Case 1 Dogswell

Will a small companys new product line put it in peril?

Within months of the failure of his first company, Clear Day,

a natural beverage company, Marco Giannini was busy launching another business, Dogswell, a company that makes allnatural, healthy dog treats that contain supplements to help with conditions such as hip dysplasia and arthritisproblems that his childhood dog, Emily, suffered from. Giannini experimented with recipes before hitting on the right one and found a manufacturer to make the treats. In a tribute to guerrilla marketing, Giannini loaded his car with Dogswell treats and visited more than 200 independent pet stores, asking them to give his new product, Happy Hips, a chance. Many of them did, and in its first year Dogswells revenue was $500,000. Four years later, Dogswell appeared on Inc. magazines list of the fastest growing small companies in the United States, with 21 employees and sales of $17 million. Giannini had bigger plans, however. He wanted to launch a line of pet foods to round out the companys successful pet treats, taking the company into the much larger market for natural pet food. I wanted to become a household name, and I figured food was the way to get us there, he says. He worked with several food scientists to develop a recipe for a healthy grain-free dry dog food called Nutrisca and set up a series of canine focus groups. The results were even better than Giannini had expected: Dogs preferred Nutrisca 15 to 1 over the leading natural dog food brand. Giannini sent his sales force into the field to conduct focus groups with pet owners to determine the most effective packaging. Giannini faced the same question he had years before when he first launched Dogswell: What is the best way to launch a product on a limited marketing budget? Making personal calls on retailers was impractical now that major chains such as Target and Whole Foods carried the companys products. Giannini hired 15 new people, most of them in sales, to roll out the new line of dog food. To entice customers to try Nutrisca, Dogswell offered coupons for a free bag of Nutrisca (normally priced at $10.99) with every purchase of a bag of Dogswell treats, which retail between $16 and $20.

As with many new products, sales were slow, and the coupons that retailers were submitting for rebates were straining the companys cash flow. However, Giannini and CFO Berenice Officer were distracted by ongoing meetings with TSG Consumer Partners, a San Francisco-based private investment company that Dogswell had been negotiating with for months in an effort to raise capital to fund the companys brand-building strategy. Giannini and Officer closed an equity investment deal with TSG on December 31, but when they returned to their Los Angeles headquarters they discovered that the coupon giveaway was costing the company $100,000 a month and devastating its profits and cash flow. In addition, the promotion was not generating repeat buyers fast enough. Giannini and Officer also realized that customers purchased dog food less often than they did treats and that the profit margins on dog food were less than those on dog treats. For the first time in its history, Dogswell had incurred a quarterly loss and was clearly heading for another one. I felt like I was losing control of the company, says a frustrated Giannini. Giannini and Officer had less than 3 months to create a plan to stop the damage that the pet food line was causing and put together a presentation for TSG explaining their strategy and why it would work. Giannini knew all too well the stories of other companies whose equity investors had ousted their founders at the first sign of trouble. Would he suffer the same fate? Questions 1. What dangers do entrepreneurs face when they court equity investors to provide capital to finance their companies growth? What steps can they take to minimize these risks? 2. Develop a strategy to return Dogswell to profitability. 3. Outline at least five components for a guerrilla marketing strategy for Nutrisca. How could Dogswell tap into the power of social marketing as part of its guerrilla marketing strategy?
Source: Based on Nitasha Tiku, Case Study: Dogswell, Inc., December 2009January 2010, pp. 5663.

811

Case 2 Able Planet

How can a small company find capital to finance an innovative new product?

