RSM 392 - STRATEGIC
MANAGEMENT
Andreea Ciologariu
September 3, 2024 - December 31, 2024
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Table Of Contents
Cola Wars Continue: Coke and Pepsi in 2010
4
Creating Competitive Advantage
26
Walmart: In Search of Renewed Growth
47
Natura: Global Beauty Made in Brazil
73
Zara’s Sustainability Dilemma
100
The Walt Disney Company: If You Give this Mouse a Focus
128
Netflix in 2011
161
Uber: Changing The Way The World Moves
182
Use and Abuse of Analogies
202
9 - 71 1 - 4 6 2
DAVID B. YOFFIE
RENEE KIM
Cola Wars Continue: Coke and Pepsi in 2010
For more than a century, Coke and Pepsi vied for “throat share” of the world’s beverage market.
The most intense battles in the so-called cola wars were fought over the $74 billion carbonated soft
drink (CSD) industry in the United States.1 In a “carefully waged competitive struggle” that lasted
from 1975 through the mid-1990s, both Coke and Pepsi achieved average annual revenue growth of
around 10%, as both U.S. and worldwide CSD consumption rose steadily year after year.2 According
to Roger Enrico, former CEO of Pepsi:
The warfare must be perceived as a continuing battle without blood. Without Coke, Pepsi
would have a tough time being an original and lively competitor. The more successful they are,
the sharper we have to be. If the Coca-Cola company didn’t exist, we’d pray for someone to
invent them. And on the other side of the fence, I’m sure the folks at Coke would say that
nothing contributes as much to the present-day success of the Coca-Cola company than . . .
Pepsi.3
That relationship began to fray in the early 2000s, however, as U.S. per-capita CSD consumption
started to decline. By 2009, the average American drank 46 gallons of CSDs per year, the lowest CSD
consumption level since 1989.4 At the same time, the two companies experienced their own distinct
ups and downs; Coke suffered several operational setbacks while Pepsi charted a new, aggressive
course in alternative beverages and snack acquisitions.
As the cola wars continued into the 21st century, Coke and Pepsi faced new challenges: Could
they boost flagging domestic CSD sales? How could they compete in the growing non-CSD category
that demanded different bottling, pricing, and brand strategies? What had to be done to ensure
sustainable growth and profitability?
Economics of the U.S. CSD Industry
Americans consumed 23 gallons of CSDs annually in 1970, and consumption grew by an average
of 3% per year over the next three decades (see Exhibit 1). Fueling this growth were the increasing
availability of CSDs and the introduction of diet and flavored varieties. Declining real (inflationadjusted) prices that made CSDs more affordable played a significant role as well.5 There were many
________________________________________________________________________________________________________________
Professor David B. Yoffie and Research Associate Michael Slind prepared the original version of this case, “Cola Wars Continue: Coke and Pepsi
in 2006,” HBS No. 706-447. This version was prepared by Professor David B. Yoffie and Research Associate Renee Kim. This case was developed
from published sources. HBS cases are developed solely as the basis for class discussion. Cases are not intended to serve as endorsements,
sources of primary data, or illustrations of effective or ineffective management.
Copyright © 2010, 2011 President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800-5457685, write Harvard Business School Publishing, Boston, MA 02163, or go to www.hbsp.harvard.edu/educators. This publication may not be
digitized, photocopied, or otherwise reproduced, posted, or transmitted, without the permission of Harvard Business School.
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REV: MAY 26, 2011
Cola Wars Continue: Coke and Pepsi in 2010
alternatives to CSDs, including beer, milk, coffee, bottled water, juices, tea, powdered drinks, wine,
sports drinks, distilled spirits, and tap water. Yet Americans drank more soda than any other
beverage. Within the CSD category, the cola segment maintained its dominance, although its market
share dropped from 71% in 1990 to 55% in 2009.6 Non-cola CSDs included lemon/lime, citrus,
pepper-type, orange, root beer, and other flavors. CSDs consisted of a flavor base (called
“concentrate”), a sweetener, and carbonated water. The production and distribution of CSDs
involved four major participants: concentrate producers, bottlers, retail channels, and suppliers.7
Concentrate Producers
The concentrate producer blended raw material ingredients, packaged the mixture in plastic
canisters, and shipped those containers to the bottler. To make concentrate for diet CSDs, concentrate
makers often added artificial sweetener; with regular CSDs, bottlers added sugar or high-fructose
corn syrup themselves. The concentrate manufacturing process involved relatively little capital
investment in machinery, overhead, or labor. A typical concentrate manufacturing plant, which could
cover a geographic area as large as the United States, cost between $50 million to $100 million to
build.8
A concentrate producer’s most significant costs were for advertising, promotion, market research,
and bottler support. Using innovative and sophisticated campaigns, they invested heavily in their
trademarks over time. While concentrate producers implemented and financed marketing programs
jointly with bottlers, they usually took the lead in developing those programs, particularly when it
came to product development, market research, and advertising. They also took charge of negotiating
“customer development agreements” (CDAs) with nationwide retailers such as Wal-Mart. Under a
CDA, Coke or Pepsi offered funds for marketing and other purposes in exchange for shelf space.
With smaller regional accounts, bottlers assumed a key role in developing such relationships, and
paid an agreed-upon percentage—typically 50% or more—of promotional and advertising costs.
Concentrate producers employed a large staff of people who worked with bottlers by supporting
sales efforts, setting standards, and suggesting operational improvements. They also negotiated
directly with their bottlers’ major suppliers (especially sweetener and packaging makers) to achieve
reliable supply, fast delivery, and low prices.9
Once a fragmented business that featured hundreds of local manufacturers, the U.S. soft drink
industry had changed dramatically over time. Among national concentrate producers, Coke and
Pepsi claimed a combined 72% of the U.S. CSD market’s sales volume in 2009, followed by Dr Pepper
Snapple Group (DPS) and Cott Corporation (see Exhibits 2, 3a and 3b). In addition, there were
private-label manufacturers and several dozen other national and regional producers.
Bottlers
Bottlers purchased concentrate, added carbonated water and high-fructose corn syrup, bottled or
canned the resulting CSD product, and delivered it to customer accounts. Coke and Pepsi bottlers
offered “direct store door” (DSD) delivery, an arrangement whereby route delivery salespeople
managed the CSD brand in stores by securing shelf space, stacking CSD products, positioning the
brand’s trademarked label, and setting up point-of-purchase or end-of-aisle displays. (Smaller
national brands, such as Shasta and Faygo, distributed through food store warehouses.) Cooperative
merchandising agreements, in which retailers agreed to specific promotional activity and discount
levels in exchange for a payment from a bottler, were another key ingredient of soft drink sales.
The bottling process was capital-intensive and involved high-speed production lines that were
interchangeable only for products of similar type and packages of similar size. Bottling and canning
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lines cost from $4 million to $10 million each, depending on volume and package type. But the cost of
a large plant with multiple lines and automated warehousing could reach hundreds of millions of
dollars. In 2010, DPS completed construction of a production facility in California with a capacity of
40 million cases at an estimated cost of $120 million.10 While a handful of such plants could
theoretically provide enough capacity to serve the entire United States, Coke and Pepsi each had
around 100 plants for nationwide distribution.11 For bottlers, their main costs components were
concentrate and syrup. Other significant expenses included packaging, labor, and overhead.12
Bottlers also invested capital in trucks and distribution networks. For CSDs, bottlers’ gross profits
routinely exceeded 40% but operating margins were usually around 8%, about a third of concentrate
producers’ operating margins (see Exhibit 4).
The number of U.S. soft drink bottlers had fallen steadily, from more than 2,000 in 1970 to fewer
than 300 in 2009.13 Coke was the first concentrate producer to build a nationwide franchised bottling
network, and Pepsi and DPS followed suit. The typical franchised bottler owned a manufacturing
and sales operation in an exclusive geographic territory, with rights granted in perpetuity by the
franchiser. In the case of Coke, territorial rights did not extend to national fountain accounts, which
the company handled directly. The original Coca-Cola franchise agreement, written in 1899, was a
fixed-price contract that did not provide for renegotiation, even if ingredient costs changed. After
considerable negotiation, often accompanied by bitter legal disputes, Coca-Cola amended the
contract in 1921, 1978, and 1987. By 2009, 92% of Coke’s U.S. concentrate sales for bottled and canned
beverages was covered by its 1987 Master Bottler Contract, which granted Coke the right to
determine concentrate price and other terms of sale.14 Under this contract, Coke had no legal
obligation to assist bottlers with advertising or marketing. Nonetheless, to ensure quality and to
match Pepsi, Coke made huge investments to support its bottling network. In 2009, for example,
Coke contributed $540 million in marketing support payments to its top bottler.15
The 1987 contract did not give complete pricing control to Coke, but rather used a formula that
established a maximum price and adjusted prices quarterly according to changes in sweetener
pricing. This contract differed from Pepsi’s Master Bottling Agreement with its top bottler. That
agreement granted the bottler perpetual rights to distribute Pepsi’s CSD products but required it to
purchase raw materials from Pepsi at prices, and on terms and conditions, determined by Pepsi.
Pepsi negotiated concentrate prices with its bottling association, and normally based price increases
on the consumer price index (CPI). Over the last two decades, however, concentrate makers regularly
raised concentrate prices, often by more than the increase in inflation (see Exhibit 5).
Franchise agreements with both Coke and Pepsi allowed bottlers to handle the non-cola brands of
other concentrate producers. Bottlers could choose whether to market new beverages introduced by a
concentrate producer. However, concentrate producers worked hard to “encourage” bottlers to carry
their product offerings. Bottlers could not carry directly competing brands, however. For example, a
Coke bottler could not sell Royal Crown Cola, yet it could distribute 7UP if it did not carry Sprite.
Franchised bottlers could decide whether to participate in test marketing efforts, local advertising
campaigns and promotions, and new package introductions (although they could only use packages
authorized by their franchiser). Bottlers also had the final say in decisions about retail pricing.
In 1971, the Federal Trade Commission initiated action against eight major concentrate makers,
charging that the granting of exclusive territories to bottlers prevented intrabrand competition (that
is, two or more bottlers competing in the same area with the same beverage). The concentrate makers
argued that interbrand competition was strong enough to warrant continuation of the existing
territorial agreements. In 1980, after years of litigation, Congress enacted the Soft Drink Interbrand
Competition Act, which preserved the right of concentrate makers to grant exclusive territories.
3
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Cola Wars Continue: Coke and Pepsi in 2010
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Cola Wars Continue: Coke and Pepsi in 2010
In 2009, the distribution of CSDs in the United States took place through supermarkets (29.1%),
fountain outlets (23.1%), vending machines (12.5%), mass merchandisers (16.7%), convenience stores
and gas stations (10.8%), and other outlets (7.8%). Small grocery stores and drug chains made up
most of the latter category.16 Costs and profitability in each channel varied by delivery method and
frequency, drop size, advertising, and marketing (see Exhibit 6).
CSDs accounted for $12 billion, or 4% of total store sales in the U.S., and were also a big traffic
draw for supermarkets.17 Bottlers fought for shelf space to ensure visibility for their products, and
they looked for new ways to drive impulse purchases, such as placing coolers at checkout counters.
An ever-expanding array of products and packages created intense competition for shelf space.
The mass merchandiser category included discount retailers, such as Wal-Mart and Target. These
companies formed an increasingly important channel. Although they sold Coke and Pepsi products,
they (along with some drug chains) could also have their own private-label CSD, or sell a generic
label such as President’s Choice. Private-label CSDs were usually delivered to a retailer’s warehouse,
while branded CSDs were delivered directly to stores. With the warehouse delivery method, the
retailer was responsible for storage, transportation, merchandising, and stocking the shelves, thereby
incurring additional costs.
Historically, Pepsi had focused on sales through retail outlets, while Coke commanded the lead in
fountain sales. (The term “fountain,” which originally referred to drug store soda fountains, covered
restaurants, cafeterias, and any other outlet that served soft drinks by the glass using fountain-type
dispensers.) Competition for national fountain accounts was intense, especially in the 1990s. In 1999,
for example, Burger King franchises were believed to pay about $6.20 per gallon for Coke syrup, but
they received a substantial rebate on each gallon; one large Midwestern franchise owner said that his
annual rebate ran $1.45 per gallon, or about 23%.18 Local fountain accounts, which bottlers handled in
most cases, were considerably more profitable than national accounts. To support the fountain
channel, Coke and Pepsi invested in the development of service dispensers and other equipment, and
provided fountain customers with point-of-sale advertising and other in-store promotional material.
After Pepsi entered the fast-food restaurant business by acquiring Pizza Hut (1978), Taco Bell
(1986), and Kentucky Fried Chicken (1986), Coca-Cola persuaded competing chains such as Wendy’s
and Burger King to switch to Coke. In 1997, PepsiCo spun off its restaurant business under the name
Tricon, but fountain “pouring rights” remained split along largely pre-Tricon lines.19 In 2009, Pepsi
supplied all Taco Bell and KFC restaurants and the great majority of Pizza Hut restaurants, and Coke
retained deals with Burger King and McDonald’s (the largest national account in terms of sales).
Competition remained vigorous: In 2004, Coke won the Subway account away from Pepsi, while
Pepsi grabbed the Quiznos account from Coke. (Subway was the largest account as measured by
number of outlets.) In April 2009, DPS secured rights for Dr Pepper at all U.S. McDonald’s
restaurants.20 Yet Coke continued to lead the channel with a 69% share of national pouring rights,
against Pepsi’s 20% and DPS’ 11%.21
Coke and DPS had long retained control of national fountain accounts, negotiating pouring-rights
contracts that in some cases (as with big restaurant chains) covered the entire United States or even
the world. Local bottlers or the franchisors’ fountain divisions serviced these accounts. (In such cases,
bottlers received a fee for delivering syrup and maintaining machines.) Historically, PepsiCo had
ceded fountain rights to local Pepsi bottlers. But in the late 1990s, Pepsi began a successful campaign
to gain from its bottlers the right to sell fountain syrup via restaurant commissary companies.22
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Retail Channels
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In the vending channel, bottlers took charge of buying, installing, and servicing machines, and for
negotiating contracts with property owners, who typically received a sales commission in exchange
for accommodating those machines. But concentrate makers offered bottlers financial incentives to
encourage investment in machines, and also played a large role in the development of vending
technology. Coke and Pepsi were by far the largest suppliers of CSDs to this channel.
Suppliers to Concentrate Producers and Bottlers
Concentrate producers required few inputs: the concentrate for most regular colas consisted of
caramel coloring, phosphoric or citric acid, natural flavors, and caffeine.23 Bottlers purchased two
major inputs: packaging (including cans, plastic bottles, and glass bottles), and sweeteners (including
high-fructose corn syrup and sugar, as well as artificial sweeteners such as aspartame). The majority
of U.S. CSDs were packaged in metal cans (56%), with plastic bottles (42%) and glass bottles (2%)
accounting for the remainder.24 Cans were an attractive packaging material because they were easily
handled and displayed, weighed little, and were durable and recyclable. Plastic packaging,
introduced in 1978, allowed for larger and more varied bottle sizes. Single-serve 20-oz PET bottles,
introduced in 1993, steadily gained popularity; in 2009, they represented 35% of CSD volume (and
52% of CSD revenues) in convenience stores.25
The concentrate producers’ strategy toward can manufacturers was typical of their supplier
relationships. Coke and Pepsi negotiated on behalf of their bottling networks, and were among the
metal can industry’s largest customers. In the 1960s and 1970s, both companies took control of a
portion of their own can production, but by 1990 they had largely exited that business. Thereafter,
they sought instead to establish stable long-term relationships with suppliers. In 2009, major can
producers included Ball, Rexam (through its American National Can subsidiary), and Crown Cork &
Seal.26 Metal cans were essentially a commodity, and often two or three can manufacturers competed
for a single contract.
The Evolution of the U.S. Soft Drink Industry27
Early History
Coca-Cola was formulated in 1886 by John Pemberton, a pharmacist in Atlanta, Georgia, who sold
it at drug store soda fountains as a “potion for mental and physical disorders.” In 1891, Asa Candler
acquired the formula, established a sales force, and began brand advertising of Coca-Cola. The
formula for Coca-Cola syrup, known as “Merchandise 7X,” remained a well-protected secret that the
company kept under guard in an Atlanta bank vault. Candler granted Coca-Cola’s first bottling
franchise in 1899 for a nominal one dollar, believing that the future of the drink rested with soda
fountains. The company’s bottling network grew quickly, however, reaching 370 franchisees by 1910.
In its early years, imitations and counterfeit versions of Coke plagued the company, which
aggressively fought trademark infringements in court. In 1916 alone, courts barred 153 imitations of
Coca-Cola, including the brands Coca-Kola, Koca-Nola, and Cold-Cola. Coke introduced and
patented a 6.5-oz bottle whose unique “skirt” design subsequently became an American icon.
Candler sold the company to a group of investors in 1919, and it went public that year. Four years
later, Robert Woodruff began his long tenure as leader of the company. Woodruff pushed franchise
bottlers to place the beverage “in arm’s reach of desire,” by any and all means. During the 1920s and
1930s, Coke pioneered open-top coolers for use in grocery stores and other channels, developed
5
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Cola Wars Continue: Coke and Pepsi in 2010
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Cola Wars Continue: Coke and Pepsi in 2010
Woodruff developed Coke’s international business as well. During World War II, at the request of
General Eisenhower, Woodruff promised that “every man in uniform gets a bottle of Coca-Cola for
five cents wherever he is and whatever it costs the company.” Beginning in 1942, Coke won
exemptions from wartime sugar rationing for production of beverages that it sold to the military or to
retailers that served soldiers. Coca-Cola bottling plants followed the movement of American troops,
and during the war the U.S. government set up 64 such plants overseas—a development that
contributed to Coke’s dominant postwar market shares in most European and Asian countries.
Pepsi-Cola was invented in 1893 in New Bern, North Carolina, by pharmacist Caleb Bradham.
Like Coke, Pepsi adopted a franchise bottling system, and by 1910 it had built a network of 270
bottlers. Pepsi struggled, however; it declared bankruptcy in 1923 and again in 1932. But business
began to pick up when, during the Great Depression, Pepsi lowered the price of its 12-oz bottle to a
nickel—the same price that Coke charged for a 6.5-oz bottle. In the years that followed, Pepsi built a
marketing strategy around the theme of its famous radio jingle: “Twice as much for a nickel, too.”
In 1938, Coke filed suit against Pepsi, claiming that the Pepsi-Cola brand was an infringement on
the Coca-Cola trademark. A 1941 court ruling in Pepsi’s favor ended a series of suits and countersuits
between the two companies. During this period, as Pepsi sought to expand its bottling network, it
had to rely on small local bottlers that competed with wealthy, established Coke franchisees.28 Still,
the company began to gain market share, surpassing Royal Crown and Dr Pepper in the 1940s to
become the second-largest-selling CSD brand. In 1950, Coke’s share of the U.S. market was 47% and
Pepsi’s was 10%; hundreds of regional CSD companies, which offered a wide assortment of flavors,
made up the rest of the market.29
The Cola Wars Begin
In 1950, Alfred Steele, a former Coke marketing executive, became CEO of Pepsi. Steele made
“Beat Coke” his motto and encouraged bottlers to focus on take-home sales through supermarkets.
To target family consumption, for example, the company introduced a 26-oz bottle. Pepsi’s growth
began to follow the postwar growth in the number of supermarkets and convenience stores in the
United States: There were about 10,000 supermarkets in 1945; 15,000 in 1955; and 32,000 in 1962, at
the peak of this growth curve.
Under the leadership of CEO Donald Kendall, Pepsi in 1963 launched its “Pepsi Generation”
marketing campaign, which targeted the young and “young at heart.” The campaign helped Pepsi
narrow Coke’s lead to a 2-to-1 margin. At the same time, Pepsi worked with its bottlers to modernize
plants and to improve store delivery services. By 1970, Pepsi bottlers were generally larger than their
Coke counterparts. Coke’s network remained fragmented, with more than 800 independent
franchised bottlers (most of which served U.S. cities of 50,000 or less).30 Throughout this period, Pepsi
sold concentrate to its bottlers at a price that was about 20% lower than what Coke charged. In the
early 1970s, Pepsi increased its concentrate prices to equal those of Coke. To overcome bottler
opposition, Pepsi promised to spend this extra income on advertising and promotion.
Coke and Pepsi began to experiment with new cola and non-cola flavors, and with new packaging
options, in the 1960s. Previously, the two companies had sold only their flagship cola brands. Coke
launched Fanta (1960), Sprite (1961), and the low-calorie cola Tab (1963). Pepsi countered with Teem
(1960), Mountain Dew (1964), and Diet Pepsi (1964). Both companies introduced non-returnable glass
bottles and 12-oz metal cans in various configurations. They also diversified into non-CSD industries.
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automatic fountain dispensers, and introduced vending machines. Woodruff also initiated “lifestyle”
advertising for Coca-Cola, emphasizing the role that Coke played in a consumer’s life.
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Coke purchased Minute Maid (fruit juice), Duncan Foods (coffee, tea, hot chocolate), and Belmont
Springs Water. In 1965, Pepsi merged with snack-food giant Frito-Lay to form PepsiCo, hoping to
achieve synergies based on similar customer targets, delivery systems, and marketing orientations.
In the late 1950s, Coca-Cola began to use advertising messages that implicitly recognized the
existence of competitors: “American’s Preferred Taste” (1955), “No Wonder Coke Refreshes Best”
(1960). In meetings with Coca-Cola bottlers, however, executives discussed only the growth of their
own brand and never referred to its closest competitor by name. During the 1960s, Coke focused
primarily on overseas markets, apparently basing its strategy on the assumption that domestic CSD
consumption was approaching a saturation point. Pepsi, meanwhile, battled Coke aggressively in the
United States, and doubled its U.S. share between 1950 and 1970.
The Pepsi Challenge
In 1974, Pepsi launched the “Pepsi Challenge” in Dallas, Texas. Coke was the dominant brand in
that city, and Pepsi ran a distant third behind Dr Pepper. In blind taste tests conducted by Pepsi’s
small local bottler, the company tried to demonstrate that consumers actually preferred Pepsi to
Coke. After its sales shot up in Dallas, Pepsi rolled out the campaign nationwide.
Coke countered with rebates, retail price cuts, and a series of advertisements that questioned the
tests’ validity. In particular, it employed retail price discounts in markets where a company-owned
Coke bottler competed against an independent Pepsi bottler. Nonetheless, the Pepsi Challenge
successfully eroded Coke’s market share. In 1979, Pepsi passed Coke in food store sales for the first
time, opening up a 1.4 share-point lead. In a sign of the times, Coca-Cola president Brian Dyson
inadvertently uttered the name Pepsi at a 1979 bottlers’ conference.
During this period, Coke renegotiated its franchise bottling contract to obtain greater flexibility in
pricing concentrate and syrups. Its bottlers approved a new contract in 1978, but only after Coke
agreed to link concentrate price changes to the CPI, to adjust the price to reflect any cost savings
associated with ingredient changes, and to supply unsweetened concentrate to bottlers that preferred
to buy their own sweetener on the open market.31 This arrangement brought Coke in line with Pepsi,
which traditionally had sold unsweetened concentrate to its bottlers. Immediately after securing
approval of the new agreement, Coke announced a significant concentrate price increase. Pepsi
followed with a 15% price increase of its own.
Cola Wars Heat Up
In 1980, Roberto Goizueta was named CEO of Coca-Cola, and Don Keough became its president.
That year, Coke switched from using sugar to using high-fructose corn syrup, a lower-priced
alternative. Pepsi emulated that move three years later. Coke also intensified its marketing effort,
more than doubling its advertising spending between 1981 and 1984. In response, Pepsi doubled its
advertising expenditures over the same period. Meanwhile, Goizueta sold off most of the non-CSD
businesses that he had inherited, including wine, coffee, tea, and industrial water treatment, while
retaining Minute Maid.
Diet Coke, introduced in 1982, was the first extension of the “Coke” brand name. Many Coke
managers, deeming the “Mother Coke” brand sacred, had opposed the move. So had company
lawyers, who worried about copyright issues. Nonetheless, Diet Coke was a huge success. Praised as
the “most successful consumer product launch of the Eighties,” it became within a few years not only
the most popular diet soft drink in the United States, but also the nation’s third-largest-selling CSD.
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Cola Wars Continue: Coke and Pepsi in 2010
Cola Wars Continue: Coke and Pepsi in 2010
In April 1985, Coke announced that it had changed the 99-year-old Coca-Cola formula. Explaining
this radical break with tradition, Goizueta cited a sharp depreciation in the value of the Coca-Cola
trademark. “The product and the brand,” he said, “had a declining share in a shrinking segment of
the market.”32 On the day of Coke’s announcement, Pepsi declared a holiday for its employees,
claiming that the new Coke mimicked Pepsi in taste. The reformulation prompted an outcry from
Coke’s most loyal customers, and bottlers joined the clamor. Three months later, the company
brought back the original formula under the name Coca-Cola Classic, while retaining the new
formula as its flagship brand under the name New Coke. Six months later, Coke announced that it
would henceforth treat Coca-Cola Classic (the original formula) as its flagship brand.
New CSD brands proliferated in the 1980s. Coke introduced 11 new products, including CaffeineFree Coke (1983) and Cherry Coke (1985). Pepsi introduced 13 products, including Lemon-Lime Slice
(1984) and Caffeine-Free Pepsi-Cola (1987). The number of packaging types and sizes also increased
dramatically, and the battle for shelf space in supermarkets and other stores became fierce. By the late
1980s, Coke and Pepsi each offered more than 10 major brands and 17 or more container types.33 The
struggle for market share intensified, and retail price discounting became the norm. Consumers grew
accustomed to such discounts.
Throughout the 1980s, the growth of Coke and Pepsi put a squeeze on smaller concentrate
producers. As their shelf space declined, small brands were shuffled from one owner to another.
Over a five-year span, Dr Pepper was sold (all or in part) several times, Canada Dry twice, Sunkist
once, and A&W Brands once. Philip Morris acquired Seven-Up in 1978 for a big premium, racked up
huge losses in the early 1980s, and then left the CSD business in 1985. In the 1990s, through a series of
strategic acquisitions, Cadbury Schweppes emerged as the third-largest concentrate producer—the
main (albeit distant) competitor of the two CSD giants. It bought the Dr Pepper/Seven-Up
Companies in 1995, and continued to add such well-known brands as Orangina (2001) and Nantucket
Nectars (2002) to its portfolio. Then in 2008, Cadbury’s beverage business was spun off into an
independent company, Dr Pepper Snapple Group.
Bottler Consolidation and Spin-Off
Relations between Coke and its franchised bottlers had been strained since the contract
renegotiation of 1978. Coke struggled to persuade bottlers to cooperate in marketing and promotion
programs, to upgrade plant and equipment, and to support new product launches.34 The cola wars
had particularly weakened small, independent bottlers. Pressures to spend more on advertising,
product and packaging proliferation, widespread retail price discounting—together, these factors
resulted in higher capital requirements and lower profit margins. Many family-owned bottlers no
longer had the resources needed to remain competitive.
At a July 1980 dinner with Coke’s 15 largest domestic bottlers, Goizueta announced a plan to
refranchise bottling operations. Coke began buying up poorly managed bottlers, infusing them with
capital, and quickly reselling them to better-performing bottlers. Refranchising allowed Coke’s larger
bottlers to expand outside their traditionally exclusive geographic territories. When two of its largest
bottling companies came up for sale in 1985, Coke moved swiftly to buy them for $2.4 billion,
preempting outside bidders. Together with other recently purchased bottlers, these acquisitions
placed one-third of Coke’s volume in company-owned operations. Meanwhile, Coke began to replace
its 1978 franchise agreement with what became the 1987 Master Bottler Contract.
Coke’s bottler acquisitions had increased its long-term debt to approximately $1 billion. In 1986,
the company created an independent bottling subsidiary, Coca-Cola Enterprises (CCE), selling 51% of
its shares to the public and retaining the rest. The minority equity position enabled Coke to separate
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711-462
711-462
its financial statements from those of CCE. As Coke’s first “anchor bottler,” CCE consolidated small
territories into larger regions, renegotiated contracts with suppliers and retailers, merged redundant
distribution and purchasing arrangements, and cut its work force by 20%. CCE also invested in
building 50-million-case production lines that involved high levels of automation. Coke continued to
acquire independent franchised bottlers and sell them to CCE. “We became an investment banking
firm specializing in bottler deals,” said Don Keough. 35 In 1997 alone, Coke put together more than $7
billion in such deals.36 As of 2009, CCE was Coke’s largest bottler. It handled about 75% of Coke’s
North American bottle and can volume, and logged annual sales of more than $21 billion.
In the late 1980s, Pepsi acquired MEI Bottling for $591 million, Grand Metropolitan’s bottling
operations for $705 million, and General Cinema’s bottling operations for $1.8 billion. After operating
the bottlers for a decade, Pepsi shifted course and adopted Coke’s anchor bottler model. In April
1999, the Pepsi Bottling Group (PBG) went public, with Pepsi retaining a 35% equity stake in it. By
2009, PBG produced 56% of PepsiCo’s total volume, while the total number of Pepsi bottlers had
fallen from more than 400 in the mid-1980s to 106.37
Bottler consolidation made smaller concentrate producers increasingly dependent on the Pepsi
and Coke bottling networks for distribution of their products. In response, DPS in 1998 bought and
merged two large U.S. bottling companies to form its own bottler. In 2009, Coke had the most
consolidated system, with its top 10 bottlers producing 94% of domestic volume. Pepsi’s and DPS’
top 10 bottlers produced 89% and 79% of the domestic volume of their respective franchisors.38
Adapting to the Times
Starting in the late 1990s, the soft drink industry encountered new challenges that suggested a
possible long-term shift in the marketplace. Although Americans still drank more CSDs than any
other beverage, U.S. consumption began to fizzle (see Exhibit 1). That stood in contrast to annual
growth rates of 3% to 7% during the 1980s and early 1990s.39
This shift in consumption patterns evolved around the growing linkage between CSDs and health
issues such as obesity and nutrition. New federal nutrition guidelines, issued in 2005, identified
regular CSDs as the largest source of obesity-causing sugars in the American diet.40 Schools
throughout the nation banned the sale of soft drinks on their premises. Several states pushed for a
“soda tax” on sugary drinks like sodas and energy beverages. A U.S. government study suggested
that a 20% tax could cut the calorie intake from sugary drinks by up to 49 calories a day per person in
the United States.41 As of April 2010, 29 states already taxed sodas and around 12 more states were
considering the measure.42 In addition, a greater number of consumers started to perceive highfructose corn syrup as unnatural and unhealthy. According to one market research study, 53% of
Americans were concerned that the ingredient posed a health hazard in 2010, compared to 40% in
2004.43 In fact, Coke’s 2009 annual report identified obesity and health concerns as the number one
risk factor to its business.44
In face of dwindling CSD sales (see Exhibit 7), Coke and Pepsi tried to stem the tide by enticing
consumers with stepped-up innovation and marketing. In Coke’s case, the company revealed a new
Freestyle soda machine in 2009 which could create dozens of different kinds of custom beverages;
restaurants had to pay a 30% premium for the Freestyle compared to a regular soda fountain. 45 Coke
also placed a greater emphasis on promoting its brands, such as spending $230 million in advertising
for its flagship Cola-Cola drink (see Exhibit 8). It also upped spending on sponsorships and global
marketing, including $600 million for the World Cup in 2010.46 Meanwhile, Pepsi redesigned its logo
in 2008 with a three-year rebranding plan that could cost over $1 billion to rejuvenate its image. Pepsi
9
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Cola Wars Continue: Coke and Pepsi in 2010
Cola Wars Continue: Coke and Pepsi in 2010
focused on promoting the company’s overall portfolio as a snack and beverage company, such as
through “The Power of One” concept. Market surveys on brand loyalty indicated that more
consumers preferred Coke over Pepsi as their favorite CSD brand towards 2010, a slight setback for
Pepsi after it had significantly narrowed the gap in the late 1990s.47
The Quest for Alternatives
Expanding the product mix offered another avenue for growth. Diet sodas, for example, rose to
capture 30% of the CSD market in 2009 compared to 24% a decade ago.48 Coca-Cola Zero became the
most successful new CSD product launched in the second half of the decade. The beverage, which
offered the “real Coca-Cola taste with zero calories”, experienced consecutive double-digit growth
since its introduction in 2005. It was primarily marketed to younger men around the world who
shunned the “diet” label.
At the same time, both Coke and Pepsi intensified their efforts to use alternative sweeteners. Pepsi
replaced high-fructose corn syrup with natural sugar for its brands, Pepsi Throwback and Mountain
Dew Throwback. Another possible alternative was Stevia, an herb that could be used as a natural,
zero-calorie sweetener. Coke and Pepsi both developed their own versions of a Stevia-based
sweetener, which were approved to be used as a food additive by the U.S. Food and Drug
Administration in 2008. New Stevia-based product releases followed, including Pepsi’s reducedcalorie Trop 50 (orange juice), and Coke’s Sprite Green, with plans to expand to more CSDs as well.
Despite some success with diet drinks, Coke and Pepsi realized that growth would involve “noncarbs”—a category that included juices and juice drinks, sports drinks, energy drinks, and tea-based
drinks—and also on bottled water (see Exhibit 9). In 2009, while CSDs accounted for 63% of U.S. nonalcoholic refreshment beverage volume (down from 81% in 2000), the remaining volume was made
up of bottled water at 20% (up from 7%) and non-carbs at 17% (up from 13%).49
Initially, Pepsi was more aggressive than Coke in shifting to non-CSDs. Declaring itself to be a
“total beverage company,” Pepsi developed a portfolio of non-CSD products that outsold Coke’s
rival product in several key categories, such as sports drink (Gatorade) and tea-based drinks (Lipton).
Between 2004 and 2007, 77% of Pepsi’s new products released in the U.S. market were non-carbs
compared to Coke’s 56%.50 But starting in 2007, Coke aggressively expanded its non-carbs product
portfolio through acquisitions. Most notable was its $4 billion purchase of Energy Brands, maker of
the popular Vitaminwater drinks. The deal was the biggest acquisition Coke had ever made. Coke
also entered the business of supplying coffee and tea to fountain/foodservice customers. By 2009,
Pepsi had 43% of the U.S. non-carbs market share compared to Coke’s 32%.51
In the $14 billion bottled-water category, both Pepsi (with Aquafina, 1998) and Coke (with Dasani,
1999) had introduced purified-water products that had surged to become leading beverage brands.
Using their distribution prowess, they had outstripped competing brands, many of which sold spring
water. However, the economic downturn in the late 2000s dampened future prospects for what had
been the fastest growing beverage category between 2000 and 2007.52 Price-sensitive consumers
sought cheaper alternatives such as private label bottled-water or tap water, exhibiting little brand
loyalty compared to CSDs. Environmentalists also became more vocal in their criticisms against the
use of plastic bottles, known as PET, which had a recycling rate below 25%.53 Bottled water started to
generate negative operating profit margins. Coke also saw its market share in this category slip to
15% in 2009 (compared to 22% in 2004) while Pepsi’s fell to 11% (compared to 14%).54
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711-462
Cola Wars Continue: Coke and Pepsi in 2010
711-462
As U.S. demand for CSDs softened, Coke and Pepsi also looked abroad for new growth. The
United States remained the largest market, accounting for a third of global CSD consumption,
followed by Mexico, Puerto Rico, and Argentina.55 But improved access to markets in Asia and
Eastern Europe stimulated new demand. In particular, China and India emerged as future
battlegrounds with a large, growing middle class population. Each company planned to invest about
$2 billion in China over the next few years to build up their market presence.
Coke flourished, and also relied upon, international markets far more than Pepsi. Through steady
expansion, the Coca-Cola name had become synonymous with American culture. Served in more
than 200 countries, Coke derived about 80% of its sales from international markets.56 Pepsi, on the
other hand, depended on the U.S. for roughly half of its total sales.57 Earlier efforts to go after Coke in
core international markets generated relatively little success. By the early 2000s, Pepsi chose to focus
on emerging markets that were still up for grabs. Several of its top CSD markets were in Asia, Middle
East, and Africa.
Since CSD consumption abroad was generally lower compared to the United States, Coke and
Pepsi aggressively pursued non-carbs opportunities in global markets. For instance, juice was a
popular category—its retail value in China was expected to grow 94% by 2012 compared to 30% for
CSDs.58 In Russia, Pepsi and PBC paid $1.4 billion for a 76% stake in Russia’s largest juice producer,
OAO Lebedyansky, in 2008. International operations, however, encountered several obstacles,
including antitrust regulation, foreign exchange controls, advertising restrictions, and local
competition. In one high-profile incident, the Chinese government rejected Coke’s $2.4 billion bid to
buy Huiyan Juice, a leading juice company in China. At the same time, overseas markets enabled
Coke and Pepsi to broaden the scope of innovation. To tailor to local tastes, Coke offered Sprite Tea,
which blended green tea with Sprite, while Pepsi experimented with beverages made out of Chinese
herbs. New approaches to packaging abounded as well.59 In China and India, use of small returnable
glass bottles allowed Coke to reach poor, rural consumers at a very low price point, while boosting
revenue-per-ounce.60
Evolving Structures and Strategies
Both at home and abroad, the growing popularity of alternative beverages brewed complications
for CSD makers’ traditional production and distribution practices. Concentrate companies became
more directly involved in the manufacturing of several non-CSDs, ranging from Gatorade to Lipton
Iced Tea. Such finished goods required a smaller but specialized production process that were
challenging for bottlers to make with their existing infrastructure. As the popularity of non-carbs
continued to grow, bottlers were frustrated that they were not fully participating in the new growth
businesses. Coke and Pepsi sold the finished goods to their bottlers, who distributed them alongside
their own bottled products at a percentage markup. In addition, Coke and Pepsi distributed some
non-CSDs directly to the retailers’ warehouses, bypassing bottlers.
Energy and sports drinks promised better margins than CSDs because they commanded premium
prices and were usually chosen for immediate, single-serve consumption (see Exhibit 10). In
convenience stores, energy drinks had an average case price of $34.32 compared to CSD’s $8.99.61 Yet
volume for such products, while growing fast, remained small in comparison with CSD volume. This
created issues with DSD, which worked best with high-volume, high consumer demand products.
All CSD companies faced the challenge of achieving pricing power in the take-home channels. In
particular, the rapid growth of the mass-merchandisers, led by Wal-Mart, and various club stores
11
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Internationalizing the Beverage Wars
Cola Wars Continue: Coke and Pepsi in 2010
posed a new threat to profitability for Coke, Pepsi, and their bottlers. Consolidation in the retail
sector meant that the top ten customers represented as much as 40% of Coke’s U.S. package volume.62
In the case of Wal-Mart, it not only used its size to exert pricing pressure, it also insisted on
negotiating marketing and shelving arrangements directly with concentrate makers. This left bottlers
feeling vulnerable in their traditional practice of distributing products in their exclusive territories.
In addition, bottlers had to manage an ever-rising number of stock-keeping units (SKUs).63 For
instance, Pepsi wanted its bottlers to carry 47 different Gatorade SKUs in exchange for gaining
distribution rights to smaller but more profitable channels like convenience and dollar stores.64 Many
non-CSDs sold in relatively low volume, leading to an increased use of “split pallets.” By loading
more than one product type on a pallet (the hard, wooden bed used to organize and transport
merchandise), bottlers incurred higher distribution and sales costs. Some of Coke’s biggest bottlers
saw their cost of goods sold (including operating expenses) reach 90% of their sales, the highest level
in more than two decades.65
Not surprisingly, bottlers complained over Coke’s practice of charging a flat rate for its
concentrate in the U.S. market. Coke’s profits were tied to volume growth while bottlers’ profits were
driven by package types and where the drinks were sold.66 Then in 2003, Coke and CCE moved
toward “incidence pricing”, an approach that Coke often used with its overseas bottlers, whereby
Coke agreed to vary concentrate prices according to prices charged in different channels and for
different packages. By 2009, around 90% of Coke’s total volume was covered under incidence pricing
agreements. Annual price negotiations were also replaced with multi-year concentrate-price
agreements. With some bottlers, Coke pursued more 50-50 joint ventures. Motivating its independent
bottlers became critical, especially for Coke, as they accounted for nearly 90% of Coke’s worldwide
sales volume.67
Bottler Consolidation, Again
In 2009, Pepsi announced that it would buy two of its biggest bottlers, PBG and PepsiAmericas, in
a transaction worth $7.8 billion. The offer came just about ten years after Pepsi had spun off PBG into
an independent company. The merger would consolidate more than 80% of Pepsi’s North America
beverage operations under one roof.68 One analyst noted that the deal acknowledged the “changing
realities of the North American beverage business.”69 Then Coke, which had been a loyal defender of
the franchise bottling system, surprised the world with its decision to buy CCE’s North American
operations in February 2010. The deal brought back 90% of Coke’s North America business under its
control. In return, CCE bought Coke’s own bottling operations in Norway and Sweden, and received
the option to buy Coke’s stake in its German bottling business at a later date.
Future of the Cola Wars?
Declining CSD sales, declining cola sales, and the rapid emergence of non-carbonated drinks
appeared to be changing the game in the cola wars. By spending billions of dollars to bring bottling
operations under Coke and Pepsi’s direct control again, observers couldn’t help but wonder: was this
a fundamental shift in the cola wars or was this just one more round in a 100 year rivalry?
12
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711-462
Page 16 of 213
182.5
68.0
114.5
22.7
22.8
18.5
―
35.7
6.5
5.2
―
―
1.3
1.8
3,090
22.7
12.4%
182.5
56.0
126.5
26.3
21.8
21.6
1.2
33.0
6.8
7.3
―
4.8
1.7
2.0
3,780
26.3
14.4%
1975
182.5
49.2
133.3
34.2
20.6
24.3
2.7
27.2
6.9
7.3
―
6.0
2.1
2.0
5,180
34.2
18.7%
1981
182.5
36.0
146.5
40.3
24.0
25.0
4.5
26.9
8.1
7.3
―
6.2
2.4
1.8
6,500
40.3
22.1%
1985
182.5
28.7
153.8
46.9
24.0
24.2
8.1
26.2
8.5
7.0
―
5.4
2.0
1.5
7,780
46.9
25.7%
1990
182.5
31.0
151.5
50.9
21.9
22.8
10.1
21.3
8.9
6.8
1.3
4.5
1.8
1.2
9,000
50.9
27.9%
1995
182.5
31.6
150.9
53.0
21.8
21.3
13.2
16.8
9.5
7.0
2.2
3.0
1.9
1.2
9,950
53.0
29.0%
2000
182.5
27.6
155.2
51.7
21.4
20.3
19.5
16.4
8.2
7.0
4.2
2.6
2.2
1.4
10,220
51.9
28.3%
2005
182.5
24.8
155.9
49.3
22.0
21.7
22.5
16.0
8.1
7.1
4.9
2.2
2.5
1.4
9,920
49.3
27.1%
2007
182.5
28.9
152.7
47.4
21.7
21.4
21.4
15.9
7.6
7.3
4.6
2.3
2.6
1.4
9,620
47.4
26.0%
2008
For use only in the course RSM 392 - Strategic Management at University of Toronto - Rotman School of Management from 9/3/2024 to 12/31/2024.
Use outside these parameters is a copyright violation.
e This analysis assumes that each person consumes, on average, one half-gallon of liquid per day.
d For pre-1992 data, sports drinks are included in “Tap water/hybrids/all others.”
c For 1985 and afterward, coffee and tea data are based on a three-year moving average.
b Bottled water includes all packages, single-serve as well as bulk.
a One case is equivalent to 192 oz.
Source: Compiled from Beverage Digest Fact Book 2001, The Maxwell Consumer Report, Feb. 3, 1994; Adams Liquor Handbook, casewriter estimates; and Beverage Digest Fact Book 2005. Data for
1990 and afterward comes from Beverage Digest Fact Book 2005 and 2010, which reports that some of that data has been “restated compared to previous editions of the Fact Book.”
Totale
Tap water/hybrids/all others
Subtotal
Carbonated soft drinks
Beer
Milk
Bottled waterb
Coffeec
Juices
Teac
Sports drinksd
Powdered drinks
Wine
Distilled spirits
U.S. Liquid Consumption Trends (gallons/capita)
Casesa (millions)
Gallons/capita
As share of total beverage consumption
1970
U.S. Beverage Industry Consumption Statistics
Historical Carbonated Soft Drink Consumption
Exhibit 1
182.5
31.8
150.7
46.0
21.0
21.5
20.6
15.8
8.1
7.3
4.0
2.4
2.6
1.4
9,420
46.0
25.2%
2009
711-462
-13-
711-462
U.S. Soft Drink Market Share by Unit Case Volume (%)
1970
1980
1985
1990
1995
2000
2005
2009Ea
Coca-Cola Company
Coca-Colab
Diet Coke
Sprite and Diet Sprite
Caffeine Free Coke, Diet Coke
Fantac
Barq’s and Diet Barq’s
Minute Maid brands
Tab
Others
Total
28.4
―
1.8
―
―
―
―
1.3
3.2
34.7
25.3
―
3.0
―
―
―
―
3.3
4.3
35.9
21.7
6.8
4.7
1.7
0.9
―
―
1.1
2.6
39.5
20.7
9.3
4.5
2.9
0.7
―
0.7
0.2
2.8
41.1
20.9
8.8
5.7
2.6
0.7
0.2
0.7
0.1
3.3
42.3
20.4
8.7
7.2
2.2
0.2
1.2
1.5
―
4.2
44.1
17.6
9.8
6.3
1.8
1.6
1.1
0.1
―
4.9
43.1
17.0
9.9
6.1
1.4
1.8
1.1
―
―
4.6
41.9
PepsiCo, Inc.
Pepsi-Cola
Mountain Dew
Diet Pepsi
Sierra Mist
Diet Mountain Dew
Caffeine Free Pepsi, and Diet Pepsi
Mug Root Beer
Slice and Diet Slice
Others
Total
17.0
0.9
1.1
―
―
―
―
―
0.8
19.8
20.4
3.3
3.0
―
―
―
―
―
1.1
27.8
19.3
3.1
3.9
―
―
2.5
―
1.4
0.1
30.3
17.6
3.9
6.3
―
0.5
2.3
0.3
1.4
0.1
32.4
15.0
5.7
5.8
―
0.7
2.0
0.3
1.2
0.2
30.9
13.6
7.2
5.3
0.1
0.9
1.7
0.8
0.6
1.2
31.4
11.2
6.5
6.0
1.4
1.4
1.4
0.7
0.1
2.7
31.4
9.9
6.7
5.6
1.3
1.9
1.0
0.7
0.1
2.7
29.9
Dr Pepper Snapple Groupd
Dr Pepper (all brands)
7UP (all brands)
A&W brands
Sunkist
Canada Dry
Schweppes
Others
Total
3.8
7.2
―
―
―
―
―
11.0
6.0
6.3
―
―
―
―
―
12.3
4.5
5.8
―
1.2
1.5
0.5
1.5
15.0
5.2
3.9
―
0.7
1.2
0.6
0.7
12.3
6.8
3.3
0.9
0.7
1.0
0.5
1.9
15.1
7.5
2.8
0.9
0.8
0.9
0.4
1.4
14.7
7.6
1.7
1.0
1.1
0.8
0.4
2.0
14.6
8.3
1.6
1.1
1.2
1.0
0.5
2.7
16.4
Cott Corporation
Royal Crown Cos.
Other companies
―
6.0
28.5
―
4.7
19.3
―
3.1
12.1
―
2.6
11.6
2.7
2.0
7.0
3.3
1.1
5.4
5.4
―
5.5
4.9
―
6.9
Total case volume (in millions)
3,670
5,180
6,385
7,780
8,970
9,950
10,224
9,416
Source: Compiled from Beverage Digest Fact Book 2001, 2005, and 2010; The Maxwell Consumer Report, February. 3, 1994; the
Beverage Marketing Corporation, cited in Beverage World, March 1996 and March 1999.
a Expected market share. One unit case is equivalent to 192 oz.
b Between 1985 and 1995, market share includes Coca-Cola Classic. Coca-Cola drops the name “classic” in 2009.
c For the period before 1985, Fanta sales are included under “Others.”
d For the years preceding 1988, Dr Pepper and 7UP brand shares refer to the shares of the respective independent companies,
the Dr Pepper Company and the Seven-Up Company. Then, Cadbury Schweppes acquired A&W brands in 1993, Dr
Pepper/Seven-Up Cos. brands in 1995, and Royal Crown brands in 2000. In 2008, Cadbury Schweppes’ beverage brands came
under the control of the Dr Pepper Snapple Group.
14
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Exhibit 2
Cola Wars Continue: Coke and Pepsi in 2010
Page 18 of 213
2,368
10.3%
―
―
―
―
5,975
4.4%
20.0%
31.0%
―
―
―
―
2,709
4.6%
18.0%
35.0%
5,475
7.7%
20.0%
10.0%
2,773
9.0%
21.0%
3.0%
1,065
10.4%
2,349
21.0%
―
―
7,585
5.6%
30.0%
36.0%
―
―
―
―
2,725
10.4%
5,879
12.3%
24.0%
23.0%
2,677
22.9%
1,865
11.6%
1985
17,515
6.2%
22.0%
33.0%
―
―
1,489
6.3%
5,035
13.4%
10,236
13.5%
36.0%
8.0%
6,125
29.4%
2,461
16.5%
1990
19,067
7.5%
19.4%
35.9%
―
―
3,040
3.9%
7,427
16.7%
18,127
16.5%
55.4%
7.6%
12,559
29.1%
5,513
15.5%
1995
20,438
10.7%
30.1%
12.8%
―
―
1,981
8.0%
6,171
22.3%
20,458
10.6%
23.4%
4.0%
12,588
27.1%
7,870
17.9%
2000
32,562
12.5%
28.6%
7.3%
―
―
―
―
9,146
22.3%
23,104
21.1%
29.8%
3.9%
16,345
35.4%
6,676
23.3%
2005
39,474
14.3%
32.8%
12.1%
11,090
22.4%
―
―
―
―
28,857
20.7%
27.5%
7.6%
20,778
33.2%
7,836
21.6%
2007
43,251
11.9%
42.5%
21.8%
10,937
18.5%
―
―
―
―
31,944
18.2%
28.4%
6.9%
22,611
35.2%
8,280
19.1%
2008
43,232
13.8%
35.4%
18.6%
10,116
21.5%
For use only in the course RSM 392 - Strategic Management at University of Toronto - Rotman School of Management from 9/3/2024 to 12/31/2024.
Use outside these parameters is a copyright violation.
As of 2000, data for “Beverages, North America” combined sales for what had been the Pepsi-Cola and Gatorade/Tropicana divisions. In 2003, PepsiCo ceased reporting its
international beverage business separately from its international food business. In 2007, Pepsi merged its North America beverage sales with Latin America sales, and started
to report their combined financial under PepsiCo Americas Beverages.
b PepsiCo’s sales figures included sales by company-owned bottlers. In 1998, PepsiCo began reporting U.S. data as part of a North American category that included Canada.
in its consolidated net income figure. In 1994, Coke began reporting U.S. data as part of a North American category that included Canada and Mexico.
―
―
―
―
30,990
22.0%
27.5%
10.4%
22,231
34.6%
8,271
20.5%
2009
a Beverage sales consist mainly of concentrate sales. Coke’s stake in CCE was accounted for by the equity method of accounting, with its share of CCE’s net earnings included
Source: Company annual reports and Capital IQ database, accessed June 2010.
PepsiCo, Inc.b
Beverages, North America:
Sales
Operating profit/sales
Beverages, International:
Sales
Operating profit/sales
PepsiCo Americas Beverages:
Sales
Operating profit/sales
Consolidated:
Sales
Net profit/sales
Net profit/equity
Long-term debt/assets
1,486
11.1%
1980
―
―
1975
Financial Data for Coca-Cola and PepsiCo ($ millions)
Coca-Cola Companya
Beverages, North America:
Sales
Operating profits/sales
Beverages, International:
Sales
Operating profit/sales
Consolidated:
Sales
Net profit/sales
Net profit/equity
Long-term debt/assets
Exhibit 3a
711-462
-15-
Page 19 of 213
―
―
―
―
―
Pepsi Bottling Group (PBG)c
Sales
Operating profit/sales
Net profit/sales
Net profit/equity
Long-term debt/assets
―
―
―
―
―
―
―
―
―
―
1980
―
―
―
―
―
―
―
―
―
―
1985
―
―
―
―
―
3,933
8.3%
2.4%
6.0%
39.0%
1990
―
―
―
―
―
6,773
6.9%
1.2%
5.7%
46.3%
1995
7,982
7.4%
2.9%
13.9%
42.3%
14,750
7.6%
1.6%
8.3%
46.7%
2000
11,885
8.6%
3.9%
22.8%
34.2%
18,743
7.6%
2.7%
14.0%
36.1%
2005
13,591
7.9%
3.9%
20.3%
36.4%
20,936
7.0%
3.4%
14.8%
30.7%
2007
13,796
4.7%
1.2%
12.1%
36.9%
21,807
-28.9%
-20.1%
NA
46.5%
2008a
13,219
7.9%
4.6%
25.3%
40.5%
21,645
7.1%
3.4%
85.1%
48.1%
2009
-16-
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Use outside these parameters is a copyright violation.
PBG’s net earnings was included in PepsiCo’s consolidated net income figure. 2009’s data does not reflect PepsiCo’s purchase of PBG, as announced that year.
c PBG financial data for the pre-1999 period refer to the PepsiCo bottling operations that were combined and spun off to form PBG in 1998. From 1999, PepsiCo’s share of
operations to Coke and CCE’s purchase of Coke’s bottling operations in Norway and Sweden. CCE’s consolidated financial statements reflect wide fluctuations, affected by issues such as, but not limited
to, debt write-offs, reassessments of franchise intangible assets to fair market value, and tax charges related to restructuring activities.
b Data represents CCE’s consolidated financial data, as reported in CCE’s annual reports, and does not reflect the combined financial data of the new CCE, following the sale of CCE’s North America
a
In 2008, CCE wrote off $7.6 billion to readjust the fair value of the company’s intangible franchise assets and goodwill contracts, which resulted in a significant losses for the fiscal year. For more
information, see “Notes to Consolidated Financial Statements” in CCE’s 2008 annual report.
Source: Company annual reports.
―
―
―
―
―
Sales
Operating profit/sales
Net profit/sales
Net profit/equity
Long-term debt/assets
1975
Financial Data for Coca-Cola and PepsiCo’s Largest Bottlers ($ millions)
Coca-Cola Enterprisesb (CCE)
Exhibit 3b
711-462
Cola Wars Continue: Coke and Pepsi in 2010
Comparative Costs of a Typical U.S. Concentrate Producer and Bottler, 2009
Net sales
Cost of goods sold
Gross profit
Direct marketing expense
Selling & delivery expense
General & admin expense
Operating income
Concentrate Producer
Dollars
Percent
per casea
of net sales
$0.98
100%
$0.22
22%
$0.76
78%
$0.21
21%
$0.00
0%
$0.24
25%
$0.30
32%
Bottler
Dollars
per casea
$4.63
$2.67
$1.97
$0.45
$0.85
$0.31
$0.36
Percent
of net sales
100%
58%
42%
10%
18%
6%
8%
Sources: Compiled from estimates provided by beverage industry source, October 2010.
a One case is equivalent to 192 oz.
Exhibit 5
U.S. CSD Industry Pricing and Statistics, 1988-2009
Retail price per case, adjusted for inflationa
Change in retail priceb
Total Change 1988-2008:
1988
$10.79
—
-1.4%
1994
$8.48
-3.9%
1998
$7.63
-1.7%
2002
$7.57
-0.1%
2006
$7.47
-0.2%
2008
$7.66
0.4%
2009
$7.98
0.7%
Concentrate price per casec
Change in concentrate price
Total Change 1988-2009:
$0.79
—
3.6%
$1.00
4.0%
$1.14
3.3%
$1.35
4.3%
$1.50
2.7%
$1.59
3.0%
$1.65
3.8%
Volume (cases, in billions)
Change in volume
Total Change 1988-2009:
7.40
—
1.2%
8.70
2.0%
9.90
3.3%
10.09
0.3%
10.16
0.2%
9.62
-2.7%
9.42
-2.1%
Consumption (gallons/capital)
Change in consumption
Total Change 1988-2009:
40.30
—
0.6%
50.00
2.7%
54.00
1.9%
52.60
-0.4%
51.10
-0.7%
47.40
-3.7%
46.00
-3.0%
Consumer Price Index (2005=100)
Change in CPI
Total Change 1988-2009:
60.57
—
2.9%
75.91
2.9%
83.48
2.4%
92.11 103.22
2.5%
2.9%
110.23 109.88
3.3% -0.3%
Source: Compiled from Beverage Digest Fact Book, 2001, and every edition between 2006 and 2010.
a Refers to a 192-oz. case. Prices reflect inflation using the inflation calculator tool, U.S. Bureau of Labor Statistics website,
http://data.bls.gov/cgi-bin/cpicalc.pl, accessed June 2010.
b All change figures are calculated using Compounded Annual Growth Rate (CAGR).
c For the purpose of this item only, concentrate price refers to a 288-oz. case. Concentrate price data for previous years appear
in aggregated form in Beverage Digest Fact Book 2003, p. 64. After 2004, price is based on a weighted average of concentrate
prices for the top 10 CSD brands, as released in Beverage Digest Fact Book, Appendix G, and based on the brands’ market share
for the given year. Concentrate prices were also affected by specific ingredients, such as corn and ethanol, which varied
significantly from CPI in certain years.
17
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Exhibit 4
711-462
711-462
U.S. Refreshment Beverages: Bottling Profitability per Channel, 2009
Supermarkets
Share of industry volume
37%
Index of bottling profitabilityb
Net price
1.00
Variable profit
1.00
Convenience Superretail
centersa
Mass
retailersa
Club
storesa
Drug Fountain,
stores vending, Total
and other
10%
11%
2%
7%
2%
31%
100%
2.24
1.24
1.13
1.24
1.10
1.39
0.93
1.37
1.23
1.68
2.09
1.56
NA
NA
Source: Compiled from estimates provided by beverage industry source, October 2010. All figures refer to the entire
refreshment beverage industry.
a “Supercenters” include Wal-Mart Supercenter stories and similar outlets. “Mass Retailers” include standard Wal-Mart stores,
Target stores, and the like. “Club Stores” include Sam’s Club, Costco, and similar membership-based retailers.
b Using supermarket information as a baseline, these figures indicate variance by channel of both by-volume pricing and by-
volume profit. The variable profit figures take into account cost of goods sold as well as delivery costs.
Exhibit 7
Non-Alcoholic Refreshment Beverage Megabrands, 2004 and 2009a
Brand (Owner)
Coke (Coke)
Pepsi (Pepsi)
Mountain Dew (Pepsi)
Dr Pepper (DPS)
Sprite (Coke)
Gatorade (Pepsi)
Aquafina (Pepsi)
Dasani (Coke)
Poland Spring (Nestlé Waters)
7UP (DPS)
Minute Maid (Coke)
Sierra Mist (Pepsi)
Lipton (Pepsi/Unilever)
Crystal Geyser (CG Roxanne)
Arrowhead (Nestlé Waters)
PowerAde (Coke)
Nestlé Pure Life (Nestlé
Waters)
Barq’s (Coke)
Sunkist (DPS)
2009
Cases
Category
(mil)
CSD
2,913.1
CSD
1,681.5
CSD
900.1
CSD
784.0
CSD
573.0
Non-Carb
553.7
Water
325.0
Water
289.7
Water
280.1
CSD
150.9
CSD/Non-Carb
95.5
CSD
149.9
Non-Carb
235.3
Water
223.7
Water
156.4
Non-Carb
177.6
Water
CSD
CSD
469.4
103.7
116.9
2009
2004
Share
Cases
(%)
(mil)
19.6% 3,272.3
11.3% 2,098.4
6.1% 871.1
5.3% 738.3
3.9% 683.2
3.7% 546.0
2.2% 251.0
1.9% 223.0
1.9% 217.0
1.0% 186.7
0.6% 176.4
1.0% 166.9
1.6% 164.0
1.5% 135.5
1.1% 127.0
1.2% 122.7
3.2%
0.7%
0.8%
113.2
112.5
105.2
Annual
Annual
2004
Volume
Change in
Share Changeb Market Shareb
(%)
2004–09
2004–09
23.4%
-2.3%
-3.5%
15.0%
-4.3%
-5.5%
6.2%
0.7%
-0.3%
5.3%
1.2%
0.0%
4.9%
-3.5%
-4.5%
3.9%
0.3%
-1.0%
1.8%
5.3%
4.1%
1.6%
5.4%
3.5%
1.5%
5.2%
4.8%
1.3%
-4.2%
-5.1%
1.3%
-11.5%
-14.3%
1.2%
-2.1%
-3.6%
1.2%
7.5%
5.9%
1.0%
10.5%
8.4%
0.9%
4.3%
4.1%
0.9%
7.7%
5.9%
0.8%
0.8%
0.8%
32.9%
-1.6%
2.1%
32.0%
-2.6%
0.0%
Source: Compiled from Beverage Digest Fact Book 2005 and 2010; and casewriter estimates.
a Beverage Digest Fact Book defines a “megabrand” as a “brand or trademark with total volume of more than 100 million 192-oz
cases.” A megabrand encompasses all varieties (Coke Classic, Diet Coke, Cherry Coke, and so on) of a given trademark
(“Coke”). Only single-serve products are included here.
b All changes calculated using compounded annual growth rates.
18
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Exhibit 6
Cola Wars Continue: Coke and Pepsi in 2010
Cola Wars Continue: Coke and Pepsi in 2010
Advertising Spending for Selected Refreshment Beverage Brands (in $ thousands)
Market sharea
2009
2008
Coca-Cola
Pepsi-Cola
Mountain Dew
Dr Pepper
Gatorade
15.3%
8.8%
4.6%
4.1%
3.1%
15.2%
9.0%
4.5%
3.9%
3.6%
Advertising spendingb
2009
2008
234,000
136,000
24,000
76,000
119,000
Per 2009
share pointc
254,000
145,000
31,000
64,000
162,000
$15,294
$15,456
$5,217
$18,537
$38,387
Source: Created by casewriter based on “Special Report: 100 Leading National Advertisers,” Advertising Age, June 21, 2010.
Share of the total single-serve non-alcoholic beverage market. Advertising Age’s market share data may slightly differ from
Beverage Digest’s data, seen in case Exhibit 2.
a
b
Spending as measured across 19 national media channels using data tracked by Kantar Media and Kantar Media's Marx.
Exhibit 9
U.S. Non-CSDs Unit Case Volume (in millions)
Packaged water
Juice & juice drinks
Sports drinks
Ready-to-drink tea
Energy drinks
2002
3,221.6
3,030.5
488.1
430.7
28.9
2004
3,785.6
3,034.2
620.5
455.2
63.7
2006
4,588.1
2,612.2
912.3
556.6
135.3
2007
4,847.2
2,534.9
950.4
625.4
177.0
2008
4,712.1
2,512.4
856.9
623.7
217.3
2009
4,588.9
2,498.8
843.3
706.1
218.0
Source: Compiled from estimates provided by beverage industry sources, September 2010. One case is equivalent to 192 oz.
Exhibit 10
Gross Profit Margins for Selected Beverages (%)
Ready-to-drink coffee
Ready-to-drink tea
Energy
Sports
Juice
Water
CSD
Retail’s gross margin
35%
35%
35%
35%
25%
35%
30%
Brand’s gross margin
60%
60%
70%
65%
35%
45%
70%
Source: Compiled by casewriter using data from Marc Greenberg, “Coca-Cola Company Presentation” Deutsche Bank
Securities Inc., April 12, 2010, p. 7.
