mittal Steel USA's principalproducts included a broad range of hot-roLled cold-rolle{ and coated sheets; tin mill producs; carbon andalloy plates; rvire rod: rail producs; bars and semifin-ished slrapes to serve the automotive, constuction,pipe and tube, appliance, container. and machinerymarkets. All of these products are available in stan-dard carbon grades as rvell as high-stength, Iorv-alloygrades for more dernanding applications.

N3{.JCER'S C!.{$EF

DGMTSTBC CSMPHT$TORS

Cor:solidation of the industry into a smaller num-ber of larger and more efficient steel producershad heightened competitive pressures for Nucorand most other steelmalcers. Nucor had three major

Industry ConsolidationStates and across the rvorld,

both the Unitedlast hvo industry

dorvntums had resulted in numerous mergers andacquisitions. Some of the mergerVacquisitions rverethe result of a financially and managerially shongcompany seeking to acquire a high-cost or strugglingsteel company at a bargain price and then pursue costreduction initiatives to make nervly acquired steel milloperations more cost competitive. Other mergers/acquisitions reflected the stategies of grorvth-mindedsteel companies looking to expand both their produc-tion capacify and their geographic market presence-

In 2006, the rvorld's two largest steel produc-ers, Mittal Steel and Arcelor, both headquartered inEurope but with operations in various parts of thervorld, rnerged to form a giant company rvith totalsteel production of over 116 million tons (equal toabout a l0 percent market share worldrvide). Priorto its merger rvith Arcelor, Mittal Steel in 2005 hadacquired International Steel Group, the second larg-est steel producer in the United States, rvith l3 mojorplants in eight states, and Inland Steel, anotherstruggling U.S. steel producer. In 2006,ArcElor Minal hadtotal production capacity of nearly 125 million tons.annual revenues of $7?billion. earnings of S 13.3 bil-lion. plants'in2? 66untries on five continents (NorthAmerica. South America. Europe. Asia, and Africa),and 330,000 employees-

Also in 2006, Tata Steel in lndia acquiredCorus Steel (Creat Britain), the rvorld's eighth lar-u-

est steel company; the nerv company produced over27 million tons ir 2005. Tata Steel rvas one of thelorvest-cost steel producers in the rvorl{ rvith accessto loriv-cost iron ore deposits, and rras adding newproduction capacity at thrce sites in India, a plant inIran. and a plant in Bangladesh; Corus rrms regardedas a relativety high-cost producer but had been prof-itable in 2004-2005 after posting huge losses in2000*2003. Corus had a 50 percent share of the steeln:arket in Creat Britain and substantial sales in partsof Europe: it was formed iu 1999 as the resuit of a

Irtthe

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I ftonpso*-Sticltland-Garnble: I

Cratting ard Etecuting

Stratsgy Csncepa 80d

Casos. lrth Fdition

Case 1o: Nucor I c.."Sorpcndon: fanpcting

against low-Con Steel

hEDTrs

I @ Ttre Mc6ov.HillCsnpanias. Z}I0

l@l

rivals headquartered in the United States-MittalSteel USA, U.S. Steel. and AK Steel. Miual SteelUSA competed only in carbon steel product catego-ries; it had seven integrated mills, three plants thatused electric axc furnaces, and four rolling and fin-ishing facilities. About 17,200 of its approximately20,500 employees lvere represented by unions. U.S.Steel had rnostly integrated steel mills, a unionizedworkforce, rvorldrvide annual raw steel production

c-215

capacity of 26.8 million tons, and worldwide rarvsteel production of 21.2 million tons in 2005.AK Steel had seven steel mills and finishing plantsin four states; about 6,300 of its approximately 8,000employees were represented by unions. It sold muchof its ouput to automotive companies-its trvobiggest customers rvere General Motors and Ford.Exhibit l2 presents selected financial and operatingdata for these three competitors.