enture capitalist Kevin Semcken discovered Able Planet, a small startup in Wheat Ridge, Colorado, that produces headphones with an imbedded magnetic coil to enhance sound quality, at a technology conference in Denver, Colorado. Semcken, who suffers from a hearing loss in one ear, was intrigued and tested the small companys product by listening to Dean Martins Youre Nobody Til Somebody Loves You. I was instantly a fan, he says. Semcken invested in Able Planet and soon became the companys CEO and chairman. Two years later, the companys unique noise-cancelling Linx headphones won an award for innovation at the Consumer Electronics Show, and orders began pouring in. In no time, the companys annual revenue reached $2 million. Semcken was pleased with Able Planets progress, but he had a bigger vision for the company. Inspired by stents, balloonlike devices used in medical procedures to clear blocked arteries, Semcken came up with the idea of earphones that incorporated an inflatable disk that could conform perfectly to the size and shape of a persons ear canal. The result would be a set of earphones that fit snugly into the ear canal, stay in place even during strenuous activity, and block out ambient noise. He even had a great name for the product: Sound Fit. Semcken saw the potential for Sound Fit not only to improve substantially the performance of earphones, but also to revolutionize the design of other products, such as Bluetooth headsets and hearing aids. He had lined up 30 potential customers who were interested in learning more about the innovative earphones and had convinced them to sign nondisclosure agreements. What Semcken needed now was financing so that Able Planet could manufacture production-quality prototypes of the Sound Fit earphones and generate orders. Then Able Planets banker called with bad news. The bank was changing the terms of Able Planets $2.5 million line of credit. Under the new terms, the bank would no longer finance the upfront cost of raw materials and manufacturing. Semcken was stunned because even though Able Planet was not yet cash flow positive, the company had always made its payments to the bank on time for the last 3 years. Without a flexible line of credit, Able Planet would not be able to purchase the materials and manufacture the headphones that its retail customers,

including Costco and Walmart, demanded. The credit line restriction came at the worst possible time. Able Planet was gearing up for the late-spring graduation season, its second biggest sales period of the year after Christmas. The company normally cranked up production for the crucial back-to-school and Christmas seasons (which account for 60 percent of its sales) during the summer, but the banks new restrictions on its line of credit put its most lucrative sales seasons in jeopardy. Semcken met with Able Planets two board members, Rob Cascella and Steve Parker, both of whom are investors in the company. They advised him to put the Sound Fit earphones on hold for the time being and to focus on increasing sales of Linx headphones. Without a way to finance production of the headphones, however, Semcken knew that opening new retail accounts and increasing production would be impossible. He needed $1.5 million to finance current operations for Linx, build the Sound Fit prototypes, and market both products to new and existing customers. Semcken traveled around the country to call on 15 different banks, but none of them was interested in making a loan. A crisis in the financial markets had all but slammed shut the lending window at most commercial banks. Semcken pondered his options. Questions 1. Experts say that entrepreneurs who need between $100,000 and $3 million often face the greatest obstacles when raising capital for their businesses. Why? 2. How should Kevin Semcken raise the $1.5 million in capital that Able Planet needs? Be sure to consider sources of both debt and equity financing. 3. Write a short memo to Kevin Semcken explaining what he should do before he approaches potential lenders and investors to maximize his chances of getting the capital that Able Planet needs.
Sources: Based on Jamie Kripke, Case Study: Able Planet, Inc., JulyAugust 2009, pp. 5861; About Us, Able Planet, www.ableplanet.com/ aboutus.html.

812

Case 3 Zatswho LLC

Can a motherdaughter team be successful entrepreneurs?

rish Cooper, 52, spent the last 13 years of her career working as the chief financial officer for a small telecommunications company near her home in Hope, New Jersey. When the company merged with another business and moved out of state, Cooper lost her job. She sent out lots of resumes to other businesses but knew that her job prospects were slim because of her age and an ongoing recession. She began spending more time with her granddaughter, Gianna, using family photographs to teach the child about family members. There was only one problem: She was destroying my photos, says Cooper, who began laminating the photographs. Thats when Cooper had a flash of inspiration. Our photo recognition game was such fun, and she was learning so much, says Cooper. What if I make a real game out of it, using individual photo flashcards that are soft and she can hold in her own little hands? Cooper envisioned a learning tool for toddlers that consisted of soft, flexible protective frames into which parents could slip family photographs and create their own flashcards. She began researching the market. I learned there were no products on the market like that, she says. Cooper made a few prototypes herself from nontoxic foam and put them in a small tote-bag carrying case but realized that she would need help to launch her business. Cooper turned to the one person who had been advising her all along: her 26-yearold daughter Carrie Schwinoff. She was a stay-at-home mom, says Cooper. I said, Look, you are not going to have another opportunity like this to be a business owner. Schwinoff agreed because she wanted to supplement her familys income but retain flexibility in her schedule to care for Gianna. She also liked the idea of building a business with her mother. Shes my best friend, my partner in crime, laughs Schwinoff. Cooper invested $30,000 in the startup, which they named Zatswho, and the two women assembled 500 sets of Zatswho cards and began selling them. One of their first decisions was dividing business responsibilities. Cooper has a strong financial background and serves as CEO and CFO. Schwinoff, who has a degree in marketing, is responsible for sales and marketing. Tweeting wasnt something I could wrap my head around,

