Irish ports

John Mangan and James Cunningham

The cuxe describes the chimge.\' that have occurred in Irish pm"! ad1nirzislra-
tron and outlines the imluslijy structure in the 1990s. Major change in I996
resulted from lieu legislalions which f0rt'erl[)m'ts to consider their strategic
future as well HS to address operational issues. The case study lends itself Io
the use of induslrjy anatrsis frameutm-ks and the considemtion of strategic
options and change nianageinenr in a ])lII)1it sector context.
THE INTERNATIONAL TREND TOWARDS PORT REFORM
The tendency to reform the operational and institutional structures of ports is
a matter of strategic interest within the maritime sector intemaiionally. Ports
are critical nodes which facilitate trade flows and. to a lesser extent, tourism
flows. In tum, their operational CfCiCllC) can have a considerable impact upon
the wider economy. Alfred Baird of Napier University in Scotland described the
four different models of port administration which are in place variously in dif-
ferent countries and these are shown in Exhibit l.
As can be seen from Exhibit 1. ports can have any combination of three dif~
ferent functions. Land ownership concems the physical assets such as vessel
berths. terminals. parking areas etc. which comprise the port. Regulation con-
cems vessel navigation. ensuring compliance with various regulations such
as waste disposal and crew safety. Cargo handling concerns the loading and
unloading of vessels, storage of freight. provision of value added services. etc.
Four models of port administration
PORT FUNCTIONS
MODELS LAND OWNERSHIP REGULATION CARGO HANDLING
1. Pure public sector public public public
2. PUBLlClprivate public public private
3. PRlVATEIpublic private public private
4. Pure private sector private private private
This case was prepared by John Mangan, Irish Management Institute and James
Cunning-
ham, National University of Ireland, Galway. It is intended as a basis for class
discussion
and not as an illustration of either good or bad management practice. O John
Mangan
and James Cunningham, 2001. Not to be reproduced or quoted without
permission.

652,- mtsn PORTS

Much debate surrounded the question of what combinations of these tne-
tions should be controlled by the state and What combinations should be left
to the free market and be controlled by the private sector.
STRUCTURE OF THE IRISH MARKET
The Republic of Ireland. a member of the European Union (EU) since 1975, is
an island country geographically located in the north-west of Europe with a
population of some 5.6 million people, The island of Ireland comprises both
the Republic of Ireland. established initially as a Free State under a treaty with
the United Kingdom in I922, and Northcm Ireland which remains part of the
United Kingdom. A feature of the whole island of Ireland is that, since the
opening of the Channel Tunnel linking England with Continental Europe,
Ireland is now the only EU member country without a landlink to the rest of
the EU and is thus totally dependent on both the air and maritime transport
modes for external access and egress. In addition, Ireland has both a large eco-
nomic dependence on external trade and is in a peripheral location tiis-[1-tiis
the economic centre of gravity of the EU. Consequently, ports are of special
importance to the Irish economy.
The Celtic tiger
Economic conditions in Ireland in recent years have been so positive that it has
been dubbed the Celtic tiger (the once-vibrant economies of South East Asia
were referred to as tiger economies; the term Celtic refers to the earliest
immigrants to Ireland, the Celts, who arrived from central Europe in the period
up to 150 uc and who fashioned the course of Irish life and culture for the next
1,000 years). This economic success has resulted from growth in both the
manufacturing and service sectors and is a consequence of, inter alin, a com-
bination of careful economic planning, investment in infrastnicture. high stan-
dards of education and. not least, EU grant aid. A member of the EU since 1975,
Ireland was one of the rst qualiers for European Monetary Union (EMU) and
became a member of the single currency (Irish pound IRS. = 61.27). Over the
last decade many multinational companies have located high-tech manufactur-
ing facilities in Ireland. Ireland became an essential node in the global value
chains of many of the world's leading manufacturers. In recent years there
has been signicant growth, in particular in exports of high-value products
such as electronics and pharmaceuticals which are exported to diverse over-
seas locations. In I997 exports were valued at ca. IR.55 billion and imports
at ca. IR26 billion, yielding a balance of trade surplus of ca. IR.9 billion.
Unemployment has fallen sharply in recent years and now stands at a record
low of ca. 6 per cent. Inflation. previously relatively high, has fallen to a low of
2 per cent, although there was some evidence pointing to overheating in the
economy leading to potential rises. Lastly, in 1998, gross national product
(GNP) stood at IR.46.8 billion (having grown by S0 per cent in real terms since
1995) and gross domestic product (GDP) per eapita was US$2l.5O0 (GDP per

capita was substantially lower, however, because of prot repatriation by

foreign rms and interest payments on the national debt).
Ireland's maritime past and present
Ireland has been influenced by maritime trade since the arrival of the Celts
from centntl Europe in the period up to I50 utz. The next major influx of set-
tlers were the Viking warriors who arrived by sea (mostly from Scandinavia) in
the ninth and tenth centuries and built fortied settlements, including one at
the mouth of the River Liffey, thus giving birth to what is now Dublin, Irelands
capital city, and establishing it as a centre for maritime trade. The next wave of
settlers were the Normans in 1169, thus effectively beginning some 80() years
of association between England and Ireland. This then was to dene the basis
for the development of Ireland's maritime trade which revolved largely around
shipping between England/Wales and Ireland. Unlike the great maritime
nations such as England. Fmnce, Spain and Portugal, Ireland was not to have a
large maritime fleet and thus did not participate in overseas conquests and
empire building. Indeed the domination of maritime trade by flows between
Ireland and England was to continue up to and even beyond Irelands inde-
pendence from the British Empire in the twentieth century. The twentieth cen-
tury saw Ireland increasingly engage in intemational trade, particularly since
joining the EEC in 1975, and with it a growth in maritime transportation
occurred.
Over 57 million tonnes of goods were handled at Irish ports in I997
(Exhibit 2), This represents an increase of 45 per cent on the 1990 volume.
Over 95 per cent of the volume handled in 1997 was at the nine corporatised
ports, with the remaining volume spread over some I6 smaller ports. Over
two-thirds of the goods handled at Irish ports in I997 Was bulk freight (i.e.
coal, oil, livestock etci) while under one-third was unitised. The unitised
freight typically comprises higher-value commodities such as electronics and
is typically held in 20- or 40-foot-long boxes which are either lifted on and off
vessels (LoLo) or driven on to vessels (RoRo). Over two-thirds of the volume
of sea freight to and from Ireland transits ports along the eastern and southem
seaboards of Ireland, reflecting their proximity to England and Wales (which
was of importance when Ireland was a member of the British Empire), the cur-
rent direction of trade. and their proximity to the areas of greatest economic
activity in Ireland.
A signicant, EU aided, progmmme of investment has taken place into port
infrastructure i.n the Republic of Ireland. Between I994 and 1999 a total EU
conanced investment of IRl65 (6207) million was made at Irish ports -
one of the aims of this investment was a reduction in combined port and ship-
ping costs to users over the period I994 to 1999 by a cumulative minimum
of 15 per cent, in real terms Concomitant with this investment programme
was a substantial programme of reform conceming the management of Irish
ports. EU conancing of port infrastructure investment has largely arisen as a
result of Ireland's classication as an Objective I region by the European
Commission (i.e. a region whose GDP per capita is 75 per cent or less than the
IRISH PORTS 553

65 IRISH PORTS
Trade handled by the principal ports in Ireland
1990 1997
Arklow 275 501
Cork* 5,857 8,182
Drogheda* 1,004 826
Dublin 6,383 12,362
Dundalk 320 218
Dun Laoghaire* 261 448
Foynes* 1,084 1,200
Galway 429 535
Greenore 491 344
Shannon Estuary* 5,933 8,359
New Ross* 1,021 1,107
Rossla re* 806 1,116
Waterford 1,327 1,131
Wicklow 205 167
Others 676 731
Total 25,072 37.227
" Corporatised ports
EU average). Given the improvements in indigenous economic: conditions, it
was likely that such EU aid would be largely discontinued after 1999.
Many of the ferry companies in the Irish market who carry RoR0 freight
also carry passengers. Between four and ve million passengers travel on RoRo
ferries between Britain and Ireland each year, while in contrast over eight
million travel by air; a relatively small number (approximately three hundred
thousand) travel on ferries between Ireland and France. Deregulation in the air
transport market has led to considerable growth in this sector and the ferry
companies now face stiff competition from the air mode. One major cloud on
the horizon of the passenger travel market was the intended abolition of duty-
frec sales in late June 1999.
GOVERNMENT POLICY
Together with the investment programme in port infrastructure there has been
a substantial programme of reform concerning the management of Irish ports,
Irish ports had been govemed by relatively old legislation, namely the Harbours
Acts 1946-1976. A government-appointed Review Group was established in
1991 to review the policy and legislation goveming commercial ports in Irew
land. The Review Group was chaired by Patrick Murphy, a highly successful Irish
industrialist. and comprised eight other members who represented the various
stakeholders interests. The Review Group's report noted that lrelands ports
have been severely constrained in their ability to respond commercially be-
cause of the restricted legislation under which they operate. Prior ministerial
approval was, for example, required for matters such as setting rates and

charges. borrowing money. carrying out harbour improvements. and acquiring

and disposing of property. The Review Group considered four alternative
structures for Irish ports in order to bring about greater commercialisation:
0 privatisation:
0 anialgamation/regionalisation of ports;
0 a national seaports company. on the tnodel of/ier Rianm (the state-owned
company which operated Ireland's three main airports);
0 separate state companies to operate individual ports on a commercial foot-
ing (i.e. the state remains the sole shareholder).
The Review Group recommended that commercial state companies should be
set up to manage twelve key (in effect the largest) Irish ports. Consequently
the Harbours Act I996 was passed with the purpose of freeing Ireland's key
ports from direct Departmental control and giving them the commercial free-
dom they need to be able to operate as modern. customer-oriented service
industries. In A/larch 1997 the rst eight ports (see Exhibit 5) out of a planned
twelve ports were corporatised and vested as commercial harbour companies
(previously they were known as harbour authorities). The pon of Waterford
was subsequently coiporatised in January 1999. There were a number of
reasons for the delay in corporatising Waterford. which included the port's
largest customer going out of business. storm damage to two cranes (key assets
in any ports infrastructure and which are not possible to replace over a short
period). and an outstanding loan from the European lnvestment Bank (EIB).
It was intended to corporatise a further three ports (Arklow. Dundalk and
Wicklow) but this did not subsequently happen.
PROGRESS TO DATE
The govcmmcnt department responsible for the ports sector. the Department
of the Marine and l\'atural Resources, was committed to enhancing the effec-
tiveness of lrish maritime transport infrastructure and services, especially in
the context of the critical role which maritime transport played in Irelands
geographically peripheral island economy. The Department in their strategy
statement for the period 1998-2000 stressed that sea transport and port ser-
vices must be efficient. adequate. responsive and competitive. Dr Michael
Woods TD. the Minister for Marine and Natural Resources. st Wed at a national
ports conference in late 1998 that freeing tip ottr key ports from direct state
control gave them the commercial freedom to operate as modern. customer-
oriented service industries, While tightening up accountability for operational
and nancial procedures. Dr Woods. a noted scientist and long-serving politi-
cian. was regarded by his peers as a hard-working minister (he also served as
Minister for the Marine in a previous government) who achieved results. aided
and abetted by a new breed of astute and commercially focused civil servants.
By mid-1999 the corporatised ports were enjoying signicant successes.
buoyed up by very healthy domestic economic conditions. Whether these
ports would have been as successful had economic conditions not been so
IRISH PORTS G55
Major ports in Ireland and the types of traffic handled
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and Bulk (O vanuus
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REPUBLIC Dr Ma esunanom
or IRELAND "3 R<>R~w UK
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UNITED
KINGDOM
Channel Tunnel
FRANCE
2?
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It sing.

good was a moot point. Many of the ports had made strides to becoming much
more commercially focused and began to explore other value-adding and non-
core commercial activities. Areas of business being developed included the
development of marinas, industrial parks. transhipment facilities. car park
developments. and the cruise liner business. A number of ports also introduced
lcadingcdge navigation technologies for vessels (VTIMS) using their ports and
also introduced quality standards. In addition, the corporatised ports submitted
ve-year development plans to the Department oi the Marine and Natural
Resources. invariably, it would take some time for matters to settle and for the
ports to further develop and prosper under their new status.
Under the l)~i6l*)',(> Acts individual ports were overseen by boards of
Z5 harbour commissioners. The hoards of the corporatised ports. however.
which had previously comprised 25 members under the 1946-1976 Acts. now
comprised I2 members (typically a chairman. the chief executive. two worker
directors and ten directors). l)irt-ctors were appointed on the basis oftheir abil-
ity to have a strategic and commercial input into the running of the corpora-
tiscd ports. ln practice, many were appointed for reasons such as this. but also
on the basis of their political connections. Furthermore. conflict sometimes
arose between the management of corpomtised ports pursuing a wholly com
mercial mandate and directors pursuing a more S()Cll)fJOllllCill mandate.
Typical
examples of this would have been the question of whether to develop areas
of a port for commercial or community uses or whether to provide berths for
military vessels (which in practice did not have to pay harbour dues). ()ne
benet which accrued to the Department of the .\/larinc and Natural Resources
was that the eorpomtised ports could now get on with their job and did not
have to pester the minister and his department with mundane matters. as was
the case under the 1946-l9"'(> Acts.
The eorpomtised ports (lid. however, inherit certain tlifculties with their
change of status. Many port employees had been guaranteed that there would
be no threat to their jobs. Pensions provisions were complex and in some
instances lacking. The new corporatised ports had to deal with certain restric-
tive Work practices and other issues such the results of :1 lack of investment
in staff training over previous years. in addition. the corporatised ports were
expected to he cognisant of various cxternalities which might affect the many
varied stakeholder groups. Issues which arose here included noise pollution
from cargo handling disturbing local communities. marine engineering works
affecting aquaculture developments and shing interests. and the introduction
of new services disturbing marine leisure users. Confusion also arose over
ownership of the foreshore (i.e. that part of the shore between the high- and
low-tide marks) which was governed by very dated legislation. namely the I955
Foreshore Act. Finally. difficulties with surface transport access (primarily con-
gestion) also affected some ports.
ISSUES FOR THE FUTURE
lt had been intended to corporatise a further three ports (Arklow. Dundalk and
Wicklow) but this did not happen. In addition. the question arose in the late
IRISH PORTS 551

nusn PORTS
1990s as to what should he done with the thirteen other smaller ports, This
combined group of sixteen ports still operated under the rather dated 1946-
19"/6 Harbours Acts. Exhibit 2 illustrated the relatively small volumes handled
by these ports In effect. policy makers had six options, which were not mutu-
ally exclusive, to choose from with regard to the future of these ports, namely:
I Allow the status qtto to remain and make small legislative changes as
necessary
to the 1946- 1976 Acts (this would of course involve these ports still being quite
dependent upon the Department of the Marine and Natural Resources).
2 Corporatise the ports under the I996 Harbours Act as was done with the
nine larger ports (one pragmatic issue which would have to be addressed
was board remuneration: the chairman of a corpotatised port received an
annual fee of IRA,0O0 and each director received IR2,5()0; some of the
smaller ports had annual revenues below IRl()(),000 and could not afford
such a structure. lt should he noted that fees payable to directors under the
1946-1976 Acts were insignicant in comparison).
5 Transfer ownership of ports to local authorities.
4 Sell ports to the largest customer (in some instances the hulk of the trafc
through the smaller ports was derived from one large customer).
5 Develop the ports jointly with the private sector on a pub|icprivate part
nership (PPP) basis - there were precedents elsewhere in Ireland for such
an undertaking (e.g. toll roads etc.).
6 Stipulate that mergers or alliances are made between different combinations
of ports.
Key aspects of whatever strategy would be chosen included ensuring that
public expenditure would he kept to a minimum. and also ensuring that traffic
would not merely be displaced from one small port to another. but instead that
real growth would occur and would be of benet to the port hinterland and
the wider economy. Furthemmre. policy makers also decided that they would
review progress under the Harbours Act I996 with regard to the nine corpor~
atised ports by completing statutory audits on these ports in March 2000.
References
Baird, A (I995) Privatisation of trust ports in the UK: review and analysis of the
rst sales.
TrullrpnrlP0llq1'. Z (2) lf -I45.
Mangan. J. and Hannigan. K. (eds). (Z000) Llzgislics and 'I'rans[Jor1 In u Fast
Gt~ou'ing
Economy. Blackhall Publishing. Dublin.
The following websites are recommended for further information concerning the
Irish
economy:
Irish Govemment (with links to (iovemment departments) t1'!l!l.itlg0t'.le
Irish Economic and Social Research Institute mt-ucest1.ie
Irish Central Statistics Office u'wtt'.r.rn.ie
Irish Industrial Development Authority wwu.lrlalrelandmom
Economic Review and Outlook 2000, Department of Finance, Dublin. available at
u-wu-.lrl-
gov. le/nance/ecm|2000.pdf
The Irish Times (daily newspaper with various links) u'wu'.IreIand.com

KPN telecommunications strategies

for the twenty-rst century
D.Jan Eppink
Like mos! previously stale-owned telecomnmntcations companies, KPN was
for many years a monopoly supplier in its small home market in the
Netherlands. After deregulation the company embarked on a large number
of international activities, either in the form of alliances or by taking stakes
in other companies.
The case describes these developments up to the middle of 2000. Their
strategy was to become one of the three leading companies in Europe in
three specied elds of telecommunication (mobile telephony; 1P/data; and
Internet, call centres and media services). Quite an ambitious goal for a
telecommunications operator from a small country.
In December 2000, joop Drechsel had been on the executive hoard of KPN for
almost four years. Marten Pieters had joined the board in March 2000. The two
of them had direct responsibility for achieving the aims they had set for the
company of becoming one of the leading three players in selected elds in
the European telecommunications arena. In the eight months that had passed
since the stock market was at its highest point, much had changed. The share
price had taken a deep drop (along with other European telecoms stocks) and
voice revenue per mobile customer was not growing ZIS it used to in the past,
New revenue from third~generation mobile broadband technology (UMTS) was
uncertain and large investments were needed to gain licences. For a relatively
small competitor the strategic aims were very ambitious.
BACKGROUND
KPN was bom out of the public sector Post and Telecommunications corpora-
tion in the Netherlands. On 1 January I989 the legal fomi of the PTl' was
changed from a department of the Ministry of Transportation and Public Works
into a plc - initially I00 per cent govemmcnt owned. From the early 19805.
various committees had studied the needs for and possibilities of liberalis
ing mail and telecommunications. In the middle of the 19805 the Steenbergen
This case was prepared by D. Jan Eppink, Professor of Strategy at Vrije
Universiteit
Amsterdam and adviser Boer & Croon Management Consultants, Amsterdam.' It
is intended
as a basis for class discussion and not as an illustration of either good or bad
management
practice. D. Jan Eppink, 2001. Not to be reproduced or quoted without
permission.

660 tom
committee proposed that the date for the privatisation be set as the rst day of
l989. The mission of the new company, called KPN (Koninklijke Pl l Nether
lands). was stated as:
Royal lTT Netherlands is a company that within and outside of the concession it
has
been granted will deliver to the business and private market a complete set of
high
quality products and services. concentrated around the national and
international
transportation of infomtation. goods. and valuables.
The concession described the products and services that would be the
exclusive domain of KPN and the terms of trade. The annual report for 1989
mentioned that the progressive deregulation of markets would erode the
concession. For PTT Telecom (one of the two subsidiaries, the other being
PT! Post) this would mean that. for instance. it would lose its monopoly on
the sales of hardware. ranging from telephones for private homes, costing a
few hundred guilders, to telecom infrastructures for hig companies, costing
several millions. Further. in the future, new entrants in the home market would
compete for existing business as well as for new growth opportunities. But
deregulation would provide new opportunities also.
The change from govemment department into govemmentnwned company
was not just a legal one. Govemment decided that in view of the liberalisation
of the markets and the expected increase in competition. a change ofm:ulagc-
ment style was also required. After a short transition period the whole execu-
tive board consisted of newcomers. The new CEO of KPN came from Unilever
and another director was lured away from IBM. Also. top managers for the two
divisions (Post and Telecom) were attracted from outside. The new CEO of
PIT Telecom, Ben Verwaayen. was recruited from the Dutch subsidiary of
Alcatcl, a French company supplying to the telecoms industry. One of his main
challenges was to change the culture from a bureaucratic one into an entre-
preneurial one.
The I989 annual report stated:
External conditions change at high speed. Because of this. our company is
continu-
ally confronting new challenges.
Rather than seeing these changes as threats, the company applauded them:
Pll telecom is in favour of this deregulation, provided it is based on international
reciprocity and on equal terms for all suppliers of telecom services. (Annual
report
1994)
ln 1994 about one-third of the shares that had been held by the government
were sold to the public when the company was quoted on the Amsterdam
Stock Exchange.
In 1997 KPN was split up into several companies. Of these PIT Telecom
would carry the name KPN in future, whereas the mail and courier activities
would he named TPG. Both companies were quoted on the Amsterdam Stock
Exchange. The cable company Vision Networks was eventually sold to France
Telecom.
In the years after the privatisation, the environment changed dtamatically for
a number of reasons. First was the gradually increasing deregulation in the

international market. This was a particularly important factor. Until the early
19905 intemational calls were handled on the basis of bilateral agreements
between countries. A call from Holland to Germany would cost a certain
amount per minute and the revenue would be split between the German and
Dutch operators on an agreed basis. A call from Holland to Italy would involve
four national operators. There was a clearing system for making these pay-
ments. Deregulation meant that the exclusive rights of the national operators
would soon disappear and that operators would start looking, for the least
costly way to route trafc. Second, deregulation had as an objective to stimu-
late competition. National govemments had to make it possible and attractive
for new companies to enter their markets. For companies that for decades had
been monopolists this meant an enormous change in the playing eld. Some
entrants were relative newcomers in the telecoms business. but had quite an
impact in the parts of the market they chose to enter - for example, Worldcom.
Third were the technological developments that enabled the rise in the use of
Internet. Particularly important in this respect were methods of increasing the
speed of data transmission and data processing (microprocessors and routers).
KPN started giving Internet-related issues serious top management attention
early in the second half of the 1990s.
STRATEGY
The strategy of the company was stated as follows in the 1999 annual report:
in 1999 KPN has identied its core activties: xed telecommunication; mobile
telecommunication; data communication (IP/data) and Internet, call centre, and
media services (ICM) (abbr. added, DJE). ln all these elds KPN wants to excel.
That means: in three of the four sectors (mobile, lP/data, and Internet, call centre
and media services) KPN aims for fast growth and a position in the European top
three.
Joop Drechsel, responsible in the executive board for mobile and ICM,
expressed a vision in which transactions in future would increasingly take
place in cyberspace. He expected enormous increases in the number and value
of transactions. These transactions could be in the elds of commerce, nan-
cial services, entertainment. information. etc. Cyberspace would connect sup-
pliers and customers. Companies that facilitated such transactions could eam
vast amounts of money. Customers could access cyberspace through various
means, for instance cable, xed lines (narrow band and fast lines), mobile and
satellite. KPN would provide all means of access except cable. Combined with
the KPN-Internet providers for the private and the business market this should
give a good position for the future.
Marten Pieters, member of the executive board of KPN and responsible for
IP/data, commented on the characteristics of some of the activities:
Fixed telecommunication is basically a service for the domestic marker. . . .
Data/IP is very international . . . requires fast global or at least pan-European
infra-
structures. . .
KPN G61

KPN
. . . scale is very imponant for development of products and sen/ices for mobile.
If
you look at UMTS, you need not only to buy the licences, you must also offer new
services, for which you need large numbers of customers. . . . branding may
become
very important: in Germany we have the E-Plus brand.
Data/I'P and mobile differ in customers and services . . . technologies are
converging
In the eld of xed telecommunication KPN aimed at maintaining its market
leadership in the Netherlands and a leading position in Europe in selected seg-
ments. among which was network/DSL services.
The European expansion would mainly be achieved by means of acquisi-
tions, joint ventures and /or partnerships. It was of major importance to have
management control over these activities. Where useful because of flexibil-
ity in the market, speed. transparency and value creation. KPN would create
separate entities with or without their own quotations.
CUSTOMERS
Historically. PTT Telecom had two groups of customers in its home market:
private individuals and small businesses (which did not spend large amounts
on telecommunications). and big companies whose telecommunication bills
could run into tens of millions of guilders. The latter group was especially
important for future success. for two reasons. First. it was expected that
because of the ongoing intemationalisation of business. telecommunications
needs would increase. Second. developments such as just-in-time deliveries.
enterprise resource planning systems. the Intemet. and increasing size of
companies (through mergers and acquisitions) were also expected to have an
impact on the demand for telecommunication and the competitive situation.
In the course of the 1990s the strategy of the company changed, not only to
include more and new services (mobile and Intemet), but also in a geograph-
ical sense. The market was no longer just the familiar home market, but also
countries nearby and far away.
STRATEGIC ALLIANCES AND PARTNERSHIPS
One of the pillars of achieving the strategic goals was the formation of so-at<
egic alliances. Initially these were relatively small-scale. In I991 the alliance
with Televerket from Sweden (now Telia) was announced iust before the inter-
national Telecommunication Exhibition in Geneva. Both companies would
eventually join their intemational activities in a new company called Uni-
source. Unisource would offer network and advanced fax services for larger
international companies worldwide. Depending on the area and the service,
Unisource would seek appropriate additional partners. In 1992 the Swiss PTT
Telecotn announced it would ioin Unisource. In that year an agreement was
also signed between Unisource and US-based Sprint for the distribution of
worldwide network services.
The fomtation of Lnisouree had two aims for the parents. The rst was
to achieve economies of scale. To give an idea of the relative size of the
companies in the international arena: PTI Telecom was the sixth largest com-
pany in the eld of international telecommunications, but only one-tenth of the
size of the fth largest. The other aim was to make possible one-stop shop-
ping for intemational businesses.
In 1995 Lfnisource made deals with SITA, the worldwide telecommunica-
tions systems of the airlines; an agreement was signed with KDD, a Japanese
telecoms company. for the distribution of services. In 1995 Telefonica. a
Spanish operator. signed an agreement for mutual support for international
clients. It was agreed that in 1995 T elefonica wottld become the fourth equal
partner in Unisource: this was effected in May 1996.
In December 1994 the European perspective was broadened when IFS-based
A'I8tT and Unisource decided to start a joint venture named Lfniworld. The
new entity targeted large. internationally operating companies with an inte-
gntted package of worldwide data and voice services. The company offered its
services via its own ofces or through local providers. Uniworld also repres-
ented in Europe World Partners (the alliance of Unisource, AT&T. KDD froth
Japan and Singapore Telecom). 1n I996 the name Uniworld was changed into
AT8tT-Unisource Communication Services (AUCS). in which Unisource had a
(>0 per cent share and AT&T a 40 per cent share.
The structure and market approach of Unisource is shown in Exhibit I.
The alliance between Unisource and AT8:T was not the only worldwide tele-
com alliance aimed at multinational companies. Global One had been formed
in early 1996 by US-based Sprint and Europes Atlas. which was fomied by
Deutsche Telekom and France Telecom (each 50 per cent). Another major
alliance was Concert. formed in 1994 by British Tcleeom and MCI from the
USA. In November 1996 BT and MCI announced that they had entered into a
merger agreement. BT would offer S20 billion for the shares of MCI (in fact the
merger never took place - it was overtaken by other events).
In April 1997 Telefonica, BT anti MCI announced they had formed a new
strategic alliance. To compensate for the damage this caused to Unisource,
T elefonicu had to pay several hundreds of millions of dollars to the three other
Unisource partners. Finally \l(/orld(Iom made a far higher bid ($57 billion) in
October I997 for MCI's shares and won the contest with BT. Telefonica
was, for the time being, left without a partner. In March 1998 Telefonica.
WorldCom and MCI announced a new partnership, which later was dissolved.
WorldCom and Sprint announced a merger in I999. with WorldCom offering
$129 billion for the shares of Sprint (including debt); anti-trust authorities on
both sides of the Atlantic blocked this in July 2000. After the Telefonica, BT and
MCI partnership fell apart. BT teamed up with AT&T to form the Concert
global equity joint venture. Concert aimed at the business customer with com-
plex teleeommunication needs. It installed an intemational IP-network.
At the end of I997 there were rumours in the nancial press that because of
a possible lirtk with Norwegian Telecom, T elia might also leave Unisource. At
around the same time it was disclosed that Unisource and Telecom'Italia Were
negotiating a deal that would tie the Italian company to the Unisource group,
either as owner or as strategic partner.
KPN 553

~-n ._
KPN
E) U9}3 31
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10)
CUSTOMERS
telecom operators - large companies -
small and medium sized companies locally
.. ' DISTRIBUTION
" - CHANNELS
to
U! VI
AT8iT
Corp.
Z
%SZ
%SZ
SERVICE
PROVIDERS
40%
NETWORK
PROVIDER
BREAKING UP
In the course of I998 there were fundamental discussions within Unisource
about the strategy the company should follow. The nancial results were still
negative (1998 loss of DFI 382 million on revenues of DFI 2.610 million) and
the interests of the original partners seemed to be diverging. The 1998
Unisource annual report made the newly developed strategy look like a leap
forward rather than a split-up of Unisource:
Unisource made a thorough analysis of what had been achieved since 1992,
against
the background of the rapidly changing telecommunications market. This
resulted
in a new strategy in which Unisource will concentrate on the segment of small-
and medium-sized enterprises with a full range of products and services, but with
a
special focus on data services and Internet protocol (IP) services in the largest
telecommunications market in Europe. We can realise this ambition only from an
independent position.
Observers within KPN would remark later that Unisource missed a compelling
strategic raisnn d 'tre and that the alliance model was not working any longer.
Stronger links between companies were required.
It was decided that the three owners of Unisourcc would each buy the
Unisource Business networks that served their home market. KPN bought the
Belgian network as well. Later. other parts of Unisourcc were sold to other
operators and parties.
ln the course of 1998 .-\T&T decided it would withdraw from AUCS and
WorldPartners. This again weakened the position of what was left of
Unisource. ln the same period other strategic alliances were dissolved also.
Global One fell apart after France Telecom and Deutsche Telekom fought over
a participation in Italy.
NEW PARTNERS
ln 1998 KPN and Qwest from the USA decided to establish KPNQwest, a new
jointly owned company which was quoted on exchanges in the Netherlands
and USA in November of the next year. By 2001 this company was a leading
pan-European provider of data-centric services hascd on the Internet protocol.
lt has an advanced 20,000 km bre optic network. which connects 50 cities
in Europe. lt was one of the largest business lntemet service providers (lSls)
in Europe, operating in li countries. The company was developing a network
with a large capacity. the socalled EuroRings which will connect 50 cities. ln
18 of these locations Cyhercenters will provide hosted customers with unlim-
ited bandwidth. The rst CyberCenter opened in Munich injuly 2000, whereas
Paris and London were ready for service at the end of 2000. Milan, Frankfurt
and Stockholm would be offering serviccs in 2()()l. KPNQWest wants to
become the highest quality and lowest costs bre optic network in Europe.
ln view of the increasing investments as well as the required scale of
operations, in May 2000 KPN discussed the possibility for cooperation with
Telefonica of Spain, the fomter partner in linisource. But Spanish political
developments were said to he an obstacle to the merger of the two companies.
At the same time Kl-N Mobile was discussing an agreement with N'lT~
DoCoMo. the immensely successfuljapanese mobile operator. who could prev
vide not only nancial resources but also advanced technology for future
generations of mobile telecommunications. It was decided that NTI-Do(IoMo
would acquire shares in KlN.\/lohile in exchange for several billion euros.
N'IT-l)o(IoMo also bid for (ierman UMTS licences together with KPN Mobile.
Initially Hutchinson Whampoa from Hong Kong was also involved. but this
company later sold its shares to KPN. KPNs share in the licences is estimated
at (>.4 billion. KPN expected that another 3.5 billion would have to be
invested before the network became operational. On 51 October 2000 the
Finuncial Times wrote that N'l"l'<DoCoMo was discussing with AT&T the
possibility of buying a 10-20 per cent share in AT&'l' Wireless.
Research agency Forrester had zt much higher estimate: between 4 and (2
billion euros for the
inl't-astnicture and another 2-5 billion euros [or marketing efforts.
KPN 655