19
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Exhibit 8
711-462
711-462
Cola Wars Continue: Coke and Pepsi in 2010
1 Beverage Digest Fact Book 2010, p. 15. Beverage Digest’s definition includes energy drinks.
2 See Exhibits 1, 3a, and 3b in this case.
3 Roger Enrico, The Other Guy Blinked and Other Dispatches from the Cola Wars (New York: Bantam Books,
1988).
4 Beverage Digest Fact Book 2010, p. 24.
5 Robert Tollison et al., Competition and Concentration (Lexington Books, 1991), p. 11.
6 Beverage Digest Fact Book 2010, p. 42.
7 Unless otherwise noted, information on industry participants and structures comes from Michael E. Porter
(with research associate Rebecca Wayland), “Coca-Cola versus Pepsi-Cola and the Soft Drink Industry,” HBS
No. 391-179 (Boston: Harvard Business School Publishing, 1994); Andrew J. Conway et al., “Global Soft Drink
Bottling Review and Outlook: Consolidating the Way to a Stronger Bottling Network”, Morgan Stanley Dean
Witter, August 4, 1997; and from casewriter interviews with industry executives.
8 Casewriter conversation with industry insider, October 2010.
9 Ibid.
10 “Dr Pepper Snapple Group Breaks Ground on $120 Million Production Facility in Southern California,” Dr
Pepper Snapple Group press release (Victorville, CA, October 22, 2008).
11 Coca-Cola 2009 Annual Report (Atlanta, The Coca-Cola Company, 2010), and PepsiCo 2009 Annual Report
(Purchase, PepsiCo, 2010).
12 Bonnie Herzog and Daniel Bloomgarden, “Coca-Cola Enterprises”, Salomon Smith Barney, February 19,
2003, pp. 31–32; Bonnie Herzog and Daniel Bloomgarden., “Pepsi Bottling Group”, Salomon Smith Barney,
February 24, 2003, pp. 26–27.
13 Timothy Muris, David Scheffman, and Pablo Spiller, Strategy, Structure, and Antitrust in the Carbonated Soft
Drink Industry (Quorum Books, 1993), p. 63; Beverage Digest Fact Book 2010, p. 73.
14 Coca-Cola 2009 Annual Report, p. 7.
15 Coca-Cola Enterprises 2009 Annual Report (Atlanta: Coca-Cola Enterprises, 2010), p. 50.
16 Beverage Digest Fact Book 2010, p. 40.
17 Casewriter conversation with industry observer, October 2010. Total store sales include those from
supermarkets, mass merchandisers, and drug stores.
18 Nikhil Deogun and Richard Gibson, “Coke Beats Out Pepsi for Contracts with Burger King, Domino’s,”
The Wall Street Journal, April 15, 1999.
19 “History” section of entry for PepsiCo, Hoover’s Online, http://www.hoovers.com, accessed December
2005; Beverage Digest Fact Book 2005, p. 62.
20 Beverage Digest Fact Book 2010, p.60.
21 Ibid, p.59. Market shares do not include duel outlets, such as those where Coke’s pouring rights overlap
with Dr Pepper’s. If such outlets were included, Pepsi and DPS’ market share would be higher.
22 Ibid, p. 63.
23 Casewriter examination of ingredients lists for Coke Classic and Pepsi-Cola, November 2005.
20
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Endnotes
Cola Wars Continue: Coke and Pepsi in 2010
711-462
25 Beverage Digest Fact Book 2010, p. 69.
26 Ibid, p. 70.
27 Unless otherwise attributed, all historical information in this section comes from J.C. Louis and Harvey
Yazijian, The Cola Wars (Everest House, 1980); Mark Pendergrast, For God, Country, and Coca-Cola (Charles
Scribner’s, 1993); and David Greising, I’d Like the World to Buy a Coke (John Wiley & Sons, 1997).
28 Louis and Yazijian, The Cola Wars, p. 23.
29 David B. Yoffie, Judo Strategy (Harvard Business School Press, 2001), Chapter 1.
30 Pendergrast, p. 310.
31 Ibid, p. 323.
32 Timothy K. Smith and Laura Landro, “Coke’s Future: Profoundly Changed, Coca-Cola Co. Strives to Keep
on Bubbling,” The Wall Street Journal, April 24, 1986.
33 Muris, Scheffman, and Spiller, p. 73.
34 Greising, p. 88.
35 Ibid, p. 292.
36 Beverage Industry, January 1999, p. 17.
37 Beverage Digest Fact Book 2010, p. 73.
38 Ibid, p. 74.
39 Beverage Digest Fact Book 1999, p. 38.
40 Rosie Mestel, “Soft Drink, Soda, Pop: Whatever You Call Them, These Sugar Drinks Are Getting
Nutritional Heat,” The Evansville Courier, September 26, 2005, p. D1; Scott Leith, “Obesity Weighs Heavily on
Colas,” The Atlanta Journal-Constitution, February 6, 2005, p. C1; Raja Mishra, “In Battle of Bulge, Soda Firms
Defend Against Warning,” The Boston Globe, November 28, 2004, p. A1.
41 “Coke and Pepsi Are Vulnerable to Tax on Soda,” Forbes.com, September
http://blogs.forbes.com/investor/2010/09/10/coke-and-pepsi-are-vulnerable-to-tax-on-soda/,
September 13, 2010.
10, 2010,
accessed
42 Tom Graves and Esther Y. Kwon, “Industry Surveys: Foods & Nonalcoholic Beverages,” Standard &
Poor’s, June 10, 2010, p. 4.
43 Melanie Warner, “For Corn Syrup, the Sweet Talk Gets Harder,” The New York Times, May 1, 2010.
44 The Coca-Cola Company 10K filing for fiscal year ending December 31, 2009, p. 14.
45 Jeremiah McWilliams, “Coke Bets of Freestyle Growth,” The Atlanta Journal - Constitution, August 1, 2010,
via Factiva, accessed September 2010.
46 Valerie Bauerlein and Robb M. Stewart, “Coke Pours the Pressure on in World Cup of Marketing,” The
Wall Street Journal, June 29, 2010.
47 “A Growing World of Refreshment,” Coca-Cola Investor Relations Overview, 2010, http://www.thecoca-
colacompany.com/investors/pdfs/investor_relations_overview.pdf, accessed October 2010.
48 Beverage Digest Fact Book 2010, p. 48.
21
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24 Casewriter conversation with industry analyst, January 2006.
711-462
Cola Wars Continue: Coke and Pepsi in 2010
Beverage Digest Fact Book 2001, p. 11, Beverage Digest Fact Book 2005, p. 11, and Beverage Digest Fact Book
2010, p.11.
50 Marc Greenberg, “Beverage Industry, A Cup Half-full: Gulping the US Profit Pool,” Deutsche Bank, May
17, 2007, p. 22.
51 Beverage Digest Fact Book 2010, p. 102.
52 Ibid, p. 25.
53 Bob Keefe, “Coke’s Bottle Recipe Sweet: New Material Includes Sugarcane, Molasses,” The Atlanta Journal-
Constitution, May 14, 2009.
54 Beverage Digest Fact Book 2010, p. 110.
55 Ibid, p. 87.
56 Christopher Williams, “Coke’s Fortunes are Set to Pop,” Barron’s, August 17, 2009, via Factiva, accessed
September 2010.
57 Citigroup Global Markets Research, “PepsiCo”, October 17, 2010.
58 Sky Canaves, Geoffrey A. Fowler, and Betsy McKay, “Coke Bets $2.4 Billion on Chinese Juice Market,” The
Wall Street Journal Asia, September 4, 2008.
59 Caroline Wilbert and Shelley Emling, “Obesity Weighs on Coke,” Atlanta Journal-Constitution, October 27,
2005, p. A1.
60 Leslie Chang, Chad Terhune, and Betsy McKay, “As Global Growth Ebbs, Coke Makes Rural Push into
China and India,” The Asian Wall Street Journal, August 11, 2004, p. A1.
61 Beverage Digest Fact Book 2010, p. 46.
62 “The Coca-Cola Company and Coca-Cola Enterprise Inc. Announce Strategic Advancement of Their
Partnership in North America and Europe,” Thomson StreetEvents Final Transcript, February 25, 2010.
63 “CSDs Have Most—and Proliferating—SKU’s, but Number Is Small Relative to Volume,” Beverage Digest,
November 22, 2002, http://www.beverage-digest.com/editorial/021122.php, accessed December 2005;
casewriter communication with industry analyst, November 2005.
64 Beverage Digest Newsletter, September 24, 2010, p. 3.
65 Beverage Digest Fact Book 2010, p. 86.
66 Chad Terhune, “Advertising: Coke Bottler in Mexico Threatens to Cut Marketing,” The Wall Street Journal,
November 1, 2005.
67 Christopher Williams, “Coke’s Fortunes are Set to Pop,” Barron’s, August 17, 2009, via Factiva, accessed
September 2010.
68 PepsiCo, “Q4 2009 PepsiCo Earnings Conference Call” transcript, February 11, 2010, p. 4.
69 “Special Issue: PepsiCo Seeks to Buy Two Big Bottlers,” Beverage Digest, April 20, 2009, vol. 54, no. 9.
22
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49
9-798-062
PANKAJ GHEMAWAT
JAN W. RIVKIN
Creating Competitive Advantage
Some companies generate far greater profits than others. The pharmaceutical maker ScheringPlough produced an economic profit of more than $10 billion during the period 1984-2002. That is,
the accounting profit it generated exceeded its cost of equity capital by that amount. Over the same
period, U.S. Steel produced an economic loss of nearly $500 million; its cost of capital exceeded its
accounting profit by a wide margin. Such large differences in economic performance are
commonplace. Understanding their roots is crucial for strategists.
1
Differences in industry structure shed some light on such differences in performance. To a
certain extent, Schering-Plough has generated more economic profit than U.S. Steel because the
pharmaceutical industry is structurally more attractive than the steel industry. Rivalry in the
pharmaceutical market is muted by factors such as patent protection, product differentiation, and
expanding demand; in contrast, rivalry in the steel industry is fierce—fueled by excess capacity,
limited differences across products, and slow growth. Many pharmaceutical users hesitate to switch
among products or brands, while steel customers are usually willing to switch among producers to
get a better price. Many pharmaceuticals are made from commodities with little labor input, while
unions exercise such power in the steel industry that labor costs often account for a quarter of total
revenue. Such contrasts in industry-level competitive forces are one reason that the profit levels of
firms in different industries differ. Figure 1 shows, for each of many industries, the spread between
the industry’s return on equity and its cost of equity (the vertical axis) and the average equity in the
industry (the horizontal axis) for the period 1984-2002. Reflecting differences in industry-level
competitive forces, the pharmaceutical industry has been among the greatest generators of economic
profit, while the steel industry as a whole has produced losses. The typical pharmaceutical maker is
2
far more profitable than the typical steel producer.
Schering-Plough, however, is not a “typical pharmaceutical maker,” nor is U.S. Steel a “typical
steel producer.” As Figures 2a and 2b illustrate, industry averages can mask large differences in
economic profit within industries. Schering-Plough was far more effective at producing economic
profits than were many drug makers during the 1984-2002 period, while U.S. Steel performed far
worse than many other steel producers. Indeed, recent research indicates that intra-industry
differences in profitability like those shown in Figures 2a and 2b may be larger than differences
3
across industries such as those in Figure 1. Industry-level effects appear to account for 10-20% of the
variation in business profitability while stable within-industry effects account for 30-45%. (Most of
the remainder can be assigned to effects that fluctuate from year to year.)
________________________________________________________________________________________________________________
Professors Pankaj Ghemawat and Jan W. Rivkin prepared this note as the basis for class discussion. It is based in part on earlier notes by Pankaj
Ghemawat, Tarun Khanna, and Anita McGahan.
Copyright © 1998 President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800-545-7685,
write Harvard Business School Publishing, Boston, MA 02163, or go to http://www.hbsp.harvard.edu. No part of this publication may be
reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means—electronic, mechanical,
photocopying, recording, or otherwise—without the permission of Harvard Business School.
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REV: FEBRUARY 25, 2006
798-062
Creating Competitive Advantage
Avg. Spread
(1984-2002)
Toiletry & Cosmetic
40%
Tobacco
30%
Soft Drinks
Pharmaceutical
Med Supplies
20%
Computer Software
Publishing
Financial Services
Petro-Integergrated
Aerospace/
Defense
Bank
10%
Retail Store
Railroad
Computers & Peripherals
Auto Parts
Building Materials
Insurance Property & Casualty
Auto & Truck
For El/Ent.
For Telecom
0%
Tele Service
Semiconduct
Air Transport
Textile
(10%)
Steel
(20%)
0
200
400
600
800
1,000
1,200
Power
Paper & For.
1,400
Entertain
1,600
1,800
2,000
Avg. Equity ($B) (1984-2002)
Source: Compustat, Value Line, Marakon Associates analysis
Figure 2a
Economic Profits in the Pharmaceutical Industry, 1984-2002
Mylan Laboratories
Watson Pharmaceuticals Inc
Forest Laboratories -Cl A
Pharmaceutical Prod Dev Inc
Covance Inc
Albany Molecular Resh Inc
Avg. Spread
(1984-2002)
40%
King Pharmaceuticals Inc
Schering-Plough
Merck & Co
Novo-Nordisk A/S -ADR
Novartis AG - ADR
Barr Laboratories Inc
Lilly (Eli) & Co
Bristol Myers Squibb
Pfizer Inc
Idec Pharmaceuticals Corp
Perrigo Co
Ivax Corp
Andrx Corp
Wyeth
20%
0%
Medicis Pharmaceut Cp -Cl A
Genzyme Corp
Parexel International Corp
Aventis Sa -ADR
(20%)
(40%)
(60%)
(80%)
0
5
10
15
20
25
Icn Pharmaceuticals Inc
Quintiles Transnational Corp
Chiron Corp
Protein Design Labs Inc
Sicor Inc
Gilead Sciences Inc
Enzon Pharmaceuticals Inc
Abgenix Inc
Cephalon Inc
Neurocrine Biosciences Inc
Tularik Inc
Medimmune Inc
Medarex Inc
Celgene Corp
30
Avg. Equity ($B) (1984-2002)
Source: Compustat, Value Line, Marakon Associates analysis
2
Page 27 of 213
35
40
Nektar Therapeutics
45
50
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Economic Profits of U.S. Industry Groups, 1984-2002
Figure 1
Creating Competitive Advantage
Figure 2b
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Economic Profits in the Steel Industry, 1984-2002
Worthington Industries
Gibraltar Steel Corp
6%
Steel Technologies
4%
Commercial Metals
Nucor Corp
2%
0%
(2%)
Quanex Corp
(4%)
Carpenter Technology
Dofasco Inc
Cleveland-Cliffs Inc
(6%)
United States Steel Corp
(8%)
AK Steel Holding Corp
(10%)
Ampco-Pittsburgh Corp
(12%)
Ryerson Tull Inc
(14%)
0
1
2
3
4
5
6
7
8
Avg. Equity ($B) (1984-2002)
Source: Compustat, Value Line, Marakon Associates analysis
In light of this, strategists need a systematic way to understand and analyze within-industry
differences in performance. Toward that end, this note uses the notion of competitive advantage. A
firm is said to have a competitive advantage over its rivals if it has driven a wide wedge between the
willingness to pay it generates among buyers and the costs it incurs—indeed, a wider wedge than its
4
competitors have achieved. A firm with a competitive advantage is positioned to earn superior
profits within its industry. In examining the logic of how firms create competitive advantage, this
note emphasizes two themes. First, to create an advantage, a firm must configure itself to do
something unique and valuable. The firm must ensure that, were it to disappear, someone in its
network of suppliers, customers, and complementors would miss it and no one could replace it
5
perfectly. The first section of the note uses the concept of “added value” to make this point more
precisely. Second, competitive advantage usually comes from the full range of a firm’s activities—
from production to finance, from marketing to logistics—acting in harmony. The essence of creating
advantage is finding an integrated set of choices that distinguishes a firm from its rivals. The second
section of the note shows how managers can analyze the full range of activities to understand the
sources of competitive advantage.
As a preface to the main discussion, it is important to address a few possible misconceptions.
Creating vs. sustaining competitive advantage. The note separates the challenge of creating
competitive advantage at a point in time from the problem of sustaining advantage over time. In
reality, the two issues are married: the choices that establish a firm’s advantage also influence
whether the advantage can be sustained. For instance, in launching its personal financial software
“Quicken,” Intuit chose to offer customers outstanding post-sale assistance over the telephone.
Customers valued the help from trained operators, and customer service became a tool for creating
competitive advantage. Moreover, customer service helped Intuit sustain its advantage over rivals
such as Microsoft. Competitors found it hard to match Intuit’s service operations and its reputation
3
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Avg. Spread
(1984-2002)
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Creating Competitive Advantage
Despite the connections between creating and sustaining advantage, we find it important to
discuss the two processes separately. Each is so complicated that it would be unwieldy to deal with
both at once.
Links to industry analysis. Within-industry differences in performance are often larger than
differences across industries, but it would be wrong to conclude that industry analysis is
unimportant. Industry analysis is crucial to creating competitive advantage for several reasons.
First, companies that generate competitive advantages typically do so by devising strategies that
neutralize the unattractive features of their industries and exploit the attractive features.
Second, industry conditions appear to have a large influence on whether competitive advantages
7
are even possible. In some industries (e.g., computer leasing), conditions “strait-jacket” firms and
leave them little room to establish a superior wedge between willingness to pay and costs. In other
industries (e.g., prepackaged software), conditions permit the most effective firms to enjoy large
advantages over the least.
Finally, market leaders often face a tension between managing industry structure and pursuing an
advantage within that structure. When deciding whether to build a new aluminum smelter, for
instance, Alcoa must consider the impact of the new capacity on industry supply-demand conditions,
not just its effect on Alcoa’s competitive advantage. This is true not only because Alcoa is a large
player in the business, but also because Alcoa is closely tracked by its rivals.
Analysis and creativity. This note takes an analytical approach to competitive advantage. In
actuality, many of the greatest advantages come not from analysis, but from entrepreneurial insight
and trial-and-error. The cold, hard analysis described here is not intended to deny the importance of
insight and trial-and-error. Rather, it aims to guide entrepreneurial creativity and to set a battery of
tests for new business ideas.
The Logic of Value Creation and Distribution
The first and foremost test in this battery concerns “added value,” a concept developed by Adam
8
Brandenburger, Barry Nalebuff, and Harborne Stuart. To introduce the concept, we use the example
9
of the portal crane business of Harnischfeger Industries. We then link added value to competitive
advantage.
Harnischfeger, based in Milwaukee, Wisconsin, manufactured equipment for industrial
customers. Its material handling equipment division served a range of customers, including forest
products companies such as International Paper. In the late 1970s, Harnischfeger began to offer these
customers a new product: portal cranes. Portal cranes were designed to lift entire tree-length logs off
of railcars and trucks and to hoist them around woodyards. The cranes were a significant
improvement over the giant forklifts that they replaced.
In fact, it was possible to calculate the customer benefits reasonably precisely. Each crane
replaced a fleet of forklifts which cost roughly $1.0 million. A crane was also less expensive to
operate than a forklift fleet; it required less labor, fuel, and maintenance, for instance. Altogether
over its lifespan, each crane generated a net present value of $6.5 million of savings in operating
costs. It cost Harnischfeger only $2.5 million to produce and install each crane. Thus a large gap
4
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for excellent support. In addition, Intuit used information from its service operations to generate a
6
stream of ideas for improving its product.
798-062
existed between the customer benefits associated with a crane ($1.0 million + $6.5 million) and
Harnischfeger’s costs ($2.5 million). Despite this gap, Harnischfeger was making little profit on its
sales of portal cranes by the late 1980s. What happened?
Willingness to Pay and Supplier Opportunity Cost
A customer’s willingness to pay for a product or service is the maximum amount of money that a
customer would be willing to part with in order to obtain the product or service. In the
Harnischfeger example, a customer considering the purchase of a portal crane would be willing to
pay as much as $7.5 million for the crane. If it cost more than that, the customer would be better off
buying the forklifts for $1 million and paying the extra operating costs of $6.5 million.
The concept of supplier opportunity cost is precisely symmetrical to willingness to pay. It is the
smallest amount that a supplier will accept for the services and resources required to produce a good
or service. We call this an “opportunity cost” because it is dictated by the best opportunities that the
suppliers have to sell their services and resources elsewhere. In the example, the actual cost that
Harnischfeger incurred to deliver a portal crane was $2.5 million. We don’t know what the lowest
amount the suppliers would have accepted actually was, but we will speculate that it was not far
below $2.5 million, say $2.0 million.
Imagine that Harnischfeger is bargaining with International Paper, one of the largest paper
manufacturers, over the price of a portal crane. For now, suppose that Harnischfeger is the only
company that can provide a portal crane and International Paper is the sole customer. The price that
emerges from the bargaining may fall anywhere between $2.5 million, Harnischfeger’s cost, and $7.5
million, International Paper’s willingness to pay. (See Figure 3.) Our theory says nothing about
where the price will fall within this range. If Harnischfeger is a particularly tough bargainer, then the
price will tend toward $7.5 million. If International Paper is the shrewder negotiator, the price will
edge toward $2.5 million.
Figure 3: Division of Value
Supplier
opportunity
cost
Cost
Price
$2.0
mm
$2.5
mm
?
Supplier
share
Harnischfeger share
Willingness
to pay
$7.5
mm
International Paper share
Source: Brandenburger and Stuart, “Value-Based Business Strategy,” 1996
The total value created by a transaction is the difference between the customer’s willingness to pay
and the supplier’s opportunity cost. In the example, a sale of a crane to International Paper creates
value of $5.5 million: an item worth $7.5 million to the customer is created from supplied resources
that had a value of only $2.0 million in their next-best use. The value captured by Harnischfeger is
the difference between the negotiated price and $2.5 million. International Paper captures value
equal to $7.5 million minus the price. And suppliers capture $0.5 million (Figure 3).
5
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Creating Competitive Advantage
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Creating Competitive Advantage
A firm’s added value plays a large role in determining how much value it actually captures. The
added value of a firm is the maximal value created by all participants in a transaction minus the
maximal value that could be created without the firm. In essence, it is the value that would be lost to
the world if the firm disappeared. Consider the situation with Harnischfeger as the sole provider of
cranes and International Paper as the only customer. If Harnischfeger opts out of the transaction, the
entire $5.5 million of value goes un-created. Similarly, if International Paper refuses to participate,
$5.5 million of value is no longer generated. Both Harnischfeger and International Paper have an
added value of $5.5 million.
Now consider what happens in the late 1980s when Kranco, a management-buyout firm headed
by former Harnischfeger executives, enters the market for portal cranes. Assume that Kranco
produces an identical product, with costs of $2.5 million and supplier opportunity costs of $2.0
million, and it generates the very same willingness to pay of $7.5 million. The added value of
Harnischfeger is now $0. If it participates in a deal with International Paper, the total value created is
$5.5 million. If it opts out, Kranco can fill its place, and total value of $5.5 million is still generated.
Under a condition known as unrestricted bargaining, the amount of value a firm can claim cannot
exceed its added value. To see why this is so, assume for a moment that a lucky firm does strike a
deal that allows it to capture more than its added value. Then the value left over for the remaining
participants is less than the value that those others could generate by arranging a deal amongst
themselves. The remaining participants could break off and form a separate pact that improves their
collective lot. Any deal which grants a firm more than its added value is fragile because of such
separate pacts. Once Kranco enters, it is not surprising that Harnischfeger captures little value and is
barely profitable. After all, it has little or no added value. (See the top half of Figure 4.)
Figure 4: Added Value with Harnischfeger and Kranco Providing Cranes
Supplier opportunity cost of
Harnischfeger crane = $2.0 mm
Willingness to pay for
Harnischfeger crane = $7.5 mm
Harnischfeger
added value =
$0.0 mm
Total value created = $5.5 mm
Total value created = $5.5 mm
Supplier opportunity cost
of Kranco crane = 2.0 mm
Willingness to pay for
Kranco crane = 7.5 mm
Supplier opportunity cost of
Harnischfeger crane = $3.0 mm
Willingness to pay for
Harnischfeger crane = $9.0 mm
Total value created = $6.0 mm
Total value created = $5.5 mm
Supplier opportunity cost
of Kranco crane = 2.0 mm
Willingness to pay for
Kranco crane = 7.5 mm
6
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Harnischfeger
added value =
$0.5 mm
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Added Value
798-062
Suppose now that Harnischfeger discovers a way to add some new services to its core product.
(See the bottom half of Figure 4.) The services boost the willingness to pay of International Paper to
$9.0 million, but, because the services entail additional labor, they raise supplier opportunity costs to
$3.0 million. The total value created with Harnischfeger participating is now $9.0 million - $3.0
million = $6.0 million. The total value if Harnischfeger opts out and Kranco provides the crane is $7.5
million - $2.0 million = $5.5 million. The new service boosts Harnischfeger’s added value from $0 to
$0.5 million, essentially because it raises willingness to pay by more than it increases supplier
opportunity costs. By widening the gap between willingness to pay and supplier opportunity cost,
Harnischfeger increases the amount of value than it can potentially claim.
The Link to Competitive Advantage
The larger is a firm’s added value, the greater is its potential for profit. The logic laid out so far
suggests that a firm can boost its added value by widening the wedge it achieves between customer
willingness to pay and supplier opportunity cost beyond what rivals attain. We say that a firm with
a wider wedge has a competitive advantage in its industry. A firm with a competitive advantage has
added value and therefore the potential for profit. The notion of added value highlights the fact that
competitive advantage derives fundamentally from scarcity. A firm establishes added value by
making sure that it is unique in some valuable way—that the network of suppliers, customers, and
complementors within which it operates is more productive with it than without it and that it is not
readily replaced.
There are two basic ways a firm can establish an advantage. First, the firm can raise customers’
willingness to pay for its products without incurring a commensurate increase in supplier
opportunity cost. Second, the firm can devise a way to reduce supplier opportunity cost without
sacrificing commensurate willingness to pay. Either establishes the wider wedge that defines
competitive advantage.
Costs vs. supplier opportunity costs. So far, we have tried to treat buyers, with their willingness
to pay, and suppliers, with their opportunity costs, symmetrically. Just as willingness to pay captures
the most that buyers will pay for a product, opportunity cost is the least that suppliers will accept for
the resources used to make a product. The symmetry is useful: it reminds us that competitive
advantage can come from better management of supplier relations, not just from a focus on
downstream customers. Recent efforts to streamline supply chains reflect the importance of driving
down supplier opportunity costs.
In practice, however, managers often examine actual costs, not opportunity costs, because data on
actual costs are concrete and available. In the remainder of this note, we focus on the analysis of
actual costs. We assume, in essence, that supplier opportunity costs and actual costs track one
another closely. A firm’s quest for competitive advantage then becomes a search for ways to widen
the wedge between actual costs and willingness to pay.
Activity Analysis of Cost and Willingness to Pay
10
The Tension Between Cost and Willingness to Pay
Widening the wedge is difficult because, often, a firm must incur higher costs in order to deliver a
product or service for which customers are willing to pay more. Almost all customers would be
willing to pay more for a Toyota automobile than for a Hyundai, but the costs of manufacturing a
7
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Creating Competitive Advantage
Creating Competitive Advantage
Toyota are significantly higher than the costs of making a Hyundai. Toyota’s higher profit margins
derive from the fact that the difference in willingness to pay is greater than the incremental costs
associated with its product. As noted above, a firm can achieve a competitive advantage by devising
a way to (1) raise willingness to pay a great deal with only slight increases in costs or (2) reap large
cost savings with only slight decreases in customer willingness to pay. We call the first a
11
differentiation strategy and the second a low-cost strategy (Figure 5).
Figure 5: Types of Competitive Advantage
$
Industry
average
competitor
Successful
differentiated
competitor
Successful
low-cost
competitor
Competitor with
dual advantage
Willingness to pay
Supplier opportunity cost
(The term “differentiated” is often misused. When we say that a firm has differentiated itself, we
mean that it has boosted the willingness of customers to pay for its output—that it can command a
price premium. We do not mean simply that the company is different from its competitors. Hyundai
is certainly different from Toyota, but it is not differentiated with respect to Toyota. Similarly, a
common error is to say that a company has differentiated itself by charging a lower price than its
rivals. A firm’s choice of price does not usually affect how much customers are intrinsically willing
12
to pay for a good. )
The tension between cost and willingness to pay is not absolute: firms can discover ways to
produce superior products at lower cost. In the 1970s and 1980s, for instance, Japanese
manufacturers in a number of industries found that by reducing defect rates, they could make higherquality products at lower cost. More recently, Dell has developed a build-to-order model for
personal computers that reduces the costs of components, inventories, and obsolescence while also
boosting willingness to pay among knowledgeable computer buyers who value the speedy
customization that the model permits. Such examples of dual competitive advantage are eye-catching
13
and well worth understanding.
Strategy scholars debate, however, how common dual advantages are. Some have argued that
dual advantages are rare and are typically based on operational differences across firms that are
14
easily copied. Others contend that breaking the trade-offs between cost and willingness to pay—
replacing trade-offs with “trade-ons”—is a fundamental way to transform competition in an
8
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798-062
Creating Competitive Advantage
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15
!
Accenture is regarded as a leader in information-technology consulting because of its deep
experience, reinforced by its research and development, its Knowledge Xchange portal, its
stringent hiring and training practices, its close relationships with CEOs as well as CIOs of
global corporations, and its successful attempts to build its brand. Some of the activities that
Accenture undertakes to differentiate itself are clearly costly: R&D and training, for instance,
swallow up 5% of revenues, even though they have been cut in recent years. On the other
hand, Accenture often faces no competing bids when it pitches consulting work and is able to
keep its revenues per consultant high, especially by maintaining a high utilization rate
16
(reportedly 78% in 2003, versus roughly 65% for the industry as a whole). This more than
compensates for the extra costs it incurs: Accenture has historically earned returns
significantly higher than most other large IT services companies.
!
Southwest Airlines has configured itself to focus on budget customers particularly well. It
standardizes its fleet around fuel-efficient Boeing 737s, concentrates on short-haul point-topoint routes between midsize cities and secondary airports, offers very low ticket prices and
no-frills service (no assigned seats, food service, baggage transfer or connections with other
airlines), emphasizes quick turnaround times, and manages to keep its planes in the air onethird longer each day than the average airline. Its stripped-down offering may generate
slightly less willingness to pay than the offering of a full-service airline, but it incurs far lower
costs than a full-service rival. As a result, Southwest is the only U.S. airline to have been
consistently profitable during the last 30 years, has grown at an annual rate of 20–30% over
the last five years, and maintains the lowest debt levels among the major carriers.
!
Cirque du Soleil is an innovative firm that combines elements of circus and theater. In
designing its performances, Cirque excluded many of the high-cost components of traditional
circuses—animals, star performers, and three ring shows—and focused on what it considered
to be the three elements responsible for the lasting allure of the circus: the clowns, the tent,
and the acrobatic acts. By refining the clowns’ acts, glamorizing the tent, and incorporating
elements from the world of theater—themes and storylines, for example—Cirque de Soleil
17
created a new category of entertainment with which it is synonymous. In essence, the firm
stripped out certain costly elements of the traditional circus and added costs in other areas for
which a segment of customers is willing to pay a great deal. In 2003, more than 7 million
people paid a total of $650 million to see its live performances, and the value of this privately18
held firm was estimated at $1.2 billion.
Activity Analysis
How can one identify opportunities to raise willingness to pay by more than costs or to drive
down costs without sacrificing too much willingness to pay? Sheer entrepreneurial insight certainly
plays a large role in spotting such opportunities. A Michael Dell sees that customers are becoming
comfortable with computer technology, realizes that retail sales channels add more costs than
benefits for many customers, and acts on his insight to start a direct-to-the-customer computer
19
business. Or a Liz Claiborne perceives huge pent-up demand for a collection of medium- to high20
end work clothes for female professionals. Dumb luck also plays a role. Engineers searching for a
coating material for missiles in the 1950s discovered the lubricant WD-40, whose sales continued to
generate a return on equity between 40% and 50% four decades later.
9
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industry. Regardless, it is clear that there is a rich variety of ways to resolve the tension between
cost and willingness to pay favorably. Some examples illustrate the possibilities:
Creating Competitive Advantage
We believe, however, that smart luck beats dumb luck and analysis can hone insight. To analyze
competitive advantage, strategists typically break a firm down into discrete activities or processes
and then examine how each contributes to the firm’s relative cost position or comparative willingness
21
to pay. The activities undertaken to design, produce, sell, deliver, and service goods are what
ultimately incur costs and generate customer willingness to pay. Differences across firms in
activities—differences in what firms actually do day-to-day—produce disparities in cost and
willingness to pay and hence dictate competitive advantage. By analyzing a firm activity by activity,
managers can (1) understand why the firm does or does not have a competitive advantage, (2) spot
opportunities to increase a firm’s competitive advantage, and (3) foresee future shifts in competitive
advantage.
An analysis of activities usually proceeds in four steps. First, managers of a firm catalog the firm’s
activities. Second, the managers examine the costs associated with each activity, and they use
differences in activities to understand how and why their costs differ from those of competitors.
Third, they analyze how each activity generates customer willingness to pay, and they use differences
in activities to examine how and why customers are willing to pay more or less for the goods or
services of rivals. Finally, the managers consider changes in the firm’s activities. The objective is to
identify changes that will widen the wedge between costs and willingness to pay. In the following
subsections, we discuss these steps in order.
Step 1: Catalog Activities (The Value Chain)
In the remainder of this note, we employ an activity template, the value chain, that can guide
22
managers in breaking down the firm into activities. The value chain divides all activities into two
classes: primary activities that directly generate a good or service, and support activities that make
the primary activities possible. Primary activities are broken down further into inbound logistics,
operations, outbound logistics, marketing and sales, and after-sales service. Support activities
include procurement of inputs, development of technology and human resources, and general firm
infrastructure. Figure 6 shows the value chain of an Internet start-up that sells compact discs online
and ships them by mail to customers.
Once activities have been cataloged, they must be analyzed in terms of cost and willingness to pay
relative to the competition. To illustrate how this is done, we focus on a simple example: the snack cake
market in the western region of Canada.* Between 1990 and 1995, Betsy Baking grew its share of this
market from a meager 1% to nearly 20%. At the same time, Collins Kitchen, the maker of such longtime favorites as Dinklets and Angel Dogs, saw its dominant 45% share dwindle to 25%. An analysis
of relative costs and willingness to pay shows why Betsy Baking and Collins fared so differently.
Step 2: Use Activities to Analyze Relative Costs
Competitive cost analysis is the usual starting point for the strategic analysis of competitive
advantage. In pure commodity businesses such as wheat farming, customers refuse to pay a
premium for any company’s product. In such a setting, a low-cost position is the key to added value
and competitive advantage. But even in industries that are not pure commodities, differences in cost
often wield a large influence on differences in profitability.
* The authors thank Roger Martin of Monitor Company for this example. Identities of the companies and other items have
been altered substantially to protect proprietary information.
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Creating Competitive Advantage
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FIRM
INFRASTRUCTURE
HUMAN
RESOURCES
TECHNOLOGY
DEVELOPMENT
PROCUREMENT
Financing, legal support, accounting
Recruiting, training, incentive system, employee feedback
Inventory
system
Site software
Pick & pack
procedures
Site look &
feel
Customer
research
CDs
Computers
Telecom lines
Shipping
services
Media
Shipping
Inbound
shipment of
top titles
Server
operations
Picking and
shipment of
top titles from
warehouse
Pricing
Returned items
Promotions
Customer
feedback
Shipment of
other titles
from thirdparty
distributors
Product
information
and reviews
OUTBOUND
LOGISTICS
MARKETING
& SALES
Warehousing
INBOUND
LOGISTICS
Billing
Collections
OPERATIONS
Advertising
Return
procedures
Support
activities
Primary
activities
Affiliations
with other
websites
SERVICE
Cost analysis was one of the efforts that managers at Collins Kitchens undertook in the mid-1990s
as they struggled to understand why their financial performance was poor and their market share
plummeting. They cataloged the major elements of their value chain and calculated the costs
associated with each class of activities. As Figure 7 shows, although Collins sold the typical package
of snack cakes to retailers for 72¢, raw materials (ingredients and packaging material) accounted for
only 18¢ per unit. Operation of automated baking, filling, and packaging production lines, largely
depreciation, maintenance, and labor costs, amounted to 15¢. Outbound logistics—delivery of fresh
goods directly to convenience stores and supermarkets, and maintenance of shelf space—constituted
the largest portion of costs, 26¢. Marketing expenditures on advertising and promotions added
another 12¢. A mere penny remained as profits for Collins.
The managers then determined the set of cost drivers associated with each activity. Cost drivers
are the factors that make the cost of an activity rise or fall. For instance, the managers realized that
the cost of outbound logistics per snack cake fell rapidly as a firm increased its local market share;
total delivery costs depended largely on the number of stops that a truck driver had to make, and the
larger was a firm’s market share, the greater was the number of snack cakes a driver could deliver
per stop. Urban deliveries tended to be more expensive than suburban because city traffic slowed
down drivers. Outbound logistics costs also rose with product variety; a broad product line made it
difficult for drivers to restock shelves and remove out-of-date merchandise. Finally, the nature of the
product affected logistics costs: snack cakes with more preservatives could be delivered less
frequently. The managers developed numerical relationships between activity costs and drivers, for
outbound logistics activities and for the other activities in Figure 7.
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Figure 6: Value Chain for an Internet Start-up
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Creating Competitive Advantage
80
70
Cents per unit
60
Profit
Marketing: Promotions
50
Marketing: Advertising
40
Outbound logistics
Operations: Manufacturing
30
Operations: Packaging
Operations: Ingredients
20
10
0
Cost drivers are critical because they allow managers to estimate competitors’ cost positions. One
usually cannot observe a competitor’s costs directly, but one can often observe the drivers. One can
see, for instance, a competitor’s market share, the portion of its sales in urban areas, the breadth of its
product line, and the ingredients in its products. Using its own costs and the numerical relationships
to cost drivers, a management team can estimate a competitor’s cost position.
When Collins’ managers did this for Betsy Baking, they found the results sobering. Because Betsy
Baking used inexpensive raw material, purchased in bulk, and tapped national scale economies, its
operations costs totaled 21¢, in contrast to 33¢ for Collins. Betsy Baking packed its product with
preservatives so that deliveries could be made less frequently, kept its product line very simple, and
benefited from growing market share. Consequently, its logistics costs per unit were less than half of
Collins’. Also, Betsy Baking did not run promotions. Altogether, the managers estimated, a package
of Betsy Baking snack cakes cost only 34¢ to produce, deliver, and market. Comparisons with the
two other major competitors, Ontario Baking and Savory Pastries, were not so discouraging. Indeed,
Collins had a small cost advantage over each. (See Figure 8.)
23
This specific example illustrates a number of general points about relative cost analysis:
!
When reviewing a relative cost analysis, it is important to focus on differences in individual
activities, not just differences in total cost. Ontario Baking and Savory Pastries, for instance,
had similar total costs per unit. The two firms had different cost structures, however, and as
we will discuss below, these differences reflected distinct competitive positions.
!
Good cost analyses typically focus on a subset of all of a firm’s activities. The cost analysis in
Figure 8, for example, did not cover all the activities in the snack cake value chain. Effective
cost analyses usually break out in greatest detail and pay the most attention to cost categories
that (1) pick up on significant differences across competitors or strategic options, (2)
correspond to technically separable activities, or (3) are large enough to influence the overall
cost position significantly.
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Figure 7: Collins' Cost Components
Creating Competitive Advantage
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90
80
Profit
Cents per unit
70
Marketing: Promotions
60
Marketing: Advertising
50
Outbound logistics
40
Operations: Manufacturing
Operations: Packaging
30
Operations: Ingredients
20
10
0
Collins Kitchen
Betsy Baking
Ontario Baking
Savory Pastries
!
Activities that account for a thicker slice of costs deserve deeper treatment in terms of cost
drivers. For instance, the snack cake managers assigned several cost drivers to outbound
logistics and explored these drivers in depth. They spent little time considering the drivers of
advertising costs. The analysis of any cost category should focus on the drivers that have the
biggest impact on it.
!
A particular driver should be modeled only if it is likely to vary across the competitors or the
strategic options that will be considered. In the snack cake example, manufacturing location
influenced wages rates and therefore operations costs. All of the rivals manufactured their
snack cakes in western Canada, however, and manufacturing elsewhere was not an option
because shipping was costly and goods had to be delivered quickly. Consequently,
manufacturing location was not considered as a cost driver.
!
Finally, since the analysis of relative costs inevitably involves a large number of assumptions,
sensitivity analysis is crucial. Sensitivity analysis identifies the assumptions that really matter
and therefore need to be honed. It also tells the analyst how confident he or she can be in the
results. Under any reasonable variation of the assumptions, Betsy Baking had a substantial
cost advantage over Collins.
A number of references discuss cost drivers in greater detail and suggest specific ways to model
24
them numerically. The catalog of potential drivers is long. Many relate to the size of the firm:
economies of scale, economies of experience, economies of scope, capacity utilization, etc. Others
relate to differences in firm location, functional policies, timing (e.g., first-mover advantages),
institutional factors such as unionization, government regulations such as tariffs, and so forth.
Differences in the resources possessed by a firm may also drive differences in activity costs. A farm
with more productive soil, for instance, will incur lower fertilization costs.
A number of pitfalls commonly snare newcomers to cost analysis. Many companies, particularly
ones that produce large numbers of distinct products in a single facility, still have grossly inadequate
costing systems that must be cleaned up before they can be used as reference points for estimating
competitors’ costs. As courses on management accounting point out, conventional accounting
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Figure 8: Relative Cost Analysis
Creating Competitive Advantage
systems often overemphasize manufacturing costs and do a poor job of allocating overhead and other
indirect costs. As firms increasingly sell services and transact on the basis of knowledge, these
25
outdated systems make it harder and harder to analyze costs intelligently. Also problematic is a
tendency to compare costs as a percentage of sales rather than in absolute dollar terms. This
confounds cost and price differences. It is also common, but dangerous, to mix together recurring
costs and one-time investments. Some analysts confuse differences in firms’ costs with differences in
their product mixes. One can avoid this problem by comparing the cost positions of comparable
products; compare Ford’s four-cylinder, mid-sized family sedan to Toyota’s four-cylinder, mid-sized
family sedan, not some imaginary “average” Ford to some “average” Toyota. Finally, a focus on
costs should not crowd out consideration of customer willingness to pay—the topic of the next
section.
Step 3: Use Activities to Analyze Relative Willingness to Pay
The activities of a firm do not just generate costs. They also (one hopes) make customers willing
to pay for the firm’s product or service. Differences in activities account for differences in willingness
to pay and hence for competitive advantage and differences in profitability. In general, it appears
that differences in willingness to pay account for more of the variation in profitability observed
26
among competitors than do disparities in cost levels.
27
Virtually any activity in the value chain can affect customers’ willingness to pay for a product.
Most obviously, the product design and manufacturing activities that influence physical product
characteristics—quality, performance, features, aesthetics, durability—affect willingness to pay.
Consumers pay a premium for New Balance athletic shoes in part because the firm offers durable
shoes in hard-to-find sizes. In fact, by avoiding deals with superstar athletes and publicizing that its
shoes are “endorsed by no one,” New Balance actively emphasizes to consumers that they should
pay attention only to the physical characteristics of its shoes. More subtly, a firm can boost
willingness to pay through activities associated with sales or delivery—the ease of purchase, speed of
delivery, availability and terms of credit, convenience of the seller, quality of presale advice, etc. In
the 1990s, for example, the catalog florist Calyx and Corolla commanded a premium because it
28
delivered flowers faster and fresher than most competitors did. Activities associated with post-sale
service or complementary goods—customer training, consulting services, spare parts, product
warranties, repair service, compatible products—also affect willingness to pay. For example,
American consumers may hesitate to buy a Fiat automobile because they fear that spare parts and
service will be hard to obtain. Signals conveyed through advertising, packaging, branding efforts,
etc. also play a role in determining willingness to pay. Nike’s advertising and endorsement activities,
for instance, affect the premium it commands. Finally, support activities can have a surprisingly
large, if indirect, impact on willingness to pay. The hiring, training, and compensation practices of
Nordstrom create a helpful, outgoing sales staff that permits the department store to charge a
premium for its clothes.
Ideally, a company would like to have a “willingness to pay calculator”—something that tells it
how much customers would pay for any combination of activities. For a host of reasons, however,
such a calculator is virtually always beyond a firm’s grasp. Willingness to pay often depends heavily
on intangible factors and perceptions that are hard to measure. Moreover, activities can affect
willingness to pay in complicated (i.e., nonlinear and non-additive) ways. And when a business sells
to end-users through intermediaries rather than directly, willingness to pay depends on multiple
parties.
Lacking a “willingness to pay calculator,” most managers who analyze relative willingness to pay
do so in a simplified manner. A typical procedure is as follows. First, the managers think carefully
about who the real buyer is. This can be tricky. In the market for snack cakes, for instance, the
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immediate purchaser is a supermarket or convenience store executive. The ultimate consumer is
typically a hungry school child. But the pivotal decision maker is probably the parent who chooses
among the brands.
Second, the managers work to understand what the buyer or buyers want. The snack cake-buying
parent, for example, selects among brands on the basis of price, brand image, freshness, product
29
variety, and the number of servings per box. The supermarket or convenience store executive
chooses a snack cake on the basis of trade margins, turnover, reliability of delivery, consumer
recognition, merchandising support, and so forth. Marketing courses discuss ways to pinpoint such
30
customer needs and desires through formal or informal market research. It is important that such
research identifies not only what customers want, but also what they are willing to pay for. Moreover,
the research should reveal what the most important needs are and how customers make trade-offs
among different needs.
Third, managers assess how successful they and competitors are at fulfilling customer needs.
Figure 9 shows such an analysis for the snack cake market. The analysis helps us understand both
the statics and the dynamics of the marketplace. Betsy Baking stands out on an attribute that
customers value highly, low price, while Collins is superior on none of the customer needs. This
helps us understand the large shifts in market share. Ontario Baking enjoys the best brand image—a
position it has paid for via relatively heavy advertising and promotion. (See Figure 8.) Savory
Pastries delivers the freshest product, reflected in its high manufacturing and raw materials cost.
Further analysis, not carried out in the snack cake example, can assign dollar values to the customer
needs. For example, it can estimate how much a customer will pay for a product that is one day
fresher.
Figure 9: Relative Success in Satisfying Customer Needs
4
Rating
3
Collins Kitchen
Betsy Baking
Ontario Baking
2
Savory Pastries
1
0
Price (****)
Brand image
(****)
Freshness (***)
Variety (**)
Size (*)
Custome r ne ed (and importance ****)
Fourth and finally, the managers relate differences in success in meeting customer needs back to
activities. Savory Pastries’ high score on the freshness need, for instance, can be tied directly to
specific activities regarding procurement and selection of ingredients, manufacturing, and delivery.
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Creating Competitive Advantage
Creating Competitive Advantage
At this point, managers should have a refined idea of how activities translate, through customer
needs, into willingness to pay. They also understand how activities alter costs. Now they are
prepared to take the final step, the analysis of different strategic options. Before we move on to that
step, however, we should highlight some guidelines concerning the analysis of willingness to pay.
A major challenge in analyzing willingness to pay is narrowing the long list of customer needs
down to a manageable roster. In general, needs that have little effect on customer choice can be
ignored. Needs that are equally well satisfied by all current and contemplated products can usually
be neglected. If the group of competing products plays a small role in satisfying a need relative to
other products outside the group, the need can often be removed from the list.
So far, we have treated all customers as identical. In reality, of course, buyers differ in what they
want and how badly they want it. Some customers in a bookstore want novels while others look for
business books. (This type of disparity, in which different customers rank products differently, is
known as horizontal differentiation.) Among those customers who want J.K. Rowling’s new Harry
Potter novel, some are willing to pay for the hardback edition sooner while others will wait for the
less expensive soft-cover version. (Vertical differentiation arises when customers agree on which
product is better—the hardback edition, now—but they differ in how much they will pay for the
better product.) The analysis of willingness to pay is trickier, but more interesting, when customers
differ in their preferences. The usual response is segmentation: one first finds clumps of customers
who share preferences and then analyzes willingness to pay segment by segment. In our experience,
firms that identify segments pinpoint between two and twelve clusters of customers. The more
diverse are customer needs and the cheaper it is to customize the firm’s product or service, the more
segments a firm typically considers. Some observers have even argued that companies should move
31
beyond segmentation to embrace mass customization. In this approach, enabled by information and
production technologies, companies begin to tailor their products to individual customers. Thus,
Blinds to Go receives up to 20,000 custom orders for window blinds and shades per day, and it
promises to process each order within 48 hours. New approaches to customization have enabled it to
32
build up a business with more than $100 million in revenues and 20% net margins.
Finally, we want to emphasize the limits to analyzing willingness to pay. In some settings, it is
possible to quantify willingness to pay quite precisely. For example, when a firm provides an
industrial good that saves its customers a well-understood amount of money, it is relatively easy to
calculate willingness to pay. (Think of the Harnischfeger example.) Calculations are much more
difficult, however, when there is a large subjective component to buyer choice, when customer tastes
are evolving rapidly, and when the benefits the customer derives from the product are hard to
quantify. A wide range of market research techniques—surveys, hedonic pricing, attribute ratings,
conjoint analysis, etc.—are designed to overcome such problems. We remain leary, however,
especially when the market research asks people to assess their willingness to pay for new products
that they have never seen or for the satisfaction of needs that they themselves may not realize they
have. Fine market research “proved” that telephone answering machines would sell poorly, for
33
instance. In some settings, creative insight may have to replace analysis. In all settings, analysis
should serve to hone insight, not displace it.
Step 4: Explore Options and Make Choices
The final step in the analysis of cost and willingness to pay is to search for ways to widen the
wedge between the two. The management team has the machinery in place to understand how
changes in activities will affect competitive advantage. The goal now is to find favorable options.
The generation of options is ultimately a creative act, and it is difficult to lay down many guidelines
for it. We can, however, suggest a few patterns from past experience:
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!
It is often helpful to distill the essence of what drives each competitor. Betsy Baking, for
instance, saw that preservatives were a substitute for fast delivery. By adding preservatives to
its physical product, it could reduce its delivery costs substantially. This also reduced
customers’ willingness to pay, but the reduction was smaller than the corresponding cost
savings for many customers. Such a distillation process often suggests new ways to drive
wedges. Savory Pastries, for instance, was tapping a willingness to pay for freshness. The
Collins managers, however, felt that Savory was not exploiting this customer need fully; a
product even fresher than Savory’s might command a large premium, and this might be the
basis for a substantial competitive advantage.
!
When considering changes in activities, it is crucial to consider competitor reactions. In the
snack cake example, the Collins managers felt that Betsy Baking would readily launch a price
war against any competitor that tried to match its low-cost, low-price strategy. They were less
concerned about an aggressive response from Savory Pastries, whose managers were
distracted by an expansion into a different business.
!
In crafting alternatives, managers tend to fixate on physical product characteristics and think
too narrowly about benefits to buyers. Rarely do they consider the full range of ways in
which all of their activities can create a wedge between willingness to pay and costs. One way
to avoid a narrow focus is to draw out not only one’s own value chain, but also the value
34
chains of one’s customers and suppliers and the linkages between the chains. Such an
exercise can highlight ways to reduce buyers’ costs, improve buyers’ performance, reduce
suppliers’ costs, or improve suppliers’ performance. Some apparel manufacturers, for
instance, have found new ways to satisfy department store buyers, ways that have nothing to
do with the physical character of the clothes. By shipping clothes on the proper hangers and
in certain containers, the manufacturers can greatly reduce the labor and time required to get
clothes from the department store loading dock to the sales floor.
!
In rapidly changing markets, it is often valuable to seek options by paying special attention to
“bleeding edge” customers—exacting customers whose demands presage the needs of the
larger marketplace. Yahoo!, the Internet portal, releases test versions of new services to
sophisticated users in order to shake down software and sense the future needs of the wider
35
Similarly, underserved customer segments often point the way to creative
market.
alternatives. Circus Circus, the casino operator, built much of its remarkable success in the
early 1990s on the insight that Las Vegas offered little to the family-oriented segment of the
market. And the Southwest example reminds us that overserved customers can offer an
opportunity as well.
!
More generally, one of the most potent ways that a firm can alter its wedge between
willingness to pay and costs is by adjusting the scope of its operations—that is, changing the
range of customers it serves or products it offers within an industry. Broad scope in an
industry tends to be advantageous when there are significant economies of scale, scope, and
learning (including vertical bargaining power based on size), when customers’ needs are
relatively uniform across market segments, and when it is possible to charge different prices
in different segments. Of course, broader isn’t always better: there may be diseconomies
rather than economies of size, and attempts to serve heterogeneous customers may introduce
compromises into a firm’s value chain or blur its external or internal message by creating
36
cognitive conflicts in the minds of customers or employees. And even when broader is
better, there tend to be a variety of ways in which a firm can expand its reach, some of which
(such as licensing, franchises, or strategic alliances) fall short of an outright expansion of
scope.
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Creating Competitive Advantage
!
Creating Competitive Advantage
Here, we have laid out a process in which a management team develops a comprehensive
grasp of how its activities affect costs and willingness to pay, then considers options to widen
the wedge between the two. In practice, it is often efficient and effective to reverse this
process: to start with a set of options, articulate what each option implies for activities, then
analyze the impact of each alternative configuration of activities on the wedge between costs
and willingness to pay. By reverse-engineering the analyses they do from the options they
have, managers can focus on the analyses that truly matter. Of course, this alternative process
37
works best when managers start with a good grasp of the options available to them.
In general, a firm should scour its value chain for, and eliminate, activities that generate costs
without creating commensurate willingness to pay. It should also search for inexpensive ways to
generate additional willingness to pay, at least among a segment of customers.
The Whole Versus the Parts
The analysis we have described focuses on decomposing the firm into parts—discrete activities.
In the final step of exploring options, however, the management team must work vigilantly to build a
vision of the whole. After all, competitive advantage comes from an integrated set of choices about
activities. A firm whose choices are internally inconsistent is unlikely to succeed.
We have found a landscape metaphor helpful to describe the dilemma facing managers who are
38
searching for a favorable set of choices. In conceptual terms, the managers of a firm operate in a
high-dimensional space of decisions. Each point in this space represents a different set of choices, a
different configuration of activities. The elevation corresponding to each point is the added value
generated by that configuration. The goal of the senior management team is to guide its firm to a
high point on this landscape—a set of decisions that, together, generate a great deal of added value.
The search for high ground is made difficult by the fact that the different choices interact with one
another: production decisions affect marketing choices, distribution choices need to fit with
operations decisions, compensation choices influence a whole range of activities, and so forth. Each
interaction implies that a choice made on one dimension affects the cost and willingness-to-pay
impact of another choice. Graphically, the interactions make the surface of the landscape rugged
with lots of local peaks.
The ruggedness of the landscape has a couple of vital implications. First, it suggests that
incremental analysis and incremental change are unlikely to lead a firm to a new, fundamentally
higher position. Rather, a firm must usually consider changing many of its activities in unison in
order to attain a higher peak. To improve its long-run prospects, a firm may have to step down and
tread through a valley. (Consider the wrenching and far-reaching changes required to turn around
IBM during the mid-1990s.) Second, the ruggedness implies that there is often more than one
internally consistent way to do business within an industry. There is certainly only a limited number
of viable positions, but when the interactions among choices are rich, there is usually more than one
high peak. In the retail brokerage business, for instance, both Merrill Lynch and Edward Jones
succeed, but they do so in very different ways. Merrill Lynch operates large offices in major cities,
provides access to a full range of securities, advertises nationally, offers in-house investment vehicles,
and serves corporate clients. Edward Jones operates thousands of one-broker offices in rural and
suburban areas, handles only conservative securities, markets by means of door-to-door sales calls,
produces none of its own investment vehicles, and focuses almost exclusively on individual
39
investors. The two firms occupy quite different peaks on the landscape of the financial services
industry.
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The landscape metaphor reminds us that the creation of competitive advantage involves choice. In
occupying one peak, a firm foregoes an alternative position. It also highlights the role of competition:
it is often more valuable to inhabit one’s own, separate peak than to crowd onto a summit that is
already heavily populated. Finally, it emphasizes the importance of internal consistency. Peaks are
coherent bundles of mutually reinforcing choices.
Conclusion
This note has covered a lot of ground, but the main ideas are fairly simple:
!
A successful firm does not simply participate in an attractive industry. It also strives to
generate more economic profits than the typical firm in its industry.
!
The ability to generate and capture profits in an industry derives from added value. A firm
has added value when the network of customers, suppliers, and complementors in which it
operates is better off with the firm than without it; the firm offers something that is unique
and valuable in the marketplace.
!
A firm usually can’t claim any value unless it adds some value.
!
To have added value, a firm must drive a wedge between customer willingness to pay and
supplier opportunity cost—indeed a wider wedge than rivals achieve. A firm that attains a
wider wedge is said to have a competitive advantage.
!
To establish a competitive advantage, a firm has to do different things than its rivals on a dayto-day basis. These differences in activities, and their effects on relative cost and relative
willingness to pay, can be analyzed in detail.
!
A firm can use its analysis of activities to generate and assess options for creating competitive
advantage. In doing so, the management team must decompose the firm into parts, but also
craft a vision of an integrated whole.
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Creating Competitive Advantage
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Creating Competitive Advantage
1
M.E. Porter, Competitive Strategy, New York: Free Press, 1980, Chapter 1.
2
We are grateful to Uta Werner of Marakon Associates for making available the data for Figures 1 and 2.
3
R. Rumelt, “How Much Does Industry Matter?,” Strategic Management Journal (12), 1991, pp. 167-185. A.M.
McGahan and M.E. Porter, “How Much Does Industry Matter, Really?,” Strategic Management Journal (18), 1997,
summer special issue, pp. 15-30. A.M. McGahan, “The Influence of Competitive Position on Corporate
Performance,” Harvard Business School mimeo, 1997.
4
For further discussion of the definition of competitive advantage, see R. Rumelt, “What in the World is
Competitive Advantage,” UCLA Working Paper, 2003, and S. Postrel, “Competitive Advantage: A Synthesis,”
Southern Methodist University Working Paper, 2004.
5
A.M. Brandenburger and B.J. Nalebuff, Co-opetition, New York: Doubleday, 1996. A.M. Brandenburger and
H.W. Stuart, “Value-based Business Strategy,” Journal of Economics and Management Strategy (5), 1996, pp. 5-24.
6
J.L. Heskett, “Scott Cook and Intuit,” Harvard Business School Case 396-282, 1996.
7
J.W. Rivkin, “Reconcilable Differences: The Relationship Between Industry Conditions and Firm Effects,”
Harvard Business School Working Paper, 1997.
8
This section is based on the work of A.M. Brandenburger and H.W. Stuart, especially the article “Value-Based
Business Strategy,” Journal of Economics and Management Strategy (5), 1996, pp. 5-24. See also M.E. Porter,
Competitive Strategy, New York: Free Press, 1980, Chapter 2, and A.M. Brandenburger and B.J. Nalebuff, Coopetition, New York: Doubleday, 1996.
9
A.M. Brandenburger and H.W. Stuart, “Harnischfeger Industries: Portal Cranes,” Harvard Business School
Case 391-130, 1992.
10
This section draws heavily on ideas first developed in M.E. Porter, Competitive Advantage, New York: Free
Press, especially Chapters 2-4.
11
M.E. Porter, Competitive Strategy, New York: Free Press, 1980, Chapter 2.
12
Exceptions to this rule arise when the price of a good conveys information about it.
13
R. Hallowell, “Dual Competitive Advantage in Labor-Dependent Services: Evidence, Analysis, and
Implications,” in D.E. Bowen, T.A. Swartz, and S.W. Brown (eds.), Advances in Services Marketing and Management
(6), Greenwich: JAI Press Inc., 1997.
14
M.E. Porter, Competitive Strategy, New York: Free Press, 1980, Chapter 2, and M.E. Porter, “What Is Strategy?,”
Harvard Business Review (74: 6), 1996, pp. 61-78.
15
A.M. Brandenburger and B.J. Nalebuff, Co-opetition, New York: Doubleday, 1996, pp. 127-130.
16
Accenture Q4 2003 conference call.
17
W.C. Kim and R. Mauborgne, “Blue Ocean Strategy,” Harvard Business Review (82: 10), 2004, p. 76.
18
M. Miller, “The Acrobat,” Forbes, March 15, 2004, p. 100.
19
D. Narayandas and V.K. Rangan, “Dell Computer Corporation,” Harvard Business School Case 596-058, 1996.
20
N. Siggelkow, “Change in the Presence of Fit: The Rise, the Fall, and the Renaissance of Liz Claiborne,”
Academy of Management Journal (44), 2001, pp. 838-857.
21
M.E. Porter, Competitive Advantage, New York: Free Press, 1985, Chapters 2-4, and M.E. Porter, “What Is
Strategy?,” Harvard Business Review (74: 6), 1996, pp. 61-78.
22
M.E. Porter, Competitive Advantage, New York: Free Press, 1985, Chapter 2.
20
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Notes
Creating Competitive Advantage
798-062
See P. Ghemawat, Commitment: The Dynamic of Strategy, New York: Free Press, 1991, Chapter 4 for a more
extensive list of general guidelines.
24
See M.E. Porter, Competitive Advantage, New York: Free Press, 1985, Chapter 3 and D. Besanko, D. Dranove, and
M. Shanley, Economics of Strategy, New York: John Wiley, 1996, Chapter 13.
25
See H.T. Johnson and R.S. Kaplan, Relevance Lost: The Rise and Fall of Management Accounting, Boston: Harvard
Business School Press, 1987.
26
R.E. Caves and P. Ghemawat, “Identifying Mobility Barriers,” Strategic Management Journal (13), 1992, pp. 1-12.
Of course, this is a general pattern that may or may not hold up in a particular setting.
27
See M.E. Porter, Competitive Advantage, New York: Free Press, 1985, Chapter 4 and D. Besanko, D. Dranove, and
M. Shanley, Economics of Strategy, New York: John Wiley, 1996, Chapter 13.
28
W.J. Salmon and D. Wylie, “Calyx and Corolla,” Harvard Business School Case 592-035, 1991.
29
We present “low price” as an attribute that buyers seek. This should not be misunderstood as a statement that
price determines willingness to pay. Rather, price is included as an attribute in surveys of customer needs so
that one can calibrate the willingness of customers to pay a price premium for the other attributes in the survey
(such as freshness).
30
See, for instance, P. Kotler, Marketing Management: Analysis, Planning, Implementation, and Control, Englewood
Cliffs: Prentice Hall, 1994.
31
B.J. Pine, Mass Customization: The New Frontier in Business Competition, Boston: Harvard Business School Press,
1993.
32
L. Menor and K. Mark, “Blinds to Go: Invading the Sunshine State,” Richard Ivey School of Business Case no.
901D04, 2001.
33
O. Harari, “The Myths of Market Research,” Small Business Reports, July, 1994, p. 48 ff.
34
M.E. Porter, Competitive Advantage, New York: Free Press, 1985.
35
M. Iansiti and A. MacCormack, “Developing Products on Internet Time,” Harvard Business Review (75: 5), pp.
108-117.
36
M.E. Porter, “What Is Strategy?,” Harvard Business Review (74: 6), 1996, pp. 61-78.
37
J.W. Rivkin, “An Options-led Approach to Making Strategic Choices,” HBS Note 702-433, 2002.
38
D. Levinthal, “Adaptation on Rugged Landscapes,” Management Science (43), 1997, pp. 934-950 and J.W. Rivkin,
“Imitation of Complex Strategies,” Management Science (46), 2000, pp. 824-844. The landscape metaphor is
derived from evolutionary biology, especially S.A. Kauffman, The Origins of Order, Oxford: Oxford University
Press, 1993.