says Cooper. As in any business, disagreements arise, but the motherdaughter entrepreneurs have managed them effectively. For instance, Schwinoff thought that her mothers use of the word tactile on the products packaging missed the mark. Why dont we say pliable or sensory? asked Schwinoff. People get that more easily. They changed the wording on the packaging to soft and easy to hold. Because I am the mother and she is my daughter, my natural feeling might be, I know better because I am more experienced. But I have to listen to her point of view. We are both learning that it takes discipline and respect to make this work. Cooper and Schwinoff are negotiating with a U.S.-based company that has a manufacturing operation in China to massproduce Zatswho flashcards, which currently sell for $15.95 per set in stores in seven states. Questions 1. What tips can you offer Cooper and Schwinoff about family members who start and run a business together? What pitfalls would you warn them to avoid? 2. Suppose that Cooper and Schwinoff had approached you when they were launching Zatswho concerning the form of ownership they should use. Which form of ownership do you recommend they use. Why? 3. Work with a team of your classmates to brainstorm potential groups of people who make up Zatswhos target market. 4. Help Cooper and Schwinoff develop a guerrilla marketing strategy for Zatswho. Write a two-page memo to Cooper and Schwinoff that highlights the key points of your strategy and the reasoning behind each one. 5. Visit the Zatswho Web site at www.zatswho.com. What recommendations can you make for improving the site?
Sources: Based on Colleen Debaise, Emily Maltby, and Sarah E. Needleman, Parent & Child Inc., Wall Street Journal, November 15, 2010, http://online .wsj.com/article/SB10001424052748703794104575546553171806306.html? KEYWORDS=family+business+mother+daughter; About, Zatswho, www.zatswho.com/pages/About-.html.

813

Case 4 Circle R Ranch

How can a venue that hosts corporate events counter declining sales?

Steven and Wendy Foster purchased the Circle R Ranch, located

10 miles north of Dallas, Texas, as newlyweds in 1997. The ranch specializes in hosting corporate meetings, conventions, and events in an authentic Western-style setting, complete with barbecues, steers, hayrides, country music, and almost anything else a corporate event planner requests. The ranch is known for its stellar customer service. Friendly cowboys and cowgirls greet arriving guests and guide them to the appropriate venues, which include the Western Pavilion, an enclosed 28,000-square-foot structure that features a performance stage, a dance floor, a game arcade, and adjacent recreation area, or the smaller Chisolm Ranch House and Conference Center, which overlooks a pond and can accommodate between 20 and 200 guests. In addition to barbecues and picnics, the Circle R Ranch offers guests a multitude of options for their events, including fireworks shows, a huge swimming pool, a biker bar (complete with airbrushed tattoos), and team-building activities with its reality television-based Survivor Rodeo Team Challenge. Companies can even order steaks branded with their logos. An economic recession not only resulted in a 38 percent decline in annual sales (from $4 million to $2.5 million) but also was a harbinger of an era of corporate austerity. Companies are cutting back on high-end (and highly profitable) options such as staged gunfights, ice sculptures, rodeos, and fireworks and are sticking to tried-and-true (and less expensive) options such as barbecues, picnics, and hayrides. The business remains profitable and debt free, but the Fosters are seeing their profit margins squeezed ever smaller. To restore their lost sales, the Fosters, both veterans of the hospitality industry, are considering branching out into the wedding market. They are hesitant to make the move, however, because the revenue per event is much smaller than they are accustomed to but the work involved in creating the perfect wedding is not. Steven and Wendy are worried about burnout; they both regularly put in as many as 100 hours a week at the ranch. Their full-time staff of 12 employees, which they supplement with as many as 200 part-time workers during

the busy spring-to-fall event season, also put in long hours. The Fosters want to make sure that their employees are not overworked and stressed so that they can continue to provide the superior customer service that distinguishes the Circle R Ranch from other event venues. If an event planner visits the ranch, the Fosters say that there is a very high probability that they will win the planners business. However, they believe that as companies travel budgets continue to shrink, more planners are conducting their searches for event venues online. The Fosters know that their Web site (www.circlerranch.org) is due for an update, but doing so would cost an estimated $20,000. Can we afford not to make the investment? they wonder. Currently, the site features uninspired photos of each venue, lots of cowboys with guns, and barmaids dressed in period saloon garb. Remember, says one advisor, youre not selling meeting space; youre selling an experience. Questions 1. What steps can the Fosters take to increase sales at the Circle R Ranch? Should they enter the wedding market? What are the advantages and the disadvantages of entering this market? 2. Where should the Fosters look for new employees who are passionate about providing superior customer service? What steps should they take before they begin the employee selection process? What hiring criteria should they establish? 3. How should the Fosters motivate their staff to continue to provide the stellar service that sets the ranch apart from its competitors? 4. Visit the Circle R Ranchs Web site. How effective is the site? Develop a set of at least six recommendations for improving the site.
Sources: Based on Patricia B. Gray, Party Down, FSB, June 2009, pp. 4144; Circle R Ranch, www.circlerranch.org.