KPN
EQUITY PARTICIPATIONS AND JOINT VENTURES
The internationalisation of the Dutch P'IT Telecom also was pursued in
another way - through direct equity participation in existing or newly formed
telecoms operators in other countries. The political changes in central and
eastem Europe in the late 19805 was a trigger to explore the market possibili-
ties in that area.
The I990 annual report mentioned the start of joint ventures with the Czech
and Slovak operators Telecomspol SRO and Isysspol SRO. A consultancy agree-
ment was signed with the Czech partner in 1995. whereas with the Slovak pan-
ner further possibilities were under investigation. The Czech national operator
SPT Telecom was privatised in I995. Together with Swiss Telecom, PTT
Telecom bought a 2'7 per cent stake in the SPI'. At the time of purchase SPT
was protable, with growth opportunities: the number of telephones per I00
inhabitants was 20, a total of two million. In I996. 400.000 new telephones
were installed. with a similar expansion expected for 199: The SPT share
price showed a satisfactory increase. Despite the growth and good operational
results of the company it became increasingly difcult in the following years to
maintain management control. Because of European regulations the company
would lose its monopoly in the near future. In August 2000 Kl-N announced
that it would not bid for more shares in Cesky Telecom (formerly SP1).
In I992 PIT Telecom participated in two joint ventures in the Ukraine.
One was Utel. with the aim of modemising the national and intemational
infrastructure. The other was UMC. a company that had to build and manage
the infrastructure for mobile telecommunications in the Ukraine. As a result.
the rst intemational gateway was opened in Lvov in I995. Owing to the bad
economic situation in the Ukraine, KPN had to write off its investments in the
companies in the Ukraine. No further investments were anticipated.
In 1993 a concession for mobile communication in Hungary was granted
to a consortium called Pannon GSM. PIT Telecom was one of the partners
in this consortium. In the course of 1994 the mobile network became opera-
tional. ln the same year a licence for a regional xed network was obtained in
cooperation with Swiss Telecom and the Hungarian partner Jasz-Com. The
latter participation was sold in I999 with a prot of DFI 5 million.
At the beginning of 1998 KPN bought the shares Unisource had in Pantel, a
Hungarian company with a xed network that also provided leased lines. data
communication and V'PNs. Over time, the participations in Pannon and Pantel
were enlarged on several occasions.
Investigations into the possibility of investments in telecoms companies in
Slovakia. Romania and Bulgaria were discontinued in the course of 2000.
Besides centml and eastem Europe. the focus was also on other areas. Some
ventures were in small markets such as Antillean Telematics which was estab
lished in 1991 to provide telematic services in the Caribbean area. Other tar-
gets were large and fast~developing markets such as Indonesia where, in I993.
an umbrella agreement was signed with PT Telkom for joint activities and
projects in Indonesia and South East Asia. The two initial projects were a trial
with GSM mobile telephony in Indonesia and the building of infrastructure for
companies in the Jakarta area. The next year PIT Telecom took a 50 per cent

stake in PT Bakrie Electronics Company (BEC). Through this participation PTI

Telecom cooperated with the national Indonesian telephone company in
Ratelindo to build and manage xed networks injakarta and Westem _Iava. DEC
held 55 per cent of the shares in Ratelindo.
Participation in a mobile operator was obtained ln I996 when 17 per cent of
the shares of PT Telekomunikasi Selular (Telkomsel) were acquired. The com-
pany provided services on the main islands of Sumatra. Java, Bali, Lombok.
Kalimantan and Sulawesi. The number of mobile phones increased beyond
expectations: by the end of 1996 there were 188.000. which was 54,000 more
than anticipated.
The Asian economic crisis in 1997 hit Indonesia badly. The currency
devalued, which caused a loss for KPN on its participation in Telkomsel of
some I)Fl 80 million. ln 1997 the total investment in BEC was written off for
similar reasons. The potential for the Indonesian market (200 million inhabit-
ants) in the long run was still considered interesting.
ln I996 P'lT Telecom fomied a consortium. Comsource, with its Swedish
Unisource partner Telia to acquire a 20 per cent stake in Telecom Eireann cost-
ing 500 million Dutch guilders.
The agreement with the Irish government included an option to increase the
participation by a further 15 per cent not later than 1999. For the lrish partner.
Comsource could make an important contribution to cost reductions and thus
increase nancial and commercial pi.-rtom1ance. These could be achieved by
better management of existing operations but also by means of joint purchas
ing, and software and systems developments. For P"lT Telecom the attractive-
ness of Ireland as a new market was the international orientation of lrish
industry: the lrish partner could be a powerful distributor of Unisource prod-
ucts and services. Also, the relatively low penetration of telephones in lrish
households provided opportunities for growth. ln Holland, for 100 people
there are 54 telephone connections, whereas in Ireland there were only :56.
The results of Eircom developed satisfactorily. ln 1999 KPN decided to
increase its share in Eircom from l2 per cent to 21 per cent. Iate in 1999 KPN
decided to sell its shares in Eircomm, in part because the potential of the lrish
market is limited. By the end of I999 the market value of the KPN shares was
DFI 4.5 billion; the book value was DFl 2.8 billion.
By the end of 1997 PIT Telecom discussed internally a link with the Chinese
People's Liberation Army in setting up a telecoms company in the biggest
market in the world. It was anticipated that the initial investment would be
modest, but that in future the build-up of infrastructure would run into billions
of dollars. The critical issues were not commercial or technical. but political:
particularly the role of the army in the Tianenmen Square massacre of 1989.
ln 1998 there were further discussions with Chinese companies about joint
ventures. ln view of the decision of summer 2000 to concentrate on westem
Europe, it was decided not to extend these discussions.
On many of these participations, _I0()p Drechsel commented:
They have in common that as a minority partner we do not have much influence.
Moreover the initial capital outlays are very high with value creation expected on
the
longer term. lt is very difficult to achieve synergies and cost savings if you do not
have
management control.
tom S67

5. KPN
On 9 December I999. KPN announced that it had come to an agreement with
Bellouth to buy 74.49 per cent of its shares in the mother company of I-l~Plus.
the third German mobile operator (market share I6 per cent; 5.8 million sub
scribers). This move gave KPN an entry into the large German market of some
80 million inhabitants: 69.1 billion was paid in cash. BeIlSouth was given the
right to convert their remaining 22.51 per cent in E-Plus into shares of KI-N or
KPN Mobile; BellSouth could also continue to hold the shares. To this end.
KPN gave BeIISouth a warrant. Furthermore. they agreed that Be|lSouth. until
9 December 2005, should acquire shares in KPN other than by using the war-
rant, and that an eventual participation of Bellouth after 9 December 2005
would not exceed 24.9 per cent. As far as KPN Mobile is concemed. BelISouth
could acquire 24.9 per cent of KPN Mobile shares in addition to a possible
conversion based on the warrant. but not later than 9 December 2002. In
exceptional situations the periods mentioned above could be shortened.
INTERNET AND MEDIA
The beginning of an Internet strategy for KPN was in the early I99()s with an
investment (19.5%) in Videotex Nederland NV. This interest was mentioned
in the annual report of I992 for the rst time, in a list of subsidiaries and par-
ticipations. In the report itself no further mention was made of the activities
and the strategic importance of this activity. This company provided informa-
tion to a personal computer via telephone lines. In the beginning the service
was very slow. but later it could be used for online bank transactions.
The annual report of I995 briefly mentioned the participation in this com-
pany in a longer list of companies in the eld of tele-information services in
which KPN had a participation. In I994 KPN Multimedia was formed (a joint
venture between Post and Telecom) which aimed to develop initiatives with
interactive media. The next annual report mentioned the further integration of
telecommunication with other services in the eld of information technology,
nancial services and entertainment. These developments were considered
major opportunities. The I996 report for the rst time mentioned the word
lntemet. The interest in Videotex Nederland had been increased to 555 per
cent. In the meantime. KPN had bought Planet lntemet. an independent
Internet service provider. The company provided access to the lntemet under
the brands World Access and the Planet lntemet. These two subsidiaries were
merged in the autumn of I996. Services for target groups were developed,
such as for small and medium-sized enterprises. In time a third network, as
well as the xed and mobile telecommunications. would be built for lntemet
services. This would require considerable investment. A rst step was invest-
ment to increase the capacity of existing lines by means of ISDN technology.
By January I997 all lntemet acitivites were to be concentrated in a new unit
for lntemet services.
On 30 September I997 Het Net was opened to the public. It was an
information network for the Netherlands based on the same principle as the
lntemet. It was useful for companies and organisations that wanted to provide
information to the public. By the end of I997 more than 700 companies had a

site on l-let Net; the number of regular visitors was close to 150,000. In 1998
it became possible to transact via Het Net, including payment for goods and
services. In the meantime, the number of ISDN subscribers increased: by the
end of 1998 the number of ISDN channels had increased to 1.57 million. This
increase was in large part due to the increase in Intemet trafc. The number of
analogue lines decreased by 3.5 per cent to 7.77 million. Also, the equity inter-
est in World Access/Planet Internet was increased to 100 per cent, whereas
two other ISPs were acquired: Capitol ()nline (l2,()0O subscribers) and XS4ALL
(40,000) by the end of 1998.
When by the end of June 1999 Het Net became a fullblown ISP, KPN had
brands of several types: Het Net, a free ISP; World Access with a moderate
subscription fee; and the high-end XS4ALL. By the end of 1999 KPN's lSPs had
l.2 million subscribers in the Benelux region. As an ISP, Planet lntemet
co-operated with content providers as well. An exclusive contract was made
with Disney for distribution of services in the Benelux region.
To accomodate the enormous increase in Intemet traffic KPN built the
Lambda network of 10.000 km optic bre with a capacity to handle Z0 million
telephone calls and Internet sessions simultaneously. This network will be
linked to the KPNQWest network, thus securing fast access to other parts of
the world. it was also decided that ADSL would increasingly become available
to Internet users.
As far as the services for business were concemed_ KPN was active in
supponing companies in implementing an e-business strategy by offering
applications for lnternct sites. intra- and extranets, web hosting. securing
payments etc.
ORGANISATION
In 1997 the responsibility for the intemational activities of PIT Telecom were
concentrated in the Business Development department. But its origin was
the department that since 1989 had taken care of the administration of inter-
national calls, then called Business Unit International Telecommunications.
This accounting-Oriented department had to be tumed around to become the
initiator of acquisitions and intemational cooperation as well as the manager
of investments in foreign tclecom companies.
In I994 it was decided that the centralised PT! Telecom would be reorgan-
ised to become more market oriented. The changes brought with them, among
other things, the reshaping of the Business Development department (BD),
which was given responsibility for the international activities of PIT Telecom.
To he included in BD was the former Business Unit lntemational Tele-
communications, which took care of the administration of intemational calls.
There were two options for redesigning BD. One was to set it up along func
tional lines, the other was to create geographical divisions. The latter had the
disadvantage that there would be some duplication of groups such as nance
and support, acquisition etc. Initially :1 functional form was chosen because of
the scarcity of people and the need for efciency. The following managers
reported to the director for Business Development: International Acquisitions.
V-
KPN G55

KPN
KPN organisation structure
National
Royal KPN NV
Services via the lP/Data ICM Mobile
xed network
telecommunication
BU Fixed Telephony BU Corporate BU Telecommerce KNP Mobile
BU Business
BU Carrier Services
Networks Planet Internet
XS4ALL
Het Net
SNT
Communication
international
Eircom KPNQwest Planet Internet
Cesky Telecom lnfonet
E-Plus (G)
KPN Orange (B)
Pantel Pannon GSM (H)
Telkomsel (lnd)
UMC (Ukraine)
Belgium
Intemationzil Operations. and Finance and Support. later a manager for human
resources joined the management team. The BD department saw its role as
orchestrator and co-ordinator of all the activities that were necessary to grow
the business internationally. For this, it had to get the co-operation of many
other departments and business lines within PTT Telecom. lf, for instance, in
a foreign project there was a need for certain types of specialists, the HRM part
of Business Development had to seek them out from other parts of the com-
pany and persuade them to work abroad for a while.
Joop Drechsel and others on the executive board found the organisational
set-up for BD and other parts of KPN too loosely structured and not trans-
parent and resultsoriented enough. It was expected that, in future. demands
for shareholder value would increase and that :1 high share price was necessary
to make possible future acquisitions. It was decided there should be more
clarity, transparency and accountability. This led to a reorganisation of which
the nal result was the establishment in the course of 1997 of KPN lntema-
tional. This unit consisted of three regions, (1) Westem Europe, The Americas
and Africa, (2) Asia, (3) Central and Eastern Europe, and the product-group,
(4) lntemational Solutions Provision. KPN Telecom would deal with the
national market, including the national mobile market.
The organisation in January 2000, as far as subsidiaries are coneemed, is
shown in Exhibit 2.

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672 KPN
When the executive hoard of KPN was enlarged in March 2000, some of the
responsibilities were reshuffled. Mr L. Roobol was made responsible for ser~
vices on the xed net when he joined the executive board. The board member
responsible for IP/Data, Marten Pieters, was also made responsible for Eircom
and (Iesky Telecom. ln an earlier position within KPN he had held operational
responsihilites for the foreign operations and knew hoth companies and actors
around them well. Joop Drcchsel was responsible for all mobile and Internet.
Call centre and Media (ICM) activities.
Where appropriate. parts of the company would be set up as separate entities,
with the possibility of their own quotation on the stock market. This was done
with KPN/Qwest and KPNMobile. The rst was quoted on the stock market. In
July 2000 KPN announced that it would establish a separate plc for most of its
Internet, call centre and media activities (IMC). This would give subsidiaries
the flexibility needed to respond quickly to developments that might unfold in
the years ahead. Moreover. stock market quotations made visible the value of
the separate units.
Segmentation of turnover, gross prot and investment of KPN
1999
1998
1997
1996
Turnover"
Fixed telephony, equipment, etc.
Mobile
International activities
Internal deliveries
Total
Gross prot
Fixed telephony, equipment, etc.
Mobile
International activities
Total
Investment In Plant & Equipment"
Fixed telephony, equipment, etc.
Mobile
International activities
Total
14,849
3,851
3,465
-2,041
20,124
844
516
960
2,320
4, 303
900
360
5,563
Investment In immaterial and nancial assets
Fixed telephony, equipment, etc.
Mobile
International activities
Total
N/A
N/A
N/A
NIA
13,923
3,002
2,258
-1 ,464
17,719
2,898
252
320
3,470
3,658
444
350
4,452
150
290
1,372
1,812
12,977
2,153
1,934
~ 1,284
15,780
2,850
227
211
3.288
2,572
378
48
2.997
5
0
371
376
10,202
1,886
2,188
N/A
14,276
2,893
209
361
3,463
2,178
336
36
2,425
13
0
1.154
1,167
' Investment in goodwill and licences.
" I million Dutch Guilders.

Exhibit 5 Some information on competitors

TURNOVER REG|ON(S) one on YEAR
Mobile telephony
Vodatone AirTouch:
Group turn
France Telecom
Deutsche Telekom
British Telecom
over 7,873m
2,901 m
2,030m
3,956m
2,470m
2,4SSm
2, 1 70m
Subscribers
Deutsche Telekom
KPNMobile
British Telecom
France Telecom
26.5m
6.6m
4.8m
7r4m
I2.6m
22.1 m
Vodafone AirTouch 12m
Internet etc.
Tiscali
T-Online
KPN Planet
France Telecom:
10.7m
7.0m
over 2m
2.2m
UK
EMEA
USA/Asia Pacic
not specied
not specied
not specied
not specied
Germany
Netherlands
not specied
France
outside France
USA, Australia,
New Zealand
15 countries
not specied
not specied
not specied
1999/2000
1999/2000
1999/2000
1999/2000
9 months 2000
9 months 2000
1999/2000
3rd quarter 2000
Dec. 2000
Dec. 2000
31 March 2000
31 Sept. 2000
31 Sept. 2000
31 March 2000
January 2001
30 Sept. 2000
end 2000
30 Sept. 2000
Incl. World on Line + Liberty Surf
Aims for 10m active users in 2003
Information on Data/IP is very difficult to extract in a consistent and reliable way.
KPN-Qwest indicates they are one of the top players.
Exhibit 6 Glossary of abbreviations
ADSL
BD
DSL
GSM
ICM
IP
IP/Data
ISP
ISDN
UMT5
VPN
Asynchronous digital subscriber line: an advanced technology to increase the
capacity of
normal telephone lines. Increases the speed of web-surng
Business Development: in the mid-1990s this department was responsible for
creating new
business opportunities for KPN
Digital subsciber line: allows transfer of digital infomation only. Used for
customers wanting
to transfer large quantities of data
Second-generation technology for mobile telecommunication in use in many
parts of Europe
and Asia. Not used in the USA
Internet. Call centres and Media sen/ices: a division of KPN
Internet protocol: a standard for sending messages over the Intemet
Divison of KPN responsible for data transmission for corporate customers
Internet service provider: company that provides acces to the Internet. May also
provide
addtional services, such as content
Integrated services digital network: an early technology to increase the capacity
of telephone
lines
Technology that will eventually succeed GSM as the mobile technology. Can
provide fast
mobile Internet access
Virtual private network: for instance an intranet that is operated by a telecoms
operator

Amazon.com from start-up

to the new millennium
Gary Stockport and David Street
This case study provides an ideal example of ernerging eeommerce strategic
thinking because of Amazons rst-mover development and prominence, its
accelerated growth and its recent and rapid emergence as a signicant
e-commerce player Amazon.coms development is signicant because of its
strategic approach in a still emerging indusnjy, its dominance over more
traditional retailers, as well as its explosive growth in new products, ser-
vices and new geographic areas. The case also provides an example of the
m1iqile[n'0blerns. risks am! opportunities experienced witlrlin the e-commerce
environment.
INTRODUCTION
Jcrff Bczos as CEO of Amazon.com. lnc. is facing a grand opportunity to suc-
ccctl in a U555 trillion World retail market. with one major concern - thc more
Amazoncoin sells. the greater are its losses. These losses arc also expected to
increase into the near future. as thc competitive focus has remained clearly on
gaining market share as opposed to gcncrating prots.
This strategy is embraced by many investors who have assisted in driving
Amazon.com's stock-beyond any cstablishcd benchmark of pricc-to-revenues.
On the other hand, othcr investors bclicvc that thc price is overvalued and that
the company is facing an increasing range of challenges from both local and
intcmationul competitors.
Undcrjcff Bczoss leadership, Amazon.com appears to be pursuing a strategy
to make itself the Wal-Mart of the Internet, and in doing so is facing increasing
competition on every front. Many investors bclicvc it is spreading itself too
thinly as it moves imo more low-margin businesses. and expectations for thc
year 2001 include a signicant growth in revenue, an improvcmcnt in gross
margins, and decreasing operating costs as a percentage of revenue as well as
an increase in marketing cxpcnditurc, Along with its growing rcvcnnc and cus-
tomer base is an increasing long-term debt position combined with a growing
loss per share.
This case was prepared by David Street, University of Cape Town, under the
supervision of
Professor Gary J. Stockport, Graduate School of Management, University of
Western
Australia. It is intended as a basis for class discussion and not as an illustration of
either
good or bad management practice. Gary J. Stockport, 2001. Not to be
reproduced or
quoted without permission.

AM/\ZON.COM FROM START-UP T0 THE NEW MILLENNIUM G15

With the explosive growth in Internet companies market capitalisation
positions, the rational investor would iustiably ask whether or not some over-
hyped mania is at play. But the truth is, in spite of the noise and hyperbole. the
lnternet is for real and the trend data clearly reveal that what is happening is
nothing more than an embryo taking shape. According to Forrester Research
(a company that creates, publishes and sells technology research reports).
the total value of goods and services purchased over the Web exceeded
US$45 billion in 1998 and is expected to increase to US$13: trillion in Z005
(Amazmtcom l998Am1unI Rejmrt, 1999). Al'llilZOl'l.C()lTl believes it is well po-
sitioned to capitalise on this growth. According to Media Metrix (a company that
provides audience measurement products and services to Intemet advertisers,
lnternet advertising agencies, lntemet properties. technology companies
and nancial institutions), approximately 16 per cent of Web users visited
Amazon.com"s stores in December I998 (Anzazmrcozn I 998 Annual Reporl.
1999). Many analysts are optimistic and point out that Amazons problems.
though real. do not necessarily mean that the stock is destined to fail.
Some of the achievements backing the optimism of analysts include the
following:
O Amazonicom (Antazoitcom, lnc., and its subsidiaries) is the Internets No. l
retailer. Amazoncom opened its virtual doors on the World Wide Web in
July 1995 and today offers Earth's Biggest Selection. along with online
auctions and free electronic greetings cards. Aniazoneom seeks to be the
worlds most customer~centric company. where customers can nd and (lis-
cover anything they might want to buy online. Amaz0n.com lists more than
Z8 million unique items in categories such as electronics, kitchen products.
books. music. DVDs. videos. camera and photo items, toys, software, com-
puter and video games. tools and hardware. and lawn and patio items.
Through Amazoncom zShops, any business or individual can sell virtually
anything to Amazon.com's more than 25 million customers. and with
Amazoncom Payments, sellers can accept credit card transactions. avoiding
the hassles of offline payments.
0 Amazoncom operates three international Web sites: www.amazon.fr.
Www.ama7.on.co.uk and www.amazon.dc. It also operates the Internet
Movie Database (WWw.imdb.coin). the Wehls compreliensive and author-
itative source of information on more than 250,000 movies and entertain-
ment titles and l million cast and crew members dating from the birth of
lm in 1891 to 2001.
0 Amazon Anywhere is the leader in mobile c-commerce. providing access
from anywhere in the world to Amazon.com, Amazon.co.uk and Amazonide
on personal digital assistants (PDAs) and through handheld Wireless Internet
devices that use HDML or the Wireless Application Protocol.
In a very short period of time, Amazon.com has become one of the world's
most recognized brands, said Jaleh Bisharat. vice-president. marketing,
Amazon.com. We updated our logo to match the vitality of the brand and to
reflect our most important core value - customer satisfaction. We believe the
new logo exudes happiness, is fresh and unique. and has the potential, over
time, to join the world's great consumer marks (Arnazoncom, 200()).
r
575 AMAZON COM F'lOM START-UP T0 THE NEW Mll.LENNlUM
With Amazon.coms current strategy combined with the ongoing recruitment
of an entrepreneurial top management team for each business segment, the
challenge for Amazoncom is increasingly on the strategic implementation
front. With a growing customer base (exceeding 25m customers at November
2000), a well-respected brand, strong customer service and order fullment
together with a signicant cash position, Bezos appears to be bringing together
the assets necessary to make Amazon.com's vision a reality.
BACKGROUND JEFF BEZOS
Be/.os had always been fascinated with technology. At the age of 14, he had
admitted to wanting to be an astronaut or a physicist, or something that would
allow him to use cutting-edge technology. During high school he fotmded his
rst business. DREAM Institute, a summer school programme that was aimed
at stimulating creative thinking in youngsters.
At age 50, Jeff Bezos. with an electrical engineering and computer science
BA from Princeton, was the youngest senior vice-president of i).E. Shaw. run-
ning a Wall Street hedge fund. At some time, Bezos came up with the statistic
that the electronic world known as the World Wide Web would grow at the
incredible rate of 2,500 per cent monthly. Bezos has used the term compelled
to describe his emotional reaction to the growth gures of the World Wide
Web. if he had not acted immediately, he has said, he would have regretted it
his whole life: When something is growing that fast, every second counts.
One reporter reported Bczos saying:
l decided that when l was eighty l wouldnt regret quitting a Wall Street job when
I
was thirty. but when [was eighty l might really regret missing this great
opportunity.
(Quoted in Saunders. 199*), p. 8)
in June 1994 Bezos quit his job, climbed into a Chevy Blazer with his wife,
MacKenzie, and their Librador, pointed the car west, and began driving. His last
day of work at [).E. Shaw was 50 June I994 and he arrived in Seattle on Sjuly.
Bezos considered selling a variety of products and his list of top ve con-
tenders comprised computer hardware. computer software, (IDs, videos and
books. He eventually settled for books because the worldwide market is
large (US$82 billion in I994), the price point is low, and the range of titles is
large. Webbased technologies were also described as being able to effectively
organise and select information in ways that could positively enhance the sales
of books.
Being unsure of the ideal location, four likely locations were identied: Port-
land, Oregon: Lake Tahoe, Nevada; Boulder, Colorado; and Seattle, Vi/ashington.
Seattle was eventually chosen because it was the location of hook distributor
Ingram, which has continued to provide approximately 60 per cent of
Amazon.com's books. Additional factors for choosing Seattle included its
favourable sales-tax climate as well as its high-tech workforce. During the
next I2 months, Bezos, his wife, and three others raised money, established
relationships with shippers and wholesalers, and developed the software that
would go live with the launch of the online store in July 1995.

AMAZON.COM - FROM START-UP TO THE NEW MILLENNIUM G77

Despite his contacts in the New York money markets, Bezos had to turn to
Silicon Valley for funding for his rm By selling on the lntemet, he told his
investors, he would change the economics of the book industry as a whole.
Investors recall that Bezos said in their early discussions:
I know nothing about the hook industry, nothing, l want to tell you that up front.
But
lct me iust tell you this: I know that l can get the books here. and l can get them
to
the customer and forget about bricks and mortar,
(Quoted in Saunders. 1999. p. ll)
1995/1996
in June 1995 Amazon.com. lnc. launched on the World Wide Web. Ever con-
scious of the need for effective branding on the Web, Bezos chose to name his
site after the world's largest river. telling newsgroups that Amazon.com, in
tum, would become the biggest bookstore in the world. Bezos considered
branding evcn more important on the Internet than in traditional retailing
because of the power of the Internet in continuous communication and word
of mouth.
After its initial entry into the market, Amazon.com had no signicant rivals
and there were no dominant traditional players. Barnes 84 Noble had 15 per
cent market share and no online presence. Despite the rapid growth of the
business, the rst few months found Bezos doing the manual work, loading and
unloading packages in the back of his Blazer and delivering them to the post
office himself.
Within one year. Amazoncom was recognised as the Web's largest
and best bookstore with over l,0()O_l)00 titles to choose from. Even at this
time, Amazoncom was providing a powerful search facility as well as a
host of services not provided by other online competitors. These services
included:
Q Personal Notication Sermte (which lets you know by e-mail when a par-
ticular book you want comes out in paperback or when your favourite
author releases another book);
0 Recornmendations Section (exceeding 20 categories);
Q Awnrzls Section (where hooks that have won various prizes are listed):
0 Associate Program (where other sites can link to Amazon.com where they
sell selections from Amazon.coms database and receive a commission for
each sale).
While a host of physical bookstores entering the virtual domain, there were
still no large competitors competing for market share. The reality was that few
retail sites on the Internet had made back their start-up costs, Amazoncom
included, with Bezos waming investors not to expect a prot in the rst ve
years. Analysts also wamed of a highly volatile lntemet sector with strategic
plans constantly being revised and speedy growth being no guarantee of earn-
ings, let alone of a companys long-term success.
m AMAZON COM - FROM START-UP TO THE NEW MILLENNIUM
1997
Despite aggressive competitive entry (i.e. Barnes and Noble went online in
February 1997) into the c-commerce market, Amazoncom passed many mile-
stones in 1997. They reached the l,000_0()0th new customer milestone with
customers in over I60 countries, exceeded 15,000 Associate Websites, signed
relationship agreements with a number of key lntemet players. and launched
a range of new features. Probably the most notable achievement, however, was
its ability to raise net proceeds of almost US$50 million in its initial public
offering of 5,000,000 shares of common stock in May. These proceeds enabled
aggressive investment in building the business, brand and customer base, as
well as enhancing its product and service offerings.
With a growing employee base (from l5l in I996 to 868 in 1997)
Amazon.com focused on establishing its executive team, which included
the recruitment of Richard Dalzell. a fortner Wal-Mart vice-president from
their information systems division, Richard Dalzell joined Amazon.com as chief
information ofcer during August. He brought with him experience in mer-
chandising and logistics systems, supply chain systems. intemational retailing
and merchandising systems, and commercial decision support and data mining
systems.
Amazon.com lowered its hook prices in I997, which meant that for more
than 400.000 titles, every hardcover was at least 50 per cent off and every
paperback was at least 20 per cent off. Specially featured books were up to
40 per cent off. With these prices, Amazoncom offered the lowest book prices
anywhere in the world. online or off. Additional discounts were also available
on all audio books as well as calendars in all categories. These price reductions
encouraged customers to do more of their book purchasing online with cumula-
tive customer accounts growing to over l,S00,()0() at 31 December. a growth
of some 740 per cent from l8(),()()() customer accounts at 51 December. i996.
The combination of Amazon.com's editorial ability, technological develop-
ment. and growing customer base allowed the company to offer customers new
features and services that were not available anywhere online or in physical
stores. New features launched during 1997 included:
0 a state-of-the-art Recommendations Centre (including recommendations
to customers that other customers who shared their taste have enjoyed by
tapping its extensive information about book purchasers, thereby assisting
customers to nd books that match their tastes);
0 22 subject browsing areas;
0 the use of a proprietary technology - l(I|ick Ordering - to streamline the
ordering process; and
0 An innovative Gift Centre to make gift-giving fast and easy, thereby augment-
ing its powerful recommendations centre.
Extensive promotional relationships with other dominant lntemet players
were concluded which reinforced Antazon.coms momentum as the leading
online bookseller through the generation of substantial brand awareness and
customer flow for the business. Some of these relationships were concluded

AMAZON.COM FROM START-UP TO THE NEW MILLENNIUM 575

with Yahool, Excite. America Online, Prodigy. Netscape, @Home Network and
GeoCities, some of which are Considered below:
0 Amazon.c0m became the premier bookseller featured on Yahoo!. This
alliance brought together Yahoo.com (the worlds largest Internet naviga-
tional guide) with Amazoncom (the largest online bookseller) and provided
a seamless transition for Yahoo! users researching information to be able to
purchase relevant books directly from Amazon.com.
Q Amazon.com made a multi-million-dollar Internet advertising purchase on
Excite as well as establishing a strategic relationship where Amazoncom
became Excite's exclusive bookseller integrated throughout Excites chan-
nels. Excite, Inc. was committed to providing consumers with the most
comprehensive network of directory and search services online through its
four brands Excite, Webcrawler, Excite Travel by City and Magellan.
Q America Online (AOL.com) was the most visited site on the Web, and the
agreement provided Amazoncom the exclusive bookseller position on
AOL.com and AOL's NetFind search engine. This meant immediate access to
over S million members Worldwide.
I The agreement with Prodigy Shopping Network ensured Amazon.coms
prominence in the Prominent Shopping Network Mall with direct links to
Amazoncom content from relevant areas inside the Prodigy Internet ser-
vice. The Prodigy Shopping Network search engine is used by a large and
loyal customer base to shop across a database of more than 20,000 items.
I Under the terms of the agreement with Netscape Communications Corp.
Amazoncom became the exclusive bookseller on Netscape Netcentres
newly launched commerce section. Netscape Communications Corporation
was a leading provider of open software for linking people and information
over enterprise networks and the Internet.
Q The agreement with @Homc Network (the leader in high-speed Internet ser-
vices via the cable infrastructure) made Amazon.com the premier bookseller
throughout the @Home service.
0 Amazoncom was incorporated throughout GeuCities 59 themed communit-
ies, offering GeoCities members and visitors new book features and services
based on their areas of interest. (}eoCities was the world's largest and fastest-
growing community on the Intemet.
Amazoncom opened its second distribution centre in New Castle, Delaware.
The 200,000 square foot state-of-the-art distribution centre, together with the
expansion of its original Seattle distribution centre, increased the company's
stocking and shipping capacities to approximately six times their previous
levels. The new Delaware centre positioned Amazoncom closer to its East
Coast customers and publishers and provided immediate reductions in shipping
times for many Amazon.com book buyers.
Amazon.com also completed a US$75 million credit facility aimed to provide
the company with substantially increased resources to execute its long-term
strategy. Aimed at enhancing Amazon.coms flexibility, it allowed the company
to pursue its goal of extending its market position.