Case l0 Nucor Corporation: Competing against Low-Cost Steel lmports

Erhihit I2 Selected Financial and Operating Data for Nucor's Three Largest U.S.-basedCompetitors

Mittal Steel USA . .: .:Nelsales ' ' . :

Cost of goods sold

Selling, general, and administrative eipensesNet income

Net income as a percent of net sales

Shiprnents of finished steel products (millions of tons)

Raw steel production (millions of tons)

U.S. SteelNet salesCost of sales

Selling, general, and adrninislrative expenses

lncome (loss) lrom operations

Net income

Net income as a o/" of net sales

Shipments of steel products (millions of tons)

Flaw steel production (miuions of tons)

Domestic

Foreign

Production as a 9'o of total capability

Domestic

Foreign

AK Steel GroupNet salesCost of producls sold

Selting and administrative expenses

Operating profit (loss)

Net income {loss} i

Operaling profit as a 9'o of nel sales

Net income as a o/o of net sales

Shipments of finished steel products (millions of tons)

s 12,237

10,617

371

$ 491

4.O70

't8.8

20.0

s 14,039

11,601

698

1,439

$ 89e10.3%

19.7

21.2

15.3

5.9

79.1aio

79.5

s5,647.44,996.8

208.4

113.1

s (2.3)

2,Ao/o

(0.04)o,'.

6.4

s 12,174

10,315

301.S 1'286 ,

10.6%

21.1

23.9

s 13,975

1 1,368

739

1,625

s 1,117

8.096

21.8

23.0

17.3

5.7

89.06/o

76.8

s5,217.34,553.6

246.4

(7e.7)

s 38.4(1.5r/.4.60/o

6.3

s 9,328

8,458

673(71s)

s (4s6)

$.l)a/a19.2

19.8

14.9

4.9

90.1olo

87.S

s4,04'1.7

3,886.9

243.6

(6s1.8)

s (560.4)

6.0%(13.9)o/,

5.8

Surca ComPanY 1 0'K reports.

L-

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| ftoqsoa-sricfhd-thdu: I

Crafting rod Btecuting

St'oregf ConreFls snd

Gasss, l7lft Edilion

Caso 1& Nucor

Gorporatiom Gompeting

against Low-Coa Srael

lmporrs

I c".. @IheMcGaw-Hill

Companies,20l0

c-216 Part 2 Cases in Crafting and Executing Strategy

ln addition to the thre€ major domestic rivals,there rvere a numkr of lesser-sized U.S.-based steel-makers rvith plants that competed directly againstNucor plants. However, Nucor's most formidablecompetitive threat in the U.S. marketconsisted ofMit-tal Steel USA and foreign steelmakers that rvere intent

Endnotes

on exporting some of their production to the UnitedStates; there rvere many foreign steel producers thathad costs on a par rvith or even belorv those of Nucor,although their competitiveness in ttre U-S. market var-ied sigrificantly according to the prevailing stengthof their local cumencies versus the U.S. dollar.

f Tom Peters and Nancy Auslin, A Passion lor Excettence: The Leader-st ip DilfercncelNewYorft: Bandom House, 19BS), and'Olher Low.Cosl Champions,'Fodune. June 24, 1S85.zAccordlrp lo inlormation posted al v,riv!r.nurr:r.i:rn (accessedOctober 11. 2006).sThls discussion is based on intorma[on po$ed al r;xti.;i,-rc+r.r:i.i:,(accessed October 17, 2006).a Nanette Bymes,'The Arl o, Molitralbn,'Busires$Week, May 1,2006.p.59.s tbtd., p. sz.

6rbid., p.60.7lbid.Btbid.tBased on inlonnation h the STAT.USA dala base, U.S. Deparhent

Ol Commgrce. lt::p r.;.'ie.ira.cac.slr,'iii:: i.'iil+:riillSillP-rr:. .,s'.*-'GIE$Cs3.ii.:,ii;lT_Aii-_i;-L_ I 3Lt.i;in: (acce$ed october 27. 2006).roCompanypress release. February 2. 2002.tr lbid.

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