39
R. Teitelbaum, “The Wal-Mart of Wall Street,” Fortune, October 13, 1997, pp. 128-130.
21
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23
PUBLISHED ON
AUGUST 20, 2020
Walmart:
In Search of Renewed Growth
BY STEPHAN MEIER* AND FELIX OBERHOLZER-GEE†
Introduction
In early 2020, Walmarti Stores, Inc., the world’s largest retailer, faced several strategic challenges.
The company had just been ranked number one on the Fortune 500 list, with same-store sales in
the United States improving after many years of slow growth. However, international expansion
had yielded uneven results, and competition in online sales remained fierce. Wall Street’s support
for Walmart was mixed: Market Realist reported in early 2019 that the firm’s stock performance
was “minimal upside,” noting that “Target, Costco, and Walmart stock have risen 23.1 percent,
20 percent, and 5.3 percent, respectively for the year.”1 See Exhibit 1.
Finding new sources of growth would be no easy task. With more than 5,000 stores across the
United States, the company had achieved broad geographic coverage.2 Cutting costs to boost
financial performance seemed equally daunting. Walmart’s laser-like focus on its famous
“Everyday Low Prices” (EDLP) policy seemed to have wrung almost every conceivable expense
from the firm’s supply chain and operations. Competitive pressure from ultra-low-cost dollar
store chains had increased substantially. As a result, the company found itself looking outside its
traditional paths for growth opportunities.
One option was to make a strategic shift toward a more upscale shopping experience. Target had
already staked a claim to this positioning in discount retail, with its “Expect More, Pay Less”
message and exclusive deals with top designers. Could Walmart top Target? As CEO Doug
i
Wal-mart officially changed its name to Walmart in 2018.
Author affiliation
*James P. Gorman Professor of Business Strategy, Columbia
Business School
†
Andreas Andresen Professor of Business Administration, Harvard
Business School
Acknowledgments
Axel Ramm, MBA’16, provided valuable research and insights for
the updated version of this case.
Kate Permut, MBA’83, and Lori Qingyuan Yue, PhD’10, provided
research and writing support for earlier versions of the case.
Maris Moon’ 20 provided research and writing support for the
revised version of this case.
Copyright information
©2008–2020 by The Trustees of Columbia University in the City
of New York. This case includes changes made to the version
originally published on July 30, 2008.
This case is for teaching purposes only and does not represent an
endorsement or judgment of the material included.
This case cannot be used or reproduced without explicit permission
from Columbia CaseWorks. To obtain permission, please visit
www.gsb.columbia.edu/caseworks, or e-mail
ColumbiaCaseWorks@gsb.columbia.edu
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ID#080408
McMillon envisioned a new kind of Walmart, he carefully weighed the risks and benefits of such
a move.
In 1962, Sam Walton and his brother opened the first Wal-Mart Discount City store in Rogers,
Arkansas. Walton was already an experienced retail manager, having worked both at J. C. Penney
and as a franchise manager for the Ben Franklin chain. He had become intrigued by a growing
trend in retailing—discount stores. These new establishments combined the low-margin/lowprice strategy of supermarkets with the broader selection of merchandise often seen in
department stores. Discount stores featured minimal decor, bare-bones staffing, and few services,
rarely providing delivery or credit. By eliminating these costs and charging margins at least 10 to
15 percent lower than other retailers, discounters were able to offer customers a wide variety of
goods at sharply reduced prices. Top discounters such as Woolco, Korvettes, King’s, Caldor, Two
Guys, and Mammoth Mart were already prospering with this low-price, high-volume strategy.
In 1962, Kmart and Target were also launched as discount retailers.
Walton’s idea was to bring the discount store concept and the benefits of lower prices to a
neglected consumer demographic—shoppers in rural America. He opened his first stores in small
towns, in contrast to his competitors who were reluctant to do business in cities with populations
below 50,000. By operating in locations that larger competitors shunned, Walmart found itself
competing primarily against small, locally owned shops—just the type of businesses Walton
could challenge with his EDLP policy. The crux of EDLP was to sell goods at a lower price per
item at all times, not just during holidays or special sales periods, and to reap profits by selling a
larger volume of those goods. Walton described his strategy:
Here is the simple lesson we learned . . . say I bought an item for 80 cents. I found that
by pricing it at $1.00, I could sell three times more of it than by pricing it at $1.20. I
might make only half the profit per item, but because I was selling three times as
many, the overall profit was much greater. Simple enough. But this is really the
essence of “discounting”—you can lower your markup but earn more because of the
increased volume.3
To be successful, Walton paid close attention to costs, carefully monitored prices charged by each
store’s neighboring competitors, and invested heavily in operations and logistics.
CONTROLLING COST
Walmart’s concern with controlling costs reached into every aspect of the business. To reduce
expenses, Walton shunned bureaucracy and traditional marketing. Walmart housed its lean
senior team in a nondescript building in rural Bentonville, Arkansas. When managers visited
suppliers, they rented inexpensive cars, stayed in low-cost hotels—often sharing a room—and
walked instead of taking taxis. The operational rule was to hold trip expenses to less than 1% of
purchases. As Walmart grew, the company asked buyers to come to Bentonville, where
negotiations were conducted in sparse rooms. Meetings with suppliers were set up via collect
calls. In the early 1990s, in a move that was challenged and upheld in the courts, Walmart
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Humble Beginnings
bypassed manufacturer representation altogether to deal directly with suppliers, thus saving 3
%–4% on the cost of goods.
While Walmart’s competitors set prices at headquarters, Walton delegated pricing and
merchandising decisions to store managers who often visited neighboring stores to observe their
rivals’ prices. Decentralization allowed the company to react quickly to local market conditions.
For example, Walmart prices were approximately 1% lower when Walmart and Kmart were
located next to each other. However, if a store had no immediate local competition, prices were
about 6% higher than the company’s average.4
INFORMATION TECHNOLOGY
Starting in the early 1980s, the company made large investments in technology. Walmart was an
early adopter of electronic scanning, automated distribution systems, and satellite-supported
electronic data interchange (EDI) with its suppliers. By the 1990s, EDI supported inventory
management throughout the company. At the same time, Walmart launched Retail Link, a private
exchange that gave thousands of suppliers access to point-of-sale data and offered inventory
information for the previous two years on a store-by-store basis. This wealth of data allowed store
managers and suppliers to determine the specific traits of a Walmart location by indexing local
demand against more than 1,000 other stores and market characteristics.
Distribution
Walmart’s distribution strategy reflected the isolated locations of many of its stores (see Exhibit
2 for sociodemographic information about Walmart and competitors). Walton said, “We were in
the boondocks, so we didn’t have distributors falling over themselves to serve us . . . Our only
alternative was to build our own warehouse so we could buy in volume at attractive prices and
store the merchandise.”5
The company’s first warehouse served 18 stores. Suppliers delivered goods to the warehouse, but
Walton used his own trucks to ship the merchandise to his stores. Walmart expanded its retail
network by adding stores that were within one day’s drive of each associated distribution center
(see Exhibit 3). Professor Thomas J. Holmes, an economist at the University of Minnesota who
studied Walmart’s distribution strategy, explained:
Walmart started in a relatively central spot in the country and store openings radiated
from the inside out. . . Walmart always placed new stores close to where it already
had store density . . . When stores are packed close together, it is easier to set up a
distribution network that keeps stores close to a distribution network . . . And when
stores are close to a distribution center, Walmart can save on trucking costs.6
Walton’s trucks were usually able to reach a store in time for shelves to be restocked within one
day, a critical advantage over the weeklong delivery time historically experienced by Walmart’s
competitors. Over 80% of sales went through the company’s own distribution centers. Walmart
introduced cross docking—moving merchandise items from one truck to another without ever
storing them in a warehouse. Because the company owned its own fleet of trucks, it controlled all
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PRICING PRACTICES
Creating a Culture
Walton died in 1992, but the core company values he created live on. He had articulated them
with three phrases—"respect for the individual, service to our customers, and striving for
excellence.” These values were reflected in numerous company policies:
COST
Throughout its history, cost concerns remained front and center at Walmart. Walton’s own
behavior exemplified this in many ways: when he traveled between stores (first in his old pickup
truck and then in the plane he flew himself, thus saving the cost of hiring a pilot); when he
designed his stores (which had cement floors and industrial shelving); when he eschewed fancy
corporate trappings (keeping a cramped, spartan office at headquarters); when he banned gifts
from suppliers (believing those costs might be passed on to Walmart); and when he was reluctant
to add overhead (Walmart did not have a PR department until the 1990s). As Walmart grew,
Walton’s midwestern values, emphasizing frugality, independence, and propriety, permeated
the company.
CUSTOMER FOCUS
Walton said:
There is only one boss: the customer. And he can fire everybody in the company from
the chairman on down, simply by spending his money somewhere else. Whenever I
come within 10 feet of a customer, I look him in the eye, greet him, and ask if I can
help him.8
The yellow smiley-face logo became the corporate symbol. At the entrance of every store a greeter
said, “Welcome to Walmart” as shoppers arrived. Suppliers were called partners, and employees
were called associates, implying that both had a different, closer relationship to management than
was common at other companies. To build a bond between management and associates, everyone
was asked to give a Walmart cheer at the start of meetings (see Exhibit 5 for a photo of Walton
doing the “squiggly”).9 Senior executives were expected to avoid ostentatious displays of power
or wealth.
AGILITY
Walmart’s culture was fast-paced, allowing it to react to market opportunities swiftly. Walton
started his work day at 4:30 a.m., and his management team arrived by 6:30 a.m. At the
mandatory company-wide 7 a.m. Saturday meeting, executives shared (live via satellite to all
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parts of the delivery and schedule process. Walmart had even taken over the transportation of
some of its suppliers’ merchandise—which, due to the size of Walmart’s trucking fleet, it could
do more efficiently than the suppliers themselves.7 As a result, the company was able to
drastically reduce the number of items that experienced stockouts or overstocks. At the same
time, a typical store allocated just 10% of its footprint to inventory storage, versus the 25%
historical retail-industry average. The continued expansion of Walmart’s network made it more
likely that people would shop at its stores, since many customers lived within a short walking
distance of several Walmart locations (see Exhibit 4).
COMPETITION
Walmart’s culture was characterized by a fierce sense of competition and a keen focus on business
improvement. After managers visited the stores of local rivals, they had to come up with ways to
undercut their prices. Every associate was asked to make suggestions about ways to improve
sales for his or her area. Buyers aggressively negotiated the best prices from their suppliers and
then went back each year to demand another 5% savings. The company was not shy about asking
suppliers to modify their products or packaging. Despite such pressures, many manufacturers
continued to view Walmart as the best retailer to do business with. Walmart had taken the top
spot in Kantar Retail’s annual ranking of about 350 retailers every year since the first survey was
published in 1997. Out of nine categories in the 2019 survey,11 Walmart scored first in seven, with
key competitor Kroger topping the remaining two.12
New Store Formats
To grow its business, Walmart experimented with a variety of new store formats (see Exhibit 6).
SAM’S CLUBS
Modeled after San Diego’s Price Club, Walmart’s warehouse club offered a limited selection of
merchandise (3,500 SKUs, compared to 70,000 at a regular store) at near-wholesale prices
exclusively for Sam’s Club members. The company delineated the differences between these
ventures and Walmart stores clearly. Sam’s Clubs’ inventory was purchased separately from
Walmart’s, seasonal merchandise played a much bigger role, and inventory turnover was much
faster. As was typical for stores of this format, Sam’s Clubs sold merchandise in industrial
quantities. Although the division’s gross margin was 13%—significantly lower than Walmart
stores’ average of 23%—each Sam’s Club had sales-per-square-foot averaging $401, versus $150
at a Walmart.13
SUPERCENTERS
In the late 1980s, Walmart adapted the European hypermarket store format, pioneered by the
French retailer Carrefour, to create supercenters. Supercenters added a grocery market to an
existing Walmart store. Despite the thin margins in the grocery business—3%–4% was considered
typical, compared to 20% in the general merchandise segment—supercenters came to fuel
Walmart’s growth and profitability (see Exhibit 7). The company expanded into supercenters at
a blistering pace; by 1999 it had opened 683. By the mid-2000s, this figure had grown to 1,980. In
2020, groceries accounted for 56% of the company’s annual revenues.14
NEIGHBORHOOD MARKETS
As Walmart’s grocery business grew, the company seized on closely related opportunities, as
reported in the company’s 1999 Annual Report:
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store locations) the week’s priorities, including up-to-the-minute sales trends, new products, and
competitive developments. Saturday meetings were “equal parts talk show, financial update,
merchandising workshop, town-hall forum, talent revue, gripe session and pep rally.”10 Actions
called for on Saturday morning were implemented by the end of that day.
Neighborhood Markets signaled Walmart’s entry into the small-scale grocery business, and by
2015, growth in that format had intensified. A Neighborhood Market store was one-quarter the
size of a supercenter and carried one-fifth the number of items available there. The smaller size
also gave Walmart a useful format for trying out new merchandise and service concepts. For
example, the company first tested pharmacies in Neighborhood Markets and found them to be
an attractive new revenue stream. Walmart also experimented with private-label grocery and
household product brands in its Neighborhood Markets. While the number of Neighborhood
Markets had increased dramatically, in 2015 there were still none in New York, New Jersey,
Pennsylvania, Massachusetts, Ohio, Michigan, and many other states.
International Expansion
In the early 1990s, Walmart’s executives turned to global markets for growth opportunities. The
company’s initial move outside the United States was to the south, where it entered into a joint
venture with Cifra, Mexico’s largest retailer. Walmart purchased Cifra outright in 1998. In similar
moves, Walmart acquired 122 Canadian Woolco discount stores in 1994, and 21 hypermarkets in
Germany in 1998. One year later, Walmart completed the purchase of ASDA, a 232-store
supermarket chain in the United Kingdom with $14 billion in sales. In 1996, Walmart entered
China. By 2020, Walmart International operated in 26 countries, producing 28% of the company’s
revenue in 6,146 locations.16
While international sales grew quickly, Walmart often faced savvy competitors who matched the
company’s management skills and sophisticated consumers who were not impressed by its
midwestern frugality. The company was forced to exit Germany and South Korea in 2006, ceding
these markets to better-positioned rivals.17 Competition was especially strong in Germany, where
labor laws were very different than in the United States, and zoning regulations were extremely
strict and unfavorable to megastores.18
Mexico was an encouraging growth story, and Walmart’s sales there were by far the largest of
any country outside the United States; however, the Mexican market had slowed in recent years.
In June 2012, Walmart’s senior executives in Mexico were charged by the US Justice Department
for allegedly bribing local officials to sidestep zoning laws in order to fast-track new store permits.
In 2019 after years of investigation, Walmart agreed to pay $282 million to the SEC for allowing
a third-party to bribe foreign officials in Mexico, Brazil, China, and India.19
In view of these setbacks, Walmart started to take a more measured approach to international
expansion. For example, the company scaled back its ambitions in China, setting more modest
growth targets.20
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Supercenters effectively serve a large trade area, but we think there may be some
business that we are not getting purely because they may not be as close to the
customer or convenient for small shopping trips. That’s where we think there may be
an opportunity for the small grocery/drug store format where we are testing the
Neighborhood Market.15
In 2013, Doug McMillon became Walmart’s new CEO, the youngest CEO since Walton first took
the helm and only the fourth since Walton’s death in 1992. McMillon had started out in a Walmart
distribution center as a summer intern and had spent almost his entire career at the company. A
tough-minded buyer for many years, McMillon assumed responsibility for Walmart’s
international business in 2009. When McMillon was appointed CEO, he led the largest retailer in
the world—an international behemoth with 2.2 million associates (1.4 million employees in the
United States alone) and $482 billion in annual sales (see Exhibits 8A and 8B).21 Walmart revenues
surpassed those of its top five competitors combined.22 As McMillon soon learned, the company’s
scale invited scrutiny, posing management challenges in two distinct areas: labor relations and
community impact.
LABOR RELATIONS
Walmart had a long history of staunch opposition to labor unions. Rather than allowing its
workforce to organize, the company preferred to restructure its operations to eliminate positions
that could potentially be unionized. Although Walton had emphasized maintaining good
relations between employees and management, the company’s reputation as an employer grew
increasingly negative. Many saw Walmart’s culture as bullying and mean-spirited and believed
the firm exploited its market power.23 Critics alleged that Walmart’s wage policies kept
employees below the poverty line. According to these estimates, a typical sales clerk earned $8.50
an hour, or about $14,000 a year, which was $1,000 below the poverty line for a family of three in
2003 (see Exhibit 9 for information on labor costs).24 Low wages, these critics argued, also
prevented Walmart employees from participating in the company’s health plan.25
Gender discrimination was another matter of contention. In a 2001 lawsuit, six Walmart
employees claimed that women earned 5 %–15% less than men in similar positions.26 Women also
seemed less likely to be promoted. While two-thirds of Walmart’s hourly employees were
women, only one-third of salaried managers and 14% of the company’s top managers were
female. The company’s competitors had about 20% more women in managerial positions.
Walmart challenged the plaintiffs’ statistical studies, arguing that female associates were less
likely to apply for management positions.27 Reviewing the evidence, a federal judge certified the
class in June 2004 and Walmart’s stock fell by 1.6 percent on the day of the announcement.28 The
Supreme Court ultimately sided with Walmart. But the suit—and similar allegations in
subsequent years—indicated how costly the antagonistic labor relations had become. Poor labor
relations also impacted operating costs; the turnover rate among Walmart associates was close to
50% each year, historically more than double that experienced at Costco and other retailers.29
COMMUNITY IMPACTS
As the retail industry in the United States grew more concentrated (the average US county had
3.86 small retail stores in 1988, but this number fell by more than 10% in the following decade),
Walmart’s critics linked the rise of the discount retailer to deserted city centers and main streets.
One independent academic study attributed at least 50% of the decline in the number of small
stores to the rise of Walmart.30 When Walmart opened a new store, it created 100 new jobs, but as
small rivals unable to compete with the discounter were forced to shut their businesses, 70% of
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Continuing Challenges
Strained community relations impeded not only store growth; when Walmart applied for a
banking license so it could take deposits and make loans, there was massive public outcry. There
were “thousands of public comments and a letter from nearly 100 lawmakers” against approving
Walmart’s application.32 In 2007, the firm had to withdraw its bid. As the cost of sour community
relations became more visible, Walmart began to soften its stance. Former CEO Lee Scott
explained the evolution:
No question, it has been a hard transition for us going from being the darling to being
under attack. At first, we threw the sandbags up and got the machine guns out and
believed anybody who criticized us was our enemy. But I think we’re taking down
those sandbags one at a time.33
The company’s attempts to put on a friendlier face seemed to have paid off. Rather than trying to
embarrass the retailer, unions started to work with the company on proposals for improved
healthcare, for instance. David Nassar, executive director of Walmart Watch, a largely unionfinanced group that sought to shame the company with stinging newspaper advertisements and
public pronouncements, noted “It is fair to say we have been less in-your-face.”34 Reflecting the
better relations, the company shut down the campaign-style war room created to battle the unions
and disbanded “Working Families for Walmart,” a company-supported advocacy group.
Seeking Fresh Opportunities for Growth
Walmart’s expansion began to falter in the mid-2000s, and its stock price flattened. At the
company’s 2015 shareholders meeting, McMillon acknowledged that same-store sales had been
negative in some quarters.35 The rate of increase in comparable store sales had slowed to virtually
zero in 2014 and 2015 and had only grown 2.6% overall since 2009 (see Exhibit 10). Later in the
decade, Walmart was able to increase its comparable store sales to 4.0 percent and 2.7 percent in
2019 and 2020, respectively.36 By comparison, Walmart’s key competitor, Costco, posted gains of
approximately 5% annually from 2015 to 2019.37
McMillon and his team faced a number of challenges as they sought further growth. One issue
was sales cannibalization (see Exhibit 12). By 2006, 60% of the US population lived within five
miles of a Walmart, and 96% lived within 20 miles of one. There were still some potential areas
for expansion, such as California and New York, but the company acknowledged that “additional
stores may take sales away from existing units.”38 McMillon estimated that comparable store sales
in fiscal years 2014 and 2015 were negatively impacted by the opening of new stores by
approximately 1% each year (see Exhibit 13).
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the initial increase in local jobs was eventually lost.31 Everyday low prices, some argued, came at
a significant social cost. As a result, the company found it increasingly difficult to develop new
sites. Supported by unions and grassroots groups, towns used zoning laws and referenda to
stymie the company’s expansion plans. When citizens kept Walmart from opening stores in
Inglewood, California, and Littleton, Colorado, the company’s defeat was widely publicized,
further encouraging Walmart’s detractors.
Third, online sales were another headache. With a market share of 1.6% of US online sales,
Walmart was lagging behind Amazon (12.1%), the largest e-retailer in the world.43 Amazon didn’t
have brick-and-mortar stores and optimized its distribution to the particular needs of e-tailing.
In contrast, Neil Ashe, CEO of Global eCommerce for Walmart, admitted at the company’s 2015
shareholder meeting “we’re rebuilding the business from scratch.”44 Walmart was investing
heavily in online sales by improving its platform and opening new e-commerce distribution
centers. To compete with Amazon’s Prime, a popular service that offered customers free shipping
and entertainment for an annual membership fee of $99, Walmart introduced unlimited free
shipping for a $50 annual fee.45
In 2016, Walmart acquired Jet.com for $3.3 billion in order to compete more effectively with other
online retailers.46 Jet was an e-commerce startup that offered a broad selection of merchandise. It
operated on a unique pricing scheme that found the true marginal cost of getting the product to
the customer. Prices dropped when the customer purchased multiple items from the same
distribution center, when the customer purchased multiple units of the same item, and when the
customer waived their right to return the item. Despite continued efforts, however, Jet was never
profitable and Walmart finally closed it down in 2020.47
Jet’s demise was gradual. Walmart took several intermediate steps before closing it down.
Walmart shifted much of its budget from Jet to Walmart.com starting in 2018. Jet’s team was
transferred to Walmart.com, including Jet cofounder Marc Lore who became the CEO of
Walmart.com. Marc Lore introduced free two-day shipping for orders over $35 without a
membership fee, a move that was a direct threat to Amazon Prime. Walmart’s physical stores
were a key advantage against Amazon, and it utilized the power of its store base to introduce
two-hour express delivery. From 2016 to 2019, Walmart.com sales tripled and the company
became the second biggest player in e-commerce but still lagged far behind Amazon (see Exhibit
14).
Fourth, customer preferences appeared to have evolved in ways that hurt Walmart. Shoppers
seemed to have become increasingly sensitive to the appearance, cleanliness, and convenience of
Page 9 | Walmart: In Search of Renewed Growth
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Grocery margins were a second area of concern. The company remained the price leader in the
food business, but supermarkets such as Kroger and Publix were beginning to close the gap. The
innovations that Walmart had created in merchandising, logistics, and transportation had been
well studied by its competitors and were being duplicated.39 Even more importantly, dollar stores
and “deep discount” grocers created enormous price pressure; during the Great Recession of
2009, even wealthier customers patronized such venues. Even though they were no-frills stores,
people enjoyed shopping at them, especially for fill-in trips, because they were more centrally
located and smaller than supercenters.40 In 2014, Dollar Tree announced it was taking over Family
Dollar to create a chain with more than 13,000 stores and $18 billion in annual sales; competitor
Dollar General had around 12,000 stores.41 Germany’s Aldi and Lidl stood out among the
discount grocers—both companies offered mainly private-label products, a far smaller number
of SKUs, and a reduced store format of about 5,000 square feet filled with cut boxes and
rudimentary shelf displays. As a result, Aldi’s and Lidl’s prices compared favorably to Walmart’s.
In some studies, consumers saved more than 20% by shopping at Aldi.42
Upscaling the Walmart Experience
Walmart’s competitors had long emphasized their superior products and a more pleasant
shopping experience to compete with the company’s low-price value proposition. Former Target
President Bob Ulrich said, “If Walmart was striving to be the king of logistics with enough muscle
to force vendors to deliver on price, Target could deliver on a great store experience and a product
that was exciting and unique.”49
Ulrich made innovation, design, and quality the hallmarks of Target’s offerings. He set up a
trend-tracking department, founded a user-experience research center, and aggressively pursued
design leaders to create unique products for Target stores. He launched fashion trendsetter Isaac
Mizrahi’s line of value-priced women’s clothing. Target’s eye-catching TV and print ads
suggested that shoppers could find joy in buying a broom or a toothbrush. Target’s motto,
“Expect More, Pay Less,” embodied its offerings—upscale products including Michael Graves’s
line of housewares, Todd Oldham’s home decor and furniture, and Philippe Starck’s kitchenware
at discount prices. This positioning appeared to be a success; for a similar mix of merchandise,
Target’s prices exceeded those of Walmart by about 10%, but Target’s same-store sales still grew
more quickly.50
Lured by the attractive margins of products with a stylish design―fashion clothing, for instance,
had a 31 percent profit margin, compared to 20% for general merchandise and 4% for
food51―Walmart introduced branded clothing at higher price points beginning in 2000. To
support these efforts, the company installed simulated wood floors and more dressing rooms in
its stores, moved its office from Bentonville to a 40,000-square-foot space in New York City’s
Fashion District, and added more than 300 fashion merchandisers to the company’s payroll.
Walmart inked a series of deals to bring brand-name designer goods to its shoppers: surfer brand
OP (Ocean Pacific) signed on to develop a line of casual clothing, footwear, and accessories; junior
jeans brand l.e.i. agreed to partner with Walmart; and designer Norma Kamali was tapped to
create a new line of women’s wear.52 These forays into the world of fashion had limited success,
however, and the executive in charge resigned in 2010 due to “slow growth in sales.”53 One
analyst commented: “Without imagery, apparel just becomes a commodity business. Without the
nuances of making a brand have an essence, as opposed to just a product, there is no additional
sale.”54
Upscaling 2.0
Under McMillon’s leadership, Walmart renewed its efforts to reposition the company. An
important goal was to improve customers’ in-store experience. To increase the engagement of its
associates, McMillon raised the hourly wage of 500,000 employees to $9 in early 2015, and to $12
in early 2020.55 The company also adjusted the pay bands for many full- and part-time workers,
Walmart: In Search of Renewed Growth | Page 10
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the store environment. The allure of EDLP did not always overcome the minimal customer
service, disheveled aisles, and aging physical spaces that could make a trip to Walmart
exhausting and depressing. In the 2019 American Consumer Satisfaction Index, Walmart scored
at the bottom, far behind competitors like Target, Sears, and Costco.48
To strengthen its grocery business, Walmart broadened its relationship with Wild Oats, a wellknown label for organic products. In an aggressive move, the company promised to sell organic
products at the same price as conventionally produced items. Competitors typically charged a
25% premium. “We’re removing the premium associated with organic groceries,” said Jack L.
Sinclair, executive vice president of Walmart’s US grocery division.58 The company also worked
on getting produce to its stores more quickly, and hoped to teach associates to cull fruit and
vegetables more consistently to leave only high-quality produce on the floor. As Barclays analyst
Meredith Adler remarked, these efforts were unlikely to produce quick results. “Since produce is
a seasonal business, it can take a year to train a produce clerk on exactly how to handle all the
different kinds of fruits and vegetables.”
When Walmart announced its first quarter results for 2015, its share price fell by more than 4%.
By early June, Walmart’s valuation had declined by more than 10%. Adler noted:
Perhaps investors were hoping that the many initiatives . . . would have benefited
results this quarter. We don’t think that view was realistic, since many initiatives are
still being rolled out, and in most cases, the only communication to customers about
the changes is coming via word of mouth.
Others were more skeptical. Patricia Edwards, retail fund manager at Wentworth, Hauser and
Violich, pointed out: “The challenge that Walmart faces is value. An upper-end consumer defines
value differently than a moderate-income shopper. If it was just price, they would drink the office
coffee instead of going to Starbucks.”59
Was moving upscale the right strategy for McMillon to pursue?
Page 11 | Walmart: In Search of Renewed Growth
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raising compensation for those making more than the starting wage. It added staff to shorten
check-out lines and hired almost 8,000 department managers. McMillon introduced this new
management tier hoping to improve the availability and presentation of products. In early 2015,
in-stock positions were close to 95%.56 The company also developed new training programs. The
estimated cost of all these initiatives was about $1 billion.57
For use only in the course RSM 392 - Strategic Management at University of Toronto - Rotman School of Management from 9/3/2024 to 12/31/2024.
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Exhibits
Exhibit 1
Ten-Year Trend in Stock Prices, December 2009 to July 2020
Source: Yahoo Finance.
Walmart: In Search of Renewed Growth | Page 12
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Page 59 of 213
1,362
Standard
Deviation
$3,926,236
3795.6
634.61
0.20
$7,578.02
0.20
$85,461
0.42
0.38
0.38
0.46
0.47
0.39
567.09
121.57
Standard
Deviation
$4,301,172
4200.67
717.17
0.20
$7,475.11
0.13
$184,103
0.21
0.20
0.33
0.45
0.47
0.44
428.08
95.08
1,443
Mean
$3,523,082
4922.78
700.23
2.62
$45,519.59
0.86
$670,149
0.95
0.04
0.12
0.28
0.34
0.26
913.92
117.83
Target
Standard
Deviation
$2,993,719
3719.22
495.78
0.19
$8,038.29
0.23
$346,157
0.47
0.39
0.32
0.43
0.50
0.36
368.72
52.57
3,345
Mean
$1,671,212
3417.85
371.05
2.57
$39,731.92
0.70
$991,846
0.68
0.19
0.11
0.25
0.49
0.15
695.32
75.93
Walmart
For use only in the course RSM 392 - Strategic Management at University of Toronto - Rotman School of Management from 9/3/2024 to 12/31/2024.
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BY STEPHAN MEIER* AND FELIX OBERHOLZER-GEE†
Page 13 | Walmart: In Search of Renewed Growth
Source: Paul B. Ellickson, Stephanie Houghton, and Christopher Timmins, “Estimating Network Economies in Retail
Chains: A Revealed Preference Approach,” RAND Journal of Economics 44, no. 2 (2013): 169–193.
Population in 2006
Land area (in square miles)
Population density
Average household size
Median income
Percentage urban population
Average weekly sales volume
Metropolitan statistical area
Micropolitan statistical area
Northeast
Midwest
South
West
Distance to HQ (in miles)
Distance to closest own DC
(in miles)
Number of stores
Mean
$2,254,909
3515.56
513.46
2.56
$41,640.98
0.76
$241,942
0.78
0.17
0.18
0.31
0.33
0.18
713.24
153.17
Kmart
Exhibit 2
Sociodemographic Information by Store for Various Firms,
2006
Source: Thomas J. Holmes, “The Diffusion of Wal-Mart and Economies of Density,” Econometrica 79, no.
1 (January 2011): 253-302.
Walmart: In Search of Renewed Growth | Page 14
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Exhibit 3
Diffusion of Walmart Stores and General Distribution Centers, 1970–
2005
The table reports the likelihood that a customer would shop at Walmart as a function of
population density and customer distance. For example, a customer in an area with 10,000 people
within a five-mile radius shops at Walmart with a probability of 61.5 percent if the closest store
is five miles from home.
Store
Distance
(miles)
Population Density
(thousands of people within a 5-mile radius)
1
5
10
20
50
100
250
0
.999
.989
.966
.906
.717
.496
.236
1
.999
.979
.941
.849
.610
.387
.172
2
.997
.962
.899
.767
.490
.288
.123
3
.995
.933
.834
.659
.372
.206
.086
4
.989
.883
.739
.531
.268
.142
.060
5
10
.978
.570
.803
.160
.615
.083
.398
.044
.184
.020
.096
.011
.041
.006
Source: Thomas J. Holmes, “The Diffusion of Wal-Mart and Economies of Density,” Econometrica 79, no.
1 (January 2011): 253-302.
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Exhibit 4
Probability of Customers Shopping at Walmart
For use only in the course RSM 392 - Strategic Management at University of Toronto - Rotman School of Management from 9/3/2024 to 12/31/2024.
Use outside these parameters is a copyright violation.
Exhibit 5
Sam Walton Does the “Squiggly” in the Walmart Cheer
Give me a W!
Give me an A!
Give me an L!
Give me a squiggly!
Give me an M!
Give me an A!
Give me an R!
Give me a T!
What’s that spell?
Wal-Mart!
Whose Wal-Mart is it?
It’s my Wal-Mart!
Who’s number one?
The customer! Always!
Source: Company documents.
Walmart: In Search of Renewed Growth | Page 16
BY STEPHAN MEIER* AND FELIX OBERHOLZER-GEE†
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Source: Walmart Stores, Inc. Annual Report.
Exhibit 7
Estimated Net Present Value (NPV) per New Store, 2003 ($ millions)
Type of Store
Discount Store
Supercenters
Long-Run Operating Margin*
10%
7%
8%
9%
Estimated NPV
$16.3
$15.0
$19.0
$22.9
Notes: Discount stores are assumed to generate long-run sales of $39 million per year with an initial investment of $10.6 million, and
supercenters are assumed to generate long-run sales of $75 million per year with an initial investment of $15.5 million. NPVs are net
of these initial investments.
*Operating margin is assumed to ramp up to its long-run level in five years.
Source: Pankaj Ghemawat, Stephen P. Bradley, and Ken Mark, Wal-Mart Stores in 2003 (Abridged
Version) (Cambridge, MA: Harvard Business Publishing, 2003).
.
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Exhibit 6
Number of Walmart Stores, 1962–2020
IN MILLIONS OF REPORTED CURRENCY (CONVERSION: HISTORICAL)
Walmart
Target
Total (incl. rev
other ops)
Last Twelve Months
12 months
12 months
For the Fiscal Period Ending
Jan-2020
Feb-2020
In Currency
Costco
Kroger
12 months
Sept-2019
12 months
Jan-2020
Total Revenue
USD
523,964.0
USD
78,112.0
USD
152,703.0
USD
122,286.0
Cost Of Goods Sold
Gross Profit
394,605.0
129,359.0
54,864.0
23,248.0
132,886.0
19,817.0
95,294.0
26,992.0
Selling General & Admin Exp.
108,791.0
18,590.0
15,080.0
24,741.0
Operating Income
Interest Exp.
20,568.0
452
4,658.0
468
4,737.0
17.0
2,251.0
123
-
-
-
-
20,116.0
4,190.0
4,720.0
2,128.0
-
-
-
-
Income Tax Expense
Net Income
4,915.0
15,201.0
921.0
3,269.0
1,061.0
3,659.0
469.0
1,659.0
Profitability
Return on Assets %
Return on Capital %
Return on Equity %
6.7%
10.9%
20.2%
7.8%
11.2%
18.4%
8.6%
16.5%
26.1%
3.6%
7.3%
19.9%
Compound Annual Growth
Rate Over Five Years
Total Revenue
Gross Profit
EBITDA
EBITA
EBIT
Earnings from Cont. Ops
Net Income
10.5%
12.5%
11.3%
10.8%
10.8%
10.5%
9.9%
11.1%
12.2%
12.9%
13.3%
13.4%
15.7%
11.9%
11.0%
11.0%
9.6%
9.4%
9.4%
10.9%
10.9%
6.3%
4.0%
-0.3%
-2.6%
-2.6%
-0.6%
-0.4%
EBT Excl. Unusual Items
Operating Profit Before Tax
EBT Incl. Unusual Items
Source: S & P Capital IQ.
Note: There are variations with regard to the month in which each company’s accounting year
ends.
Walmart: In Search of Renewed Growth | Page 18
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Exhibit 8A
Financials: Comparable Income Statements, 2019–2020
Exhibit 8B
Segment Income Statements ($ billions)
519.92
20.57
236.50
10.99
31.56
10.71
Walmart US
Walmart Int'l
321.00
17.38
110.35
6.41
23.79
6.32
120.1
3.37
105.81
2.68
6.05
2.80
Sam's Club
58.79
1.64
13.49
0.61
2.25
0.53
Source: Walmart 2020 10-K report.
Exhibit 9
Distribution of Labor Costs at Selected Walmart Locations
Quartile
Store Location
Minimum
25
50
75
Maximum
Pineville, MO
Litchfield, IL
Belleville, IL
Miami, FL
San Jose, CA
Annual Payroll per
Worker ($)
12,400
19,300
21,000
23,000
37,900
Wages as
Percent of Sales
4.5
7.0
7.6
8.3
13.7
Source: Thomas J. Holmes, “The Diffusion of Wal-Mart and Economies of Density,” Econometrica 79, no
1. (January 2011): 253-302).
Page 19 | Walmart: In Search of Renewed Growth
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Consolidated
Net
Sales
Operating Income
Total Assets
Depreciation
EBITDA
Capital Expenditures
Note: Comparable store sales are defined as sales in stores and clubs for those units which were open at
least 12 months as of January 31 of the prior year; for example, 11 percent for 1993 is the comparable
sales growth during 1993 for stores open as of January 31, 1992.
Source: Financial summary notes from each year’s Walmart Annual Report.
Exhibit 11
Competitors’ Same-Store Sales, January 2013–January 2015
Total US
Target
Costco US
Kroger
Dollar General
Dollar Tree
Family Dollar
Jan/13
2.4%
2.7%
7%
4.5%
4.7%
3.4%
4.7%
Jan/14
-0.5%
-0.4%
6%
3.3%
3.3%
2.4%
3.0%
Jan/15
0.5%
1.3%
5%
4.2%
2.8%
4.3%
-2.1%
Source: Company 10-K reports.
Walmart: In Search of Renewed Growth | Page 20
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Exhibit 10
Walmart Same-Store Sales, 1987–2020
Year
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
Rate
0.62%
0.87%
0.55%
0.67%
1.28%
1.38%
1.43%
1.27%
1.00%
1.00%
1.50%
1.10%
0.60%
0.80%
0.80%
0.70%
0.80%
0.90%
Note: Cannibalization measures the reduction in same-store sales as a result of new store openings. For
example, in 2003 same-store sales would have been 1.38 percent higher if Walmart had not opened any
new stores.
Source: Thomas J. Holmes, “The Diffusion of Wal-Mart and Economies of Density,” Econometrica 79, no.
1 (January 2011): 253-302.
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Exhibit 12
Walmart Cannibalization Rates, 1998–2015
Incremental Sales
Incremental
Operating Profit
Average for All Stores
36.3
3.1
How Many Years After Walmart’s Entry Into the State Did the Store Open?
1-2 years
38.0
3.5
3-5 years
39.5
3.5
6-10 years
37.6
3.3
11-15 years
36.1
2.9
16-20 years
32.9
2.8
21 or more years
29.5
2.4
Incremental
Distribution Center
Distance (miles)
168.9
343.3
202.2
160.7
142.1
113.7
90.2
Part B: New Supercenters
Incremental Sales
Incremental
Operating Profit
Average for all Centers
All Supercenters
40.2
3.6
How Many Years After Walmart’s Entry Into the State Did the Store Open?
1-2 years
42.4
3.9
3-5 years
42.7
4.0
6-10 years
41.0
3.6
11-15 years
36.7
3.2
16-20 years
30.1
2.8
Incremental
Distribution Center
Distance (miles)
137.0
252.9
171.2
113.5
95.3
94.0
Source: Thomas J. Holmes, “The Diffusion of Wal-Mart and Economies of Density,” Econometrica 79, no.
1 (January 2011): 253-302.
Walmart: In Search of Renewed Growth | Page 22
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Exhibit 13
Incremental Values of New Store Openings
Part A: All Stores
For use only in the course RSM 392 - Strategic Management at University of Toronto - Rotman School of Management from 9/3/2024 to 12/31/2024.
Use outside these parameters is a copyright violation.
Exhibit 14
Top 10 US Companies, Ranked by Retail E-Commerce Sales Share,
2020
Source: eMarketer
Page 23 | Walmart: In Search of Renewed Growth
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Page 69 of 213
Endnotes
Amit Singh, “Is Kroger Losing to Walmart, Target, and Costco?” Market Realist,
https://marketrealist.com/2019/04/is-kroger-losing-to-walmart-target-and-costco/.
2 Walmart, “Location Facts,” https://corporate.walmart.com/our-story/locations/united-states.
3 Sam Walton and John Huey, Sam Walton: Made in America (New York: Doubleday, 1992).
4 George C. Strachan, “The State of the Discount Store Industry,” Goldman Sachs Report, April 6,
1994.
5 Walton and Huey, Sam Walton: Made in America.
6 Thomas J. Holmes, “The Diffusion of Wal-Mart and Economies of Density,” Econometrica 79,
no. 1 (January, 2011): 253-302), http://www.econ.umn.edu/~holmes/papers/ecta7699.pdf. A
video of Holmes’s interactive map charting the opening of US stores and distribution centers
from 1962 to 2004 is available at http://www.youtube.com/watch?v=EGzHBtoVvpc.
7 Carol Wolf, Chris Burritt, and Matthew Boyle, “Why Wal-Mart Wants to Take the Driver’s
Seat,” BusinessWeek, May 27, 2010, https://www.bloomberg.com/news/articles/2010-05-27/whywal-mart-wants-to-take-the-drivers-seat.
8 Walmart, “10-Foot Rule,” http://walmartstores.com/AboutUs/285.aspx.
9 See the Wal-Mart cheer performed by executives at the annual shareholders meeting
(http://www.youtube.com/watch?v=z48kJTYSl8s).
10 Brent Schlender, “Wal-Mart’s $288 Billion Meeting,” Fortune, April 18, 2005,
https://money.cnn.com/magazines/fortune/fortune_archive/2005/04/18/8257009/.
11 “PoweRanking Leaders Harness the Climatic Winds of Change for Growth in Retail Today . . .
and Tomorrow,” Kantar, https://consulting.kantar.com/growth-hub/poweranking-2019/.
12 Kantar Retail, PoweRanking® 2013: Navigating the Storm.
13 Schlender, “Wal-Mart’s $288 Billion Meeting.”
14 Walmart, “Financial Information,” https://stock.walmart.com/investors/financialinformation/sec-filings/default.aspx, p. 76.
15 1999 Wal-Mart Stores, Inc. Annual Report,
https://www.annualreports.com/HostedData/AnnualReportArchive/w/NYSE_WMT_1999.pdf.
16 Walmart.com, “Financial Information,” https://stock.walmart.com/investors/financialinformation/sec-filings/default.aspx, pp. 8-10.
17 “Wal-Mart Exits Korean Market,” Los Angeles Times, May 23, 2006,
https://www.latimes.com/archives/la-xpm-2006-may-23-fi-walmart23-story.html.
18 David Macaray, “Why Did Walmart Leave Germany?” Huffington Post, August 29, 2011,
http://www.huffingtonpost.com/david-macaray/why-did-walmart-leave-ger_b_940542.html.
19 U.S. Securities and Exchange Commission, “Walmart Charged with FCPA Violations,” press
release no. 2019-102, June 20, 2019, https://www.sec.gov/news/press-release/2019-102.
20 Laurie Burkitt, “Wal-Mart Says It Will Go Slow in China,” Wall Street Journal, April 29, 2015,
https://www.wsj.com/articles/wal-mart-to-open-115-stores-in-china-by-2017-1430270579.
21 2014 Wal-Mart Stores, Inc. Annual Report,
https://cdn.corporate.walmart.com/66/e5/9ff9a87445949173fde56316ac5f/2014-annual-report.pdf.
22 Top 100 Retailers,” National Retail Federation, https://nrf.com/2015/top100-table.
Walmart: In Search of Renewed Growth | Page 24
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1
“Stop the Bullying, Wal-Mart,” Bloomberg Business, April 2007,
https://web.archive.org/web/20101027154612/http://www.businessweek.com/debateroom/archi
ves/2007/04/stop_the_bullying_wal-mart.html.
24 Steven Greenhouse, “Wal-Mart, Driving Workers and Supermarkets Crazy,” New York Times,
October 19, 2003, https://www.nytimes.com/2003/10/19/weekinreview/the-nation-wal-martdriving-workers-and-supermarkets-crazy.html.
25 William Selway, “Wal-Mart Loses to the Little Guy,” Miami Herald, April 8, 2004.
26 Martin J. Jenkins, United States District Court for the Northern District of California, Betty
Dukes et al. v. Wal-Mart Stores, Inc. (C 01-02252 MJJ), June 21, 2004, 29.
27 Betty Dukes et al. v. Wal-Mart Stores, Inc., 38.
28 Ann Zimmerman, “Judge Certifies Wal-Mart Suit as Class Action,” Wall Street Journal, June 23,
2004.
29 Wayne Cascio, “Decency Means More than Always Low Prices: A Comparison of Costco to
Wal-Mart’s Sam’s Club,” Academy of Management Journal 20, no. 3 (August 2007).
30 Panle Jia, “What Happens When Wal-Mart Comes to Town: An Empirical Analysis of the
Discount Retailing Industry,” (working paper, MIT, Cambridge, MA, July 2007),
http://economics.mit.edu/files/7575.
31 Jia, “What Happens When Wal-Mart Comes to Town.”
32 “Walmart Financial Services Hampered by Regulation,” Seeking Alpha, March 23, 2015,
https://seekingalpha.com/article/3021596-walmart-financial-services-hampered-by-regulation.
33 Brent Schlender, “Wal-Mart’s $288 Billion Meeting,” CNN Money, April 18, 2005,
https://money.cnn.com/magazines/fortune/fortune_archive/2005/04/18/8257009/.
34 Michael Barbaro, “Wal-Mart’s Detractors Come in from the Cold,” New York Times, June 5,
2008, https://www.nytimes.com/2008/06/05/business/05walmart.html.
35 CuriousObserver, “Wal-Mart: Digging for Clues Behind the June 5th Shareholder Meeting,”
Seeking Alpha, June 12, 2015, http://seekingalpha.com/article/3255925-wal-mart-digging-forclues-behind-the-june-5th-shareholders-meeting.
36 Walmart, “Financial Information,” https://stock.walmart.com/investors/financialinformation/sec-filings/default.aspx, p.29.
37 Costco, SEC Filing Details, September 1, 2019, https://investor.costco.com/sec-filings/secfiling/10-k/0000909832-19-000019.
38 Matthew Zook and Mark Graham, “Wal-Mart Nation: Mapping the Reach of a Retail
Colossus,” in Wal-Mart World: The World’s Biggest Corporation in the Global Economy, ed. Stanley
Brunn (London: Routledge, 2006), 20.
39 Financial data provided by Capital IQ from annual reports from Kroger Co. and Wal-Mart
Stores, Inc.
40 Jack Hitt, “The Dollar-Store Economy,” New York Times Magazine, August 18, 2011,
https://www.nytimes.com/2011/08/21/magazine/the-dollar-store-economy.html.
41 Lauren Debter, “Family Dollar Sales Rise Ahead of Dollar Tree Merger,” Forbes, April 8, 2015,
http://www.forbes.com/sites/laurengensler/2015/04/08/family-dollar-second-quarter-earnings/.
Page 25 | Walmart: In Search of Renewed Growth
BY STEPHAN MEIER* AND FELIX OBERHOLZER-GEE†
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23
Hayley Peterson, “This Rapidly Expanding Grocery Chain Is Shockingly Cheaper than WalMart,” Business Insider, January 5, 2015, http://www.businessinsider.com/this-grocery-store-hasthe-lowest-prices-2015-1#ixzz3hDC7COqv.
43 Euromonitor International, US Online Sales (Table 21), June 2015.
44 CuriousObserver, “Wal-Mart: Digging for Clues.”
45 Brian O’Keefe, “The Chosen One,” Fortune, June 15, 2015.
46 Walmart, “Walmart Completes Acquisition of Jet.com, Inc.,” press release, September 9, 2016,
https://corporate.walmart.com/newsroom/2016/09/19/walmart-completes-acquisition-of-jetcom-inc.
47 Neil Stern, “Walmart Grounds Jet.com,” Forbes, May 19, 2020,
https://www.forbes.com/sites/neilstern/2020/05/19/walmart-grounds-jetcom/#294e2da12e6c.
48 American Consumer Satisfaction Index (ACSI) Retail Report 2014, February 18, 2015,
https://www.theacsi.org/news-and-resources/customer-satisfaction-reports/report-archive/acsiretail-report-2014.
49 Jennifer Reingold, “Target’s Inner Circle,” Fortune, March 31, 2008,
https://money.cnn.com/2008/03/18/news/companies/reingold_target.fortune/.
50 Target Corporation Form 10-K for the period ending 31 January 2015,
https://www.sec.gov/Archives/edgar/data/27419/000002741915000012/tgt-20150131x10k.htm.
51 Zimmerman, “After Misstep, Wal-Mart Revisits Fashion,”
https://www.wsj.com/articles/SB120899828876040063
52 Zimmerman, “After Misstep.”
53 Matthew Boyle, “Wal-Mart Apparel Chief Leaves Duties after Split,” Bloomberg Business, July
23, 2010, www.bloomberg.com/news/articles/2010-07-23/wal-mart-apparel-chief-mattisonleaves-after-retailer-splits-job-duties.
54 Emily Scardino, “Wal-Mart’s Fashion Sense Chain’s Best Kept Secret,” DSN Retailing Today,
February 7, 2005.
55 Lauren Thomas, “Walmart Raises Starting Hourly Wage to $12 in 500 Stores, As Part of a
Test,” CNBC, January 24,2020, https://www.cnbc.com/2020/01/24/walmart-raises-startinghourly-wage-to-12-in-500-stores.html#:~:text=Menu,Walmart%20raises%20starting%20hourly
%20wage%20to%20%2412%20in%20500,as%20part%20of%20a%20test&text=In%20roughly%205
00%20stores%2C%20Walmart,to%20a%20new%20workflow%20model.
56 “Wal-Mart Stores: No Light at the End of the Tunnel Yet,” Barclays Equity Research, May 20,
2015.
57 Paul Ziobro and Eric Morath, “Wal-Mart Raising Wages as Market Gets Tighter,” Wall Street
Journal, February 19, 2015, https://www.wsj.com/articles/wal-mart-plans-to-boost-pay-of-u-sworkers-1424353742.
58 Elizabeth A. Harris and Stephanie Strom, “Walmart to Sell Organic Food, Undercutting Big
Brands,” New York Times, April 10, 2014,
https://www.nytimes.com/2014/04/10/business/walmart-to-offer-organic-line-of-food-at-cutrate-prices.html.
59 “Wal-Mart Turns Attention to Upscale Shopper,” USA Today, March 22, 2006,
http://usatoday30.usatoday.com/money/industries/retail/2006-03-22-walmart_x.htm.
Walmart: In Search of Renewed Growth | Page 26
BY STEPHAN MEIER* AND FELIX OBERHOLZER-GEE†
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42
9 -8 0 7 -0 2 9
GEOFFREY JONES
RICARDO REISEN DE PINHO
Natura: Global Beauty Made in Brazil
Beliefs create strong bonds throughout the whole value chain.
— Luiz Seabra, Natura’s Founder and Chairman
It was an unusually mild fall day in October of 2005 as Luiz Seabra, Guilherme Leal, and Pedro
Passos, the three men responsible for founding and growing the Brazilian company Natura, walked
through Red Square in Moscow. They were headed to a nearby business center to monitor focus
group discussions designed to help them decide if Natura, the largest direct sales beauty company in
Brazil, should invest in Russia.
Natura had come a long way since it was founded by Seabra as a small store in São Paulo, Brazil
in 1969. Although sales outside Brazil still constituted only 3% of its total revenues, Natura had
grown its international operations in recent years. The company had recently established a new
direct-selling operation in Mexico, and Venezuela and Colombia were likely to join Natura’s portfolio
in coming years. The company had just opened a flagship store in Paris, the very heart of global
fashion and home to L’Oréal, the world’s largest beauty company, and was actively seeking other
growth opportunities worldwide.
Natura’s international development was met with mixed reviews from industry analysts and
investment bankers. Some perceived the development as blind ambition on the part of the company’s
founders, while others viewed it as a carefully thought-out growth strategy. Even among Natura’s
senior executives there were differences in opinion on the optimal business model or regions for
expansion. Possibilities for growth included moving to Internet sales, selling products in duty-free
shops in airports, and creating retail chains in certain countries. The executives were strongly inclined
to keep international investments relatively low until a final decision was made.
In 2005, after an initial public offering (IPO) the previous year, Natura had become Brazil’s biggest
domestic cosmetics company, with expected gross revenues of around US$1.5 billion.1 Natura,
considered one of the best brands in Brazil, was a leading company in the sustainable use of Brazil’s
biodiversitya and was known as one of that country’s best employers. However, Seabra, Leal, and
a The term “biodiversity” as used in this case refers to the diverse plant life found in Brazil. In general terms, biodiversity is
defined as the variety of life in all its forms, levels, and combinations in a given habitat. It also includes ecosystem diversity,
species diversity, and genetic diversity.
________________________________________________________________________________________________________________
Professor Geoffrey Jones and Senior Researcher Ricardo Reisen de Pinho of the Latin America Research Center prepared this case. HBS cases are
developed solely as the basis for class discussion. Cases are not intended to serve as endorsements, sources of primary data, or illustrations of
effective or ineffective management.
Copyright © 2006, 2007, 2012 President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1800-545-7685, write Harvard Business School Publishing, Boston, MA 02163, or go to http://www.hbsp.harvard.edu. No part of this publication
may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means—electronic, mechanical,
photocopying, recording, or otherwise—without the permission of Harvard Business School.
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REV: OCTOBER 20, 2012
Natura: Global Beauty Made in Brazil
Passos knew that their proven ability to face global competitors in their own market was no longer
enough. The rapid consolidation of the global beauty industry was forcing smaller companies to be
even more aggressive in developing new product lines, segmenting existing markets, and challenging
the previously strong borders between the mass and prestige sectors.
However, despite the well-dressed Russian women walking past them in Red Square, the three
founders wondered what this country would have in common with their home market, known for its
luxuriant Amazon Forest, warm tropical beaches, and an ethnically and culturally diverse
population. “Beginning with its Cyrillic alphabet, almost everything was initially beyond our
understanding,” Leal remembered.
As they approached the door to the business center, many thoughts crossed the minds of the
Brazilians. Natura, they felt, was a unique company with a growing vision for humanity. Would
globalization facilitate the achievement of this vision or prove the ultimate undoing of the company?
Was the company ready to build a global business? Was Russia a step too far?
The Brazilian Beauty Market
Regardless of culture, geographical location, or era, beauty had always created significant
economic and social advantages. Economists agreed that there was a beauty premium: physical
attractiveness, which could be enhanced by products of the beauty industry, appeared to exercise a
major impact on individual lifestyles, ranging from the ability to attract sexual partners to lifelong
career opportunities and earnings.2
The modern beauty industry was established during the late nineteenth century, as social
attitudes toward the use of cosmetics became more favorable and as branding strategies and mass
production began to be applied to the former craft industry.3 In 2004, beauty was a US$231 billion
global business, with compound annual growth rates (CAGRs) close to 5% since 1999.4 It appeared
largely recession-proof. This growth had been driven by aging baby boomers in Western countries
with higher amounts of disposable income and growing middle classes in developing countries such
as Brazil (see Exhibit 1 for sales of cosmetics and toiletries by major markets). Preteen girls,
metrosexuals, and seniors all offered huge future growth potential.
Brazil was the fifth-largest country in the world in terms of area and as of 2005 held 20% of the
planet’s biodiversity, mainly located in the Amazon region in the northern part of the country.5 It had
a total population of 180 million and gross domestic product (GDP) that ranked 10th in the world.6
Approximately 80% of its population lived within 350 kilometers of the coast, with the majority of its
47 million households (83% of the population) located in urban areas.7
The diverse Brazilian population resulted from the Native American, Portuguese, and African
groups (the country’s original inhabitants, colonizers, and slaves, respectively) and massive
immigrant waves of job-seeking Europeans and Asians during Brazil’s industrialization at the end of
the nineteenth century.8 Due in part to liberal attitudes toward interracial marriage, these different
groups gradually created a Brazilian melting pot of ethnic origins and cultures. A 2003 survey found
that the Brazilian population was 51.4% Caucasian, 48% Afro-Brazilian, and 0.6% Asian and
indigenous.9
However, opportunity was not color blind. Brazil suffered from high rates of income inequality
that had deep historical and regional roots. With the income share of the richest 20% of the
population equal to 33 times the corresponding share of the poorest 20%, Brazil had one of the
2
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807-029
807-029
highest levels of income inequality in the world. According to a World Bank report, approximately
12% of income inequality in Brazil was attributed to skin color, while the same figure for the United
States was 2.4%.10 In Brazil, the lighter a person’s skin, the richer they were likely to become.
Brazilian Market Main Trends
According to a 2005 Euromonitor survey, the Brazilian beauty industry’s total sales soared from
12.9 billion Brazilian reais (R$) in 1999 to R$28.5 billion in 2004,11 easily outpacing the growth rate of
the country’s GDP. The total sales of cosmetics and personal-care products in Brazil were relatively
high (see Exhibit 2). Brazil ranked third worldwide in deodorants and hair-care products, fourth in
perfumery, and sixth in personal-care products for men.12
Brazil’s rapidly growing population included an increasing number of women working outside
the home. By 2004 females made up 22% of the workforce. Some surveys showed that working
women spent around 60% more on beauty products than nonworking women. 13 The average salary
for women had also grown substantially relative to the average salary for men, from 59% in 1993 to
70% in 2004.14 Demographic and social trends were converging with those of developed countries.
Divorce rates increased almost 300% between 1984 and 2002.15
The cultural importance of self-image in Brazil helped boost pharmaceutical sales of products and
services that enhanced attractiveness and self-confidence. In 2004, Brazil was reported as the secondbiggest market for Botox and Viagra and the fourth for Roacutan, a popular anti-acne drug.16 In 2000,
Brazil had the largest number of per capita plastic surgeries in the world, with 207 operations per
100,000 inhabitants, up from 40 in 1990; in comparison, there were 185 plastic surgeries per 100,000
people in the United States.17 Whereas in the United Kingdom 80% of all plastic surgery was
reconstructive, in Brazil 80% of all plastic surgery was cosmetic. 18 Finally, Brazil’s wide range of
women’s and men’s beauty magazines had increasingly influenced the development of the cosmetics
and toiletries market in recent years.19
Carnival and the general sensuality that seemed to permeate Brazilian culture often gave foreign
observers the impression that Brazil was unusually permissive and liberated, especially compared
with other predominantly Roman Catholic nations. “Brazil is a country of contradictions, as much in
relation to sexuality as anything else,” observed one anthropologist. “There is a certain spirit of
transgression in daily life, but there is also a lot of moralism.”20 One Natura executive noted, “You
see women wearing small bikinis at Brazilian beaches, for instance, but you will never see one topless
or bottomless as in France, Spain, or Greece.”
Natura
Natura was established in 1969 by Antonio Luiz da Cunha Seabra as a small laboratory and
cosmetics store in the city of São Paulo. Seabra came from a humble background and was not able to
attend university until the age of 25, after the birth of two children. After a period of experimentation,
the company opted to follow Avon’s path and adopted a direct-selling model in 1974. Avon was the
world’s leading direct seller in beauty products and had successfully operated in Brazil since the
1960s. The door-to-door distribution system allowed Natura to expand at low marginal cost even
during economically adverse periods. In 1979, Guilherme Leal, an administrator by training who had
acted as a consultant to Natura and had opened a distribution company in the south of the country to
sell its products, joined the company. In 1983, Pedro Passos, Leal’s colleague, who had worked with
3
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Natura: Global Beauty Made in Brazil
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Natura: Global Beauty Made in Brazil
In a certain way we were an idea looking for a conduit. None of us had previous experience
in the cosmetic industry or even a background that would naturally lead us in this direction.
We all started our own production or distribution companies or worked as consultants to each
other by a series of coincidences and opportunities. At a certain point we realized we were
three people with different styles and experiences who shared the same ideals in terms of our
role as individuals and as a company, as part of something bigger.
The 1980s were known in Brazil as the “lost decade,” explained Passos:
Brazil experienced rampant inflation and low growth rates. However, it was also a period
of many opportunities for a company such as Natura. International players left the country or
halted their investments while we saw a lot of women, the primary source of Natura’s
workforce, eager to enter the market. Without close competition and with our ability to quickly
expand our sales network, we experienced a 43% CAGR between 1979 and 1989.
Following this strong expansion in Brazil, we decided to also invest in a few select countries
in South America. But without focus, planning, resources, and the knowledge where we
needed it, they were either a downright failure or showed unimpressive results.
In 1989, Seabra, Leal, and Passos bought out the other Natura partners’ shares and consolidated
the companies that made up the initial Natura system into a single company, Natura Cosméticos. At
the beginning of the 1990s, the company defined its beliefs and values, formalizing them among its
stakeholders. In 1994, Natura decided to pursue a new international business and opened an
operation in Argentina. In 2000, it launched the Ekos line, a landmark product line made from raw
material from Brazilian biodiversity sources gathered through sustainable methods. Seabra had
originally envisioned such a product when the firm was founded, but it had taken over three decades
to bring the concept to fruition. Finally, in 2004, Natura floated approximately 25% of its shares in a
massively oversubscribed IPO at the São Paulo Stock Exchange’s “Novo Mercado,”21 with 70% of the
interest coming from outside Brazil.22 (See Exhibit 3 for Natura’s timeline.)
Product Lines and Brand
Natura sold premium, high-margin cosmetics and personal-care products to middle- and upperclass customer segments in Brazil. The brand was present in all main categories of the cosmetics
market but was most prominent in fragrances and perfumes, creams, lotions, and makeup. In 2005,
its portfolio contained approximately 600 products23 aggregated into seven main product lines, with
three of them—Ekos, Chronos and Mamãe e Bebê—considered to be conceptual (see Exhibit 4 for
Natura’s main line of products).
Continuous reinventing and reformulating of its product portfolio was crucial to Natura’s
marketing strategy. Between 2001 and 2005, the company launched or improved an average of 153
products per year, reinvesting approximately 2.9% (US$29 million) of its annual net revenues in the
company, which was a fraction in absolute terms when compared with reinvestments by its larger
competitors. In 2005, L’Oréal spent US$587 million on research and development (R&D),24 while
Shiseido invested approximately US$156 million.25 To continuously innovate and develop products
in-house, Natura acquired patents and technology from universities and research centers in Brazil
and abroad. The timeline for the creation and commercialization of a new product ranged from six
4
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him at a state-owned railway company, was also invited to participate in Natura. Leal remembered
their early years:
Natura: Global Beauty Made in Brazil
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Our innovation process and product launch have been a mix of brainstorming sessions,
where the three founders still have a crucial role in defining the concepts behind new products,
and a feedback [process] encompassing our sales network and customers. This dynamic allows
us to promptly respond to consumer tastes, support the sales efforts, and promote our brand.
We take care of all details. Even the packaging design of our products tries to reflect the
attractiveness and positive impact of our values.
One industry analyst said: “Natura’s products are aspirational. You can give a Natura product
nicely wrapped in a stylish natural fiber bag to a friend or colleague as a present or a gift and you will
look good, but generally speaking you wouldn’t dare to do the same with another brand.”26
Natura focused particular research efforts on skincare products and on the sustainable use of
ingredients from Brazil’s biodiversity, launching product lines such as Chronos and Ekos. Leal
stated:
Brazil has a disproportionate amount of the world’s biodiversity, presenting business
opportunities in several sectors such as pharmacology, food, and cosmetics. However, we
cannot just take the best from the world’s natural resources and from traditional knowledge
and put it in a nice packaging. This is the way of the old-fashioned global products. Therefore,
we have to ensure that extraction of any raw material is economically feasible, environmentally
correct, and socially just for the protection and progress of communities we want to deal with.