3 AMAZON COM - FROM START-UP TO THE NEW MILLENNIUM

1998
By the end of 1998. Amazon.eom had served a cumulative 6.2 million cus-
tomers, exceeded the cumulative US$l billion revenue level, exceeded 60,000
members in its Associate Program. launched music, video and gift stores in
the US. and expanded operations into the UK and Germany. Sales grew from
US$148 million in 1997 to US$610 million (an increase of _>l5 per cent) and
cumulative customers grew by over 500 per cent. Despite this rapid customer
growth, the percentage of orders placed on the Amazon.com website by repeat
customers grew from over 58 per cent in the fourth quarter of 1997 to over 64
per cent in the same period in l998.
Following the cornpanys October launch in the UK and Germany under the
Amazon.com brand and with Amazoncom technology. the combined fourth-
quarter sales in the UK and German stores nearly quadrupled over the third
quarter, establishing Amazon.co.uk and Ama7.on.de as the leading online book-
sellers in their markets. Twenty-ve per cent of fourth-quarter sales for 1998
were derived from Amazon.co.uk. Amazon.tle, as well as music, video and gift
sales on Amazoncom, which were all very new businesses.
The growth in Amazon.com's infrastructure continued with a staff
increase from 600 in December 1997 to over 2,100 in December 1998. This
staff increase included the strengthening of the management team with the
appointment ofjimmy Wright who joined Amazoncom as vice-president, chief
logistics ofcer. Jimmy Wright joined from Wal-Mart and had more than 26
years of experience in logistics management. He became responsible for all
global supply-chain activities at Amazon.com, including the management of the
company's distribution centres. product purchasing, distribution and shipping.
Additional new products included Amazmtcom Admmmge, an innovative
new programme designed to increase the visibility and sales of titles from inde-
pendent publishers. lt levelled the playing eld for smaller publishers by pro-
viding tools and the framework to ensure their books appeared more often and
more prominently throughout Amazon.coms catalogue of titles. Amazrmcom
Kids was also launched, which became the most comprehensive resource for
children's and young adult books on the World Wide Web.
Amazon.coms expansion programme is evidence of a growth strategy via
acquisitions, strategic relations and intemal development. Since launching
Amazon.com, Bezos has used both strategic relationships and acquisitions to
grow sales. improve services and bring in new customers. Extensive relation-
ships with other dominant lntemet players concluded in i998 reinforced
its momentum as the leading online bookstore. Some of these relationships
included Quicken, Intuit and Yahoo!
0 The agreement with Quicken resulted in Amazon.com becoming Quicken's
exclusive bookseller in the US, and the preferred provider of books in the
UK and Gennany. Quicken.com, :1 leading online personal nance site.
brings together tools. resources and expertise to help empower consumers.
thereby enabling them to make condent investment and nancial choices.
I The agreement with lntuit meant that Amazon.com will be promoted on
the desktop within select Quicken software. Intuit, a nancial software and
I

AMAZON.COM FROM START-UP TO THE NEW MILLENNIUM 581

Web-based services company, developed and marketed Quicken, the leading
personal software; Turbo'Iax, the best-selling tax preparation software; and
QuickBooks. the most popular small business accounting software.
0 During 1998, Yah0o!s globally branded network of World properties
included Web guides in japan, Korea, Canada, Australia and New Zealand.
France, Germany, UK and Ireland, Denmark, Sweden, Norway and Italy.
lt also included language-based websites, Yahoo! hinese and Yahoo! En
Espanol, as well as an English-language site based in Singapore, Yahoo In
Asia. With a far-reaching network of globally branded Yahoo! Properties,
they were in a unique position to provide Amazoncom with the ability to
reach simultaneously a variety of markets and an unsurpassed worldwide
audience. Amazoncom was featured on all Yahoo! World sites.
Amazon.com also expanded by acquiring leading Internet companies. Both
Bookpages (one of the largest online bookstores in the UK) and Teleboole
(ABC Telebuck Germany's no. l online bookstore) were acquired to become
fundamental components of its expansion into the European marketplace.
The sites made available to Europeans a vast selection. guaranteed safety of
transactions, unparalleled convenience. and electronic gift certicates for
worry-free gift~giving.
Amazon.de (Germany) had its headquarters and a distribution centre in
Regensburg and editorial and marketing offices in Munich. The store featured
555,000 titles from German publishers, fast and easy access to 5'7-4,000 US
titles, swift delivery, as well as an array of recommendation features to better
serve book buyers, including instant recommendations. A Munich-based staff
of expert German editors develop reviews and recommendations of German-
title books.
Amazon.C0.uk had headquarters and a distribution centre in Slough,
England. The store carried a complete catalogue of 1.2 million UK titles in
print, fast and easy access to 200,000 US titles, and speedy delivery. A staff of
expert UK editors provides recommendations and reviews.
Internet Movie Database (www.imdh.com) was also acquired. Launched
in 1990, [ntemet Movie Database was a comprehensive repository for movie
and television information on the lntemet and was acquired to support
Amazon.c0m's eventual entry into online video sales.
Everyone at lMDh is excited about becoming a part of l\mazon.eom . . . because
of
their similar passion for hooks. the Ama'/.on.com team understands and fully
supports
lMl)h's mission of providing the best possible information to movie lovers. said
Colin
Needham, lMDb Managing Director.
(Amazoncom. I999)
The company incurred total charges of approximately $55 million in connec-
tion with all three transactions (Amazon.co.uk, Amazonde and imdb.com).
Consideration comprised cash and common stock, and the company antici-
pated issuing an aggregate of approximately 540,000 shares of common stock
as a result of these transactions.
PlanetAll and Junglee were acquired to enrich Amazon.coms e-commerce
experience for customers. PlanetAll had approximately 1.5 niillion members

M AMAZON COM - FROM START-UP TO THE NEW MILLENNIUM

and provided a unique Webbased address book, calendar and reminder
service. Junglee was the leading provider of advanced Wetrbasetl virtual
database technology that could assist shoppers to nd millions of products on
the Intemet. Amazon.com acquired 100 per cent of the outstanding shares and
assumed all outstanding options of Junglee and PlanetA1l in exchange for
equity having an aggregate value of approximately $280 million.
Additional distribution and customer service centres were opened in the UK
and (iermany, and the planned lease of a highly mechaniscd distribution centre
of approximately 325,000 square feet in Femley. Nevadas. was concluded. This
latest addition more than doubled Amazon.com's distribution capacity and
allowed it to further improve time-to-mailbox for customers. lnventories rose
from llS$9 million at the beginning of the year to US$50 million by yearend.
enabling improved product availability and improved product cost through
direct purchasing from manufacturers.
Amazon.coms rst major product expansion took place with the launch of
its music store. which became the leading online music retailer in its rst full
quarter. Once the addition of more than 42,000 classical and opera CDs to its
music store was completed. the store's total number of CDs exceeded 2()(),()()0
- 25 times the selection of a typical music store. with everyday savings of up
to 40 per cent. This addition of music was followed by the addition ol' video
and gifts in November. and Amazon.com became the leading online video
retailer in only six weeks.
It is these economics, a product of being onlinc. that is enabling
Amazon.com to rewrite the retail industry. In 1998. Amazon.com received top
honours in the prestigious Computerworld Smithsonian Award competition.
taking rst place in Business and Related Services. The award recognises those
who have demonstrated vision and leadership in the innovative use of informa-
tion technology. Amazon.com was said to he a driving force behind e-retail.
with technology that allows customers to nd and purchase books in a con-
venient and secure manner (Saunders, 1999, p. 15).Jeff Bezos said of the award:
"We were flattered. of course. but more important this is recognition that online
com-
merce has arrived. Millions of people, not just the digemti. are taking advantage
of the
benets of secure online shopping.
(Quoted in Saunders, 199). p. I6)
1999
Cumulative customer accounts exceeded l7 million in over I50 countries.
Amazon.com had at the end of 1999 built the leading global ecommerce brand
and platform. Repeat customer orders represented more than 73 per cent
of orders. A major focus on customers helped Amazon.com continue to im-
prove customer experience and grow its brand and extend operational reach.
Amazon.com was rated as the most widely recognised e-commerce brand in
the United States, as rated by online shoppers in a nationwide survey by
Opinion Research Corp. Some 117.8 million adults, or 60 per cent of the adult
population in the US, recognised the Amazon.com brand, according to the

._i_ _
_i__ _
AMAZON.COM - FROM START-UP TO THE NEW MILLENNIUM 533
survey. .~\mrt'/.on.com was also rated as the 57th most valuable brand world
wide. just above Hilton. Guinness and Tvlarriott, and just below Pampers. in a
June study of global brands by lnterbrand Newell and Sorrell. Additional
achievements included ratings as:
Q the \lo 1. Toys store. Books. Music. and Video stores. and General Mer-
chandise store in Fon-ester Research's recently released PowerRankingsT-;
Q the best online toy store in a Microsoft (i\4S\'ll(1) survey. barely one month
after the launch of the Aniazoncom Toys Store. beating longer-established
e-commerce players:
0 the No. l place to save money on the Internet. as rated by online shoppers
in zl nationwide survey by Opinion Research Corp. (company provides an
cxtensive research service);
0 the No. l online shopping site and the No. " Web property during Septenr
her. according to Media Metrix;
0 the No. l Video store. the No.l Music store. and the No. l Bookstore by
Gomez Advisors (21 company that provides support to consumers \\'antin_: to
transact onlinc and information to businesses that want to attract and retail
onlinc customers) in their most recent scorecards of onlinc stores in these
categories:
Q the most-visited music storc onlinc, according to (ireencltl ()n|ines stud)
of more than 5.000 COt|SUmL'tS who have shopped for music onlinc.
The compzuty continued to build on its management strength. naming Warren
C. Jenson as its senior vice-president and chief nancial ofcer (CFO). Jcnson
had been executive vice-president and (IEO at Delta Airlines. the largest
domestic
airline. Prior to Delta, jenson was CFO of NBC, a division of (iencral Electric.
jenson came to Amazoncoin with a strong record of achievement in nancial
management. innovative transactions and Wchahascd initiatives. _let't'rey A.
Wilkc
was named vice-president, general manager of operations. Wilke was formerly
vice-president and general manager of Al|icdSignal's Pharmaceutical Fine
Chemicals unit, Wilke was directly responsible for I5 plants/distribution ceri-
tres in the US, Europe and Asia.
Joseph Galli was named president and chief operating otcer and a few
months later was elected onto Amazon.com's board of directors. (ialli ioined
.-\ma7.on.com after a highly successful l9~ycar career with Black 8: Decker
where he had led resurgence in the power tools business. His exceptional per
fomiance reestablished market leadership for the Black 8; Decker brand as he
introduced new products and signicantly improved customer service.
With a focus on offering its customers compelling value for money.
Amazon.com launched a range of new products and services. New products
during 199') included a broad selection of toys and games ranging from new
to speciality toys from hundreds of toy makers and an electronics store
featuring a full range of popular electronics products and brands. Amazon.com
also launched a home improvement centre that had a comprehensive range
of home improvement products, as well as Amnzon.com Advantage-for Video

584 AMAZON COM FROM START-UP TO THE NEW MILLENNIUM

where customers had access to a broad selection of hard-to-nd books. CDs
and videos.
zSI.m/1s and Auctions were also introduced during the year. zShops made
it possible l'or any individual or business to sell through Amaztmcom. reach-
ing more than 15 million experienced online she; pt-rs. zhops enables
anyone to offer nterchandise for sale at Amazon.com, whether they are micro-
manttfactttrers or major manufacturers. small businesses or global corporations.
or specialised retailers. With the launch of 1.Shops. Ama7.on.com introduced
Anta'/.on.com Payments. which allowed individuals to pay for purchases with
credit cards using Amazon.coms l-(Zlick payment feature.
Auctions were aimed at assisting people nd. discover. buy and now sell -
virtually anything online with current Amazon.coms customers being pre-
registered to begin buying and selling immediately in more than 800 product
categories. The new service was easy to use, with innovative and time-saving
features such as Bid-(J|ick for hassle-free bidding. To enhance customer safety.
the .-\ma7.on.com Auctions Guarantee covers purchases of up to US$250 in
the event that a buyer did not receive what a seller promised. ln an important
innovation, sellers will automatically have their auctions cross-ntcrchandised
across Amazon.com's millions of book. CD and video product pages.
New services included Anmzoncrml Cards which consisted of a free elec-
tronic greetings card service. Cards can be sent by visiting www.an1azon.com
and clicking on the e-cards tab. The new site offers diverse styles of electronic
greetings cards and a unique selection. with hundreds of illustrations, pictures.
animated cards. and messages to choose from. Card senders also have the
ability to customise their messages. Anmzoncom Anywlwre is an initiative in
wireless ecommercc that allows customers to shop and check the status oi
auction items at Amazoncom securely when they are away from their desktop
computers (with the national launch of the new Palm Vll""" organiser by 5Com.
Amazon.com's vast selection of merchandise is now accessible to customers
anywhere. anytime).
Am:t1.on.com also introduced Wish List. consisting of an advanced and extens
ive online gift registry (Wish List was the No. I customer request during l998s
holiday shopping season and since its introduction has seen faster adoption
than almost any other feature Amazon.com has offered its customers). The new
All Pruzlucrs .S'em'cI.1 is located in the search box on the upper-left of the
Amazoircom Welcome page and helps shoppers nd anything for sale on
the Net. providing customers with a convenient. easy-to-use guide for nding
and discovering exactly what they want among the Net's millions of offerings.
An expanded and improved Recmnmenrlations Centre offers music fans
authoritative guides to the hcst CDs in more than I00 music styles. Designed
to help beginners and expens alike. the new features included introductions to
a wide range of music styles. as well as a comprehensive guide to essential CDs
by style. artist and year. Purchase (Iirc!es"'M features thousands of bestseller
lists for hometowns. workplaces. universities. and more.
A relationship between Dell and Amaz0n.com was concluded. Both
Dell.com zutd AmazQn.com launched links from the checkout sections of their
respective sites that led to new. cobrztnded Dell and Ama7.on.com home pages.
The sites recognise and welcome customers to the full www.amazon.com and
y.
l
AMAZON.COM FROM START-UP T0 THE NEW MILLENNIUM 585
www.dell.com online experience. Amazon.com is the rst company Dell has
linked to from its www.dell.c0m site, and Dell is the rst computer system
company Amazon.com has linked to.
Amazon.com also announced strategic investment in the following com-
panies that it believes share its passion for bringing, customers value through
selection, service. convenience and community:
Q Drttgstorecom. an online source for thousands of brand-name health.
beauty and wellness products. Amazon.com has an investment of approxi-
mately 46 per cent of Drugstore.coms outstanding Shares.
0 PeLs.com, the leading pet-oriented company on the lntemet, specialising in
popular and rare pet accessories, products and food for all types of animals.
0 As pan of the strategic relationship with Amazon.com. Della 8: Jamess wed-
ding gift registry is available through Amazon.com. enabling Amazon.com's
15 million customers to nd wedding registries and purchase wedding
gifts through Della 8: James. Della &_lames was the rst company to bring
together wedding registries front a broad selection of premier national
retailers and local stores, creating the best way to register for and purchase
wedding gifts.
Q Amaz0n.com's investment will give it a 55 per cent stake in
HomeGrocer.con1 and allow the online grocer. which served customers
in the Seattle, Washington, and Portland, Oregon. areas. to accelerate its
national rollout. HomeGrocer was the rst fully integrated lnternet grocery
shopping and home delivery service.
l 0 Amazon.coms investment in Gearcom gives its customers access to the
only lntemet store to offer l0() per cent closeout merchandise (in a com-
pany staffed by knowledgeable sports enthusiasts) in all sports categories.
Sporting goods closeouts resulted front overproduction, a change of style.
colour, or function, and the cancellation of pre-season orders placed by
retailers. Merchandise is new and comes in mint condition and original
packaging.
Amazon.com also expanded by acquiring the following lnternet companies.
Amazon.com acquired l1>ccl1ange.mn1, the premier online marketplace for
hard~to-nd antiquarian hooks, thereby adding more than 12 million books and
music items for sale and auction. Bi!7Il'11ml.com was acquired for its ntnge of
used books While Musiclacam was acquired for hard-ttrnd recordings and
music memorabilia. Adding LiveBids technology and services to Amazon.com
Auctions expanded the breadth and types of items customers could nd and
gave local and regional auction houses full access to at vast Internet auction
community (LiveBi:i.c0n1 was the sole provider of live-event auctions on the
Internet).
Amazon.com substantially increased its customer-service capability and
increased distribution square footage from roughly 500.000 square feet to over
5 million square feet in less than 12 months at several distribution centres
nationwide - more than l0 times the distribution centre floor space the com-
pany had in 1998. With its IT and distribution centre investments, Amazon.com
was clearly building supply ahead of demand (Exhibit 1).

l
I
l
5 /\MAZON.COM FROM START-UP T0 THE NEW MILLENNIUM
Distribution centre locations (November 1999)
225' <$ -1? 10 Q);
Seattle WA Qb ac (1998) Z
0 _ United Kin *
R? *1 U,//E? f oc (1998)
F / Germany
oc (1999)
i Kentucky L DC (1999)
A Dc (1999) a 0 Germany
Kentucky L!
DC (1997) F
Delaware
*1; DC (1999) V5
DC (1998) Georgia
Nevada
DC (1999) <
Kansas U
* DC = Distribution Centre
Head Office & DC
6
Q2
Some of the expansion plans completed in 1999 included the leasing of a
-i6().()0(squarefoot distribution facility in Coffeyvillc, Kansas, which enabled
faster delivery to AmlZ0n.COn'i customers across the Midwest and southeast
United States. This was expanded to :1 75().OO(l-square-foot distribution facility
with the result being that customers in such places :l.\ (lhicago. St Louis, Dallas
and Minneapolis would receive their orders much taster. as :1 consequence of
deeper inventory. faster processing and shorter delivery times. Amazur1.com's
highly mechanised 522.6(square-foot facility in Fernley. Nevada, began Ship
ping on a limited basis. increasing availability and improving delivery times
for customers in the western US. The acquisition of two Kentucky distribution
centres also played an integral role in the companys overall global logistics
strategy. The existing 5'/0i0()0-square-foot (lampebellsville facility was
expanded to approximately 770,000 square feet and the Lexington facility
has a capacity of 600,000 square feet. The acquisition of a highly mechanised
distribution facility in McDoi-tough. Georgia, allowed the company to reduce
standard shipping times to customers in key markets in the southeastern US
This 800,00(square-foot distribution centre was the largest Amazon.com distri-
bution facility to date. Amal.on.de also leased a new distribution centre in Bad
Hersfeld. Germany, which began operations during the second half of 1999.

AMAZONIOM FROM STARTUP T0 THE NEW MILLENNIUM 687

2000
Amazon.com celebrated its ve-year anniversary in July with over 15 million
cumulative customers and continued to grow its customer base so that
worldwide cumulative customer accounts increased to over 25 million as of
September 2000. Sales per active customer for the twelve months ending
50 September 2000 were $l50,l)U. up from $108.00 for the same period a
year ago. Gross margin for the third qttarter was 2o per cent. up from 20 per
cent for the third quam-r of 1999.
Our vision rcmains being Earths most LlI$ll)mt:l'1ILnil'iK.' company, the best
place for
customers to nd and discover anything they want to buy online. said Jeff Bezns.
Amazonxom founder and (IEO. While we continue to sec improvements in all of
our
businesses. we are especially pleased with the protability in our (LS. Hooks.
Music
and Video group and the unusual growth in otir Electronics store. For the
company
as a whole, we're well on our way to achieving our 2000 objectives.
(Antttzmtcom jnl Quarler 200!) Report, 2000)
Achievements for the 2000 nancial year included the following:
0 The Worlds Most Valuable Brands 2000, 1nterhr.tnds annual survey. valued
the Amazonicom brand as the 48th most valuable brand in the world, up
from 57th in I999
O The Amazon Tools and Hardware. Toys. \"ideo/DVD. Mtlsic. Books and
Home Living stores were named the overall top stores in their respective
categories in the most recent Gomez lntemct Scorecard and/or Forrester
Research PoWerRankings.
0 A rst - Amazoncom panncred with Stephen King to provide online pay-
ment services for downloading instalments of 7710 Plant. a new episodic
novel that can be found at www,amazon.com/stephenking,
0 Amazoncom, in connection with a strategic alliance with 'l'oysrus.com_
latmched a co-branded toy store. The new nnlinc store combined the
strengths of the two e-tailers prior stores, to bring customers the best toy~
buying experience available online:
0 Microsoft Corp. (NASDAQ: MSFT) announced that its Microsoft Reader bad
been selected by Antazottcom as the preferred format for Amazon.coms
forthcoming c-Books store.
0 Amazoncom launched a Camera & Photo store, offering digital and lm
cameras, optical gear, and accessories, and announced an alliance with
Ofoto, lnc., a premier online photography sewice.
0 Apple (NASDAQ: AAPL) announced that it had licensed .-\mazon.com'.~;
1-Click patent and trademark for use in its Apple Onlinc Storct as part of an
ecommcrce patent crosslicensing agreement.
0 Ama7.nn.com launched a Computer 8: Video Games store, offering the
largest selection of computer and video games and accessories available,
online or offline, to provide a one-stop gaming destination for'both casual
and hard-core gaming enthusiasts.

6 AMAZON COM FROM START-UP T0 THE NEW MILLENNIUM

0 Amazoncom launched a new-car buying service, providing customers
with a superior car-buying experience backed by service and support from
an expansive network of premier auto dealers atliated with its partner
(ireenlightcom.
Amazon Anywhere. Amazon.coms mobile e-commerce initiative, extended
beyond Amazoncom and Amazon.co.uk to provide easy access to Amazontde
using the Wireless Application Protocol. The global Amazon Anywhere init-
iative underscores Amaz0n.com's commitment to enhancing the customer's
buying experience with the convenience, safety and speed of state-of-the-art
Wireless commerce.
This global mobile e-commerce initiative using WAP was one of many
global initiatives. Key global expansion initiatives during 2000 included the
following:
0 According to the MMXI Europe May 2000 European Audience Ratings
Report. the Amazon.co.uk, Amazon.de and Amazon.com sites were the top
three online retail sites based on reach.
0 Within the third quarter. Amazon.co.uk added Software and Video Games
stores and Amazon.de added a Video Games store.
0 Amazoncom launched Amazon.fr. a French-language site offering books,
music (IDs. DVDs and videos dedicated to customers in France and to
French-speaking customers around the world. Amazon.fr was named the
best overall online retailer by leading French publications Capital, [.0
illmule and journal du Net.
0 Amazon.de launched a Software store.
0 Amazoncom launched Anta7.on.co.jp with a comprehensive catalogue of
Japanese and foreign books for Japanese speakers worldwide.
Many new product and technology expansions were undertaken in 2000. Some
of these selection extensions and partnerships for 2000 included:
0 Ama'/.on.com launched the Amazon Kitchen store (www.amazon.com/
kitchen). featuring thousands of culinary products and accessories alongside
indepth editorial content. including original product reviews, recipes, and
cooking and entertaining tips.
0 Amazon.com launched a Home Living store, providing Arnazon.com cus-
tomers direct access to livingcom from the top of Arnazon.eoms welcome
page. Home Living visitors can shop for fumiture, decorative accessories.
bed and bath linens. lighting and rugs.
Q Amazon.com introduced the Amaz0n.com NextCard Visa, offering no
annual fee and the ability to purchase both online and offline while earning
reward points that can be redeemed for Amazoncom gift certicates.
Q Amtr/.on.com announced the availability of more than 22,000 hours of spoken
audio content from Audible. Inc. Located within the Amazon bookstore, the
new audible.com Audio Downloads Store is the only place Amazomeom
customers can nd more than 4,700 audiobooks plus a vast array of
comedy. audio newspapers, magazines. speeches. lectures, language lessons.

AMAZON.COM - FROM START-UP TO THE NEW MILLENNIUM G89

motiyattional programmes, business information and subscriptions to public
radio programmes.
0 Amazon Books added Spanish Language, Large Print and Gay 8: Leslvian
stores within the Amazon bookstore.
O Amazon Music. the No. 1 online music retailer. added several new areas to
its store, including Bargain i\/lusic. Music Accessories and Classical for
Beginners, and it opened the .\lusic Lovers Lounge. which features exclusive
live streaming concerts. artist spotlights. interviews. digital downloads and
discussion boards.
0 Amazon.com entered into an agreement with lle\\'lett~Packa|'d to he
Amazun.c0m's primary Internet inirastrucuire provider and become an
anchor tenant in the Ama'/.on lilectronics store. providing Ama7.on.eoms
customers with an even more extensive selection of Ill products.
0 The Amazon Electronics store also added Handspring \'isor handheld
computers to its ever-growing electronics selection. Handspring appointed
Amazon Electronics as thc exclusive online reseller l'or its Visor and Visor
Deluxe handheld computers through July zooo.
0 Amazon.com's DVD store. the largest online retailer of l)\/Ds. has become
thc top retailer (online or oflline) for pre-order sales of many of the
industry's top DVDs. including the highly anticipated .2) .\ugust I3mt'el.n'r/1'!
l)Vl) release. \vith over l(i.l)(l() units ordered to date.
0 Amazon zShops introduced new storefront features that offer sellers custom
browse. search. featured items. merchant photos and business description
functionality.
The company continued to recruit for its management strength. naming Paul
Misener vice-president oi global puhlic policy. Mr Misener joined Arnazon.com
from the Washington. l)(I. law rm of Wiley, Rein & Fielding. where he was at
partner and chaimiztn of the e-commerce and Internet practice group. He was
fomlerly manager of telecommunications and computer technology policy at
Intel Corps where he also co-founded and led the Internet Access Coalition.
Mr Misener is a 1985 graduate of Princeton University with a BSE in electrical
engineering and computer science and has a _|l) from the George Mason
University School of Law. .
The company also named l)iego Piacentini senior vice-president and gen-
eral manager - International. From April W9? until joining Amazoncom. he
was vice-president and general manager, Europe. of Apple Computer. lnc., with
responsibility for Apple Computers operations in Europe. the Middle Fast and
Africa. From April I996 to April I997. he was European sales director of Apple
Computer. lnc.. from May I995 until April I996, he was general manager of
Apple (Iomputefs Italy operations. and before that. from September 1994 to
May W95. he was Apple (Iomputer's sales director for ltaly. He joined Apple
(lomputer in l987. Prior to that time he held a tinaneial management position
at Fiatimpresit in ltaly. Mr Piaecntini received zt degree in economics from
Bocconi University in Milan. ltaly. in 198%.
Amazon.com also announced strategic investment in the following com-
panies that it believes share its passion for bringing customers value through

G90 AMAZON COM - FROM START-UP TO THE NEW MILLENNIUM

selection. service. convenience and community. The rst of these is
Asltfordcom. :ul online retailer of luxury and premium products offering new
and vintage watches. fragrances. leather accessories, sunglasses, and writing
instruments, at wwvw.asliford.com. Another one of these was eZib:|.cum. a
leading online retailer of ltantlerafted products front around the world, at
w\\'w.el.iba.com.
Sales for the nal quarter of 2000 were expected to be between S950 mil-
lion and $1.05 billion. Gross margin was expected to he seasonally down com-
pared to the third quarter of 2000. although up strongly over the fourth quarter
of I99). Pro fom1a operating losses are expected to he between 5 and 8 per
cent of sales. Cash and marketable securities at year~end arc expected to he
over $1 billion.
Z001
Some projections for the 200] nancial year include:
0 Sales are expected to be approximately $4 billion.
I Pro forma loss from operations is expected to narrow to less than 3 per cent
of sales, perhaps substantially so.
0 (lash and marketable securities as of 51 March 2001 are expected to be
approximately S"U() million, and the company expects to generate
signicant positive cash flow from operations for the nine months ended
5| December 2001.
DEFINING THE BUSINESS
It would seem that the vision behind Amazoneom has changed over the past
ve years. although if anhing. the vision has been expanded beyond creating
a successful online bookstore. to creating a successful cyberstore with the
worlds largest selection. During I-)9). Jeff Bezos otttlined a vision, to he the
world's most custontercetttric company. and in conjunction with the desire
to he the place where people come to nd and discover anything they might
want to buy online'.
Amazoneom is more fomtally dened as an onlinc retailer offering a range
of products and services that are broader than its speciality retail sector
comparisons allow. Since opening for business as 'Eanh's Biggest Bookstore in
July I995. Amazoncom has changed focus and quickly become one of the
most widely known. used and Cited retail commerce sites on the Web. What
makes Antazoncorn different is that it is clearly an lntemet-based company
that develops proprietary software to make its retail operations work. Industry
analysts have suggested during l'~)99 (due to the increasing growth in product
offerings over 1998/ 1999) that Amazonconfs offering may soon be as various
as those offered by Wal-Mart.
Despite Amazon.cum's growth over the past ve years, its strategic focus has
remained on the customer. The focus is on creating a customer experience

AMAZON.COM - FROM START-UP TO THE NEW MILLENNIUM 591

(front the rst time a potential customer types in amazon.com on an Internet
browser to after the package has arrived at the customer's door) that is com-
pelling enough to get the person to retum. By establishing a new business
model. Amazoncom has fullled one of its primary goals to change the
way business is conducted. While the book market was a starting-point for
Amazoncom. the company now oversees a network of lntemet sites. which
offer a constantly expanding host of other consumer goods.
The key components of Arnazon.coms offerings include browsing. searching.
reviews and content. recommendations and personalisations. 1-Click technol-
ogy. secure credit card payment and availability and fullment:
I Brutusing: The Amazoncom site offers visitors a variety of features arranged
in a simple. easywtouse fashion intended to enhance product search and
selection.
0 Svurclaiitgz A primary feature of Amazoneom websites is their interactive.
scarchable catalogues of books. music CD. video. DVD. computer games
and other titles. The company provides a selection of search tools to nd
products based on keyword. title. subject, author. artist. musical instrument.
label. actor, director, publication date or ISBN. Customers can also use more
complex and precise search tools such as Boolean search queries.
I Reviews and conleul: Amal.on.com stores offer numerous forms of content
to enhance the customer's shopping experience and encourage purchases.
\"arious types of content are available for particular titles. including cover
art. synopses. annotations. review by editorial staff and other customers. and
interviews by authors and artists.
0 Rucmnmemlations zmrl /Jersnmtlisaollsz Amazon.com personalises its
product and service offerings. These features include greeting customers
by name, instant and personalised recommendations. bestseller and chart-
topper listings. personal notication senices, purchase pattern ltering and
a number of other rclatctl features.
0 I-Click technology: Amazon.com offers a streamlined ordering process
using l-Click technology. lfa customer has previously activated 1-Click func-
tionality. he or she can place an order by clicking one button without having
to ll out an order form The customer's shipping, and billing information is
automatically referenced on the eompanys secure server.
O Secure credit card /mymenlz .~\mazon.com utilises secure server software
for secure commerce transactions. it encrypts all of a customer's personal
information. including crctlit card number. name and address. so that it
cannot be read as the information travels over the lntemet.
0 .4t'm'1n(:iIit_1' amlfuf/ilnwrtlt Most of the company products are available for
shipment within 24 hours. others are available within 2-5 days and the
remainder are generally available within 4-6 weeks.

AMAZON COM FROM START-UP T0 THE NEW MILLENNIUM

Critical organisational divisions
Amazoncom has rapidly and signicantly expanded its staff both in the USA
and intemationally to keep pace with the operational requirements and will
further expand its current staff levels to address potential growth of its pro-
duct, service oerings and customer base. The expansion. training and manage
mcnt of employees will be crucial to its long-term protability Its current and
planned personnel. systems. procedures and controls will continue to he under
pressure to support and effectively manage its future operations. The ability to
hire, train, retain. motivate and manage staff may limit its growth.
Within the company there are three critical divisions. but it is probable
that as the company continues with its rapid growth. its structure is likely to
change:
0 Product development: includes everything that involves the website as
a product to customers. Departments Within this area include editorial,
marketing, as well as site design and site navigation.
0 Technology: The technology drives the organisation - it is the systems that
drive the functionality for the customer. The technology group consists of
developers who work on e-merchandising, product databases. information
technology systems (fullment, distribution-centre software. as well as
nance and human resources software). and all the engineering that cus-
tomers experience on the website, including i-Click Shopping, a recom-
mendations centre, and search features. While there is overlap between all
departments, it can be broken down into wehsite development and hack-
end fullment systems.
I Supply chain and distribution: Operations staff, together with those in
the distribution centres, report to the chief logistics ofcer (CLO). Customer
service also falls under this group. The operations business unit includes dis-
tribution, supply chain management. and the engineering and logistics
related to creating distribution centres and making them work as effectively
as possible. This is clearly the largest part of the company with the largest
growth potential. Customer Service is a customer-focused service department
that is also one of the largest in Amazon.com - and acts as :1 feeder for the
rest of the organisation.
MARKET POSITIONING
Jeff Bezos studied the hook market before choosing it as :1 starting point
for Amazon.com. But, more importantly. he identied and took advantage
of opportunities with the growth of the lntemet. Bezos has stated that this
know-how is Amazons hardeamed advantage over bamesandnohlecom and
bortlerscom. With increasing competition from a range of online players, this
expertise should make fora level playing eld.