814

Case 5 Penn Brewery

Should an entrepreneur buy back the brewery that he launched nearly a quarter-century before?

om Pastorius and his wife Mary Beth started Penn Brewery, an authentic German microbrewery in Pittsburgh, Pennsylvania, in 1986. They built the brewery into a successful business, producing more than 15,000 barrels a year and generating annual sales of $3.5 million. Along the way, their microbrewery won 14 medals at the Great American Beer Festival and built a base of devoted customers for its brands, which included Penn Pilsner, Penn Oktoberfest, and others. They also added a Germanthemed restaurant that Mary Beth managed. In 2003, Tom and Mary Beth, both approaching 60, decided to cash out and sold the brewery to Birchmere Capital, a local private equity firm. Tom retained 20 percent ownership and agreed to stay on as president of the company for 5 years. He had lived up to his contract but was miserable working for the new owners, who made many significant changes to the companys strategy. I am not a good employee, says Tom. Im a solo act. Not only did Birchmere Capital close the brewerys restaurant, but it also decided to outsource production of beer to the Lion Brewery in nearby Wilkes-Barre and close Penns brewing operation. The moves proved to be disastrous; once-devoted customers departed, and sales tumbled. It was so hard to sit back and watch this place sink, says Tom, who was becoming bored with retirement. Then Birchmere offered to sell the brewery back to Pastorius for a fraction of what they had paid him for it a few years before. Tom was ready to buy the brewery back and restore it to its former grandeur, but convincing Mary Beth would take some doing. She had been instrumental in its success but told Tom that she had no intention of going back to it. Its too risky at our age (now 65), she says. We dont have the

luxury of time. Besides, Mary Beth had launched a retirement business of her own, a company that restores historic buildings. Tom, however, could not get rid of the idea of owning Penn Brewery again. He began working clandestinely on a business plan preparing a risk-benefit analysis. The principal risks he identified included the brewerys $1 million debt, the tarnished brand name, and the fact that he would be buying back his former business at age 65. However, he was still very energetic and had the experience necessary to turn around the foundering brewery. He was confident that he could restore the luster to the Penn Brewery name by returning beer production to the Victorian-style red brick building in which he had launched the company years before. After weeks of candid discussions, Mary Beth told Tom, If you want to do it, you are crazy, but keep me out of it. Questions 1. Should Tom Pastorius buy Penn Brewery? Explain. 2. Tom Pastorius says, Im not a good employee. What does he mean? Do you think the same is true of most entrepreneurs? 3. What challenges does selling the businesses they create pose for entrepreneurs? 4. If Pastorius decides to buy the brewery, what steps should he take before closing the deal?
Sources: Based on Cristina Rouvalis, Case Study: Penn Brewery, Inc., JulyAugust 2010, pp. 7174; The Pennsylvania Brewing Company, www.pennbrew.com/data/english/about.htm.

815

Case 6 James Confectioners

How can a confectioner cope with rising costs?

Telford James and his wife Ivey are the second-generation

owners of James Confectioners, a family-owned manufacturer of premium chocolates that was started by Telfords father, Frank, in 1964 in Eau Claire, Wisconsin. In its nearly 50 years, James Confectioners has grown from its roots in a converted hardware store into a large, modern factory with sophisticated production and quality control equipment. In the early days, all of Franks customers were local shops and stores, but the company now supplies customers across the United States and a few in Canada. Telford and Ivey have built on the companys reputation as an honest, reliable supplier of chocolates. The prices they charge for their chocolates are above the industry average but are not anywhere near the highest prices in the industry even though the company is known for producing quality products. Annual sales for the company have grown to $3.9 million, and its purchases of the base chocolate used as the raw materials for their products have increased from 25,000 pounds 20 years ago to 150,000 pounds today. The Jameses are concerned about the impact of the rapidly rising cost of the base chocolate, however. Bad weather in South America and Africa, where most of the worlds cocoa is grown, and a workers strike have disrupted the global supply of chocolate, sending prices upward. There appears to be no relief from high chocolate prices in the near future. The International Cocoa Organization, an industry trade association, forecasts that world production of cocoa, from which chocolate is made, will decline by 7.2 percent this year. Escalating milk and sugar prices are squeezing the companys profit margins as well. Much to James and Iveys dismay, James Confectioners long-term contracts with its chocolate suppliers have run out, and the company is purchasing its raw materials under short-term, variable-price contracts. They are concerned about the impact that these increases in cost will have on the companys financial statements and on its long-term health. Ivey, who has the primary responsibility for managing James Confectioners finances, has compiled the balance sheet and the income statement for the fiscal year that just ended. The two financial statements are as follows:

Balance Sheet, James Confectioners December 31, 2xxx Assets Current Assets Cash Accounts receivable Inventory Supplies Prepaid expenses Total current assets Fixed Assets Land Buildings, net Autos, net Equipment, net Furniture and fixtures, net Total fixed assets
.

$161,254 $507,951 $568,421 $84,658 $32,251 $1,354,536

$104,815 $203,583 $64,502 $247,928 $40,314 $661,142 $2,015,678 Liabilities

Total Assets

Current Liabilities Accounts payable Notes payable Line of credit payable Accrued wages/salaries payable Accrued interest payable Accrued taxes payable Total current liabilities Long-term Liabilities Mortgage Loan Total long-term liabilities Owners Equity James, Capital Total liabilities and owners equity $776,036 $2,015,678 $346,697 $217,693 $564,390 $241,881 $221,725 $141,097 $40,314 $20,157 $10,078 $675,252

816

CASE 6

817

Income Statement, James Confectioners Net sales revenue Cost of goods sold Beginning inventory, 1/1/xx + Purchases Goods available for sale Ending inventory, 12/31/xx Cost of goods sold Gross profit Operating expenses Utilities Advertising Insurance Depreciation Salaries and benefits E-commerce Repairs and maintenance Travel Supplies Total operating expenses Other expenses Interest expense Miscellaneous expenses Total other expenses Total expenses Net income $3,897,564 $627,853 $2,565,908 $3,193,761 $568,421 $2,625,340 $1,272,224 $163,698 $155,903 $74,054 $74,054 $381,961 $38,976 $58,463 $23,385 $15,590 $986,084 $119,658 $1,248 $120,906 $1,106,990 $165,234

To see how the companys financial position changes over time, Ivey calculates 12 ratios. She also compares James Confectioners

ratios to those of the typical firm in the industry. The following table shows the value of each of the 12 ratios from last year.

James Confectioners Ratio Liquidity Ratios Current ratio Quick ratio Leverage Ratios Debt ratio Debt-to-net-worth ratio Times interest earned ratio Operating Ratios Average inventory turnover ratio Average collection period (days) Average payable period (days) Net sales to total assets Profitability Ratios Net profit on sales ratio Net profit to assets ratio Net profit to equity ratio 7.40% 9.20% 29.21% 4.75 34.6 31.1 2.17 0.64 1.71 2.49 Current Year Last Year

Confectionery Industry Median*

1.86 1.07

1.7 0.8 0.7 1.0 2.3 4.9 23.0 33.5 2.1 7.1% 5.6% 16.5%

*Annual Statement Studies: Financial Ratio Benchmarks, Risk Management Association.

818

CASE 6

How does the financial analysis look for this year, Hon? Telford asks. Im about to crunch the numbers now, says Ivey. Im sure that rising chocolate prices have cut into our profit margins. The question is how much? I think were going to have to consider raising prices, but Im not sure how our customers will respond if we do, says Telford. What other options do we have? Questions 1. Calculate the 12 ratios for James Confectioners for this year. 2. How do the ratios you calculated for this year compare to those Ivey calculated for the company last year? What factors most likely account for those changes?

3. How do the ratios you calculated for this year compare to those of the typical company in the industry? Do you spot any areas that could cause the company problems in the future? Explain. 4. Develop a set of recommendations for improving the financial performance of James Confectioners using the analyses you conducted in questions 13. 5. What pricing recommendations can you make to Telford and Ivey James?
Source: Cocoa forecast information obtained from Cocoa Forecasts, International Cocoa Organization, May 27, 2009, www.icco.org/about/ press2.aspx?Id=0ji12056.