Natura sourced some raw materials from the Iratatpuru community deep in the Amazon. The
price of raw materials aimed to cover the costs incurred by the supplier while paying a 15% fair trade
premium. Because a cosmetic product’s life cycle was usually short, it was important that the
suppliers received support in structuring themselves socially and economically to minimize the
impact of periods when raw materials were in low demand. Partnerships with NGOs and the
attainment of international certifications were also important for successful sustainability and
dissemination.27
Leal elaborated:
On the consumer’s end, Natura’s products are based on the “well-being/being well”
concept, which refers to the harmonious, pleasant relationship between oneself and one’s
body, combined with the concept of rewarding, empathetic relationships with others and with
nature. Natura believes this overall approach has contributed to strengthening relationships
along the value chain and has been a key differentiation factor for its products.
In 1999, Natura acquired Flora Medicinal, a phytotherapeutic product manufacturer, with the aim
of developing complementary product lines such as herbal teas and vitamin pills and of boosting
Natura’s research on raw materials gathered from Brazilian biodiversity. However, legal
impediments made Natura unable to sell Flora’s products through its direct-sales distribution
channel, forcing the company to slow its investments and rethink its strategy.
In 2003, a study that focused on the image of Natura’s brand vis-à-vis those of its main
competitors ranked the company as the leading brand in the Brazilian cosmetic market. (See
Exhibit 5a for selected brand attributes and Exhibit 5b for Natura’s positioning.) In a 2005 Morgan
Stanley survey, 100% of the interviewees were aware of Natura’s brand, 86% had tried its products,
5
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months to five years, depending on the degree of innovation. Alessandro Carlucci, who became
Natura’s CEO in 2005 at the age of 40 after 15 years with the company, elaborated:
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Natura: Global Beauty Made in Brazil
Operations
Natura’s main operations were concentrated in its exquisite “Espaço Natura” facility, an
integrated production, logistics, and R&D center situated in a replanted green area on the outskirts of
São Paulo. A futuristic construction of concrete and steel, with huge glass windows showing its
ample internal open spaces, the building was one of the biggest and most advanced of its kind in
Latin America. It consisted of four production units for cosmetics, shampoos, and fragrances; a
walkway with a nursery, restaurant, and shop; and a sports compound. In 2005, Natura had an
installed annual manufacturing capacity for 209 million items. Due to the building’s modular
characteristics, Natura could expand its manufacturing and storage facilities by up to 370 million
items per year without having to substantially increase its storage, conditioning, or distribution
capacities.
Product manufacturing involved the separation of raw materials, and then the mixture of
materials in accordance with the company’s formulas, bottling, and wrapping. The manufacturing of
some products, such as soap bars and products containing aerosols, was outsourced to a third party.
The company bought its raw materials from diverse suppliers, many of which had been partners with
Natura for over 20 years. In 2005, Natura’s 10 largest suppliers accounted for 43% of total raw
material costs, with domestic suppliers responsible for approximately 90% of raw material costs.
Packaging costs totaled approximately 44% of the raw material expenses. “Our main international
suppliers for fragrances and glass bottles have historically been located in France. This created a
strong bond with the country,” stated Seabra.
When an order was placed, the stock management system immediately indicated the stock status
to the sales representative. The vertical warehouse then used an automated system that retrieved raw
materials and finished products from the shelves and sent manufacturing orders to the production
facilities. Within 24 hours orders were automatically checked, packed, and labeled for delivery to the
sales representative’s residence.
In 2005, Natura received an average of over 40,000 orders per day and shipped approximately
98% of those orders to more than 5,000 municipalities in Brazil. During peaks in demand, such as
Mother’s Day and Christmas, the number of daily orders could increase by almost 60%. To ensure
timely delivery of its products, Natura used 26 different delivery companies as well as the Brazilian
postal service to transport products to its representatives. Delivery time varied from one to two days
in the city of São Paulo and from five to six days for more remote locations.
Sales and Distribution
In 2005, Natura’s products were distributed through a nationwide network of 483,000 active sales
representatives in Brazil and 36,000 agents in other countries. Its sales representatives, known as
Natura consultants, were well-trained autonomous female salespeople with no exclusivity contract
with Natura. (A few men held senior management posts.) The sales force included mainly middleclass housewives selling to their friends, independent professionals, secretaries and staff personnel at
all kinds of companies leveraging their in-company contacts, and maids selling to colleagues or
employers.
6
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and 63% were regular clients. In addition, 63% had a Natura sales representative, and 21% knew how
to reach one if they desired.28
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With no direct remuneration and no work attachment, this model allowed the company to expand
without having to assume debt or hurt profit margins. “However, due to the nature of our open
relationship with our sales representatives,” stated Natura CEO Carlucci, “we believe that
approximately 30% of our sales force also sells products from some of our competitors.” Carlucci
went on to describe Natura’s sales process and structure:
Our selling network is composed of market managers, sales managers, sales promoters, and
sales representatives structured in hubs and knots covering specific geographic regions. They
work in a three-week cycle, which we considerer long enough to keep the machine pumping
but sufficiently short for clients to remember you. In each cycle, 1,260,000 copies of the Revista
Natura catalogue presenting all products on sale and the promotional offers are printed, and
each consultant receives at least one copy. The catalogues contain end-consumer reference
prices for each product, which normally incorporate a 30% margin. This margin, combined
with premium prices, assures the highest commissions in the industry and strengthens the
loyalty of our sales force.
Although catalogue-based retailing was practically nonexistent in Brazil, Natura’s catalogues
became an important sales tool, and frequent updates provided the consultants with a reason to pay
repeated visits to their clients. Natura consultants had an average of 20 to 30 clients, which meant that
Natura’s products were seen by 7 million potential consumers every three weeks. “It’s important to
note that although approximately 30% of total orders come via the Web and are around 80% cheaper
to process than those through the call center, we seldom accept purchases from end users to avoid a
conflict of interest with our sales network,” stated Passos.
Natura’s focus on sales allowed consultants to place orders at any time and to place more than
one order within the same cycle, with the company adapting its logistics and distribution
arrangements and costs to this end. Avon’s representatives could only place an order at a specific
moment in the cycle, in such a way that all the logistics and distribution processes could be planned
and optimized in advance, potentially hampering its sales process and making the process somewhat
inflexible.29 In 2005, Natura’s sales productivity was almost twice the average direct-selling market
performance in Brazil. “The direct-selling business model is the core of Natura’s DNA,” stated Leal.
Natura’s Leadership Model
The Natura leadership team was frequently described as the soul, head, and body of one living
being. Seabra was considered the “soul” of the company. Having founded Natura at the age of 27, he
had developed a passion for cosmetics over the years. Although he never formally studied
philosophy, Seabra was deeply influenced by Greek philosophers. He was a soft-spoken man with an
enigmatic face who resembled a beatific Buddhist monk. He had been the person responsible for
providing inspiration and insights to the company. He was perceived as the company icon, bringing
an emotional and holistic approach to all levels of the organization. Seabra summarized some of his
thoughts about the industry:
Beauty, what a wonderful and dangerous word!
We believe that through the formulas, the touch, and the intimacy that cosmetics allow you
to have with your own body, one can develop a better perspective about oneself, communities,
and nature as a whole. It can be a way for people to express their emotions, their feelings, and
a growing concern about the Earth’s preservation and their quest for a harmonious
development of human potential.
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However, the industry has overpromised things to the customers, especially exaggerating
aging and death fears. Moreover, we believe that there is a gap between the beauty stereotypes
sold by the industry and the idea of beauty as something connected with being well with your
body and soul. In an increasingly transcultural and multiethnic world, people want science
and technology to be controlled so that human health and the environment are respected and
preserved.
Seabra became increasingly convinced that the fragmented world needed to discover a new way
of thinking, based on a holistic view of life and the idea of “trying to share in a proper way.” The
mission of Natura and its consultants was to explore and share this vision. He described the use of
manipulative advertising in the cosmetics industry as a “cultural crime.” He sought, instead, to help
people find the inner beauty within themselves.
Leal was portrayed as Natura’s “head”: the straightforward man with a visionary touch who was
constantly challenging and stretching Natura’s structure. He had overseen strategic issues and led
initiatives on the internationalization process, the search for new potential partners and products, the
engagement in social endeavors, and the idea that a long-lasting relationship with all stakeholders
was fundamental to sustainable success. Leal elaborated:
We believe that our principles and vision have been important in the development of our
company and in the development of our strong reputation in 36 years of operations in the
Brazilian market. We believe that our distinct principles and vision help us attract and retain
our extensive network of independent sales representatives and promote a corporate culture
that produces innovative marketing concepts and products.
Through our business practices, the quality of our products and the relationships we
establish, we seek to make Natura a brand ultimately recognized worldwide and identified
with a community of people who are committed to creating a better world. In addition, we
believe these principles and vision increase the attractiveness of our products among
consumers and will be important as we expand our operations in other geographic markets. 30
Passos represented Natura’s “body.” Pragmatic and down-to-earth, Passos joined Natura in 1983
as a plant manager, in charge of structuring the company and creating a high-quality standard, and
was promoted to CEO in 1998. In 2005 he stepped down as CEO and joined the board of directors.
He commented on the decision process among the three founders and its effects across the
organization:
We have known each other for a very long time, and therefore our strengths and
weaknesses as well as expertise and capabilities are transparent. Not surprisingly, we often
disagree openly, which leads us to an impasse. However, through a series of formal and
informal meetings and committees in which we tend to include as many executives and as
many daring opinions as possible, we seek consensus. Through this mechanism, we centralize
the decision process across all business units, aligning the whole company and making all of
our key employees responsible for deciding if issues are consistent with our values.
The three founders closely monitored new products and brands to ensure that they were fully
consistent with the overall vision of the company, and they were prepared to wait to launch a
product until they felt completely confident that it was in sync with the company’s mission. For
example, starting in the mid-1980s, market research revealed that there was demand for a product
line for babies. However, the founders were not happy with any of the proposals that they had
received over the years. On April 25, 1992, Seabra suddenly had a vision:
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I was reading a newspaper when I saw a small item reporting research at the University of
Miami in Florida showing that little babies given massage slept better, had a better sense of
balance, and gained weight. When I read that small item, I thought that it would be best if a
mother knew how to massage herself before she massaged her baby. It came to me that a brand
should be about the bond between a mother and her baby. When I arrived at the office
everyone was completely moved. Within two days someone was sent to the United States to
learn more about the research. Remarkably, that very day was the birthday of my deceased
mother. It’s as if she had spoken to me about the quality of the bond between mother and
child.
The highly successful Mamãe e Bebê product line was launched in 1994.
Natura’s Culture and Corporate Sustainability
The result of these different styles and mind-sets was an organizational culture characterized by
its openness, transparency, and respect for its stakeholders. Middle management was constantly
challenged and empowered to assume new projects and loftier goals. New talents were developed inhouse or hired from the outside, creating a diversified group of managers. However, this had not
always been the case, remembered Carlucci:
We understand Natura as being two companies within one. The first is the industrial part,
responsible for production and brand. The second is the commercial part, tackling issues such
as relationships, marketing, and distribution channels. Until a few years ago they were almost
separate entities in terms of career development, with very few executives migrating from one
side to the other. With a new concept of leadership, this type of migration is becoming more
common.
Natura’s marketing philosophy was that behind each product, there would be a concept capturing
the emotions, feelings, and aspirations of its customers. However, instead of molding a product to
market demands, Natura sold its beliefs to customers. Philippe Pommez, Natura’s international vice
president, explained: “When we develop a new market we first move ideas, then the brand, and
finally the product. The company identified 11 attributes for Natura’s brand and evaluates them each
time it decides to enter a new market. Our challenge is therefore to enhance specific attributes when
they are poor in specific regions or countries.”
Another important feature of the company was the perception that its success was a consequence
of its ability to intimately connect universal values to some perceived Brazilian characteristics, as
described by Seabra and Leal:
Brazilians are generally depicted as a cordial, generous, joyful, and open people. In some
places, innovation and the capability to solve problems are linked with the country. In Latin
America, for instance, Brazil is perceived as big, powerful, and different. However, the old
stereotype of Brazil being comprised of soccer, samba, and naked women is still vivid in many
minds and souls. These sometimes contradictory perceptions bring some tensions and
questions of how to sell the positive attributes or how to express the true sense of
“Brazilianity.” This is important because although we think of ourselves more and more as
part of the global environment, we are Brazilians.
Carlucci elaborated on the results achieved through this model:
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By truly living by these values and through the stringent implementation of these concepts,
Natura became Brazil’s most admired socially responsible company and owned the third-most
valuable brand in Brazil in 2004. Concurrently, our revenues went from R$1,168 million in 2001
to an expected R$3,540 million in 2005, with EBITDA [earnings before interest, taxes,
depreciation, and amortization] margins jumping from 17% to 24% in the same period. [See
Exhibit 6 for Natura’s financial information.]
The Growth of Competition
During the 1970s and 1980s, the Brazilian market was relatively closed to imports, and
competitors were mostly multinational companies who manufactured mass-market products locally.
Unilever, the Anglo-Dutch consumer products company, had begun manufacturing toilet soap in
Brazil in 1929, followed by toothpaste, and by the 1980s its Gessy Lever affiliate was one of Brazil’s
biggest businesses.31 However, few other companies, especially U.S.-based firms, had been willing to
face the political instability and hyperinflation of Brazil. The relative isolation of the market until the
early 1990s had facilitated the growth of firms like Natura, which were developing higher-quality
products designed especially for local customers. However, with the economic stabilization of the
1990s and a broader trend toward globalization, the Brazilian consumer market experienced rapid
change. Inflation rates dropped to single digits, which helped strengthen Brazilians’ purchasing
power and allowed for the emergence of new consumer groups.
According to a 2004 survey by the Brazilian Association for the Personal Hygiene, Perfume and
Cosmetics Industry (ABIHPEC), there were approximately 1,258 companies operating in the
cosmetics, perfume, and personal-hygiene products market in Brazil. Sixteen had net annual sales of
over R$100 million, accounting for 73% of the market.32 “Scale, globalization and ongoing high
investments in marketing and product development are the main drivers for consolidation in the
household and personal care,” wrote an analyst from a leading investment bank.33
The sector’s most important and widely known brands and companies were already participants
in Natura’s home market, through either direct sales, franchises, or retail channels, some with a solid
position and high reputation. Natura’s most relevant competitor in the direct-sales segment was
Avon; with approximately 1 million consultants, the company was Brazil’s direct-sales market leader.
In the retail segment, Natura competed with global consumer products giants including Unilever,
Johnson & Johnson, and Procter & Gamble, the latter having strengthened its position after acquiring
Gillette and Wella in recent years. The selective retail channel competitors included L’Oréal, Nivea (a
Beiersdorf brand), Louis Vuitton, and Chanel. (See Exhibit 7a for main competitors in Brazil and
Exhibit 7b for product category leaders in Brazil.)
Market Description
The Brazilian cosmetics and toiletries market was one of the largest and most developed in Latin
America. Multinationals and local niche players catered to its complex ethnic, cultural, climatic, and
socioeconomic characteristics. These firms generated an increasingly competitive environment that
stimulated overall capacity for developing more technologically advanced products and products
tailored to the requirements of a broad range of consumers. Product segmentation played a key role
in market development, with manufacturers increasingly targeting products by gender, ethnic group,
and specific age profiles—mainly teenagers and more mature women—thereby fulfilling all
consumer needs and desires.
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Among the industry segments, the predominance of the personal-hygiene sector clearly reflected
the success of products associated with primary needs that had a low per unit value and a large retail
market presence. Given the distribution of Brazilian incomes and the low average disposable income
levels, the fact that 36% of cosmetics sales were for products within the more expensive core beauty
categories—such as color cosmetics, fragrances, and skin care—indicated their importance to the
Brazilian consumer. Lines developed specifically for the summer season as well as those labeled as
“well-being” products proved to be a strong, successful trend in 2003 and 2004. These product
development and marketing strategies enabled manufacturers to achieve more effective results by
tailoring their marketing and advertising campaigns. (See Exhibit 8 for sales of cosmetics and
toiletries by sector in Brazil.)
Sales channels in Brazil played an important role in industry dynamics. Supermarkets/
hypermarkets were the dominant channel, contributing almost 40% of total sales, but were mainly
focused on mass-market products. Department stores and discounters played a less important role in
Brazil than elsewhere in the world, many of them having failed during the 1980s. Likewise,
pharmacies and drugstores, with a 26% share in Western Europe, contributed only 10% to total sales
in Brazil. On the other hand, specialists such as O Boticário, the second-largest Brazilian cosmetic
company, had a well-established position in Brazil, occupying sixth place in terms of market share. O
Boticário was founded in 1977 and had adopted a franchising model. In 2005, O Boticário had 2,328
stores in Brazil and 59 stores and over 1,000 point of sales in 24 countries, selling product lines that,
similar to Natura’s, emphasized the company’s Brazilian roots and a connection with nature.34
Direct selling, with 27% of all purchases, was a popular and well-developed sales method in
Brazil. However, by concentrating almost 55% of sales on the core beauty categories, which
represented 36% of the total cosmetic and toiletries market in Brazil, the channel had begun to show
signs of exhaustion. Most consumers already had a sales representative, and the model relied on a
push by sales representatives, rather than on impulse buys by consumers. (See Exhibit 9 for sales
distribution through retail channels.)
Natura’s International Growth
Natura’s global ambitions were born early but took two decades to come to fruition. In 1980,
Seabra, who had just bought a small apartment in Manhattan, was walking down 5th Avenue when
he was struck not only by the immense competition in the cosmetics market but also by the feeling
that “there was a place for Natura in the world.” At that time data on the worldwide beauty market
did not exist in any systematic way. Seabra and Leal decided to do field research, traveling abroad to
explore and understand different markets, trends, and strategies. Visiting countries such as France,
Italy, and Greece, they quickly recognized that fragrance was a key product line and shortly
thereafter introduced perfume in Brazil, along with new hair, skin-care, and makeup segments. “At
that moment we also had an insight that most of our values and beliefs were universal and crossshared among different regions and cultures. To have a global presence in the long run could be a
way to enlarge how the company could change the way people think and act,” said Seabra.
In 1982, Natura made its first attempt to go international through an agreement with an
outsourced distributor in Chile. Leal recalled Natura’s first international steps:
I would say that we were moved by an impulse, without any proper planning or
knowledge of the markets. In 1983, we allocated a $100,000 budget and created a special brand,
Numina, for a new project and started exporting products to Florida, quickly followed by
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another small operation in Portugal. In both cases, people who used to work for Natura or had
a personal relationship with us were responsible for the local operations. After a short period
we discontinued these operations. It was a financial loss but important as part of the learningcurve process.
Natura developed a partnership with a local distributor in Bolivia in 1988, opened an operation in
Peru in 1992, and founded a local partnership with a distributor in Argentina in 1994. Natura’s
decision to expand internationally coincided with political and macroeconomic changes in Brazil.
After lengthy staggering inflation and low economic growth, the country entered into a stabilization
period. At the same time, other Latin American countries such as Mexico, Argentina, and Chile were
experiencing favorable growth rates and were trying to scale up their commercial ties with Brazil. In
addition, a cultural emphasis on beauty and a better understanding of how to use beauty products,
propelled by mass advertising, had created a rising uniform trend in beauty concepts and demands
in the region.
Latin America, of which Brazil constituted 40%, accounted for roughly 10% of world cosmetic
consumption and showed a significant potential for international diversification. Carlucci
commented: “However, adaptations to Natura’s business model had to be made in specific countries
due to a lack of widespread acceptance or knowledge of direct selling as a mechanism to distribute
cosmetics, as well as subtle cultural differences or management problems. Chile, for instance, had a
good retail network and a more Western European consumer behavior when compared with other
Latin American countries.” Carlucci remembered further challenges:
We had learned that successful penetration of a new market is a long process and involves
building brand equity, quickly developing a sizable network of consultants, managing and
promoting their productivity, as well as mastering logistics and distribution. We also have to
be prepared to adapt some products in terms of formulas and labels or even launch new
product lines for a specific market. All of these require strategy, people, process, money, and
fundamentally, commitment. We did not have any of them in the beginning.
Renata Ribeiro, Natura’s director for new market development, explained the company’s main
drivers for selecting regions for its international expansion:
We are currently covering 10 to 15 actual or potential markets. We have collected detailed
data about population; size of the cosmetic, fragrance, and toiletries market; its adherence to
the direct-sales model; and regulatory issues, among others. Furthermore, we have extensively
visited some of these countries to understand cultural aspects and their attachment to Natura’s
values. None of them have enough weight, on a stand-alone basis, to support or disqualify a
certain market. We should ponder the combination of all factors.
At the end of the day, to develop a new market is a financial decision, but strongly
supported by the triple-bottom-line concept. Natura’s decision-making process combines
financial, philosophical, and emotional components envisioning a balanced value creation to
shareholders, society, and environment.
Carlucci also had discussions with the three founders about the benefits of including more
countries in Natura’s portfolio:
In the long run we’ll probably have a global portfolio that will be constantly adjusted to
reflect the knowledge acquired or developed in different markets. This will be fundamental to
enhance our overall quality and to develop specific product lines focused on particular
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markets. This will help us create a better balanced portfolio where we can quickly introduce
products depending on the local needs, even if some are not 100% aligned with the company
proposition, without jeopardizing our global brand awareness.
Cost of capital, another key variable in any growth strategy and even more sensitive for
companies operating in emerging markets, was not as much of an issue for Natura as for other
companies expanding abroad. Carlucci stated, “Cost of capital is fundamental but not as critical as
for other companies operating in and from Brazil. We are a nonleveraged company, with high cash
generation and low capital expenditure, mostly towards manufacturing and technology.”
The Argentinean Lesson
In 1994 Natura hired a former Natura manager originally from Avon to open its operations in
Argentina. However, despite a steady growth in the sales force network and resulting revenues, the
results were far from satisfactory. Passos commented:
We started our international expansion with people who knew the direct-selling business
model quite well, but Natura’s culture was absent. After a while, we realized we had quite
different companies with just the products in common. Our value proposition, positioning
price, and mix of products were not in accordance with our main practices and guidelines in
Brazil. We knew that we had to fix the problem, but Natura did not have sufficient in-house
talents to send abroad while our operation in Brazil was experiencing unprecedented growth
rates.
In 1999, Carlucci, then a sales director at Natura in Brazil, was sent to Argentina as general
manager to restructure the business. It was the first time that Natura sent a senior executive abroad
with enough resources and empowerment to work on the brand, values, and beliefs. The company
invested in the sales structure, expanding it, strengthening relationships, and keeping a low labor
turnover. Logistics were also improved, and a distribution center was created to better deal with
products coming from Brazil that were then locally distributed. Revenues quickly grew around 30%
per year.
However, in December 2001, Argentina experienced its worst political and economic crisis ever,
suffering from a currency devaluation of approximately 40%, which threw the country into a deep
recession. Carlucci explained:
This crisis immediately created an impasse within the company. How could we increase
prices in Argentina without losing face when we were building a brand? How could we widen
our distribution network without compromising the existing one, preserving the close and
strong relationship with current resellers and maintaining a high retaining rate? How could we
optimize marketing expenditures in order to enhance brand awareness? How could we
maintain and disseminate our commitment to the company’s fundamental concepts and
values, our backbone to success?
When we perceived that all of our main competitors were frantically adjusting prices,
trying to avoid risks, we saw an opportunity and decided to move in the opposite direction.
We looked for ways to reduce costs and put ads in the major magazines stating that we would
keep our prices steady for the time being and would change them if and when local salaries
were adjusted. The idea was to create a kind of social pact involving suppliers, employees,
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The strategy paid off. From 2002 to 2005, revenues increased sixfold, and the number of
consultants grew from 7,000 to 20,000, with low turnover in the same period. (See Exhibit 10 for
Natura’s ads in Argentina.)
The lessons learned in Argentina were quickly transferred to other South American countries
where Natura had opened operations in the early 1990s and where the company was facing similar
managerial or positioning problems. Carlucci stated: “In Peru, where we had a more entrepreneurial
operation, we started focusing more on brand awareness, and in 2005 we were among the best 10
companies to work for in the country. In Chile and Bolivia we just decided to change the local
management or to better monitor our sales distributor there, respectively, making them closer to us.”
Shopping at the Capital of Beauty
In early 2005, Paris was clad in the yellow and green colors of Brazil, celebrating the “Year of
Brazil” in France with dozens of cultural and business initiatives. Taking advantage of this overall
marketing push, Natura produced intriguing advertisements showing a city divided by the Seine,
with the luxuriant Amazon Forest on one side and famous Parisian landmarks, such as the Place
Vendôme, on the other. In April 2005, Natura opened a two-story flagship store in the elegant
neighborhood of St-Germain-des-Prés. Although Natura was on the same street as L’Occitane and
The Body Shop, its “well-being lifestyle proposal” ambiance made it stand out from the others,
attracting a wide range of clients.35
“The decision to open in Paris was both a rational and an emotional move. France has historically
been a source of knowledge and raw material for our products as well as a source of inspiration,”
recalled Seabra. Leal added, “Although our decision to open a store in Paris raised passionate debate,
it has been an opportunity to better understand the company and improve our collective decision
process.”
The stylish but simple Natura store in Paris was designed initially to offer only the Ekos line.
Although some small changes in the products’ packaging and size had to be made in order to comply
with French regulations or local consumer standards, Natura’s “well-being lifestyle proposal” was
kept intact. Natura was betting that its average client would be attracted to the store not only by
Natura’s Latin background or a familiarity with the company’s origins but also by the different look
of the store and its product offerings.36
However, more than a point of sale, the store was conceived as a reference. Passos recalled,
“More than anything, it became a strong symbol.” The store could be used as a place where Natura’s
beliefs and vision could be displayed. Its second floor functioned as a gathering place, where
customers could sample Natura’s products and the company could promote events that evoked
Natura’s brand as well as its Brazilian roots.
The store’s opening also meant that the company had to adopt a new sales paradigm. The Paris
store marked the first time that the company, previously devoted to the direct-sales model, had
opened a retail store. Pommez stated:
The French market is not a traditional market for direct selling. However, some research
has shown a recent social trend in which people have been looking for more friendship,
intimacy, and different ways of enhancing their social contact. Tupperware, for instance, has
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and customers, showing to the Argentinean market that we were there for good and we
expected profits in the long run.
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successfully expanded its operation there. Our aim in France is perhaps to develop and test a
model that combines different concepts. We have to keep in mind that although direct selling
is the core of our business, a focus on just one business model or region could drive the
company away from promising markets, jeopardizing our efforts to become an international
company. Concurrently, the diversification risk is to drain management attention, energy, and
resources.
With a $20 million budget through 2007 for France, management was also looking for other
possibilities, including the introduction of the Internet to sell products to end users. “We believe we
have an appealing proposal to Europeans. France is the place to test different formats since, unlike
Germany or the United Kingdom, we face low direct-sales acceptance in the country,” commented
Passos.
The Mexican Hybrid Model
Plans for a Mexican operation began developing in 2003 when Natura’s executives assessed that
the country’s economy, demographics, and social spectrum, as well as the Mexican passion for
cosmetics, were similar to those of the Brazilian market. According to Euromonitor, total Mexican
cosmetics and toiletries market sales accounted for $5.3 billion in 2004. Avon was the third-largest
company after Colgate-Palmolive and Procter & Gamble. Avon started its operations in 1956, and its
Mexican sales, which included jewelry, toys, and cooking utensils, made Mexico Avon’s secondbiggest market after the U.S. It employed 400,000 salespeople and was one of Mexico’s 50 largest
companies.37
However, if Mexico was considered a good market in terms of distribution channels, it was poor
in terms of brand management and would require a different strategy, especially because Natura was
a late entrant in the country. Carlucci elaborated:
In terms of our recent international expansion effort, our biggest challenge so far has been
how to adapt a very successful “Brazilian model” to other countries without losing our roots
and culture. We could say that when we start our Mexican operation in November 2005 it will
already be the result of a learning curve developed in other Latin American countries and,
more recently, with our flagship store in Paris. Therefore, we opted for a hybrid model that
could mix different components and reflected adjustments based on the Paris experience.
Our first initiative there was the creation of the “Natura’s House” concept, a place where
our sales representatives could be in touch with the brand, could meet each other and
exchange experiences, be trained through speeches and exhibitions, or test our products by
receiving a hand massage using Natura’s creams or oils. This has been instrumental in
strengthening the relationship. Furthermore, Natura’s House can be seen as a middle ground
between a pure direct-selling model and a store chain. It can be replicated in different parts of
the biggest towns or regions at a cost that is a fraction of a traditional store.
Natura also decided to introduce several new marketing tools that could help develop brand
awareness. A series of small products named “The Icon,” presented in special packages with folders
explaining the concept of the brand, were freely distributed to potential sales representatives and
customers. Natura would also pioneer the use of its “magalogue” in Mexico, a combination magazine
and catalogue, where along with Natura’s products and special offerings there were articles on
related health and beauty issues. In the same manner as in other Latin American countries, Natura
planned catalogues and magalogues in Brazil, but final decisions and printing were done locally to
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Management was another crucial issue in the operation. Leal stated, “The lack of a professional
pool of talent has been a bottleneck in our international strategy. In the early 1990s, for instance, we
had just one employee who spoke proper English. Now this has changed.”
Carlucci recalled:
Initially, the general manager in Mexico was a Brazilian with experience from other Natura
Latin American operations. However, we hired a Mexican executive with a solid background
in direct selling who had been trained in Brazil and will serve as a shadow executive until 2006
when he will replace the Brazilian. Operating in multiple international platforms has forced us
to develop local employees able to create the same kind of aspiration and bonds that Natura
has in Brazil, but with a local touch.
Mexico could also be used as a platform to enter the attractive American market. In 2005, O
Boticário had seven stores and a presence in 26 department stores in Mexico City. An O Boticário
executive stated:
Mexico became [O Boticário’s] biggest expansion market, [and] it is the door to the U.S.
economy. Because there are lots of U.S. companies in Mexico and lots of Mexicans living in the
United States who visit their families across the border, our [presence] in Mexico City builds
our brand name. So, if one day we decided to open stores in Texas, we’d already have name
recognition there.38
Natura shared similar views, but with an edge, as elaborated by Leal: “The American West Coast
would be an obvious market to go to. Its society is environmentally engaged, and it has the wellbeing concept already entrenched in its culture. However, we believe we need to expand to places
where people are looking for something different, places where Natura evokes singular feelings and
aspirations.”
According to Natura’s executives, the expansion of international operations could create logistical
problems in the future since Natura’s products were developed, manufactured, and shipped from
Brazil to warehouses and distribution centers in each country. Passos explained:
This has obliged us to not only manage increasingly small quantities of SKUs [stockkeeping units] in different locations but also to deal with different sizes, labels, ingredients,
and regulations. At this stage cost is not a problem, but service is. Therefore, we have thought
about alternatives to anticipate solutions and tackle the upcoming problem. They range from
the management of higher local stocks to the possibility of manufacturing some products in
proprietary or outsourced plants in other regions.
Creating a Global Face
In 2005, Natura’s international sales accounted for 3% of consolidated total sales with results still
below break-even. “The percentage of revenues generated abroad will be always the result of our
efforts abroad and our growth in Brazil, which has a disproportional weight on this equation,” Leal
summarized. Another senior executive added, “We have approximately 0.4% of the Latin American
market share, and we expect to have something between 5% and 10% in 10 years. At the end of the
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avoid cultural clashes and to minimize costs. In addition, the company adapted pricing policies to
each country to reflect local income levels.
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The right business model to be used in these multiple platforms remained a source of debate
inside the company. Leal explained:
We have to develop a discipline to implement a defined strategy. When we have too many
options it is easy to lack focus and energy. Consistency is key, and we have to avoid the
temptation of using shortcuts. In 2005, for instance, we had the opportunity to analyze the
acquisition of an important stake in a global company. It had a strong brand and a well-placed
network of stores spread out in the main developed markets. However, after many tense
internal discussions, we decided to decline it. We thought the combination of two brands and
distribution channels wouldn’t be complementary, could jeopardize Natura’s culture and, over
time, destroy brand value.
A partnership with another international company was also under discussion at that time. “It is
not clear to the management that in order to create a global brand it is necessary to have an
international partner, even one with strong direct-selling expertise. To preserve our values and beliefs
is fundamental, and a new partner will just know to sell its own brand,” stated Seabra.
It was the search for new opportunities that had led the three founders to Russia in the fall of
2005. Russia had a $6.4 billion fast-growing cosmetic and toiletries market. The share of the market
held by direct-sales companies had grown from 5.4% in 1999 to 18.7% in 2004, encompassing
approximately 1.6 million consultants. The direct sellers Avon and Swedish-owned Oriflame had
recently become the market leaders, ousting both traditional retail competitors such as P&G and
L’Oréal and local manufacturers, led by the company Kalina. On the other hand, Russia was still
known as a market with strong bureaucratic obstacles, poor legislation in terms of product quality,
counterfeiting, and tough competition. 39 Seabra found Moscow, in which the founders had sat for
hours in traffic jams, somewhat bewildering, and was disturbed by the apparent materialism of
people whose consumption had for so long been subdued.
While observing the focus group discussion behind two-way mirrors, the founders quickly
observed that the Russians were not very concerned about environmental sustainability, knew little
about Brazil, and knew nothing at all about Natura. Nevertheless, they placed the company’s
products alongside well-regarded Russian and international brands in terms of pricing and value
perception. While Passos and Leal checked out some figures and projections, Seabra gently smiled as
he observed, “Data analysis and metrics will be always important tools, but the emotional touch is
fundamental to making a decision.”
As they walked back to their hotel through Red Square, the three founders had more questions
than answers. Russia could be a great opportunity, but was it still too soon for Natura to pursue it? If
not Russia, where else should the company look to expand, and what criterion should be used to
decide whether or not to invest? Could a Brazilian brand ever have the same global cachet as one
based in France or the United States? Should Natura consider further globalization through
acquisition or permit itself to be acquired by an established global player? Or should it try to grow
internationally by trying to find independent entrepreneurs abroad who shared Natura’s values?
Were Natura’s strong ethical and environmental commitments a source of competitive advantage in
global markets, or a liability which was blocking the pursuit of profitable opportunities?
17
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Use outside these parameters is a copyright violation.
day, we will be always a Brazilian company with several international platforms growing at a fast
pace.”
807-029
Natura: Global Beauty Made in Brazil
Sales of Cosmetics and Toiletries by Selected Major Market (US$ billions)
2004 Sales
2004 Global
Sales (%)
1999 Sales
1999 Global
Sales (%)
United States
Japan
France
Germany
United Kingdom
Brazil
China
Spain
Russia
Mexico
South Korea
India
Argentina
Philippines
Venezuelaa
Colombia
Others
45.6
30.7
14.0
12.4
11.6
9.8
8.2
6.9
6.4
5.3
4.7
3.3
1.5
1.5
1.3
1.2
66.5
19.7%
13.3%
6.1%
5.4%
5.0%
4.2%
3.6%
3.0%
2.8%
2.3%
2.0%
1.4%
0.6%
0.6%
0.6%
0.7%
28.7%
41.3
27.3
9.4
9.6
9.1
7.2
5.1
4.0
3.6
4.3
3.3
2.6
2.8
1.5
1.2
1.2
47.2
22.9%
15.1%
5.2%
5.3%
5.0%
4.0%
2.8%
2.2%
2.0%
2.4%
1.8%
1.4%
1.5%
0.8%
0.7%
0.6%
26.3%
Total
230.9
100.0%
180.7
100.0%
Source:
Adapted by casewriter from “The World Market for Cosmetics and Toiletries,” Euromonitor, October 2005, and
“Cosmetics and Toiletries in Venezuela,” Euromonitor International, August 15, 2005.
aVenezuelan bolivar converted to American dollars by the exchange rate of the last available day of the year. Available at
http://www.bankofcanada.ca/en/rates/exchform.html, accessed April 12, 2006.
Exhibit 2
Global per Capitaa Spending on Cosmetics and Toiletries, 2004, in US$
France
United Kingdom
Russia
United States
Argentina
Brazil
Chile
Colombia
Mexico
Venezuela
China
Thailand
Source:
Fragrance
Color
Cosmetics
Skin Care
Others
All Cosmetics and
Toiletries (CT)
All CT, % of
GDP per Capita
36
19
9
21
5
9
7
4
8
4
0
1
26
27
6
29
3
4
6
2
6
10
1
3
60
29
6
25
5
6
8
4
7
7
2
8
113
120
24
86
26
36
44
18
30
29
3
14
234
195
45
160
39
55
65
28
51
50
6
26
0.7%
0.5%
1.1%
0.4%
1.0%
1.7%
1.2%
1.4%
0.8%
1.2%
0.5%
1.0%
Adapted by casewriter from Lore Serra and Robert Wertheimer, “Natura: Great Company; suggest waiting for better
entry point,” Morgan Stanley, May 24, 2005, available at Investext, accessed November 12, 2005.
aPer capita calculation includes total population, men and women.
18
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Use outside these parameters is a copyright violation.
Exhibit 1
Natura: Global Beauty Made in Brazil
Natura’s Timeline
1969
Natura is founded by Luiz Seabra
1974
Introduction of direct-sales system
1979
Establishment of the Natura System as a group of several companies
Guilherme Leal joins the company
Launches its first men’s product line, Sr. N
1980
Brand recognition in Brazil
1981
Introduces makeup and fragrances for the first time
1982
Starts operations in Chile
1983
Pioneering in the launch of products with refills
Pedro Passos joins the company
Regional and product portfolio expansion
1986
Launches Chronos product line, its first generation of anti-signs facial treatment
1989
Merger of the companies that integrated the Natura System
Introduction of external auditors
1990
Natura states its “Reasons for Being and Beliefs”
1992
Establishes the Truly Beautiful Women concept, stating that beauty is not a matter of age, but
of self-esteem
1994
Launches Mamãe e Bebê product line
Starts operations in Argentina and Peru
1995
Creates “Crer para Ver” program with Abrinq
1998
Creates the Board of Directors
1999
Audit and Risk Management Committee
Acquisition of Flora Medicinal
2000
Launches Ekos product line, made from Brazilian biodiversity in sustainable way
2001
Construction of Cajamar plant
Creation of the Human Resources Committee
2002
Creation of Sustainability Committee
Catalogue Vitrine Natura is launched
2003
Elected as The Best Company for Women to Work for
2004
Obtains the NBR ISO 14001 certification
Floats shares through an IPO
2005
Starts operations in France
Starts operations in Mexico
Source:
For use only in the course RSM 392 - Strategic Management at University of Toronto - Rotman School of Management from 9/3/2024 to 12/31/2024.
Use outside these parameters is a copyright violation.
Exhibit 3
807-029
Compiled by casewriter from Natura’s annual reports.
19
Page 91 of 213
Page 92 of 213
A line of premium makeup products
containing ingredients that protect
the skin and use tested and patented
formulas. It includes face, eye, and
lip products.
Natura Única
Natura.
Consists of personal-hygiene
products, including pregnancy and
baby products.
Mamãe e Bebê
Source:
Tododia
Consists of perfumery and personalhygiene products using the
resources of Brazil’s biodiversity and
inspired by the traditional recognition
of plant ingredients. The natural
ingredients used are obtained in a
sustainable manner and the line’s
products are biodegradable. Refills
are offered for some products.
Natura Ekos
Offering alternatives for all ages,
genders, and styles. The line
includes fragrances, perfumes, antiperspirants, and hydrating emulsions
that vary according to price,
wrapping, and mode of use.
A wide variety of products developed
for day-to-day use, utilizing natural
ingredients such as milk, sugar. and
honey.
A complete cosmetics and personal
hygiene line directed at the modern
young woman. It offers products for
skin treatment, cosmetics, and
fragrances.
Description
For use only in the course RSM 392 - Strategic Management at University of Toronto - Rotman School of Management from 9/3/2024 to 12/31/2024.
Use outside these parameters is a copyright violation.
Fragrances
and perfumes
Faces Natura
A line offering a variety of options for
facial treatment developed for
women over 30. It also includes a
variety of skin cleansing, toning, and
hydration products, as well as antisigns skin-care products, divided into
three categories for women aged 30
to 45, 45 to 60, and over 60.
Product Line
Chronos
Picture
Description
Natura’s Main Line of Products, 2005
Product Line
Exhibit 4
Picture
807-029
-20-
Natura: Global Beauty Made in Brazil
Brand Attribute Survey—Selected Indicators in Brazil, 2003
Brand Attributes
Natura
O Boticário
Avon
Niveaa
Transparency
Social responsibility
Reliability
Innovation
Quality
A brand the person would buy again
A brand a person would recommend
Brand preference
51%
54%
63%
59%
70%
58%
60%
41%
48%
43%
54%
47%
61%
41%
43%
24%
35%
29%
45%
37%
45%
54%
47%
17%
13%
11%
18%
12%
23%
20%
18%
3%
Source:
Daniela M. Bretthauer and Bernando T. Carneiro, “Natura: Natural Growth in Brazilian Consumer Sector,”
Santander Investment, February 22, 2005, available at Investext, accessed November 12, 2005.
Note:
For a given brand attribute, 2,200 men and women of various social classes in six Brazilian cities compared Natura’s
position with those of its main competitors.
aLeading Beiersdorf brand in Brazil.
Exhibit 5b
Source:
Value Perception Times Price in the Brazilian Cosmetics and Toiletries Market
Adapted by casewriter from Juliana Rozenbaum and Iram Yuji de Siqueira, “More than a pretty face,” Itaú Corretora,
July 6, 2004, available at Investext, accessed November 12, 2005.
21
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Use outside these parameters is a copyright violation.
Exhibit 5a
807-029
807-029
Natura: Global Beauty Made in Brazil
Natura’s Financial, Business, and Social Performance (in R$ millions, as of December 31)
2005
2004
2003
2002
2001
3,150
93
1
3,244
2,282
564
533
397
112
11
1,369
521
(200)
2,472
67
1
2,540
1,770
432
395
300
83
(3)
1,016
436
(91)
1,860
48
2
1,910
1,329
296
230
64
24
(30)
724
354
(19)
1,375
35
1
1,411
993
199
121
22
25
(44)
647
226
119
1,140
28
-1,168
876
120
72
10
7
(36)
600
209
205
4,496
3,531
2,652
1,952
--
11,984
519
11,277
433
10,283
375
8,875
322
-299
213
0.63
551.8
55.0%
27.7
182
0.67
603.7
39.5%
28.8
117
0.87
785.2
29.0%
35.5
91
1.22
1,025.7
16.0%
47.4
165
1.65
1,252.1
-67.1
2.2855
2.7182
2.9253
3.6259
2.3627
Financial Performance
Domestic gross sales
International gross sales
Other sales
Gross operating revenues
Net operating revenues
EBITDA
Operating income
Net income
Investments
Financial income
Total assets
Shareholders’ equity and profit-sharing debenture
Net indebtedness
Business Performance
Consolidated business volume (in R$ millions)
Consolidated business volume per sales
(in R$ per sales representative/year)
Number of sales representatives (in thousands)
Research & Development
Number of products launched
Water consumption per unit sold (liters/unit)
Energy consumption per unit sold (joules/unit)
Water reuse (% of total water treated)
Generation of waste per unit sold (grams/unit)
Exchange Rates
Exchange rate as of December 31, US$1.00
equal to R$
Source:
Natura annual reports and Banco Central do Brasil, “Economia e Finanças—Séries Temporais—código 3698,” Banco
Central do Brasil Web site, http://www.bcb.gov.br.
22
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Use outside these parameters is a copyright violation.
Exhibit 6
Page 95 of 213
24%
34%
24%
18%
38%
32%
44%
48%
30%
18%
Share (%)
Natura
O Boticário
Avon
Natura
Colgate
Avon
Unilever
Unilever
Beiersdorf
L’Oréal
#2
10%
23%
20%
14%
13%
11%
14%
16%
13%
16%
Share (%)
L’Oréal
Avon
Beiersdorf
Colgate
Matarazzo
Natura
Natura
J&J
Natura
P&G
#3
8,100
2,700
2,900
-1,400
1,500
1,300
--200
8%
12%
7%
13%
11%
7%
5%
10%
9%
10%
Share (%)
408
192
130
--50
120
--55
Advertising
Expenditure—2003
(R$ millions)
Adapted by casewriter from “Cosmetics and Toiletries in Brazil,” Euromonitor, August 2005, and company reports.
For use only in the course RSM 392 - Strategic Management at University of Toronto - Rotman School of Management from 9/3/2024 to 12/31/2024.
Use outside these parameters is a copyright violation.
Avon
Natura
Natura
J&J
Unilever
Unilever
Gillette
Colgate
J&J
Unilever
Color cosmetics
Fragrances
Skin care
Baby care
Bath & shower
Deodorants
Men’s grooming
Oral hygiene
Sun care
Hair care
Source:
Leader
Product Category Leaders in Brazil
Category
Exhibit 7b
SM = Supermarket, HM = Hypermarket, DS = Direct Selling, P = Pharmacies, D = Drugstores, F = Franchise.
Key:
SM, HM, P, D
DS
DS
SM, HM, P, D
SM, HM, P, D
F
SM, HM, P, D
SM, HM, P, D
SM, HM, P, D
SM, HM, P, D
Net Sales—2003
(R$ millions)
Adapted by casewriter from “Cosmetics and Toiletries in Brazil,” Euromonitor, August 2005, and company reports.
13.0%
11.3%
7.5%
7.4%
6.1%
5.9%
5.0%
2.5%
2.3%
1.8%
Main Retail
Channel
Source:
Netherlands/United Kingdom
Brazil
United States
United States
France
Brazil
United States
United States
Brazil
Germany
Country of Origin
Brazilian Market
Share (%)
Leading Cosmetics and Toiletries Companies in Brazil, 2003
Unilever
Natura
Avon
Colgate-Palmolive
L’Oréal
O Boticário
Gillette
Johnson & Johnson
Belcosa
Beiersdorf
Exhibit 7a
807-029
-23-
807-029
Natura: Global Beauty Made in Brazil
Sales of Cosmetics and Toiletries by Sector in Brazil, 1999–2004 (in %)
1999
2000
2001
2002
2003
2004
Color cosmetics
Fragrances
Skin care
Baby care
Bath and shower products
Deodorants
Hair care
Men’s grooming products
Oral hygiene
Depilatories
Sun care
8.9%
13.4%
9.9%
2.4%
10.1%
6.6%
26.4%
8.9%
14.3%
0.5%
1.4%
9.1%
14.2%
8.5%
2.2%
10.3%
7.1%
27.0%
9.4%
13.4%
0.5%
1.4%
9.1%
15.0%
9.5%
2.6%
9.5%
7.9%
25.1%
9.8%
12.7%
0.5%
1.9%
8.9%
16.5%
9.6%
2.7%
8.4%
8.0%
26.5%
9.9%
10.7%
0.5%
2.2%
7.9%
16.8%
10.9%
2.6%
8.9%
8.1%
26.5%
9.9%
9.7%
0.5%
1.8%
8.1%
16.1%
11.4%
2.6%
8.2%
8.1%
28.7%
9.0%
9.3%
0.4%
1.8%
Total Sales (R$ millions)
Growth from prior year (%)
12,978.3
--
14,247.5
9.8%
16,935.9
18.9%
20,117.6
18.8%
24,141.6
20.0%
28,537.3
18.2%
Source:
“Cosmetics and Toiletries in Brazil,” Euromonitor, August 2005.
Note:
Sum of sectors is greater than the market size because men’s toiletries products are included in men’s grooming and
in the relevant toiletry sector.
Exhibit 9
Sales of Cosmetic and Toiletries through Retail Channels—2004 (in %)
Supermarkets/Hypermarkets
Independent Food Stores
Convenience Stores
Pharmacies/ Drugstores
Discounters
Department Stores
Specialists
Direct Sales
Outdoor Markets
Others
Source:
Brazil
Latin
America
Western
Europe
Eastern
Europe
North
America
Asia
Pacific
39.4
0.3
0.1
10.2
0.1
4.3
16.1
27.4
0.8
1.4
39.2
2.4
1.0
11.6
0.2
4.8
12.0
25.9
0.7
2.2
34.3
3.0
1.5
26.9
3.1
9.8
14.3
4.7
0.4
2.1
16.5
5.4
0.8
10.3
1.5
19.2
13.5
18.9
10.8
3.2
14.8
0.9
0.2
17.3
24.9
17.4
7.0
9.0
0.2
8.2
17.6
5.1
7.2
16.1
3.2
16.0
14.6
17.2
1.2
1.8
“The World Market for Cosmetics and Toiletries,” Euromonitor, October 2005, and “Cosmetics and Toiletries in
Brazil,” Euromonitor, August 2005.
24
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Exhibit 8
Natura: Global Beauty Made in Brazil
Natura’s Ads in Argentina
Victoria Saéz
38 years old
Natura Consultant
The other face of
cosmetics:
Yes. We want to maintain our prices.
Because, as a company, we are part of Society and we bet that
things will be better if each of us does their part, while thinking of
the whole.
Thinking of our Consultants, who will be able to maintain their
activity and bring to their clients Natura’s products and values
with the same enthusiasm.
Thinking of our Suppliers, who will earn more with the increase
in sales volume, and not with the increase in prices and costs.
And thinking of our Customers, who will enjoy the best products
available in the market, at the same prices as ever.
We make this important financial effort because we believe that
from now on companies will begin to be better known not for
what they say, but for what they do.
Source:
Natura. Translated by casewriter.
25
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Use outside these parameters is a copyright violation.
Exhibit 10
807-029
807-029
Natura: Global Beauty Made in Brazil
1 Unless noted otherwise, the sign $ stands for U.S. dollars, and the sign R$ stands for Brazilian reais.
2 Nancy Etcoff, Survival of the Prettiest (London: Abacus Books, 2000), chapters 3 and 4; D. S. Hamermesh and
J. F. Biddle, “Beauty and the Labor Market,” American Economic Review, 84, 5 (1994): 1174–1194; M. M. Mobius
and T. S. Rosenblat, “Why Beauty Matters,” American Economic Review, 96 (2006).
3 Geoffrey Jones, Beauty Imagined. A History of the Global Beauty Industry (Oxford and New York: Oxford
University Press, 2010); Kathy Peiss, Hope in a Jar (New York: Metropolitan Books, 1998).
4 “The World Market for Cosmetics and Toiletries,” Euromonitor, October 2005.
5 “Cosmetic trends in transcultural spaces,” Beauty-on-line newsletter no. 108, available at www.beauty-online.com, accessed December 3, 2005.
6
Adapted from the Economist Intelligence Unit, accessed August 30, 2005. Nominal GDP in US$ at
purchasing power parity.
7 Adapted from “Síntese de Indicadores Sociais—2003” and “Sistema de Contas Nacionais—Brasil—2000—
2002,” IBGE—Instituto Brasileiro de Geografia e Estatística, 2003, available at www.ibge.gov.br; and “Brazil—
Encyclopedia Article,” available at www.encarta.msn.com.
8 Statistics showed that 4.5 million people emigrated to Brazil between 1882 and 1934. Boris Fausto,
“Immigration,” available at www.mre.gov.br/cdbrasil/itamaraty/web/ingles/consnac/imigra/apresent/
apresent.htm, accessed June 24, 2005.
9 Adapted from “Síntese de Indicadores Sociais—2003” and “Sistema de Contas Nacionais—Brasil—2000—
2002,” IBGE—Instituto Brasileiro de Geografia e Estatística, 2003, available at www.ibge.gov.br.
10 “Brazil: Inequality and Economic Development.” A joint report by Instituto de Pesquisa Econômica
Aplicada and Brazil Country Management Unit, Poverty Reduction and Economic Management Sector Unit,
Latin America and the Caribbean Region—Report No. 24487-BR, Volume 1, October 2003, available at
http://wbln0018.worldbank.org/LAC/LACInfoClient.nsf/d29684951174975c85256735007fef12/6bdf1e43f71565
5785256df2005afa04/$FILE/Brazil%20Inequality%20Report_Main_doc.pdf, accessed April 10, 2006.
11 In dollar terms, Brazilian beauty industry total sales went from US$7.2 billion to US$9.8 billion.
12 “Panorama do Setor,” ABIHPEC, available at www.abihpec.com.br, accessed January 12, 2006.
13 Lore Serra and Robert Wertheimer, “Natura: Great Company; suggest waiting for better entry point,”
Morgan Stanley, May 24, 2005, available at Investext, accessed November 12, 2005.
14 Adapted from “Pesquisa Nacional por Amostra de Domicílios—Síntese de Indicadores—2004,” IBGE—
Instituto Brasileiro de Geografia e Estatística, 2004, available at www.ibge.gov.br.
15 Ibid.
16 “Melhores e Maiores,” Revista Exame—Editora Abril, July 2004.
17 “Brasil, império do bisturi,” Revista Veja—Editora Abril, January 17, 2001.
18 Mark Sheldon Lloyd, “An elective with a top plastic surgeon in Brazil,” BMJ Career Focus, available at
www.careerfocus.bmjjournals.com.
19 “Cosmetics and Toiletries in Brazil,” Euromonitor, August 2005, p. 11.
20 Adapted from Larry Rother, “Letter from Brazil: She who controls her body can upset her countrymen,”
The New York Times, April 27, 2006, available at www.nytimes.com, accessed April 27, 2006.
26
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Use outside these parameters is a copyright violation.
Endnotes
Natura: Global Beauty Made in Brazil
807-029
this category primarily obliged the company to (1) issue ordinary shares only; (2) maintain at least 25% of
circulating shares in the capital market; and (3) make annual financial data available in accordance with Brazil
GAAP and U.S. GAAP. Additionally, Natura was the first Brazilian company to adopt, in full, the divulgation
methods recommended by the Global Reporting Initiative (GRI). (For more information, see www.bovespa.com
and www.globalreporting.org.)
22 Michael V. Copeland and Owen Thomas, “Hits & Misses,” CNNmoney, August 1, 2004, available at
www.money.cnn.com/magazines/business2/business2_archive/2004/08/01/377376/, accessed December 2,
2005.
23 In stock-keeping unit (SKU) terms, different colors or sizes of any given product were counted as different
products.
24 For the year ending December 31, 2005, US$1.0 = €0.8445.
25 For the year ending March 31, 2005, US$1.0 = ¥107.20.
26 Juliana Rozenbaum, Deutsche Bank’s senior analyst, interview by authors, São Paulo, Brazil, March 13,
2006.
27 “Natura Fosters New Supplier Relations for Sustainable Raw Materials Use” (case study), Weatherhead
School of Management, March 28, 2006, available at http://worldbenefit.cwru.edu/Innovation/bankInnovation
View.cfm?idArchive=407; and “Placing sustainable development at the center of business thinking,” World
Business Council for Sustainable Development, 2005, available at http://www.wbcsd.org/web/publications/
case/natura_full_case_final_web.pdf.
28 Lore Serra and Robert Wertheimer, “Natura: Great Company; suggest waiting for better entry point,”
Morgan Stanley, May 24, 2005, available at Investext, accessed November 12, 2005.
29 Juliana Rozenbaum and Iram Yuji de Siqueira, “More than a pretty face,” Itaú Corretora, July 6, 2004,
available at Investext, accessed November 12, 2005.
30
Extracted and adapted from “Natura’s Vision and Principles,” Natura corporate site, available at
www.natura.net/portal_ri/ing.
31 Geoffrey Jones, Renewing Unilever (Oxford: Oxford University Press, 2005), pp. 174–179.
32 “Panorama do Setor,” ABIHPEC, available at www.abihpec.com.br, accessed January 12, 2006.
33 Marcelo Mesquita, Marcio Brito, and Tina Barroso, “Natura Cosméticos: The Brazilian Beauty,” UBS
Investment Research, July 6, 2004, available at Investext, accessed November 12, 2005.
34 Adapted by casewriter from www.boticario.com.br/portal/site/home/.
35 Daniela M. Bretthauer, “Natura,” Santander Investment—Latin American Equity Research, June 25, 2005,
available at Investext, accessed November 12, 2005.
36 Ibid.
37 “Cosmetics and Toiletries in Mexico,” Euromonitor International, September 16, 2005.
38 Michael Kepp, “Best face forward: Brazil’s homegrown cosmetics companies are building global brands,
step by step,” Latin Trade, June 2005, available at Factiva.
39 “Cosmetics and Toiletries in Russia,” Euromonitor International, June 2005.
27
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21 The “Novo Mercado” encompassed a stringent set of greater corporate governance demands. Entrance to
PUBLISHED ON
AUGUST 25, 2022
THE JEROME
CHAZEN CASE
SERIES
Zara’s Sustainability Dilemma
BY VANESSA BURBANO, * BENNETT CHILES, * AND DAN J. WANG ‡
With €27.7 billion in 2021 sales and over 6,650 stores globally , Inditex was one of the most
valuable fashion companies in the world. 1 The company’s growth was remarkable,
considering that just two decades earlier, Inditex had just 622 stores and €1.2 billion in sales
across fashion and home goods retail. 2 The company’s success was predicated on what
analysts referred to as a “fast-fashion” retailing strategy – which was deployed primarily
through its flagship brand, Zara – prompting many other fashion retailers to replicate the
model across the world.
In June 2022, Zara launched its first limited-edition “sustainable fashion” line. Textiles used in
collection were produced using a technique that transformed carbon-dioxide emissions – that
would have escaped into the atmosphere – to create low-carbon polyester yarn.3 The release
of its sustainable fashion collection was a major shift for Inditex. Zara was a pioneer of fast
fashion, an innovative model of fashion design, production, and distribution that was adopted
a wave of retailers such as such as H&M and Asos. Yet, for years, Zara faced criticism from
consumers and investors alike that this very model contributed to the acceleration of climate
change through its supply chain practices, which entailed overproduction, waste, and
excessive fossil fuel emissions. In response, Inditex issued its first annual sustainability report
in 2019 committing to several long-term goals, including net zero carbon emissions by 2040.4
As the pressure to clean up its production processes intensified, Inditex was also grappling
with the emergence of ultra-fast fashion companies. Consumers were increasingly attracted to
brands like Shein, a digital-first fashion retailer headquartered in Nanjing, China, that
achieved even quicker turnaround and release times than Zara, becoming a fixture for Gen Z
shoppers. In April 2022, Shein’s valuation was estimated at $100 billion, exceeding Inditex’s
market capitalization of $77 Billion at the same period. 5 Between sustainability-conscious
Author affiliation
*
Assistant Professor of Business, Columbia Business School
‡
David W. Zalaznick Associate Professor of Business, Columbia
Business School
Copyright information
© 2018-2022 by The Trustees of Columbia University in the City
of New York. This version of the case replaces an earlier version
that was published on August 30, 2018.
This case is for teaching purposes only and does not represent an
endorsement or judgment of the material included.
This case cannot be used or reproduced without explicit permission
from Columbia CaseWorks. To obtain permission, please visit
www.gsb.columbia.edu/caseworks, or e-mail
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ID#190401
The Origins of Zara
Industria de Diseño Textil (Inditex) was founded in 1963 in Spain. The company was founded
by Amancio Ortega, who began by making and selling dresses and dressing gowns. In 1975,
the first Zara store opened in La Coruña, in northwest Spain, a region known for its
concentration of textile factories. More Zara locations were opened throughout Spain, and in
1988 Zara expanded internationally, opening a store in Porto, Portugal.
By 2021, Inditex had 2,220 stores in 88 countries. Via its eight retail concepts, Zara, Pull & Bear,
Massimo Dutti, Bershka, Stradivarius, Oysho, Zara Home, and Uterqüe, Inditex offered its
customers “the latest fashion trends (clothing, footwear, accessories and household textile
products) at attractive prices, in due time and with high quality and sustainability standards.”6
Inditex operated what its management described as a “fully integrated online and store
business,”7 and each of its retail concepts was carried out through a store and online model.
Zara, Inditex’s flagship retail concept, contributed 66% of the company’s sales and 70% of
Ebitda. (See Exhibit 1 for a company timeline, Exhibit 2 for Inditex’s historic sales growth,
Exhibit 3 for a financial summary for each retail concept and a breakdown of sales by country,
and Exhibit 4 for a breakdown of Zara stores by country.)
Zara’s Business Model
PRODUCT DESIGN
Commercial and design teams have a clear customer orientation. Inditex listens and
transmits the demands of the clients both in stores and online to the teams…[who] use this
information to react quickly, manufacturing the desired items in very short lead times, in
order to make them available for sale as soon as possible.8
—Inditex 2017 Annual Report
Inditex employed more than 700 designers, based exclusively at its headquarters in Spain.
These designers produced 65,000 new designs per year, utilizing technology, such as radio
frequency identification (RFID) chips embedded in Inditex products, to understand consumer
demand. This “hard data” on which styles, colors, etc. were selling was supplemented by the
use of “soft data.” Soft data included feedback from frontline store personnel on what
customers in the stores were saying. Inditex had worked hard to ensure that information
flowed efficiently throughout the company.9 One article described that this was reinforced by:
…getting various business functions to sit together at the headquarters and also by
encouraging a culture (through structures and processes) where people
continuously talk to each other. The sales and marketing teams who receive trend
feedback talk regularly with designers and merchandisers. It is important that there
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consumers pushing for Zara to slow down and competition from even faster competitors
pressuring Zara to speed up, Zara was caught in a dilemma: in which direction should the
company adapt its strategy? Which stakeholders were most important for Zara to sustain
long-term competitive advantage?
is constant two-way communication so that sales and marketing teams can talk
about new lines to customers and designers/merchandisers have a strong visibility
of customers’ needs and preferences enacted at a store level.10
It took 15 business days on average for Inditex’s designs to move “from drawing board to
store.”11, 12 This compared with industry norms of a six- to nine-month product cycle for “basic
items” and 16 weeks for seasonal items.13 One analyst explained that the quick product cycle
enabled Inditex to “exist on the curve, evaluating trends first, then following.”14
Inditex would generally cut fabric in its company-owned factories and then ship the fabric
pieces out to small studios to be sewed. The completed garment would then be returned to the
factory, where it was ironed, wrapped in plastic, and shipped.15 Fifty-nine percent of Inditex’s
products were manufactured in factories and studios in Spain, Portugal, North Africa, and
Turkey, many of which Inditex owned. 16 By contrast, competitors like Gap sourced almost
exclusively from countries in Asia and Latin America through partnerships.17 (See Exhibit 5
for labor costs in the textiles industry globally.) Overall, Inditex worked with 824 suppliers in
7,210 factories in 47 countries. Factories farther from Inditex’s Spanish headquarters produced
items considered to be less trendy—and, as such, time to market was less of a concern. They
also produced large quantities of unfinished “greige goods,” raw fabric that had not yet been
dyed or printed, which sat ready so that finishers could quickly transform it into products for
sale based on demand. This kept waste to a minimum, lowering material costs. Inditex’s
factories generally operated very leanly on a 4½-day workweek, allowing for excess capacity
to respond to increased demand as needed.18 (See Exhibit 6 for a list of countries in which
Inditex factories were located.)
New merchandise was delivered to each Inditex store at least two times per week.19 From its
10 company-owned logistics centers in Spain, 20 Inditex was able to get products to every
company store in less than 48 hours via the selected use of air shipping. 21 That way, if a
particular color was selling out or a style was selling slowly, the company could adjust its
orders accordingly. Airfreight was also used selectively to transport goods from factories in
Asia to distribution centers in Europe. One analyst estimated that 36% of Inditex’s inbound
shipments to the Americas, Asia, and Africa traveled via air, and 15% of goods traveling
inbound to Europe were shipped via airfreight. 22 By contrast, traditional fashion retailers
relied almost entirely on sea-based shipping. A study by the World Bank concluded that
airfreight was “typically priced 4–5 times that of road transport and 12–16 times that of sea
transport.”23
Inditex produced most items in small batches. Because of this, one industry observer
commented, “With Zara, you know that if you don’t buy it, right then and there, within 11
days the entire stock will change. You buy it now or never.”24 Inditex embedded RFID chips
in the plastic security tags attached to each garment (allowing the chips to be reused, because
the security tags were detached at the point of sale). RFID was piloted by Inditex in 2007, and
the company eventually purchased 500 million RFID chips in order to roll out the technology
to all its stores.25 The chips emitted radio signals to scanners transmitting detailed product
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MANUFACTURING AND DISTRIBUTION
In 2015, Stanford professor Dr. Warren H. Hausman analyzed data from 53 businesses in an
effort to understand the impact that promotional and markdown strategies had on prices. He
determined that discounted items at U.S. apparel retailers and department stores generally
constituted 50% to 70% of total items. However, Zara typically discounted only 15% of total
items. The percentage discount that Zara employed on marked-down items also tended to be
lower than that of its competitors. Hausman dubbed this differential the “Zara Gap.”27 (See
Exhibit 7 for more details on this gap.)