Major US book retailers by revenue (Dec. 1998)

AMAZON.COM - FROM START-UP TO THE NEW MILLENNIUM
COMPANY
98 REVENUES 1-YR GROWTH 98 NET INCOME
(U5$M)
("/o) (U 5$M)
1-vn GROWTH
(%)
Barnes & Noble
Borders
Amazon.com
Books-A-Million
Crown
2,796.9
2,266.0
610
325.8
297.5
14.2 53.2
15.7/o 80.2
413.0 (124.6)
16.6 7.0
3.4 (48.7)
3.9
38.5
N/A
20.7
N/A
Source: Wall Street Journal, 20
August 1998.
US retail market
The US retail market sales total approximately US$2.'7 trillion annually in sales
(1998). and of that, about a quarter comes from general merchandise, apparel
and fumiture sales. Taking every consumer item sold, then taking out cars,
building material and food, the rest (computers, clothing. sports equipment.
and so forth) falls into the total of US retail market sales. These goods are
retailed in department stores, high-volume stores, and speciality stores, and via
catalogues and Websites.
In contrast to traditional retailers, shopping via PC screen, on the Internet,
is growing at an increasing rate, despite early failures of online malls and cyber-
shops. Expected to reach US$50 billion in Z000, sales via the Net are strongest
for companies such as Amazoncom, Dell Computers, Gateway (computers),
and FFD (floral delivery), whose products dont require help with t or
colour.
Amazon.com began in this retail and wholesale sector, with a focus on
books. Amazon.c0ms objective is. however, far broader than books and it aims
to be the leading online retailer of information-based products and services.
A comparison of the major US book retailers ranked by revenues (Exhibit 2)
higltlights that within the retail book segment it is clear that Ama'/.on,com has
a relatively small segment of a very large market and the breakdown shown in
Exhibit 5 indicates the relative market share of the different players.
Amazon.coms primary sector is that of services Its if1(1LlSif has been
dened as speciality retail although much of its competition is clearly within
the electronic commerce medium. While it is difficult to detail the exact indus-
try position of Amazon.com, there are strong signals from Jeff Bezos as the fol-
lowing statement made during 1999 highlights:
Sixteen months ago. we were zl place we could come to nd books, he said.
Tomorrow. we will be a place to nd anything, with a capital A.
(Amazoncom, I999)
If Amazon.coms position is compared to other C0l1l]X-l.lli5 that are similar -
all
of them being lnternetbased companies - it is clear that Amaznn.c0m is one of
the leading Internet-based companies in the world,
694 AMAZON COM FROM START-UP TO THE NEW MILLENNIUM
Market share of retail store sectors (Dec. 1998)
COMPANY /n OF MARKET AMOUNT (US$BN)
Superstores (Barnes & Noble, Borders) 25.2 4.23
Book clubs 20.0 3.36
Independent bookstores 17.2 2.89
Price clubs 6.0 1.01
Massmerchandisers (WalMart) 5.9 0.99
Amazon.com 3.0 0.6
Other 22.7 3.89
Total 100.0 16.8
Source Wall Street Journal, 20 August 1998.
Geographic expansion
While AlT|2lI.0fl.C0l'l1 delivers books and other products to over 160 countries
throughout the World. its dominant focus remains in the US. mainly due to the
growth in electronic commerce. ln April 1998, Amazoncom acqtiircd three
lntemet companies in the United Kingdom and Germany. ln October I998. the
company relaunched two of these businesses under the Amazon.com bmnd.
The company ineorpomted An1:tzt>n.con1's technology and look-and-feel into
the
European sites. www.amazon.co.uk (United Kingdom) and wW\v.nma7.on.de
(Germany). Expansions into the UK and Germany have been very successful.
and following expansions into France (Amazonfr) and japan (Amazon.eo.ip)
its global expansion is well under way.
BUILDING THE TEAM
Bezos has brought together a talented and diverse group of people who are
enthusiastic about making An1azon.com a success. He has also given them a
sense of ownership through generous stock option incentives. Amazoneom.
Inc. had 2.l()tl employees at the I998 nancial year-end, a signicant change
from the I997 yearend gure of 868 employees, and 151 in I996. This repres-
ents a Z42 per cent growth in employee numbers over the 1998 nancial year.
Along with Bezos. the vice-presidents make the strategic decisions. (Group
directors and managers report to a vicepresident. Despite this. many employees
insist that Aniazoncom is an extremely tlat organisation. The executive-level
staff are composed of highly skilled and experienced staff, many of whom came
from large US organisations. The full team details can be found in Exhibit 4.
STRATEGIC CHOICES
The fact that Amazoncom has yet to make a prot has resulted in some
investment managers taking their money elsewhere. Bezos has expressed

AMAZON.COM -- FROM START-UP T0 THE NEW MILLENNIUM 695

Senior executive staff (Nov. 2000)
flQ
Chairman of the Board, Chief Executive Officer, President, Chief Operating Officer
Mr Bezos became President and Chief Operating Officer on Z5 July 2000 and has
been Chairman of the
Board of Amazon.com since founding it in 1994 and Chief Executive Officer since
May 1996. Mr Bezos
served as President from founding until June 1999 and Treasurer and Secretary
from May 1996 to March
1997. From December 1990 to June 1094, Mr Bezos was employed by D.E. Shaw
& Co., a Wall Street
investment rm, becoming Senior Vice President in 1992. From April 1988 to
December 1990, Mr Bezos was
employed by Bankers Trust Company, becoming Vice President in February 1990.
Mr Bezos is also a
Director of drugstore.com, inc. Mr Bezos received his BS in Electrical Engineering
and Computer Science
from Princeton University.
N
Director
Tom A. Alberg has been a Director of the Company since June 1996. Mr Alberg
has been a Principal in
Madrona Investment Group, L.L.C., a private merchant banking rm, since
January 1996. From April 1991
to October 1995, he was President and a Director of LIN Broadcasting
Corporation, and from July 1990 to
October 1995, he was Executive Vice President of McCaw Cellular
Communication, lnc.; both companies
were providers of cellular telephone services and are now part of AT&T Corp.
Prior to 1990, Mr Alberg was
a partner of the law rm Perkins Coie, where he also sewed as Chairman of the
rms Executive
Committee. Mr Alberg is also a Director of Active Voice Corporation, Advanced
Digital Information
Corporation, Emeritus Corporation, Mosaix, lnc., Teledesic Corporation and Visio
Corporation. Mr Alberg
received his BA from Harvard University and his J.D. from Columbia University.
mk
Director
Scott D. Cook has been a Director of the Company since January 1997. Mr Cook
co-founded lntuit, lnc., a
leading personal nance, tax and accounting software company, in 1983, served
as President and
Chairman of the Board of Intuit since that time until April 1994 and has served as
its Chairman of the Board
since April 1994. Prior to co-founding intuit, Mr Cook was a consultant for. Bain &
Company, a strategy
consulting rm, and a brand manager for Proctor & Gamble. Mr Cook is also a
Director of Broderbund
Software, Inc. and Intuit. Mr Cook received his BA in Mathematics and Economics
from the University of
Southern California and his MBA from Harvard Business School.
Ilo.eu.L._.I_ohn_(QJ
Director
L. John Doerr has been a Director of the Company since June 1996. Mr Doerr has
been a general partner
of Kleiner Perkins Caueld & Byers, a venture capital rm, since September
1980. Prior to joining Kleiner
Perkins Caueld & Byers, Mr Doerr was employed by Intel Corporation for ve
years. Mr Doerr is also a
director of Intuit, Macromedia, lnc., Netscape Communications Corporation,
Platinum Software, Inc. and
Sun Microsystems, as well as several private companies. Mr Doerr received his
MEE and BSEE from Rice
University and his MBA from Harvard Business School.

Director
Patricia Q. Stonesifer has been a Director of the Company since February 1997.
Ms Stonesifer is President
and Chairman of the Board of the Gates Library Foundation, which is dedicated to
partnering with public
libraries to bring access to computers, the Internet and digital information for
patrons in low-income
communities in the United States and Canada. Prior to joining the Gates Library
Foundation, Ms Stonesifer

696 AMAZON.COM - FROM START-UP T0 THE NEW MILLENNIUM

Exhibit 4 Continued
ran her own management consulting rm whose clients included DreamWorks
SKG. From 1988 to 1997,
Ms Stonesifer worked in many roles at Microsoft, most recently as Senior Vice
President of the Interactive
Media Division. In that role, she managed Microsoft's investment in new online
content and service
products, notably MSNBC on the Internet. Ms Stonesifer is a Director of the Fund
for America's Libraries
and Kinko's, Inc. Ms Stonesifer received her BA in General Studies from Indiana
University.
Leus_o_n._mLaccen_<;._(4Z)
* Senior Vice President, Chief Financial Officer, Chief Accounting Officer
Mr Jenson joined Amazon.com in September 1999 as Senior Vice President,_Chief
Financial Officer and
Chief Accounting Officer. Before joining Amazon.com, Mr Jenson was the Chief
Financial Officer and
Executive Vice President for Delta Air Lines from April 1998 to September 1999.
From September 1992 to
April 1998, Mr Jenson sewed as Chief Financial Officer and Senior Vice President
for the National
Broadcasting Company (NBC), a subsidiary of General Electric, and participated
in efforts to develop
MSNBC, the cablelnternet joint news venture between NBC and Microsoft. Mr
Jenson earned his Masters
of Accountancy ~ Business Taxation, and BS in Accounting from Brigham Young
University.
Piagentigi, Diego (391
Senior Vice President and General Manager lntemational
Mr Piacentini joined Amazon.com as Seniorvice President and General Manager,
International in February
2000. From April I997 until joining Amazon.com, Mr Piacentini was Vice President
and General Manager,
Europe of Apple Computer, lnc., with responsibility for Apple Computer-s
operations in Europe, the
Middle East and Africa. From April 1996 to April 1997, Mr Piacentini was European
Sales Director of Apple
Computer, Inc. From May 1995 until April 1996, Mr Piacentini was General
Manager of Apple Computer's
Italy operations, and before that, from September 1994 to May 1995, Mr
Piacentini was Apple Computer's
Sales Director for Italy. Mr Piacentini joined Apple Computer in 1987. Prior to that
time he held a nancial
management position at Fiatimpresit in Italy. Mr Piacentini received a degree in
Economics from Bocconi
University in Milan, Italy in 1985.
Bislle-.r._mhn_l1._iM)
Senior Vice President and General Manager, US Retail Group
Mr Risher has sewed Amazon.com as Senior Vice President and General Manager,
US Retail Group since
February 2000. Mr Risher joined Amazon.com in February 1997 as Vice President
of Product Development.
Mr Risher served as Senior Vice President of Product Development from
November I997 to February 2000
and as Vice President of Product Development from February 1997 to November
1997. From July I991 to
February I997, Mr Risher held a variety of marketing and project management
positions at Microsoft
Corporation, including Team Manager for Microsoft Access and Founder and
Product Unit Manager for MS
Investor, Microsoft's Web site for personal investment. Mr Risher received his BA
in Comparative Literature
from Princeton University and his MBA from Hanrard Business School.
Peek, Mark S. [Q1
' Vice President Finance
Mr Peek joined Amazon.com in March Z000 as Vice President, Finance, and has
been selected to become
Chief Accounting Officer beginning 1 April 2000. Prior to joining Amazon.com, Mr
Peek was, since 1990,
a partner at the independent public accounting rm of Deloitte & Touche LLP
where he served as lead
partner for a number of that rms multinational technology clients. Mr Peek
joined Deloitte & Touche in
1980. He received a BS in Accounting, Economics and International Business in
1980 from Minnesota State
University.

AMAZON.COM FROM START-UP TO THE NEW MILLENNIUM 597

willge, Jeflgey A. (33)
Vice President and General Manager of Operations
Mr Wilke has sewed as Vice President and General Manager, Operations since
September 1999. Previously,
Mr Wilke held a variety of positions at AlliedSignal from 1995 to 1999, including
Vice President and
General Manager of the Pharmaceutical Fine Chemicals unit from March 1999 to
September 1999 and
General Manager of the Carbon Materials and Technologies unit from August
1997 to February 1999. Prior
to his employment at AlliedSignal, he was an information technology consultant
with Andersen
Consulting. He received a ESE in Chemical Engineering from Princeton University
and has an MBA and
Master of Science in Chemical Engineering from the Massachusetts Institute of
Technology.
Q$l=_dLKi;han'l_L._(21
Vice President, Chief Information Officer
Mr Dalzell joined Amazon.com in August 1997 as Vice President and Chief
Information Officer. From
February 1990 to August 1997, Mr Dalzell held several management positions
within the Information
Systems Division at Wal-Mart Stores, lnc., including Vice President of Information
Systems from January
1994 to August 1997. From 1987 to 1990, Mr Dalzell acted as the Business
Development Manager for
E-Systems, Inc. Prior to joining E~Systems, Inc. he served seven years in the
United States Army as a
teleprocessing officer. Mr Dalzell received a BS in Engineering from the United
States Military Academy,
West Point. ~
EIZISIQ-_M.ii2l$.L_fl5)
. Vice President, Strategic Alliances
Mr Brirto has served as Vice President, Strategic Alliances since August 1999.
From June 1999 to August
1999, Mr Britto served as Director of Business Development. Mr Britto joined
Amazon.com in June 1999 as
part of the acquisition of Accept.com, which he co-founded in October 1998 and
sen/ed as a Vice President.
From October 1994 through October 1998, Mr Britto was Executive Vice President
of Credit Policy at
FirstUSA Bank, where he was responsible for their credit risk management
practice. Prior to that, he sewed
as Senior Vice President of Risk Management at NationsBank. Mr Britto received
an MS in Operations
Research and a HS in industrial Engineering and Operations Research from the
University of California at
Berkeley.
Mimer.auLE.
Vice President, Global Public Policy
Mr Misener joins Amazon.com from the Washington, D.C., law rm of Wiley, Rein
8| Fielding, where he
was a Partner and Chairman of the e-commerce and Internet practice group. He
was formerly manager of
, telecommunications and computer technology policy at Intel Corp, where he
also co-founded and led the
Internet Access Coalition. Mr Misener is a 1985 graduate of Princeton University
with a BSE in Electrical
Engineering and Computer Science and has a JD from the George Mason
University School of Law.

698 AMAZON COM FROM START~UP TO THE NEW MILLENNIUM

more concerns that to focus on prohtability could tlistmct the management
attention from what he considers to be more critical business, which is, in his
opinion, introducing more and more customers to Amazoncom. Bezos sees
Amazottcom in what he calls an Tmieslmeril plmse. not unusual for a rm in
its rst ve years. The Imrves! cycle will come later, he has said.
investors point to the fact that the retailer only need bring more customers
to its single online site, not build stores of bricks and mortar to raise sales.
According to an interview with Jeff Bezos during 1999, he highlighted an
aspect of Amazon.eoms growth strategy (after being questioned on its lack
of protability) by stating that:
We're focused on longtcrm retums for investors. And to throttle back on
investment
now would be shortsighted. When we have less opportunity that will probably
happen. but as long as We have lots of opportunity, we're going to continue to
invest
commensurate with that opportunity in a very disciplined and methodological
way.
hut in a long-term context. To do anything else. we believe. is irrational.
(Quoted in Hot", 1999)
Amazon.com is clearly showing at commitment to long-term nancial results,
managing the business for ROIC and prots and not for per cent margin. Exiti-
bits 5, 6 and 7 give consolidated statements of operations. cash flows and
balance sheets for 1994 -1999. Exhibit 8 shows stock trends May l997Octoher
2000 and Exhibit 9 gives a market guide ratio comparison at November 2000.
In conjunction with Bezos, joy Covey (chief nancial ofcer) stated that:
We've always said we would sacrice short-term prots to generate long-term
value
for our customers. I think investors will punish us if we stray from that. Right
now.
they see us making tlccisions consistent with what we've said.
(Quoted in Koselka. 1999)
The company intends to continue developing itsdistribution infrastructure to
increase cfciency and to support greater demand. Similarly, the company has
implemented numerous site management. search, customer interaction. recom-
mendation, transaction processing and fullment services and systems using a
combination of its own proprietary technologies and commercially available.
licensed technologies. The company's can-ent strategy aims to focus its develop-
ment effotts on creating and enhancing the specialised proprietary software
that is unique to its business and to license or acquire commercially developed
technology for other applications where available and appropriate.
COMPETITIVE RIVALRY
Bezos recognizes that quality service is a moving target and believes that once
you satisfy customers in one area. their needs shift and Al|l2lZOii.C(JiiI has to
be alert to these changes and innovate or adapt to meet these new needs
(that may mean acquisition and strategic alliances). There is also a necessity to
constantly reinvent oneself to remain competitive (as the increasing rivalny
between Amazoncom and barnesztndnoblecom intensities). Bczos sees a prob-
lem with an obsession with competition:

I
AMAZON.COM FROM START-UP T0 THE NEW MILLENNIUM IQ
Consolidated statement of operations (in US$'000, except per share
data)
JULY 5TH YEAR YEAR YEAR YEAR YEAR
DEC 3151', ENDED ENDED ENDED ENDED ENDED
1994 DEC 1995 DEC 1996 DEC 1997 DEC 1998 DEC 1999
Sales
Cost of Sales
Gross Prot
Operating expenses:
Marketing and sales
Technology & content
General and administrative
Merger and acquisition related costs
Stock-based compensation
Amortisation of goodwill & other
intangibles
Merger. acquisiton & investment
related costs
Unusual expenses (income) '
Other operating expenses
Total operating expenses
Loss from operations
Interest income
Interest expense
Other expense, net
Net interest income (expense)
Loss before equity in losses of
equity-method investees
Equity in losses of equity-method
investees
511 15,746 147,787
409 12,287 118.969
609,996 1,639,800
476,155 1,349,200
38
14
102 3,459 28,818
200 6,090 40,486
171 2,401 13,916
35 1,41 1 7,011
133,841 290,600
133,023 483,300
46,807 159,700
1 5,799
50,172
214,700
- 8,100
- 30,600
52
406 9.902 61,413
24s,ao1 3,245,600
(52)
(304) (6,443) (32, 595)
1 202 1,901
- 1 (5) (326)
(111,960) (1,955,000)
14,053 45,500
(26,639) (39,100)
1,700
1 197 1,575
_(12,sas)_ 6,400
(52)
(303) (6,246) (31,020)
(124, 546) (1 ,948,600)
Net loss (52) (303)_ J,Z46)_ (31,020)
Basic and diluted loss per share (QQQ) (Q QQ) (_Q,Q) (Q Z5)
Sharesused in computation of pro
(1241545) (L948i5)
forma basic and diluted loss per share 79,146 86.364 111,271 130,341
Source: Arnazoncom, lnc., 2000.
_(9$l. ii"
14a,112 -
The obsession should be with dening the future needs of customers and
translating
that information into innovations that give the rm a competitive edge . . . Intel
Chairman Andy Grove taught us all that only the paranoid survive, and hes
right . . .
but the thing that drives everything is creating genuine value for customers.
Nothing
happens without that.
THEFUTURE
The lntemet is an increasingly signicant global medium for onlinc commerce
and Amazoncom appears to be well positioned to capitalise on this growth.

7170 AMAZON.COM - FROM START-UP T0 THE NEW MILLENNIUM

Consolidated statement of cash flows (in US$'000)
YEAR ENDED YEAR ENDED YEAR ENDED YEAR ENDED
DEC 315T.
1996
DEC 3151,
1997
DEC 315T, DEC 315T,
1998 1999
OPERATING ACTIVITIES
Net loss
Adjustments to reconcile net loss to net cash
provided by (used in) operating activities:
Depreciation and amortisation
Amortisation of deferred comp . . . related
to stock options
Non-cash merger and acquisition related costs,
including amortisation of goodwill and other
purchased intangibles
Equity in losses of equity-method investees
Non-cash revenue for advertising &
promotional services
Loss on sale of marketable securities Non-cash
interest expense
Changes in operating assets and liabilities:
Inventories
Prepaid expenses and other
Deposits and other
Accounts payable
Accrued advertising '
Other liabilities and accrued expenses
Net cash provided by (used in) operating
activities
INVESTING ACTIVITIES
Maturities of marketable securities
Purchases of marketable securities
Purchases of xed assets
Acquisitions, -dispositions, and investments in
businesses
Net cash used in investing activities
FINANCING ACTIVITIES
Net proceeds from initial public offering
Proceeds from exercise of stock options
Proceeds from issuance of capital stock
Proceeds from long-term debt
Repayment of long-term debt
Financing costs
Net cash provided by nancing activities
Effect of exchange rate changes
Net increase in cash
Cash at beginning of period
Cash at end of period ,
Source: Arnazoncom, lnc., 2000.
(6, 246)
2 96
(554)
(315)
(148)
2,756
595
1.603
(31,020)
3,442
1,354
64
(8,400)
(3,034)
(21)
30,172
2,856
5,274
(124, 546) (719,968)
9,692 36,806
2,386 30,618
47,065 222,766
76,769
- (5,837)
8,688
23,970 29,171
(20,513) (172,069)
(16,465) (60,628)
(293)
78,674 330,166
9,617 42,382
21.448 90.261
(2,010)
(5,233)
(1,335)
687
4,311
(122,385)
(7,603)
31,035 (90,875)
332,084
(546, 509)
(28, 333)
4,024,551
(4,290,173)
(287,055)
(19,019) (369,607)
(6, 568)
195
8,443
(125,677)
49, 1 03
509
3, 746
75, 000
(47)
(2. 309)
_(2s1,177) (922,2s4)'
5,983 64,469
8,383
325.987 1,263,639
(78,108) (188,886)
(7,783)_ (35,151)
8,638
126,002
254,462 ' 1,104,071
60
804
1,012
864
(35) 489
23,685 91,401
1,876 25,561
864
1,s1s
25,561 116,962

AMAZON.(0M FROM START-UP T0 THE NEW MILLENNIUM 701

Consolidated balance sheets (in US$'000, except per share data)
So
DEC DEC
3151', 31ST,
1994 1995
DEC
315T,
1996
DEC
3151',
1997
DEC
315T,
1998
DEC
31ST,
1999
JUNE
30TH.
2000
ASSETS
Current assets:
Cash E cash equivalents
Marketable securities
Inventories
Prepaid expenses and other
Total current assets
Fixed assets. net
Deposits and other
52 996
24 17
- 14
6,248
571
321
1,876
123,499
8,971
3,363
25,561
347,884
29,501
21,308
133,309
572,879
220,646
85,344
720,377
187,244
172,360
86,659
7e 1,027
- 57
Goodwill & purchased intangibles, net -
Investments in equity-method investees - -
Other investments
Other assets
Deferred charges
Total Assets
7,140
985
146
137,709
9,726
169
2.240
424,254
29.791
626
186,377
7,412
1,012,178
317,613
730,144
226,727
144,735
40,154
1,166,640
344,042
596,778
211,715
88,261
53,294
76 1,084
8,271
1 49, 844
648,460
2,471,551
2,460,730
LIABILITIES AND STOCKHOLDERS EQUITY
Current liabilities:
Accounts payable
Accrued advertising
Other liabilities and accrued expenses
Accrued product development
Unearned revenue
Interest payable
Current portion of LT debt 81 lease
Total current liabilities
Long-term debt & portion of
lease obligation
Commitments and contingencies
Stockholders equity:
Preferred stock. $0.01 par value:
Authorised shares - 10,000
Issued and outstanding shares none
Common Stock, $0.01 par value:
Authorised shares 300,000
Issued and outstanding shares
Additional paid-in capital
Note receivable from ofcer for
common stock
Deferred compensation
Other gainsllosses
Other gains/losses
Accumulated decit
Total stockholders equity (decit)
- 99
-s
2,852
sea
920
500
33,027
3,454
6,570
1,500
113,273
13.071
34,547
684
463,026
181,909
54,790
24,888
14,322
286,239
146,874
115,566
41,213
17,731
- 107
- 1,075
150
(16) (248)
4,870
6
159
9,873
(612)
(6,02 5)
44.551
75,702
1,449
66,586
(1,930)
(37, 5 1 4)
161,575
348,140
1,593
300,130
(1,099)
(1,625)
1,806
(162,060)
733,935
1,466,338
3,452
1,194,369
(47,806)
( 1 , 709)
(882, 028)
607,623
2,131,531
3.554
1,335,733
(25,410)
(34,554)
(1,507,637)
8 977
3,401
28,591
138,745
266, 278
(278,424)
Total liabilities and stockholders equity 76 1,084
urce: Amazon.com, lnc., 2000.
s,z_71
149,841:
648,460
2,471,551
2,460,730

Exhibit s 1 Stock trends

DATE
OPEN
HIGH
LOW
CLOSE
VOLUME ADJ. CLOSE
Oct-00
Sep-00
Aug-00
Jul-O0
Jun-00
May-00
Apr-00
Mar-O0
Feb-00
Jan-00
Dec-99
Nov-99
Oct-99
Sep-99
38.1875
42.125
30.625
36.6875
48.875
56
65.4375
67.625
67.5
81.5
87.25
68.0625
77
127
38.4375
49.625
49.9688
43.9375
58.125
62.375
68.625
75.25
85.9375
91.5
1 13
96.875
90
127
19.375
35.5
29.3125
27.875
32.4688
40.4375
40.8125
60
63.0625
58.4375
76
61
65.875
57.375
36.625
38.4375
41.5
30.125
36.3125
48.3125
55.1875
67
68.875
64.5625
76.125
85.0625
70.625
79.9375
11,215,100
6,686,900
6,201,000
9,926,200
9,233,600
5,940,300
0,526,900
6,808,000
10,372,800
13,1 10,400
11,254,400
13,364,200
12,110,000
14,792,100
36.625
38.4375
41 .5
30.125
36.3125
48.3125
55.1875
67
68.875
64.5625
76.125
85.0625
70.625
79.9375
Sep-99
2:1 Stock Split (before market open)
Aug-99
Jui-99
Jun-99
May-99
Apr-99
Mar-99
Feb99
Jen-99
98.375
125.25
111.5
166.875
179.375
127
117.75
327.6875
135.5625
142.5
129.5
167.0625
221.25
82
97.5
89.75
104.5
151
178 114
130
356
84.25
92.5625
124.375
100.0625
125.125
118.75
172.0625
172.1875
128.125
116.9375
10,433,700
9,253,500
8,289,700
7,594,100
8,649,600
7,195,800
8,372,200
16,319,800
62.1875
50.0312
62.5625
59.375
86.0312
86.0938
64.0625
58.4688
Jan-99
3:1 Stock Split (before market open)
Dec-98
Nov-98
Oct-98
Sep-98
Aug-98
Jui-98
Jun-98
185.5
128.125
108
76.125
109.75
101.8125
88
361.875
233.125
129.8125
120
137.5
147
104.75
182
120.75
80
65
83.125
94.25
41.25
321.25
192
126.4375
111.625
83.75
110.875
99.75
5,486, 500
5,431 , 500
3, 82 1 , 500
5, 379,600
3,496,800
5, 029,900
4, 392,800
53.5417
32
21.0729
18.6042
13.9583
18.4792
16.625
Jun~98
2:1 Stock Split (before market open)
May-98
Apr-98
Mar-98
Feb-98
Jan-98
Dec-97
Nov-97
Oct-97
Sep-97
Aug-97
Jul-97
Jun-97
May-97
92.75
85.25
75.875
59.375
60
50.875
62.625
53.25
28.125
28.125
18.5
18.125
23.625
95.875
100
88.25
79.625
64.125
60.5
62.625
66
57.75
29
30.875
20.5
23.75
79.75
77.125
70
57.25
49.75
49.625
44
.42.25
27.75
23.25
18.125
16.5
15.75
88.125
91.75
85.5312
77
59
60.25
49.5
61
52.0625
28.0625
28.75
18.5
18
728, 600
1 ,408, 200
783,400
572, 900
467, 000
246, 1 O0
297, 300
381 , 1 00
428,000
1 26, 600
41 1 ,400
Z 1 0, 900
768, 1 00
7.3438
7.6458
7.1276
6.4167
4.9167
5.0208
-4.125
5.0833
4.3385
2.3385
2.3958
1.5417
1.5
" Adjusted for dividends and stock splits.
Source: Yah0o.com, Z000.

Market guide ratio comparison (Nov. 2000)

AMA2ON.COM RETAIL IND . . . SERVICES SECTOR S81? 500
SPECIALITY
Valuation Ratios
P/E Ratio (1'l'M)
PIE High - Last 5 Yrs.
P/E Low - Last 5 Yrs.
Beta
Price to Sales ('iTM)
Price to Book (MRQ)
Price to Tangible Book (MRQ)
Price to Cash Flow (1T M)
% Owned Institutions
Dlvidents
Dividend Yield
Dividend Yield - 5 Year Avg.
Dividend 5 Year Growth Rate
Payout Ratio (TTM)
Growth Rates (96)
Sales (MRQ) vs Qtr. 1 Yr. Ago
Sales (TTM) vs Ti'M 1 Yr. Ago
Sales 5 Yr. Growth Rate
EPS (MRQ) vs Qtr. 1 Yr. Ago
EPS (TTM) vs Ti'M 1 Yr. Ago
EPS - 5 Yr. Growth Rate
Capital Spending 5 Yr. Growth Rate
Financial Strength
Quick Ratio (MRQ)
Current Ratio (MRQ)
LT Debt to Equity (MRQ)
Total Debt to Equity (MRQ)
interest Coverage (T1' M)
Protability Ratios (%)
Gross Margin (1T M)
Gross Margin - 5 Yr. Avg.
E8lTD Margin (1TM)
EBITD - 5 Yr. Avg.
Operating Margin (TTM)
Operating Margin - 5 Yr. Avg.
Pre-Tax Margin (1'l'M)
Pre-Tax Margin - 5 Yr. Avg.
Net Prot Margin (1'l' M)
Net Prot Margin 5 Yr. Avg.
Effective Tax Rate (TTM)
Effective Tax Rate 5 Yr. Avg.
Management Effectiveness (96)
Retum On Assets (1TM)
Retum On Assets - 5 Yr. Avg.
Return On investment (TTM)
Return On Investment - 5 Yr. Avg.
Return On Equity (1TM)
Return On Equity 5 Yr. Avg.
Efficiency
Revenue/Employee (TTM)
Receivable Tumover (TT M)
inventory Turnover (1T M)
Asset Turnover (TTM)
NM
NA
NA
2.78
5.01
NM
NM
NM
29.70
NA
NA
NM
0.00
79.29
102.67
652.65
NM
NA
NM
534.1 1
1.37
1.77
NM
NM
-7.01
21.06
20.21
-19.97
-29.67
-32.13
-35.46
-34.84
-35.82
-34.84
-35.82
NM
NM
-35.33
54.49
-46.56
94.49
NM
-203.02
324,430.00
NM
11.48
1.01
22.97
50.14
15.93
1.41
1.81
3.99
4.42
17.31
49.32
1.88
0.32
21.31
3.11
29.31
34.08
20.34
21.41
26.65
26.31
1 1.90
0.62
2.00
0.44
0.53
12.23
28.92
28.50
3.71
2.37
0.34
-0.44
0.39
-0.89
-2.58
-2.86
38.16
39.42
1.21
-1.89
3.20
~4.96
15.89
16.38
392,990.00 377,981.00 516,316.00
29.66
50.91
16.57
0.96
4.94
4.96
7.65
19.60
42.41
1.98
1.21
0.93
17.26
30.87
25.83
26.91
14.21
18.16
22.80
28.47
1.02
1.51
0.78
0.97
5.42
41.48
40.29
20.19
19.20
11.13
10.24
10.83
8.67
4.47
2.84
37.12
38.44
4.11
4.82
6.41
6.95
11.57
13.92
33.46
49.21
17.12
1.00
6.96
8.70
12.17
25.60
57.00
1.57
1.20
8.96
23.35
26.07
24.33
20.67
28.82
26.02
21.38
19.26
1.23
1.76
0.57
0.86
9.68
50.37
48.55
23.09
21.74
18.37
17.65
18.12
17.10
12.83
10.69
34.71
35.41
10.29
8.89
14.16
14.04
23.32
22.34
41.51 12.97 8.98
6.72 ' 13.06
2.25
0.99
9.81
1.00
$0
urce: Yahoo.com, 1999.

794 AMAZON COM FROM START-UP T0 THE NEW MILLENNIUM

\X"hile the outlook is positive, there are numerous risks and uncertainties that
could negatively affect this potential.
With a limited operating history and the unpredictability of the industry,
Amazoncom (currently in a highly debt-leveraged position) has an accumu-
laled decit and anticipated further losses. Aggressive pricing has further
resulted in low product gross margins. requiring Amazon.com to generate and
sustain substantially higher revenues in order to become protable. The
current growth rate may be unsustainable and the percentage growth rate is
expected to decrease into the future. Amazoncom is therefore expected to
incur substantial operating losses for the foreseeable future, and these losses
may be signicantly higher than its current losses. Combined with this is
evidence that investors may he getting impatient with Aniazoncom showing
no signs of prot. If investor condence continues to flag, Amazoncom could
nd itself gasping for capital just when it needs more to compete with a grow-
ing competitor base (Business Week, 1999, p. 52).
The online commerce market is new, rapidly evolving and intensely
competitive. Competition in the Internet and online commerce markets is
expected to intensify as various Internet market segments obtain large, loyal
customer bases, and participants in those segments may use their market
power to expand into markets in which Amazoncom operates. In addition,
new and expanded Web tecluiologies may increase the competitive pressure
on online retailers. This increased competition may reduce Arnazon.coms
operating margins further, diminish its market share or impair the value of
its brand. These risks will intensify as Am-azon.com continues its international
expansion as well as expansion into new business areas.
As Ainazon.com continues to expand its operations by entering into business
combinations, investments, joint ventures or other strategic alliances with
other companies. so the risks increase. These include the difculty associated
with assimilating the operations, technology and personnel of the combined
companies, and the additional operating losses and expenses of acquired
businesses. Combined with this is the requirement for rapid technological
development on a cost-effective and timely basis. Amazon.com will need to
adapt quickly to changing customer requirements and industry standards.
Other risks involve its reliance on key suppliers, systems reliance. and domain
name risks as well as intellectual property protection.
As Amazon.com continues to develop, these factors together with broad
market and industry fluctuations may adversely affect the business and its nan-
cial situation. The future may look rosy or bleak. Reflecting upon 2000, Jeff
Bezos acknowledged that it had been a brutal year and during the year rumours
began to circulate that Amazorrcom might be taken over by Wal-Mart. Never-
theless. Amazon.com served 20 million customers in 2000, up from 14 million
in 1999, and sales grew to US$2.76bn from US$1.64bn. Operating loss shrank
to 6 per cent of sales in the fourth quarter 2000 from 26 per cent in the com-
parable 1999 period. Bezos revealed, in a letter released in a Securities and
Exchange Commission ling, that his top priority was to achieve an operating
prot in the fourth quarter 2001. In a separate ling, Amazoncom indicated
that in 2000, Bezos had a base salary of US$81,840, the same as in 1999 and
1998. He owned 52.4 per cent of the company. During February 2001,

AMAZON.COM FROM START-UP TO THE NEW MILLENNIUM

Arnazon.com announced that it would slash up to 1.500 jobs and on 12 April
2001. .-\mazon.com shares closed at US$14.67. During the past 52 weeks. the
stock had seen lows of US$8.10 and had moved as high as US$68.44. Reflect-
ing upon these results as well as upon his hopes for the future. Jeff Bezos
concluded:
Online retailing, wont replace in-store retailing. I've never said that. But 1 do
think it
can be a different, enriching experience . . . Our mission is to create :1 new level
of
expectation In customers. which will cause all companies to raise their level. And
if
we can do that. that would be tnily meaningful. ThatlI he something we can tell
our
grandchildren about. That's the difference between a mission and a job. If its .1
ioh.
then you won't have stories to tell your grandchildren.
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Amal.on.com (I999) Amnz1m.t'om l998Annunl Repurl. .-\m;izon.com. Inc.
Amazon.com (2000) Arnuzm1.cnm I999 Annual Reporl. Amazon.com. Inc.
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Gibson. P. (I999) The sharp rise of ecommerce, Information 7'ndn_i'. l6(7). 28-
$5.
Haylock. C.F. and Muscarella, L. (I999) Net Success: 24 Lenders in II/ab
commerce slaowynu
how In [mt lbe Web to tmrlefnryour business. Adams Mcdin Corporation.
Massachusetts.
I-Iof. RD. (I998) A new chapter for Amazon.com'. Business Week. vol. 5591. 39-
41.
Hoovers Ltd (I999) www.hoovers.com.
Kalakota. R. and Robinson, M. (I999) E-business: Ruadma/1 for Suc*esr. Addison
Wesley
Longman. Inc.. Massachusetts.
Kzrlgaard. R. (1999) Digital rules. Forbes. 164(2). -I3-4-l.
Koselka. R. (I999) A real Amazon. Forbes. 163(7). 50~5_'1.
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52(2l). 8-
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Nucifora. A. (1999) Despite the hype. Marketing Intei-net's numhers adding up,
Business
Press, 12(8). I5-I4.
Overstreet. J. (1999) Bookseller plans 600employee Memphis centre. Naslaville
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Porter. M.E. (I985) The value chain and competitive advantage. in M.E. Porter
Cmn])e!i-
live Advantage: Creating and sustaining superior perfonnance. The Free Press.
New
York.
Roth, D. (I999) Meg muscles Ebay uptown. Fortune. I-i0(I). 8l -87.
Sacharow_ A. (I998) Amazon Adweele. 48(24). 7i)-.1.
Saunders, R. (I999) Business the Ama.zon.C0m Way: Secrets of Ibe world: mos!
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ing Web business. Capstone Ltd. Washington. _
Schwartz. ND. (I999) The tech boom will keep on rocking. Furnme. 159(3). 64-6'.