Case 7 James ConfectionersPart 2

How can a small confectioner forecast cash flow?

elford James and his wife Ivey, the second-generation owners of James Confectioners, a family-owned manufacturer of premium chocolates that was started by Telfords father, Frank, in 1964 in Eau Claire, Wisconsin, have become increasingly concerned that turmoil in the banking and financial industries could have a negative impact on their business. They have read the headlines about bank closures, heightened government scrutiny of the banking industry, and tight credit conditions, especially for small businesses. The company has a $150,000 line of credit with Maple Leaf Bank, but the Jameses want to increase it to $250,000 as a precautionary move. Last week, they contacted Claudia Fernandes, their personal banker at Maple Leaf, about increasing their line of credit. Fernandes said that in addition to

reviewing the James Confectioners most recent balance sheet and income statement, she would need a cash flow forecast for the upcoming year. Although Telford and Ivey have prepared budgets for James Confectioners and have analyzed their financial statements using ratio analysis, they have not created a cash flow forecast before. They expect sales to increase 6.2 percent next year to $4,139,213. Credit sales account for 96 percent of total sales, and the companys collection pattern for credit sales is 8 percent in the same month in which the sale is generated, 54 percent in the first month after the sale is generated, and 34 percent in the second month after the sale is generated. The Jameses have gathered the following estimates from their budget for the upcoming year:

Jan Other cash receipts Purchases Utilities Advertising Insurance Salaries and benefits E-commerce Repairs and maintenance Travel Supplies Loan payment Other cash disbursements $105 13,600 18,000 0 33,583 2,700 5,000 4,100 1,088 10,000 125

Feb $55 14,100 11,000 0 33,583 4,500 5,000 2,700 1,836 10,000 125

Mar $60 13,700 10,000 19,650 33,583 2,900 5,000 2,700 1,190 10,000 125

Apr $75 13,200 7,000 0 33,583 3,000 5,000 2,000 1,207 10,000 125

May $85 13,200 9,000 0 33,583 1,900 5,000 3,000 782 10,000 125

Jun $55 13,600 10,000 19,650 33,583 2,400 5,000 2,600 1,309 10,000 125

Jul $65 14,800 12,000 0 33,583 3,200 5,000 2,200 1,156 10,000 125

Aug $60 15,900 12,000 0 33,583 3,300 5,000 3,100 952 10,000 125

Sep $65 14,900 15,000 19,650 33,583 3,400 5,000 3,800 1,377 10,000 125

Oct $85 14,100 20,000 0 33,583 3,900 5,000 4,500 1,683 10,000 125

Nov $95 13,800 22,000 0 33,583 5,000 5,000 5,500 2,006 10,000 125

Dec $110 14,000 24,000 19,650 33,583 6,000 5,000 6,500 2,414 10,000 125

365,280 174,400 294,300 190,750 193,745 125,350 209,825 185,300 152,600 220,725 269,774 321,549

The companys cash balance as of January 1 is $22,565. The interest rate on James Confectioners current line of credit is 8.25 percent. Questions 1. Develop a monthly cash budget for James Confectioners for the upcoming year.

2. What recommendations can you offer Telford and Ivey James to improve their companys cash flow? 3. If you were Claudia Fernandes, the Jamess banker, would you be willing to increase the companys line of credit? Explain.

819

Case 8 eMusic
Should an online music company with a base of loyal fans sign on with a major music house and raise its prices?

Danny Stein is considering making some significant changes

to his online music retail business, eMusic, the company that he had founded in 1998 and built into the nations second largest music download site. eMusic has established itself as the place for music aficionados to discover the latest independent artists, but recently several independent labels, including Drag City and Tzadik, dropped eMusic as a distributor because they complained that the prices it charged were too low and left their artists with royalty payments as low as 15 cents per track. In fact, pricing has been an issue for eMusic for some time. Originally, customers could pay just $9.99 per month for unlimited downloads, but Stein switched to higher monthly rates with limits on the number of downloads. Songs at eMusic still are bargains about 25 cents eachcompared to iTunes and Amazon, where tracks sell for 69 cents to $1.29. Stein wants to avoid other labels dropping eMusic because of low prices and is considering a tiered pricing arrangement that ranges from $11.99 for up to 24 tracks to $35.99 for up to 73 tracks. Even if eMusic adopts the new pricing strategy, music downloads will average between 49 cents and 89 cents, still 20 to 50 percent lower than iTunes pricing. Another issue is how to deal with the long-time customers whose legacy contracts allow them to pay far lower prices than new customers. These legacy customers now number in the tens of thousands, and their outdated pricing schedules are creating a drag on eMusics revenue. An even bigger change that Stein is considering is adding songs from one of the major music labels, Sony BMG. Under the deal, Sony BMG would make its back catalog of 1 million songs available to eMusic customers. The idea of partnering with the biggest of the major music houses would have been unthinkable in the early days of eMusics history, but Stein believes that he has to offer customers something new if he raises prices. In addition, the landscape in the digital music business is changing fast, and online music aficionados are looking for a broader range of