STORE NETWORK
Inditex’s stores were largely company owned. (See Exhibit 8 for a breakdown of companyowned and franchised stores.) The company utilized an “oil stain” pattern when launching in
a new market; it would open a large flagship store and follow up with smaller stores in the
same market, allowing for greater economies of scale. 28 Inditex’s communications director,
Jesus Echevarría, elaborated, “When we open a market, everyone asks, ‘How many stores will
you open?’…Honestly, I didn’t know. It depends on the customer and how big the demand is.
We must have the dialogue with the customers and learn from them. It’s not us saying you
must have this. It’s you saying it.”29
Stores were in high-profile shopping areas, often next to high-end designers like Gucci and
Prada. The company made its stores look like designer boutiques; with the appearance and
positioning of these stores effectively acting as brand advertising,30 and each of Inditex brand’s
stores had a “distinctive store aesthetic.”31 As the company website stated, “Our stores are
where our relationship with customers is forged… Everyday face-to-face interaction between
our customers and store staff is all-important for our fashion decisions, helping us understand
customer needs.”32 This focus on the customer experience was important to Zara’s strategy. As
one industry analyst noted, shoppers visited Zara stores two to three times more frequently
than a typical women’s apparel retailer. 33
In 2011, Inditex paid $324 million for retail space in 666 Fifth Avenue, one of New York’s most
high-profile commercial addresses.34 The company had invested in other highly visible and
costly metropolitan locations globally. Between 2014 and 2017, Inditex’s leasing costs averaged
10% of revenues. And capital expenditure, which was largely driven by the opening of new
physical space, averaged 7.5% of revenues.35
MARKETING
Inditex did very little marketing. However, the firm had worked to develop a strong brand—
Zara ranked number 24 on Interbrand’s Best Global Brands of 2017.36 One analyst described
the company’s approach to marketing: “Our billboards are our store windows.”37 Whereas
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information. This allowed inventory to be tracked real-time and allowed for automated
inventory reordering. A periodic stock take could be completed in half the time—with store
personnel simply waving a scanner as they walked across the floor to pick up the RFID chip
data. (Previously, each item’s tag would have been individually scanned.) Sales associates also
used the RFID chip data to help customers find items not available at a particular store. While
many other retailers were experimenting with RFID technology, Inditex was the first to
implement it on a wide-scale basis.26
most fashion retailers spent 3% to 4% of sales on advertising, Inditex’s advertising expense
was just one-tenth of this industry average.38
Apparel Industry
The global apparel and footwear market generated $1.4 trillion in sales in 2021 and was
forecasted to grow at a 2.6% CAGR through 2028. Geographically, the biggest growth markets
over the next few years were expected to be India and China.39 (See Exhibit 10 for a breakdown
of industry sales by category and region.)
The retail fashion landscape included a range of players: department stores (e.g., Macy’s,
Nordstrom), discount stores (e.g., Target), online-only retailers (e.g., Shein, Amazon, ASOS,
Boohoo), and specialty retailers (e.g., Zara, Gap, H&M). Globally, specialty retailers accounted
for 58% of apparel and footwear sales, representing the largest retail channel. Department
stores accounted for 15% of sales.40
SELECTED COMPETITORS
Gap
The first Gap store was opened in 1969 in San Francisco. The company went public in 1976. In
1993, it acquired Banana Republic (an apparel chain with a more upscale focus), and in 1994
Gap launched Old Navy (an apparel chain with a discount focus). Gap also owned Athleta, an
athletic apparel retailer, and Intermix, a retail concept focused on younger customers and upand-coming third-party designers.
It achieved high growth and profitability through the 1980s and much of the 1990s, with its
extensive collections of T-shirts, jeans, and “smart casual” work clothes. More than 90% of
Gap’s production was outsourced from outside the United States and shipped to its stores,
most of which were based in the United States. Like many typical industry competitors, it had
long lead times between design, manufacturing, and in-store arrival.
Gap had experienced challenging results in recent years. Supply chains had become too long,
the market was saturated, and the company lacked a clear positioning. A failed attempt to
reposition to more fashion-forward clothing in 2001 led to the departure of its CEO. In June
2015, Gap announced it would close 25% of its North American stores over the next few years.41
One analyst complained that the company’s response to weak sales growth had been to take
the “easy” way out of this problem by pushing lower-priced products in order to generate
sales rather than focusing on its higher-end brand, Banana Republic.42 Moreover, while Gap’s
sticker prices tended to be, on average, similar to those at Zara, Gap relied heavily on
promotional pricing, including “Gap Cash,” where customers who purchased goods could
credit a percentage of that purchase price when buying items at a later date. Art Peck, who
was named CEO of Gap in 2015, had described attempts to wean customers off the constant
promotional pricing cycle as a “game of chicken”—with decreased promotional activity
leading to weak sales.43
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(See Exhibit 9 for selected financial data for Inditex.)
Peck favored a decentralized approach to product design. Following the 2015 departure of
Gap’s creative director, Rebekka Bay, who had joined the company in 2012 from H&M, Peck
opted not to replace her and to let go of the creative directors for the company’s other brands,
calling them “false messiahs.” In their place, Peck installed operational executives at the head
of each of the company’s brands and pushed product teams to focus on increasingly available
data on customer tastes. “There is now science and art, and they can come together,” Peck
stated.44 Peck also focused on reducing product lead times. In 2017, he announced that the time
frame from design board to store on some products had fallen from 10 months to 10 weeks.45
Gap began selling clothes online in the United States in 1997 and started online sales outside
the United States in August 2010. To support its online operations, Gap had invested in local
distribution centers in the U.K., from which it serviced online operations in Europe, Canada,
China, and the United States. Additionally, in countries where some Gap brands did not have
a physical presence, Gap partnered with online vendors.46 Approximately 16% of Gap’s total
sales were online. 47 In the United States, Gap charged $7 for standard shipping on orders
below $50; shipping was free on orders of $50 or more. Items purchased online could be
returned or exchanged online or in store for no charge.
(See Exhibit 11 for selected financial data.)
Hennes & Mauritz
Hennes & Mauritz (H&M) was founded in Västerås, Sweden, in 1947. By 2018, H&M had
more than 4,700 stores in 69 markets. Only 219 of the company’s stores were franchised.
Franchised stores were primarily in the Middle East. The company also offered online sales
in 44 markets. H&M had a number of retail concepts, including H&M; COS; Weekday;
Cheap Monday; Monki; H&M Home; & Other Stories; and Arket. H&M put out a spring and
a fall collection, in line with traditional apparel industry practices, but also offered a number
of sub-collections to keep merchandise fresh.
In 2008, H&M expanded into home furnishings. Over the years, H&M had launched a number
of high-profile collaborations with well-known designers, including Karl Lagerfeld, Stella
McCartney, Viktor & Rolf, Roberto Cavalli, Marimekko, Matthew Williamson, and Jimmy
Choo. The company had also released clothing collections designed with pop stars, including
Madonna and Kylie Minogue.
Like Zara, H&M was considered a “fast-fashion” retailer. It aimed to “offer fashion and quality
at the best price in a sustainable way.”48 H&M’s sticker prices were slightly below Zara’s, and
its stores tended to offer a larger product assortment, i.e., more stock keeping units (SKUs). At
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As of 2017, Gap had 3,165 company-owned and 429 franchised locations in North America,
Europe, and Asia. Gap’s products were manufactured by third party factories, none of which.
Gap owned. The company utilized 800 vendors in 50 countries. Substantially all of these
factories were outside the United States, with 25% of 2017 inventory purchases from factories
in Vietnam, and 22% from China.
H&M had a team of approximately 150 designers and 100 buyers based in Sweden who
created its clothing collections. Production was outsourced to a network of 800 suppliers;
40% of production was done in Europe, and 60% in Asia. (At Inditex, on the other hand, 59%
of items were produced at factories in Spain and neighboring countries.)50 Product logistics
were managed by a network of nearly 30 production offices, close to the company’s
suppliers. These offices selected suppliers, reviewed samples, and checked quality. Similar to
the method employed by Inditex, trendier products with shorter lead times were produced
in Europe.51
H&M’s online business accounted for 13% of the company’s total 2017 sales, and 22% of H&M
profits. 52 Analysts criticized the lack of integration between H&M’s online and physical
shopping channels—in-store pickups were available only in the U.K., and in-store returns
were available in only one-third of markets where H&M had an online presence. 53 In the
United States, H&M offered free shipping on orders over $40. Below that amount, standard
shipping was $3.99 per order. Items could be returned in store (no charge) or via mail (at a cost
of $5.99).54 In the United Kingdom, H&M launched H&M Club in 2017. Shoppers who signed
up for this free loyalty program earned points with every purchase and received other perks,
such as free online shipping and birthday discounts.55
In recent years, H&M had struggled. Sales grew only 4% in 2017, and profits declined. Analyst
Michael Dart commented,
Consumers have felt that H&M has been somewhat drab and not on trend as much
as competitors…With a slower supply chain (unlike super-fast Zara), they have not
responded as quickly to rapid shifts in taste and increasing fragmentation in the
consumer market with many more small segments. As a result, they have had more
markdowns, promotions and less inspiration for the consumer. It’s a formula for
sagging results.56
In response to its recent challenges, H&M had launched a turnaround plan that included
improved online offering and improved stock management using RFID technology.57 Looking
forward, company targets included 10% to 15% sales growth in local currencies, diversification
of categories to reduce dependence on apparel, expansion of its brand portfolio, and online
growth.58
(See Exhibit 12 for selected financial data.)
A Sustainability Dilemma
ENVIRONMENTAL ACTIVISM AND FAST FASHION
Led by Zara, the fast fashion sector was valued at close to $99 billion USD in 2022.59 Yet, even
before Zara rose to market prominence, social activists had publicized the risks that the
dominant business practices of fashion retail posed to the natural environment. According to
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H&M, however, stock was replenished less frequently. And its customer base was younger
than the typical Zara customer—15 to 25 years old, versus 18 to 35 for Zara.49
Although climate change activists had long surfaced the harms that the fashion industry posed
to the environment, until 2015, the issue lacked widespread exposure among the general
public. A watershed moment came on April 24, 2015 when the documentary film The True Cost
premiered at the Cannes Film Festival, coinciding with Fashion Revolution Day. The
documentary aimed to shed light on labor practices and the environmental cost of fast
fashion’s business model. Although it received mixed critical reviews, the film ultimately
reached tens of millions of viewers across streaming platforms. By 2018, other climate change
activism organizations, such as the Sunrise Movement in US and Extinction Rebellion in the
UK had attracted millions to their protest campaigns, explicitly targeting fashion retailers. In
the years since, climate change protests had become fixtures outside of major fashion events.
These protests achieved social media virality on October 5, 2021 when a climate activist
associated with Extinction Rebellion walked the entire length of runway at the Louis Vuitton
show during Paris Fashion Week, carrying a banner with the words “Overconsumption =
Extinction.”63
ZARA’S PLEDGES AND PRACTICES
In addition to pressure from social activists, Inditex and its competitors also faced calls from
shareholders and investors that were increasingly benchmarking their performance against
emerging ESG (environment, social, and governance) standards. For example, in 2022, among
public companies, 33% of shareholder resolutions concerning social and environmental impact
were approved, an increase from a 22% approval rate just five years earlier. 64 Influential
shareholders, such as Blackrock, had also pledged to vote against appointing directors who
did not commit to acting meaningfully on issues such as climate change. The wave of
shareholder activism was felt especially in the fast fashion sector. Even private companies like
Shein sought to appoint new executives focused on raising its ESG profile as it prepared to go
public out of concern that investors would object to the company’s supply chain practices.65
Inditex’s most public response to critics came in the form of an announcement in July 2019 to
commit to several goals. 66 Most of its commitments concerned the usage of materials,
including converting to 100% sustainable cotton, zero waste in offices and logistics centers,
and eliminating single-use packaging by 2023. By 2025, the company promised to use
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a Morningstar report in 2022, the fashion industry was responsible for 10% of annual carbon
emissions worldwide, 20% of wastewater is used for fabric dyeing and treatment, and 190,000
metric tons of microplastic pollution from textile manufacturing each year end up in the
Earth’s oceans (about 35% of the total).60 In addition, as fast fashion retailers like Zara shifted
away from natural materials, such as cotton, toward synthetic fabrics, such as polyester, fast
fashion’s per-garment carbon footprint was 25% larger than the traditional fashion retailer.
Finally, the same Morningstar report found that “85% of the clothing that Americans consume
is sent to landfills as solid waste…per year”, most of which is non-biodegradable. 61 , 62
Therefore, although the average fast fashion retailer produced about same total volume of
apparel each year as an average traditional fashion retailer, its rapid turnover of clothing lines
encouraged more frequent buying and consequently, more waste.
To enforce these commitments, Zara pledged to work with its manufacturing and supplier
partners to restructure their sourcing, design, and production processes. Doing so, however,
required sustained long-term investments of both human and financial capital, raising the
company’s costs significantly. The high cost of producing sustainable fashion, according to
industry analysts, was largely why only luxury or niche brands, which had considerably larger
profit margins, chose to engage in sustainable production.
Furthermore, although Zara was public in its commitments, other critics suggested that Zara’s
goals were simply another case of “greenwashing": deploying seemingly environmentally
responsible strategies that are mainly meant to market the “greenness” of a company’s
practices while actually improving the company’s environmental performance only
marginally, if at all. 68 Although many acknowledged that these were steps in the right
direction, Zara’s proposed changes did not address the core reason behind the environmental
harm imposed by the company and its competitors: the fast-fashion business model itself.
Because the company relied on quick turnovers, its profitability came from customers buying
and discarding large amounts of Zara clothing, which in turn meant excessive amounts of waste.
In other words, the sheer volume of production was the main culprit for many climate change
activists while the culture of widespread affordable yet trendy clothes made it harder for
consumers to quit fast fashion.
Zara and other fast fashion retailers faced an even more vexing dilemma with the growing
buying power and cultural influence of younger consumers. Gen Z shoppers – defined as those
born between 1997 and 2012 – were among the loudest voices in agitating for environmental
action. Climate change was often being their number one issue concern when polled across
public opinion surveys. 69 Likewise, among fashion resale and thrifting companies such as
Depop, Gen Z shoppers also composed the majority of their consumer base.
Yet, at the same time, younger shoppers were also a major consumer force sustaining the
growth and popularity of fast fashion retailers, which included both established players like
Zara and newcomers like Shein. Driving the attraction to fast fashion was the prominence of
social media and creator platforms. In particular, fashion influencers, with millions of
followers on TikTok and Instagram, frequently displayed their latest purchases, channeling
sales directly to the very companies that many of their peers castigated for their poor
environmental performance. 70 71
SHEIN: FASTER AND CHEAPER
On top of pressure from climate change activists and young consumers pulling the company
in opposite directions, Zara also contended with the emergence of an influential global rival.
Launched in 2012 in Nanjing, China, Shein was an online-only fast fashion retailer that had
cultivated a sprawling network of suppliers across China. Although compared to Zara, there
were cheaper fast fashion retailers, such as Primark, and faster digital-first retailers, such as
Boohoo, by 2018, no competitor could rival Shein in both speed and affordability. Whereas
Zara’s design team delivered tens of thousands of designs per year, Shein produced designs
Page 9 | Zara’s Sustainability Dilemma
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sustainable linen across all production lines, move to 100% recycled polyester, and reduce
water use by 25%. The loftiest goal Inditex set for itself was to reach zero emissions by 2040.67
Moreover, Shein’s marketing, design, production, and distribution were tightly anchored to
its presence on social media, amassing data from trendsetting fashion influencers and
integrating their insights directly into the design process. The ultra-fast fashion model
pioneered by Shein, however, also meant greater reliance on even less durable synthetic
materials in production and a higher proportion of shipping by air freight in distribution. As
a result, a mounting backlash intensified against the company as climate activists and some
fashion influencers alike discouraged shoppers from buying clothes from Shein. 74 Despite
these activist efforts, Shein remained steadfast toward a planned IPO in 2024, as the private
company was valued at $100 Billion in its latest round of financing in April 2022, exceeding
the market capitalization of Inditex and H&M combined.
Looking Ahead
As Inditex eyed its goal of achieving net zero emissions by 2040, it was caught between two
extremes. On the one hand, its efforts to achieve greater sustainability performance was
criticized as greenwashing by environmental activists as not doing enough. On the other
hand, restructuring Inditex production and supply chain to be more sustainable opened the
door wider for ultra-fast rivals like Shein to seize greater market share. Furthermore,
alternative business models, such as ThredUp and TheRealReal, which innovated in the resale
market, and Rent the Runway, which encouraged reuse, were positioned as greener
alternatives while also growing in popularity among consumers, creating the possibility that
completely novel business models might offer a considerable challenge to fast fashion. With
these contravening pressures, executives at Inditex faced a critical strategic decision about the
future direction of the company.
Zara’s Sustainability Dilemma | Page 10
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at a rate of 700 to 1000 per day.72 In terms of product releases, whereas Zara’s online presence
touts 600 new products each day, Shein’s online inventory introduces 6,000 new items daily.73
The sheer scale meant that almost a nearly identical piece on Shein was orders of magnitudes
cheaper than it was on Zara (see Exhibit 13 for an example of a “Zara vs Shein” price
comparison video on TikTok).
Guiding Questions
2. Would you describe Zara’s manufacturing and distribution strategies as efficient
vis-à-vis Gap and H&M? Why or why not?
3. Going forward, which competitors should Zara view as its main rivals – (1) brickand-mortar fashion retailers like Gap and H&M, (2) online only fast fashion
retailers like Shein and Boohoo, (3) alternative fashion resuse/resale/rental players
like Rent The Runway and ThredUp?
4. To what extent should Zara transform its business model and operations to
achieve greater sustainability performance? What are the strategic trade-offs of
doing less or doing more?
Page 11 | Zara’s Sustainability Dilemma
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1. In traditional retail, does Zara have a competitive advantage over competitors
like Gap and H&M? If so, what trade-offs make Zara’s strategy difficult for
competitors like Gap and H&M to implement?
1963
Inditex is founded in La Coruña, northwest Spain.
1975
The first Zara store opens.
1983
Zara expands across Spain.
1984
Zara builds a state-of-the-art logistics center in Arteixo, Spain.
1988
Zara goes international, opening a store in Porto, Portugal.
1989
Zara goes transatlantic, opening its first U.S. store on Lexington Avenue in
NYC.
1991
Pull&Bear and Massimo Dutti join Inditex.
2001
Oysho is launched, and Inditex goes public.
2003
Zara Home is launched.
2004
Inditex reaches the 2,000-store milestone.
2005
Pablo Isla becomes deputy chairman and CEO.
2007
Zarahome.com launches, becoming Inditex’s first online store.
2008
Inditex creates its eighth brand, Uterqüe.
2010
Zara begins to sell its products online in September, and by the end of
2010, the online platform is live in 16 European markets.
2013
Inditex opens new high-profile flagship stores: Zara on the ChampsÉlysées in Paris, Oysho and Zara Home in Shanghai, etc.
2014
Inditex opens a new logistics center in Cabanillas, Spain.
2015
Inditex reaches the 7,000-store milestone and starts a profit-sharing plan for
employees.
2017
Zara.com is launched in India, Malaysia, Singapore, Thailand, and Vietnam.
2019
Inditex releases first annual sustainability report, committing to net zero
emissions by 2040
Source: Case writer from company website, https://www.inditex.com/about-us/our-story.
Zara’s Sustainability Dilemma | Page 12
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Exhibits
Exhibit 1
Inditex—Time Line
€ 35.0
€ 30.0
€ 28.2
€ 25.3
€ 25.0
€ 23.3
€ 20.9
€ 20.0
€ 15.9
€ 15.0
€ 10.0
€ 27.7
€ 26.1
€ 9.4
€ 10.4€ 11.1
€ 12.5
€ 16.7
€ 20.4
€ 18.1
€ 13.8
€ 5.0
€2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021
Note: CAGR calculated based on 2007-2021 revenue data.
Source: Company financials.
Page 13 | Zara’s Sustainability Dilemma
BY VANESSA BURBANO,* BENNETT CHILES,* AND DAN J. WANG‡
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Exhibit 2
Inditex—Sales Growth
(Euros in millions)
Segment Financials, 2021
Zara /
Zara Home
Bershka
Other
Inter-segment
Total
Sales to third parties
19,714
2,178
5,955
(131)
27,716
Profit before taxes
2,838
330
991
39
4,199
Amortization and
depreciation
2,040
233
623
5
2,901
Segment total assets
23,693
1,426
3,826
28,945
ROCE
25%
32%
37%
28%
Number of stores
2,489
971
3,017
6,477
Sales by Region, 2021
Net Sales
Non-current assets
2021
2020
31/01/2022
31/01/2021
Spain
4,267
3,229
4,657
4,449
Rest of Europe
14,051
10,430
5,901
6,068
Americas
4,877
2,763
2,051
2,032
Asia and rest of the world
4,521
3,980
1,215
1,255
Total
27,716
20,402
13,824
13,805
Source: Inditex Annual Report 2021.
Zara’s Sustainability Dilemma | Page 14
BY VANESSA BURBANO,* BENNETT CHILES,* AND DAN J. WANG‡
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Exhibit 3
Inditex—Segment Financial Summary and Sales by Region
SPAIN
256
UKRAINE
12
GUATEMALA
MAINLAND CHINA
3
133
ARGENTINA
11
JORDAN
FRANCE
3
116
CROATIA
10
LATVIA
3
UNITED STATES
99
IRELAND
10
LEBANON
3
ITALY
92
CHILE
9
LUXEMBOURG
3
RUSSIA
86
TAIWAN, CHINA
9
PUERTO RICO
3
MEXICO
80
EGYPT
9
DOMINICAN REPUBLIC
3
JAPAN
75
PHILIPPINES
9
ARMENIA
2
PORTUGAL
72
HUNGARY
9
BAHREIN
2
GERMANY
70
MALAYSIA
8
BELARUS
2
UNITED KINGDOM
59
SINGAPORE
8
MACAO SAR
2
SAUDI ARABIA
45
SWEDEN
8
COSTA RICA
2
BRAZIL
43
CYPRUS
7
ECUADOR
2
POLAND
42
KUWAIT
7
ESTONIA
2
GREECE
39
SERBIA
7
HONDURAS
2
TURKEY
39
BULGARIA
6
NORTH MACEDONIA
2
SOUTH KOREA
37
FINLAND
6
PANAMA
2
CANADA
32
QATAR
6
URUGUAY
2
NETHERLANDS
28
SOUTH AFRICA
6
VIETNAM
2
BELGIUM
27
KAZAKHSTAN
5
ALBANIA
1
ISRAEL
25
LITHUANIA
5
ANDORRA
1
25
NORWAY
5
ARUBA
1
ROMANIA
INDIA
SWITZERLAND
20
CZECH
REPUBLIC
TUNISIA
AUSTRALIA
18
DENMARK
INDONESIA
UAE
21
5
EL SALVADOR
1
5
ICELAND
1
4
MALTA
1
16
SLOVAKIA
4
MONACO
1
15
SLOVENIA
4
MONTENEGRO
1
MOROCCO
13
GEORGIA
4
NICARAGUA
1
AUSTRIA
12
PERU
4
NEW ZEALAND
1
HONG KONG SAR
12
ALGERIA
3
OMAN
1
COLOMBIA
12
AZERBAIJAN
3
PARAGUAY
1
12
BOSNIA
3
TOTAL
THAILAND
Note: Store count is as of January 2022.
Source: Inditex Annual Report 2021.
Page 15 | Zara’s Sustainability Dilemma
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1939
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Exhibit 4
Zara Locations by Country in 2022
Switzerland
Australia
Austria
Belgium
France
Germany
Ireland
Japan
UK
Italy
Spain
U.S.
Israel
Taiwan
South Korea
Portugal
Slovenia
USD /
Hour
$51.36
$38.67
$35.42
$34.77
$31.61
$30.03
$25.33
$25.10
$24.01
$22.67
$19.37
$17.71
$12.86
$10.61
$10.22
$9.64
$9.39
Indexed to
U.S. = 100
290
218
200
196
179
170
143
142
136
128
109
100
73
60
58
54
53
Estonia
Czech Republic
Latvia
Poland
Turkey
Argentina
Colombia
Brazil
Tunisia
Morocco
Mexico
South Africa
Peru
China
Bulgaria
Thailand
Malaysia
USD /
Hour
$8.09
$7.89
$7.25
$5.70
$5.48
$3.82
$3.27
$3.22
$3.18
$3.12
$3.06
$2.94
$2.78
$2.65
$2.33
$2.26
$2.12
Indexed to
U.S. = 100
46
45
41
32
31
22
18
18
18
18
17
17
16
15
13
13
12
Source: Werner International, http://www.werner-newtwist.com/en/newsl-vol-011/index.htm.
Zara’s Sustainability Dilemma | Page 16
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Exhibit 5
Hourly Labor Cost Textile Industry, 2014
Spain
Portugal
Morocco
Turkey
India
Bangladesh
Suppliers with purchase
during the year
208
170
121
175
136
94
Active factories in the year
466
1,357
283
1,427
394
262
Workers in active factories
10,298
49,714
73,772
192,173
200,139
479,859
Vietnam
Cambodia
China
Brazil
Argentina
Pakistan
Suppliers with purchase
during the year
4
1
393
15
45
42
Active factories in the year
134
125
1,654
65
83
107
Workers in active factories
152,101
126,843
368,428
10,712
5,099
125,316
Source: Company website, http://static.inditex.com/annual_report_2016/en/our-priorities/sustainablemanagement-of-the-supply-chain/strategic-plan-2014-2018-2016-review.php.
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Exhibit 6
Suppliers and Factories by Country
Zara
Typical European
Specialty Apparel
Retailer
Typical U.S.
Specialty Apparel
Retailer
Typical U.S.
Department Store
15% of items
40% of items
60% of items
70% of items
15% markdown
30% markdown
40% markdown
40% markdown
Source: Bain & Co., from “The Zara Gap: Retail’s Big Arbitrage,” October 28, 2014,
https://sourcingjournal.com/topics/retail/zara-gap-retails-big-arbitrage-18976/.
Exhibit 8
Inditex—Company Managed and Franchised Stores, 2022
Store count
Concept
Zara
Company Managed
1,684
Franchised
255
Total
1,939
Zara Kids
68
-
68
Zara Home
402
80
482
Pull&Bear
706
158
864
Massimo Dutti
560
122
682
Bershka
804
167
971
Stradivarius
717
198
915
Oysho
472
84
556
Total
5,413
1,064
6,477
Sales %
Company
Managed
88%
Franchised
12%
Pull&Bear
82%
18%
Massimo Dutti
84%
16%
Bershka
82%
18%
Stradivarius
77%
23%
Oysho
84%
16%
Total
86%
14%
Concept
Zara (Zara and Zara Home)
Source: Inditex Annual Report 2021.
Zara’s Sustainability Dilemma | Page 18
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Exhibit 7
The “Zara Gap”
Exhibit 9
Inditex: Selected Financial Data (€ in millions)
2022
2021
2020
2019
2018
Revenues
27,716
20,402
28,286
26,145
25,336
COGS**
11,902
9,013
12,479
11,329
13,878
Gross Profit
15,814
11,390
15,806
14,816
11,458
Gross Margin
57.10%
55.80%
55.90%
56.70%
45.20%
SG&A
8,596
6,807
8,176
9,329
6,142
EBITDA
7,183
4,552
7,598
5,457
5,511
EBITDA Margin
25.92%
22.31%
26.86%
20.87%
21.80%
Operating Income
4,282
1,507
4,681
4,357
4,429
Net Income
3,250
1,104
3,647
3,448
3,368
Total Assets
28,945
26,418
28,391
21,684
20,231
Total Cash and ST Investments
9,395
7,574
7,919
6,795
6,403
Total Receivables
1061
972
954
928
888
Inventories
3,042
2,321
2,269
2,716
2,685
Total Current Assets
13,602
10,957
11,414
10,620
10,147
Net Property Plant & Equipment
7,481
7,401
8,355
8,339
7,644
Accounts Payable
4,636
3,436
3,985
3,744
3,577
Total Current Liabilities
6,338
6,338
7,306
5,383
5,173
1
3
6
5
4
Total Liabilities
13,187
11,867
13,442
7,064
6,709
Total Equity
15,759
14,550
14,949
14,682
13,522
Common Shares Outstanding
3,114
3,115
3,114
3,114
3,114
Income Statement Key Items
Balance Sheet Key Items
LT Debt & Capital Leases
Source: Inditex Annual Reports, 2018-2021
Page 19 | Zara’s Sustainability Dilemma
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Fiscal year ended January 31*
Hosiery
3%
Apparel Accessories
4%
Footwear
21%
Womens Wear
38%
Children's Wear
9%
Menswear
25%
Source: “World Market for Apparel and Footwear,” Euromonitor International, April 2018.
Australasia
1%
Middle East and Africa
7%
Asia Pacific
36%
Western Europe
22%
Eastern Europe
5%
Latin America
7%
North America
22%
Source: “World Market for Apparel and Footwear,” Euromonitor International, April 2018.
Zara’s Sustainability Dilemma | Page 20
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Exhibit 10
Global Apparel and Footwear Sales—By Category and Region
Exhibit 11
Gap: Selected Financial Data ($ in millions)
1/29/22
1/30/21
1/31/20
2/1/19
2/3/18
Revenues
16,670
13,800
16,383
16,580
15,855
COGS *
9,514
8,601
9,700
9,693
9,789
Gross Profit
7,156
5,199
6,683
6,887
6,066
Gross Margin
42.93%
37.67%
40.79%
41.54%
38.30%
SG&A
5,854
5,003
5,117
4,982
4,562
EBITDA
1,302
196
1,566
1,905
2,063
EBITDA Margin
7.81%
1.42%
9.56%
11.49%
13.01%
Operating Income
323
(1102)
528
1,322
1,424
Net Income
256
(665)
351
1,003
848
12,761
13,769
13,679
8,049
7,989
Total Cash and ST Investments
877
2,398
1,654
1,369
1,783
Total Receivables
399
363
316
359
282
Inventories
3,018
2,451
2,156
2,156
1,997
Total Current Assets
5,165
6,008
4,516
4,251
4,568
Net Property Plant & Equipment
3,037
2,451
3,122
2,912
2,805
Accounts Payable
1,951
1,743
1,174
1,126
1,181
Total Current Liabilities
4,077
3,884
3,209
2,174
2,461
LT Debt & Capital Leases
1,484
2,216
1,249
1,249
1,249
Total Liabilities
10,039
11,155
10,363
4,496
4,845
Total Equity
2,722
2,614
3,316
3,553
3,144
371
374
371
378
389
Income Statement Key Items
Balance Sheet Key Items
Total Assets
Common Shares Outstanding
*COGS include occupancy expenses.
Source: Gap Annual Reports, 2018-2021.
Page 21 | Zara’s Sustainability Dilemma
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Fiscal year ended:
Exhibit 12
H&M: Selected Financial Data (SEK in millions)
2021
2020
2019
2018
2017
Revenues
198,967
187,031
232,755
210,400
200,004
COGS
93,961
93,487
110,302
99,513
91,914
Gross Profit
105,006
93,544
122,453
110,887
108,090
Gross Margin
52.78%
50.02%
52.61%
52.70%
54.00%
SG&A
69,048
66,440
94,626
86,281
87,521
EBITDA
35,958
27,104
27,827
24,606
29,793
EBITDA Margin
18.07%
14.49%
11.96%
11.69%
14.40%
Operating Income
15,255
3,099
17,346
15,493
20,569
Net Income
11,010
1,243
13,443
12,227
16,184
Total Assets
185,263
179,781
185,289
171,754
106,562
Total Cash and ST Investments
27,403
27,471
35,298
23,434
9,718
Total Receivables
14,134
12,787
12,185
12,070
9,049
Inventories
39,331
37,306
36,867
35,866
33,712
Total Current Assets
83,138
78,986
85,014
71,749
55,746
Net Property Plant & Equipment
81,018
79,662
79,073
82,412
39,818
-
20,382
-
-
7,215
Total Current Liabilities
63,749
61,177
62,849
56,456
40,723
LT Debt & Capital Leases
57,067
54,557
54,060
55,785
350
Total Liabilities
124,548
119,763
120,880
116,114
46,849
Total Equity
60,715
60,018
64,409
55,640
59,713
Common Shares Outstanding
1,655
1,655
1,655
1,655
1,655
Income Statement Key Items
Balance Sheet Key Items
Accounts Payable
Source: H&M Annual Reports, 2018-2021.
Zara’s Sustainability Dilemma | Page 22
BY VANESSA BURBANO,* BENNETT CHILES,* AND DAN J. WANG‡
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Fiscal year ended November 30
Source: Video posted on TikTok by @luncinastyle on December 29, 2021,
https://www.tiktok.com/@luciniastyle/video/7047264703201971461.
Page 23 | Zara’s Sustainability Dilemma
BY VANESSA BURBANO,* BENNETT CHILES,* AND DAN J. WANG‡
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Exhibit 13
Screenshot of Influencer Video Posted to TikTok Comparing Zara
and Shein Clothing
Endnotes
“Zara Owner Inditex Sees 2021 Net Profit More than Double from 2020,” Business Insider
(March 26, 2022), https://markets.businessinsider.com/news/stocks/zara-owner-inditex-sees2021-net-profit-more-than-double-from-2020-11144743.
2 “1998 Annual Report,” Inditex,
https://www.annualreports.com/HostedData/AnnualReportArchive/i/inditex_1998.pdf,
accessed August 25, 2022.
3 Frankie Leach, “Clothes made from 'carbon emissions': Why Zara's new line is just more
greenwashing,” Euronews (June 26, 2022),
https://www.euronews.com/green/2022/06/26/clothes-made-from-carbon-emissions-whyzaras-new-line-is-just-more-greenwashing.
4 “Sustainability,” Inditex, https://www.inditex.com/itxcomweb/en/sustainability, accessed
August 11, 2022.
5 Jon Markman, “Private Chinese Online Retailer Stuns Apparel World With $100 Billion
Valuation,” Forbes (April 22, 2022),
https://www.forbes.com/sites/jonmarkman/2022/04/22/private-chinese-online-retailer-stunsapparel-world-with-100-billion-valuation/.
6 “Group Consolidated Annual Accounts as at 31 January 2018,” Inditex,
https://www.inditex.com/documents/10279/563475/Annual+Accounts%2C+management+rep
ort+and+audit+report+of+Inditex+Group+2017/77a7def2-b502-ac22-003e-d1e7c900233c.
7 “Group Consolidated Annual Accounts, 2018.”
8 “Group Consolidated Annual Accounts, 2018.”
9 Bankinter Securities, “Inditex: Initiation of coverage.”
10 “The Secret of Zara’s Success: A Culture of Customer Co-creation,” MartinRoll.com (March
2018), https://martinroll.com/resources/articles/strategy/the-secret-of-zaras-success-a-cultureof-customer-co-creation/.
11 “Design,” How We Do Business, Inditex, https://www.inditex.com/how-we-dobusiness/our-model/design.
12 Greg Petro, “The Future Of Fashion Retailing: The Zara Approach (Part 2 of 3),” Forbes
(October 25, 2012), https://www.forbes.com/sites/gregpetro/2012/10/25/the-future-of-fashionretailing-the-zara-approach-part-2-of-3/.
13 Bloomberg, “‘Speed up or die’ is the new reality for U.S. apparel retailers,” Chicago Tribune
(March 26, 2018), http://www.chicagotribune.com/business/ct-apparel-retailers-speed20180326-story.html.
14 Greg Petro, “The Future Of Fashion Retailing: The Zara Approach (Part 2 of 3).”
15 “The future of fast fashion,” The Economist (January 16, 2015),
https://www.economist.com/business/2005/06/16/the-future-of-fast-fashion.
16 Greg Petro, “The Future Of Fashion Retailing, Revisited: Part 2—Zara,” Forbes (July 23,
2015), https://www.forbes.com/sites/gregpetro/2015/07/23/the-future-of-fashion-retailingrevisited-part-2-zara/.
Zara’s Sustainability Dilemma | Page 24
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Page 123 of 213
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Use outside these parameters is a copyright violation.
1
“Gap Inc. Factory List” (May 2018),
http://www.gapincsustainability.com/sites/default/files/Gap%20Inc%20Factory%20List.pdf.
18 “Zara supply chain analysis—the secret behind Zara’s retail success,” TradeGecko.com
(June 25, 2018), https://www.tradegecko.com/blog/zara-supply-chain-its-secret-to-retailsuccess.
19 “Global Growth Opportunities,” Inditex,
https://www.inditex.com/documents/10279/245194/Group+Profile/7e81b535-64aa-40bf-8625c498a72be73d.
20 “Logistics,” How We Do Business, Inditex, https://www.inditex.com/en/how-we-dobusiness/our-model/logistics.
21 “Logistics,” How We Do Business, Inditex.
22 Gavin van Marle, “Inditex invests in its supply chain as its global retail empire grows by
330 stores,” The Loadstar (March 19, 2014), https://theloadstar.co.uk/inditex-invests-supplychain-following-gloabls-sales-growth/.
23 The World Bank Group, “Air Freight: A Market Study with Implications for Landlocked
Countries” (August 2009),
http://siteresources.worldbank.org/EXTAIRTRANSPORT/Resources/5151801262792532589/6683177-1268747346047/air_cargo_study.pdf.
24 Suzy Hansen, “How Zara Grew Into the World’s Largest Fashion Retailer,” The New York
Times Magazine (November 9, 2012), https://www.nytimes.com/2012/11/11/magazine/howzara-grew-into-the-worlds-largest-fashion-retailer.html?pagewanted=all.
25 Christopher Bjørk, “Zara Builds Its Business Around RFID,” The Wall Street Journal
(September 16, 2014), https://www.wsj.com/articles/at-zara-fast-fashion-meets-smarterinventory-1410884519.
26 Bjørk, “Zara Builds Its Business.”
27 “The Zara Gap: Retail’s Big Arbitrage,” Sourcing Journal (October 28, 2014),
https://sourcingjournal.com/topics/retail/zara-gap-retails-big-arbitrage-18976/.
28 Graham Keeley and Andrew Clark, “Retail: Zara bridges Gap to become world’s biggest
fashion retailer,” The Guardian (August 11, 2008),
https://www.theguardian.com/business/2008/aug/12/retail.spain.
29 Hansen, “How Zara Grew.”
30 Keeley and Clark, “Retail: Zara bridges Gap.”
31 “Stores,” How We Do Business, Inditex, https://www.inditex.com/en/how-we-dobusiness/our-model/stores.
32 “Stores,” How We Do Business, Inditex.
33 Pamela N. Danziger, “Why Zara Succeeds: It Focuses On Pulling People In, Not Pushing
Product Out,” Forbes (April 23, 2018),
https://www.forbes.com/sites/pamdanziger/2018/04/23/zaras-difference-pull-people-in-notpush-product-out/.
34 Hansen, “How Zara Grew.”
35 Bankinter Securities, “Inditex: Initiation of coverage.”
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Use outside these parameters is a copyright violation.
17
Interbrand, “Best Global Brands 2017,” https://www.interbrand.com/best-brands/bestglobal-brands/2017/ranking/.
37 Bankinter Securities, “Inditex: Initiation of coverage.”
38 “The future of fast fashion,” The Economist (June 16, 2015),
https://www.economist.com/business/2005/06/16/the-future-of-fast-fashion.
39 “World Market for Apparel and Footwear,” Euromonitor International (April 2018).
40 “Channel Overview in Apparel and Footwear,” Euromonitor International (March 2018).
41 Hiroko Tabuchi and Hilary Stout, “Gap’s Fashion-Backward Moment,” The New York Times
(June 20, 2015), https://www.nytimes.com/2015/06/21/business/gaps-fashion-backwardmoment.html.
42 Bankinter Securities, “Inditex: Initiation of coverage.”
43 Mallory Schlossberg, “Gap and Abercrombie are trapped in retail’s nightmarish cycle,”
Business Insider (August 26, 2016), http://www.businessinsider.com/gap-and-abercrombieare-discounting-excessively-2016-8.
44 Khadeeja Safdar, “As Gap Struggles, Its Analytical CEO Prizes Data Over Design,” The
Wall Street Journal (November 27, 2016), https://www.wsj.com/articles/as-gap-struggles-itsanalytical-ceo-prizes-data-over-design-1480282911.
45 Mary Hanbury, “Gap’s constant discounts come with a hidden downside that’s infuriating
loyal customers,” Business Insider (May 19, 2018), http://www.businessinsider.com/gapdiscount-strategy-angers-loyal-customers-2018-5.
46 Christopher Bjørk, “Zara Wakes Up to Online Sales,” The Wall Street Journal (August 26,
2010), https://www.wsj.com/articles/SB10001424052748703632304575451282067480988.
47 Arthur Zaczkiewicz, “Amazon, Wal-Mart and Apple Top List of Biggest E-commerce
Retailers,” WWD (April 7, 2017), http://wwd.com/business-news/business-features/amazonwal-mart-apple-biggest-e-commerce-retailers-10862796/.
48 H&M, Annual Report 2017 (February 19, 2018),
https://about.hm.com/content/dam/hmgroup/groupsite/documents/masterlanguage/Annual
%20Report/Annual%20Report%202017.pdf.
49 Shannon, “Fast Fashion Slow to E-Commerce.”
50 Katie Hope, “Has this dress been to more countries than you?” BBC News (March 22,
2017), https://www.bbc.com/news/business-39337204.
51 Greg Petro, “The Future Of Fashion Retailing—The H&M Approach (Part 3 of 3),” Forbes
(November 5, 2012), https://www.forbes.com/sites/gregpetro/2012/11/05/the-future-offashion-retailing-the-hm-approach-part-3-of-3/
52 Richard Milne, “H&M predicts tough year ahead as it focuses online,” Financial Times
(February 14, 2018), https://www.ft.com/content/53da5158-116e-11e8-940e-08320fc2a277.
53 “H&M: Hennes & Mauritz AB in Apparel and Footwear (World),” Euromonitor
International (March 2018).
54 H&M website, http://www2.hm.com/en_us/customer-service/returns/onlinepurchases.html.
55 Fiona Briggs, “H&M launches loyalty scheme, H&M Club, in UK,” Retail Times (May 30,
2017), https://www.retailtimes.co.uk/hm-launches-launches-loyalty-scheme-hm-club-uk/.
Zara’s Sustainability Dilemma | Page 26
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36
Pamela Danziger, “Why Fast-Fashion H&M Is Losing Favor With American Fashionistas:
It’s A Mess,” Forbes (February 4, 2018),
https://www.forbes.com/sites/pamdanziger/2018/02/04/why-fast-fashion-hm-is-losing-favorwith-american-fashionistas-its-a-mess/.
57 Bankinter Securities, “Inditex: Initiation of coverage.”
58 “H&M: Hennes & Mauritz AB in Apparel and Footwear (World),” Euromonitor
International (March 2018).
59 “Fast Fashion Global Market Report 2022,” PR Newswire, April 25, 2022,
https://www.prnewswire.com/news-releases/fast-fashion-global-market-report-2022301531964.html.
60 Adam Fleck, “What Sustainability Risks Are Woven Into Fast Fashion?,” Morningstar (July
21, 2022), https://www.morningstar.com/articles/1103117/sustainability-risks-abound-in-fastfashion.
61 Fleck, “What Sustainability Risks?”
62 Lucielle Salomon, “Can You Compost Your Clothing? Here’s Why Most Fashion Isn’t
Biodegradable,” Ecocult (January 28, 2021), https://ecocult.com/can-you-compost-yourclothing/.
63 Léontine Gallois, “A Climate Activist Walked in the Louis Vuitton Fashion Show,” The
New York Times (October 6, 2021), https://www.nytimes.com/2021/10/06/fashion/louisvuitton-protester-paris-fashion-week.html.
64 Saijel Kishan, Mathieu Benhamou, Jeff Green, “Investors Crank Up Pressure on Companies
With Record Climate, Race Proxy Proposals,” Bloomberg (April 25, 2022),
https://www.bloomberg.com/graphics/2022-esg-proxy-season/.
65 Bruce Einhorn, Daniela Wei, “Fast-Fashion Behemoth Shein Says It’s Cleaning Up Its Act.
Will Anyone Buy It?” Bloomberg (July 13, 2022),
https://www.bloomberg.com/news/features/2022-07-13/shein-s-fast-fashion-waste-concernscould-harm-ipo
66 “Pablo Isla sets ouyt Inditex’s global sustainability commitments,” Inditex (July 2019),
https://www.inditex.com/itxcomweb/en/home?articleId=630055&title=Pablo+Isla+sets+out+In
ditex%27s+global+sustainability+commitments
67 “Sustainability,” Inditex, https://www.inditex.com/itxcomweb/en/sustainability, accessed
August 25, 2022.
68 Magali Delmas, Vanessa Burbano, “The drivers of greenwashing,” California management
review (2011), Volume 54, Number 1, pp. 64-87.
69 Katie Jahns, “The environment is Gen Z’s No. 1 concern – and some companies are taking
advantage of that,” CNBC (August 10, 2021), https://www.cnbc.com/2021/08/10/theenvironment-is-gen-zs-no-1-concern-but-beware-of-greenwashing.html.
70 Alex Reice, “The most eco-conscious generation? Gen Z's fashion fixation suggests
otherwise,” The Week (December 1, 2021), https://theweek.com/culture/1007212/gen-zs-fastfashion-hypocrisy
Page 27 | Zara’s Sustainability Dilemma
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56
Rory Satran, “Shein’s Rise Was Nearly Overnight. The Backlash Came Just as Fast,” The
Wall Street Journal (June 29, 2022), https://www.wsj.com/articles/shein-haul-backlash11656504321.
72 Habiba Katsha, “The Zara Vs Shein Row Is A Fast Fashion Race To The Bottom,” The
Huffington Post UK (April 22, 2022), https://www.huffingtonpost.co.uk/entry/zara-sheinfast-fashion-row_uk_62612101e4b0e900dcd238b5
73 Njoud Al Mallees, “Ultra-fast fashion site Shein has captured the wallets of young
shoppers. But at what cost?” CBC News (May 8, 2022),
https://www.cbc.ca/news/business/shein-ultra-fast-fashion-1.6442545
74 Satran, “Shein’s Rise Was Nearly Overnight.”
Zara’s Sustainability Dilemma | Page 28
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71
PUBLISHED ON
AUGUST 24, 2022
The Walt Disney Company:
If You Give this Mouse a Focus
BY JERRY KIM * AND STEPHAN MEIER †
Introduction
I suppose my formula might be: dream, diversify and never miss an angle.
—Walt Disney, Wall Street Journal, February 4, 1958
In July 2022, the board of The Walt Disney Company elected to extend current CEO Bob
Chapek’s contract by an additional three years.1 This move came as a surprise to many, since
the price of Disney’s stock in June of 2020 was lower than bottom it reached in March of 2020
when COVID-19 pandemic fears sent the entire stock market into throes.
During his tenure as CEO, Chapek experienced a mix of success and possible failings. He took
his position succeeding Bob Iger, who had served as CEO for 15 years, in February of 2020.
While the Disney Parks, Experiences, and Products segment faced a loss of $1 billion in
revenue as a result of the pandemic, Disney+ had reached over 130 million subscribers by April
of 2022.2,3 Additionally, Chapek had faced controversy over his handling of Disney employee’s
call to action over Florida’s Parental Rights in Education Act, more commonly known as the
“Don’t Say Gay Bill.”
One of the sweeping changes at Disney made during the first months of Chapek’s leadership
was the reorganization of four business segments into only two. What were previously three
segments (Media Networks, Studio Entertainment and Direct-to-Consumer & International)
became the Disney Media and Entertainment Distribution segment. The Disney Parks,
Experiences and Products segment remained unchanged.
Author affiliation
*
Assistant Professor, Rutgers Business School
†
James P. Gorman Professor of Business Strategy, Columbia
Business School
Copyright information
© 2013-2022 by The Trustees of Columbia University in the City of
New York. This version of the case replaces an earlier version that
was published on September 24, 2013.
Acknowledgements
Marie Bell and Caroline Froehlich ’20 provided research and
writing support for earlier versions of the case.
Levi Palmer, MBA’23, provided research and writing support for
this revised version of this case.
This case is for teaching purposes only and does not represent an
endorsement or judgment of the material included.
This case cannot be used or reproduced without explicit permission
from Columbia CaseWorks. To obtain permission, please visit
www.gsb.columbia.edu/caseworks, or e-mail
ColumbiaCaseWorks@gsb.columbia.edu
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ID#140403
With one segment now directly in charge on all things media and distribution, Disney was
following through on the “subtle, but seismic decision to refocus the company and most of
its more than 150,000 employees around its roster of 'franchises,' defining a franchise as
'something that creates value across multiple businesses and across multiple territories over
a long period of time.'”5
Company Background
I only hope that we never lose sight of one thing—that it was all started by a mouse.
—Walt Disney, The Disneyland Story, October 27, 1954
Founded in 1923 by two brothers, Walter Elias (Walt) and Roy O. Disney, The Walt Disney
Company became one of the most iconic businesses in the US. Walt, the animator, was the
creative visionary for the company, while his older brother, Roy, handled the finances as the
fledging business negotiated the tumultuous times for start-ups that characterized the late
1920s and 1930s. After several stutters with earlier ventures, the company, originally known
as The Disney Brothers Studio, became fully established following the premiere of the short
film Steamboat Willie at the Colony Theater in New York City in 1928. The movie was the first
to provide synchronized sound in a cartoon and the first Disney film to be distributed. Also
the very first Mickey Mouse cartoon, Steamboat Willie became an instant success both in the US
and internationally. Before long, Mickey Mouse was joined by other soon-to-be-beloved
characters (for example, Donald Duck and Goofy), with the Disney brothers actively licensing
company assets to help fund future projects.
Disney pressed forward through the Depression era transitioning into feature-length films,
releasing Snow White and the Seven Dwarfs in December 1937. The company went public in 1940
to finance a move from Los Angeles to Burbank, CA and to focus on feature films, and it
continued to achieve industry accolades for its innovative work. Committed to animation
(Fantasia 1940) but constantly cost-constrained, Disney mingled live-action segments—which
were generally less expensive to produce—with animation (Song of the South 1946), then
ultimately created live-action movies (Treasure Island 1950, Mary Poppins 1964). To further help
The Walt Disney Company: If You Give this
Mouse a Focus | Page 2
BY JERRY KIM* AND STEPHAN MEIER†
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This change was a step beyond what Iger had been building since 2018. Iger had been laserfocused on laying the groundwork for The Walt Disney Company to usher in an innovative
future centered around a state-of-the-art online streaming platform and unparalleled customer
experience. Disney had invested more than $3 billion to acquire the underlying infrastructure,
tapped executives from across the company to lead the new direct-to-consumer division, and
shelled out more than $71 billion for 21st Century Fox. In fact, one of the first people Iger
selected to lead the charge was Disney veteran Agnes Chu ‘08. She was named senior vice
president of content for Disney+, the company’s flagship direct-to-consumer entertainment
streaming service. In her new Disney+ capacity, Chu was responsible for identifying and
developing series, feature films, short-form content, and other high-quality entertainment
formats for the platform.4
Theme parks were the next frontier for Disney. According to Disney lore, Walt would take his
two young daughters to local amusement parks in Los Angeles and as he watched them ride
the carousel, he would imagine a place where children and adults could have fun together,
famously noting, “You’re dead if you aim only for kids. Adults are only kids grown up,
anyway.”6 In July 1955, that dream became reality with the opening of Disneyland, located in
Anaheim, CA on what used to be a 160-acre orange orchard. The park, which cost $17 million
to build, was financed in part based on a deal with the American Broadcasting Company
(ABC) that included a $500,000 investment and guarantees for a $4.5 million line of credit. In
return, ABC received all profits from the park’s food concessions for ten years, a 35% interest
in the park, and a Disney commitment to produce a weekly one-hour television program called
Walt Disney's Disneyland.
The Disneyland anthology television show featured new programming as well as previews of
the different themed areas planned for the upcoming park. A year later, The Mickey Mouse Club
debuted and the television show went on to become an intrinsic part of Americana. Disney's
combined focus on the animation of fairy tale classics and the creation of wholesome movies
and fun-filled experiences established the company as the American standard for family
entertainment.
The success of Disneyland inspired Walt to think even bigger. In 1965, he purchased 27,000
acres near Orlando, FL for the site of the Walt Disney World Resort and EPCOT.i With Walt’s
death in 1966, his brother Roy returned to the company from retirement and spent much of
his energy focused on realizing the potential of Disney World, which opened in October 1971.
Roy died two months later.
The Disney brothers recognized that adults and children alike were seeking an escape from
reality, and everything inside the parks created the illusion of a prettier, safer, cleaner, and
more fun place than the outside world. Fences, garbage bins, and administrative buildings
were all painted in a color known as Go Away Green to camouflage these unsightly objects
and help them blend into the landscape.7 A system of underground corridors called Utilidors
connected all parts of Disney World, so that park visitors would not have to witness waste
removal, delivery trucks, or characters in transit. According to company legend, Walt came up
with the idea for the tunnels after he saw a Frontierland cast member dressed as a cowboy
walking through Tomorrowland at Disneyland. 8 To this day, Disney exerts considerable
control over its employees. In addition to restricting where characters can go, Disney regulates
what they can say inside and outside the park. According to a former cast member who played
Snow White, costumed characters “weren’t supposed to refer to things outside the Disney
realm. Snow White does not know Thomas the Tank Engine.”9 DisneyWar author James B.
Stewart was told that he would not be allowed to write about his experiences playing Goofy
i
EPCOT: an Experimental Prototype Community of Tomorrow, a park which opened in 1982.
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finance movies, Buena Vista Film Distribution Company was formed in 1953 so that Disney
could distribute its own productions.
Over the next decade, Disney was led by employees who had all been trained by the founding
brothers and fully embraced the company’s culture. The primary focus remained theme parks.
Tokyo Disneyland was announced in 1976 and was the first asset outside Disney’s immediate
control. Though wholly owned by a Japanese partner, the park was designed by Disney to
replicate the US parks. Construction of EPCOT began in 1979; it was completed in 1982 at a
cost between $800 million to $1.4 billion. At the time, it was the largest construction project in
the world.
While the theme parks flourished, the motion picture business floundered through much of
the 1970s as the company invested in Disney World and EPCOT as well as a new cable channel,
The Disney Channel. The immediate success of The Disney Channel in 1983 proved too little
too late—in March 1984, Roy E. Disney (son of founder Roy) resigned from the board of
directors. The extended period of erratic earnings had left Disney vulnerable. That same year
corporate raider Saul Steinberg attempted a hostile takeover of the company. To thwart him,
Disney paid the greenmail, buying Steinberg’s 11.1% holding in the company at an abovemarket price totaling $325.4 million. A subsequent investment of $500 million by the Texasbased Bass Group brought its share of Disney stock to 25% and effectively ended the threat of
a hostile takeover.
The Eisner Era: 1984-2005
If you’re soft and fuzzy, like our little characters, you become the skinny kid on the beach,
and people in this business don’t mind kicking sand in your face.
—Michael Eisner11
With the threat of a takeover abated, Disney moved quickly to make changes that would
stabilize and grow the company. Roy E. Disney was restored to the board and named vice
chairman. Michael Eisner, former president and CEO of Paramount Pictures, was named
chairman and CEO of Disney, and Frank Wells, an entertainment industry lawyer known for
his savvy negotiating skills, was appointed president.
Under Eisner and Wells, the next decade was a period of change and growth. (See Exhibit 1
for Disney’s stock price beginning in 1983.) Television and movie production were reenergized
under the direction of Jeffrey Katzenberg, who previously worked with Eisner at Paramount.
Touchstone Pictures was created as a separate brand for movies with more mature themes so
as to maintain the wholesome Disney image. Disney Stores offering a range of children’s
products as well as collectibles were launched. Animation returned to Disney with The Little
Mermaid, Beauty and the Beast, and Aladdin. Importantly, under Eisner’s direction, the company
used Buena Vista Home Video to tap into the previously unknown demand for home videos,
offering consumer prices (about $30) for its feature films, both new releases and rereleases of
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“in a way that stated that Goofy was an actor inside a costume” because “the illusion the
Disney characters are real had never been publicly breached with the company’s
cooperation.”10
Theme parks that had remained profitable in the downturn were updated and expanded with
new attractions. Additional hotels were built; nightlife locations and complementary activities
such as water parks were added. Euro Disneyland (later renamed Disneyland Paris) opened
in 1992. Disney had a 49% ownership stake, having invested $200 million in the $4.4 billion
park. Disney operated the park and received 10% from ticket sales and 5% from merchandise
sales regardless of park profitability.
As 1993 came to a close, it appeared Disney could do no wrong. The company had acquired a
baseball team, the Anaheim Angels, and an NHL hockey team, the Anaheim Ducks—named
after the fictional team in the Disney movie The Mighty Ducks. Disney also turned some of its
popular movies such as Beauty and the Beast and The Lion King into profitable stage productions,
despite the theater industry's notoriously fickle nature. Disney invested $25 million in Steve
Jobs’s struggling Pixar Animation Studios for three movies and distribution rights. Toy
Story (1995), Pixar’s debut film, was the first feature-length, computer-animated movie and a
tremendous success at the box office. (See Exhibit 2.)
However, Disney’s run was not to last—the final decade of Eisner’s tenure was marked by
tragedy, turmoil, and slumping performance. After Wells died unexpectedly in 1994, Eisner
was named president and CEO. The move created distance between Eisner and Katzenberg,
who ultimately left Disney to form DreamWorks SKG with Steven Spielberg and David
Geffen. Eisner’s confrontational management style created increasing tension in the
organization. The acquisition of Capital Cities/ABC by Disney in 1995 for $19 billion seemed
to add to the discontent. As The Wall Street Journal noted at the time, “Disney’s
micromanagement has left many at ABC unhappy and anxious. The congenial atmosphere
that once dominated the network’s top ranks is gone; in its place is the high-pressure culture
of Disney, which often pits executives against each other.”12
Problems for Eisner appeared to crop up at every turn. Disney’s internet business failed to
deliver. Tensions between Pixar and Disney also started to mount. The two companies had
forged a ten-year, five-film coproduction contract in 1997, agreeing to split the costs and profits
from box office returns and sales of related products such as home videos, toys, and video
games. Disney had exclusive rights to market and distribute the films, as well as ownership of
the characters that were developed before and during the agreement. While the partnership
had been lucrative for both sides, the continuing success of Pixar films (and the foundering of
Disney's traditional animation movies) led Jobs to seek better terms for his company. The
dispute became a personal battle between two high-profile CEOs, and in 2004 Pixar declared
that it would be moving on and seeking a distribution deal with another studio once it
completed its five-film requirement with the release of Cars.13
Within the theme park realm, Disneyland Paris was failing to deliver on its initial promise,
and the prospects of ABC television seemed to dim as that network’s ratings faltered. In fact,
ABC and other acquisitions made by Eisner seemed to be hurting the Disney brand by drawing
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Disney classics. Of the most popular animated titles, only one would be on store shelves each
year. Only ten titles were available permanently.
The Iger Era: 2005-2020
As 2003 dawned, there was growing discontent with Eisner’s leadership of the company.
In a dramatic move, Roy E. Disney resigned from the board, citing several areas of concern
including low ratings at ABC, Eisner’s abrasive micromanagement style, loss of key
employees, and weakening relationships with key partners including Pixar and Miramax. The
following day, Disney’s ally on the board, Stanley Gold, resigned. Gold cited many of the same
concerns and also questioned Eisner’s compensation package as well as the independence of
Disney’s board.
The resignations were followed by a public no-confidence vote at the Disney annual meeting
in March 2004--45% of shareholders failed to support Eisner’s reelection to the board. Eisner
survived the day but soon after relinquished his role as chairman. In September 2005, after
fending off a hostile takeover bid by Comcast, Eisner resigned, and then-COO Iger was named
CEO.
At the time, most observers had low expectations for Iger. And Iger was not inheriting a feelgood company culture, as BusinessWeek noted, “Disney [had] lost its animating spirit. To say
the culture was poisonous doesn’t begin to capture the company’s dysfunction.”16 But to the
surprise of many close to the company, Iger changed the work environment, reached out to
former Disney staffers for strategic advice, and pushed decision-making and execution deeper
into the organization. Once again, Disney was a company on the move, as Iger “upended
Eisner’s centrally planned company, hacking away at the bureaucracy and unshackling a
group of veteran executives to plot their own courses.”17
Over the next 15 years, Iger transformed Disney into one of the largest entertainment empires
in the world by executing a three-pillar strategic vision: “generating the best creative content
possible, fostering innovation and utilizing the latest technology, and expanding into new
markets around the world.”18
Right away, Iger embarked on an acquisition spree, buying Pixar in 2006 for $7.4 billion, which
formalized the unofficial collaborative relationship with the beloved animated film studio. In
2009, he orchestrated the $4 billion acquisition of Marvel Entertainment, which transformed
the global box office. In 2012, Iger struck again, buying Star Wars production company
Lucasfilm for $4 billion.19
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negative attention to the company. In 1997, the Southern Baptist Convention, the largest
Protestant body in the US, called for a boycott of all Disney products after Ellen DeGeneres,
star of the ABC sitcom Ellen, came out as a lesbian.14 The Catholic League heavily criticized
Disney for The Priest (1994) movie produced by its Miramax subsidiary, which portrayed a
priest struggling with his sexuality, and successfully pressured Disney into selling the
distribution rights for Dogma (1999), a film that depicted angels leading a bloody massacre and
controversial pop singer Alanis Morissette as a Skee-Ball-loving God.15
We’re thrilled to welcome Lucasfilm to the Disney family. Star Wars is one of the
greatest family entertainment franchises of all time and this transaction combines
that world-class content with Disney’s unique and unparalleled creativity across
multiple platforms, businesses, and markets, which we believe will generate
growth as well as significant long-term value.21
Within months of the acquisition, Disney announced that a new feature film, Star Wars: The
Force Awakens, would be in theaters by 2015 with additional movie releases planned, followed
by television programming, games, and merchandise, and an expanded presence of Star Wars
in Disney’s amusement parks.
Many industry observers viewed the acquisition favorably, seeing natural synergies between
Star Wars and Disney’s core businesses (theme parks, films, licensing, and television) focused
on family entertainment. These observers pointed to Disney’s recent success in purchasing
companies such as Pixar and Marvel and leveraging those assets to drive growth. As Iger
himself noted, “Our remarkably successful acquisitions of Pixar and Marvel, in particular,
have proven our unique ability to nurture strong brands and expand fantastic creative content
to its fullest potential and maximum value.”22
After a successful series of acquisitions, including 21st Century Fox in 2019, Disney had
amassed an unrivaled collection of intellectual property. Iger was ready to turn his attention
to the final piece of his legacy: launching a global streaming empire fit to give the current
powerhouse, Netflix, a run for its money.