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Smckpon. GJ. and Street, D. (2000) 'Amzzon.com: from stattup to the new
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Watson, R.T.. Bcrthon, F.. Pitt, L.F. and Zinkhin. G.M. (1999) Electronic Commerce.
Dryden
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Volgelsteln, F. (1999) Amazon toys with success, U. News G World Report,
127(4). 43-45.
Yudkowsky. C. (1997) A ml: of two Inrcmet sites: a slartup and a national giant
who
copied. San Francisco Business Times, 11(44), 18-20.

Car dealers in the headlights

The relative power of buyers and suppliers throughout a value chain can
change considerably as a result of changes in the business environment. This
article from the Financial Times on 20 March 2001 shows the pressure being
felt by cur dealers in the UK as they were squeezed between the powerful car
manufacturers and consumers who were exerting more buying power than
ever before.
Like a vehicle in a tiafc jam, Britains car dealers are stuck between the com-
peting interests of consumers and manufacturers.
With two well-known groups, the publicly-quoted DC Cook and privately-
owned HMG, falling into receivership in recent months, the pressure is begin-
ning to show.
Their demise is the latest in a series of setbacks in the 50bn-a-year UK car
dealing market. According to some estimates. about 400 of Britain's nearly
50,000 dealerships have gone out of business in the past year.
This month, Perry Group conrmed the industry's plight by pulling out of
car retailing with the sale of its 27 dealerships to management.
john Woollatt, Perry chief executive. says tough market conditions
prompted its withdrawal. Car dealerships are just not attractive as an invest-
ment, he says. Faced with heavy investments in the business and unsatis-
factory retums, we decided to look for higher retums elsewhere.
The reasons for the malaise afflicting the industry are simple: car prices have
fallen sharply over the past year while dealers costs - driven by the investment
required by manufacturers - have remained the same.
This double whammy rst hit car dealers last year - described by the head of
a large group as the industry's annus horribilis.
Throughout the rst half of 2000, the UK car market was unsettled by an
investigation by competition authorities into claims that car prices in the UK
were up to 12 per cent higher than in the rest of Europe.
in April, the inquiry found the claims - part of the Rip-Off Britain Campaign
launched by the Consumers Association and supported by sections of the
press - were justied and urged the govemment to take action.
This case is based on an article in the Financial Times, 20 March, 2001 by
Francesco
Guerrera. It is intended as a basis for class discussion and not as an illustration of
either
good or bad management practice. 0 Financial Times, 2001. Not to be
reproduced or
quoted without permission.

I.
CAR DEALERS IN THE HEADLIGHTS
Four months later, the govemment introduced measures that sparked a fall
of about l0 per cent in car prices.
Richard Barber, chief executive of Quicks, one of the largest dealers,
believes dealers margins and cash flow were hit by consumers deciding to wait
for the expected price cuts to buy a new car.
At the same time, the expected fall in new car prices prompted sharp cuts
in the price of used cars. hitting dealers that accept old vehicles in part-
exchange for new ones.
Last year was the most problematic year l had witnessed in 26 years in the
industry, Mr Barber says.
We had fewer customers in the showrooms as people waited for the govern-
ment to curb prices. We had to increase volume at the expense of margins. The
market was just out of order and there was a sense of desperation in the
industry.
However. in the last part of Z000, demand picked up, driven mainly by the
fall in prices, and has can'ied on growing in Z001.
ln February new car registrations rose by 7.5 per cent - the fth consecutive
month of growth The market is forecast to rise by about 1.3 per cent in 2001
- slightly more than last year - partly due to further falls in prices.
Mr Barber believes the worst is over. DC Cook and I-[MG were the victims of
2000. The market is now more settled and there is more consumer condence.
This month [March 2001] the industry is looking forward to the introduction
of the new Y number plates, which is expected to lure a large number of people
into buying a car.
But many industry gures believe dealers face serious longer-term problems
due to their relationship with manufacturers.
Dealers say manufacturers have too much power. They claim that the large
car-makers decide which dealer will sell their cars exclusively in a particular
area and have a large degree of influence on how much dealers invest on
premises and training.
The manufacturers are holding the whip hand. We need measures to even
up the power between dealers and manufacturers, says Mr Woollatt.
The carrnakers reject these criticisms. lt's unfair to lay the blame at the door
of manufacturers. The motor industry is facing a tough time and margins are
under pressure for everybody, says the Society of Motor Manufacturers and
Traders, the industry body.
It claims the block exemption system, which allows manufacturers to grant
exclusive geographical licences to dealers. ensures that it is in manufacturers
interests to have a protable retail network.
Many dealers disagree but refuse to go public, due to what one chief execu-
tive calls the climate of fear instilled by manufacturers.
The tension is set to come into the open in the coming months in the run-
up to the end of the block exemption system in September next year. Several
dealers want new rules, similar to the US model where contracts between man-
ufacturers and retailers last ve years, rather than two, to give them more time
to absorb the cost of the investment required by carmakers.
The manufacturers are opposed to these changes and some of them, such as
Ford and Mercedes, have started taking stakes or buying in their dealers in
order to keep a close tab on the cost of selling their cars.

CAR DEALERS IN THE HEADLIGNTS

Experts believe the answer to the problems is consolidation. According to a
report by market research group MBD, analysts expect the number of dealers
to halve over the next two years, with smaller dealers either bought by larger
groups or forced to tum to used cars.
The need for corporate activity has been noted by activist investors.
Guinness Peat Group, the investment vehicle of the corporate raider
Sir Ron Brierley has recently taken stakes in car groups such Quicks, Perry and
lnchcape. Analysts say GPG could pressure management to explore merger
opportunities if the shares start showing signs of weakness.
Trevor Finn. chief executive of Pendragon, one of the UKs largest dealers
with 160 outlets_ agrees. It's a difficult market and the only way to survive is
to become more efciem and reduce costs through economies of scale.

The Formula One Constructors

Mark Jenkins
This case describes three examples of the creation of competitive advantage
in it highly competitive technological context. F1 motorsport is the pinnacle of
automotive technology and involves highly specialised constructors design-
lng and building single-seat race cars which compete for annual champion-
ships which bring huge nancial and reputational rewards. These three cases
explore the stories of three contrasting companies: Ferrari. McLaren and
Williams in terms of how they both created and lost the basis for sustained
competitive advantage.
Between two and four on a Sunday afternoon this is a sport. All the rest of the
time
it's commerce.
(Frank Williams. Managing Director. Williams Fl)
ln 1945 the Fdration Intemationalc cle l'Automobile (FIA) established
Formula A as the premier level of motorsport. In the years that followed.
Formula A became referred to as Formula One and a drivers world champion-
ship was introduced in 1950. The rst World champion was Giuseppe Farina
of ltaly driving an Alfa Romeo. At that time Alfa dominated the racing along
with the other Italian marques of Ferrari and Maserati. Drivers such as Juan
Fangio, Alberto Ascari, Jack Brabham, Jim Clark and Graham Hill were to take
the championship during the 19505 and 60s driving cars built by Alfa Romeo,
Ferrari, Mercedes-Benz, Lancia, Cooper and Lotus. By the mid-sixties Formula
One had moved from being a basis for car manufacturers to promote their
products and develop and test technology, to a highly specialist business
where purpose-built cars were developed through leading~edge technology to
win a TV sporting event enjoying the third highest TV audience in the world,
surpassed only by the Olympics and World Cup Soccer,
There have been between 10 and 14 race car manufacturers or constructors
competing in Fon-nula One at any one time. The constructors themselves
can be grouped into a number of different categories, in the late nineties the
top four teams were Williams, Ferrari, McLaren and Benetton. all medium-
sized businesses turning over 30-60 million a year. Patrick l-lead, technical
director of Williams, estimates that it required between 25 and 50 million
capital investment in research facilities to set up the minimum basis for
This case was prepared by Mark Jenkins, Craneld School of Management. It is
intended
as a basis for class discussion and not as an illustration of either good or bad
management
practice. Craneld School of Management, 1998. Not to be reproduced or
quoted with-
out permission.

V-
THE FORMULA ONE CONSTRUCTORS 7"
being competitive. The top teams would typically have their own testing and
development equipment which would include wind-tunnels and other facil-
ities. In the 19905 Mclarcn, Williams and Benetton all employed around 200
people in their Formula One operations, a quarter of whom were the engineer/
mechanics who travelled round the world attending Grand Prix every two to
three weeks throughout the F1 season (March to November). Labour costs
account for around 25 per cent of the larger teams budgets. All the teams
would have highly qualied technical staff which would include race engineers
(who work with the driver to set up the car), designers, aerodynamicists,
composite experts (to work with specialised carbon-composite materials) and
systems specialists.
The revenues to run these operations come from a number of sources:
commercial sponsorship from non-related companies such as cigarettes and
clothing (e.g. Marlboro, Rothmans, Benetton, Hugo Boss); support through the
provision of free products and services such as engines. fuel and lubricants
(e.g. Renault, Ford, Shell, Elf and Agip) and systems support (e.g. Andersen
Consulting, Bull and Sun Microsystems). ln order to secure these inflows of
capital and services the top teams have sophisticated marketing departments
to establish and manage the relationships with these sponsors. More recently,
the automotive manufacturers have become major sources of nance, with
Ford, Daimler-Chrysler, BMW, Honda and Toyota all becoming major partners,
and in many cases owners or equity holders of the F1 teams.
In addition, revenue is provided by prize money generated by Winning cham-
pionship points. A rst place earns 10 points. second 6 points, third 4 points
then down in single steps to sixth place earning 1 point. The prize money is
a way of dividing up the royalties eamed from media coverage and other
revenues which is negotiated, on behalf of all the teams, by the constructors
association (FOA). ln 1996 the Jordan team estimated that around 351.8 million
(1 l per cent) of their revenue would come from prize money.
Most of the constructors are located in what has been referred to as Motor-
sport Valley, an area of the UK covered by a broad are from Oxfordshire,
stretching into East Anglia and down into Surrey. Whilst there are other teams
located in other countries such as Ferrari ( M3111'lllO. Italy). Prost
(Guyancourt,
near Paris. France) and Sauber (1-linwil, Switzerland), the majority of teams
reside in the UK. The focus on the UK has been attributed to the network of
specialist engineering talent which is fundamental to success in F1, as sum-
marised by the MD of the Benetton team, Flavio Briartore, in 1994: If you like
proscuitto you come to ltaly. lf you like champagne, you come to France. For
Formula One you come to England. l dont like the English weather, but the
best engineering is here.
The Formula One Constructors provide a unique context where we can con-
sider the competitive advantage of different multi-million-pound organisations
over time. The pace of change and the basis of advantage is constantly
changing,
shown by the fact that since the start of the world championships, no construc-
tor has Won the championship consecutively more than four times (McLaren
1988-91) and only Ferrari (1975-77) and Williams (1992-94) have won for
three consecutive years (Exhibit 1). The remainder of the case considers each
of these periods of competitive dominance in chronological order.

Exhiblt 1
YEAR
7-1; rue FORMULA one consrnucrons
DRIVER
CAR
CONSTRUCTOWS CUP
1950
1951
1952
1953
1954
1955
1956
1957
1958
1959
1960
1961
1962
1963
1964
1965
1966
1967
1968
1969
1970
1971
1972
1973
1974
1975
1976
1977
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1969
1990
1991
1992
1993
1994
1995
1996
1997
_1998
1999
-2000
Giuseppe Farina
Juan Manuel Fangio
Alberto Ascari
Alberto Ascari
Juan Manuel Fangio
Juan Manuel Fangio
Juan Manuel Fangio
Juan Manuel Fangio
Mike Hawthom
Jack Brabham
Jack Brabham
Phil Hill
Graham Hill
Jim Clark
John Surtees
Jim Clark
Jack Brabham
Denny Hulme
Graham Hill
Jackie Stewart
Jochen Rindt
Jackie Stewart
Emerson Flttipaldi
Jackie Stewart
Emerson Fittipaldi
' Niki Lauda
Jaaues Hunt
Niki Lauda
Mario Andrettl
Jody Scheckter
Alan Jones
Nelson Piquet
Keke Rosberg
Nelson Piquet
Niki Lauda
Alain Prost
Alain Prost
Nelson Piquet
Ayrton Senna
Alain Frost
Ayrton Senna
Ayrton Senna
Nigel Manseil
Alaln.Prost '
Michael Schumacher
Michael 5-chumacher
Damon Hill ~ '
Jacques Villeneuve
Mika Hakkinen
Mika,Ha_kkinen
Micliael_Schumac_ller
Alfa Romeo
Alfa Romeo
Ferrari
Ferrari
Maserati
Mercedes-Benz
Lancia-Ferrari
Maserati
Ferrari
Cooper
Cooper
Ferrari
BRM
Lotus
Ferrari
Lotus
Brabham
Brabham
Lotus
Matra
Lotus
Tyrrell
Lotus
Tyrrell
McLaren
Ferrari
McLaren
Ferrari
Lotus
Ferrari
Vlfllliams -
Brabham
Williams
Brabham
McLaren
McLaren
McLaren
Williams
McLaren
McLaren
McLaren
McLaren
Williams
Williams
Benetton
Benetton
Williams
Williams
McLaren
Mctaren
Ferrari
Vanwall
Cooper
Cooper
Ferrari
BRM
Lotus
Ferrari
Lotus
Brabham
Brabham
Lotus
Matra
Lotus
Tyrrell
Lotus
Lotus
McLaren
Ferrari
Ferrari
Ferrari
Lotus
Ferrari
Williams
Williams
Ferrari
Ferrari
McLaren
McLaren
Williams
Williams
McLaren
Mclaren
McLaren
Mcbaren
Williams
Williams
Williams
Benetton
Williams
Williams
McLaren
Ferrari
Ferrari
Bold type
occasions
signies that the constructors championship has been won on three or more
consecutive

THE FORMULA ONE CONSTRUCTORS 713

FERRARI
The period 1975-77 saw the renaissance of the Ferrari team. Their last Fomiula
One World Championship had been won in I964, one of tlte few reminders of
the glorious 50s and early 60s when the bright red cars of Ferrari dominated
motor racing. In the mid-70$ they won 15 of the 45 races during I975, I976
and I977.
Ferrari are the oldest of all the Grand Prix teams who are still racing. Their
heritage gives them a special place in the hearts of all motor racing enthusiasts.
Founded by Enzo Ferrari. an exdriver and manager of the Alfa Romeo racing
team in I950, they and other Italian marques such as Maserati and Alfa
dominated the sport during the 1950s. Ferraris have taken part in more than
550 Grand Prix (the next highest is Mclaren with 440) and, despite the variable
nature of the teams performance, drivers continue to view a contract with
Ferrari as something very special. Perhaps this is why world champions such
as Alain Prost, Nigel Mansell and Michael Schumacher have been attracted
to the team at times when their cars have been far from the fastest or most
reliable.
In an era when the majority of constructors are British specialists who buy
in central components such as engines and gearboxes. Fermri are distinctive
in that they have always done everything themselves: engine, gt'at'b0x, suspen-
sion. chassis are all made at their Maranello factory. which enjoys the most
uptt>date facilities in terms of designing. developing and building all the
necessary components of a race car. While other constructors such as Mclztren
and Williams will paint their cars whatever colour required by their flagship
sponsor. Ferraris always have been and, one assumes, always will be, bright
red, the national motor racing colour of Italy. The cars have. until recently.
displayed very little evidence of sponsorship: it has always been the Ferrari
emblem - a black prancing horse - which has the most prominent position.
The Italian public see Ferrari as a national icon, as observed by Niki Lauda in
an interview in I996: The Italians love you when you win and hate you when
you lose and whatever you do, win. lose or simply break wind everyone in Italy
wants to know about it!
The influence of Enzo Ferrari, or II Commendatore as he was frequently
known, was total and the myths and stories surrounding him still permeate the
team, despite his death in I988. It was legendary that Femtri himself hardly
ever attended a race and very rarely left the Maranello factory where his
beloved cars were made; he relied on the media and his advisers for informa-
tion which often created a highly political atmosphere in the team. Ferrari's
rst love was motor racing; this was despite having created a very successful
range of road-going cars which he saw primarily as the source of funding for
his racing. The merger (or rather takeover) between Fiat and Ferrari in 1969
provided Ferrari with a huge cash injection which simply allowed Enzo, who
was then 71, to concentrate on his rst love. motor racing at the highest level:
Formula One.
The resources which Ferrari have at their disposal have always been the
envy of every other team; they had always built their own engines and have a
large technical team dedicated to the task of engine design and development.

THE FORMULA ONE

CONSTRUCTORS
In 1971 they opened their own test track at Fiorano, literally :1 few hundred
yards from the Maranello factory. At the time, it was the most advanced and
sophisticated test circuit in the world, enabling the cars to be constantly tested
and developed between the track and the factory. Ferrari himself attended
most of the tests and would make sure he was kept informed as to exactly what
was being tested and why. Enzo himself had always declared his love for the
distinctive sound and power of a Ferrari engine, as indicated by former Ferrari
driver, Nigel Manse]: Enzo Ferrari believed that the engine was the most
important part of the race car. Colin [Chapman - head of Lotus] believed it was
the chassis.
The early seventies began shakily for Ferrari; the new ownership and
influence from Fiat meant increased resources, but also increased pressure for
results. In 1971 the cars were very fast, but not reliable. It got worse in 1972
and 1973 with cars only nishing every other race and rarely in the points.
Enzo himself had been suffering poor health and the team seemed to be unable
to tum around despite having the huge resources of Fiat at their disposal.
However, through 1974 things began to change. The brilliant technician Mauro
Forghieri had been recalled to Ferrari in 1973 as technical director; Forghieri
had been responsible for some of the more successful Ferraris of the 1960s. lt
is not clear why he left, but in 1973 he retumed.
In addition to the arrival of Forghieri, a new team boss was also appointed
to try to tum Ferrari fortunes around. At 25 years old, a qualied lawyer and
a member of Fiats aristocratic Agnelli dynasty. Luca Montezemolo was an
unlikely right-hand man for II Commendatore. However. he was given a rel-
atively free hand hy Ferrari and brought much-needed management discipline
to the team. While there had always been il huge supply of talent at Ferrari. par-
ticularly in the design and development of engines. gearboxes and suspension
systems, it had not always reached its collective potential. Enzo's autocratic
style of divide and rule had created much confusion and rivalry within the
team. Montezemolo dened strict areas of responsibility in order to reduce the
a.mount of interference and intemal politics. This created a situation where
the various technical teams (chassis and suspension; engine; gearbox) concen-
trated on and were fully accountable for their own area. Montezemolo was also
instrumental in the recruitment of driver Niki lauda, of whom he was a close
friend. lauda was of Austrian aristocratic descent, but was totally committed
to his racing. He had been very successful in Fonnula Two but was having
a torrid time with the ailing BR team in Formula One. ln 1975 Enzo Ferrari
told Iauda he wanted him to drive for Ferrari, an offer which very few drivers
have ever refused.
In 1974 Ferrari was in the ascendant. Lauda and the design team had
embarked upon an exhaustive testing and development programme at the
Fiorano test tuck. The new car, the 312B, was very much the fastest car on the
track. However, there were still reliability problems and, although Iauda was
leading the championship at the British Grand Pr-ix, the lead was lost through
technical problems which resulted in Emerson Fittipaldi in a Mclaren taking
the eventual honours.
In 1975 the tables were tumed. The fruits of Forghieris creative ideas and
the intensive testing at Fionino was exemplied in the 3121' which featured

THE FORMULA ONE CONSTRUCTORS TQ5

a powerful 12-cylinder engine and a revolutionary transverse (sideways
mounted) gearbox which improved the balance of the car, making it handle
extremely well. While the new car was not ready until the season had already
started, Lauda, with the support of team-mate Regazzoni, was easily able to
secure both the drivers and constructors world championships. The Ferraris
dominated the 1975 season; with their elegant handling and the power advant-
age of the engine, they were in a class of their own. Because the maiority of
the competition all had the same engine-gearbox combination (Ford V8 and
Hcwland gearbox), they were unable to respond to a chassis/gearbox/engine
combination which was unique to Ferrari.
In 1976 things continued in much the same vein, with Lauda and Regazzoni
winning the early races. The intensive testing did not let up and new ideas
and innovations, such as a revised rear suspension system. were constantly
being tried out. On the management front. Montezemolo had been promoted
to head up Fiat motorsport, which included the Lancia rally programme as
well as Ferrari, and Daniele Audetto was moved from managing the rally team
to become sporting director at Ferrari. However, things were not to go as
smoothly as in 1975, At the German Grand Prix Lauda lost control of the car
in the wet and crashed in flames. He was rescued by four other drivers. but not
before suffering severe burns and inhaling toxic fumes. His life was in the
balance for some Weeks, while the Grand Prix series continued with james
Hunt (McLaren) reducing Laudns lead in the championship. Miraculously
lauda recovered from his injuries and, although still scarred, he returned to
the Grand Prix series. He and Hunt went into the last Grand Prix of 1976
(Japan) with Landa leading by three points. There was heavy rain and Iauda
pulled out of the race, leaving the drivers championship to Hunt, while Ferrari
still collected the constructors championship, While. on paper, it was a good
year. by rights Ferrari should have dominated 1976 as they had 1975. Audetto
who, perhaps not surprisingly, had been unable to live up to the role cre-
ated by Montezemolo and had failed to develop a strong relationship with
Lauda, returned to the world of tallying. Ferrari went into 1977 in a state of
disarray.
In 1977 Ferrari were still the team to beat, although the testing and develop-
ment lost through Laudas six-week convalescence seemed to have reduced
the crushing dominance which the team had earlier shown. The competition
were also beginning to nd ways of catching upl The Brabham team moved
away from the Ford V8 and used an Alfa Romeo flat l2 similar to the Ferrari
engine. Tyrrell launched the revolutionary P54 six-wheeled car which seemed
to be the only car able to stay with the Ferrari. Ferrari themselves were not
standing still and launched the 512T2 in 1976. which was a signicant develop-
ment of the original 512T. Ferrari won the 1977 drivers and constructors
championship, but this was the end of the partnership with Niki Lauda; the
relationship had never been the same since the Nurburgring accident. Lauda
left to join Brabham but did not regain the world championship until he drove
for McLaren in 1984, He retired from driving in 1985, and became a success-
ful airline entrepreneur before returning to F1 as chief operating ofcer of
Ford's perfomtance motorsport group in 2001. While Lauda was not perhaps
the fastest racer on the track he was always able to develop a car and build

115 THE FORMULA ONE

CONSTRUCTORS
relationships with the design team. which enabled Ferrari to translate the
driver's senses into reliable technical solutions.
The unprecedented run of Ferrari success continued in 1978 with the .vl2'l3
car driven by two highly talented drivers: Argentinean Carlos Reutemann was
joined by the flamboyant Gilles Villencuve and. while they Were not able to
win the constructors championship. they achieved a very strong second place.
ln 1979 Reutemann was replaced by South African Jody Scheckter whose con-
sistency contrasted with Villeneuves emttic speed. Scheckter won the driver's
championship. with Ferrari taking the constructors championship. Their
greatest moment was when Scheckter and Villeneuve nished rst and second
at the Italian Grand Prix at Monza.
However. I979 was the last time that Ferrari were to win a Drivers World
Championship for 21 years. The I980 season was something of a disaster for
Ferrari. Scheckter and Villcnettve were totally uncompetitive in the 5lZT5.
which. while a signicant development from the 5 I ZT~i, was outclassed by the
competition. innovations in car design brought the ground effect revolution,
pioneered by Lotus and quickly adopted by Williams and Brabham. Here the
underside of the car featured two venturi. or channels. either side of the
driver. These were aerodynamically designed to create a vacuum which held
the car to the track. allowing faster comcring. While the Ferrari's engine
was one of the most powerful. it was a flat 12. meaning that the cylinders
were horizontal to the ground. creating a low and wide barrier which gave
no opportunity to create the ground effects which were being achieved with
the slimmer V8 engines. In I978 Alfa Romeo had launched :1 V12 engine to
replace their flat 12 for this very reason. No such initiative had been taken
at Ferrari who were concentrating on a longer-term project to develop a V6
turbocharged engine. Autosport correspondent Nigel Roebuck provided a suc~
cinct overview of Ferrari's 1980 season: Maranellos llat-12. still a magnicent
racing engine. is incompatible with modem chassis. Villeneuve and Scheckter
were competing in yesterday's cars. The lowest point came in the Canadian
(ii-and Prix: the reigning world champion. Jody Scheckter. failed to qualify his
Ferrari for the race. a bit like Italy or England failing to qualify for the World
Cup. Once again the full wrath of the ltalian press descended on the team.
Ferrari's longer-term view. focusing on the V6 turbo-charged engine, also
paid off in I982 and 1985 when they were able to secure the constructors
championship. In the mid-eighties more and more investment was poured
into facilities but to no effect on performance. ln I986 British designer john
Bamard was recruited and surprisingly allowed to establish a design and manu<
facturing facility near (iuildford in Surrey that became known as the Ferrari
GTO or (iuiltlford Technical Ofce. it seemed that rather than being a unique
and distinctively Italian F1 team. Ferrari were now trying to imitate the British
constructors whom Enzo had once. rather contemptuously. referred to as the
Gamglsles. Enzo Ferrari's death in 1988 created a vacuum which was lled
by executives from the Fiat organisation for a number of years and it wasn't
until the appointment of Luca di Montezemolo as CEO in I992 that Fermri
seriously began the ioumey that was to allow Michael Schumacher to retake
the drivers championship for them in 2000. fty years from their rst Fl
race.

THE FORMULA one coustnuctons 717

MCLAREN
The period from I988 to I991 was highly unusual in the hypercompetitive
world of Formula One where a new car is created each year and the pace of
change is rarely matched in any other competitive environment. This period
was notable because of the dominance of one constructor. ln this four-year
period the Mclaren team won 58 of the 48 races: such dominance had not
been seen before and will almost certainly never be seen again.
Founded by the New Zealand Fl driver Bruce McLaren in 1966. the McLaren
team had their rst victory in the Belgian Grand Prix of 1968. Tragically
McLaren himself was killed two years later while testing a sports car for the
American Can-Am series at Goodwood. Lawyer and family friend Teddy
Mayer took over as team principal and the team continued to develop and in
1974 secured sponsorship from Phil.ip Morris to promote the Marlboro brand
of cigarettes. This was a partnership that was to last until 1996. probably the
most enduring relationship between a constructor and a flagship sponsor. In
September 1980 Ron Dennis, a former mechanic, became joint team principal
with Mayer, a position which he took over solely in 1982, when Mayer was
encouraged by Philip Morris to take a less active role in the management of
McLaren. In the previous year McLaren moved from their modest site in
Colnbrook to a modern facility in Woking.
Dennis was a mechanic for the highly successful Cooper team in 1966, but
left to set up his own Formula Two (a smaller. less expensive formula) team in
1971. By the end of the 70s he had built up a reputation for professionalism
and immaculate presentation. His Project Four company brought in designer
John Barnard who had some radical ideas about using carbon bre. rather than
metal. as the basis for a race car chassis. These ideas were to provide the basis
for the MP4 car (Mclaren Project Four).
Before Denniss arrival. the team had enjoyed some success during the
mid-seventies, winning their rst drivers and constructors championships
with Emerson Fittipaldi in the M25 car in 1974. However. the real period of
dominance which McLaren enjoyed was in the period from 1988 until 1991
when they won the drivers title (Alain Prost: 1989; Ayrton Senna: 1988; 1990;
1991) and constructors championship for four consecutive years.
In 1986 designer john Bamard left to join the struggling Ferrari team.
Barnard was considered by many to he the reason for McI.aren's developing
dominance. The partnership between Dennis and Barnard had been stormy
but a huge amount had been achieved through the energy of these two indi-
viduals, Dennis providing the managerial and commercial acumen and Barnard
highly innovative design skills (by the end of the 905 Barnard was still regarded
by many as the best designer in Fl). To replace Bamard, Brabham designer
Gordon Murray was brought into the team. perhaps best known for develop
ing the innovative fan car for Brabham in 1978. Murray, like Barnard, was at
the leading edge of F1 car design.
Halfway through 1987 McLaren announced that they had recruited two of
the top drivers in F1 to their team: Alain Prost and Ayrton Senna, for the 1988
season, as reported in Motorsport:

'lHE FORMULA ONE CONSTRUCTORS

Aynnn Senna is ht-ing ntoved from Lotus to Melaren to join Prost in one of the
most
professional and well lvalaticed teams of all time. Prost and Senna have been
announced as joint number one drivers. and Mclaren lntemational has shown in
the
past that it is well capable of handling t\vo top drivers. which few other teams
have
managed.
Ayrton Senna, the young Brazilian. had made a name for himself as being
extremely talented and totally committed. but very difficult to manage. In his
previous team. Lotus. he is alleged to have blocked the recruitment of driver
Derek Warwick as he regarded him too great a threat and persuaded the team
to bring in the less experienced and younger Johnny Dumfries instead. Prost
and Senna were real contmsts: Senna was fast and had unparalleled commit-
ment to winning races; Pros! was fast too. but a great tactician and adept at
team politics. making sure that the whole team was behind him. However, it
was ultimately Senna who was able to change the balance of power within the
team.
ln 1988 the Honda-powered MP4 car designed by john Bamard was without
question the fastest and most reliable car on the circuit. This meant that effec-
tively the only real competition for Prost and Senna was each other. ln a
remarkable year Mclaren won 15 out of the 16 Grand Prix. 'l11is competition
between two highly committed and talented drivers resulted in one of the most
enduring and bitter feuds the sport has ever known. in 1988 Senna swerved at
Frost as they raced wheel to wheel at 190 mph; Pros! told him, lf you want
the world championship badly enough to die for it. you are welcome. In 1990
the acrimony with Senna culminated in Prosts moving to Ferrari. Senna now
had the team to himself. But the battle between them continued. reaching a
dramatic climax at the Japanese Grand Prix when Senna forced lrosts Fenari
off the road, and as a consequence became world champion. Despite these
darker moments, Senna's brilliance was undisputed. The accolades from the
industry following his tragic death in I994 were sincere and he is widely
regarded as one of the greatest drivers of all time.
The other element in the success of the Melaren in 1988 was the fact that
Ron Dennis had negotiated exclusive use of Honda engines. The engines were
supported by a signicant commitment from Honda in hoth people and
resources, Honda using this as an opportunity to develop some of their most
talented engineers. ln I988 Honda engines were among the most powerful and
certainly the most reliable. Honda had been engine supplier to the Williams
team since 1985. Sadly, team principal Frank Williams was seriously injured
in a car accident in 1986 which left him tetraplegic. This caused concem in
Honda over the future of the Williams team.
The combination of Prost and Senna made Mcl.aren an attractive altemative
to Williams for Honda, as identied by a ioumalist at the time: Honda. said
our source, want to dominate Fl and it knows it can never do that if it does
not have Frost. Honda switched allegiance exclusively to .VlcLaren for I988
after also supplying the Lotus team (and driver Ayrton Senna) in 1987. This
meant that Honda-powered cars had won six consecutive world champi-
onships from 1986 to l99l (Williams: 1986 and 1987; Mclztren 1988. 1989,
1990 and 1991).
THE FORMULA on: cousmuctons -119
Ron Dennis. with his professional management style. has been synonymous
\vith the success of Mclaren. indicating that the era of the one-man band
Formula One constructor was past. His record since taking over in 1982 has
been unsurpassed. Eddie Jordan. principal of the Jordan team. made the
following statement when planning to enter F1 in I990:
I know it sounds far fetched. but l want to emulate Ron Dennis. Hes won that
many
Grand Prix, he's won that many championships. hc's been on pole that many
times
and he's got the best drivers. Everyone hates him: hut they only hate him
because
hes the best. l believe I'm as good as he is: l believe lni in the same league. but
only
time will tell.
Dennis's negotiating and marketing abilities were legendary throughout
Formula One. Melaren also created their own marketing consultancy opera-
tion where the smaller teams engaged them to nd sponsors. In 1991
Mmmgemen! Week had Ron Dennis on the front cover with the question: ls
Ron Dennis Britain's best manager? Dennis likens the management of Mclaren
to that ofa game of chess: . . . you've got to get all the elements right. the over-
all package. the budget. the designer. the engine. the drivers. the organisation.
John Barnard once likened working with Dennis as being in at room with a
hand grenade rolling about without its pin. about to go off and make a horrible
mess. lt should also be said that Barnard himself was not particularly famous
for having a long temper. Dennis's ambitions wcrc beyond Fl and in I988 he
began a project to build a roadgoing car. the Mclaren Fl. ln many ways this
mirrored the development of Ferrari who had made the progression from pro-
ducing dedicated FACC cars to also developing road-going cars. The MeLaren
Fl was launched in I994 and with a price tag of .65~i.()()() and a top speed of
251 mph became the most expensive and fastest road-going car in the world.
The design skills of Gordon Murray were uscd heavily in the development of
the car. which has a BMW engine.
However. in 1992 the slippage began. The Renault-powered Williams was
developing into the fastest and most reliable car on the circuit. ln September.
following widespread speculation. Honda conrmed that that they were
pulling out of Fl racing. Honda's reasons were simple: they had been hugely
successful and achieved all of their objectives: it was now time to stand back
from Fl and nd some new challenges. While Dennis had been told about
Hondas thinking in late 1991. it appeared that he hadnt taken it seriously
enough and the team had no real engine altematives. This meant they lost
valuable winter development time as they tried to nd a new engine supplier.
ln I995 they competed with off the shelf Ford engines available to any
team who had the cash to buy them. Sennals skills still gave Mclaren ve
victories. despite having a less than competitive car. However. at the end of
1993 Senna left the Mclaren team to move to Williams. whom he saw as
having the superior car and engine combination. Former world champion and
adviser to Ferrari. Niki lauda. saw this as the temiinal blow: Senna was a
leader. He told them exactly what was wrong with the car. Hakkinen (Sennas
replacement) is not in a position to do that, so the reaction time is much
longer. Senna motivated the designers. John Hogan. VP of European market-
ing for Philip Morris and holder of the Mcl.aren purse strings, saw the problem

,.
HI THE FORMULA out
CONSTRUCTORS
as design leadership and was advocating that Barnard be brought back to
Mclaren.
The mid-nineties were a particularly difcult period for Mclaren. Having
tried Peugeot engines in 1994 they moved to Mercedes in 1995. However,
1995 was perhaps best remembered for the debacle at the start when neither
Nigel Mansell or Mika Hakinnen could t into the new 50 million MP4/ 10 and
then Mansells alleged 45 million contract to race for the year fell apart when
neither he nor the car came up to expectations. In 1996 the relationship
between Mcl.aren and Philip Morris came to an end, Philip Morris moving
support of their Marlboro hrand to Ferrari driver Michael Schumacher. while
McLaren entered into :1 substantial agreement with German-based tobacco rm
Reemtsma to support their West brand. In 1997 Mclaren acquired the services
of Williams designer Adrian Newey for a reputed 2 million contract. Neweys
design talents coupled with a more powerful and reliable Mercedes engine
meant that Mclaren again became the team to beat.
WILLIAMS
lf the Mciaren MP4 was the dominant car in the late eighties, the Williams
F1 FWIS and 16 powered by a Renault V10 was the car to beat in the early
199Os. During the period 1992-94 Williams cars won 27 out of 48 races, they
secured the Fl constructors title for all three years and the world cham-
pionship for drivers was won in a Williams in 1992 (Nigel Mansell) and 1995
(Alain Prost).
Like most of the founders of the Formula One constructors, Frank Williams
began as a driver, perhaps not of the same standing as Bruce Mciaren or Jack
Brabham, but nonetheless someone who lived, breathed and loved motor
racing. His desire to remain in the sport led him.to develop a business buying
and selling racing cars and spare parts, and in 1968 Frank Williams (Racing
Cats) Ltd was formed. A series of triumphs, tragedies and near bankruptcies led
up to die establishment of Williams Grand Prix Engineering in 1977 when Frank
Williams teamed up with technical director Patrick Head. Frank Williams
approach and style owes a lot to the difcult years in the seventies when he
survived on his wits and very little else. l-lis style could be described as auto
cratic, entrepreneurial and certainly frugal. despite the multi-million-pound
funding he managed to extract from the likes of Canon, RJ. Reynolds and
Rothmans. Williams saw his role as providing the resources for the best car to
be built and to hire the best driver to sit in it. His long-standing relationship
with Head was pivotal to the team and brought together a blend of entre-
preneurial energy and technical excellence needed to succeed in Fl.
The rst car from this new alliance was the FW06. designed by Patrick Head
with support from Saudi Airlines. The team enjoyed some success in 1980/81
by winning the constructors championship both years and with Alan Jones
winning the driver's title in 1980. Jones was a forthright Australian who knew
what he wanted. His approach to working with the team was very influential.
in Frank Williams view of drivers: l took a very masculine attitude towards
drivers and assumed that they should behave - or should be treated - like Alan.