music content. A deal with Sony BMG would provide that breadth, but Stein knows that adding content from a major music house might alienate eMusics core customers, who would see the move as a betrayal of the cool, alternative music niche that eMusic has carved out. eMusics image always has been linked closely to its identity as the place to discover cool, up-andcoming, independent musical artists, and a deal with Sony BMG could mar that image. However, Stein believes that most ardent music fans care more about finding the music they like rather than the record label it is on. The question is whether they would be willing to pay more for access to a greater selection of music. Stein has two very important and very difficult decisions to make. He has called in his executive team to seek their ideas and input. Questions 1. What are the risks that eMusic faces if it raises prices? If it does not raise prices? 2. Should eMusic raise its prices using the new tiered pricing schedule? If so, how should the company communicate the price increase to its customers? Compose an e-mail to existing customers that explains the rationale behind a price increase. 3. What are the risks that eMusic faces if it signs the deal with Sony BMG to expand its online music catalog? If it does not sign the deal with Sony BMG? 4. Should eMusic sign the deal with Sony BMG? Explain.
Sources: Based on Adam Bluestein, Case Study: eMusic, Inc., March 2010, pp. 5558; Bruce Houghton, eMusic Relaunches with Variable Pricing, Hypebot, November 2011, www.hypebot.com/hypebot/2010/11/emusicrelaunches-with-variable-pricing.html; Chris Foresman, eMusic Changes Pricing Structure to Nab Major Music Tracks, ARS Technica, November 2010, http://arstechnica.com/media/news/2010/11/emusic-changes-pricing-structureto-nab-major-label-tracks.ars.

820

Case 9 Fikes Products

How can the CEO of a fast-growing company improve his poor track record at hiring stars?

In 1997, Mark Sims began working in sales and service for Fikes
Products, a company in Kent, Washington, with 30 employees that sells janitorial supplies and services to restaurants, retailers, and other businesses. In 2003, Sims became the owner of the company when his parents, the founders of the company, retired. Sims used his sales talent to increase annual sales at Fikes to more than $4 million and opened a branch in Portland, Oregon. He is proud of the companys growth but realizes that it has created a problem: The day-to-day tasks of managing a fastgrowing company are draining him professionally and personally. He wants to hire several employees, including an office administrator, two route drivers, and a warehouse worker. Dan Price, a fellow entrepreneur and mentor, suggests that Sims also hire an operations manager to handle the daily operations of the company and allow Sims to focus on leading the company. There is no one to take work off of Marks plate, says Price. Yet he understands Sims hesitation. A first senior hire is daunting for an entrepreneur, he says. Sims also is a bit gun shy when it comes to making hiring decisions because his track record is not that good. Recently, he hired several employees who seemed fine, but none of them lasted. A route driver that he found on Craigslist wrecked a new vehicle before he quit. A new office staffer spent 30 percent of her workday on personal social media, distracting coworkers and raising their ire. Sims also sees the time he spends sorting through resumes as unproductive because he could be out in the field landing new customers. The high unemployment rate means that the number of applicants, qualified or not, for each job has surged. I get resumes for driver positions from applicants who dont even

have a drivers license, he laments. We arent attracting the quality candidates wed hoped for, he says, citing a deteriorating work ethic among many applicants. I want to get people excited about working hereeven if we do sell toilet paper and Dumpster deodorizers. To find candidates for the operations managers position and lower-level jobs, Sims is considering placing employment ads on state employment agency Web sites because they are free. He also has considered hiring a professional recruiting company but is hesitant because recruiters typically charge a fee that is the equivalent of 20 to 30 percent of the new hires first year salary. Sims knows that his company has to attract quality workers if it is to continue to grow and prosper, but he is unsure of the best way to find them. Questions 1. What steps should Mark Sims take to ensure that he hires the right employees for Fikes Products? 2. Write a two-page memo to Sims that outlines a selection process that will produce the results he wants. 3. Where should Sims look for quality employees? How should he structure the interviews for prospective employees? 4. What methods should Sims use to motivate his employees to achieve higher levels of performance?
Sources: Based on Adriana Gardella, Hiring Employees, With Help or Without, New York Times, October 27, 2010, www.nytimes.com/2010/ 10/28/business/smallbusiness/28sbiz.html?ref=casestudies; Meet the Owner, Fikes Products, www.fikesproducts.com/company/meet-the-owner.