Following the successful launch of Disney+, Iger stepped down as CEO in February of 2020
and became the executive chairman and chairman of the board of directors. In his place, Bob
Chapek, previously the chairman of Disney's parks, experiences, and products, was named
CEO.23
The Chapek Era
In August of 2020, Chapek announced the launch of a new international streaming platform
under the Star brand. 24 The Star brand name originated as a Hong Kong broadcasting
company in 1991, which Disney gained as part of the acquisition of 21st Century Fox. In
December of the same year, Chapek officially announced both Star and Star+. Star would be
available as a part of the Disney+ catalog for certain countries, while Star+ would exist as its
own platform in other regions.25
These complicated streaming platform designations came months before Disney’s
reorganization which merged the three Media Networks, Studio Entertainment and the DirectPage 7 | The Walt Disney Company: If You
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Lucasfilm’s assets included the well-known Star Wars franchise as well as live-action film
production businesses, consumer products, animation, visual effects, and a range of high-end
entertainment technologies. The Star Wars assets alone featured “a universe of more than
17,000 characters, inhabiting several thousand planets, spanning 20,000 years.”20 At the time of
the announcement, Iger stated,
Disney in 2019: Before the Reorganization
As seen in Exhibit 3, in 2019, The Walt Disney Company operated in four business segments:
media networks; parks, experiences, and products; studio entertainment; and direct-toconsumer & international (DTCI). Table 1 below summarizes revenue and operating income
from each of the segments from 2017 through 2019. Table 2 shows the new corporate structure
which went into place in 2020. See appendices for additional financial information.
TABLE 1. THE DISNEY COMPANY: SEGMENT REVENUE AND OPERATING INCOME 2019.
(IN MILLIONS)
2019
2018
2017
Revenues:
Media Networks
$ 24,827
$ 21,922
$ 21,299
Parks, Experiences, and Products
26,225
24,701
23,024
Studio Entertainment
11,127
10,065
8,352
Direct-to-Consumer & International
9,349
3,414
3,075
Eliminations
(1,958)
(66)
(613)
$ 69,570
$ 59,434
$ 55,137
Segment operating income (loss):
Media Networks
$ 7,479
$ 7,338
$ 7,196
Parks, Experiences and Products
6,758
6,095
5,487
Studio Entertainment
2,686
3,004
2,363
Direct-to-Consumer & International
(738)
(738)
(284)
Eliminations
(10)
(10)
13
$14,868
$ 15,689
$ 14,775
Source: The Walt Disney Company, 10K, 2019, 40.
TABLE 2. THE DISNEY COMPANY: SEGMENT REVENUE AND OPERATING INCOME 2021.
(IN MILLIONS)
2021
2020
2019
Revenues:
Disney Media and Entertainment Distribution
$ 50,866
$ 48,350
$ 42,821
Disney Parks, Experiences and Products
16,552
17,038
26,786
$ 67,418
$ 65,388
$ 69,707
Segment operating income (loss):
Disney Media and Entertainment Distribution
$ 7,295
$ 7,653
$ 7,528
Disney Parks, Experiences and Products
471
455
7,319
$7,766
$ 8,108
$ 14,847
Source: The Walt Disney Company, Annual Report, 2021, 75.
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to-Consumer & International segments into a single Disney Media and Entertainment
Distribution segment.26 This reorganization became immediately apparent, with the upcoming
Disney Investor Day in December 2020 featuring two and a half hours of time dedicated to
showcasing the Disney’s streaming content pipeline, which included new content for Disney+,
ESPN+, Star, and Hulu.27
ESPN:ii ESPN was the most profitable division within Disney. Forbes estimated ESPN’s value
at $40 billion of Disney's $85 billion total, noting, “The reality is that there is not another media
property in the world worth as much as ESPN because no media asset delivering content
generates close to as much money.”28 At the time of Disney’s acquisition of ESPN (as part of
the Capital Cities/ABC deal), then-CEO Eisner characterized it as the most important
component of the deal, noting:
We know that when we lay Mickey Mouse or Goofy on top of products, we get
pretty creative stuff. ESPN has the potential to be that kind of brand. ABC has never
had our resources, and we haven’t had ESPN. Put the two together and who knows
what we get.29
Disney did indeed forecast growth for ESPN, but it proved to be primarily organically driven
rather than synergistic growth generated from a relationship with Disney. While ESPN was
never integrated into Disney’s theme parks, in 1998, Disney launched the theme restaurant
and entertainment center chain ESPN Zone to merge ESPN’s brand with Disney’s familyfriendly reputation. Serving sports bar fare, the upscale restaurants featured walls of bigscreen TVs broadcasting sporting events, with separate rooms providing access to interactive
games. In 2010, after several years of uneven performance, Disney closed most of the locations
except those tied to a Disney property, such as the ESPN Club (formerly Zone) on the
BoardWalk in Walt Disney World.
Many industry observers, however, wondered how long ESPN could continue to dominate
the sports broadcast space with newer entrants such as Fox Sports and NBC Sports. ESPN
agreed to double the annual rights fees it pays for Major League Baseball and in 2011 reached
an eight-year, $15.2 billion deal to broadcast the National Football League.30
Disney Channels: Unlike ESPN, which had no overt programming connection to Disney, the
Disney channels (more than 100 channels or channel feeds in 35 languages across 167
countries/territories) showcased Disney and its brand. Most well-known was the 24-hour cable
network the Disney Channel, which broadcast original content and movies targeted to
children ages 6 to 14 and their families. The channels offered live-action, animated, and
preschool programming. Key programs included the series Hannah Montana (2006-2011), the
animated Phineas and Ferb (the longest-running show on the Disney Channel), and Mickey
Mouse Clubhouse, which used computer-generated imagery. In 1999, Disney transitioned the
ii
ESPN operated eight 24-hour sports networks and five high-definition television simulcast services, with an
additional 27 international sports networks that reached households in 190 countries and territories in 11 languages.
ESPN held rights for a number of high-profile professional and college sports programming events, including
those of the National Football League (NFL), the National Basketball Association (NBA), Major League Baseball
(MLB), college football and basketball conferences, car racing (NASCAR), the Wimbledon tennis championships,
US Open Tennis, and the Masters golf tournament.
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Media Networks
ABC: The most significant broadcasting segment of Disney Media Networks division was
ABC.iii. With 329 local affiliates, ABC reached 99% of all US households. Its performance, or
lack thereof, had been a major contributor to dissatisfaction with Eisner after the $19 billion
purchase of Capital Cities/ABC in 1995.
Since that time, ABC had surged and retrenched in terms of its programming performance. In
addition to trying to stay atop the ratings, another cause for concern was the degradation of
network television media as advertising spending transitioned to cable channels and online
media. In the first quarter of 2013, The Wall Street Journal noted, “Among viewers ages 18 to
49, the demographic most prized by advertisers, this season’s average prime-time audiences
through March 17 were down 23% at News Corp.’s Fox; 7% at Comcast Corp.’s NBC; 3% at
CBS; and 8% at Walt Disney Co.’s ABC.”31
Recognizing the future distribution challenges, ABC was the first television network to license
its shows for download on Apple’s iTunes Store. ESPN and ABC also actively embraced the
iPod. As BusinessWeek noted, “Putting Disney movies and ABC shows on the iPod is not just
groundbreaking. It’s a reflection of a faster-moving and more aggressive Disney.”32
Fox: In March 2019, Disney made its biggest acquisition ever with its $71.3 billion takeover of
21st Century Fox's entertainment assets.33 In 2018, the deal had hit a roadblock when Comcast
submitted a surprise bid of $65 billion to lure Fox away from Disney. But Disney was able to
keep the deal going when it raised its offer to $71 billion. 34 The US Department of Justice
approved the merger in exchange for Disney agreeing to sell off 22 regional sports networks
that were originally part of the purchase.35
Through this acquisition, Disney reshaped the media landscape and became an even larger
entertainment giant. Disney purchased a vast array of movies and TV shows (The Simpsons), a
movie studio (20th Century Fox), TV networks (FX Networks, National Geographic Partners),
and a controlling stake in Hulu. Fox Corp, owned by Rupert Murdoch, still existed
independent of Disney, and controlled The Wall Street Journal and TV channels such as Fox
Sports, Fox News, and Fox Business Network.36
Disney owned 30% of Hulu prior to the deal and added Fox’s 30%, giving the company
majority ownership, with the remaining split between NBCUniversal (30%) and WarnerMedia
(10%). This move also effectively reduced the number of big movie studios in Hollywood to
five: Disney, Warner Bros., Sony, Universal, and Paramount. In addition to Deadpool, Disney’s
Marvel Studios now had access to all the X-Men and Fantastic Four characters, whose rights
were sold to Fox back in the 1990s when a pre-Disney Marvel was struggling financially37.
iii
The ABC television networks included ABC Studios and eight domestic television stations, six of which were
located in the top ten US markets.
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Disney Channel from a premium cable service to a basic channel, significantly increasing its
reach.
Parks, Experiences, and Products
In 2019, Disney was the worldwide leader in amusement parks (see Exhibit 4). Disney owned
and operated its flagship theme parks: Disneyland in Anaheim, CA and Disney World in
Orlando, FL. In addition, Disney managed and had partial ownership of Disneyland Paris
(51%), Hong Kong Disneyland (48%), and Shanghai Disneyland (43%). In addition to its theme
parks, Disney owned Aulani, a Disney resort and spa in Hawaii, the Disney Cruise Line, the
Disney Vacation Club (timeshares), National Geographic Expeditions (73% stake) and
Adventures by Disney, a travel agency.38
For many American families, visiting Disneyland or Disney World was a childhood rite of
passage. It was a treasured experience that invited parents to relive their own first trip to
Disney, but it was not inexpensive. As of February 2020, a one-day ticket to the Magic
Kingdom at Walt Disney World was $109, while at Disneyland, a 1-Day 1 Park adult pass
started at $10439 As NBC News noted, “Experiencing the magic of Disney is now going to take
a little more magic from mommy and daddy’s wallet.” One parent noted, “It wouldn’t make
me mad if the lines were shorter… But to pay $400 for a family of four for one day and stand
in lines forever is ridiculous.”40
One notable development in theme parks that occurred outside the Disney gates was the
opening of The Wizarding World of Harry Potter at rival Universal Studios Florida. Many
questioned why the global phenomenon did not become part of the Disney collection,
especially since Disney had been involved in early negotiations with Harry Potter author J.K.
Rowling. Speculation suggested that Disney was unwilling to offer the sum she demanded,
and that each party was adamant about retaining creative control of the project, leaving
Rowling to pursue other options.
HOTELS
In the US, Disney mostly owned and operated hotels within its theme parks. At Disney World,
the company owned and operated 18 resort hotels offering a total of 24,000 rooms and almost
500,000 square feet of meeting space. In the Downtown Disney Resort area of the park, there
were seven independently operated hotels on property leased from Disney, and near EPCOT,
the Walt Disney World Swan and Dolphin Resort (comprising 2,300 rooms) was operated by
Marriott Hotels, part of the Westin Hotels and Resorts family of brands, on property leased
from Disney. The on-site Disney properties at Disney World were classified by value, as
moderate and deluxe properties with rates ranging from $100 per night to more than $500 per
night depending on the property and time of year. (See Exhibit 5.) At Disneyland, Disney
owned and operated three hotels with a total of 2,400 rooms.
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THEME PARKS
In 2019, hotel occupancy across Disney hotels was 90% for domestic properties and 81% for
international hotels; per room guest spendingiv was $353 and $330, respectively.
Disney Cruise Line operated four ships: Disney Magic, Disney Wonder, and the newer Disney
Dream and Disney Fantasy. Unlike other more adult-focused cruise lines, the ships were Disney
branded and catered specifically to children, families, and grown-ups, with themed areas and
activities for each group. Many Disney’s cruise vacations included a visit to Disney’s Castaway
Cay, a 1,000-acre private island in the Bahamas.
Despite well-publicized issues experienced by competitor cruise lines, v Disney remained
committed to the cruise experience, believing its brand meant “quality and service for family
entertainment.”41
CONSUMER PRODUCTS
Disney was a market leader in licensing and publishing from its intellectual and creative
properties, earning $3.2 billion in revenue and an operating income of $937 million in 2012.
Disney retained a stable base of licensed goods based on its traditional animation characters
such as Winnie the Pooh, Cinderella, etc. Licensing revenues were fueled by the launch of
successful movie franchises. One notable example of the interconnectivity of Disney’s
products was the 2006 Pixar movie Cars. The original movie grossed $462 million worldwide
and was followed by sequels; Cars-related products sold $2 billion per year, with licensing fees
usually between 8% and 10% of total retail sales42; Pixar created a series of Cars shorts that
aired on the Disney Channel and were packaged as a CD; the internet and gaming division
devised a virtual Cars world; and Cars Land opened at Disneyland’s California Adventure in
2012.43
Disney’s presence in retail through its Disney Stores also bolstered its consumer products
business. Launched in 1987, the stores exclusively stocked Disney products and were designed
to act as brand ambassadors to the public. All store employees had to undergo the usual
Disney training program to maintain the Disney experience.44 The company sold the chain in
November 2004 under a long-term licensing agreement to a subsidiary of The Children’s Place,
a specialty retailer of children’s apparel and accessories. The impetus for the sale was that
much of Disney’s licensed merchandise was bought at big retailers like Walmart, not Disney
Stores. According to the terms of the deal, Disney was paid a royalty on the retail store sales
of Disney-branded products, and The Children’s Place was expected to bring retail experience
and operating efficiencies. However, in March 2008, Disney bought back the chain after
becoming dissatisfied with how The Children’s Place handled the stores.45
iv
Per room guest spending included the average daily room rate as well as guest spending on food, beverages, and
merchandise at the hotel.
v
During 2012-13, several large cruise lines experienced well-publicized disasters, resulting in threats to passenger
safety, most notably the Costa Concordia disaster in January 2012.
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CRUISES
Similar to the Cars example above, Disney planned to integrate some of Marvel’s assets into
Disney’s theme parks in California, Paris, and Hong Kong. Disney’s cable channels, in
particular Disney XD, anticipated mining the new intellectual property, while those in
consumer products envisioned huge international and domestic licensing opportunities.46
Disney appeared to have a rare miscue in the consumer products space with the launch of
Princess Merida, the protagonist of the hit Pixar movie Brave. A reimagined version of that
character caused an immediate public furor, and was satirized on The Daily Show with Jon
Stewart in a segment titled ‘The Princess and the P.R.”47 The Los Angeles Times covered the
kerfuffle:
The modified Merida was created specifically to welcome the character into the
company’s princess collection… The version causing the outrage envisions the
cartoon character with a much more tamed mane of red curls, a plunging neckline,
a narrowed waistline and an angled face. She’s also sporting eyeliner and not
showing off her trademark bow and arrow… It sparked Brave creator Brenda
Chapman to take to the internet, voicing her displeasure with the modifications.48
Studio Entertainment
Encompassing Disney’s theatrical distribution under the Walt Disney Pictures, 20th Century
Fox, Pixar, and Marvel labels, the studio entertainment division played an important role in a
broader revenue stream for the company. As noted by The Wall Street Journal, “It creates the
material that feeds the parks, TV channels, and video games. That strategy makes it very
valuable for Disney to fully own its movies, so the company doesn’t use financing partners to
temper risk, as most of its competitors do.”49
HITS AND MISSES
After taking on the role of CEO, Iger immediately set the acquisition wheels in motion in the
studio entertainment division, completing the $7.4 billion purchase of Pixar in 2006 and the $4
billion acquisition of Marvel, the comic book publisher and movie studio, in 2009.
As per CNN, within six months of becoming CEO:
Iger had formulated another idea that he now shared with the board: Buy Pixar.
Iger had been working behind the scenes to mend the relationship with Jobs, and
had also put in time with top Pixar executives Ed Catmull and John Lasseter, who
initially balked. Iger noted that he too had been acquired, twice: when Cap Cities
bought ABC in the mid-1980s and then when Disney bought ABC. Plus, Catmull
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The ability of Disney to leverage assets played a role in its purchase price of Marvel. Although
that company had leveraged its comic book characters across motion pictures, video games,
and consumer products, Disney saw an opportunity to “plug Marvel into its vaunted global
marketing and distribution system.” As Iger noted, “Marvel’s brand and its treasure trove of
content will now benefit from our extraordinary reach. We paid a price that reflects the value
they’ve created and the value we can create as one company. It’s a full price, but a fair price.”
In the seven years following the acquisition, Disney released seven Pixar animated films (Cars,
Ratatouille, WALL-E, Up, Toy Story 3, Cars 2 and Brave), which generated $4.5 billion in
worldwide ticket sales according to Box Office Mojo, and roughly $1.15 billion in DVD sales,
which typically had profit margins around 50%.51
Similarly, while the Marvel acquisition brought box office success, the integration of “a
scrappy company whose artists and writers waged battles against supervillains, social ills, and
(perhaps most insidious of all) corporate marketing departments”52 into the Disney corporate
fold was perceived by most industry observers to be a risky venture.
In 2009, Iger dismissed the previous movie chairman and hired Richard Ross, an executive
with an extensive television background but limited film experience to “fix” the movie studios.
Soon after his arrival, Ross restructured not only the management of the studio business, but
also consolidated key departments (marketing, production, distribution, communications)
into adjacent buildings to try to build increased collaboration and coordination. Taking a
global brand management approach, Ross required projects to be approved by marketing,
distribution, and franchise management before being green-lighted for production. As Fast
Company noted, "Ross focuses on profitability—and not solely from his Disney Studios
division. The networks, parks, and resorts, and consumer-products division often enjoy fatter
margins, so Ross wants to give them movies with tons of spin-off potential."53
The poorly received Cars 2, for example, barely broke even at the box office, and only achieved
that based on the international box office—but was still driving $2 billion in merchandising.
Following the disappointing box office performance of John Carter and a record of more
“misses than hits,” Ross resigned in April 2012, leaving a movie studio that “continues to
operate in turmoil more than two years after he [Iger] first moved to fix it.” Despite the change
in leadership, it was expected that Disney would continue to make fewer but more expensive
movies each year with “franchises with characters that can be turned into smash merchandise
lines, theme park rides, and small-screen spin-offs.” 54
Throughout the years, Disney steadily gained studio market share to become the industry
leader by vast margins (see Exhibit 6). After its release in April 2019, Disney’s Avengers:
Endgame became the highest-grossing movie of all time, selling $2.8 billion worth of tickets
worldwide. By 2020, Disney's movie studio division was stronger than ever following the Fox
acquisition. With this move, the entertainment giant gained a number of valuable properties
including Avatar, one of the highest-grossing movies of all time. Disney plans to release Avatar
and Star Wars sequels in alternating Decembers from 2021 to 2027, likely giving the company
a stranglehold on the holiday box office over the next decade.55
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and Lasseter would have a bigger canvas because Disney animation would now
report to them.50
Walt Disney’s DTCI division was formed as part of The Walt Disney Company’s March 2018
strategic reorganization in anticipation of integrating 21st Century Fox's assets into the
organization. DTCI consisted of three major units: Disney’s direct-to consumer platforms,
technology, and international media businesses.56
Streaming: In 2017, following its acquisition of 21st Century Fox (which resulted in controlling
ownership of Hulu), Disney announced it would enter the SVOD market with new streaming
platforms including the sports-oriented ESPN+, followed by a new Disney-branded
entertainment service, Disney+. Users also had the option to subscribe to a bundled package
of Disney+ with Hulu and ESPN+ at $12.99 per month. 57
Initially launched in 2010, Hulu was an American SVOD service that aggregated recent
episodes of television series from their respective television networks. It was originally
established as a joint venture between News Corp, NBCUniversal, Providence Equity
Partners, and later Disney, but became fully controlled and majority owned by Disney when
the company merged with Fox. In 2017, the company launched Hulu with Live TV, an overthe-top Internet Protocol television (IPTV) service featuring linear television channels. As of
the first quarter of 2020, Hulu had 30.4 million subscribers.58
ESPN+, Disney’s first direct-to-consumer service, launched in April 2018. ESPN President
Jimmy Pitaro lauded it as the “beginning of a new era of innovation at ESPN,” as the service
included live sports, exclusive sports-related studio programming, a library of on-demand
programs, and past sporting events. The service debuted at $4.99 a month or $49.99 for the full
year.59
Launched in November 2019, Disney+ was the company's online hub for streaming almost
everything it produces. Disney+ streamed shows and movies from Disney franchises and
brands, including Star Wars, Marvel, and Pixar, and all the family-friendly properties from
Disney itself, plus programming it acquired by taking over Fox.60 Reviews of Disney’s original
content were generally positive, with particular attention paid to The Mandalorian, a series set
in the Star Wars universe. The show received widespread acclaim, reaching a 100% Rotten
Tomatoes rating for the final episode of the season. The series achieved social media virality
with the popularity of its baby Yoda character.61
According to Agnes Chu, who was tapped to helm the launch of Disney+, “The first thing I
did was make sure that the library was going to be ready for our launch… [This] was
everything from going into our vault and physically looking at things that had not yet been
restored to [paging through] binders of pieces of paper with legal deals," Chu said. She also
took meetings with the heads of Disney's various divisions, sitting down with Walt Disney
Studios Motion Picture Production president Sean Bailey and Lucasfilm president Kathleen
Kennedy to discuss what a Disney+ original film or Star Wars TV series could look like.62 In
charting out her strategy, Chu declared:
Page 15 | The Walt Disney Company: If You
Give this Mouse a Focus
BY JERRY KIM* AND STEPHAN MEIER†
Page 142 of 213
For use only in the course RSM 392 - Strategic Management at University of Toronto - Rotman School of Management from 9/3/2024 to 12/31/2024.
Use outside these parameters is a copyright violation.
Direct-to-Consumer & International
With Disney+, Disney broke into a saturated SVOD market, with Netflix, Hulu, Amazon, and
HBO representing significant competitive threats. While Disney estimated that the service
would run at a $1 billion loss in its first year due to up-front investment costs in original
content and technology, the company also expected significant growth, hoping to exceed
Netflix’s total subscribers by 2024. The service was initially priced at $6.99 per month, and in
its first two weeks, the Disney+ app was downloaded 15.5 million times and generated $5
million in revenue.64 Disney announced that in 2019 it would end its distribution agreement
with Netflix for subscription streaming of new releases, projecting that it would lose $150
million from this move.65
Technology: The technology group was composed of DTCI technology, Disney streaming
services, DTCI streaming services, and DTCI digital media, which included ABC News and
FiveThirtyEight.
In August 2017, Disney announced that it would pay $1.58 billion to acquire a controlling stake
in BAMTech, the MLB’s industry-leading streaming company specializing in direct-toconsumer streaming technology and marketing services, and data analytics. Disney renamed
it Disney Streaming Services and began to develop ESPN+ and Disney+ based on its
underlying direct-to-consumer streaming infrastructure.66
International: Groups in the international unit included Disney Channels Worldwide, Fox
Networks Group, and The Walt Disney Companies in Latin America, Europe/Middle
East/Africa (EMEA), Asia Pacific, Philippines, Southeast Asia, Malaysia, Indonesia, Thailand,
and Australia.
Looking Forward
“Disney has repeatedly shown that it is exceptionally resilient, bolstered by the quality of
our storytelling and the strong affinity consumers have for our brands”67
—Bob Chapek
In August 2022, Disney announced that its total subscriptions from Disney+, ESPN+, and Hulu
(221 million) had eclipsed Netflix’s subscription base (220 million); however, revenue per user
across Disney’s streaming platforms remained just a fraction of what Netflix enjoyed.68
The Walt Disney Company: If You Give this
Mouse a Focus | Page 16
BY JERRY KIM* AND STEPHAN MEIER†
Page 143 of 213
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We’re leaning into the nostalgia. We’re leaning into the fact that many of our
subscribers will be fans who love titles we have created in the past [and love] seeing
new extensions or reimaginings or reboots of them. On the service they’ll also be
able to watch… [Star Wars] films from a decade ago. We’re not making a large
volume of things just to make them. Everything we do, we have a very clear focus
that it needs to meet the standards that the originals set, and hopefully take it to
another level on Disney+. So we’re pretty thoughtful about harnessing the
nostalgia.63
Complaints about Disney theme parks abounded, with more than 100,000 customers signing
a position to remove Chapek after introducing changes to Genie+, the app used to help
customers navigate the parks. Overall, the parks were more expensive and more packed for
consumers than they were pre-pandemic.
Was the growing consolidation of media towards all things streaming the right idea, with
Disney’s focus on a few core franchises?
Page 17 | The Walt Disney Company: If You
Give this Mouse a Focus
BY JERRY KIM* AND STEPHAN MEIER†
Page 144 of 213
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As a result, analysts were not completely optimistic about Disney’s outlook. Some were
concerned for political reasons – Florida Governor Rob DeSantis signed a bill that would
revoke a special tax status that Disney had held since 1967 because of the company’s stance on
the “Parental Rights in Education” act, also known as the “Don’t Say Gay” bill.69 Others were
concerned about Disney not being able to capture a broader (and older) audience if it did not
expand from its Star Wars, Marvel and Pixar franchises. There were examples of Disney going
too far in merchandising some of these brands, with BB-8 themed oranges and Yoda themed
grapes.70
For use only in the course RSM 392 - Strategic Management at University of Toronto - Rotman School of Management from 9/3/2024 to 12/31/2024.
Use outside these parameters is a copyright violation.
Exhibits
Exhibit 1
Disney Stock Price vs. S&P 500, 2010-2020
Source: Stock price data from The Motley Fool, compiled July 2020
The Walt Disney Company: If You Give this
Mouse a Focus | Page 18
BY JERRY KIM* AND STEPHAN MEIER†
Page 145 of 213
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Use outside these parameters is a copyright violation.
Exhibit 2
The Walt Disney Company Business Portfolio in 2020
Source: TitleMax website, accessed July 2020, https://www.titlemax.com/discovery-center/moneyfinance/companies-disney-owns-worldwide/
Page 19 | The Walt Disney Company: If You
Give this Mouse a Focus
BY JERRY KIM* AND STEPHAN MEIER†
Page 146 of 213
Source: Themed Entertainment Association (TEA) and the Economics Practice at AECOM. Global
Attractions Attendance Report, 2018.
The Walt Disney Company: If You Give this
Mouse a Focus | Page 20
BY JERRY KIM* AND STEPHAN MEIER†
Page 147 of 213
For use only in the course RSM 392 - Strategic Management at University of Toronto - Rotman School of Management from 9/3/2024 to 12/31/2024.
Use outside these parameters is a copyright violation.
Exhibit 3
2018 Worldwide Theme Park Attendance – Top 25 Locations
Star
Rating
Price*
Disney
Proximity
(miles)
Disney’s All-Star Movies Resort
2
$158
Owned
2.6
Best Western Lake Buena Vista Resort Hotel
3
$73
Non-Disney
2.9
Holiday Inn Lake Buena Vista Downtown
3
$108
Non-Disney
2.8
Disney’s Art of Animation Resort
3
$173
Owned
1.9
Disney’s Port Orleans Resort French Quarter
3
$196
Owned
1.2
Disney’s Fort Wilderness Resort &
Campground
3
$372
Owned
2.1
Sheraton Lake Buena Vista Resort
4
$101
Non-Disney
3.1
Hilton Orlando Lake Buena Vista
4
$124
Non-Disney
2.7
Buena Vista Palace
4
$137
Non-Disney
2.5
Hyatt Regency Grand Cypress
4
$149
Non-Disney
2.7
Hilton Orlando Bonnet Creek
4
$159
Non-Disney
2.1
Walt Disney World Dolphin
4
$189
Licensed
0.9
Wyndham Bonnet Creek Resort
4
$217
Non-Disney
1.7
Walt Disney World Swan
4
$219
Licensed
1
Disney’s Yacht Club Resort
4
$487
Owned
0.5
Disney’s Old Key West Resort
4
$497
Owned
1.4
Disney’s Contemporary Resort
4
$502
Owned
2.7
Waldorf Astoria Orlando
5
$219
Non-Disney
2.3
Name
*Prices per night, without taxes, from Kayak.com, for one room, four occupancy, 6/7/13-6/9/13,
accessed 5/21/13.
Page 21 | The Walt Disney Company: If You
Give this Mouse a Focus
BY JERRY KIM* AND STEPHAN MEIER†
Page 148 of 213
For use only in the course RSM 392 - Strategic Management at University of Toronto - Rotman School of Management from 9/3/2024 to 12/31/2024.
Use outside these parameters is a copyright violation.
Exhibit 4
Hotel Price Comparison
Rank
Title
1 Avengers: Endgame
2 The Lion King
3 Frozen II
4 Captain Marvel
Spider-Man: Far from
5
Home
Star Wars: The Rise
6
of Skywalker
7 Toy Story 4
8 Joker
9 Aladdin
Jumanji: The Next
10
Level
International
Domestic
Worldwide
($ millions)
2,797.8
1,656.9
1,447.5
1,129.7
($ millions)
858.3
543.6
477.3
426.8
($ millions)
1,939.4
1,113.3
970.1
702.9
Sony
1,129.7
390.5
738,6
Disney
1,073.4
515.2
558.2
Disney
Warner Bros.
Disney
1,073.3
1,072.8
1,050.9
434.0
335.5
335.5
639.3
737.3
695.4
795.3
316.8
478.4
Studio
Disney
Disney
Disney
Disney
Sony
Source: The-numbers.com, https://www.the-numbers.com/box-office-records/worldwide/allmovies/cumulative/released-in-2019
STUDIO MARKET SHARE
Rank
1
2
3
4
5
6
7
8
Distributor
Disney
Warner Bros.
Universal
Sony/Columbia
Lionsgate
Paramount
20th Century Studios
Other
Market
Share
33.1%
13.8%
13.4%
11.7%
6.8%
5.0%
4.9%
11.2%
2019
Movies
Released
14
22
29
17
36
17
16
Sources: Statista, https://www.statista.com/statistics/187171/market-share-of-film-studios-in-northamerica-2010/#:~:text=With%20a%20record%2Dbreaking%20domestic,Disney%
20acquired%20early%20in%202019; Movie Insider,
https://www.movieinsider.com/movies/busiest/2019
The Walt Disney Company: If You Give this
Mouse a Focus | Page 22
BY JERRY KIM* AND STEPHAN MEIER†
Page 149 of 213
For use only in the course RSM 392 - Strategic Management at University of Toronto - Rotman School of Management from 9/3/2024 to 12/31/2024.
Use outside these parameters is a copyright violation.
Exhibit 5
Top 10 Movie Titles for 2019 Based on Consumer Spending
Source: Statista, accessed July 2020, https://www.statista.com/chart/19970/disney-10-millionsubscribers-24-hours/
Page 23 | The Walt Disney Company: If You
Give this Mouse a Focus
BY JERRY KIM* AND STEPHAN MEIER†
Page 150 of 213
For use only in the course RSM 392 - Strategic Management at University of Toronto - Rotman School of Management from 9/3/2024 to 12/31/2024.
Use outside these parameters is a copyright violation.
Exhibit 6
SVOD Competitive Landscape
Page 151 of 213
1,287
1,004
1,287
1,560
1,804
2,262
3,024
3,945
3,779
3,035
2,743
2,832
2,384
2,713
4,048
4,107
5,510
6,855
7,443
5,697
6,726
7,781
8,863
9,450
11,540
13,224
14,487
13,873
14,837
Earnings
Before Interest
and Taxes
1,825
1,799
2,047
2,589
3,412
4,115
6,968
8,903
7,533
6,814
7,407
4,586
3,426
3,790
5,258
5,446
6,946
8,346
9,025
7,328
8,439
9,622
10,850
11,642
13,828
15,578
17,014
16,655
17,848
Earnings
Before Interest
6
4.78
1.52
1.23
2.04
2.6
1.96
2.86
0.89
0.62
0.57
0.11
0.6
0.65
1.12
1.24
1.64
2.24
2.28
1.76
2.03
2.52
3.13
3.38
4.26
4.9
5.73
5.69
8.36
Earnings Per
Share (Diluted)
1,825
1,799
2,047
2,589
3,412
4,115
6,968
8,903
7,533
6,814
7,407
4,586
3,426
3,790
5,258
5,446
6,946
8,346
9,025
7,328
8,439
9,622
10,850
11,642
22,393
24,101
25,768
24,831
26,708
Gross Profit
(Loss)
6
4.78
1.52
1.23
2.04
2.6
2.48
2.75
0.91
0.58
0.55
0.69
0.53
0.66
1.11
1.23
1.66
2.36
2.36
1.87
2.18
2.58
3.11
3.4
4.38
5.2
5.88
5.74
7.1
Earnings Per
Share from
Operations
5,844
6,182
7,504
8,529
10,055
12,112
18,739
22,473
22,976
23,402
25,402
25,269
25,329
27,061
30,752
31,944
34,285
35,510
37,843
36,149
38,063
40,893
42,278
45,041
48,813
52,465
55,632
55,137
59,434
Revenue Total
BY JERRY KIM* AND STEPHAN MEIER†
The Walt Disney Company: If You Give this
Mouse a Focus | Page 24
824
637
817
300
1,110
1,380
1,214
1,966
1,850
1,300
920
(158)
1,236
1,267
2,345
2,533
3,374
4,687
4,427
3,307
3,963
4,807
5,682
6,136
7,501
8,382
9,391
8,980
12,598
Net Income
(Loss)
For use only in the course RSM 392 - Strategic Management at University of Toronto - Rotman School of Management from 9/3/2024 to 12/31/2024.
Use outside these parameters is a copyright violation.
Source: Case writer analysis based on data from S&P Capital IQ
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
Data Year Fiscal
Appendices
Key Financials (1990-2018)
Page 152 of 213
0.4
(20.4%)
NA
636.6
10.4%
636.6
10.4%
933.7
15.3%
0.5
824.0
14.3%
824.0
14.3%
1,200.6
20.9%
1,197.2
19.6%
1,094.5
17.9%
1,339.1
23.3%
1,403.7
24.4%
6.2%
6,112.0
5,757.3
NA
USD
12
months
Sep-301991A
USD
12
months
Sep-301990A
27.3%
0.51
816.7
10.9%
816.7
10.9%
1,287.1
17.2%
1,604.4
21.4%
1,435.3
19.1%
22.8%
7,504.0
USD
12
months
Sep-301992A
(19.0%)
0.41
299.8
3.5%
671.3
7.9%
1,560.3
18.3%
1,924.5
22.6%
1,724.5
20.2%
13.7%
8,529.2
USD
12
months
Sep-301993A
65.2%
0.68
1,110.0
11.0%
1,110.0
11.0%
1,693.0
16.8%
2,103.0
20.8%
1,972.0
19.5%
18.3%
10,090.0
USD
12
months
Sep-301994A
27.8%
0.87
1,380.0
11.4%
1,380.0
11.4%
2,227.0
18.3%
2,697.0
22.2%
2,466.0
20.3%
12,151.
0
20.4%
USD
12
months
Sep-301995A
(25.1%)
0.65
1,214.0
6.5%
1,214.0
6.5%
3,024.0
16.1%
3,997.0
21.3%
3,333.0
17.8%
54.2%
18,739.0
USD
12
months
Sep-301996A
46.2%
0.95
1,966.0
8.7%
1,966.0
8.7%
3,945.0
17.6%
5,122.0
22.8%
4,751.0
21.1%
19.9%
22,473.0
USD
12
months
Sep-301997A
(6.3%)
0.89
1,850.0
8.1%
1,922.0
8.4%
3,915.0
17.0%
5,155.0
22.4%
4,510.0
19.6%
2.2%
22,976.0
USD
12
months
Sep-301998A
(30.3%)
0.62
1,300.0
5.5%
1,389.0
5.9%
2,969.0
12.7%
4,276.0
18.2%
3,425.0
14.6%
23,455.
0
2.1%
USD
12
months
Sep-301999A
(8.1%)
0.57
920.0
3.6%
1,027.0
4.1%
2,525.0
10.0%
4,720.0
18.6%
3,758.0
14.8%
25,325.
0
8.0%
USD
12
months
Sep-302000A
(80.7%)
0.11
(158.0)
(0.6%)
224.0
0.9%
2,832.0
11.3%
4,586.0
18.2%
3,599.0
14.3%
25,172.
0
(0.6%)
USD
12
months
Sep-302001A
445.5%
For use only in the course RSM 392 - Strategic Management at University of Toronto - Rotman School of Management from 9/3/2024 to 12/31/2024.
Use outside these parameters is a copyright violation.
BY JERRY KIM* AND STEPHAN MEIER†
Page 25 | The Walt Disney Company: If You
Give this Mouse a Focus
0.6
1,236.0
4.9%
1,337.0
5.3%
2,384.0
9.4%
3,426.0
13.5%
2,384.0
9.4%
0.6%
25,329.0
USD
12
months
Sep-302002A
Notes:
¹All results are taken from the most recently filed statement for each period. When there has been more than one, earlier filings can be viewed on the
individual statement pages.
2All forward period figures are consensus mean estimates provided by the brokers and may not be on a comparable basis as financials.
Growth Rates are calculated in originally reported currency only and will not reflect any currency conversion selected above.
Diluted EPS
Excl. Extra
Items2
Growth Over
Prior Yr
Margin %
Net Income
Earnings from
Cont. Ops.
Margin %
Margin %
EBIT
Margin %
EBITDA
Margin %
Growth Over
Prior Yr
Gross Profit
Currency
Total Revenue
For the Fiscal
Period Ending
Key
Financials¹
(IN MILLIONS)
Appendix 1A
The Walt Disney Company Key Stats – 1990-2002
Page 153 of 213
4,048.0
13.2%
2,713.0
10.0%
0.65
8.7%
1,267.0
4.7%
1,465.0
5.4%
2,713.0
10.0%
1.12
72.3%
2,345.0
7.6%
2,542.0
8.3%
4,048.0
13.2%
5,258.0
17.1%
30,752.0
13.6%
27,061.0
6.8%
3,790.0
14.0%
12 months
Sep-302004A
USD
12 months
Sep-302003A
USD
1.19
5.7%
2,533.0
8.1%
2,637.0
8.4%
3,931.0
12.5%
5,272.0
16.8%
3,931.0
12.5%
31,374.0
2.0%
12 months
Oct-012005A
USD
1.6
34.9%
3,374.0
10.0%
3,487.0
10.3%
5,355.0
15.9%
6,801.0
20.2%
5,355.0
15.9%
33,747.0
7.6%
12 months
Sep-302006A
USD
2.24
40.1%
4,687.0
13.2%
4,851.0
13.7%
6,807.0
19.2%
8,298.0
23.4%
6,855.0
19.3%
35,510.0
5.2%
12 months
Sep-292007A
USD
2.28
1.5%
4,427.0
11.7%
4,729.0
12.5%
7,443.0
19.7%
9,025.0
23.8%
7,443.0
19.7%
37,843.0
6.6%
12 months
Sep-272008A
USD
1.76
(22.8%)
3,307.0
9.1%
3,609.0
10.0%
5,697.0
15.8%
7,328.0
20.3%
5,697.0
15.8%
36,149.0
(4.5%)
12 months
Oct-032009A
USD
2.03
15.3%
3,963.0
10.4%
4,313.0
11.3%
6,726.0
17.7%
8,439.0
22.2%
6,726.0
17.7%
38,063.0
5.3%
12 months
Oct-022010A
USD
2.52
24.1%
4,807.0
11.8%
5,258.0
12.9%
7,827.0
19.1%
9,668.0
23.6%
7,827.0
19.1%
40,893.0
7.4%
12 months
Oct-012011A
USD
3.13
24.2%
5,682.0
13.4%
6,173.0
14.6%
8,984.0
21.2%
10,971.0
25.9%
8,984.0
21.2%
42,278.0
3.4%
12 months
Sep-292012A
USD
3.1
17.7%
5,600.0
13.1%
6,090.0
14.2%
8,884.0
20.7%
10,900.0
25.4%
8,884.0
20.7%
42,840.0
4.6%
LTM²
12 months
Dec-292012A
USD
3.45
12.32%
For use only in the course RSM 392 - Strategic Management at University of Toronto - Rotman School of Management from 9/3/2024 to 12/31/2024.
Use outside these parameters is a copyright violation.
BY JERRY KIM* AND STEPHAN MEIER†
The Walt Disney Company: If You Give this
Mouse a Focus | Page 26
-
-
-
-
-
-
12,375.8
27.4%
-
45,153.5
6.80%
-
12 months†
Sep-302013E
USD
Notes:
¹All results are taken from the most recently filed statement for each period. When there has been more than one, earlier filings can be viewed on the individual statement pages.
²Growth rates for the LTM period are calculated against the LTM period ending 12 months before.
³All forward period figures are consensus mean estimates provided by the brokers and may not be on a comparable basis as financials.
†Growth rates for forward periods are calculated against prior period estimates or actual pro forma results as disclosed on the Estimates Consensus page.
Growth Rates are calculated in originally reported currency only and will not reflect any currency conversion selected above.
Source: S&P Capital IQ.
Diluted EPS Excl. Extra
Items³
Growth Over Prior Yr
Margin %
Net Income
Earnings from Cont.
Ops.
Margin %
Margin %
EBIT
Margin %
EBITDA
Margin %
Growth Over Prior Yr
Gross Profit
For the Fiscal Period
Ending
Currency
Total Revenue
Key Financials¹
(IN MILLIONS)
Appendix 1B
The Walt Disney Company Key Stats – 2003-2013E
Page 154 of 213
3,259.0
Consumer Products
-
(94.0)
(495.0)
1,757.0
Interactive
Corporate
Media Networks
4,585.0
1,647.0
-
-
720.0
226.0
1,992.0
-
-
23,455.0
8,012.0
-
-
-
3,126.0
6,176.0
6,141.0
-
-
12 months
Sep-30-1999
USD
4,112.0
1,985.0
-
-
386.0
126.0
1,615.0
-
-
25,325.0
9,836.0
-
-
-
2,762.0
5,918.0
6,809.0
-
-
Reclassified
12 months
Sep-30-2000
USD
4,005.0
1,758.0
-
-
401.0
260.0
1,586.0
-
-
25,172.0
9,569.0
-
-
-
2,647.0
5,952.0
7,004.0
-
-
Reclassified
12 months
Sep-30-2001
USD
2,822.0
986.0
-
-
394.0
273.0
1,169.0
-
-
25,329.0
9,733.0
-
-
-
2,509.0
6,622.0
6,465.0
-
-
Reclassified
12 months
Sep-30-2002
USD
3,174.0
1,213.0
-
-
384.0
620.0
957.0
-
-
27,061.0
10,941.0
-
-
-
2,396.0
7,312.0
6,412.0
-
-
Reclassified
12 months
Sep-30-2003
USD
4,860.0
2,574.0
-
-
547.0
662.0
1,077.0
-
-
30,752.0
11,778.0
-
-
-
2,587.0
8,637.0
7,750.0
-
-
12 months
Sep-30-2004
USD
For use only in the course RSM 392 - Strategic Management at University of Toronto - Rotman School of Management from 9/3/2024 to 12/31/2024.
Use outside these parameters is a copyright violation.
BY JERRY KIM* AND STEPHAN MEIER†
Page 27 | The Walt Disney Company: If You
Give this Mouse a Focus
4,015.0
810.0
Consumer Products
Total Operating Profit Before Tax
749.0
Studio Entertainment
1,288.0
-
Parks and Resorts
-
Media Networks - Broadcasting
22,976.0
Media Networks - Cable Networks
Operating Profit Before Tax
Total Revenues
7,433.0
Parks and Resorts - International
Media Networks
-
Parks and Resorts - United States
260.0
6,492.0
Studio Entertainment
Interactive
5,532.0
-
Parks and Resorts
-
Media Networks - Broadcasting
12 months
Sep-30-1998
USD
Media Networks - Cable Networks
For the Fiscal Period Ending
Currency
Revenues
(IN MILLIONS)
Appendix 2A
Revenues and Operating Profit by Segment – 1998-2005
4,968.0
3,040.0
-
-
543.0
207.0
1,178.0
-
-
31,374.0
12,637.0
-
-
-
2,215.0
7,499.0
9,023.0
-
-
Reclassified
12 months
Oct-01-2005
USD
Page 155 of 213
-
6,350.0
7,837.0
4,534.0
-
(291.0)
689.0
1,195.0
1,710.0
-
-
35,510.0
14,913.0
-
-
490.0
1,990.0
7,491.0
10,626.0
-
-
Reclassified
12 months
Sep-29-2007
USD
6,672.0
-
-
(295.0)
609.0
175.0
1,418.0
505.0
4,260.0
36,149.0
-
-
-
712.0
2,425.0
6,136.0
10,667.0
5,654.0
10,555.0
12 months
Oct-03-2009
USD
7,586.0
-
-
(234.0)
677.0
693.0
1,318.0
659.0
4,473.0
38,063.0
-
2,357.0
8,404.0
761.0
2,678.0
6,701.0
-
5,687.0
11,475.0
12 months
Oct-02-2010
USD
BY JERRY KIM* AND STEPHAN MEIER†
8,825.0
-
-
(308.0)
816.0
618.0
1,553.0
913.0
5,233.0
40,893.0
-
2,495.0
9,302.0
982.0
3,049.0
6,351.0
-
5,837.0
12,877.0
12 months
Oct-01-2011
USD
The Walt Disney Company: If You Give this
Mouse a Focus | Page 28
8,484.0
4,981.0
-
(258.0)
778.0
1,086.0
1,897.0
-
-
37,843.0
15,857.0
-
-
719.0
2,415.0
7,348.0
11,504.0
-
-
Reclassified
12 months
Sep-27-2008
USD
For use only in the course RSM 392 - Strategic Management at University of Toronto - Rotman School of Management from 9/3/2024 to 12/31/2024.
Use outside these parameters is a copyright violation.
Source: S&P Capital IQ.
Total Operating Profit Before Tax
3,481.0
-
Media Networks
-
Corporate
607.0
Consumer Products
Interactive
728.0
Studio Entertainment
1,534.0
-
Parks and Resorts
-
Media Networks - Broadcasting
33,747.0
Media Networks - Cable Networks
Operating Profit Before Tax
Total Revenues
14,186.0
Parks and Resorts - International
Media Networks
-
Parks and Resorts - United States
2,107.0
Consumer Products
-
7,529.0
Studio Entertainment
Interactive
9,925.0
-
Parks and Resorts
-
Media Networks - Broadcasting
Reclassified
12 months
Sep-30-2006
USD
Media Networks - Cable Networks
For the Fiscal Period Ending
Currency
Revenues
(IN MILLIONS)
Appendix 2B
Revenues and Operating Profit by Segment – 2006-2012
9,964.0
-
-
(216.0)
937.0
722.0
1,902.0
915.0
5,704.0
42,278.0
-
2,581.0
10,339.0
845.0
3,252.0
5,825.0
-
5,815.0
13,621.0
12 months
Sep-29-2012
USD
Endnotes
Luke Dammann, “Disney CEO Bob Chapek Will Receive $20 Million Bonus Each Year,”
InsideTheMagic.com, July 5, 2022, https://insidethemagic.net/2022/07/bob-chapekcontract-bonus-ld1/.
2 Natalie Jarvey, “Disney Estimates $1 Billion COVID-19 Impact on Parks, Experiences
Division,” The Hollywood Reporter, May 5, 2020,
https://www.hollywoodreporter.com/news/general-news/disney-estimates-1-billioncovid-19-impact-parks-experiences-division-1293441/.
3 Dade Hayes, “Disney+ Adds Almost 8M Subscribers In Fiscal Q2, Nearly 20M Over Past
Six Months,” Deadline, May 11, 2022, https://deadline.com/2022/05/disney-streamingquarter-results-million-encanto-moon-knight-1235021363/.
4 Agnes Chu's bio on the Produced by Conference website, June 9, 2019,
https://www.producedbyconference.com/los-angeles/team-member/agnes-chu.
5 Siklos, “Bob Iger Rocks Disney.”
6 Walt Disney quote, D23 the Official Disney Fan Club, https://d23.com/walt-disneyquote/page/4.
7 Adam Raymond, “8 Secrets from the Wonderful World of Disney,” Mental Floss, last
updated February 25, 2016, http://mentalfloss.com/article/28255/8-secrets-wonderful-worlddisney.
8 David Wallace, “Magic Under the Park – Walt Disney World’s Utilidors,” Disney-O-Rama,
June 15, 2009, https://www.disneyorama.com/magic-kingdom-utilidors.
9 “IAmA Former Disney Princess, AMA,” Reddit, 2012,
http://www.reddit.com/r/IAmA/comments/p0cdm/iama_former_disney_princess_ama.
10 James B. Stewart, DisneyWar (New York: Simon & Schuster, 2005), 6.
11 John Huey, “Eisner Explains Everything,” Fortune, April 17, 1995,
https://money.cnn.com/magazines/fortune/fortune_archive/1995/04/17/202090/index.htm.
12 Elizabeth Jensen, Thomas King, “For ABC Executives, World Of Disney Isn't So
Wonderful,” The Wall Street Journal, July 12, 1996,
https://www.wsj.com/articles/SB837126026344053000.
13 “Pixar says ‘So long’ to Disney,” last modified January 29, 2004,
https://www.wired.com/2004/01/pixar-says-so-long-to-disney.
14 Allen R. Myerson, “Southern Baptist Convention Calls for Boycott of Disney,” The New
York Times, June 19, 1997, https://www.nytimes.com/1997/06/19/us/southern-baptistconvention-calls-for-boycott-of-disney.html.
15 Duncan Campbell, “Catholics vilify Dogma,” Guardian, November 12, 1999,
https://www.theguardian.com/film/1999/nov/13/world.news.
16 Ronald Grover, “How Bob Iger Unchained Disney,” BusinessWeek, February 5, 2007,
https://www.bloomberg.com/news/articles/2007-02-04/how-bob-iger-unchained-disney.
17 Grover, “How Bob Iger Unchained Disney.”
Page 29 | The Walt Disney Company: If You
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BY JERRY KIM* AND STEPHAN MEIER†
Page 156 of 213
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Use outside these parameters is a copyright violation.
1
Robert A. Iger's bio on Disney's website,
https://thewaltdisneycompany.com/leaders/robert-a-iger.
19 "Disney to Buy Pixar for $7.4 Billion," The Associated Press,
https://www.nytimes.com/2006/01/24/business/disney-to-buy-pixar-for-74-billion.html.
20 Devin Leonard, “How Disney Bought Lucasfilm—and Its Plans for ‘Star Wars,’” Bloomberg,
March 7, 2013, https://www.bloomberg.com/news/articles/2013-03-07/how-disney-boughtlucasfilm-and-its-plans-for-star-wars.
21 “The Walt Disney Company Completes Lucasfilm Acquisition,” press release, December
21, 2012, https://thewaltdisneycompany.com/the-walt-disney-company-completes-lucasfilmacquisition.
22 The Walt Disney Company, Fiscal Year 2012 Annual Financial Report and Shareholder
Letter, January 1, 2013, https://ditm-twdc-us.storage.googleapis.com/2015/10/2012-AnnualReport.pdf.
23 Jill Goldsmith, Patrick Hipes, "Disney Names Bob Chapek CEO As Bob Iger’s Successor;
Iger Becomes Executive Chairman Through 2021," Deadline,
February 25, 2020, https://deadline.com/2020/02/disney-bob-chapek-ceo-replacing-bobiger-1202868176.
24 Julia Alexander, “Disney is launching a new Star-branded streaming service
internationally,” The Verge, August 4, 2020,
https://www.theverge.com/2020/8/4/21354712/disney-star-streaming-serviceinternational-expansion-hulu-plus-abc-fx-fox.
25 Julia Alexander, “Disney unveils Star, its Hulu replacement for international Disney
Plus subscribers,” The Verge, December 10, 2020,
https://www.theverge.com/2020/12/10/22165950/disney-star-streaming-service-hotstarinternational-movies-tv.
26 The Walt Disney Company, Fiscal Year 2021 Annual Financial Report,
https://thewaltdisneycompany.com/app/uploads/2022/01/2021-Annual-Report.pdf.
27 The Walt Disney Company, 2020 Investor Day, December 15, 2020,
https://www.youtube.com/watch?v=CRdYiquh8Bg.
28 Kurt Badenhausen, “Why ESPN Is Worth $40 Billion As The World’s Most Valuable Media
Property,” Forbes, November 9, 2012.
29 Bill Carter and Richard Sandomir, “The Trophy In Eisner’s Big Deal,” New York Times,
August 6, 1995.
30 Kurt Badenhausen, “Why ESPN Is Worth $40 Billion As The World’s Most Valuable Media
Property,” Forbes, November 9, 2012,
https://www.forbes.com/sites/kurtbadenhausen/2012/11/09/why-espn-is-the-worlds-mostvaluable-media-property-and-worth-40-billion/#16015dad6527.
31 Suzanne Vranica, William Launder, “Signals Weak for TV-Ad Market,” The Wall Street
Journal, March 24, 2013,
https://www.wsj.com/articles/SB10001424127887324373204578377032005060920..
32 Grover, “How Bob Iger Unchained Disney,” Bloomberg BusinessWeek.
The Walt Disney Company: If You Give this
Mouse a Focus | Page 30
BY JERRY KIM* AND STEPHAN MEIER†
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For use only in the course RSM 392 - Strategic Management at University of Toronto - Rotman School of Management from 9/3/2024 to 12/31/2024.
Use outside these parameters is a copyright violation.
18
Emily VanDerWerff, "Here’s what Disney owns after the massive Disney/Fox merger," Vox,
March 20, 2019, https://www.vox.com/culture/2019/3/20/18273477/disney-fox-merger-dealdetails-marvel-x-men.
34 Matthew S. Schwartz, "Disney Officially Owns 21st Century Fox," NPR,
March 20, 2019, https://www.npr.org/2019/03/20/705009029/disney-officially-owns-21stcentury-fox.
35 Matthew S. Schwartz, "Disney Officially Owns 21st Century Fox."
36 Emily VanDerWerff, "Here’s what Disney owns after the massive Disney/Fox merger."
37 Emily VanDerWerff, "Here’s what Disney owns after the massive Disney/Fox merger."
38 The Walt Disney Company, Fiscal Year 2019 Annual Financial Report,
https://thewaltdisneycompany.com/app/uploads/2020/01/2019-Annual-Report.pdf.
39 Disney World Ticket Price Chart as of February 2020, MouseSavers.com, February 2020,
https://www.mousesavers.com/disney-world-magic-your-way-ticket-price-chart.
40 Ben Popken, “Disney hikes some park prices to over $90,” NBC News, June 3, 2013,
https://www.nbcnews.com/business/travel/disney-hikes-some-park-prices-over-90flna6C10167279.
41 Ronald Grover, Lisa Richwine, “Cruise industry woes not affecting Disney, CEO says,”
Reuters, March 2, 2012, https://www.reuters.com/article/us-disney-boat/cruise-industrywoes-not-affecting-disney-ceo-says-idUSTRE8211PL20120302.
42 “Disney sees merchandise retail sales over $30 billion,” Reuters, June 10, 2008,
http://www.reuters.com/article/2008/06/10/industry-disney-license-dcidUSN1034177720080610.
43 Richard Siklos, “Bob Iger Rocks Disney,” Fortune, last updated February 3, 2009,
https://money.cnn.com/2009/01/02/news/newsmakers/siklos_eisner.fortune/index.htm.
44 Michael G. Rukstad, David J. Collis, Tyrell Levine, “The Walt Disney Company: The
Entertainment King” Harvard Business School Case 9-701-035, revised January 5, 2009,
https://www.hbs.edu/faculty/Pages/item.aspx?num=27931.
45 Peter Sanders, “Disney to Buy Back Most Namesake Stores,” Wall Street Journal, March 21,
2008.
46 Brooks Barnes, Michael Cieply, “Disney Swoops Into Action, Buying Marvel for $4
Billion.”
47 “The Princess and the P.R.,” The Daily Show with Jon Stewart, May 16, 2013,
http://www.cc.com/video-clips/jwn1in/the-daily-show-with-jon-stewart-the-princess-andthe-p-r-.
48 Nicole Sperling, “Disney’s sexier, skinnier Merida to stay, despite protests,” Los Angeles
Times, May 15, 2013, https://www.latimes.com/entertainment/movies/moviesnow/la-et-mndisney-merida-makeover-brave-20130515-story.html.
49 Ben Fritz, “More Action, Less Drama at Disney,” The Wall Street Journal, March 7, 2013,
https://www.wsj.com/articles/SB10001424127887324034804578344372132435986.
50 Siklos, “Bob Iger Rocks Disney.”
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33
Jeffrey Goldfarb, “Buzzkill Lightyear,” Breakingviews, August 5, 2013.
https://www.breakingviews.com/features/disney-magic-hasnt-exactly-worked-on-pixar.
52 J. D. Biersdorfer, “Spinning Their Web: ‘Marvel Comics: the Untold Story’ by Sean Howe,”
The New York Times, November 16, 2012,
http://www.nytimes.com/2012/11/18/books/review/marvel-comics-the-untold-story-by-seanhowe.html.
53 Jay Woodruff, “Rich Ross Makes Moves (And Movies) at Disney,” FastCompany.com,
August 10, 2011, http://www.fastcompany.com/1769074/rich-ross-makes-moves-and-moviesdisney.
54 Brooks Barnes, “Rich Ross, Disney Studio Chairman, Is Forced Out,” New York Times, April
20, 2012 Brooks Barnes, “Rich Ross, Disney Studio Chairman, Is Forced Out,” The New York
Times, April 20, 2012, https://mediadecoder.blogs.nytimes.com/2012/04/20/rich-ross-disneystudio-chairman-quits.
55 Jeremy Bowman, "Where Will Disney Be in 5 Years?," The Motley Fool, May 27, 2019,
https://www.fool.com/investing/2019/05/27/where-will-disney-be-in-5-years.aspx.
56 Brooks Barnes, "Disney Reorganization Anticipates 21st Century Fox Assets," The New
York Times, March 14, 2018, https://www.nytimes.com/2018/03/14/business/media/waltdisney-21st-century-fox.html.
57 Aparna Narayanan, “The Disney+ Statistic Point to ‘Pure Genius Strategy’: Analyst,”
Investor’s Business Daily, November 26, 2019, https://www.investors.com/news/disneystock-rises-disneyplus-streaming-service-app-hits-15-million-downloads.
58 Cynthia Littleton, "Disney Plus Reaches 28.6 Million Subscribers, Hulu Hits 30.4 Million,"
Variety, February 4, 2020, https://variety.com/2020/tv/news/disney-plus-reaches-26-5million-subscribers-1203492187.
59 Stephen Desaulniers, "Disney launches ESPN+ streaming service with live sports and a
show from Kobe Bryant," CNBC, last updated April 16, 2018,
https://www.cnbc.com/2018/04/12/disney-launches-espn-plus.html.
60 Joan E. Solsman, Mike Sorrentino, "Disney Plus: Everything to know about Disney's
streaming service," CNET, August 14, 2020, https://www.cnet.com/news/disney-pluseverything-to-know-europe-launch-release-dates-prices-shows-movies-hamilton.
61 Adam Barnhardt, “Star Wars: The Mandalorian Finale Scores Rate 100% Positive Rating
on Rotten Tomatoes,” ComicBook.com, December 28, 2019,
https://comicbook.com/starwars/news/star-wars-the-mandalorian-finale-rotten-tomatoesscore-perfect.
62 Jarvey, "Disney Over the Top: Bob Iger Bets the Company (and Hollywood's Future) on
Streaming,” Hollywood Reporter, October 16, 2019,
https://www.hollywoodreporter.com/movies/movie-features/bob-iger-bets-companyhollywood-s-future-streaming-1247663/.
63 Joy Press, "Meet the Brains Behind the Disney+ Content Flood," Vanity Fair, September 19,
2019, https://www.vanityfair.com/hollywood/2019/09/disney-plus-marvel-star-warsinterview-ricky-strauss-agnes-chu.
The Walt Disney Company: If You Give this
Mouse a Focus | Page 32
BY JERRY KIM* AND STEPHAN MEIER†
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51
Narayanan, “The Disney+ Statistic Point to ‘Pure Genius Strategy’: Analyst.”
Sarah Whitten, "Disney expects to take a $150 million hit as it cuts ties with Netflix — and
that’s OK," CNBC, February 5, 2019,
https://www.cnbc.com/2019/02/05/disney-expects-to-take-a-150-million-hit-as-it-cuts-tieswith-netflix.html.
66 "The Walt Disney Company to Acquire Majority Ownership of BAMTech," press release,
August 8, 2017, https://thewaltdisneycompany.com/walt-disney-company-acquire-majorityownership-bamtech.
67 “The Walt Disney Company Reports Second Quarter and Six Months Earnings for
Fiscal 2020,” The Walt Disney Company (press release), May 5, 2020,
https://thewaltdisneycompany.com/the-walt-disney-company-reports-second-quarterand-six-months-earnings-for-fiscal-2020/.
68 Todd Spangler, “Disney Now Has More Total Streaming Subscriptions Than Netflix —
but Disney Generates Much Lower Per-Sub Revenue,” Variety, August 11, 2022,
https://variety.com/2022/digital/news/disney-streaming-subscribers-netflix-1235338752/.
69 Selim Algar, “Ron DeSantis officially ends Disney’s special tax status in Florida,” New
York Post, April 22, 2022, https://nypost.com/2022/04/22/ron-desantis-officially-endsdisneys-special-florida-tax-status/.
70 “Star Wars-Themed Fruit and Veggies Join Disney and Marvel Healthy Offerings at
PMA Fresh Summit,” The Disney Driven Life, October 26, 2015,
https://thedisneydrivenlife.com/2015/10/26/star-wars-themed-fruit-and-veggies-joindisney-and-marvel-healthy-offerings-at-pma-fresh-summit/.
64
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65
9 -6 1 5 -0 0 7
WILLY SHIH
STEPHEN KAUFMAN
Netflix in 2011
Netflix used to be a perfectly good horror movie. Company management swings a chainsaw; investors
scream and are cut to bits; audience is titillated. Now it has become one of those avant-garde films your pseudointellectual friend recommends: no fun to watch, surreal and confusing . . . . The no-fun-to-watch part is the
damage that Netflix's abrupt price increase has had on subscriber numbers. Subscriber growth ground to a halt
in the third quarter, after the increase was announced in July. In the current quarter, as the price increase is put
into effect, the company expects its physical DVD service to lose 3m—about a fifth—of its subscribers.
Streaming video subscribers are expected to be flat to down. Given that Netflix's strategy is designed to
encourage growth in streaming, this is far worse news than the hit to DVDs.
— LEX Column: Netflix, Financial Times, October 25, 20111
Reed Hastings, founder and CEO of Netflix, was having a rough September. Only a few months
earlier, he was on top of the world. Named Fortune magazine’s businessperson of the year in 2010,2
Hastings had built the DVD-by-mail company into an enormously popular consumer service. (See
Exhibit 1 for a Netflix income statement.) In July 2011 Netflix announced that it would start charging
separately for its streaming video service and its DVD service—and that each service would cost
$7.99 a month. The streaming service was formerly a $2 add-on to the basic DVD monthly charge of
$7.99 for its entry-level one-DVD-at-a-time plan. Customers who wanted both would now have to
pay $15.98 a month. Although most new consumers who wanted only the streaming service would
actually see a price reduction, the public outcry over the 60% price increase for the combination
drowned out that fact.3
Things got worse when Hastings announced that the company would split the DVD-by-mail into
a separate business named Qwikster, and that the online streaming business would retain the Netflix
name. On September 18, 2011, he announced on his blog:
It is clear from the feedback over the past two months that many members felt we
lacked respect and humility in the way we announced the separation of DVD and
streaming, and the price changes. That was certainly not our intent, and I offer my
sincere apology. I’ll try to explain how this happened.