THE FORMULA ONE CONSTRUCTORS 711

A similar situation occurred in 1986/87 with Nelson Piquet winning the
driver's title in i987 and Williams the constructors title in both years. This was
despite the road accident in 1996 which left Frank Williams tetraplegic and
conned to at wheelchair. However, the most dominant period in the history of
Williams, so far. has been the period I992-)4 when they were able to win the
constructor championship for three consecutive years.
Williams 1986/87 success had been. in part. due to the use of powerful and
reliable Honda engines. However. Frank Williams accident in I986 caused
concern at Honda over the future of the team and in 1987 they made their
engines available to Lotus and withdrew front Williams (a year before the end
of the contract) to supply Mclaren in the 1988 season. The 1988 season was
Williams worst. as they were forced suddenly to switch to off the shelf ' Judd
V10 engines which were available to anyone who wanted one. Williams tlidnt
win a single race. \vhile McI.aren won 15 out of the to Grand Prix of 1988 and
zt disillusioned Nigel Mansell left and went to Ferrari. Frank Williams had to
search frantically for a new engine deal which he found in I990 with Renault.
in 1985 Renault had withdrawn from Formula One as a constructor, having
failed to win a world championship. However. they continued their engine
development activities with the aim of building a new Fl engine to meet the
new non-turbo standards due to be introduced in 1989. Frank Williams was
able to form an agreement for Renault to supply him with the new V10 engine.
This relationship became a far-reaching and durable one. with Renault putting
human and nancial resources into the project with Williams. They also sought
to develop the relationship further and extended their activities with Renault
by running their team of saloon cars for the British Touring Car Championship.
In W90 a lack of real driver talent meant that the team were only able to win
two races. ln 1991 Nigel Mansell was persuaded to retum from retirement by
Frank Williams and narrowly missed taking the 1991 title, but in 1992 the team
dominated the circuits, effectively winning the championship by the middle of
the season. Nigel Mansell went into the record books by winning the rst ve
consecutive races of the season. This was a phenomenal achievement as it
emphatically demonstrated that McLarcn were no longer at the top: Williams
most certainly were. However. a deterioration in the relationship between
Williams and Mansell led to the drivers retirement front racing at the end of
the year.
The Williams approach to design and development of a car was always the
highest priority. Patrick Head had always been one of the more conspicuous
and forthright of the technical directors in Formula One. a role which is often
shadowed by the head of the team and driver. ln a spon where personnel
change teams frequently, the stable relationship between Williams and Head
(and up to 1996. Adrian Newey, who was a brilliant aerodynamicist and design
assistant) provided enviable continuity compared with the rest of the eld.
While Heads designs had often been functional rather than innovative. he
had always been able to take a good idea and develop it fttrther. These have
included ground effect (originally developed by Lotus). carboncomposite
monocoque (Mclaren). semi-automatic gearbox (Ferrari). and active suspen-
sion (botus). The car development process was always a top priority at
Williams and Head was supported by many designers who went on to be highly

w THE ronuutn out

CONSTRUCTORS
influential in Formula One, such as Neil Oatley and Adrian Newey (who left for
McLaren), Frank Dernie (Ligier, Lotus and Arrows) and Ross Brawn (Benetton
and then technical director at Ferrari).
This focus on developing the car and engine combination has sometimes
meant that the driver took second place in the Williams philosophy, despite
the fact that a good test driver. who could tell the technicians what needed to
be done to the car to improve its performance, was essential to the develop-
ment process. There had been a number of high-prole disputes between
drivers and Williams which had. in part, been attributable to Frank Williams
masculine approach to dealing with drivers. Controversy, and unpleasant
hints of xenophobia from the tabloid press, broke out when the relationship
between Williams and two top British drivers broke down. In 1992 Nigel
Mansell left when he felt his number one driver position was threatened by
the recruitment of Alain Prost for 1995 (HIIIIOI-lgh PFOSI him$<?lf 1611 Ihfl
F0110/~
ing year for the same reason regarding the hiring of Ayrton Senna). A similar
situation arose when the 1996 world champion, Damon Hill. was not retained
for the 1997 season and was replaced with German Heinz-Harald Frentzen. In
an interview with the Sunday Times. Patrick Head set out the reasons for the
decision not to hold on to Hill:
We are an engineering company and that is what we focus on. Ferrari are
probably
the only team where you can say the driver is of paramount importance and that
is
because Schumacher is three-quarters of a second a lap quicker than anyone
else.
This emphasis on the driver being only part of the equation was not lost on
Paul Stewart who was concentrating on developing the Stewart Grand Prix
entry to F 1:
lf you haven't got the money none of it is possible. so money is one key to
success
but what makes a difference is how the money is used. lt's not down to any one
thing
like a driver or a engine, but the interaction that matters. lf you look at the
Williams
team, they rely on a solid framework. their organisation, their engine, their car
design
is all amalgamated into something that gives a platfonn for everyone to work on.
They
dont believe putting millions into a driver is going to make all the difference.
Williams emphatic dominance in the 1992 season was due to a number of
factors: the development of the powerful and reliable Renault RS5 V10 engine
was perfectly complemented by the FW15 chassis which incorporated Patrick
Heads development of some of the innovations of the early nineties, namely
semi-automatic gearboxes, drive-bywire technology and their own active
suspension system. As summarised by a senior manager at Williams F 1:
l think we actually were better able to exploit the technology that was available
and
led that technology revolution. We were better able to exploit it to the full, before
the others caught up . . . it wasnt just one thing but a combination of ten things,
each
one giving you another 200/500th of ct second. if you add them up you a get a
couple of seconds of advantage.
However, other teams were also able to use these innovations and in 1993 the
Benetton team made a great deal of progress with both the gearbox and sus
pension innovations largely attributed to the development skills of their new
driver, Michael Schumaeher. However, Williams technical lead coupled with

THE FORMULA ONE CONSTRUCTORS

the tactical race skills of Alain Prost, supported by promoted test driver Damon
Hill (due to Mansells sudden exit), secured the 1993 World championship and
constructors championship for Williams Fl.
1994 was a disastrous year, but not for reasons of performance as Williams
won the constmctors championship for the third successive year (this was
always their declared primary objective, with the drivers championship very
much a secondary aim). Frank Williams had, for some time. regarded Brazilian
Ayrton Senna as the best driver around and, now with the obvious perfor-
mance advantagc of the I-W15 chassis and the Renault V10 engine, Senna was
keen to move to Williams. The problem was that a bitter and prolonged feud
between Senna and Prost. originating from their time together at Mclaren,
meant that if Senna an-ived Prost would leave. This was exactly what hap
pened. Prost decided to retire (though he retumed to run his own team) and
Ayrton Senna was partnered by Damon l-lill for the 1994 season. However,
tragedy struck in the San Marino Grand Prix at Imoln and Senna was killed in
an accident, an event which not only devastated the Williams team but the
sport as a whole. For the remainder to the season Hill found himself as lead
driver supported by the new test driver. David Coulthard, and a couple of
comebacks from Nigel Mansell. While Williams lost the drivers title to the
rising star of German driver Michael Schumacher, amazingly despite these
huge setbacks Williams retained the constructors title for 1994.
In 1995 the Benetton team was eclipsing the Williams domination. Benetton
had developed a car using many of the technological innovations used by the
Williams (with the help of ex-Williams designer Ross Brawn). In addition,
Renault's ambitions to match Honda's previous domination of the sport as an
engine supplier from 1986 to 1991 led them to supply Benetton with their
engines as well as Williams, a decision which particularly incensed Head and
Williams. 1995 was the year of Benetton and Michael Schumacher, breaking
the three-year domination of the Williams team. However, in 1996 Schumacher
moved to the then uncompetitive Ferrari team for 27 million, putting him in
third place in the Forbes chart of sports top eamers. This left the way clear for
Williams to dominate the season, with Benetton failing to ll the gap left by
Schurnacher.

Broken Hill Proprietary (BHP)

Company Limited turnaround
strategy
Gary Stockport and Gary Norvall
BHP is a major international resources company with headquarters in
Melbourne, Australia. Ihe case study is an example of corporate turnaround
in practice. It takes the reader through the stages of a turnaround and exam-
ines the actions the company look at each stage. The importance of hiring an
external CEO with experience in turnaround management is also considered
within the case. The case concludes with the announcement in March 2001
that BHP was to merge with UK-based Billiton, which would create a global
resources powerhouse with dominant positions in coal and copper.
INTRODUCTION
On 27 July 2000, BHP announced its highestever prot with an A$l.63 billion
net prot for the I3 months tojune (A$2.03 billion excluding abnormals). This
remarkable tumaround from the losses in 1998 and 1999 can be traced back to
the appointment of Paul Anderson as CEO and MD in 1998.
Broken Hill Proprietary Company is a major intemational resources company
with headquarters in Melhoume, Australia. The company was incorporated in
1885 in the State of Victoria, Australia. In 1999, the company employed some
50,000 employees and had a market capitalisation of AS27.l5Om, which rnatle
it Australias third largest company after National Australia Bank and News
Corporation Ltd. BHP has interests and operations in the following sectors:
0 minerals exploration, production and processing;
0 oil and gas exploration and development;
0 steel production and merchandising;
In 1999, the company generated A5192 billion in extemal sales revenues to
markets around the globe in Australia, Japan, America, Europe, Korea, China.
Taiwan and the UK (Exhibit 1 gives BHP nancial performance 1995-99 and
This case was prepared by Gary R. Norvall, University of Cape Town, under the
supervision
of Professor Gary J. Stockport, Graduate School of Management, University of
Western
Australia. It is intended as a basis for class discussion and not as an illustration of
either
good or bad management practice. Gary it Stockport, 2001. Not to be
reproduced or
quoted without permission.
BROKEN HILL PROPRIETARY (BHP) COMPANY LIMITED TURNAROUND STRATEGY
725
Exhibit 1 BHP nancial performance 1995-1999
BHP Prot and loss account (A$m)
Sales
Other revenue
less
Operating expenses 81 Cost of sales
Depreciation 81 amortisation
Group Centre 81 general administrative expenses
interest expense
Operating prot before interest and tax
Operating prot before tax
less Income tax attributable to operating expense
Operating prot/(loss) after income tax
add Outside equity interests - operating prot
after tax
Operating prot/(loss) after tax (including abnormals)
add Retained prot at beginning of the nancial year
Total available for appropriation
less Dividends provided or paid for
Retained earnings at year end
Prot 5 Loss Account detailing abnormal items
Operating prot before abnormal items
less Abnormal items after income tax
BHP Balance sheet items
Assets
Current assets
Non-current assets
Total assets
Liabilities
Current liabilities
Non-current liabilities
Total liabilities
Net assets
Shareholders equity
BHP Financial statistics
BHP Balance sheet items
Gearing % (a)
Capital investment expenditure
BHP prot and loss statistics
Return on shareholders equity
Dividend payout ratio
Current ratio
Earnings to interest expense
Sales to operating income (operating 111319171)/a
1 999
1 9. 229
2, 692
1998
21.189
3,475
1997
20.947
1,373
1996
19,124
690
1995
17,696
748
21,921
20,973
2,218
143
732
24.664
22, 594
2, 206
161
71 6
22, 320
1a.1o1
1,914
145
139
19.814
15.392
1,798
134
477
18,444
13,732
1,651
129
407
24,065
(1,413)
(2.145)
164
25,677
(297)
(1,013)
518
20,960
2,099
1.360
885
17,801
2.490
2,013
752
15.919
2.932
2.525
1,014
(2. 309)
(3)
(1,531)
57
475
(65)
1.261
(215)
1,511
(295)
(2,312)
4.826
(1,474)
7,077
410
7.434
1,046
7,184
1,216
6,651
2,514
766
5.603
777
7.844
767
8.230
744
7.867
653
1,748
365
(2,667)
4.826
1.302
(2,776)
7,077
1.386
(976)
7.486
1.293
(247)
7,194
1,617
(401)
1 999
5,852
25.635
31,487
6,194
15,932
22.126
1998
7,218
29,864
37.082
6,175
18,498
24,673
1997
8.399
28,336
36,735
7.328
13.194
20,522
1996
6,820
28,410
35.230
6.503
12.981
19,484
1 995
6,105
24,182
30,287
5.357
10.123
15,430
9.361
9,361
1 999
54.2
2.675
(26.7)
(negative)
0.9
(1.9)
-12%
12,409
12,409
1998
52.7
4.014
(12.7)
(negative)
1.2
(0.4)
~-7/.
16,213
16,213
1997
39.4
4,149
3.3
2.0
1.1
2.8
2%
15,746
15,746
1996
39.4
6,827
8.6
0.8
1.0
5.2
7%
1 4, B07
1 4. 807
1995
31.3
3,100
10.2
0.6
1.1
7.2
9%

72 BROKEN HILL PROPRIETARY (BHP) COMPANY LIMITED TURNAROUND

STRATEGY
Exhibit 1 Continued
1 999 1998 1 997
Cash flow statiscs
Operating cash flow to sales 0.2
Operating cash flow to total assets employed 0.1
Operating cash flow to annual interest expense 4.9
Operating cash flow to total debt 0.2
Share infonnation
Price/earnings ratio (times) (negative) (negative)
3.3 3 7
Earnings per share (incl. abnormal) (133.5) (87.2)
Market capitalisation at year end 27,150 28,125
50 55
Dividend yield %
Number of employees (O0O's)
NONI
(a) Based on the borrowings (current and non~turrent excluding nante leases,
bank overdrafts
as a percentage of total borrowings and shareholders equity
BHP Cash flows
1999
3,585
(1 ,264)
(2,677)
Net operating cash flows
Net investing cash flows
Net nancing cash flows
0.2
0.1
5.0
0.1
1998
3.559
(1,523)
(1,515)
0.2
0.1
5.4
0.2
75
2.7
25.0
37,753
61
etc.)
1997
3.996
(4.348)
(32)
1996
0.2
0.1
6.9
0.2
29
2.7
65.1
37,106
60
1996
3,305
(7,177)
(3,578)
1 995
0.2
0.1
10.0
0.3
22
2.7
78.7
34,154
49
1995
4,090
(3,218)
(429)
Net (decrease)flncrease in cash flow (356)
Cash & cash equivalents at beginning of year 949
Effect of exchange rate changes on cash (20)
(521)
363
65
(384)
735
12
(294)
883
(34)
(443)
431
9
Cash & cash equivalents at end of year 573
Abnormal items
1999
Asset write-downs
Minerals
Other minerals
Copper
Coal -
Steel
Petroleum -210
Group -13
-2996
-1196
-1 B00
-105
949
1998
-2483
-834
-1617
-32
-246
-17
363
1 997
-739
-1 89
-550
-220
-124
555
1996
-222
-151
883
1995
-542
TONI -3324
Asset sales
Minerals 347
Steel
Petroleum 121
Services 173
Group 6
-2745
-146
99
-1083
107
-373
61
-542
234
Total 647
-47
107
61
234
Sourre: BHP.

BROKEN HILL PROPRIETARY (BHP) COMPANY LIMITED TURNAROUND STRATEGY

721
Exhibit 2 Revenues by geographic location and industry 1995-1999
V.
Revenue by geographic market
Australia
USA
Japan
Other"
Total
Revenue by industry
Minerals
Steel
Petroleum
Other
1999
8,430
3,383
2,815
7,293
1998
9,375
4,780
2,755
7,754
1997
7,415
4,310
3,090
7,505
1996
6,790
3,498
2,906
6,620
1995
7,051
2,782
2,845
5,766
21,921
9,235
8,096
3,093
1,389
24,664
8,303
8,320
5,054
2,987
22,320
8,465
8,217
4,963
675
19,814
7,316
7,531
4,284
683
18,444
6,105
7,155
4,428
756
Total 21,813 24,664 22,320
Prot by industry
Minerals (2,288) (1,993) 239
Steel 115 202 1 13
Petroleum 162 106 509
Other (298) (249) (431)
19,814
1,083
155
329
(306)
1 8,444
953
643
71 1
(796)
Total (2, 309) (1,934) 430
1,261
1,511
' lncudes South Korea, China, Taiwan, Europe, UK, New Zealand and South
America.
Sourcei BHP.
Exhibit 2 gives a breakdown of revenue by geographic region), The company
operates in 50 different countries from as diverse regions as: Yellowknife,
Canada (Diamonds); the Atacama Desert in Chile (Copper); and the North West
Shelf, Australia (Oil).
In scal 1999, the operating loss of BHP including abnormal items attribut-
able to BHP shareholders was A$2,5l2m. compared with a loss of ASl.~i74m
for scal 1998. The poor nancial performance of the company reflected the
difficult global economic environment over 1998/99 and. in parliculatx the
scvcrc downward pressure on commodity prices over this period. The results
also reflect the BHP hoztrtls decision to close and sell off poorly performing
Op<f12l[iOl1S and adjust the carrying value of certain assets. BHP's stock has
historically traded on a premium for its management capacity and its ability to
take up an opportunity in any kind of business and turn it into a stellar pcrr
former. it was the argument of former CEO. John Prescott. that the sum of
BHPs components is far greater than the whole.
THE COMMODITIES BUSINESS
The commodities business is no different from any other business in that the
fundamental laws of economics - demand and supply - apply. As a consequence

718 BROKEN HILL PROPRIETARY (BHP) COMPANY LIMITED TURNAROUND

STRATEGY
of the immense volumes of product that are traded, minor fluctuations in either
demand or supply can have major consequences on individual comrnodity
prices and therefore, upon an individual businesss bottom line.
The Asian crisis starting in late 1997 saw a major crash in the demand for
commodities, and by 1999 the market had still not recovered. In 1999, the
Asian markets still remained weak but showed preliminary signs of recovery.
For Bl-IP, the prices of nearly all of its major products remained depressed
in 1999 and there was overcapacity in the world market of most of BHPs
products. The down cycle of the commodity prices from 1997 to 1999 severely
affected the bottom line of Bl-{P and in scal 1999, increased the loss by
some A$1,080 million. The major products that were affected were: export
steel prices declined by approximately 50 per cent: realised crude oil prices
declined by 16 per cent; copper prices declined by 15 per cent: and coal prices
declined by 12 per cent. Furthermore, the reduction in sales volumes through
a fall in demand affected prot by A$17() million compared with the previous
period.
Based upon company projections for scal 2000, a USSI movement in the oil
price would affect the BHP bottom line by A$47 million and a US11 movement
in the copper price by A516 million. The cost of doing international business
can also be high. and a l cent currency fluctuation between the US and the
Australian dollars affects prot by A526 million. As a consequence of the
volatility of the commodity markets, companies make use of nancial hedging
techniques in an attempt to create some predictability in their eamings. As
at May I999, BHP had 27 per cent of their projected oil sales covered by for-
ward contracts and swaps at an average price of US$16/46 per barrel on a
market-tomarket basis, these positions were showing an unrealised loss of
USS4 million.
Following the Asian crisis and the decrease in demand for Bl-lPs products in
the Pacic region and in Australia, BHP mitigated the impact of these adverse
trading conditions by transferring its export business to altemative markets
primarily in Europe and the Americas. But the increased pressure on the steel
market led to the European and US steel industries protecting their markets
with anti-dumping laws, which has compounded steel production in other
parts of the world. Further competitive pressure has been experienced by BHP
in the 1998 devaluations of the Brazilian, South African and Indian currencies
which have made these countries more competitive intemationally.
EARLY ATTEMPTS AT TURNAROUND
Proposals to redene BHP and address cost structures were issues at Bl-ll
during the latter 19905. john O'Connor, former head of Petroleum until
1998 (under whose leadership the division on most measures such as reserve
growth, nding costs per barrel, development costs and operating margins
had measured up to and surpassed industry benchmarks), proposed Project
Leopard - a proposal to float Petroleum as an independent company. He
claimed that Petroleum was subsidising other divisions of the conglomerate

V.
BROKEN HILL PROPRIETARV (BHP) COMPANY LIMITED TURNAROUND STRATEGY
729
while it was itself being starved of capital. Former CEO Prescott had also put
forward a proposal to float Steel independently. The board rejected both
proposals.
The boards intentions to shelve plans to float both the petroleum and the steel
divisions separately indicate a clear intention to run BHP as a portfolio, despite
the
clear preference of the nancial markets for specialist companies rather than
conglomerates
(llusilless Ret'1'el1' Weekly, 8 .\/larch 1998)
Floating the two divisions would have cost the company and shareholders
millions of dollars in capital gains tax, stamp duties and lost benets from joint
ventures. Other analysts argued that the company and the hoard simply had no
decisive strategic vision as to where to take the company.
But the prohlem the company had was that it couldn't actually work out what it
wanted. Nobody could answer what it was that was going to happen to the rest
of
Bl-ll. lt did not have a clear idea of its own future so the default position was
dont
do it.
(Busine.\2v Rel-few Weekltz 8 March l'~)'~)8)
PAUL ANDERSON
In December 1998. Paul Anderson was appointed CEO and managing director
of BHP by outgoing chairman of the hoard. Jerry Ellis. Andersons appointment
was the result of a global search process conducted by the hoard and sup-
ported by the international executive recruiting rm, Heidrick 8: Struggles. Hts
appointment to CEO and MD of BHP brought with it positive reactions from
shareholders, analysts, the media and later Bl-ll employees. Anderson stated
that it was his rst priority to restore condence in the company with the
employees and with the external public.
Anderson came to BHP with a track record of turning around companies
from a position of weakness to one of strength. His experience covered
mergers and acquisitions and restructuring companies to improve performance.
Anderson, an engineer by trade, obtained his MBA from Stanford University
in 1969. He was previously chief operating officer (COO) of Duke Energy
Corporation. the w0rlds seventh largest energy company with a market
capitalisation of US$_>(> billion and operations in 50 different countries. Duke
Energy was created after the merger of Duke Power and Panlinergy. a company
he was instrumental in tuming around and increasing its stock value vefold.
He has led two public offerings: been a principal in three mttlti-billionalollar
mergers on either side of the offering, acquirer and aquiree; fought off a
hostile public tender offer; and led several dozen transactions of projects in
the hundreds of millions of dollars. He is also no stranger to the steel business.
having served as chief nancial officer (CFO) at Inland Steel in the US.
His style is considered inclusive of all employees - if any less formal it
would be shorts and a t-shirt, and the emphasis is on teamwork and share-
holder value. The difference in Anderson's style from that of former CEO John

130 BROKEN HILL PROPRIETARV (BHP) COMPANY LIMITED TURNAROUND

STRAYEGY
Prescott highlighted BHPs need for :1 modern chief executive, not only to lead
the organisation strategically, but also publicly. At BHP. Anderson is the rst
CEO to have any remuneration based on meeting dened achievement goals
(previous CEOs have held company-provided shares). The press described
his package as one of Australia's most unusual and creative remuneration
deals. With a salary including benets of A523 million, the package includes
l million share options and 1 million performance rights, both dependent on
performance He surprised his colleagues with his determination to place
much of his remuneration at risk by being performance based.
THE BIG AUSTRALIAN RENEWS
While 1998 saw the beginnings of a major cost restructuring drive by Ron
McNeilly, acting CEO of BHP while the board conducted its search for a new
CEO, 1999 represented a year in Bl-IPs history of signicant changes led by
Paul Anderson.
On the one hand there is a need to continue to clean up the balance sheet and
non-
core assets, with some minor write offs and a.-set sales to be completed and
tweak
ing the remaining assets to realise their full value. On the other hand, the
company
must make shareholders richer, not poorer. through growth. BHP has a suite of
not-insignicant new projects and expansions. but the emphasis today. will be on
innovation rather than the old method of digging bigger holes. BHP has no
consumer
brands and operates in a depressed commodity business. It simply has to be the
best.
(Business Rc'ii1'eu' Weekly. 7 February 1999)
When Anderson addressed shareholders at his rst extraordinary general meet-
ing he laid out his intent to create value for shareholders but emphasised the
point that there was no magic solution to be unveiled that would create instant
value and that the road to protability would be systematic and untheatrical.
The rst priority will be to get alignment \vithin the company and establish a
work-
able management team. There is nothing l can do myself, we have to have a
team that
works together. The intent is to simplify the organisation. provide the
organisational
glue that pulls it together. set out clear aecountabilities and responsibilities and
above
all to expedite decision-making. You will see a number of incremental actions - a
new
paee in the way we do business - a speed in bringing issues to a head.
(Paul Anderson. CEO BHP, Shareholders Address. .26 February 1999)
The methodology of rebuilding BHP was structured as a three-phase process,
of which, by December 1999. only phase one was complete. Phase l. in
Anders0ns words. was a matter of righting the ship, facing up to immediate
problems and xing them. Phase II is to take the assets that are healthy and
with which the company wishes to continue and optimise their return. Phase
Ill is to develop the overall strategy for the company and the portfolio of
business units. Anderson notes that while the activities are discussed as three
distinct phases, they are continuous and they overlap. but are also sequential
in the priority that they receive.

BROKEN HILL PROPRIETARY (BHP) COMPANY LIMITED TURNAROUND STRATEGY

131
PHASE I RIGHTING THE SHIP
By May 1999, the formerly eight business units were consolidated into three
distinct business units: minerals; steel; and petroleum. The multi-tiered man-
agement structure was replaced by a much smaller management structure of
which only one member had been with the company for longer than four
years. The board of directors appointed a new chairman, saw four resignations
and appointed two new directors. both of whom had international experience.
The corporate culture has been revised through the elimination of hierarchical
structures. and a reorientation of compensation towards perfomtance-based
stock options and salary awards. thereby aligning employee interests rmly
with those of shareholders.
Cost structure reduction
The cost structure reduction began in 1998 when Ron McNeilly. the then
chief operating ofcer, took over in the interim as acting CEO. Through
lowering overhead costs, reduction in labour. and streamlining operating
costs the company saved some A$565 million during scal 1998 and further-
more, AS540 million during scal 1999 and A$290 in the rst quarter of scal
2000.
The company further reduced its labour at the iron ore operations in
Western Australia by 25 per cent, closed down the previously held corpor
ate headquarters in San Francisco, and downsized the operating base of the
Minerals exploration division by reducing eld ofces from $0 to 6. In steel,
the company closed part of the Newcastle Steelworks, effectively taking
1.75 million tonnes or 21 per cent of Bl-ll Australias raw steel capacity out of
the system. lt thereby reduced the companys exposure to low margin exports
markets while adding to the efciency of the total steel business. In coal, over
and above labour reductions and changes in work practices, the company
negotiated a more equitable freight regime for the Queensland operations with
the adoption of a common 7 per cent royalty for all producers. The company
also cut discretionary spending on capital, adding A526 million to the bottom
line of the rst quarter of scal 2000, and cut R&D and exploration spending
in the scal 2000 budget by 40 per cent.
Project selection and assessment criteria
A number of countries and commodities were red lined or blacklisted by
new Bl-IP management to reduce risk and exposure. A Project Review Com-
mittee was set up to ration capital to all new projects and eliminate some
projects early before further management time and cash were wasted on
feasibility studies. Project champions were required to test their proposals
against a predetermined commodity price mnge and a matrix of hurdle rates
reflecting the nature of the business, leverage, technical and country risk. New

132 BROKEN Hlll PROPRIETARY (BNP) COMPANY LIMITED TURNAROUND

STRATEGY
projects had to demonstrate that they are able to achieve acceptable retums
even at the bottom of the price cycle before being approved. Once the pro
jccts have been approved and are up and running, they will be independently
monitored to ensure that they engage in best practice project management and
that they progress according to plan, if not. they will be stopped.
Problem assets
While in the pursuit of a lower cost structure, there was also a need for the
company to address both the immediate and long~term value of a number of
existing projects and then assess and reshape the asset and business portfolio.
The long-term strategy of the stnicture of this portfolio is for Phase Ill. Phase I
dealt with the need to dispose of. or transform: those underperfonning assets
which were not currently protable or would not be protable in the fore-
seeable future; were non-core assets; were assets of limited strategic value: or
could have more value to somebody else.
ln scal 1999. BHP generated AS175 billion from restructuring. which
included the successful sale of the manganese business for A$547 million and
the power business for AS175 million. This also included the sale of oil assets
in the Timor Sea for AS l 2| million and the sale of the Eastern Gas pipeline. The
sale of the 1.400 km gas pipeline which supplied the BHP power station
Pilbara Energy in Kalgoorlie. and supplied numerous mines and proiects in
and around Port Headland. signalled a change in corporate strategy where BHP
no longer saw a need to control the supply chain in order to get into and run
projects in new markets. New Zealand Steel was subject to signicant asset
write-downs to reflect the market outlook.
Fiscal 2000 saw the sale of other problematic projects owned by BHP. prim-
arily Hartley Platinum in Zimbabwe, Beenup 'l'itanium minerals in Australia
and the North American copper operations. All three opemtions had been part
of the signicant asset write-downs of scal I999. These decisions to sell
did not take place without BHP incuning cost both in nancial terms and at a
cost of some of its pcoplc. Hartley Platinum saw the retrenchment of some
5,000 people in May I999. The mine was sold to Anglo American (Zimplats)
subject to various conditions of the mining lease for only USS} million. at a cost
to l3HP's prot in asset write-downs of AS500 million in scal 1998 and a fur-
ther A$542 million in scal I999. The mine lost AS_>l million in operating loss
in the rst quarter of scal I999 and was also responsible for four of the
Group's six fatalities in scal I999. It was considered uneconomical because of
low ore grades compared with the feasibility studies as well as very unstable
ground conditions. Beenup Titanium Minerals was sold in April 1999 and the
decision to close Beenup followed an extensive study into the technical proh-
lems caused by the high clay content of the Beenup ore body, which had
impacted upon the ability to reach protable production levels. Beenup lost
some A58 million in the rst quarter of scal I999 and the cost to the Group
prot in scal 1999 was A5154 million in asset writedowns. in August I999, at
decision to cease operations of the North American copper assets was made.