821

Case 10 Firehouse Subs

How can the owners of a franchise reverse declining sales?

obin and Chris Sorenson are the owners of Firehouse Subs, a chain of submarine sandwich shops with more than 400 locations in 21 states. The Sorensons, both former firefighters, opened their first Firehouse Subs restaurant in 1994 in Jacksonville, Florida, and used a firehouse theme and authentic firefighting gear to decorate it. Their menu followed suit, featuring sandwiches with names such as the Hook and Ladder, the Firehouse Hero, and the New York Steamer. In 2001, the Sorensons operated 30 Firehouse Subs restaurants across Florida and began selling franchises to expand across the Southeast and beyond. Their goal is to have 2,000 locations by 2020. Sales at Firehouse Subs restaurants were growing until 2008, when year-over-year sales declined throughout the chain by 3.4 percent. In our entire history, we had never had a period like that when our entire system was running negative sales, says Don Fox, the companys CEO. It was something completely foreign to us. The sales decline was particularly puzzling because lower-priced restaurants such as Firehouse Subs normally are well-positioned in economic downturns to attract customers who continue to dine out but look for less expensive options. Something besides the recession was causing sales to decline. Firehouse Subs provides franchisees with a complete business system, strong brand name recognition, and the opportunity to own their own restaurants with investments that range from just under $200,000 to $425,000. In return for the franchisors support, Firehouse Subs charges franchisees a $20,000 initial franchise fee, a royalty of 6 percent of sales, and a 3 percent advertising fee (2 percent goes toward local advertising). When the executive team met to discuss the companys declining sales, Robin Sorensen had an unconventional idea: eliminate the 2 percent local advertising fee and allow franchisees to create and execute their own marketing strategies. The Sorensons and Fox presented the idea to franchisees, who approved it overwhelmingly. It was pretty radical, admits Fox. Some people thought it was insane to give the money back. We didnt have an ego about who has the money. We wanted results. Six months after giving franchisees control over their local advertising budgets, the sales decline at Firehouse Subs had worsened. System-wide sales were down 6 percent from the previous year. The chains top managers believed that the problem stemmed from a lack of brand awareness and a very

successful $5 Footlong campaign that Subway, the largest company in the submarine sandwich business with more than 33,000 restaurants around the globe, had launched. Firehouse Subs executive team discussed their options and narrowed them to three: continue the existing local marketing efforts by franchisees, begin discounting sandwich prices, or launch a new marketing campaign. They were hesitant to continue the local marketing campaigns, because over 6 months sales had continued to decline. Discounting sandwich prices would cut into the companys already thin profit margins and might damage the reputation for quality ingredients that the company had built over the years. The management team began exploring a new marketing campaign and met with an experienced advertising company based in Fort Lauderdale, Florida. The advertising agency showed them that other submarine sandwich chains, including Subway and Quiznos, spend more on advertising per store and collect higher royalties and advertising fees. The agency recommended that Firehouse Subs not only reclaim the local advertising fee but that they double it to 4 percent! That would increase the payments that franchisees make to Firehouse Subs from 9 percent of sales to 11 percent of sales. The executives wondered whether franchisees would resist the move when many of them already were struggling with lower sales and profits. Questions 1. What advantages do franchisees gain when they buy their franchises? What disadvantages do they experience? 2. Develop a list of advantages and disadvantages for each of the three options the managers at Firehouse Subs are considering. 3. Which of the three options do you recommend managers at Firehouse Subs choose? Explain. 4. If the managers decide to create a new marketing campaign, what should be its unique selling proposition (USP)? What key points should the campaign emphasize?
Sources: Based on Kermit Patterson, Spending More on Ads to Overcome a Slump, New York Times, September 22, 2010, www.nytimes.com/ 2010/09/23/business/smallbusiness/23sbiz.html?ref=casestudies; Franchise Overview, Firehouse Subs, www.firehousesubs.com/Franchise-Overview. aspx; Firehouse Subs, Entrepreneur, www.entrepreneur.com/franchises/ firehousesubs/317772-0.html.

822