Professor Willy Shih, Senior Lecturer Stephen Kaufman, and David Spinola (MBA 2007) prepared the original version of this case, "Netflix," HBS
No. 607-138, which was reviewed and approved by a company designate. This version was prepared by Professor Willy Shih and Senior Lecturer
Stephen Kaufman. This case was developed from published sources. Funding for the development of this case was provided by Harvard
Business School and not by the company. HBS cases are developed solely as the basis for class discussion. Cases are not intended to serve as
endorsements, sources of primary data, or illustrations of effective or ineffective management.
Copyright © 2014 President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800-545-7685,
write Harvard Business School Publishing, Boston, MA 02163, or go to www.hbsp.harvard.edu. This publication may not be digitized,
photocopied, or otherwise reproduced, posted, or transmitted, without the permission of Harvard Business School.
Page 161 of 213
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AUGUST 19, 2014
Netflix in 2011
For the past five years, my greatest fear at Netflix has been that we wouldn't make
the leap from success in DVDs to success in streaming. Most companies that are great at
something—like AOL dialup or Borders bookstores—do not become great at new things
people want (streaming for us) because they are afraid to hurt their initial business.
Eventually these companies realize their error of not focusing enough on the new thing,
and then the company fights desperately and hopelessly to recover. Companies rarely
die from moving too fast, and they frequently die from moving too slowly. 4
Hastings went on to explain that streaming and DVD-by mail were becoming two quite different
businesses, with different cost structures and benefits that needed to be marketed differently. In
addition, each business needed to be able to grow and operate independently.
Thousands of consumers criticized the plan on Netflix’s website, and Netflix stock continued its
slide, from $300 earlier in the year to $77 in October.5 By mid-October, the company reversed course
again, abandoning the breakup plan. Asked in a television interview about how it felt to apologize
for business mistakes, Hastings was humble:
Going through marriage counseling 20 years ago was really how I moved to become
a better manager and leader . . . This marriage counselor was able to get me to see that I
was often lying to myself and my wife . . . and that the value of honesty is that people
can take honesty, even if it’s not necessarily what they want to hear, if it’s really sincere.6
The bigger challenge facing Hastings and his team was how to cope with the very different
business model for streaming in a company built on the higher margins of DVD-by-mail. How would
they manage that transition within a single business, and more importantly, with the company’s 20
million customer relationships? That was the question he now had to be honest about.
The U.S. Home Video Rental Market
In the 1990s, the U.S. home video market was a fragmented industry largely populated with
“mom-and-pop” retail outlets. Customers rented movies, primarily on VHS cassette, from a retail
location for a specified time period, usually between two days and one week, and paid a fee of $3 to
$4 for each movie rented.
Blockbuster Inc. became the market leader with the insight that movie rentals were largely
impulse decisions. To customers deciding at the last minute that a given night was “movie night,” the
ability to quickly obtain the newest release was a priority. Statistics showed that new releases
represented over 70% of total rentals. Blockbuster’s growth strategy revolved around opening new
locations, both to expand geographic coverage and to increase penetration and share in existing
markets. By 2006, Blockbuster had 5,194 U.S. locations, of which 4,255 were company owned and the
balance franchised. Locations were chosen based on customer concentration and proximity to
competition, focusing on high-visibility stores in heavily trafficked retail areas. Management often
proclaimed that “70% of the U.S. population lives within a 10-minute drive of a Blockbuster.”7 Stores
were staffed primarily with part-time employees, averaging 10 staff members per store plus one
manager. Occupancy and payroll represented a significant percentage of total costs.
Blockbuster outlets carried about 2,500 different titles per store. A substantial portion of the shelf
space in a store was dedicated to hit movies, with the newest releases receiving the most prominent
display. Locations typically acquired 100 copies of a new release, and they made up an estimated
75%–80% of demand compared to 20%–25% for catalog releases.8 Consumers liked to rent new
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releases during the first three weeks of the studio distribution window.a After that, demand fell
sharply. The studios protected this window because of the increasing share of revenues that they
received from sales (see Exhibit 2). As rental demand for a particular title dropped, the stores
remarketed used copies to reduce their inventory and generate additional income.
Blockbuster’s business model depended on maximizing the days that a movie was out for rent.
Stores were reluctant to stock large numbers of lesser-known and independent films, since the
demand for these titles was inconsistent. With a relatively narrow selection of mostly familiar movies,
customers could generally select a title with a limited amount of advice from the sales staff. Movies
not returned to the renting location by the end of the specified rental period were subject to extended
viewing fees, or “late fees.” In 2004, these fees represented about 10% of revenues. Late fees also
improved asset utilization by encouraging a timely return of each rented film, allowing it to be rented
by another customer. Late returns led to increased levels of stockouts, costing Blockbuster
incremental rental opportunities as well as reduced customer satisfaction.
The unit economics of retail video rental were straightforward. Blockbuster acquired
approximately half of its rental inventory under a purchase model in which it would pay the studios
$15–$18, rent it 9–10 times for $4 per rental, and then resell the DVD for an average of $8 per unit.b
The other half was acquired under a revenue share model in which Blockbuster paid the studio about
$5 per copy, rented it 9 times, and resold it for an average of $8, sharing 30% of the revenue with the
studios.9 The mix shifted to 81.8% revenue share by 2006.10 One analyst estimated that Blockbuster
spent $837 million on rental library purchases in 2003. Retail stores cost approximately $300K to set
up, and it was estimated that they produced $900K sales per year with an operating profit of $162K.11
In 2002 Blockbuster enjoyed record levels of revenue and profitability, riding a wave of consumer
DVD-player adoption, which increased from 24% to 37% of U.S. households in just one year. (Exhibit
3 shows Blockbuster’s income statement through 2006.) As consumers sought content for their new
players, spending for in-home movie viewing reached $22.3 billion. 12 2002 represented Blockbuster’s
fifth consecutive year of same-store sales growth, and the Blockbuster brand achieved nearly 100%
recognition with active movie renters. That same year Netflix went public, and some would say that
is when Blockbuster’s troubles really started to get serious.
Netflix History
Hastings conceived of Netflix in 1997 after he discovered an overdue rental copy of Apollo 13 in
his closet. After paying the $40 late fee, Hastings, a successful entrepreneur who had already founded
and sold a software business, began to consider alternative ways to provide a better home movie
service. At the time, most movie rentals were VHS videocassettes, but Hastings had heard from a
friend about the new DVD technology. DVDs were small and light, enabling inexpensive postal
delivery. “I went out, bought a whole bunch of CDs and started mailing them to myself to see how
quickly they would come back and what condition they would be in,” he explained. “I waited for two
days—and they all arrived in perfect condition. All the pieces started to fall into place after that.”13,14
a Motion picture studios made movies available for exhibition at different times depending on the distribution channel.
Specific times were known as “release windows.” The first distribution channel after theatrical release was home video on
DVD and VHS. This window lasted 45 days, and excluded most other forms of non-theatrical movie distribution, such as payper-view, video-on-demand, premium television, basic cable, and network and syndicated television. Thereafter, movies were
made available sequentially to television distribution channels.
b The company amortized the cost of its in-store rental library over periods ranging from 3 to 12 months, to an estimated
residual value ranging from $2 to $5 per unit, depending on the product category.
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Netflix in 2011
Hastings founded Netflix in 1997, and launched the company’s first website in early 1998. Netflix
targeted early technology adopters who had recently purchased DVD players, offering crosspromotional programs with the manufacturers and sellers of DVD players, thus providing a source of
content for customers. Hastings elaborated, “We were targeting people who just bought DVD
players. At the time our goal was just to get our coupon in the box. We didn’t have too much
competition. The market was underserved, and stores didn’t carry a wide selection of DVDs at the
time.”
Netflix’s website included a search engine that allowed its customers to sort through its selections
by title, actor, director, and genre. Using this search engine, customers built a list, called a “queue,” of
movies to be received from Netflix. Netflix sent movies to its subscribers based on the order of titles
in the queue, with subscribers receiving a new movie as soon as the previous one was returned. The
company initially used a pricing model similar to that offered by traditional video stores. Customers
chose their films using the company’s website, were charged $4 per movie rented plus a $2 shipping
and handling charge, and were expected to return films by a specific due date or be charged extended
rental fees.
Netflix’s early strategy went beyond DVD rentals. While marketing a 2000 IPO, management
described the company as the ultimate online destination for movie enthusiasts. Along with the
DVD-by-mail service, Netflix was offering its recommendation system to everyone, including
nonsubscribers, creating a Web portal rather than simply a subscription service. Hastings described
this early strategy: “Our 2000 prospectus was spun towards things that were hot . . . it reflected a
tension in our strategy. We would offer price comparisons, theater tickets. That strategic tension
didn’t resolve itself until the bubble crashed. That summer we realized we weren’t going to make it
unless we did it on rentals. . . . It was a cash-induced strategic focusing.”
This focus was pushed along by the rapid adoption rate of DVD players among U.S. households,
which followed the fastest technology adoption curve in history. U.S. household penetration, at 5% in
1999, leapt to 13% by 2000, 37% by 2002, and 65% by 2004, a pace that attracted the attention of
channels like Best Buy and Wal-Mart, which discounted them extensively to drive store traffic. DVDs
also began replacing VHS cassettes on the shelves of traditional video rental outlets. As DVDs
became more widely available both for purchase and for rental, Netflix’s value proposition to new
DVD-player owners diminished. The company shelved its plans for an IPO and struggled through a
large layoff as it began to adjust its business model in an effort to reach profitability. Chief among
Hastings’s concerns were the general customer dissatisfaction with Netflix’s value proposition and
the high cost of building a DVD library to support its growing subscriber base.
Feedback from early customers revealed a frustration with Netflix charging rental prices similar to
competing retail locations, while providing slower delivery. Neil Hunt, the company’s chief product
officer, described Netflix’s motivation for shifting to its popular no-late-fee subscription model in
1999:
Pricing had been a discussion point for a long time. Our original model didn’t
work—we needed to overcome the shipping delay. It just wasn’t a high-enough-value
product to overcome the delivery waiting time. We spent a lot of money to market to
and attract new customers, and they wouldn’t be repeat renters. We were spending $100
to $200 to bring in a customer, and they would make one $4 rental. There was no
residual value.
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Netflix’s Early Days
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Hastings believed that moving to a prepaid subscription service could provide better value to
Netflix’s customers and also turn its longer delivery times into an advantage. The first iteration of the
subscription model allowed customers to have four movies in their possession at once and receive up
to four new films each month. Hunt explained the effectiveness of the new pricing model: “We
turned the disadvantage of delivery time into having a movie at home all the time. The value to
Netflix of having our movies in the customers’ homes at all times was our key insight.”
Netflix soon changed its pricing system again, offering unlimited rentals for the first time.
Subscribers could now keep three movies at a time and exchange them as frequently as they liked.
Hunt explained the reasons behind this quick change:
We made the observation that this change would dramatically simplify the program
and make it easier to explain the service. It also allowed us to market a more compelling
value proposition. The term “unlimited” is great marketing. . . . We had some vigorous
debates about this, but in the end it was a leap of faith. The dot-com boom was still in
full growth mode, and everyone around us was growing fast. It wasn’t the time to do
months of testing and analysis. We had to make some bets and not worry about getting
it wrong. At that time, the ones who got it right would succeed, and the ones who got it
wrong wouldn’t be around.
With this change the company added a new group of fans for whom movie rentals were a regular
part of their daily entertainment. Many of these customers were turned off by the high cost of paying
for each movie rented, yet they still chose to rent from video stores because of limited alternatives.
Others were dissatisfied with high late fees, which inhibited their ability to view movies at the times
most convenient to them. If “movie night” was not an event but an ordinary form of entertainment,
the option to hold movies beyond a two-day rental period was important. For these frequent viewers,
Netflix’s “all you can eat” model was an attractive alternative to the traditional per-day fee structure.
Subscription costs—the expense of acquiring movies for rent—were still a major burden. Hunt
explained the impact that customer demand had on managing the cost of building their film library:
We began struggling with a new problem. Half of the DVDs we were shipping out
were brand new. We realized that we had to fix that. Top new releases received a lot of
external marketing support and as a result had strong customer awareness and demand.
Of course, those movies were the most expensive to acquire. . . . We couldn’t just blindly
promote movies that already had external demand generation. We needed to stimulate
demand on the older and less-known movies and things already in our catalog. By
marketing from the rest of the “tail” we could drive the average price down of building
our catalog.
Developing The Proprietary Recommendation System
Netflix initially relied on traditional merchandising to complement its search engine and connect
subscribers to the company’s library of titles. A small number of employees highlighted different
films on the website’s home page each week, effectively providing the same recommendations to all
subscribers. Hunt explained the consequence of this marketing technique:
We started with a system that relied heavily on editorial content, but we realized that
an editor could only write so many web pages. Five movies would be highlighted on the
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Moving to a Prepaid Subscription Service
Netflix in 2011
website, then everything that was promoted was instantly rented out. That changed to a
different five movies each day of the week, and they were all still instantly rented out.
We tried to improve the system to ensure that subscribers weren’t referred to movies
they had already rented. Eventually, we realized that the promotional value of writing
the editorial blurbs was zero.
Realizing the inadequacy of the traditional merchandising system, Netflix engineers developed a
proprietary recommendation system to better balance customer demand. Upon establishing a new
account for the first time, customers took a short survey to identify their favorite movie genres and
rate specific movie titles from one to five. Netflix’s proprietary algorithm then used these survey
results and the respective ratings of millions of similar customers to recommend films to its
subscribers. The recommendations page not only included a list of titles with a ranking of how
closely they matched the customer’s preferences but also a synopsis of the film, a description of why
the film was being recommended, and a collection of reviews from other subscribers. As customers
rated each movie they saw, Netflix’s software refined its understanding of customers’ preferences
and more accurately recommended movies that would appeal to each customer.c
Key to the success of Netflix’s inventory management was a filter placed between the output of
the recommendation system and the results shown to the subscriber, screening for those movies that
were out of stock. The intent was to avoid frustrating a customer by recommending a title that was
not immediately available, but a side benefit was that new releases were rarely on recommendation
lists, as they were the most likely films to be in short supply. The system increased the utilization of
Netflix’s library of films by satisfying customers with movies already acquired and in stock, rather
than requiring the purchase of more copies of newer films. Compared to traditional video rental
outlets, where new releases would make up over 70% of total rentals, new releases represented less
than 30% of Netflix’s total rentals in 2006. Hunt explained the power of Netflix’s recommendations:
The recommendation system will pick the best movie for a customer, period. But it
has to be something that can ship overnight. High-demand new releases are less visible
because they are less frequently in stock. However, the customer benefits from this
system. We have recognized improved customer satisfaction by eliminating the “bait
and switch” perception. Most revealing about the value of the recommendations is that
ratings are three-fourths of a star higher on recommended movies compared to new
releases.
While the investment in software engineering was modest, this shift marked a cultural battle
within the company with those who remained loyal to the traditional merchandising system.
Hastings described his insistence on this change by highlighting another benefit: “A personalized
experience is the benefit of the Internet. If you can otherwise do it offline, people won’t pay for it
online. If our Internet offering was going to be better than stores, we had to find something stores
couldn’t do well.”
Movies were a taste-based product, for which many titles were consumed only once. As such,
consumers needed to make a series of purchases without knowing for sure whether they would like
the product. Netflix’s website resonated with subscribers because they so frequently enjoyed the
lesser-known films recommended to them that they might not have otherwise seen. The recommendc In 2006 Netflix initiated a competition, the Netflix Prize, which offered $1 million for the best collaborative filtering algorithm
to improve its recommendation system. Contestants had to predict viewer preferences in films based on previous ratings but
no other consumer information. Netflix provided contestants with a training data set with over 100 million ratings from
480,189 viewers.
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ation software established a relationship with customers that was not matched by part-time
employees at a retail video store, nor easily replaceable if a customer switched to a competitor’s
service. Netflix’s size and growth rate also enhanced the value of its collaborative filtering system,
with its rapid growth in customer-generated ratings. Because it had the largest collection of movie
ratings in the world, customers recognized that they were more likely to have their tastes and
preferences accurately reflected in recommendations from Netflix’s site than any other offered by a
competitor.
Building the Movie Library
Even with the increased customer awareness of lower-profile films that Netflix’s recommendation
system generated, building the company’s movie library still represented a major use of cash. As a
small player in the video rental market, Netflix had no direct relationships with the major studios. It
filled its film library through relationships with a small number of movie distributors, at prices that
reflected minimal discounts. Up-front costs forced Netflix to choose carefully when stocking new
films and often resulted in fewer than the desired number of copies of a title being acquired. As a
result, one of the major sources of customer dissatisfaction was the inability to rent new releases in a
timely manner. Netflix took steps to address this by hiring Ted Sarandos as chief content officer to
manage content acquisition. Sarandos, who had been with Video City, a major U.S. video rental
chain, joined Netflix in May 2000 and led the company’s transition to revenue-sharing agreements
with the major studios. He recalled:
We were handicapped with vendors when I first arrived because other Internet
vendors at the time had not been successful. As a pure rental business that was 100%
subscription-based and 100% Internet-based, we were reinventing the wheel on three
dimensions for the studios. However, it is very much a relationship business, working
with the studios, and I had worked with those people all of my career, so I managed to
bring my relationships with me from my prior company. Within a year, Netflix had
negotiated direct revenue-sharing agreements with nearly all the major studios.
Rather than pay an up-front price of $18–$20 per DVD, the studios would reduce their unit upfront price in return for a fee based on the title’s total number of rentals for a given period of time.
Hastings described this transition with the company’s suppliers: “We spent more money, not less,
with the studios but got bigger customer satisfaction. It was like paying 20% more and getting two
times the number of copies.”
The benefit of the new relationships with the studios extended beyond lowering the acquisition
costs for new releases. Early on Hastings had recognized the number of customers who were
frustrated with the poor selection offered at many video stores, where shelf space was focused on hit
movies and new releases. Customers interested in exploring a broader range of movie titles were left
unsatisfied by their options. Sarandos explained: “The thing that Reed and I connected on before I
even joined Netflix was the promise of a business model that promoted lesser-known movies. Films
outside of the top 20 are not distributed widely. If you didn’t see a movie within six months of when
it was in the theaters, it often disappeared forever.”
The use of a national inventory allowed Netflix to satisfy the diverse demands of movie watchers,
serving the same number of customers as a local network of Blockbuster retail locations with far
fewer copies of a given movie title. Sarandos explained the difference in economics:
Half the equation of packaged media is allocation—getting the right amount of
product in the right locations. This was more of a challenge for products that did not
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Netflix in 2011
Netflix in 2011
enjoy broad promotion. The trade radius of a single video store was so small that even a
single copy of a lesser-known film had lousy economics. By using a national inventory,
we avoid that issue. We never have overstocks on one side of town with understocks on
the other side. Using the subscribers’ queues provides a great deal of data. By looking
into the demand in the near future, we can replicate near-perfect inventory. Overall, we
can satisfy demand in an area with about one-third to one-fifth of the inventory needed
by a retail chain.
Distribution and Delivery
In the summer of 2001, Netflix operated out of a single distribution center in Sunnyvale,
California. While several years of operations had allowed for improvements in this center, the
majority of the country was still not able to enjoy next-day delivery of their rented movies. These
extended delivery times were a barrier for Netflix in attracting and retaining customers in those
regions. Hastings explained: “Post office variability was long on cross-country mail. . . . It essentially
meant one-week delivery times. So in the summer of 2001, we realized that regions with overnight
delivery were being disproportionately successful. We tested the theory by upgrading Sacramento.
The numbers popped quickly.”
Netflix’s Sunnyvale distribution center could serve the San Francisco Bay Area with overnight
delivery. But while outbound mail from Sunnyvale could reach Sacramento overnight, returns often
took several days. Netflix tested Sacramento by arranging with the U.S. Postal Service (USPS) to
intercept returns at a Sacramento mail-sort center and then truck them to Sunnyvale. This would
shorten the turnaround dramatically. “As we added centers in Boston, New York, and D.C., they
started performing like the Bay Area,” Hastings said.
Armed with this evidence of success, Netflix quickly opened more distribution centers across the
country, and subscriber numbers continued to respond to the improved delivery service. The
company promised 500,000 subscribers to its investors in its 2002 prospectus, and delivered 700,000 at
the time of its May 2002 IPO. The changes in Netflix’s pricing and cost structure allowed the
company to reach profitability for the first time in the quarter ending June 2003. After establishing the
viability of its new business model, Netflix continued to build its subscriber base and upgrade the
customer experience by opening new centers. The centers themselves were inexpensive investments:
it cost about $60,000 to convert an existing warehouse to Netflix’s needs. The company continually
added centers to improve on its nationwide coverage and reduce delivery time to its customers. With
the number of distribution centers reaching 58 by early 2009, most of Netflix’s 10.6 million
subscribers could be reached within one delivery day.15,16 Next-day delivery to more regions of the
country allowed it to compete more successfully with retail video stores for new customers drawn by
all three of the characteristics Netflix aimed for—convenience, value, and selection.
Netflix considered delivery time to be the key measure of customer satisfaction and continually
sought to improve the operations within each of its existing distribution centers. Much of the process
of opening return envelopes and filling outgoing mailers with DVDs was still performed manually.
However, with careful hiring practices and thorough time and motion studies, Netflix’s employees
could open and re-stuff an average of 800 DVDs per hour, allowing the entire distribution center
network to ship over 1.6 million DVDs per day. (See Exhibit 4 for photos of the distribution center
operations.)
Netflix’s relationship with the USPS grew. While the USPS was facing a general decline in firstclass mail, Netflix represented its fastest-growing first-class customer. Along with receiving the
standard discount for presorting its outbound envelopes by zip code, Netflix worked with the USPS
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to reduce the time it took to receive a movie return. Rather than deliver returns to the distribution
center of origin, the USPS brought the easily recognizable red Netflix envelopes to the closest Netflix
distribution center.
Growing Content Acquisition
As the company added subscribers, content acquisition continued to grow in importance for
Netflix. Sarandos explained:
For a technology company like Netflix, we are the group that is most dependent on
art. What we do is probably 70% science, 30% art. Our buying staff has to have their
finger on the pulse of the market to make their decisions. A high box-office performer
won’t necessarily be a high video performer, and vice versa. The box office is an
indicator, as a proxy for awareness, but not for demand. . . . If rental demand for a title is
lower than we forecast, it is a tax on the overall economics of Netflix’s model. Even with
the benefit of profit sharing, it is a margin eroder. If we underforecast demand, the
problem is correctable, but it takes time.
As Netflix built its film library, it grew in importance as a distribution channel for many small and
independent film studios. For lower-profile and independent films that did not enjoy the advertising
support of major releases, generating customer awareness was a major priority. As Netflix became
known as the best source for lesser-known movies, the studios began to look on this partnership with
increasing favor. Sarandos explained:
It wasn’t all about fulfilling demand for mainstream videos. We were also providing
the studios large markets for their films that they were having trouble reaching. And for
the independent films, Netflix can be the dominant channel, representing between 60%
and 75% of the earnings for some films. At Netflix, a lesser-known film can really
succeed on its merits.
Hotel Rwanda, the Don Cheadle film about the genocide in Rwanda, is an excellent
example. It enjoyed some box-office sales, but generally it was a difficult topic and a
difficult film to market, with a low viewership. At Netflix, however, it is our fourthmost-rented film. The rest of the top 10 are movies you would expect, but there is this
wonderful independent film right there at number four. More people have seen it at
Netflix than at the box office.
In 2006, Netflix evolved from its de facto marketing efforts and began acquiring the distribution
rights to certain independent films through its Red Envelope Entertainment subsidiary. Sarandos,
who led this initiative, explained the shift in strategy:
Red Envelope Entertainment is 90% about content acquisition. While we do
distribute films in other channels, including retail and other video stores, we did this to
bring more excellent movies to DVD. Of the 100 films that are featured at a festival such
as Sundance, only 10 will make it to DVD. We are looking through the other 90 films for
top-tier content to bring to our customers.
By helping to bring high-potential films to market, Netflix hoped to enhance its reputation as the
highest-quality source of independent films, an attribute that contributed to its popularity.
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Netflix in 2011
Like many other subscription-based services, customer churn was a critical issue for Netflix. In an
average month in 2002, 6.3% of customers canceled their subscriptions. Although that churn rate had
been reduced to 3.6% by 2006, it was still a drag on profitability. Because customer acquisition was a
major expense, retaining existing customers and reclaiming old ones who had previously
unsubscribed were key opportunities.
Originally, customers wishing to unsubscribe had to deal with a salesperson by phone, who
attempted to convince the customer to retain his or her account. In 2002, the company changed its
approach completely. Customers could unsubscribe online from Netflix as easily as they had been
able to join. The only request was that they complete a brief survey explaining why they left.
Hastings believed it was more fruitful to encourage departing customers to return later than to try to
coerce unwilling customers to stay: “We were on the AOL style of it being really hard to cancel our
service. We realized, ‘This is stupid. It’s a false savings.’ We turned it off, enabling the customer to
unsubscribe on the website. We had a 30-day burst of churn, but we are convinced that it led to
return visitors.”
Instead of making Netflix a difficult service to leave, Hastings wanted to make it a service that
former customers would return to. Customers appreciated the personalized aspect of Netflix’s
service, a dimension that the company continued to improve. The proprietary recommendation
system grew more accurate in predicting a user’s taste as the number of films rated by a subscriber
increased. Hastings also emphasized the role of the customer’s queue as a major retention tool: “Our
explicit strategy is to invest in things that are strategically relevant to customer satisfaction potential.
The key invention behind our subscription model is the queue. Our average queue length is 50
movies. It turned out to be an amazing invention. It’s our biggest switching cost.”
Just as importantly, a customer’s profile was maintained if they left Netflix. If the customer were
to return, everything was already in place, as if they had never left. Hastings found that growing the
business in the face of a high churn rate was easier if many lost customers eventually returned.
Blockbuster Responds
Early public statements by Blockbuster dismissed the notion that its customers would benefit from
an online rental business. In May 2002, a spokesperson addressed the online rental market:
“Obviously, we pay attention to any way people are getting home entertainment. We always look at
all those things. We have not seen a business model that’s financially viable long-term in this arena.
Online rental services are ‘serving a niche market.’” 17
Three months later, clarifying that Blockbuster did not intend to launch an online business to
compete with Netflix, a spokesperson announced, “We don’t believe there is enough of a demand for
mail order—it’s not a sustainable business model.” 18 Not until 2003 did Blockbuster’s management
publicly discuss Netflix by name as a threat to their core business model.
Blockbuster finally responded with the introduction of Blockbuster Online in 2004. The service
closely matched Netflix’s business model and offered subscribers a far larger selection of movies than
was available in stores. Hastings characterized Blockbuster’s entry as a “land grab,” undercutting
Netflix’s pricing in an aggressive effort to recover lost market share (see Exhibit 5). Blockbuster also
tried to improve the performance of its service and distinguish itself from Netflix by integrating its
online offering with its traditional store-based business. By using cross-promotions, giving in-store
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Customer Retention
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rental coupons to online customers, and stocking online rental requests out of its store inventory,
Blockbuster sought to productively use its existing resources and improve value for its customers. In
2006 it introduced Blockbuster Total Access, which allowed customers to exchange DVDs by mail or
in a store. By year-end Blockbuster Online had grown to 2.2 million members, although according to
the company’s annual report, Blockbuster Online still required meaningful advertising support and
continued to suffer from “significant” operating losses.19 In the words of Hastings in 2005, “We’re
just thankful Blockbuster didn’t enter four years ago.”20
Blockbuster also unveiled its “no late fees” program, effective at all of its stores on January 1, 2005.
It felt that its competitors, most importantly Netflix, were differentiating their business offerings from
Blockbuster’s by the absence of late fees. This change in business strategy came with a cost. In
addition to $60 million of marketing and implementation costs, Blockbuster had to forgo about $600
million of revenue annually from late fees. While early signs suggested this program resulted in
increased traffic and rental volumes, it did not offset the loss of revenue as its base movie rental
revenue grew only 5%. By 2009, U.S. News & World Report described Blockbuster as one of 15 companies
that might not survive 2009: “The video-rental chain has burned cash while trying to figure out how
to maximize fees without alienating customers.” 21 Indeed, the company filed for reorganization
under Chapter 11 of the U.S. bankruptcy code in 2010. It was ultimately acquired by DISH Network.
Video Over the Internet
During Netflix’s rise, industry observers pointed to video-on-demand (VOD) as the “next big
thing.” VOD was viewed as the marriage of pay-per-view programming combined with Internet
downloading of entertainment, including movies and TV shows. The expectation was that viewers
would search through a vast library of movies online and then watch a film on their TV set in a fullscreen, DVD-quality format. The increasing popularity of content delivery methods such as highdefinition pay-per-view and streaming Internet video, as well as the participation of well-funded
players in the media industry, suggested that a VOD service fully integrating personal computers
and television was not a question of “if” but “when.”
VOD Competition
By early 2007, the VOD market had already attracted multiple competitors with approaches that
spanned the three delivery channels. Stand-alone online VOD services included Vongo, launched by
the Starz subscription cable channel, and CinemaNow, a venture formed by Lionsgate, Microsoft, and
Cisco that offered a few thousand titles from major studios. Depending on price, customers were able
to rent movies for a limited time, purchase them for viewing on a limited number of devices, or even
burn them directly to a DVD.
Other participants relied on a set-top box to bypass the computer and bring films directly to the
user’s television. Walt Disney offered MovieBeam and included Intel and Cisco as major investors.
Customers purchased a set-top box and paid per movie viewed, choosing among a limited but
regularly refreshed selection of films. In early 2007, Movie Gallery Inc., the second-largest video
rental chain in the U.S, acquired MovieBeam.
Traditional cable and satellite providers also started to offer on-demand delivery. They already
had a large share of use of the television set and did not require the user to purchase new equipment.
Cable and satellite providers offered an expanded and more flexible pay-per-view system, providing
high-definition on-demand programming and a growing number of “free” offerings included as part
of the regular monthly fee.
11
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Netflix in 2011
Netflix in 2011
All of these services had two primary limitations to broader appeal: technology and content
availability. VOD was perceived as limited until hardware to connect a user’s computer to their
television was more widely available. With the increasing adoption of big-screen, high-definition
TVs, consumers were unwilling to pay equivalent prices for movies that could only be viewed on
their computers.
Even more limiting was content availability. Concern about pirated downloads and a lack of
urgency to supplant their profitable DVD sales made studios reluctant to offer much content to VOD
websites. Hastings described the U.S. rights of physical media and the consequences they had on the
studio’s cooperation with online video distribution: “U.S. laws enable anyone to buy a DVD and rent
it as many times as they want. We can go to Wal-Mart, buy DVDs, and place them in our rental
library. We don’t need a license from the content owner to do so. Online content doesn’t work like
that. You have to negotiate the distribution rights with the studios. We’re dealing with the same
problem as everyone else.”
Hunt concurred with his analysis:
A member of the public can purchase a DVD for $20 at Wal-Mart, but most people
are not prepared to pay $20 and watch a movie only once. They want to pay $1 per hour
of viewing, not $10, and the physical media rights allow us to rent for that. . . . This does
not hold in an electronic media market. Without the rights for an external party to rent
their content, studios believe the proper price for their content is $20 per viewing, even
for a rental. Therefore, online content is limited to older or less popular films that have a
limited sell-through market that we can get more cheaply.
The Transition to Streaming Video at Netflix
We are in a new race, and we are a player [along] with some very large and substantial firms.
— Reed Hastings22
Throughout the company’s history, Hastings had repeatedly stated that Netflix’s purpose was not
to provide DVD rentals through the Internet but rather to allow for the best home video viewing for
its customers. In a 2003 interview, Hastings said, “Our hope is that we’ll eventually be able to
download more movies. It’s why we named the business Netflix and not DVD-by-Mail.” The
company signaled its plans to offer VOD services as early as 2001. Hastings’s attitude revealed his
belief that Netflix could address this growth opportunity early on. Rather than viewing VOD as an
option that could appeal only to a niche customer set, he saw the benefits it could provide to the mass
market.
The streaming service was launched as an adjunct to the company’s core DVD-by-mail offering.
The rationale was to take advantage of Netflix’s existing strengths, including its brand, its
recommendation system, and its large subscription base of online customers. By offering the
streaming feature at minimal additional cost as a “View Instantly” option, it could build its market
position simply by continuing to grow its existing business. Hastings believed that leveraging
Netflix’s existing brand and market share was the only way to differentiate his business from the
stand-alone sites such as Vongo and MovieLink. Without a clear link between the streaming offering
and the traditional DVD rental business, Netflix’s offering would have no advantage over those of its
start-up competitors.
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615-007
Netflix in 2011
615-007
Great content
When Netflix first launched streaming, competitors like Apple and Amazon
had relatively few titles for their services. Streaming content had to be licensed, often via an arduous
negotiation. Initially the company struck small deals for niche films. Netflix’s first breakthrough
streaming deal was with Starz Entertainment in 2008. This brought 2,500 titles from Walt Disney
Studios and Sony Pictures—including Spider-Man 3, Ratatouille, No Country for Old Men, and
Superbad—to its Watch Instantly library.23
Streaming content was not subject to the first-sale doctrine, which had enabled the economic
model for DVD rentals;d rather, a royalty was owed for every use of the work. This not only made the
operating expense model different, it also raised the entry cost, Hastings explained:
We have to license a large set of content for a relatively large amount of dollars just
to launch, to be able to have enough content to attract members. Then we have to market
hard, then we build the subscriber base . . . But that also means there are barriers to
other people doing the same thing. It’s a double-edged sword, it’s expensive for us to
build a big market, but it’s also expensive for someone to compete with us. 24
In 2010, Netflix signed a five-year deal worth nearly $1 billion to stream movies from Paramount,
Lionsgate, and MGM. As it became more successful, the licensing costs increased dramatically.
Competitors like Apple and Amazon were also very experienced at striking licensing deals, so the
question was how the company could sustain differentiation. This led to the idea of developing
original content, a technique that cable channels had used effectively to differentiate themselves.
Hastings explained:
I have to say [it was] my colleague Ted Sarandos who really drove that. He’s been in
the content business his whole life. He said, “Look at HBO, we’ve got to do this, we can
do it better.” And I’m like, you know . . . “We mail DVDs, Ted.” You know, what do we
know? And he said, “Well, you don’t know anything, but I know some stuff about this.”
And I said, “Okay, let’s try it.” And he picked House of Cards as his first thing.25
The success of House of Cards led Netflix to increase its investments in original content. Hastings
quickly changed his tune:
The originals are going to be just amazing. When season four of “Arrested
Development” hits and it’s exclusive anywhere in the world on Netflix, that’s going to
help us build the message that Netflix is one of the entertainment services that everyone
wants.26
Personalization and user experience The company’s goal was to leverage its existing user
experience and extend it so that streaming content would play well on whatever device the consumer
was using. Members could continue to take advantage of Netflix’s considerable investments in its
recommendation system to find relevant entertainment.
d The first-sale doctrine limited the rights of a copyright owner under U.S. copyright and trademark law. Under 17 U.S.C.
106(3), the copyright owner had exclusive rights “to distribute copies or phonorecords of the copyrighted work to the public by
sale or other transfer of ownership, or by rental, lease, or lending.” However, once a copy of the work was sold, the copyright
owner’s rights were “exhausted,” and the purchaser had the right to resell, rent, give away, or destroy it.
13
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Netflix saw several keys to success for its streaming service, including content, user
personalization, TV attachment, and streaming infrastructure.
Netflix in 2011
TV attachment and device penetration Netflix recognized that its subscribers enjoyed
watching rental DVDs on TV sets, but most streaming services targeted viewing on computers. It
mounted an aggressive campaign to create a bridge from the Internet to the TV set, working with
Roku to develop the Roku DVP, which was announced in May 2008. This device connected a home
Internet router to the composite S-Video or component video inputs on a TV and allowed Netflix
programs to be watched on the TV. The company also negotiated a deal with Microsoft to put its
service on the Xbox game console system, following the insight that gamers were already connected
to both the TV and the Internet. Netflix then embarked on an ambitious campaign to be included in
other game console systems and new breeds of Internet-connected TVs from Samsung and others. As
mobile devices like the iPad and iPhone became increasingly popular for Internet access, Netflix was
quick to make its service available on them as well.
Streaming infrastructure Netflix started out building its own streaming infrastructure. It
already had a large IT operation with its member website and DVD distribution operations, but
streaming had a wholly different character because of the large amounts of data serving. Scaling
promised to be a challenge as the number of streaming customers increased rapidly. In August 2008,
the company experienced a database corruption problem. "For a few days we had problems shipping
discs to our DVD customers,” explained Yuri Izrailevsky, VP of cloud and platform engineering. “At
that time we realized that going forward what we really needed was a more fault tolerant system that
wouldn’t be privy to failures like this.”27 In 2009 Netflix migrated its transcodinge applications to
Amazon Web Services (AWS), and then in 2010 it migrated the streaming application there as well.
This enabled it to launch the Netflix streaming service on the iPhone in 2010. Using cloud
infrastructure facilitated rapid scaling and international expansion. Netflix became the largest source
of traffic on the Internet, and by early 2011 the company reported a significant milestone. As it stated
in its February 2011 10-K:
In 2010, we passed a significant milestone with the majority of our subscribers
viewing more of their TV shows and movies via streaming than by DVD. Going
forward, we expect we will be primarily a global streaming business, with the added
feature of DVDs-by-mail in the U.S. We believe delivery of entertainment video over the
Internet will be a very large global market opportunity, and that our focus on one
segment of that market—consumer-paid, commercial-free streaming subscription of TV
shows and movies—will enable us to continue to grow rapidly and profitably.28
The rapid growth of streaming relative to DVD-by-mail was the genesis for the split that Hastings
announced in September 2011. But the customer backlash and subsequent public backtracking
presented Hastings with fresh challenges. How could he manage the transition from one business
model to another? Did Netflix have the wherewithal to compete against deep-pocketed competitors
like Amazon, which was the company’s key infrastructure provider for its streaming service?
In January 2005, Wedbush Securities analyst Michael Pachter had called Netflix a “worthless piece
of crap.”29 Reflecting on that comment a few years later, Hastings remarked, “I think it is healthy to
have smart people make a number of negative arguments about Netflix. It sharpens our thinking.”30
Hastings was going to need plenty of sharp thinking to figure out how to balance the two very
different business models going forward.
e Transcoding was the process of converting one (file movie) format to another. It was often used to alter a movie to play on a
different device, such as a tablet or smartphone.
14
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615-007
Page 175 of 213
-
Gross Profit
Source:
(1.1)
(11.1)
-
(11.1)
(11.1)
0.1
0
(29.8)
-
(29.8)
(29.8)
-
0.2
(30.0)
27.6
-
8.6
-
19.0
(2.4)
7.4
5.0
1999
(57.4)
-
(57.4)
(57.4)
-
0.2
(57.6)
56.0
-
19.7
-
36.4
(1.5)
37.4
35.9
2000
(39.2)
-
(39.2)
(38.5)
-
(1.4)
(37.1)
49.1
-
19.6
-
29.5
12.0
63.9
75.9
2001
(20.9)
-
(20.9)
(10.2)
-
0.4
(10.7)
64.9
-
17.6
-
47.3
54.2
98.6
152.8
2002
6.5
-
6.5
6.5
(3.3)
5.3
4.5
85.6
(1.2)
21.9
-
64.9
90.1
180.4
270.4
2003
21.6
0.2
21.8
21.8
-
2.4
19.4
149.5
(2.6)
29.5
-
122.6
168.9
331.7
500.6
2004
42.0
(33.7)
8.3
16.4
(0.5)
5.8
11.1
205.3
(2.0)
35.4
-
171.9
216.4
465.8
682.2
2005
48.8
31.1
79.9
79.9
(0.1)
14.8
65.2
304.5
(4.8)
47.8
-
261.4
369.7
627.0
996.7
2006
66.6
44.3
110.9
103.2
0
18.5
84.8
334.4
(7.2)
71.0
-
270.6
419.2
786.2
1,205.3
2007
83.0
48.5
131.5
128.4
0.1
6.7
121.5
332.9
(6.3)
89.9
-
249.4
454.4
910.2
1,364.7
2008
115.9
76.3
192.2
188.2
-
(1.6)
189.8
401.2
-
114.5
-
286.6
591.0
1,079.3
1,670.3
2009
160.9
106.8
267.7
267.7
For use only in the course RSM 392 - Strategic Management at University of Toronto - Rotman School of Management from 9/3/2024 to 12/31/2024.
Use outside these parameters is a copyright violation.
-
(15.9)
283.6
521.6
-
163.3
-
358.3
805.3
1,357.4
2,162.6
2010
-15-
Adapted by casewriter from Capital IQ, https://www.capitaliq.com/CIQDotNet/Financial/IncomeStatement.aspx?CompanyId=32012&statekey=c009d36820f54b51b68a1de
383cdea23.
Net Income
-
(1.1)
EBT Incl. Unusual Items
Income Tax Expense
(1.1)
0.0
0
(11.2)
11.2
1.1
(1.1)
-
3.9
1.2
6.2
0.0
1.3
1.3
1998
-
0.3
-
EBT Excl. Unusual Items
Other Non-Operating Inc. (Exp.)
Net Interest Exp.
Operating Income
Other Operating Exp., Total
Other Operating Expense/(Income)
R & D Exp.
Stock-Based Compensation
0.8
-
Cost Of Goods Sold
Selling General & Admin Exp.
-
1997
($ millions)
Revenue
Netflix Income Statement
Exhibit 1
615-007
Page 176 of 213
Source:
1980
1985
Theater
1990
Video/DVD
Motion Picture Studio Revenue Share by Release Windows
1995
Pay-TV*
2000
TV, Free
2003
2004
For use only in the course RSM 392 - Strategic Management at University of Toronto - Rotman School of Management from 9/3/2024 to 12/31/2024.
Use outside these parameters is a copyright violation.
Adapted by casewriter from “Hollywood-By-The-(Secret)-MPA Numbers,” http://edwardjayepstein.com/mpa2004.htm, accessed July 15, 2014.
0
1948
5
10
15
20
25
30
35
40
45
50
$ Billion
Exhibit 2
615-007
-16-
Page 177 of 213
2000
4,960.1
2,036.0
2,924.1
2,391.0
247.4
180.1
2,818.5
105.6
(109.2)
1.3
1.7
(0.6)
1.7
(31.6)
(30.5)
45.4
(75.9)
(75.9)
2001
5,156.7
2,224.8
2,931.9
2,477.4
244.0
177.1
2,898.5
33.4
(72.1)
0.5
(1.0)
(39.2)
(225.4)
(4.2)
(27.6)
(296.4)
(56.1)
(240.3)
(240.3)
2002
5,565.9
2,358.7
3,207.2
2,618.7
239.1
1.7
2,859.5
347.7
(45.4)
(2.2)
2.9
303.0
303.0
107.1
195.9
(1,817.0)
(1,621.1)
2003
5,911.7
2,389.8
3,521.9
2,785.3
268.4
3,053.7
468.2
(30.0)
(0.7)
(0.4)
437.1
(1,304.9)
(867.8)
106.5
(974.3)
(4.4)
(978.7)
2004
5,932.5
2,378.7
3,553.8
3,042.5
247.3
3,289.8
264.0
(34.5)
1.6
231.1
(2.9)
(1,502.7)
(1,274.5)
(20.8)
(1,253.7)
4.9
(1,248.8)
2005
5,721.8
2,561.0
3,160.8
2,964.9
224.3
3,189.2
(28.4)
(94.6)
(4.2)
(127.2)
(12.6)
(341.9)
(481.7)
62.4
(544.1)
(39.8)
(583.9)
2006
5,522.2
2,481.0
3,041.2
2,728.9
210.9
2,939.8
101.4
(91.7)
4.4
1.0
15.1
(18.2)
(5.1)
(9.0)
4.5
(12.7)
(76.4)
63.7
(13.2)
50.5
For use only in the course RSM 392 - Strategic Management at University of Toronto - Rotman School of Management from 9/3/2024 to 12/31/2024.
Use outside these parameters is a copyright violation.
This data was composed of restated figures from BB Liquidating Inc., the successor to Blockbuster Inc. During the third quarter of 2004, the company recognized non-cash charges of $1.50
billion to impair goodwill in accordance with SFAS No. 142, Goodwill and Other Intangible Assets (“SFAS 142”), related to worse-than-anticipated revenues in its core rental business, which it
attributed to increased competition from retail DVD and discounted retail DVD pricing by mass merchants. These trends also indicated that the strength of rental revenues in the fourth quarter
had been and would continue to be negatively affected by consumers purchasing DVDs during the holiday season. Additional risks included implementation risks associated with its new online
initiatives and risks associated with certain international operations, such as increased competition, two-tiered pricing, and piracy.
1999
4,463.5
1,762.5
2,701.0
2,187.0
220.5
171.8
2,579.3
121.7
(116.1)
(2.8)
(0.2)
2.6
2.6
71.8
(69.2)
(69.2)
Note:
1998
3,893.4
1,956.4
1,937.0
1,913.3
212.7
170.2
2,296.2
(359.2)
(23.7)
(1.3)
(1.3)
(385.5)
(10.5)
(396.0)
(59.4)
(336.6)
(336.6)
Adapted by casewriter from Capital IQ.
1997
3,313.6
1,360.5
1,953.1
1,753.2
208.7
168.7
2,130.6
(177.5)
(27.1)
(18.9)
8.0
(0.5)
(216.0)
(45.1)
(27.1)
(288.2)
30.0
(318.2)
(318.2)
-17-
Source:
1996
2,942.1
1,013.7
1,928.4
1,278.9
165.5
166.2
1,610.6
317.8
(18.4)
(4.0)
295.4
(50.2)
245.2
167.4
77.8
77.8
Blockbuster Inc. Income Statement
($ millions)
Revenue
Cost Of Goods Sold
Gross Profit
Selling General & Admin Exp.
R & D Exp.
Depreciation & Amort.
Amort. of Goodwill and Intangibles
Other Operating Expense/(Income)
Other Operating Exp., Total
Operating Income
Net Interest Exp.
Income/(Loss) from Affiliates
Currency Exchange Gains (Loss)
Other Non-Operating Inc. (Exp.)
EBT Excl. Unusual Items
Restructuring Charges
Merger & Related Restruct. Charges
Impairment of Goodwill
Gain (Loss) On Sale Of Invest.
Gain (Loss) On Sale Of Assets
Asset Writedown
Insurance Settlements
Legal Settlements
Other Unusual Items
EBT Incl. Unusual Items
Income Tax Expense
Earnings from Cont. Ops.
Earnings of Discontinued Ops.
Extraord. Item & Account. Change
Net Income to Company
Exhibit 3
615-007
615-007
Netflix in 2011
Netflix Sunnyvale, California, Distribution Center
Automated Sorter for Outbound Envelopes
Movie Archives
“Relabeling” Station
Repackaging DVDs for Resale
Source:
Casewriter.
18
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Exhibit 4
Netflix in 2011
Date
4/15/2004
Chronology of Netflix and Blockbuster Service Offerings
Netflix
Blockbuster
$21.99 per month
subscription, three movies out
at a time, unlimited rentals.
8/11/2004
10/14/2004
Netflix raised its price
from the previous $19.99
offering.
$19.99 per month subscription,
three movies out at a time,
unlimited rentals plus two instore rental coupons; included
free DVD upon sign-up for trial
period.
$17.99 per month
subscription, three movies out
at a time, unlimited rentals.
Netflix lowered price in
anticipation of market
entry by Amazon.
10/18/2004
$17.49 per month, three rentals
out at a time.
12/22/2004
$14.99 per month
Free DVD eliminated.
Source:
Notes
Blockbuster competitive
response to Netflix move.
Adapted by casewriter from Anthony DiClemente, “Playing a New Game—A Guide to the Future of Home Video;
Initiation of Coverage,” Lehman Brothers Global Equity Research, January 18, 2005.
19
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Exhibit 5
615-007
615-007
Netflix in 2011
1 LEX Column: Netflix, Financial Times, October 25, 2011, via Factiva, accessed July 14, 2014.
2 Michael V. Copeland, “Reed Hastings: Leader of the Pack,” Fortune, November 18, 2010, http://fortune. com/2010/11/18/
reed-hastings-leader-of-the-pack/, accessed July 15, 20014.
3 Brian Stelter, “Netflix, in Reversal, Will Keep Its Services Together,” New York Times, October 10, 2011, http://mediadeco
der.blogs.nytimes.com/2011/10/10/netflix-abandons-plan-to-rent-dvds-on-qwikster/?_p hp=true&_type=blogs&_r=0,
accessed July 15, 2014.
4 Reed Hastings, “An Explanation and Some Reflections,” Netflix US & Canada Blog, September 18, 2011,
http://blog.netflix.com/2011/09/explanation-and-some-reflections.html, accessed July 15, 2014.
5 Netflix stock reached $77.37 on October 28, 2011. Source: CapitalIQ (NasdaqGS:NFLX) Chart Builder.
6 Reed Hastings, on George Stroumboulopoulos Tonight, CBC Television, YouTube, July 19, 2013, http://www.you
tube.com/watch?v=ovinzcUxioA, accessed July 15, 2014.
7 Pete Barlas, “Blockbuster Borrows from Netflix’s Playbook, but Stays Offline Monthly DVD Rental Program Subscribers,”
Investor’s Business Daily, August 12, 2002.
8 Anthony DiClemente, “Playing a New Game—A Guide to the Future of Home Video; Initiation of Coverage,” Lehman
Brothers Global Equity Research, January 18, 2005.
9 Ibid.
10 Blockbuster Inc. Form 10-K, March 1, 2007, via Edgar, http://www.sec.gov/Archives/edgar/data/1085734/00
0119312507044360/d10k.htm, accessed July 16, 2014.
11 Ibid.
12 Blockbuster Form 10-K, March 27, 2003, via Edgar, http://www.sec.gov/Archives/edgar/data/1085734/00009
3066103001225/0000930661-03-001225-index.htm, accessed July 15, 2014.
13 Aline Van Duyn, “DVD Rentals pass their screen test,” Financial Times, October 4, 2005, p. 15.
14 “Inside Netflix,” 60 Minutes, CBS, December 3, 2006, http://www.cbsnews.com/videos/ inside-netflix/, accessed July 15,
2014.
15 Etan Horowitz, “Netflix distribution centers: a portrait of speed and efficiency,” Seattle Times, August 20, 2009,
http://seattletimes.com/html/businesstechnology/2009693850_netflixtour20.html, accessed July 15, 2014.
16 Christopher Borrelli, “How Netflix gets your movies to your mailbox so fast,” Chicago Tribune, August 4, 2009,
www.chicagotribune.com/entertainment/chi-0804-netflixaug04,0,6424990.story, accessed July 15, 2014.
17 Brian McClimans, “Frustration leads to new Internet, mail DVD service,” Associated Press Newswires, May 18, 2002.
18 Barlas, “Blockbuster Borrows from Netflix’s Playbook.”
19 Blockbuster Form 10-K, March 1, 2007.
20 Gary Rivlin, “Does the Kid Stay in the Picture?” New York Times, February 22, 2005.
21 Rick Newman, “15 Companies That Might Not Survive 2009,” U.S. News & World Report, February 6, 2009, http://money.
usnews.com/money/blogs/flowchart/2009/02/06/15-companies-that-might-not-survive-2009, accessed July 26, 2014.
22 Copeland, “Reed Hastings: Leader of the Pack.”
23 “More mainstream movies for Netflix online,” Los Angeles Times, October 1, 2008,
http://latimesblogs.latimes.com/entertainmentnewsbuzz/2008/10/more-mainstream.html, accessed July 27, 2014.
24 Greg Bensinger, “Netflix CEO Keeps Focus on Expansion, Price,” Wall Street Journal, September 26, 2012,
http://online.wsj.com/news/articles/SB10000872396390444083304578017312128187852, accessed July 17, 2014.
25 Hastings, on George Stroumboulopoulos Tonight.
20
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Endnotes
615-007
26 Bensinger, “Netflix CEO Keeps Focus on Expansion, Price.”
27 “AWS Case Study: Netflix,” Amazon Web Services, http://aws.amazon.com/solutions/case-studies/netflix/, accessed July
17, 2014.
28 Netflix Form 10-K, February 18, 2011, via Edgar, http://www.sec.gov/Archives/edgar/data/1065280/
000119312511040217/d10k.htm, accessed February 16, 2014.
29 Copeland, “Reed Hastings: Leader of the Pack.”
30 Ibid.
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Netflix in 2011
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YOUNGME MOON
Uber: Changing the Way the World Moves
Uber is evolving the way the world moves. By seamlessly connecting riders to drivers through our apps, we
make cities more accessible, opening up more possibilities for riders and more business for drivers. From our
founding in 2009 to our launches in hundreds of cities today, Uber’s rapidly expanding global presence
continues to bring people and their cities closer.
— From the Uber website, November 2015
In late 2015, Uber was among the most high-profile new companies of its generation. Founded just
six years ago, the company connected passengers to drivers at an unprecedented scale, using pointto-point software enabled by smartphone technology.
Customers raved about Uber’s reliability and convenience. The breathtaking efficiency of its value
proposition had fueled astonishing growth: It was now said to be booking 2 million1 rides a day, and
although it did not report revenues as a private company, analysts estimated Uber’s net commission
from drivers would come in between $1.5 billion and $2 billion2 in 2015.
But if there was an adage about disruptive technology companies—”move fast and break
things”— few companies embodied this adage better than Uber. Not only did the company endure
frequent customer criticisms about its surge pricing policy, Uber was constantly battling government
regulators, taxi companies, and critics who charged that they were playing fast and loose with the
legal system. Barry Korengold, President of the San Francisco Cab Drivers Association, described
Uber this way: “I think of them as robber barons. They started off by operating illegally, without
following any of the regulations and unfairly competing. And that’s how they became big—they had
enough money to ignore all the rules.”3
Still, by late 2015, there was no denying the global phenomenon that Uber had become. Like
Google, its brand name was already in regular use as a verb. It had more than a million active drivers
and operated in more than sixty countries and 330 cities around the world. It was valued by investors
at $51 billion, which made the young startup more valuable than two-thirds of the companies on the
Fortune 500. At the same time, the company was also being credited (along with a handful of other
startups) with ushering in what was being called the on-demand economy, in which people used
1 Chafkin, Max. What Makes Uber Run, Fast Company, Oct 2015.
2 Kosoff, Maya. New Revenue Figures Show $50 billion Uber is Losing a Lot of Money. Business Insider, Aug 5, 2015.
3 Swisher, Kara. Man and Uber Man. Vanity Fair, Dec 2014.
Professor Youngme Moon prepared this case. This case was developed from published sources. Funding for the development of this case was
provided by Harvard Business School and not by the company. HBS cases are developed solely as the basis for class discussion. Cases are not
intended to serve as endorsements, sources of primary data, or illustrations of effective or ineffective management.
Copyright © 2015, 2016, 2017 President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800545-7685, write Harvard Business School Publishing, Boston, MA 02163, or go to www.hbsp.harvard.edu. This publication may not be digitized,
photocopied, or otherwise reproduced, posted, or transmitted, without the permission of Harvard Business School.
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REV: JANUARY 4, 2017
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Uber: Changing the Way the World Moves
The Origins of Uber
The idea for Uber originated in 2008 when Travis Kalanick and Garrett Camp, both serial
entrepreneurs who had successfully sold their most recent startups, were in Paris, casting about for
their next business idea. Inspired by their difficulties in finding a taxi in the snow, the two began
plotting a smartphone app that would solve the problem of summoning a car service. Once back in
San Francisco, Camp bought the domain name UberCab.com and convinced Kalanick to run the
company. UberCab officially launched in 2010 as a private luxury car service catering to San
Francisco and Silicon Valley executives.
In the company’s early days, customers wishing to use the service had to email Kalanick for a
code to gain access to the app. After entering their credit card information on the app, customers
could then summon a private black car with the press of a button. The app allowed passengers to
track the car’s approach; once the chauffeur picked up the rider, the built-in GPS guided the
chauffeur to the rider’s destination. The cost of the ride was automatically charged to the customer’s
preloaded credit card at the end of the ride, with no tipping required. Uber kept 20% of the gross fare
as commission; the chauffeur kept the rest.
For executives accustomed to having to book an expensive private car service well in advance of
needing a ride, or alternatively, to walk onto the street and hail a cab, the convenience, spontaneity,
and efficiency afforded by UberCab was a revelation. Not long after launch, the prominent angel
investor Chris Sacco tweeted: “Rolling in an @ubercab. Eat your heart out Robin Leach.”4 The tweet’s
sentiment captured the instant affinity first-time users typically felt for the service.
In October 2010, just months after launch, the company received cease-and-desist orders from
both the California Public Utilities Commission and the San Francisco Municipal Transportation
Agency, demanding that the company immediately cease “all advertisements and operations” for
operating without a taxi license—or else face fines of $1,000 and 90 days in jail for every day it stayed
in business. (See Exhibit 1.) But because Kalanick believed that Uber was not in the taxi business—it
simply provided the software platform to connect town car chauffeurs and drivers—he just changed
the company name to Uber and otherwise ignored the order.
Over the next few months, the company’s momentum grew. As the company began attracting a
steady stream of customers and drivers, investors began flocking in as well. In February 2011, Uber
raised $11 million in a financing round led by Benchmark that valued the company at $60 million.
Additional investments over the next few years came in from high-profile firms like Menlo Ventures,
Google Ventures, Fidelity and BlackRock. By May 2013, Uber was valued at $330 million. Later that
same year, it was valued at more than $3 billion. By the summer of 2014, it was valued at more than
$18 billion. By late 2015, it had raised a cumulative total of $8 billion and was valued at $51 billion.5
As for the business itself, because Uber was a private company, its financial performance was a bit
of a guessing game. In 2013, Uber’s gross annual revenue was leaked to be roughly $500 million, with
4 Swisher, Vanity Fair.
5 Source: Crunchbase.
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their smartphones to connect to a distributed workforce that delivered everything from hot meals,
housekeeping services, to groceries, at a moment’s notice.
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net revenue of more than $100 million.6 In 2014, net revenue was said to have grown to more than
$400 million7 and a year later, the company was believed to have more than doubled that. As for
profitability, Uber was widely assumed to be taking a loss. But it was also believed that Uber was
profitable in dozens of its more mature cities and was simply managing its overall income statement
to prioritize for expansion and growth over profitability. Uber as much as confirmed this in a
sarcastic response to media outlets: “Shock, horror, Uber makes a loss. It’s the case of Business 101:
You raise money, you invest money, you grow (hopefully), you make a profit and that generates a
return for investors.”8
How Uber Worked
Uber should feel magical to the customer. They just push the button and the car comes. But there’s a lot
going on under the hood to make it happen.
— CEO Travis Kalanick9
Uber was a remarkably easy service for customers to use. To access Uber, customers simply had to
download the app, create an account, and input their credit card information. When they were ready
to summon a car, they simply opened the app and pressed a button. The app displayed available
drivers in the nearby location, and usually responded within seconds that a driver was on its way.
As the driver headed to pick up a customer, the customer could track the driver’s progress on a
map. The app allowed customers to view the name of the driver and the driver’s quality rating,
which ranged from 1 to 5 stars. Customers could reject a driver with a low rating; they could also
contact the driver via phone or text if necessary (with the driver’s actual phone number cloaked). The
car would generally arrive within minutes. Once the driver picked up the passenger, the driver could
navigate to the destination using Uber’s built-in GPS system.
At the end of the ride, no cash would exchange hands; instead, the fare was automatically
deducted from the customer’s account. An email receipt was sent to the customer when the trip was
completed, at which point the customer was encouraged to rate the driver. (See Exhibit 2 for
screenshots of the app.)
Uber’s prices were determined by the time and distance of the trip as measured by GPS. Uber’s
black town car service (UberBlack) was typically priced lower than the cost of a private limousine
service, but 40% to 100% higher than a comparable cab ride.10 During times of peak ridership—which
could include rush hour, bad weather, or special occasions—Uber would put something called
“Surge Pricing” into effect, which would raise the price anywhere from 1.5x to 7x of normal.
Although the precise algorithm behind these surges remained a mystery, Uber claimed they went
into effect automatically whenever demand in a given area exceeded supply.
When surge pricing was in effect, customers were notified immediately upon opening the app.
Before they could summon a ride, they had to acknowledge the surge pricing, and type the precise
6 Kosoff.
7Eric Newcomer and Jing Cao, “Uber Bonds Term Sheet Reveals $470 Million in Operating Losses,” BloombergBusiness report,
June 29, 2015. (bloom.bg/1M9YtAj)
8 DeAmicis, Carmel. Yes, Uber Lost a Lot of Money. (And It Will Lose More.) Re/code, Aug 5, 2015. (on.recode.net/1kqAouv)
9 Wohlsen, Marcus. What Will Uber Do With All That Money From Google. Wired. Jan 3, 2014.
10 We Did The Math: Uber vs. Taxi. Business Insider report. Oct 6, 2014. (read.bi/1Mb1H38)
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Uber: Changing the Way the World Moves
Uber: Changing the Way the World Moves
amount of the surge increase into the app to ensure they knew they were being charged a higher
price. (See Exhibit 3 for screenshots of surge pricing in effect.) The company’s commission remained
a flat 20% regardless of the price charge. As Kalanick put it, “What you are aiming for is the
equilibrium of supply and demand. A perfect day is when you set an all-time record for trips per
hour with zero surges.”11
On the driver’s side, Uber’s system worked in reverse. When a customer summoned a car, nearby
drivers had the option to respond, and had the right to refuse to pick up passengers whose ratings
were low. They also had the option to contact the customer by phone or text if necessary (with the
customer’s actual phone number cloaked). The driver app had additional features as well. It had
“heat maps” that gave drivers visibility into the areas where they were most likely to find passengers.
It had an earnings icon that displayed a breakdown of the money they were making, separating out
take-home pay. It had a feedback icon that displayed how passengers were rating them, including
any comments passengers may have left. (See Exhibit 4 for screenshots of Uber’s driver app.)
Meanwhile, at Uber’s San Francisco headquarters, a software tool called God View offered Uber
managers a real-time display of all of the city’s Uber vehicles—represented as tiny cars on a map—on
the move, while tiny eyeballs on the same map displayed the location of potential customers looking
at the Uber app on their smartphones. Uber used sophisticated data analysis to determine the best
locations for drivers to wait for pickups. This was a massive effort on Uber’s part; the company
employed a large data science team of PhDs from fields ranging from nuclear physics to
computational biology to hone the algorithms that kept Uber humming at maximum efficiency.
Uber’s Driver Model
Uber drivers were independent contractors rather than regular permanent employees of Uber. As
contract workers, they did not receive health benefits, retirement, disability, vacation leave,
unemployment or injured workers compensation; they were simply paid for the business they
generated driving passengers.12 Uber took a flat percentage commission fee on all fares and in 2015
this fee had been raised: Uber’s cut now ranged from 20% to 30% of the gross fare, depending on the
city and the circumstances. Drivers kept the remainder.
Uber did not own its cars; instead, it served as a referral or dispatch system for drivers who drove
their own cars. For the company’s UberBlack town car service, the company relied on a network of
established, licensed limousine drivers who applied to be part of its system. A growing number of
U.S. limousine companies (estimates ranged from 20%-40%) allowed their drivers to participate in
Uber.13 To become an UberBlack driver, drivers had to be professional chauffeurs with a commercial
license and commercial auto insurance. Their vehicles had to fit Uber’s criteria for black car service.
They also had to have clean driving records and undergo background checks at both the state and
federal level.
11 Malik, Om. Uber is the New Google. Fast Company, June 2014.
12 Uber was facing lawsuits for treating its drivers as independent contractors. It was not alone in this regard; many other
prominent “sharing economy” companies were facing similar lawsuits over the same issue. Uber’s response to these lawsuits
was to argue that the classification was appropriate, because the company was simply connecting contractors with customers
through its technology platform. In fact, many cab drivers were also independent contractors for the taxi industry. Uber
additionally noted that its drivers often preferred the flexibility that came with the classification, because it meant they could
work for multiple employers and set their own schedules.