Y
l
BROKEN HILL PROPRIETARY (BHP) CDMPANV LIMITED TURNAROUND STRATEGY
733
which cost BHP some A$1,800 million for scal I999. The assets were all part
of the Magma Copper Company purchased by BHP in 1996. The sale of these
assets was primarily because of the continually depressed copper prices. The
decision to close or cease operations at these three projects effectively stopped
the cash bleeding from these operations. resulting in a US$445 million
t'avour.tble
impact on prot in the rst quarter of scal 2000 compared to the correspond-
ing quarter.
PHASE ll FINE-TUNING
Phase ll was considered a stage in which the company attempted to get the
very best from its asset base at optimal efficiencies. Effectively. the need was
to ne-tune the organisation and to increase the level of communication and
co-ordination.
An incentive programme. which began in I999 throughout the organisation
and rewards the performance of individuals according to the company"s ability
to deliver better total shareholder return than its competitors. continues down
the organisation as part of phase ll. It was considered vital that management
continued to optimise the system in which the company pays people. which
indicated a need to place more compensation at risk.
Opportunities
Anderson felt that the improved outlook in the Asian economy in November
X999. particularly in japan. called for a more intensied marketing effort in the
East. which was expected to increase the prospects of further liqueed natural
gas (LNG) sales there. as well as provide more opportunities for Bl-lPs iron ore
business. Increased market demand and sales of both these products in this
region would mean viable opportunities for expansion in both LNG and iron
ore for Bl-ll. The Escondida copper mine in Chile was arguably the world's best
copper mine. The last extension to the mine (Phase 55) was implemented on
time and to budget and Escondida Phase 4 and Escondida Norte. two new
developments. will rely in part on existing infrastructure and will he protable
even at low copper prices. Expansion to the successtl EKATI diamond mine
in Canada is also viable. While the further development ofcxisting projects will
lift performance of the business. the company also has a range of greeneld
opportunities which the company is evaluating most notably Pctroleunfs
position in the Gulf of Mexico.
Debt restructuring
The efforts to lower costs, manage the asset portfolio and tighten control over
discretionary spending have been directed towards strengthening the balance
shcet. The company gearing (measured debt to debt plus equity) was 54.2 per

BROKEN HILL PROPRIETARY (BHP) COMPANY LIMITED TURNAROUND STRATEGY

cent at scal I999 yearend. Such gearing is in part a result of major asset write-
downs and also a weaker Australian dollar. The company target is mid-40 per
cent and the priority was to monitor and cut spending while actively managing
the asset portfolio in order to further reduce debt.
PHASE Ill FUTURE STRATEGY
Beyond phase ll. Anderson noted that the most signicant influence driving the
strategy of a resources company is globalisation, meaning the elimination of
barriers to trade, economic harriers, tariffs, political barriers and institutional
barriers. The reaction to globalisation of large companies like BHP has been
consolidation - consolidation of institutions, companies and even countries.
Financial institutions have merged and countries have consolidated. the most
obvious example being Europe which has consolidated to form the euro cur
rency. The impact of nancial institutions consolidating puts a premium on
liquidity and market capitalisation. The liquidity needs of mega funds require
mega investment altematives. The implications for BHP are that size does
matter, and that the largest, most costefcient producer will be winner in the
new environment and large capitalisation companies will be in demand. It is
therefore imperative that in order to determine future strategy, BHP deter-
mines whether it is a 'mega player or not. The Minerals division is one of the
fourth largest minerals producers in the world, and is therefore considered
megal The Petroleum and Steel businesses are not.
The BHP Steel strategy is to transform BHPs Steel business into a niche
player capable of delivering its cost of capital on a sustainable basis through the
peaks and troughs of the business and price cycle. The new BHP Steel will
base itself on the business's existing strength in flat rolled steel and focus upon
construction markets in Australia, New Zealand and Asia. lt will fully utilise
existing competitive advantages in its low cost base, strong market position,
world-leading coating technology and the wellestablished distribution channels.
The new BHP Steel will operate around BHPs world-class Port Kembla and
New Zealand steelworks. Port Kembla is one of the worlds lowesteost pro-
ducers of steel. The new BHP Steel will be a niche player in a region where
it is a leader in product technology, customer service, btand marketing
and has access to low-cost raw materials. BHP Steel will distribute a range of
nished coated and painted products for the construction industry. The
currently successful marketing brands for the coated steels ZINCALUMI-1'5
and COLORBONDT will continue to be marketed. The remainder of BHP Steel
assets, primarily in the US, including tube makers, merchandising, stmctural,
pipeline and packaging products, will be divested. It is the opinion of BHP
management that these assets in their current environment are constrained
from performing at their peak and would be better in the hands of somebody
else. This strategy primarily centres around creating shareholder value. The
breaking up of Steel into separate niche competitors will hopefully create more
value for shareholders. However, it reduces BHPs investment in the steel busi-
ness by approximately one-half.

BROKEN HILL PROPRIETARY (BHP) COMPANY LIMITED TURN

THE FUTURE
Looking to the future, the core of BHPs business will be natural resources. Tlle
company. according to the Bl'[P Charter. seeks to create shareholder value
through the discovery. development and conversion of natural resources. With
the closure of a large portion of the company's steelworks. the weightings of
the company portfolio will be increased towards the Minemls and Petroleum
businesses.
The company has experienced an intense period of change. cleaning up the
asset portfolio and improving productivity. The next phase of Bl-{P's develop-
ment is to chart the course for the future. This period will focus on returns and
shareholder value, rather than production and growth.
Although my preference is to grow the company. l would mther see it half the
size
and twice as protable than twice the size and half as protable. Our focus on
share-
holder value is on value per share, not absolute earnings.
Paul Anderson. MD and CEO. BHP
Anderson concluded:
It is a challenge to tum a resources company around during the lowest period of
com~
modity prices in two decades. The key is to position the company so that we can
make money in a down market. so we can create shareholder value when
conditions
are bad. but then be positioned when the market tums to shoot out of the pack -
not
just rise with everybody else.
On 2'7 July Z000. BHP announced its highest-ever prot with an A$l.65 billion
net prot for the I5 months to June (AS205 billion excluding abnormals) and
the results were driven by Petroleum whose eamings skyrocketed 471 per
cent. By November 2000, BHP had spent some A525 billion on new projects
during the year and it was set to approve a further A$1.5 billion over the next
few months. This was a consequence of the cash windfall from the rising oil
prices. Their big to do list at the end of 2000 included:
0 Change the asset base from 25 per cent Petroleum. 50 per cent Steel and
45 per cent Minerals to 40-50 per cent Minerals. 30-40 per cent Petroleum
and 20 per cent Steel.
0 Restructure the executive teams. splitting strategic and operational
decisions.
0 Consolidate operations to reduce duplication, gain benets of scale and
ensure that all projects advance the groups goals.
0 Achieve a 12 per cent return on capital for the ve years to June 2004.
0 Generate a net positive cash flow before dividends and funding every year.
0 Cut operating costs by at least 2 per cent per year.
0 Generate net operating cash flow of more than A51 l billion in the three years
to June 2002.
0 Raise AS4 billion from divestments by June 2001.
AROUND smnrecv

135 BROKEN IIILL PROPRIETARY (BHP) COMPANY LIMITED - TURNAROUND

STRATEGY
MERGER WITH BILLITON
During March 2001, a merger between BHP and UK-based Billiton was
announced which would create a global resources powerhouse with dominant
positions in coal and copper. A combined BHP-Billiton would have a market
capitalisation of USS28.8bn (valued 60:40 in favour of BHP to comply with
UK tax laws) which would be just short of the US aluminium giant Alcoa
(1lSS50.5bn) but ahead of Anglo American (USS28bn). Billiton was the world's
fourth largest producer of aluminium and aluminia and one of the biggest
exporters of thermal coal. which would complement 13HPs strength in coking
coal. lt was also the worlds fourth largest producer of nickel. A Billiton merger
would also give BHP exposure to global stock market liquidity through
Billitonls primary listing in London. lt was felt that the merger had parallels
with Paul Anderson's marriage of the US energy companies Duke Power and
Pan Energy in 1997. which created a much larger energy group but left him out
of the top job. Brian (iilbertson. Billiton's CEO. was regarded as an ambitious
South Afrlctut and it was announced that he would succeed Anderson as CEO
of BHP in December 2002. 1t was felt that he would provoke enormous change
at the Big Ausiralimz.
Sources
77.10 .-lge. Highest cvcr annual prot for BHP. Z_Iuly Z000.
7710 .-lge. BHP has S1.5b ready to spend: Anderson. Z1) November .!l)flO.
BHP First Quarter Prot Result. Fiscal 2000.
13111 lntcmal Press Release. BHP Announce new CEO. November 1998.
BHP internal Press Release. The right man for the job - the search for the new
(IEO ends.
Katc Dunstan. November 1998.
BH1 Protit Result. Fiscal 1999.
B111 website. http://mam-.bhp.com.:tu
BHP, A Prole of BHP in I99).
BHP. Animal Reports. Description of Business and Financial Statements. 1995-
1999.
BHP. Annual Reports. Report to Shareholders. l995~l)99.
Huxint-ss RL!!'l'1(' lVeeIel]'. A tall order for the Chairman. Z0. 8 March 1998.
Bnsinuss Rorieut Weekly. A troubled giant awaits its destiny. .20. 8 March 1998.
Bthirmts Rttt-imr Weekly. A creative deal for BHPs new l1oss'. Z0. 11 September
1998.
BIIS/Ill'S.\' Rt'!ill' l'eeIe!_1'. A good start for the new face at BHP. Z0. 11
Scptcnthcr 1998.
BIIS/l!('.\"S Rettit-u" Weekly. '1~1Hlup for redening. 20. 8 March 1998.
Bn.\'in0s.r Rettiett W'et=Iel_|'. The Big Australian renews. 21. " liebruary 1999.
B!lSiI!l.'.\X Review l\'@:.-Izly. Why BHP is hot stock. 21. Sjuly 199).
liusim-.ts Reriout W1-ekii'. After the pain. BHP is pressured to make gains. 22.
jtljunc Z000.
(Iohtlm. L. (Acting CEO). Rothwc-ll.J. ((i.\1 8: President BHP Diamonds). Adams. M.
(GM BHP
1\l11\\.1'-11>. (ktnnington). Dummett. H. (enior VP 8: GM Minerals Discovery).
BHP World
illlnt-ruls Brieng to Flrturt1al/htaiysts. 17 November 1998. Financial Review.
Marriage
of mining, giants is mutually convenient. Z2 March ZOU1.
Paul Anderson. BHP CEO and Ml). Address to Shareholders (EM. December 1998.
Paul Anderson. BHP CEO and Ml). Address to Shareholders E(iM. 26 February
1999.
Patti Anderson. BHP CEO and M1). Address to the Global Metals and Mining
Conference.
Dublin. I2 May 1999.

BROKEN HILL PROPRIETARY (BHP) COMPANY LIMITED - TURNAROUND STRATEGY

137
Paul Anderson, BHP CEO and MD. Presentation m the Ausn~.\liz\n Invcsxmem
Conference.
Edinburgh, October I999.
Paul Anderson, BHP CEO and MD. Prc$1:n\:\ti0n to rhc Securities Inslil\|(c
0I'Aus:mli;1.
Sydney. 4 August 1999.
Smckport, GJ. and Norvall G.R. (Z000) Bro/een Hill Pro/1r|'|.'tmj)- (BHP) (frml/may
Ijmilvzli
Tummwlnzd Strategy. European Case Clearing Hnusc. 28pp. N0, 500-()25-I.
Website.
Imp//www.Hlnonlbcrgcunm

Viking Sewing Machines AB

Jonas Dahlqvist and Anders Melander
The history of Viking Sewing Machines is one of considerable contextual and
organisational change. The case describes Ibis and provides a basis to con-
sider the developing strategic capability of the organisation and the process
of strategic change.
A NEW BEGINNING
Sometimes, things just happen all at once. The ownership question had been
lingering for quite some time before the deal was nally closed: articles that
explicitly mentioned Electroluxs intention to divest its sewing activities were
appearing in the Swedish business press as early as 1990. However. it was not
until 1997 that Electrolux actually did sell Viking Sewing Machines AB to
the investment fund Industri Kapital.' The deal was concluded on 6 February
1997. exactly 125 years after a decision was taken by the hoard of directors at
Husqvama AB to start manufacturing sewing machines?
In 1996, the Electrolux Group was actively working on a sale of their sewing
machine activities and had initiated discussions with Industri Kapital. During
this period, the Husqvama CEO Mr Jorgen Johansson resigned and a new CEO
had to be hired. The choice fell on t\lr Svante Runnquist of Volvo. Having been
with Volvo for over Z5 years, Mr Runnquist had worked in a number of different
positions, mainly in marketing. He had also held the position as CEO of Volvo
Germany for ve years. Svante Runnquist commented:
I was offered a position by Eleetrolux CEO Leif Johansson just before he went to
Volvo
- ironic, isn't it? He was in charge of hiring a new CEO in case the sewing
machine
activities were sold to Industri Kapital . . . l got the offer in December I996 and
accepted
right away. I thought it sounded great! l started on l January I997 so everything
The full name of the formal owner is the Industri Kapital I994 Fund. However, we
will refer to
the owner as Industri Kapital. Further details on the activities of Industri Kapital
can be found in
Appendix 2.
On 30 April I998. Husqiama Sewing Machines AB changed its name to Viking
Sewing Machines
AB. Before the purchase by Elcctrolux in 197* the company name was Husqvama
AB. For simpli-
city wc will refer to Viking Sewing Machines AB. meaning the sewing rnachine
manufacture that
stems from Husqvama AB. The brand name for products manufactured hy Viking
Sewing Machines
is Husqvama-Viking.
This case was prepared by Jonas Dahlqvist and Anders Melander, Jonkoping
International
Business School. It is intended as a basis for class discussion and not as an
illustration of
either good or bad management practice. O J. Dahlqvist and A. Melander, 2001.
Not to be
reproduced or quoted without permission.

VIKING SEWING MACHINES AB 739

happened really fast. Suddenly l found myself in the middle of the negotiation
pro
cess, hut at that time it still \vasn't obvious that Electrolux actually would sell.
A NEW DIRECTION
Viking Sewing Machines AB develops, manufactures, markets and sells house-
hold sewing machines. Electronic and computerised models are manufactured
at the Husqvama plant in Sweden. while low-priced mechanical machines and
overlockers are sourced from Asian manufacturers. When the new CEO Svante
Runnquist came to Viking Sewing Machines, much of his work was directed
towards improving the companys market orientation. The number of concur-
rent changes in the company made for a window of opportunity to redirect
the strategic focus of the company. An intense Weekend meeting in April 1997
marked the beginning of a very busy period for the top management team.
Mr Rttnnqttist explained:
We started off with a weekend meeting on a country resort. l didnt even bring in
il
consultant this time. l have done that in the past. but this time l was so fresh on
the
ioh that I was the one who could ask all those stupid questions.
During the rst meeting. the basic scope of the strategy document was laid out
while further renements and changes were made during the summer of 1997.
The new mission statement and the companion strategy document were pre-
sented to middle management and sales area managers in a series of seminars.
The opportunity to participate in the strategy process was a new experience to
most of the people involved and some took a dim view of the amount of time
spent away from more pressing matters such as low sales or the installation of
a new accounting system. Nevertheless, the high involvement seemed to pay
off. The strategy document was often referred to for guidance on operational
matters and the mission statement was frequently promoted in the companys
ptthlic relations. The physical appearance of the strategy document was very
plain: it consisted of folded and stapled photocopies wrapped in a two-colour
sleeve. This was indeed a reflection of the conccm that the Viking management
had about setting in stone something that was inherently an ongoing process.
The strategic conversation within the top management team continued with at
least ve off-site workshops a year formally dedicated to assessing the
companys
current strategic position. Summing up the initial process. Mr Runnquist said:
The rst attempts were very unstructured and people were complaining about
how
it was all empty phrases and buzz words. My point is that, it is only when you
engage
in that type of discussion that you may come to realize that your thoughts aren't
that
clear after all.
MAKING IT HAPPEN
The dealers were very important to Viking Sewing Machines in their new
plans for future protability. This crucial link to the customers became a tar-
Please refer to the mission statement in Appendix 5.
. \-

VIKING SEWING MACHINES AB

geted area for Viking Sewing Machines with the arrival of the new (IEO. One
important effort in this direction was the programme to transform the retailers
through Dealer Partnerships. The concept included extended support for
business development to encourage dealers to carry the Viking product line
exclusively. Marketing associate Soa Axelsson put it this way:
There have been tremendous changes in Viking since Svante [Runnquistl came
here,
there really have, But we may change all we want; the customer only meets the
dealer
and as long as the dealer d0esnt change, the customer won't perceive any
change at all.
In the US, Viking Sewing Machines started to co-operate with Jo-Ann Fabrics
8; Crafts, a large retailer of fabrics with over a thousand stores nationwide,
setting up small sewing machine outlets inside their fabric stores. By May 1999.
Viking Sewing Machines had opened 47 exclusive dealers in the US, many in
cooperation with ]t>Ann Fabrics & Crafts. Mr Runnquist explained:
The US is our biggest market. then comes Sweden. In Sweden. we have market
shares touching 60 per cent of the total market and in our target segment about
73-80 per cent. This country [Sweden] is the only country where We have had
exc|u~
sive retailers for a long time. ln the US we only started this a couple of years ago.
You
can make a living on t.he Husqvarna-Viking brand there. In most other parts of
the
world we have very few exclusive Viking retailers: were a brand among many
others
in the shop. A dealer in Europe typically carries 5-4 brands. Unfortunately, that's
often the type that just 'peddles' machines. We don't believe that's our future.
It was in the light of the expanding after-market that dealer integration became
really important. since the companyls strategy expanded the core product
beyond the sewing machine. The after-market included services, such as
training in sewing techniques. software for embroidery construction and ready-
made embroidery patterns, together with spare parts and auxiliary sewing
equipment. But how did the average dealer respond to Vikings proposal to
expand their activities? Mr Runnquist again:
You really can make money on training and that's what we are trying to teach the
dealers. Our organisation in the USA is particularly successful. Over there, people
willingly pay 5-600 dollars to be in on a threewlay course with a sewing expert.
SUPPORTING THE STRATEGY
Changes in organisational structure and routines accompanied the company"s
claims of a new commitment to think more about the customer and less about
technical features. The top management team was changed to incorporate the
managers of the major sales companies as well as the marketing vice-president.
However. a meeting with a management team spread out over the world made
logistics an issue. To mitigate the loss of time in travel, video conferencing was
introduced for participant managers.
The new management structure involved not only a change at the top level.
but also changes in operating systems to support the new strategic direction.
"About 45 pct cent of the tumover.

VIKING SEWING MACHINES AB "1

One maior task for the nancial manager Gunnar Viden was the installation of
a new accounting system in May I999. One important problem with the old
accounting system was that it could not report protability for each product
group. (lost information was fairly well covered, but Viking had a very vague
idea about l1ow much they spei1t on marketing a specic product. let alone
what their competitors spent. The old system may have seemed sufficient dur-
ing the Electrolux period when worries tended to end at the factory gate.
However, as a separate company. Viking needed to assess the accounting infor-
mation in new ways to keep track of the various activities in the value chain.
On an even more concrete level. the marketing and the technical devel-
opment department moved into the same ofee building in January 2000.
Hitherto. Production and Technical Development had resided in the same
building away from the rest of the depanments. Looking back, it comes as no
surprise that the turnaround programmes in R&l) during the 1980s mainly
focused on streamlining production efficiency. rather than on developing cus-
tomer value by innovative functions. The new office space was located in an
old brick building till recently used for production. it blended in with the other
buildings of the Viking plant but was given a completely new interior with
glass walls and a centrally placed multi-purpose area for business meetings as
well as the usual Swedish coffee breaks.
COMPETING IN AN INTERNATIONAL ARENA
When it came to market information. the sewing machine industry lacked
the transparency normally associated with a mature manufacturing industry.
Since very little information was collected by official bodies, Viking partici-
pated in a cooperation between competitors to collect gures of volume in
different price-brackets through a third-party intennediary. This was done in
France. Germany. Sweden. Norway. and to some extent in the US. All the major
niantifacttirers participated in this mutual exchange between competitors in
order to obtain at least some rudimentary market infomiation. Viking also col-
lected information on competition through the sales companies and dealers.
ln addition. the R&D department as well as Marketing and Sales regularly
compared their own machines with the ones manufactured by competitors.
To the CEO Mr Svante Runnquist. the lack of market information came as a
surprise:
For me. coming from the car industry. all this lack of information is very
frustrating.
That was one of my rst questions [when I came to Viking]: what does it [the
mar-
ket] look like? The industry is rather poorly monitored as to market shares. You
know
what models and specications exist. but there are actually rather few that start
from
the customer and develop the product denition that way. So now we start
asking
about market shares and we discover that the information is not nearly as good
as in
the car industry.
In terms of volume. the demand for sewing machines in the western hemi-
sphere had been declining for two decades. As a result, industry protability
had deteriorated. In the period 1976-81, total unit sales of sewing machines

"1 VIKING SEWING MACHINES AB

in westem Europe dropped 25 per cent; the decline in the US was consider-
ably less severe at 4 per cent. This downtum had been particularly hard on
manufacturers of industrial machines and low-price mechanical machines
for domestic use. ln Europe and in the US. the manufacturers competing
on the professional side were severely affected by the sharp drop in demand
for industrial sewing machines. Firms such as Pfaff, with the production of
domestic and industrial machines in the same company. experienced major
difculties in the l990s. Pfaff. with about twothirds of their sales in the pro-
fessional market, went bankrupt in September 1999. A week later, the almost
mythical Singer was on the hrink of bankruptcy and led for a Chapter ll.
mainly as a result of their 80 per cent ownership in Pfaffs industrial division.
After a reconstruction. Singer was up and running again but with no or little
in-house manufacturing. However. their huge global net of dealers managed to
stay operative in spite of the turmoil.
The aftermath of the Pfaff/Singer bankruptcy proved to be very important
for the development of Viking. When news of the demise of Pfaff reached
Viking, it posed new and intricate challenges to the owner Industri Kapital.
The original plan for Viking was to set a good track record over a ve-year
period in order to get a protable exit through an IPO. The choice facing
Industri Kapital was to go ahead as planned or to support a bid for Pfaff domes-
tic sewing machine division. However, this would necessitate a postponement
of the planned exit on Viking. In the past. Industri Kapital had been known to
seek out structural deals to develop the companies in their portfolio. True to
form. they nally decided to give the green light on the acquisition of Pfaff's
division for domestic products. The deal was closed on 2 May 2000.
By 2001. Viking Sewing Machines AB and Bemina Fritz Gegauf AG were the
only remaining independent manufacturers in Europe. Bcmina was a fourth-
gcneration family company located in Switzerland, enjoying a solid reputation
and actively demonstrating their Swiss heritage. Their product range resem-
bled that of Viking and their top model accepted embroidery les developed
for other brands. including Vikings. The nancial situation of Ber-nina was
difcult to assess since they were not publicly owned and therefore had no
obligation to inform the public about their nancial position. However. the
relative geographical proximity and a similar corporate situation made Bernina
an important quality benchmark for Viking.
In the Far East_ there existed a number of small manufacturers. primarily act-
ing as OEMs" for established brands in the lower price-bracket. However, there
were three competitors that set themselves apart. Brother. janome and Juki
were all major competitors to Viking; Janome alone produced over a million
units a year. Not only were these companies high-volume manufacturers with
complete product ranges but, more impormntly. they also sported their own
R&D facilities capable of developing advanced sewing-embroidery machines.
Being Japanese. their location gave them access to low-cost production facil-
ities in e.g. Taiwan, Thailand and Korea. However, this seemed to be a mixed
lnltial public offering. when a company sells stock to the market for the rst
time.
Original equipment manufacturer.

VIKING SEWING MACHINES AB 143

blessing since the competition from local loweost brands was erce for
modestly priced mechanical sewing machines.
Brother was a well-known manufacturer of ofce machinery such as labellers,
typewriters, fax and copying machines. However, they were also very active in
the sewing industry, both in the consumer and industrial markets. Their gross
sales of domestic sewing machines during the scal year of 2000 amounted to
$246 million.
Another big player was thejuki operation. Being more specialised on sewing
machines than Brother, they manufactured and marketed both industrial and
domestic machines. After the Singer reconstruction, juki made the entire range
of computer-controlled machines for Singer, including their top-of-the-line
embroidery models Juki did not market these expensive models under the Juki
brand in the US Rather, the models offered as Juki were very modest in fea-
tures. Total sales of juki during scal year 1999 were $704 million, of which
$129 million were in domestic sewing machines
The largest competitor by volume was Janome of Japan. Their dominant
activity was domestic sewing machines, although they maintained some side
activities in small industrial robots. They had no manufacturing of industrial
sewing machines. Total sales in the scal year of 1999 grossed S445 million
including robotics. Janome had introduced several important industry innova-
tions; they were the rst to produce computer-controlled embroidery machines
for domestic use as well as touch-screen controls, which had become an indus-
try standard on upmarket machines.
INTO CYBERSPACE BY DESIGN
When Viking presented their new topof-the line machine in early I999, it was
meant to be a world's rst in several respects. The Designer I came out as a
real engineering tour deforce retailing at a hefty $5,000. The new model made
extensive use of software to control the machine and contained no fewer than
eight motors to cater for all functions. Several features were logical develop-
ments and renements of existing solutions but the new sensor control for the
presser foot with an automatic thread cutter, the built-in disk drive and a Flash
memory made for a redenition of what a sewing machine really is.
For a long time, the engineers at Viking had Wanted to make a presser foot
that did not need manual assistance to raise and lower itself. Some mechanical
solutions to this had already been developed by competitors but were blocked
by patents. Moreover, a mechanical solution did not seem to be the way for-
ward. The way around this was to construct a unique mechanism where the
pressure on the presser foot was sensed by an electronic sensor and pressure
was applied by a step motor instead of using a mechanical spring. Since a step
motor can be controlled by a microprocessor, this solution made it possible to
Sales gures originally stated in yen for Brother, _Iuki and Janome; US dollar
equivalents were
calculated at rate of 1 IOJPY/USD.

mt VIKING SEWING MACHINES AB

bring one of the last mechanical functions into the realm of numerical control.
The specic result of this invention was a presser foot that not only applied the
same pressure regardless of fabric thickness but also raised and lowered itself
automatically.
late in the development process of the new model, the Viking engineers
decided to change the processor hardware of the machine from an EPROM to
a more expensive Flash memory. The difference in function was small but
important; both types of memory chip were reprogrammable but the EPROM
had to be upgraded by the manufacturer while the Flash memory could he
upgraded by the customer. Since all the functions of the Designer I were now
controlled by a programmable microprocessor it opened up completely new
ways of customer support. One illustration was the way Viking started to make
new versions of the operative system available for download via the lntemet.
free of charge. The customer downloaded the le from the lntemet site, saved
it on to a floppy and slid it into the built-in disk drive of the Designer I. This
method of upgrading performance was well developed in the computer busi~
ness. but was new for sewing machines.
When the Designer I was in a pre-production stage, the Viking website
presented what they referred to as a sneak peek. This translated into a list of
features together with an interactive three-dimensional model where people
who were interested could have a virtual-reality look at the new model. In
conjunction with this presentation. advance orders were accepted as well as
general comments. From this campaign. Viking collected about 7.000 requests
for more information and a contact from at retailer.
The general e-business hype during the late 1990s and the plethora of
dotcoms was the subject for recurring debates. questioning the lntemet as a
viable medium for distributive trades. Vikings position on this was extreme
and followed the lines developed in their strategy document: since Viking tried
to promote dealer partnerships. there could beno parallel mailorder distribu-
tion of Viking sewing machines. Viking was quite unique by not allowing web
shops to carry the Husqvama-Viking brand. However. Viking did sell low hulk
notions and accessories such as presser feet. needles and embroidery les on
their website. The service was .tSI offered to US residents only. and like its
competitors. Viking had not extended this service to Europe by early 2001.
The bonus clearing system on lntemet sales was one tangible sign of Vikings
intention to stay on good terms with the dealer partner. I-Iaclt customer was
given a unique identication code that linked her to the area dealer. The area
dealers were given a bonus based on web sales to clients within the assigned
area. The information on the customer was not passed on to the dealers. only
the money. As Anne jansson. the manager of lntemet marketing put it:
Up till now. we haven't had one single complaint from the dealers. l think they
rather
like the idea of getting a bonus automatically without any work involved.
ln March 1999. Viking declared that they had acquired the small British soft-
ware producer called Embroidery Networks Ltd (Enmet). This company was
founded in I988 to provided software for PC-controlled professional sewing
machines and actually had only two people employed. Viking~Emnet started to
co-operate in 1993 to develop software for embroidery in various degrees of

VIKING SEWING MACHINES AB 145

sophistication. To have this activity in-house was obviously important to the
Viking management team. CEO Svante Runnquist commented:
The notion is not that far-fetched if you think about the fact that we want the
after-
market to grow more than the total business. We cannot do that by selling more
spare
parts; we will probably he selling fewer. . . It's by selling more auxiliary
equipment
and developing new products for the after-market that we will grow and then
soft-
ware will be an imponant part for our computer-controlled machines.
With the breakthrough of the WWW, distribution of software and embroidery
les took a new tum. People could exchange embroidery pattems through the
Lnternct or download them at the website of liusqvama-Viking. This site was
one of the most accessed corporate sites of the net, recording as many as
7()().O()0 hits in one month by reaching people that are not the average lntemet
surfer.
ln just ve years, Viking had transformed itself from a trader of sewing
machines to a customeroriented marketing organisation. selling the joy of cre-
ative se\\'ing. Sewing sure isn't what it used to be!

1 VIKING SEWING MACHINES AB

APPENDIX 1 COMPANY HISTORY OF VIKING SEWING
MACHINES
An unbroken tradition of engineering and manufacturing since 1689 is sonic-
thing that is often emphasised in the company's own presentations of Viking
Sewing Machines AB. ln I846. a machine that could sew a lock stitch, using an
under-thread and a shuttle. was patented by the American engineer Elias Howe.
The sewing machines of today basically use the same principle. A manufacturer
of guns for 200 years. Husqvama AB needed something to support the com-
pany's declining sales in guns and the new invention was seen as a solution that
matched their skills in machining and precision casting. The company's rst
sewing machine appeared in 1872 but was relatively unsuccessful. Instead
Husqvama began to produce American models under licence from Weed and
Singer. ln 1883. the engineers of Husqvama AB presented a new model of their
own conception, the Freia'. lt became an instant success and was manufac-
tured for over 40 years.
ln more recent times. the Husqvama Company was early to investigate
the possibilities of sintered metal technology in the 19505 and actually held the
European patent rights for this special technology. Using sintered metal, the
l-iusqvarna engineers were able to make the moving parts of a sewing machine
permanently lubricated, thereby eliminating the need for oiling and greasing."
A century after the their rst sewing machine was produced. Husqvarna
AB had become a diversied manufacturing company. producing and market-
ing consumer durables such as cookers and refrigerators. lawnmovers. chain
saws and even cross-country motorcycles. ln November 1977 the company
was acquired by Electrolux. their ercest competitor. Looking back at the
twenty years of Electrolux ownership tells a story of major stnictural redesign
of the company. The pans of Husqvarna AB that manufactured consumer
durables became an integrated part of the worldwide manufacturing system ol
Electrolux.
Two years after Electroluxs purchase of Husqvama AB, the company was
protable except for the sewing machine division. The Electrolux approach to
this was to give some nancial slack to the management of the sewing machine
division who could invest in technical development despite persistent losses.
This strategy seemed to pay off in 1982 when Husqvama AB made a small
prot and protability peaked in I986. Three years later, volumes and margins
declined and in 1989. Husqvarna AB was once again in the red. This year. two
important decisions were made: Husqvarna AB embarked on a costcutting
programme while a new development programme was instituted.
A couple of years later, Husqvama Sewing Machines AB seemed to have
coped with the crises of 1989. The protability increased in face of the slump
in the Swedish business cycle. Firstly. the depreciation of the Swedish Krona
slashed costs by 30 per cent ovemight relative their competitors. Secondly, a
"A sintercd metal is made from a hlcnd of metal powders that is compressed
under high pressure
and temperature to form a solid metal. A sintcrcd metal can be given a number
oi properties
(cg. controlled porosity) that are not obtainable through traditional methods such
as cast alloys.
A porous metal can be permanently impregnated with oil, which gives 2 self-
lubricating effect.
VIKING SEWING MACHINES AB -141
drastic reduction of in-house manufacturing of components paid off. This was
a result of a turnaround programme that was started in I989. Some of the core
elernents were the reduction of parts in the sewing machines to streamline
production as well as sourcing parts front outside manufacturers to cut costs.
.\/Iacroeeonomic variables have seemed to affect the protability of
Husqvarna AB. The rst crisis in the late i)','()s was concurrent with a general
crisis in the .\'wedish industry. The improved protability came in I982 when
the Swedish currency was de\ aluated by I6 per cent. The prots started to
tlive in I98". t\\'o years after the US dollar had started to depreciate against
seventl of the European currencies. including the Swedish krona. Prospects
were miserable in I989 \vhen the Swedish krona was very strong. The Com
pany's competitive edge started to look really good in I992 when the Swedish
krona depreciated 25 per cent. literally ovemight. Although the antecedents
of Viking Sewing Machines initiated several programmes for technological
development and cost-cutting to improve protability. the sudden changes in
protability seem highly correlated with the cost of production as set by the
exchange rate.
APPENDIX 2 BRIEF DESCRIPTION OF INDUSTRI KAPITAL
ln ZOOI the owner of lndustri Kapital Fund 1991' was a venture capital fund.
managed by lndustri Kapital AB. The company was originally created in I989
and specialises in unglamorous but well-kept companies with moderate
annual growth. The funds for investments come mainly from large institutional
investors such as banks and insuntncc companies. lndustri Kapital AB has
ofces in Stockholm. London and Hamburg. Since the start they have acquired
5) companies and manage funds to a total value of approximately (*5 billion.
The total tumover of the companies owned by the funds managed by lndustri
Kapital reached about 8 billion in zouo.
The strategy of Industri Kapital is to huy companies where they think
they cart contribute to increase the value of the c<>|11|>:t|1y1 either by
providing
management know-how or by merging companies or parts of companies in
their portfolio. lndustri Kapital does not have the intention to run companies
indenitely; they will typically seek an exit either by an IPO or by selling to
another company. When Industri Kapital buys a company, the top manage-
ment group of the target company is offered to engage nancially in the
huy-out. In the case of Viking Sewing Machines AB. top management and other
employees hold about 8 per cent of the shares.
APPENDIX 3 MISSION STATEMENT OF VIKING
SEWING MACHINE
I To develop. produce, market and sell household sewing machines and
related products, which enhance the joy of creative sewing.
0 To grow our business by creating demand for more creative uses~of sewing.