13 Limousine, Charter & Tour Factbook, May 2014.
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In 2013, Uber introduced uberX, a cheaper version of Uber that allowed non-professional drivers
to apply to use the platform using their personal vehicles. Riding uberX generally tended to save
passengers 10% off the cost of a taxi. The criteria for being an uberX driver were less stringent than
that for UberBlack: Drivers had to be at least 21 years old, with a personal license and personal auto
insurance that covered using the vehicle for commercial purposes. They had to possess clean driving
records, pass background checks, and drive a midsize or full-size 4-door vehicle in good condition.
Drivers were also expected to have an iPhone, although if they didn’t have one, Uber would rent
them one for $10 per week.
By 2015, Uber offered additional service options as well: uberXL for passengers who wanted the
low cost of uberX service but needed a larger vehicle to fit up to six passengers; UberSUV for
passengers who wanted UberBlack service but required an SUV. (See Exhibit 5 for a comparison of a
subset of the different Uber services. See Exhibit 6 for expenses incurred by typical uberX drivers.)
When Uber prepared to launch in a new city, it would send two advance teams into the area six
weeks in advance: One team was charged with building market awareness about Uber’s impending
entry into the market; the other was charged with recruiting drivers for the service.14 This second
team would aggressively pitch potential drivers on the advantages of driving for Uber: Drivers could
set their own hours; they could earn a good income; they were guaranteed automatic payment upon
completion of each fare; and they could participate in a system in which misbehaving passengers
could be suspended from the system. In addition, Uber often granted these drivers bonus incentives
to drive for Uber, particularly in their first year of driving. As for potential drivers who did not own a
car, Uber offered favorable loan terms to help them purchase the vehicles necessary to drive for the
company.
(See Exhibits 7 and 8 for additional information on the number and earnings of UberBlack versus
uberX drivers.)
The Competition
Uber competed directly against the taxi industry, which operated differently across countries. In
the United States, most taxicabs required a license (or “medallion”) to operate. Some cities controlled
the number of available taxis through their medallion systems. For example, the number of cabs in
New York had remained constant for decades despite significant increases in the population. San
Francisco was another city that capped the number of taxi medallions even as the population had
increased. By contrast, cities like Washington DC allowed anyone to operate a cab as long as they
obtained a license and operated according to regulations.
The distinction between taxicabs and livery vehicles (“for hire” vehicles such as limousines and
black town cars) was significant. Only taxicabs could be hailed on the streets, and only taxicabs could
be dispatched immediately after a telephone call to a dispatcher. In some cases, a prearranged taxi
pickup could be requested in advance, but such pickup arrangements were generally perceived to be
unreliable by customers.
Taxis were generally required to have a distinctive appearance and to make it clear whether or not
they were “in service.” The price of a cab fare was based on the time and distance of the trip and was
regulated by an official taximeter, although exceptions to this existed—the price of trips to/from
established destinations (e.g., airports) was often fixed, for example.
14 Lagorio-Chafkin, Christine. Resistance is Futile. Inc. Magazine, July/August 2013.
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Uber: Changing the Way the World Moves
Uber: Changing the Way the World Moves
Complaints about taxicabs were widespread. Riders often found the cars to be in poor repair
(seatbelts not working, seats ripped), unclean and generally unpleasant. Some cabs accepted credit
cards, but others did not. Cab drivers were known to talk on the phone or even text while driving,
and often needed to be given directions to the destination (as not all of them were equipped with
GPS). Some cabs blared music and/or advertisements during the ride. Catching a cab generally
required standing outside and trying to hail one that drove by. This tended to be a hit-or-miss
proposition: In some parts of the city, cabs were easily hailed; in other areas, cabs were nowhere to be
found. It was generally accepted that cabs tended to avoid certain areas of certain cities. It was also
accepted that they were hard to catch at night.
Becoming a taxi driver was a complicated process due to regulatory constraints. Because the
number of medallions was capped in some cities, their prices had soared in recent years. In New
York, for example, the price of a medallion had skyrocketed, reaching a height in 2013 when an
auction of 200 medallions netted the city a total of $200 million. There were other hurdles as well. In
London, potential drivers had to pass a “knowledge test” of the city’s streets to attain a license.
Although GPS had probably made the test obsolete, the requirement persisted and it would
sometimes take up to four years for an individual to pass the test successfully.
Some drivers owned their own medallions, but because of their high price, many were purchased
by companies that operated fleets of taxis. Owners would buy them for their investment value, and
then lease their vehicles to other drivers. New York medallion owners were known to charge drivers
on a daily or weekly basis to lease a licensed vehicle, and were often able to lease the car for two
shifts a day, doubling profitability. In cities such as New York, it could cost cab drivers—who often
worked as independent contractors—as much as $75,000 a year to rent a medallion.
Once lease payments were deducted, a typical driver made somewhere around $130 per shift. The
median annual income for a full-time taxi driver tended to range from $27,000 to $41,000 with a
rough median of about $33,000, although this figure varied depending on location and company.15 As
David S. Yasskey, NYC Taxi Commissioner, put it: “Like a lot of the economy, the taxi industry has
become a winner-take-all industry where the profits at the top are very large and the wages at the
bottom are grindingly low.”16 (Exhibits 9 through 11 provide additional information on the
characteristics and earnings of Uber drivers versus taxi drivers and chauffeurs.)
Given this context, it was perhaps not surprising that some taxi drivers were defecting to Uber. A
2014 BusinessWeek article described one San Francisco taxi driver who, weary of paying $400 a week
to lease his cab, had recently made the switch. After an hour of orientation, Uber had handed him an
iPhone with its driver app and had sent him out on the road. “No one under the age of 40 with a
smartphone is going out and getting a cab anymore,” the driver was quoted as saying. “I say if you
can’t beat ‘em, join ‘em.”17 The article also described how the driver was now receiving a stream of
offers from Uber, offering discounts on new cars and other perks.
Uber also faced competition from livery services that provided limousines and black town cars. In
the United States, livery services tended to be regulated by state agencies. In most cities, these
vehicles could not be hailed on the street, nor could they respond immediately to pick-up requests;
rather, they had to be prearranged at least an hour in advance. Cars were generally unavailable on
15 Salary.com report: www1.salary.com/Taxi-Driver-Salary.html.
16 Flegenheimer, Matt. “$1 Million Medallions Stifling the Dreams of Cabdrivers,” New York Times, Nov. 14, 2013.
17 Stone, Brad. Invasion of the Taxi Snatchers: Uber Leads an Industry’s Disruption. BloombergBusiness, Feb 20, 2014.
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The typical limo driver earned between $11 and $12 an hour, plus tips. In some cases, these
drivers owned their own vehicles and worked as independent contractors for the limousine
company; in other cases, the limo company would provide vehicles to a staff of employed chauffeurs.
Finally, Uber faced newer competition from other ride-sharing services such as Lyft and Sidecar.
These companies allowed any non-professional driver with a vehicle to pick up passengers using
their apps. Some of these companies had garnered positive momentum, but none had achieved the
popularity and growth of Uber.
A Battle of Words, Regulation, and Public Relations
Although there was no disputing Uber’s market momentum, controversy swirled around the
company on a regular basis.
Uber versus the Taxi Industry
Within months after Uber’s launch, regulators, politicians, and the taxi industry had begun
fighting back against Uber, and by 2015, the battle was in full force. The response took on many
forms: In some countries such as the Netherlands and South Korea, Uber was banned or treated as an
illegal taxi service. In other countries where Uber operated, taxi drivers would sometimes go on
strike to protest their government’s failure to regulate ride-sharing businesses. These strikes
occasionally erupted into violence, inflaming public opinion and headlining global news coverage.
One long-time taxi driver who managed a seven-car fleet in Houston fumed: “For 30 years I’ve
done physicals, drug tests, keeping myself in order so I can keep my license. And now this
company’s just going to come in here, charge 20 percent, and let [their drivers] go?” He recently told
his older son, who occasionally drove for uberX: “When you’re out there for a few hours, you’re
stealing food from the mouth of a guy who’s out there eight or nine hours—who’s a professional.”18
In reality, the legality of Uber’s business was unclear. Although laws existed to regulate the taxi
and limousine industries, Uber’s service had unique characteristics that made comparison difficult.
The fact was, the technology that was core to Uber’s network represented an unprecedented
disruption that city and country regulators were ill equipped to deal with. Most laws had been
written before the existence of software that could coordinate real-time ride-sharing on a massive
scale. Most regulations had been written before regulators could conceive of a time when passengers
could summon rides from devices kept in their pockets.
Still, some of the charges leveled at the company from its critics appeared to have some weight.
For example, one of the criticisms was that Uber was putting non-professional drivers on the road.
This was at least partially true: While UberBlack drivers were commercially licensed professional
drivers, uberX drivers were not. What wasn’t clear was whether, as critics claimed, the company was
actually risking lives by putting these uberX drivers on the road. Uber claimed that its background
checks for drivers were more thorough than that of the taxi industry, but given the variability in how
different taxi companies vetted their drivers, this was impossible to verify. (See Exhibit 12 for driver
requirements for different industries.)
18 Kim, E. Tammy. The Taxi Wars: Uber is ‘Destroying the Taxi Industry.’ Al Jazeera, Sept 16, 2015. (bit.ly/1iBHZoS)
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short notice. These services tended to charge based on time, with a preset minimum. They also
tended to be expensive.
Uber: Changing the Way the World Moves
Critics also claimed that Uber’s prices were unfairly designed to kill off competition. Kalanick, not
known for being diplomatic, responded by calling the taxi industry a “protectionist scheme” that
“prefers not to compete at all and likes things the way they are.”19 In a blog post, he expanded on this
by writing, “Our opponent—the Big Taxi cartel—has used decades of political contributions and
influence to restrict competition, reduce choice for consumers, and put a stranglehold on economic
opportunity for drivers.”20
On its side, Uber had defenders among the many former taxi drivers who were now driving for
the company. Bloomberg BusinessWeek spoke to one former cab driver who had little sympathy for
the yellow cab operators complaining about Uber: “He bitterly recalls having to wait for hours in the
garages of a local car company before Uber entered the scene, as dispatchers decided whether they
had a spare car to give him. ‘It’s their fault,’ he says. ‘They made it so hard.’”21
In addition, Uber had legions of defenders among its customer base. One reporter described his
personal experience switching from taxis to Uber this way:
I’ve lived in New York City’s outer boroughs for a decade, first in Brooklyn and now
in Queens, and I can tell you that Uber has made life dramatically easier on those who
can’t afford a Manhattan apartment or to live especially close to a subway stop. Back in
the old days, if you wanted to take a taxi home . . . the city’s iconic yellow cabs generally
flat-out refused to take you to a borough. If you managed to get in the cab, they might
simply drive around in circles, with the meter running, until you got out, miles away
from your destination. And they also routinely racially profiled passengers and refused
to take anyone to neighborhoods like Harlem that are predominantly African
American.22
Yet another journalist, writing for Business Insider, headlined his piece: “Uber has changed my
life and as God is my witness I will never take a taxi again.”23
Uber’s Surge Pricing Model
In addition to waging battles with regulators and the taxi industry, Uber also had to contend with
persistent complaints about its surge pricing model.
Dynamic pricing was not a novel concept; it was used on a regular basis by a wide array of
companies, including hotels, airlines, movie theatres, and nightclubs. But Uber’s surge pricing had
invited a particularly high degree of negative attention as a result of several specific incidents. On
New Year’s Eve in 2011, Uber prices had surged to 7x normal rates, stunning and infuriating revelers.
Then in 2013, when winter snow storms had battered the East Coast, surge pricing had again raised
the ire of customers when Jessica Seinfeld, the wife of comedian Jerry Seinfeld, posted to Instagram a
screen shot of her $415 Uber bill with a caption that read in part “#OMG #neverforget #neveragain
#real.” Others had piled on, sharing similar experiences and accusing Uber of exploiting customers.
19 Stone.
20 Swisher, Kara. Uber Hires Top Obama Advisor David Plouffe as New ‘Campaign Manager.’ Re/code, Aug 19, 2014.
(on.recode.net/1iFFlhE)
21 Stone.
22 Chafkin, Max. Admit It, You Love Uber. Fast Company, Oct 2015.
23Edwards, Jim. Uber Has Changed My Life And As God Is My Witness I Will Never Take a Taxi Again. Business Insider, Jan 22,
2014. (read.bi/1H57FWl)
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As a result of the controversy, Uber vowed not to exceed 2.8x its normal rates during any future state
of emergency. But the anger had mounted once again when, during the 2014 Sydney hostage crisis,
Uber’s algorithms automatically put surge pricing into effect in the surrounding neighborhoods,
resulting in fares 4x normal. The company later apologized and refunded the surcharges.
Still, Uber refused to back down from its overall policy of surge pricing when demand peaked.
The company’s argument was simple: Surge pricing was necessary to lure drivers on the road to meet
demand during busy times. As Kalanick put it, “people would love to have 100% reliability at a fixed
price all the time. I get it. That is not possible.”24 Elsewhere he added, “Because this is so new, it’s
going to take some time for folks to accept it. There’s 70 years of conditioning around the fixed price
of taxis.”25
Uber’s Aggressive Market Tactics
Aside from the specific complaints leveled by critics against Uber, there was also a more
generalized perception that Uber engaged in overly aggressive market tactics. When Uber entered a
new market, it typically just ignored local regulations and began operating its service without
waiting for permission. It also had a reputation for cutthroat competitive tactics. In one case, Uber
was caught trying to slow down the service of one of its ride-sharing competitors by ordering and
cancelling cars en masse (Uber later apologized for the tactic).26 The company was also known for
attempting to poach drivers from other ride-sharing services by deploying its sales representatives to
order rides and then try to convince the drivers to defect to Uber with offers of monetary bonuses
and other incentives.
Kalanick himself had come under personal criticism for being overly combative in his words and
approach. He seemed to acknowledge the criticism at a celebration for the company’s fifth birthday
when he said, “I realize I can come across as a somewhat fierce advocate for Uber. I also realize some
people have used a different a-word to describe me.”27 Indeed, by late 2015, there were concerns that
the company’s was simply moving too aggressively—with its fast-moving forays into new markets,
with its disdain for regulatory concerns, with its disregard for consumer complaints about pricing—
and as a result, was attracting more than its share of backlash from regulators, industry incumbents,
and a public wary of its aggression.
In 2014, Uber hired David Plouffe to head the company’s public policy and communications
function. Plouffe was the high-powered political strategist best known for being the campaign genius
behind Obama’s 2008 presidential campaign. When asked whether he was hired to repair Uber’s
image problem, Plouffe replied, “I don’t subscribe to the idea that the company has an image
problem. I actually think when you are a disrupter you are going to have a lot of people throwing
arrows.”28
Kalanick added, “What we maybe should’ve realized sooner was that we are running a political
campaign and the candidate is Uber. And this political race is happening in every major city in the
24 Stone.
25 Bilton, Nick. Taxi Supply and Demand, Priced by the Mile. New York Times, Jan 8, 2012.
26 Stone.
27 Uber: Driving Hard. The Economist, June 13, 2015.
28 Swisher, Vanity Fair.
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Uber: Changing the Way the World Moves
316-101
Uber: Changing the Way the World Moves
Looking Ahead
As Uber prepared to close out 2015, it had a number of reasons to be optimistic about its future.
For one thing, it had just won a high-profile transportation skirmish in New York City: Over the
summer, Mayor de Blasio had threatened to place a cap on the number of vehicles Uber could
operate in the city. In response, Uber had spent heavily on advertisements blasting the Mayor for
being in the pocket of the cab industry. It had also introduced a feature in its app called “de Blasio
view,” that showed NYC riders the lengthy wait times they would have to endure if de Blasio’s
legislation passed. A number of celebrities had weighed in to support Uber on social media (Ashton
Kutcher, Kate Upton, Neil Patrick Harris, and others), and New York Governor Cuomo had even
chimed in, calling Uber “one of the great inventions of this new economy.”30 Mayor de Blasio had
finally caved, agreeing to delay any cap pending further study of the issue.
Other signs of Uber’s momentum were more subtle and yet intriguing nonetheless. Some real
estate experts, for example, were reporting that because Uber was making transportation more
reliable and affordable in some cities, they were seeing a real estate resurgence in these dense
locations. A few public health studies were reporting a reduction in drunk driving as a result of
Uber.31 Perhaps most interestingly, the price of a NYC taxi medallion had dropped precipitously
(down 40%) in the past year, a sure indication that the market for taxi licenses had become bearish as
a result of Uber’s presence.32
At the same time, the company continued to clash with regulators and courts in multiple countries
around the world, including Germany, Spain, Colombia, France, Australia, Italy, Denmark, China,
and England. And anti-Uber protests, sometimes violent, continued to flare up in in cities from Paris
to Madrid.
This didn’t seem to be deterring the company, however, as it continued to hew to its philosophy
of brazenly entering and operating in these markets whenever possible, despite the legal ambiguities.
Uber was putting a particular amount of energy into conquering two of the world’s largest markets,
China and India. And it was actively experimenting with new services, including the following:

Uber had recently launched a concept called UberPOOL in select cities. UberPOOL was a
service that paired riders on the same route and charged them a reduced price. In San
Francisco the UberPOOL offering accounted for as much as 50% of all trips on some days.
Kalanick noted: “We want to get to the point that using Uber is cheaper than owning a car.
Transportation that’s as reliable as running water.”33 Kalanick was hinting the company
might one day expand UberPOOL to include buses, which he referred to as the “ultimate
carpool machine.”34
29 Ibid.
30 Flegenheimer, Matt. De Blasio Administration Dropping Plan for Uber Cap, For Now. New York Times, July 22, 2015.
31 Chafkin.
32 New York City’s Yellow Cab Crisis. CNN, July 21, 2015. (cnnmon.ie/1l6OIcg)
33 Swisher, Vanity Fair.
34 Chafkin.
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world. And because this isn’t about a democracy, this is about a product, you can’t win 51 to 49. You
have to win 98 to 2.29
316-101

Uber had recently started a driverless-car initiative, and had jumpstarted the initiative by
poaching dozens of members of Carnegie Mellon’s robotics department, doubling their
salaries and offering them six-figure bonuses.35

In some cities, Uber was experimenting with a lunch-delivery service called UberEATS; in
other cities, it was exploring a food delivery service called UberFRESH. In Manhattan, it was
experimenting with a bicycle courier service called UberRUSH.
Kalanick explained the company’s approach this way: “We like to think of Uber as the cross
between lifestyle and logistics, where lifestyle is what you want and logistics is how you get it there.”
He added: “If we can get you a car in five minutes, we can get you anything in five minutes.”36
35 Ibid.
36 Video and Transcript: Uber’s Travis Kalanick. Fortune, July 23, 2013. (for.tn/1H593Iv)
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Uber: Changing the Way the World Moves
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Uber: Changing the Way the World Moves
It was now December 2016, and in the past year, Uber had continued to live up to its reputation as
an aggressive disruptor with three prominent moves:
A Complete Overhaul of its Mobile App: In late 2016, Uber had released a complete revamp of its
mobile app. Although Uber continued to use surge pricing to set prices, the app no longer referred to
surges explicitly, and instead adopted a different approach that the company argued was more
transparent: It now allowed users to know in advance what the total cost of their ride would be,
while making it easier for users to compare total ride prices across options (e.g., UberX versus
UberBlack) before booking a ride. The new app also remembered users’ most visited places, enabled
users to use their friends’ locations as a destination, and gave users the option of giving Uber access
to their calendars to mark meeting times and locations.
A Deal with Rival Didi Chuxing in China. In mid-2016, Uber had announced that it was selling its
China operations to its biggest Chinese rival, Didi Chuxing. According to insiders, Uber had lost $2
billion in two years in China. The deal enabled Uber to end the expensive price war it had been
waging with Didi, and free up resources to focus more heavily on other markets. As part of the deal,
Uber took a 20% stake in Didi, making it Didi’s largest shareholder.
An Aggressive Test Launch of Self-Driving Cars. In perhaps its boldest move, in the fall of 2016 Uber
had begun aggressively testing a fleet of autonomous vehicles on the streets of Pittsburgh. Under the
test, a subset of passengers calling for rides in the city were now being given the option a self-driving
car. The cars were monitored by a human supervisor sitting behind the wheel ready to take over the
driving if necessary. As the Uber press release for the test stated, “We can’t predict exactly what the
future will hold. But we know that self-driving Ubers have enormous potential to further our mission
and improve society: reducing the number of traffic accidents, which today kill 1.3 million people a
year; freeing up the 20 percent of space in cities currently used to park the world’s billion plus cars;
and cutting congestion, which wastes trillions of hours every year.”37
37 Uber press release, Pittsburgh, Your Self-Driving Uber is Arriving Now, Sept 14, 2016. (newsroom.uber.com/pittsburgh-self-
driving-uber/)
12
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Postscript: One Year Later
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Uber: Changing the Way the World Moves
Exhibit 1
Source:
316-101
Cease and Desist Order
Uber website. (newsroom.uber.com/2010/10/ubers-cease-desist/).
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Exhibit 2
Source:
Source:
Uber.
Exhibit 3
Screenshots of Surge Pricing in Effect
Uber.
14
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316-101
Uber: Changing the Way the World Moves
Screenshots from the Uber App
Exhibit 4
Source:
Uber.
For use only in the course RSM 392 - Strategic Management at University of Toronto - Rotman School of Management from 9/3/2024 to 12/31/2024.
Use outside these parameters is a copyright violation.
Uber: Changing the Way the World Moves
316-101
Screenshot of Uber’s Driver-Side App
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Uber: Changing the Way the World Moves
A Comparison of a Subset of the Different Uber Services
Service
Description
UberBlack and
UberSUV
Uber’s luxury service. Commercially registered and insured livery vehicles, typically a
black luxury sedan or SUV. Drivers must be professional livery drivers—they must
have a commercial license, commercial insurance—and must own a high-end black
luxury sedan or SUV.
uberX
Uber’s low-priced service. Drivers are not professional livery drivers and a commercial
license is not required. Drivers must be 21 or older with a clean driving record, and
must own a model 2000 car (2005 in some cities) or newer and pass an independent
vehicle inspection. Drivers must also have a clean driving history and pass a
background check. Typical vehicles: Honda Accord, Toyota Camry, Ford Escort.
uberXL
Slightly higher fare price than uberX. Vehicles seat at least six passengers. Vehicles
are ordinary minivans and SUVs (Honda Pilot, Dodge Caravan, etc.). Driver
requirements are the same as for uberX.
UberSelect
(aka UberPlus)
Only available in some cities. Uber’s mid-luxury service. Priced are lower than
UberBlack, but higher than uberX. Drivers are not professional livery drivers and a
commercial license is not required, but they must own a luxury sedan (Mercedes,
BMW, Audi) that seats up to four riders.
UberPOOL
Only available in some cities. Passengers share rides with other passengers and split
the cost. Because of the carpooling nature of the ride, passengers may not be picked
up first or dropped off first. An even cheaper option than uberX.
Source:
Uber.
Exhibit 6
Estimated Driver Expenses for Typical uberX Driver
Miles Traveled:
40,000 Miles
MPG
$/gallon
Depreciation
Fuel
Maintenance
Insurance
New York City
2014 Toyota Camry
San Francisco
2014 Toyota Prius
25
$3.72
$5,774
$5,952
$679
$2,676
48
$4.18
$7,763
$3,483
$919
$2,012
$15,080
$14,177
Source:
Data provided by Uber to Salmon, Felix. The Economics of Everyone’s Private Driver. Medium, June 1, 2014.
(bit.ly/1MfTNsQ).
Note:
Assumes driver drives 40 hours a week and a total of 40,000 miles a year. Note that in most cases, the IRS allows
individuals to deduct businesses expenses from business income. Typical deductions included gas, insurance, fees,
repairs, mobile phone charges, depreciation, etc.
16
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Exhibit 5
Uber: Changing the Way the World Moves
Active U.S. Uber Drivers by Type of Service (UberBlack vs. uberX)
Source:
Uber website (ubr.to/1GPVxZt). From a study commissioned by Uber: Hall, Jonathan and Alan Krueger. An Analysis
of the Labor Market for Uber’s Driver-Partners in the United States. Published Jan 22, 2015.
Note:
Sample consists of all U.S. UberBlack and uberX drivers making at least four trips in any month.
Exhibit 8 Distribution and Median Hourly Earnings of uberX Drivers versus UberBlack Drivers, by
Hours Worked (October 2014)
1 to 15 hours/week
UberBlack
uberX
Percent
of
drivers
29%
55%
Earnings
per hour
$20.87
$16.89
16 to 34
Percent
of
drivers
32%
30%
Earnings
per hour
$20.85
$18.08
35 to 49
Percent
of
drivers
19%
10%
Earnings
per hour
$21.67
$18.31
Over 50
Percent
of
drivers
20%
5%
Earnings
per hour
$20.76
$17.13
Source:
Uber website. (ubr.to/1GPVxZt). From a study commissioned by Uber: Hall, Jonathan and Alan Krueger. An
Analysis of the Labor Market for Uber’s Driver-Partners in the United States. Published Jan 22, 2015.
Note:
Data aggregated at the driver-week level. Figures exclude incentive payments that are offered to new drivers in
some markets. Earnings are net of Uber fees but do not adjust for driver expenses.
17
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Exhibit 7
316-101
316-101
Uber: Changing the Way the World Moves
Characteristics of Uber Drivers vs. Taxi Drivers/Chauffeurs and All Workers
Uber Drivers
Taxi Drivers and
Chauffeurs
All Workers
Age 18-29
30-39
40-49
50-64
65+
19.1%
30.1%
26.3%
21.8%
2.7%
8.5%
19.9%
27.2%
36.6%
7.7%
21.8%
22.5%
23.4%
26.9%
4.6%
Female
13.8%
8.0%
47.4%
Less than HS
High School
Some College/Associate
College Degree
Postgraduate Degree
3.0%
9.2%
40.0%
36.9%
10.8%
16.3%
36.2%
28.8%
14.9%
3.9%
9.3%
21.3%
28.4%
25.1%
16.0%
Previous experience
working as a driver
49%
NA
NA
Source:
Uber website. (ubr.to/1GPVxZt). From a study commissioned by Uber: Hall, Jonathan and
Alan Krueger. An Analysis of the Labor Market for Uber’s Driver-Partners in the United States.
Published Jan 22, 2015.
Note:
Uber data from a BSG study conducted December 2014 by Benenson Strategy Group, using a
survey of Uber drivers in 20 markets that represent 85% of Uber’s US drivers. All other data
from the American Community Survey, which is based on nationally representative data. The
ACS data pertain to the same 20 Uber markets as the BSG survey, and are for 2012 and 2013.
18
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Exhibit 9
Uber: Changing the Way the World Moves
Comparison of Hours Worked by Uber Drivers vs. Taxi Drivers/Chauffeurs
Uber Drivers
Taxi Drivers and
Chauffeur)
51%
30%
12%
7%
4%
15%
46%
35%
1-15 hours/week
16-34
35-49
50+ hours/week
Source:
Uber website. (ubr.to/1GPVxZt). From a study commissioned by
Uber: Hall, Jonathan and Alan Krueger. An Analysis of the Labor
Market for Uber’s Driver-Partners in the United States. Published Jan 22,
2015. Taxi driver/chauffeur data from the 2012-2013 American
Community Survey.
Note:
Data for Uber drivers pertain to each week when they worked at least
one hour in Oct 2014. ACS hours based on “usual hours worked per
week in past 12 months.”
Exhibit 11
For use only in the course RSM 392 - Strategic Management at University of Toronto - Rotman School of Management from 9/3/2024 to 12/31/2024.
Use outside these parameters is a copyright violation.
Exhibit 10
316-101
Comparison of Median Hourly Earnings of Uber Drivers vs. Drivers/Chauffeurs
Uber Drivers
OES Taxi Drivers
/Chauffeurs
Boston
Chicago
Washington DC
Los Angeles
New York
San Francisco
$20.29
$16.20
$17.79
$17.11
$30.35
$25.77
$12.92
$11.87
$13.10
$13.12
$15.17
$13.72
Average Across All 20 BSG
Survey Markets
$19.19
$12.90
Source:
Uber website. (ubr.to/1GPVxZt). From a study commissioned by Uber:
Hall, Jonathan and Alan Krueger. An Analysis of the Labor Market for
Uber’s Driver-Partners in the United States. Published Jan 22, 2015. OES
(Occupational Employment Statistics) data from the Bureau of Labor
Statistics.
Note:
Data aggregated to the driver-month level and medians of hourly
earnings reported for Uber’s drivers who drove at least one hour a week
during the month of October 2014. Earnings per hour are net of Uber fees
but do not adjust for driver expenses. For OES Taxi Drivers and
Chauffeurs: OES data from May 2013. OES average for all areas in last
row is weighted by the number of taxi drivers and chauffeurs in the 20
BSG market areas. The figure reported for Uber in the last row is the
weighted average of median earnings per hour in the 20 market areas
surveyed, where weights are the number of taxi drivers and chauffeurs in
the market area.
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Exhibit 12
Source:
Uber. (www.uber.com/driver-jobs).
For use only in the course RSM 392 - Strategic Management at University of Toronto - Rotman School of Management from 9/3/2024 to 12/31/2024.
Use outside these parameters is a copyright violation.
316-101
Uber: Changing the Way the World Moves
Driver Requirements across Industries
20
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9-703-429
GIOVANNI GAVETTI
JAN W. RIVKIN
The Use and Abuse of Analogies
Reasoning by analogy may be the most common form of logic that business strategists employ.
Facing an opportunity or a predicament, strategists think back to some similar situation they have
faced or heard about, and they apply the lessons from that previous experience. Analogies—to the
past, to other firms or industries, and to other competitive settings such as sports or war—come up
all the time in strategy discussions. A few examples illustrate how analogies are commonly used:
•
Throughout the mid-1990s, the microprocessor maker Intel resisted the urge to drop its
product prices and provide cheap chips for inexpensive PCs. During a 1997 training seminar,
however, Intel’s top management team learned a lesson about the steel industry from HBS
Professor Clayton Christensen: In the 1970s, upstart minimills established themselves in the
steel business by making cheap reinforcing bars known as rebar. Established players like U.S.
Steel ceded the low end of the business to the minimills—but deeply regretted that decision
when the minimills later crept into higher-end products. After hearing the steel story, Intel’s
former CEO Andy Grove seized on the steel analogy, referring to cheap PCs as “digital rebar.”
The lesson was clear, Grove argued: “If we lose the low end today, we could lose the high end
tomorrow.” Intel soon began to promote its low-end Celeron processor more aggressively to
makers and buyers of inexpensive PCs.1
•
Starting in the 1970s, Circuit City thrived by selling consumer electronics in large superstores.
A wide selection of products, professional sales help, and a policy of not haggling with
customers distinguished the company’s stores. In 1993, Circuit City surprised investors by
announcing that it would open CarMax, a chain of used car outlets. A spokeswoman
explained why a consumer-electronics retailer would fare well in the market for used cars:
“All we are doing is applying our expertise in customer service, financing and selling bigticket durable goods to a new market.”2 Circuit City hoped to use its retailing ability, its
information systems, its expertise in warranty management, and its other corporate skills to
succeed in a new, large, and apparently analogous industry.
•
The supermarket, a retail format pioneered during the 1930s, has served as an analogical
source many times over. Charlie Merrill relied heavily on years of experience as a
supermarket executive as he developed the financial supermarket of Merrill Lynch. Likewise,
Charles Lazarus was inspired by the supermarket when he founded Toys “R” Us in the 1950s.
In fact, Lazarus called his store the Baby Furniture and Toy Supermarket until the short
signage on his second location forced him to shrink the name. Thomas Stemberg, the founder
________________________________________________________________________________________________________________
Professors Giovanni Gavetti and Jan W. Rivkin prepared this note as the basis for class discussion. Research Associate Elizabeth Johnson
provided valuable assistance.
Copyright © 2003 President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800-545-7685,
write Harvard Business School Publishing, Boston, MA 02163, or go to http://www.hbsp.harvard.edu. No part of this publication may be
reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means—electronic, mechanical,
photocopying, recording, or otherwise—without the permission of Harvard Business School.
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REV. FEBRUARY 28, 2006
The Use and Abuse of Analogies
of Staples and a former supermarket executive, reports in his autobiography that the search
for what became Staples began with an analogical question: “Could we be the Toys ‘R’ Us of
office supplies?”3
Analogies lie at the root of some of the most compelling and creative thinking in business. For
instance, Taiichi Ohno, the foremost pioneer of Toyota’s famed Production System, supposedly
invented the kanban system for replenishing inventory after he watched stocking procedures at U.S.
supermarkets, and he devised the andon cord to halt a faulty production line after seeing how
passengers signaled a bus driver to stop by pulling a cord and ringing a bell. More broadly,
analogies have contributed to some of the greatest scientific discoveries of all time, ranging from
Charles Darwin’s recognition that natural selection drives evolution to Benjamin Franklin’s
realization that lightning is a form of electricity.4 Partly because analogy is so powerful, students are
typically taught business strategy by the case method. Cases not only illustrate underlying
principles, but they also give students a wealth of analogies from which they can draw. Cases enable
students to learn from the hard-won experience of others who have faced similar situations, not just
from their own successes and failures.
Unfortunately, it is very easy to reason poorly by analogy, and aspiring strategists are rarely taught how
to use analogies and cases well. The first part of this note discusses how and why people often get
misled by analogies. The second part explains some simple techniques managers can use to avoid
being misled.
The Problem
A few terms from cognitive psychology—the field that studies thinking—can help us understand
the potential problems in reasoning by analogy. The setting from which an analogy is drawn is called
the “source problem.” For Intel, this was the steel industry and, in particular, the challenge that
minimills posed to traditional steel makers. From the source problem emerges a “candidate
solution.” The traditional steel makers, Grove clearly concluded, should have defended their turf as
soon as the minimills arrived; U.S. Steel should never have ceded rebar, for that only gave the
minimills a beachhead from which to launch later attacks. The candidate solution is then applied to
the “target problem.” Translated into the microprocessor industry, the rebar analogy emboldened
Intel’s management team to defend the low end of the market vigorously.
A fundamental pitfall in reasoning by analogy is to form an association between a source and a target on the
basis of superficial similarity, not deep causal traits. Take, for instance, Circuit City’s CarMax venture.
On the surface, the used car business bears some resemblance to the retailing of consumer electronics.
Both offer expensive, sophisticated items to individual consumers. Both require sales people who can
educate and win over wary customers. Both involve managing expensive inventory with lots of
models. The used-car industry is dominated by lots of small, mom-and-pop dealers with
questionable reputations, much as the consumer-electronics business was when Circuit City entered
that arena. One must ask, however, whether the similarities are more than skin deep. Certain
underlying features of the electronics-retailing industry and of Circuit City’s strategy account for the
company’s historical success. Are those features present in the used-car business as well? Does the
cause-and-effect chain from Circuit City’s actions to its success in consumer electronics hold up well
in used cars? It is easy to pinpoint differences between the two industries. For example, one industry
is supplied by a handful of large, reputable electronics makers, while the other is supplied by
individuals selling their old lemons. Do such differences matter?
2
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703-429
703-429
Managers can get into deep trouble if they draw their analogies from sources that look similar to
their targets but are not really similar at a profound level. The collapse of Enron provides an
example. Many factors contributed to Enron’s startling failure, but headlong diversification based on
loose analogies played an important role. After apparent success in trading natural gas and electric
power, Enron executives moved rapidly to create markets for other goods ranging from coal, steel,
and pulp and paper to weather derivatives and broadband telecom capacity. Analogical reasoning
seemed to drive the expansion. Executives looked for markets with certain characteristics:
fragmented demand, rapid change due to deregulation or technological progress, complex and
capital-intensive distribution systems, lengthy sales cycles, opaque pricing, and mismatches between
long-term supply contracts and short-term fluctuations in customer demand, for instance.5 Managers
were confident that Enron’s market-creation and trading skills would allow the company to make
hefty profits in such markets. On the broadband opportunity, for instance, Enron Chairman Kenneth
Lay said, “We intend to become the world’s biggest buyer and seller of bandwidth, just as we have
become the world’s biggest buyer and seller of electricity and natural gas.”6 And further:
“[Broadband]’s going to start off as a very inefficient market. It’s going to settle down to a business
model that looks very much like our business model on [gas and electricity] wholesale, which
obviously has been very profitable with rapid growth.”7 However, the analogical reasoning failed to
appreciate important, deeper differences between the market for natural gas and the market for
bandwidth. The broadband market was based on unproven technology and was dominated by
telecom companies that largely resented Enron’s encroachment. Moreover, the underlying good,
bandwidth, did not lend itself to the kinds of standard contracts that made efficient trading possible
in gas and electricity. Even according to Enron’s misleadingly rosy financial reports, the broadband
venture was disastrous. The venture, motivated in part by superficial similarity, allegedly lost $494
million on revenue of $335 million during the first three quarters of 2001.8
Unfortunately, the danger of focusing on superficial similarity is very real. Psychological
experiments show that people, even well-educated people, are readily seduced by surface similarity.
In one study, students of international conflict at Stanford were told of a hypothetical foreign-policy
crisis: a small democratic nation was being threatened by an aggressive, totalitarian neighbor.9 Each
student was asked to play the role of a State Department official and recommend a course of action.
The descriptions of the situation were manipulated slightly. Some of the students heard versions
with cues that were intended to make them think of the crises that preceded World War II: the
president at the time, they were told, was “from New York, like Franklin Roosevelt,” refugees were
fleeing in boxcars, and the briefing was held in “Winston Churchill Hall.” Other students heard
versions that might have reminded them of Vietnam. The president was “from Texas, the same state
as Lyndon Johnson,” refugees were escaping in small boats, and the briefing took place in “Dean
Rusk Hall.” Clearly, there is little reason that the home state of the president, the vehicles used by
refugees, or a briefing room name should influence one’s recommendation. Yet the surface features
caused the two groups to reach very different conclusions. Students in the first group were
significantly more likely to apply the lessons of World War II—that aggression must be met with
force—than were students in the second group, who veered toward a hands-off policy inspired by
Vietnam.
Not only were the subjects of the experiment lured by superficial likeness, but—perhaps more
disturbing—they were not even aware that they had been lured. After making a recommendation,
each student was asked, “How similar is the situation to World War II?” and “How similar is the
situation to Vietnam?” The two groups gave identical answers. Small, superficial, irrelevant features
led well-educated students to draw their analogies from different sources. This caused them to
recommend very different candidate solutions. Yet the students seemed unaware that they were
drawing from different sources.
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The Use and Abuse of Analogies
The Use and Abuse of Analogies
The implications for managers are unsettling. Thanks to his or her particular history and
education, each manager carries around an idiosyncratic toolkit of potential sources of analogies.
These are solutions in search of problems. Once a problem presents itself, the manager pulls a tool—
a prior experience or a lesson from someone else’s experience—from the kit. Unfortunately, in
choosing among tools, the manager may be guided by something other than a careful look at the
problem. A screwdriver, useful for connecting two pieces of wood in the past, may be chosen when a
hammer is truly needed. In Charlie Merrill’s case, the supermarket analogy might have been chosen
because it was familiar and tempting to Merrill, not because financial services really resembled the
market for food.
The tendency to rely on surface similarity is made even worse by two other, common flaws in
how human beings reach judgments:
•
Anchoring. Once an analogy or other idea anchors itself in a management team, it is
notoriously hard to displace. Psychologists have shown that this is true even when decisions
makers obviously have no reason to believe the initial idea. In a particularly disturbing
demonstration of this effect, experimental subjects were asked to estimate, say, the percentage
of African countries in the United Nations. A roulette wheel with numbers between 0% and
100% was first spun in front of the subjects. Subjects were asked whether the actual
percentage of African countries in the United Nations was greater than or less than the
number on the wheel. They were then asked to estimate the correct percentage. Surprisingly,
the roulette result had a strong impact on final estimates. For instance, subjects who saw 10%
on the wheel estimated the real percentage at 25% on average, while those who saw 65% gave
an estimate of 45% on average. The roulette wheel knew nothing about the composition of the
United Nations, obviously, yet it had a powerful influence on the judgment of people.10
The anchoring effect suggests that early analogies that take root even casually in a company,
perhaps because of some surface similarity between the source and the target, can have a
lasting influence. Decision makers may be reluctant to abandon their analogies, even if they
are not valid.
•
Confirmation bias. The anchoring problem is reinforced by another tendency among decision
makers: the bias to seek out information that confirms one’s beliefs and to ignore
contradictory data. To some degree, this tendency arises simply because managers like to be
right—and like to be seen as right. Beyond this desire, however, there is evidence from
psychology that humans are better equipped to confirm beliefs than to challenge them, even
when they have no vested interest in the beliefs. Consider two illustrations of this.11
In the first example, suppose you are confronted with a set of four cards. For sure, each card
has a letter on one side and a number on the other. The cards are laid out before you. On the
side you can see, the cards read “A,” “B,” “2,” and “3.” You are then told a proposition that
may or may not be true: “All cards with a vowel on one side have an even number on the
other side.” Which cards would you turn over to determine whether the proposition is true?
We will return to this question below, after you have had time to think about it.
In the second illustration, experimental subjects in Israel were asked during the 1970s, “Which
pair of countries is more similar, West Germany and East Germany, or Sri Lanka and Nepal?”
Most people answered, “West Germany and East Germany.” A second set of subjects was
asked, “Which pair of countries is more different, West Germany and East Germany, or Sri
Lanka and Nepal?” Again, most people answered, “West Germany and East Germany.” How
can we reconcile the two sets of results? The accepted interpretation starts with the fact that
the typical Israeli knows more about the Germanies than about Sri Lanka and Nepal. When
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asked to test a hypothesis of similarity, subjects seek out evidence of similarity and find more
between the Germanies than between Sri Lanka and Nepal. And when asked to test a
hypothesis of difference, they seek out differences and also find more distinctions between the
Germanies.
Now let’s return to the four cards. If you are like many people, you wanted to examine the
“A” and the “2.” In fact, it is unnecessary to turn over the “2,” since either a vowel or a
consonant on the other side would be consistent with the proposition. Many people, it seems,
turn over the “2” in hope of seeing a vowel—seemingly a comforting confirmation of the
proposition. At the same time, they ignore the critical step: turning over the “3,” which might
provide disconfirming evidence by revealing a vowel.
Together, the confirmation bias and anchoring suggest real problems for decision makers who
rely on analogies. Having adopted an analogy, perhaps a superficial one, decision makers will seek
out evidence that the analogy is legitimate, not evidence that it is invalid. Intel’s managers will tend
to look for reasons that microprocessors really are like steel, Circuit City may try to confirm that
consumer electronics and used cars are truly alike, and Staples’ Thomas Stemberg may eagerly seek
evidence that the office-supply market awaits its Toys R Us. Given the variety of information
available in most business situations, anyone who looks for confirming data will doubtlessly find
something that supports initial beliefs. Thanks to the anchoring effect, whatever disconfirming
information is discovered may very well be disregarded. As a result, a company may continue to act
on a superficial analogy for a long time.
A Fix12
To defend against flawed analogies, a management team first has to recognize what analogies it is
using. Sometimes the analogies are obvious. It is hard to forget that “digital rebar” is an analogy
from the steel industry, for instance. At other times, however, influential analogies remain implicit
and hidden. Unspoken analogies often come from the backgrounds of executive leaders. Merrill
Lynch’s distinctive approach to retail brokerage, for example, owed much to the decades that Charlie
Merrill had spent in the supermarket business. Only occasionally did Merrill confess that “although I
am supposed to be an investment banker, I think I am really and truly a grocery man at heart.”13
America Online came to see itself as analogous to a television network in part because of the central
role played in the company by Robert Pittman, a veteran of MTV, VH-1, and Nickelodeon.14
Analogies may lie hidden in a company’s history or even in its name. Amazon.com, for instance, was
purposely named after the world’s largest river.15 Could a firm with such an association resist the
urge to grow quickly?
The first job, then, is to ask, “What analogy—explicit or implicit—is guiding our decisions?” The
second, more challenging question is, “Does the analogy provide valid guidance?” To answer this
question, the strategist must dive beneath the surface of the analogy and search for chains of cause
and effect. It is useful to break this task into three steps that can hone a strategist’s judgment.
1.
Why did the candidate solution solve the source problem? Or, in the language of business
strategy, why did the strategy work in the industry structure from which the analogy was
drawn? In the example of Circuit City and CarMax, this step requires that we understand
precisely why Circuit City’s strategy succeeded in the electronics-retailing industry. In the
case of Thomas Stemberg and Staples, it requires that we explore how Toys R Us rose to
prominence in toy retailing. If learning from a failure, one must ask slightly different
questions: why did the candidate solution fail to solve the source problem, and what course of
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The Use and Abuse of Analogies
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action might have addressed the problem better? Why, for instance, did the response of
traditional steel makers to minimills fail, and what approach should the established players
have taken?
The classic tools of strategy analysis—the Five Forces, the value chain, the types of
competitive advantage, techniques for analyzing competitors—all of these are extremely
useful for attaining rigor in this step.16 The key is to lay out detailed analyses of (1) the source
environment, (2) the solution that worked well (or that failed), and (3) the link between the
two.
To see these kinds of analyses in action, consider Circuit City’s effort to apply its retailing
“solution” to the used-car business. A Five Forces analysis (Figure 1) summarizes the
structure of the source environment: the electronics-retailing industry as it stood in the 1970s,
when Circuit City began its rise to prominence.17 The industry was dominated by small, local
mom-and-pop retailers of variable quality and efficiency. Burgeoning demand kept the
retailers afloat even though consumers were more committed to the national brands on the
merchandise than to the retailers, even though the cost to switch among retailers was low, and
even though customers often feared that shady mom-and-pop retailers were preying on their
ignorance of high-tech products. The environment was marked by untapped efficiencies (e.g.,
few economies of scale were exploited) and unmet customer needs (e.g., each store carried a
limited selection of brands, and products were often out of stock).
Figure 1
Structure of the Electronics-retailing Industry in the 1970s
Threat of New Entry
• Little capital, expertise, or
reputation required to enter as a
mom-and-pop retailer
• But expansion of entrant limited by
ability to monitor far-flung outlets
• Rising fixed costs and economies of
scale due to IT improvements
Supplier Power
Rivalry among Existing Players
Customer Power
• Consumers are as familiar
with manufacturers’
brands as they are with
stores
• Elaborate distribution
network allocates scarce
goods
• Rivalry mitigated by geographic
separation, rapid industry growth
• Differentiation limited by focus on
nationally branded merchandise
• But repair service provides some
distinctions
• Difficult for rivals to credibly
commit to deal fairly with
customers
• Ample, growing demand
for goods
• Easy for customers to
switch stores
• But customers
uncomfortable with their
own knowledge and fearful
of being taken advantage of
Threat of Substitution
• For low-end merchandise, close
substitutes such as mass merchants,
department stores, discounters
• But few substitutes for high-end
merchandise
Source: Casewriters’ analysis.
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Circuit City devised a highly effective strategy that took advantage of the opportunities and
neutralized the threats in its environment (Figure 2). Key to the strategy was a series of fixed
investments: large stores in which the company could stock and display an exhaustive
selection of consumer electronics from a wide variety of manufacturers; information
technology that allowed the company to track sales patterns closely; automated distribution
centers, owned by the company itself and tied to the sales-tracking technology; and brandbuilding efforts via regional advertising. The investments allowed Circuit City to satisfy
customer needs that had long gone unmet. The large stores offered broad selection, and the
information and distribution technology improved product availability. Chain-wide efforts to
build a brand, to train salespeople, to standardize procedures vigorously, and to maintain
everyday low prices—all served to professionalize the industry and build trust between
Circuit City and consumers. While differentiating itself on the basis of selection, availability,
and trust, the company also drove down its costs. Circuit City’s low prices and its superior
selection, availability, and trust led to extraordinarily large sales volumes, which reduced unit
costs, which permitted lower prices, which drove even greater volume, and so on in a virtuous
cycle.
Figure 2
Circuit City’s Strategy in Electronics Retailing
Type of advantage: Low cost + differentiation on the basis of consumer trust, selection, and availability
Scope:
Product: exhaustive selection in a narrow set of categories; mid-market to high-end merchandise
Geography: from local (1949) to biregional (1975) to national
Firm
infra.
•Rapid, centralized expansion
designed to saturate regions
•Reliance on internal funds
•Former computer consultant as CEO
HRM
•Salespeople paid largely on basis
of commissions
•Extensive training of in-store sales force
Technology
•Information gathered at point of
sale, integrated with distribution
and purchasing
•Deep investment in IT and communications
•Real-time market research at headquarters
Procure•Reliance on manufacturer-branded merchandise
ment
•Integration into
distribution
•“Push” system
with automatic
distribution
•Extensively
automated
distribution
centers
•In-store
warehousing
•“B ursting at the
seams” appearance
•Extensive
standardization of
in-store operating
procedures
•Everyday low
prices rather than
sales
•Extensive use of
media, regional
advertising
•Base of informed
salespeople
•Liberal return
policy
•Focus on
warranty sales
and repairs as
profit
generators
Logistics
In-store Operations
Marketing & Sales
After-sales Service
Source: Casewriters’ analysis.
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The Use and Abuse of Analogies
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Note how well this strategy matched the demands of the external environment. By meeting
consumer needs that mom-and-pop rivals did not and by building a brand that shoppers
valued, Circuit City reduced the power of customers. The brand also provided an alternative
to the brands of manufacturers such as Panasonic, Pioneer, and Zenith. As Circuit City’s
brand rose to prominence, as the company’s sales volume grew, and as customers came to rely
on the recommendations of Circuit City’s salespeople, the company became far more powerful
in negotiations with suppliers. Investments in branding, distribution, information technology,
and large stores raised new barriers to entry. And scale-driven cost advantages gave the
company a powerful way to overcome smaller rivals.
The last three paragraphs give what we call the fundamental causal logic of the source. They
lay out a chain of cause and effect that explains why the candidate solution solved the source
problem—why Circuit City’s original strategy worked in its original environment. The
strategist’s goal is to figure out whether this causal logic holds up in the target environment.
From this step, it is useful to distill two lists of industry features: those that play a crucial role
in the causal logic and those that do not. In the Circuit City example, the first list appears to
include the following features of the pre-Circuit City electronics-retailing industry:
•
unsatisfied customer needs, especially for product selection, product availability, and
trustworthy retailers (and on this last point, a customer base that feels vulnerable and
uninformed);
•
untapped economies of scale and latent, but largely unrealized, barriers to entry;
•
a fragmented base of current rivals, many weak and many undistinguished from one
another;
•
unexploited opportunities to apply information / distribution technology for better
management of diverse inventory;
•
a set of branded, powerful, but reliable suppliers;
•
modest switching costs among buyers; and
•
an absence of close substitutes at the high end of the market.
On the other hand, there are notable features of the industry that do not appear to play a major
role in the causal logic. For instance, demand for consumer electronics was growing rapidly
when Circuit City became a success, but the industry growth rate does not loom large in the
causal story. The sheer size of the industry plays a role (without a critical mass of demand,
economies of scale cannot be tapped), but the growth rate does not seem critical.
Of course, it is sometimes difficult to tell whether or not a particular industry feature is crucial
to the causal logic. In such circumstances, it is often useful to look at other, similar industries
and strategies. Take, for instance, the role of the industry growth rate in Circuit City’s success.
Strategies quite similar to Circuit City’s have succeeded in industries with much lower growth
rates than that of consumer electronics. High-volume discount retail specialists, often called
“category killers,” have gained prominence in retail categories ranging from food
(supermarkets) and toys (Toys R Us) to office supplies (Staples) and pet food (Petsmart). Each
of these categories has a large volume of sales, but not all were growing rapidly as category
killers emerged. This confirms our belief that the industry growth rate is not a critical part of
the Circuit City story.
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Does the target problem resemble the source problem in a more-than-superficial way? That
is, does the industry structure look similar in its essentials? In this step, it is crucial to identify
both similarities and differences. Similarities will usually spring to mind quickly. After all,
similarities are what brought the analogy to mind in the first place. There are two other parts
of this step, however, that do not come as naturally to many management teams. First, the
team must actively search for differences as well as similarities. This works against the
confirmation bias, the tendency to seek only support for one’s impressions. Second, the team
should ask whether the similarities are largely superficial. The list of industry features that are not
crucial in the causal logic is very useful in this step. If many of the similarities are on this list
rather than the list of features that were critical, the management team should sound an alarm:
the analogy may be based on superficial similarity.
Circuit City’s entry into the used-car market provides an illustration of this step. In many
ways, the used-automobile industry in the 1990s resembled the consumer-electronics retailing
industry in the 1970s:
•
Many customers were unsatisfied with current retailers. Each retailer had a very limited
selection, and retailers were notoriously shady and widely mistrusted. Many customers
feared that they would be taken advantage of in any deal.
•
Economies of scale and barriers to entry were limited.
•
The industry was fragmented, with many small, undistinguished, financially weak momand-pop players.
•
Information and distribution technology remained fairly primitive despite highly diverse
inventory.
•
Buyers incurred few costs if they switched from one retailer to another.
Note that all of these similarities match crucial elements of the causal logic we described in
electronics retailing. This bodes well for the analogy. On the other hand, there were
important differences between the source and target markets:
•
In consumer electronics, Circuit City could rely on a large base of dependable, reputable
suppliers. While these suppliers might be formidable adversaries at the negotiating table,
they could be counted on to keep their word, to deliver the goods they promised, and to
maintain quality standards. In contrast, most used-car dealers bought their autos from
individual sellers or from wholesalers, some reliable and some not. Moreover, it might be
hard for CarMax to ensure the quality of the vehicles it bought and resold since the cars
might come from owners who were trying to unload lemons with hidden defects.
•
The inventory of used cars was even more diverse than the inventory of consumer
electronics. It would be very difficult for CarMax or any other used-car dealer to keep a
predictable range of products in stock. This might make it hard for CarMax to use its
inventory-tracking technology as Circuit City had—to detect sales trends quickly and
adjust its orders precisely in order to meet demand. Moreover, much of the distribution
technology and expertise Circuit had developed in electronics retailing might not be
useful in the used-car industry. For example, used-car companies do not use automated
distribution centers.
•
It was not clear whether untapped economies of scale and unrealized barriers to entry
existed in the auto-retailing business as they had in electronics retailing.
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The Use and Abuse of Analogies
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•
Unlike in the electronics-retailing industry, the used-auto retailing market had an
important and close substitute at the high end of the market: new-car dealers. The state of
the new-car market had a major influence on the used-car industry. Moreover, new-car
dealers often tapped economies of scope by selling both new and used autos.
All of these differences affect elements of the causal logic. Other differences do not. For
instance, the growth rate in the used-auto market in the 1990s was much lower than that in the
electronics-retailing market in the 1970s. This difference does not shake our confidence in the
analogy because the industry growth rate was not on our list of important industry features.
Occasionally, it is not clear whether the source and target industries are similar or different on
a particular, crucial dimension. Such points of ambiguity highlight important avenues for the
management team to explore before it follows the analogy.
3.
Will the candidate solution work in the target environment? That is, will the original
strategy, properly translated, work in the target industry structure? This step requires, first,
that the management team say clearly what the strategy would look like in the new setting.
Precisely what would it take to be the Circuit City of the used-car industry or the Toys R Us of
office supplies? In translating the strategy, the management team should try to make
adjustments that deal with any important differences identified earlier. The step also requires
a clearheaded assessment of whether the translated strategy is likely to fare well in the new
context. It is particularly important to make sure that the differences in industry features do
not trip up the strategy.
In Circuit City’s case, the translated strategy bore a close resemblance to the company’s
electronics-retailing operation.18 On lots up to 14 acres large, each CarMax superstore offered
an unusually broad inventory of 200 to 550 vehicles. CarMax went to special lengths to avoid
the mistrust that was common between customers and traditional used-car dealers. The
company sold cars at fixed, posted prices, with no haggling permitted. It hired salespeople
with retailing experience, but not auto-retailing experience, and gave them extensive training.
While traditional auto dealers paid salespeople a fraction of the revenue they generated,
CarMax compensated salespeople with a flat fee per vehicle sold; this pay scheme eliminated
the temptation to push customers to buy more expensive cars than they wanted. The
company also put in place a sophisticated inventory-tracking system that mirrored that of the
electronics-retailing system, and it offered money-back guarantees and warranties that
resembled those in its original stores.
At the same time, CarMax adjusted the Circuit City formula to reflect the differences that we
identified between the source and target industry. This required, for instance, that the
company find reliable sources of used cars. Toward this end, CarMax placed well-trained
buyers in each of its stores and offered to buy used cars directly from consumers, even those
who did not intend to buy a vehicle from CarMax. (In contrast, some traditional dealers
would buy only trade-ins, that is, cars from customers who were purchasing a car
themselves.) The company started to sell new cars at some sites, in part to generate used cars
from trade-ins. By 2002, individual consumers were CarMax’s single largest source of used
cars.
Regardless of source, all CarMax used cars were thoroughly inspected and
reconditioned before they were resold.
The diverse inventory of used cars presented a new challenge to Circuit City and CarMax.
While each electronics superstore could display a thorough range of consumer electronics, a
single used-car lot could not show the full array of vehicles in CarMax’s inventory. After all,
the company had roughly 14,000 cars in inventory by 2002, and each car was virtually unique
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in its model, make, options, features, and mileage. To meet this challenge, CarMax developed
a computer system that allowed consumers to peruse the company’s full inventory. The
system told customers what was available nationwide and what it would cost to transfer a
desired car from its current location to the customer’s locale. A related inventory-tracking
system helped CarMax’s buyers at each store make appropriate bids.
CarMax was not an immediate success. It took Circuit City most of a decade to tailor its
formula to the used-car market. The company built some stores that were too large, and it
suffered from price wars among new cars, expansion by other used-car superstores like Auto
Nation, and an overly ambitious rollout plan. Nonetheless, the effort to reproduce Circuit
City’s advantage in the used-car industry was considered largely a success. In FY2002,
CarMax earned net income of $91 million on revenue of $3 billion. The success reflects the
close resemblance between the electronics-retailing industry and the used-car industry,
especially in features pertinent to the causal logic of the original success. It also reflects the
company’s careful attention to the critical differences between the industries—or at least the
company’s ability to adapt to those differences.
Summary
In business, analogies are pervasive because they are powerful. They enable managers to transfer
entire, internally consistent bundles of choices from one context to another. They can provide
solutions in settings that are relatively unformed and ambiguous—for instance, in industries so
nascent that one cannot yet figure out cause-and-effect relationships well, but clear enough that one
can say, “Ah, this looks like….” Moreover, analogies allow executives to see their businesses in new
and creative ways, and they convey complex ideas in simple language. Chosen well, they also have
an emotional impact that can rally a management team. By referring to cheap PCs as “digital rebar,”
Andy Grove doubtlessly sharpened his colleague’s fears that Intel could go the way of U.S. Steel, a
dominant firm laid low by a low-end threat.
Unfortunately, a management team can easily be seduced by an analogy with similarities on the
surface but differences at a deeper level. Psychologists have shown that decision makers are readily
led by surface similarity, may be unaware when misled, are reluctant to shake a notion once it is
anchored in their minds, and are prone to seek information that only confirms their preconceptions.
With discipline, a set of managers can overcome these tendencies and vet the analogies they find
attractive. The ultimate defense against a superficial, misleading analogy is a strong understanding
of cause and effect. Once a management team understands deeply why a strategy succeeded in a
source setting, the team is prepared to look actively for important differences between the source and
target industries. This enables the team both to adapt the original success formula to fit the new
setting and, if the differences prove insurmountable, to avoid a misleading analogy altogether.
Discipline in using analogy is especially important for business school students who are trained
by the case method, we feel. Cases are intended to illustrate general principles, but in our experience,
students often remember the cases themselves as clearly as the principles. We have been struck by
how often our best former students frame their entrepreneurial ideas in terms of analogies to cases.
Cases surely provide a valuable base of analogies from which students can draw. The base is most
powerful, however, only if students also learn how to use analogies with care.
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The Use and Abuse of Analogies
1
A. Reinhardt, “The New Intel,” BusinessWeek, March 13, 2000.
T. Shelby, “Circuit City Shifting Gears: Electronics Store Selling Used Cars in Test of Market,” The Baltimore Sun,
December 7, 1993.
3
E.J. Perkins, Wall Street to Main Street (Cambridge, U.K.: Cambridge University Press, 1999). A. Hast, ed.,
International Directory of Company Histories (London: St. James Press, 1992). T.G. Stemberg, Staples for Success:
From Business Plan to Billion-dollar Business in Just a Decade (Santa Monica: Knowledge Exchange, 1996).
4
See K.J. Holyoak and P. Thagard, Mental Leaps: Analogy in Creative Thought (Cambridge, MA: MIT Press, 1995),
especially Chapter 8.
5
M.S. Salter, L.C. Levesque, and M. Ciampa, “Innovation Corrupted: The Rise and Fall of Enron,” HBS working
paper 02-102, 2002, especially p. 13.
6
“Enron’s Lay Rolling Dice on Broadband Trading,” Gas Daily, February 17, 2000.
7
“Broadband to be as Big as Enron in Five Years,” Gas Daily, April 5, 2000.
8
M.S. Salter, L.C. Levesque, and M. Ciampa, “Innovation Corrupted: The Rise and Fall of Enron,” HBS working
paper 02-102, especially pp. 13-14.
9
T. Gilovich, “Seeing the Past in the Present: The Effect of Associations to Familiar Events on Judgments and
Decisions,” Journal of Personality and Social Psychology, 1981, pp. 797-808.
10
A. Tversky and D. Kahneman, “Judgment under Uncertainty: Heuristics and Biases,” Science, 1974, pp. 11241131.
11
T. Gilovich, How We Know What Isn’t So (New York: Free Press, 1991). P.C. Wason, “Reasoning,” in B.M. Foss,
ed., New Horizons in Psychology (Harmondsworth: Penguin, 1966). A. Tversky and I. Gati, “Studies of
Similarity,” in E. Rosch and B. Lloyd, eds., Cognition and Categorization (Hillsdale, NJ: Erlbaum, 1978).
12
This section was influenced significantly by the work of R.E. Neustadt and E.R. May, especially Thinking in
Time: The Uses of History for Decision-makers (New York: Free Press, 1986).
13
E.J. Perkins, Wall Street to Main Street (Cambridge, U.K.: Cambridge University Press, 1999), pp. 151-152.
14
A.K. Leamon and A. Hutton, “America Online: 1996-99,” HBS Case No. 100-090.
15
D.L. Louie and J.F. Rayport, “Amazon.com,” HBS Case No. 897-128.
16
For a description of the Five Forces framework, the generic types of competitive advantage, and a framework
for analyzing competitors, see M.E. Porter, Competitive Strategy: Techniques for Analyzing Industries and
Competitors (New York: Free Press, 1980), especially Chapters 1-3. The value chain is described in M.E. Porter,
Competitive Advantage: Creating and Sustaining Superior Performance (New York: Free Press, 1985), especially
Chapter 2.
17
For information on Circuit City’s historical environment and strategy, see J.W. Rivkin, “The Rise of Retail
Category Killers,” HBS working paper, 1995.
18
The following description of CarMax’s current operations is drawn from Circuit City Store’s FY2002 10-K filing
and from S.J. Hale, J.A. Loftus, and C. Armstrong, “CarMax Group,” Banc of America Securities, October 11,
2001.
2
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For use only in the course RSM 392 - Strategic Management at University of Toronto - Rotman School of Management from 9/3/2024 to 12/31/2024.
Use outside these parameters is a copyright violation.
Notes