VIKING SEWING MACHINES AB

o To be a consumer-driven company. securing growth. protability. and success
by providing superior satisfaction to the Consumer and our Dealer-Partner
by continuously adding value to the Husqvama-Viking brand.
0 To provide valued employees growth opportunities in an environment of
which they can be proud.
o To be recognised as the leading premium sewing machine company in the
world.
APPENDIX 4 FINANCIAL OVERVIEW
Basic statistics (scal year 2000)
Number of employees: 1.200, of which 470 are in Sweden.
Tumover: about SEK 1.9 billion ($190 million)
Export: over 90 per cent of sales
Protability: very good
Total numbers of sewing machines and overlockc-rs sold: 500,000 units.
Number of sewing machines produced: 260.000 units.
Number of sourced sewing machines and overlockers: 240,000 units
Historical data 1986-98
YEAR
SALES TURNOVERI
(SEK M) GROSS MARGIN CAPITAL
PROFITABILITY
1 986
1 987
1 988
1 989
1 990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
810
790
775
760
G86
676
631
784
808
856
858
954
974
1,200
1,900
>10% ~ Z
<5% 1.5
<5% [increasing] ~ 1.5
<5/= [increasing] ~ 1.5 [increasing]
<5"/> [increasing] - 2
>10% - 2.5
>10% [increasing] ~ 2.5 [decreasing]
>10% ~ 2.5 [increasing]
>10% [decreasing] ~ 2.5 [decreasing]
>10% [increasing] - 3
>10% [decreasing] ~ 3 [decreasing]
>10% [increasing]
>10% [stable]
Very good
Satisfactory
Unsatisfactory
Unsatisfactory
Better, but still
unsatisfactory
Still unsatisfactory
Better, but still
unsatisfactory
Very good
Very good and improving
Very good and improving
Very good, but decreasing
Very good, all-time high
Very good, but decreasing
Very good, and improving
Very good, stable

Learning the governance lessons

of Tomkins
Paul Lee, Hermes Focus Asset Management
This case stuily is concerned with issues o_/corporate governance. It describes
the situation which developed in the late I 990$ as shareholders and
investors became unhappy with the corporate strategy and flerjformance of
T omleins, a highly diversied conglomerate. In particular, it describes the dif
fereni ways in which the investors of Tomkins set about influencing the cor-
porate xtrategy and management of that organisation and the consequences
arising from ibis.
HERMES, HFAM AND CORPORATE GOVERNANCE
Hermes Investment Management Ltd is wholly owned by, and is the principal
fund manager for. the British Telecom Pension Scheme, the UK's biggest.
Hermes also manages money for other pension schemes, including that of
Consignia (the former Post ()flice), and has funds under management of around
50 billion. About half of this money is held in UK equities, the vast majority
of which is invested passively, which means that Hermes's clients hold around
1.2 per cent of every company in the ITSE ALI-Share, and will only sell those
stakes if the companies are taken over or shrink so that they no longer qualify
for the index. As a result of this passive investment strategy - so-called index-
tracking Hermes has for many years taken an active interest in the way UK
companies are run. By ensuring that all companies follow good corporate
governance, Hemtes hopes that all UK companies will run themselves wholly
in the best interests of their long-term shareholders.
Because of these concems. Hermes has been extremely active in the cor
porate govemance debate. For example, it has had a policy of voting at every
shareholders meeting in the UK since 1990, and in the early 1990s its CEO
Alastair Ross Goobey led a campaign against ve-year rolling contracts for
executive directors. These effectively guaranteed executives payments of ve
times their annual remuneration when they left ofce. even when they were
Hermes puhlishcd its latest Statement on UK Corporate Govemance 8: Voting
Policy at the start
of Z00l. This was sent to the chairman and company secretary of every I-TSIZ
All~Sltarc company.
and it is also available on the lntemel (www,herrnes.co.uk/c0rpo|
1tcgovcman1:c/intro.htm).
This case was prepared by Paul Lee, Hermes Investment Management Ltd. It is
intended as
a basis for class discussion and not as an illustration of either good or bad
management
practice. 6 Paul Lee, 2001. Not to be reproduced or quoted without permission.

750 LEARNING THE GOV

ERNANCE LESSONS OF TOMKINS
sacked for underperformance. As :1 result of this campaign, it has become best
practice in the UK for executives to have one-year rolling contracts.
Hermes argues that companies with good govemancc should perform better
than those whose gm-emance is flawed. At the least. because they allow g
orous discussion and debate in the boardroom. such companies should avoid
substantial destruction of value. Given that Hermess clients invest for the long
run, Hermes is interested in ensuring such strong long-term performance -
and. as importantly. avoidance of losses - across the market.
In 1998. Hermes decided to use the corporate govemance expenise that it
had built up over the years to create a new business. called Hermes Lens Asset
Management now known as Hermes Focus Asset Management (HFAM). This
would launch a new fund to invest in underperforming compzuties where there
was value that wasn't being recognised because of corporate governance and
or strategic problems, but which the HFAM team believed could he released by
a programme of huilding relationships with the management and helping them
to make the changes which would enable the City to reassess the business and
re-rate the company. By investing in these companies. HFAM could gain the
clout necessary to put its arguments in front of the hoard and its clients could
benet from the nancial uplift which results from the success of the programme.
By becoming a larger and active shareholder, HFAM could encourage change
in companies where Hermes's nomtal governance strategies had not been able
to move matters forward.
One of the companies in which HF.-\M invested in its rst year was Tomkins
ple. Exhibit I shows the consistent decline in 'l'omkins's share price relative to
the stock market for over seven years before HFAMs investment. While for
much of that time the share price rose, it did not do so at the rate of the mar-
ket as a whole, so that 'l'omkins"s value relative to the market was virtually cut
in half over the period.
TOMKINS: BACKGROUND AND STRATEGIC PROBLEMS
Tomkins was a spectacular performer in the l98l)s, growing by aggressive
acquisition from :1 tiny buckle-maker in the Midlands to a sprawling conglom-
erate famously stretching from buns to guns - encompassing both baker Rank
Hovis McDougall (R1-IM) and pistol ntanufacturer Smith 8; Wesson. lts formula
had been tn acquire underpcrfonning cash~cnw engineering husinesscs and
improve their operating efficiency. But the Tomkins share price had underper-
formed for eight years, as the company found it increasingly hard to nd acquisi-
tion targets at an appropriate price. to transform the companies it acquired.
and/or to develop an alternative strategy. HFAM began investing in July 1999.
The company had begun to lose investors condence by having been seen
to overpay for its acquisition of RH.\l in 1992. This acquisition was a deal
too far for many analysts creating the view in the City that the management
was interested in growth for its own sake. Analysts suspected that executives
"In 1001 HFAM changed its name to Hennes Focus Asset Management (llF,\M).

LEARNING THE GOVERNANCE LESSONS OF TOMKINS 751

. Exhibit 1 Performance to 6 July 1999 (rst investment)
TOMKINS
400
350 "
300 j
.l
250
ZOO 1
150'
100:
l
1993 1994 1995 1996 1997 1998
Key:
iwice
S Price rel, to FTSE All-share price index.
SOUFIE Datastream.
focused solely on c:1rning> per shurc (El.\) gi-o\\'tl1_ at the cxpcmc of(;uld. as
it turned 0uL [O the dclrimcm ul') long-tcrm slizwclioldcr value. Returns fmin
l|TL' lmsmuss had been h<.-low the rm's cost of capital. with inadcquzltc
improvement taking plum: post-zicqmsition.
HFAM'S ANALYSIS STRATEGY
On the strategy side, the HF/\.\-1 Ll1lill)'Si$ suggested that fundan1cntz1l
restruc-
turing of the company was likely 10 be necessary bccnusc it sccmcd to the team
that after its initial input to ucquircd businesses. Tomkins licadquurtcrs added
Wl\ilc El-S gm\\'th is 4| Slltfl ww:\rd> pnicnliully grcnlur di\'idcm_l.~. m Sl\|
rL'|\l)lLlLl'S. il is not hy it.-ll"
cuuugli to r.|i.se uliu share price, which depends at |L;\5l il much on cash
rclums ubuvc xhc <_<)~'[ 0|
cnpiml and on conalrncc thzll maunaigcnicnl um drive proliublc growih inw the
fumrcl

LEARNING THE GOVERNANCE LESSONS OF TOMKINS

Exhibit 2 Tomkins's structure
Tomkins: divisions by
turnover 1998
11%
30%
35%
Industrial/automotive division
Power transmission (Gates)
Hose & connector (Gates)
Wiper systems (T rico)
Schrader Bridgeport - valves & sensors
Stant companies valves & thermostats
Construction division
Air handling components (ASC & Ruskin)
Lasco Construction
Dexter - axles and wheels
Philips - vinyl & aluminium doors
Dearborn/Mayfran conveyor systems
Others
Food manufacturing division
UK flour milling (RHM)
UK bread baking (Hovis, Mothers Pride)
Cakes (Mr Kipling, Cadbury, Lyons)
Grocery brands (Paxo, Bisto. Sharwoods)
Partnerships
Professional, gardening and leisure division
Mowing machinery etc (Hayter & Murray)
Murray Bike
Smith & Wesson - pistols etc.
Key:
I lndustial/auto
engineering
I Construction
companies
El Food
manufacturing
Cl Professional!
GardenlLeisure-
1998 turnover (million)
546
400
236
124
202
212
200
165
171
204
2363
305
577
288
323
305
426
64
65
Source: HFAM,
little value, and the extremely disparate parts of the business were not adding
value to each other. For many of its businesses, they doubted that Tomkins
would pass the best parent test.
A Limited reorganisation (see Exhibit 2) - splitting the rm into four divisions.
including what were called the core activities of engineering, food and construe-
tion seemed to be largely cosmetic because each of those divisions was a

LEARNING THE GOVERNANCE LESSONS OF TOMKINS 753

mini-conglomerate. Although margins were good in comparison with those of its
competitors (as might be expected from a conglomerate based on tight nancial
control), organic growth was very low, suggesting that there was an over-
emphasis on costs and price levels at the expense of volumes. HFAM believed
that
this needed to be addressed to ensure that Tomkins had a successful future.
One strategic analysis would be that the company had two core businesses:
the industrial and automotive group, based around the strong Gates business
acquired in 1996; and a UKoriented food company including the recent add-
on acquisitions as well as RHM. In addition. there were the disparate holdings
in the construction sector and gardening and leisure division. Depending on
resolving tax and gun litigation issues (Smith & Wesson was at this time facing
substantial law suits in the US), this last group should be sold off piecemeal
over a period of time; this could be done either from the industrial and auto-
motive group or from a shell Tomkins after both the other businesses had been
demerged. Tomkins would be able to focus on adding value through focussed
organic. as well as acquisitive growth.
HFAM'S ANALYSIS BOARD STRUCTURE
Hermess experience is that stmtegie problems rarely come to light in com-
panies where govemance is strong. Where there are enough independent-
minded non-executives on at hoard. the right questions get asked so that
potential strategic issues are addressed early and do not become problems that
are obvious ou-side the company. ln HFAM's analysis. this was not happening
at Tomltins. indeed, the fact that the board seemed content with the com-
panys poor share price performance, that no new strategy was emerging and
that there was no challenge to the existing structure was a strong indication
that input from an influx of independent directors was needed to spark the
changes that would unlock value for shareholders who had suffered for eight
years. Not surprisingly, the existing stmcture was poor in corporate gover-
nance terms. Hermes had a history dating back to I995 of raising coneems over
the independence ,0f non-executives and calling for a stronger board.
Greg Hutchings, who had created the conglomerate. lled the roles of hoth
chairman and chief executive. The City perception was that he dominated
the board. There were further signs of board problems in an apparent dis-
agreement over strategy between Hutchings and deputy chairman and Ml)
nance lan Duncan - who was apparently arguing for some of the restructur-
ing which HFAM believed was needed. The HFAM team worried about the
strategic implications of Duncans possible resignation. and the fact that it
might unbalance the board further.
Given this. HFAM believed that the roles of chaim1an and chief executive
should be split and that the non-executive representation on the board needed
to be substantially strengthened. This seemed particularly true because of the
need to take tough decisions about the structure of the company and HFAMs
allied concems that Hutchings might not be willing to preside over the division
of a company which he had spent so long creating. This view was reinforced
by the stories of the apparent spat with Duncan and of the increasing difficulty

754 LEARNING THE GOVERNANCE LESSONS OF TOMKINS

the centre seemed to be having in adding value to its disparate businesses. ll
liutchings were to decide - or be forced - to leave, a stronger board would be
needed to ensure that there was no vacuum at the top of the company.
Plans for the dcmerger of RIl.\'l were announced on l2_Iuly. Duncan resigned
at the same time. 'lhis made HFAMs coneems about the structure of the
Tomkins board still more immediate.
THE INITIAL MEETING
ln November i999, while IIFAM was still building its initial stake in the company.
the team became aware of a former corporate nancier who was represent-
ing certain dissatised shareholders. He was trying to raise wider support for a
campaign to oust Hutchings. and was looking for tinance to build a l0 per cent
stake in Tomkins to eall an lZ(i.\l.
l-llA.\ls policy had always been to meet and discuss issues with the company
before taking any action. let alone action which might be seen as hostile.
The te:tm therefore made it clear that they would not have a meeting \vith this
dissident shareholder representative until they had met with the eompanys
executives. There were wider concerns in this instance. because llIAM
thought that the timing was entirely negative: llutchings was in the middle
of negotiations on the sale of RHM and of other smaller businesses: Smith 8:
Wesson was facing litigation in the l'S: and the team doubted that the hoard
was strong enough to prevent an evaporation of value if Hutchings were
ousted. In addition. the puhlie nature of the planned attack could easily he
value-destroying in itself.
The HFAM team rst met with Hutchings in early February 2000. He was
extremely courteous, givinp, a full two hours over to the meeting, and not
unreceptive to the team's strategic and governance agenda He was willing to
consider the idea of splitting the roles of chaimtan and chief executive. with
himself staying as chairman and the board appointing a new CEO, HF.-\M
welcomed the recent addition of David Newlands. former nance director oi
GEC. as a rst step to strengthening the board. Hutchings agreed that further
additions might add value
Following this meeting. HFAM's agenda was simple: to encourage the eom
pany to appoint an independent non-executive deputy chairman to ensure that
an independent point of view was given full weight on the board; to explore
what difference it would make were a new (ll-IO to he appointed; and to
encourage the company to make aggressive share huybacks. Given that the
share price was so undervalued, huvbacks were clearly a good way to increase
shareholder value, and this seemed to HFAM by far the best use for the prtr
cceds of the RHM sale rather than using it for further aequisitive growth.
MEETINGS WITH OTHER INTERESTED PARTIES
HFAM began its usual process of discussions with other major shareholders and
with various board members to try to advance this case. The team believed it
had support for its view from 25 per cent of the shareholders. including some

LEARNING THE GOVERNANCE LESSONS OF TOMKINS 755

who had apparently supported more aggressive change. So they felt they were
making good progress when the board considered the HFAM proposals at :1
meeting on 5 May.
In late May the HFAM team also met the representative of the dissident share-
holders. He had identied a chairman and chief executive to take over at the
company. l-ll-"AM representatives agreed to meet his suggested team, and they
seemed credible. Tlle HFAM team again told them. however, that they were
not prepared to support their activities as they were waiting for a response
from the company to their proposed agenda and had the impression that
response would be favourable.
Unfortunately. the share price continued to drift and HFAM was concerned
that this might draw in interest from venture capitalists eager to buy at a low
price. The team hoped that their plan to bolster the hoard would keep such
moves at bay to give the new board enough time to take the actions necessary
to revitalise the share price and so provide full value to long-term shareholders.
These concerns were reinforced by a slew of stories in the press suggesting
that (Iity gures were trying to oust l-lutchings. This whispering campaign was
particularly unfortunate because it was having a detrimental effect on the sale
of RHM. The venture capitalist buyers were happy to slow dotyn the process,
because I-lutchings might feel under increasing pressure to complete a deal -
at whatever price - to bolster his position.
MATTERS COME TO A HEAD
The whispering campaign came to :1 head in early June 2000. The company had
still not implemented any of the changes HF,-\.Vl had suggested, and had not
included shareholders in the non-executive director appointment process as
they had requested. But the hoard did insist that the process was well under way.
ln the meantime, the dissident campaign was gaining support in the City.
The Tomkins board were clearly not aware of the extent of the hacking that
the rebels had won. and the real danger of hostile action. Hl-AM put the rebels
in touch with Newlancls so that the exact sitttation could be made apparent to
him and to the rest of the board. HFAM made it clear that if the board made
substantial changes rapidly they believed that a number of the City institutions
then attracted by the rebel campaign could be won round. In the absence of
prompt and substantial reforms. it was possible that rapid and perhaps unfor
tunate change might be forced through.
Within two weeks, Tomkins announced that l-Iutchings was to split the
roles of chairman and CEO. However. in contrast to the fomter suggestions,
instead of his dropping the CEO role and staying on as chairman. the plan was
to install a non~cxecutive chairman. The changes were put into effect at the
prelims announcement at the end of the month. Newlands took on the role of
nonexecutive chairman. with Hutchings staying on as CEO. In addition, the
rm appointed Sir Brian Pitman widely respected as the man who turned
the flabby Lloyds Bank into one of the most efficient in the world - as a heavy-
hitting new non-executive. As HFAM had expected, this news led to the
collapse of the rebel campaign and to a rise in the share price.

LEARNING THE GOVERNANCE LESSONS OF TOMKINS

HFAM was relieved that after a long delay the company had felt able to make
the board changes which the team had argued were necessary. The moves
meant that a strong board was now in place to take the tough decisions that lay
ahead, and there was no risk of a vacuum at the head of the company.
The RHM sale was nally completed in September. raising 5.1.1 billion. The
sale of the Murray and Hayter businesses for l50 million followed shortly
thereafter. These two companies - predominantly focused on the lawnmower
market - had formed the bulk of the professional, gardening and leisure divi-
sion. Though the company's share price fell over this period, the governance
improvements led Tomkins to outperform its peers, all of which were hit by a
downtum in the US automotive markets.
HUTCHlNGS' RESIGNATION
The Tomkins AGM was held on 29 September 2000. lt was here that an event
unforeseen by both Tomkins and HFAM occurred. One fund manager asked
questions about the companys ownership of jets and flats in central London.
Hutchings gave inaccurate answers to these questions. Tomkins promptly
issued a correction and stated that it would sell the jets. But the revelation of
l980sstyle corporate excesses was enough to spark wider-mnging questions.
Newlands publicly acknowledged the existence of a fom1al investigation on
9 October. Hutchings resigned on 12 October,
HFAM was not directly involved in these events. which became a corporate
governance cause clbre. as facts emerged of inappropriate fringe benets
and executives wives on the payroll. However, HFAM had helped to put in
place the beginnings of a board structure which was independent enough
to sanction a formal enquiry, and robust enough to ensure continuity follow-
ing I-lutchings resignation. Newlands also launched a strategic review by
McKinsey & Co. in October 2000.
AN EPILOGUE: by Gerry Johnson
The press picked up the story to highlight the issues of conglomerate diversity
and corporate govemance. For example. the Inde/Jendenfs (13 October 2000)
columnist wrote:
. . .a combination of playing fast and loose with company assets whilst presiding
over a chronically under performing share price is invariably lethal. We ought not
to
become too pious here. Were it not for the precipitous decline in Tomkins share
price over the last ve years. then most investors as well as the nonexecs would
probably not have noticed that the company had slipped from the highest
standards
of good corporate govemance' as Mr Newlands put it yesterday whilst donning
his
hair shirt.
Nevertheless, it is clearly right that Mr Hutchings should have gone and gone
quickly. ln the last year he had become part of the problem not the solution.
The bigger question now is what happens to the empire he leaves behind? For all
Mr Hutchings' attempts to shake-off the conglomerate tag, noone was ever
fooled

LEARNING THE GOVERNANCE LESSONS OF TOMKINS

into believing that Tomkins remains anything other than a ragbag of
unconnected
businesses. The buns and the lawnmowets may have gone. But the guns remain.
along with the jacunis and the rubber car seals and the household ttings and
the
air handling operation. That does not sound like focus to many people
Tomkins
temporary executive chairman included. Mr Newlands has promised not to rush
to
judgement until his strategic review is complete. But a break-up and disposal of
the
group is surely on the cards, if not already long overdue.
And again (The Independent, 14 October 2000):
But the greedy and the dodgy will crop up. and shareholders should be able to
rely on
non-executive directors of quoted rms, and codes of practice on corporate
gover-
nance, to curb the most venal tendencies. lt matters to the rest of us because of
the
effect of such a culture on the efciency of the economy as a whole.
What is most disturbing about the Tomkins case ls the way that it shows how
weak
these safeguards are, and how those clubby, mutual back-scratching old City
habits
still persist . . . The solution? Even making the codes statutory and trying to
tighten
up the rules only invites the invention of new abuses. The only answer is the
vigilance
of the shareholders. Rumours about Tomldns had been circulating for years
before
institutional investors in the company bothered to raise questions. lf
shareholders
won't protect their own interests then it is hard to see what. apart from
highlighting
cases such as Tomkins, can be done.

Sheffield Theatres Trust

Gareth Morgan and Kevan Scholes
The case s!m( 1' crmcerns 1! churllallle rrusl tvhich is i'esp0r1.rih!0n' two of the
UK's lending pro:-incial Ihealres the Crucible and L_|'t'0nn! Theatres in
SI.n'j]ieI:I (plus a lhirrl sluge the Studio). ll mrvrs the [10rr'nrl from 19'!
(when the Crucible II.u.'alru opened) I0 2011/ by which lime il hurl become
[mrl of .S'hy]ielrI Theatres Trusl together will: ih refurbishell sister lheafre
the I.yceum - and under the management of u singie cl_1iefe.\~r'cz1Ii1ie. During
the 3!)-_1'enr period the theatre saw lIlINl_] m-u' (/L'l'l/(I[7HlLNl.\ um!
signimnl
changes in its envirrmmvul - /mrticrllnrly regurrling its fmuling. The Lll.\l'
srmlr sl_mu'.\' lbat xlrr1l0_qy formulation is no! :1 simple prurem" of mattlmig
cnjmlnililies In ent'ir0nrm'/rlul 'reqrlirenr('nI.\". II is crucial In umlvrslnml Ihv
polilicul '0nle.\'t u'ilI.rin u'hich _\"!rntegl'e.\ are furlnulalerl. Slnleelmldvr map-
ping is n useful NIL!/.101] of a.\:te.ssillg rI.1i_t [1uIilI'cnI dfniensiml. The fact lhul
the theulre has both (0IIlIIl('l'Ll'(![ am! /Juhlic serriice olg/vcIir''.\' Io /21/rsm:
i'lIus!ruIe.\" lhnl s!rme_q)' jimnulutimi usualir /Il'(!C(.(.(/S tliroug/J 1: /Jmcess of
CIHII/)I'()!7Il'S(.' and the Imlmiciug of dlffcrenl stakeholder inloresls am! not
Ihrough ojzlimisulimi Q/1I.n' rmezls ufjus! one gr-on/1.
Sltcliieltl Theatres is a unique cha|lr:ngr:. Often it feels like being on a high wire
with
no safety net. But it we can get it right, the potential is greater than for any
other
regional tlteznre.
(Grahame .\lnrrisr (Ihief lixecutivc ol' Slteftieid 'llieatre.s. September Ztitm)
Sltefeld has two distinct theatrical tmditions: a prole of high quality produ-
cing theatre (represented mainly by the (Irucihle) and at strong history of
touring theatre (for which the main venue is the Lyceum). This distinction is
fundamental: a producing theatre. through its artistic direction, commissions
and nances its own productions and employs its own artistes. By contrast. a
touring theatre enters into contracts with touring companies who bring their
productions (and their own artistes) to the theatre concemed.
In Shefticld, these approaclu-s are brought together in ll charitable company
known as the Sheffield Theatres Trust, Which. with three stages in all. is unique
in the UK outside London in being able to produce. co-produce and present
This case was prepared by Dr Gareth G. Morgan, Sheffield Hallam University and
Kubernesis Partnership, and Professor Kevan Scholes, Sheffield Hallam University,
with the
assistance of theatre management and external reports. it is intended as a basis
for class
discussion and not as an illustration of either good or bad management practice.
Gareth
Morgan and Kevan Scholes, 2001. Not to be reproduced or quoted without
permission,
Please note that Sheffield Theatres regret that they cannot respond to further
enquiries
related to this case study.

,_
SHEFFIELD THEATRES "must 159
independent productions all in one complex. Serving the population ol the
fourth largest English city outside London. Sheffield Theatres has around
5m income, making it one of the 500 largest charities in the UK. But the aims
of creating high quality artistic work, lling sufficient seats. and working with-
out decits have created a constant challenge for the last ten years.
THEATRE BUILDINGS IN SHEFFIELD
The l.yeeum Theatre opened in 1897; it was designed by a leading theatre
architect of the day. and is now a grade ll listed building. It has the rare advan-
tage of traditional theatres of having no pillars obstructing audience views and
having one of the deepest stages in the country. By the early part of the twen~
tieth century it had established itselfas one of the l1'K"s leading touring venues,
a reptttation which grew fttrther in the 1940s. ln the l90s and 60s it was espe~
cially famous for pantomime. But lack of investment and modem amenities
forced the Lyceum to close as a venue for music and drama in I968 and it
subsequently became a bingo hall,
Modern producing theatre in Sheffield dates from the Shcfeld Repertory
Company, founded around 1925. which became The llayhousc' in 1938.
Initially its work \vas purely commercial but in 196] it rst received an Arts
(Iouncil grant to extend the range of productions. This marked the change
from commercial to subsidised theatre. and in l965 the Playhouse became one
of only eight theatres outside London to be taken into formal association with
the Arts (Iouneil.
ln I966 Sheffield Council announced its intention to sponsor the building
of a new theatre of 8()()-<)()() seats, and a hoard of trustees was appointed.
responsible for organising the public appeal and other decisions about the new
building. This would be mainly a producing house. although with the demise
of the Lyceum_ it would also host some touring productions.
The result was the (Irucible Theatre, completed in 1971 at a total cost of
.88~'i,00(), on a site next door to the old Lyceum. The 'Crucible' name was
chosen to reflect the design of the building and Shefl-ields historically famous
steel industry. After some controversy, the nal building comprised a main
auditorium with 980 seats around three sides of a thrust stage (which critics
complained limited its use for large-scale opera and ballet), and a smaller Studio
Theatre with 250 seats (now increased to allow up to 400).
The Playhouse completed its last season in 1970/71 and the Crucible opened
in a blaze of local publicity. One of the most notable differences between the
Crucible and the old Playhouse was the range of activities which were tinder-
taken. Apart from the two stages, there was a rcstaut"ant, coffee bar. shop
and licensed bar. Most of these services were operated throughout the day on
the principle that the more people who could be enticed through the doors
for whatever purpose, the stronger the theatre-going community would be.
The foyer/bar was exceptionally large by most standards and was also used for
exhibitions and for ml boc folk music performances.
However. as early as 1981 there was a major local campaign to reopen the
Lyceum as a theatre, zuid in 1987 Sheffield City Council agreed to redevelop it

5 SHEFFIELD THEATRES TRUST

as part of the decision to build a number of rst-class sporting and leisure facil-
ities for the 1991 World Student Games. The building was by this time derelict
and the renovation cost l2.4m. On completion in 1990 the restored Lyceum
Theatre provided a superb example of a historic theatre, thoroughly refur-
bished to modem standards, and with seating for 1,100.
The Crucible and Lyceum stand physically together overlooking a paved
square. and for reasons of economy of scale it was decided to form a new
company, Shefeld Theatres, to run both venues. The distinctive role of each
theatre was, however, to be retained, with the Cmcible working largely as a
producing house, and the Lyceum now hosting a new range of touring com-
panies for the 1990s. The Studio theatre hosts a mixed programme of chamber
music and drama. and is the resident home of the Lindsay String Quartet.
CONTROVERSIES
The Crucible Theatre. and more recently Sltefeld Theatres as a whole, have
constantly faced controversy. ln I972. less than a year after the Crucible
opened. it had unprecedented losses and was at the centre of a public storm
following condential reports by the city treasurer claiming that the theatre
should slash costs and run more popular shows to attract bigger audiences.
It was only in I975 that one person became the overall director of the
theatre (previously it was run jointly by an administrator and an artistic
director). But Peterjames. who took the role. soon found himself with atten-
dances below S0 per cent of capacity. Speaking to the Sbefeld Star he said:
There is a wealth of difference between what an audience thinks they want
and what contemporary writers want to write about. The problem is trying to
strike a balance. ln 1981 he was succeeded by Clare Venables. who said in an
interview: A theatre that isnt controversial isdead. If people arent talking
about it and getting excited about the theatre. even if it includes criticism. then
you are having no impact."
A further nancial crisis in I982 led to an investigation by the Arts Council
and Shefeld City Council. According to the Sbeflield Star the subsequent
report criticised the board for meeting only twice a year. The management
committee was accused of failing to manage. and scathing comments were
made about the ill-dened and ineffective role of the nance committee.
Following this. structures were changed. The chair of the board resigned,
and the board membership was widened to give greater representation of
extemal and internal interests. The board was by then meeting bi-monthly and
the nance and management committees were replaced by a new executive
committee.
Changes were made to budgets. planning on much lower percentages of
seats lled (until then the assumption had been 70 per cent ~ despite the fact
that this had only been achieved once, back in 1974). Since 1998 this has been
further developed by using a measure of net stage contribution which con-
siders attendances, revenues and costs, for every production individually.
However, budgetary changes have never been easily received, particularly
when they impinge on artistic freedom. By the mid-1980s a new national climate

SHEFFIELD THEATRES TRUST if

of public nance had emerged, with no new monies from the Arts Council, and
no scope for local authorities to advance substantial sums to bail the theatre
out of difculties. Despite these pressures. under Clare Venables the theatre
enjoyed a considerable reputation - at least among its regular audiences - with
productions that were both controversial and challenging artistically.
But then, as the Shejeld Telegraph subsequently noted, attention began to
focus on the Lyceum, and suddenly the Crucible started to take a back seat.
With the reopening of the Lyceum. a new post of chief executive of Shef-
eld Theatres was advertised. ln January 1990, Stephen Barry was appointed
to manage the overall Crucible/Lyceum complex. Clare Venables completed
her nal season as artistic director the same year. and a number of other staff
changes took place.
The Lyceum brought big-name touring productions and popular drama and
musicals to Shefeld for much of the year - previously the Crucible had hosted
some touring productions (for up to 50 per cent of the year) but it was now
able to concentrate almost entirely on its own work. Seats at the Lyceum sold
well, with average ll at over 60 per cent of capacity, and up to 100 per cent
for some shows.
But by I991. a new crisis was emerging. In October, the S/J_iLI!1 Weekly
Gazelte reported: The artistic director has resigned. attendances are down by
50 per cent, productions planned for the new year are cancelled. the company
is heading for a..250,()O0 decit. This came after an emergency meeting of the
directors to discuss the drastic fall in Crucible box ofce receipts following the
opening of the Lyceum. However. Stephen Barry insisted that the situation could
be managed. We are not asking for more money, nor are we trying to take
audiences away from the Lyceum, he said. There are different types of audi-
ences out there and we must look at ways of attracting them to the Crucible.
Two years later he reflected: In retrospect we were too defensive about the
Crucible - narrowing our market appeal and attempting an over-specialist role.
We did not capitalise on the single-site thinking brought about by the manage-
ment structure. We knew the Lyceum would inevitably have an initial effect on
the Crucible audiences - which was no doubt deepened by the recession.
By now. a new artistic director. Deborah Paige. had been appointed. and
some relaxation of the split between the role of the two theatres was agreed.
with a few touting productions being accommodated in the Crucible. and
occasional local productions being staged at the Lyceum. Following some good
reviews. box ofce income appeared to be improving over 1992-95. The
accounts were still showing decits (as they had done for all but ve years
since the Crucible opened) but the level of decit was around 55,000: small
in relation to the total turnover.
However, attendances were overshadowed by yet another nancial crisis
which emerged in 1995, this time caused entirely from within. A senior mem-
ber of the nance staff had. over a period of two years, embezzled nearly.05m
of funds from the various companies under the Shefeld Theatres umbrella.
The person responsible was charged and convicted by the courts, and around
a third of the money was subsequently recovered. But the events of the fraud
created a major trauma for everyone involved. It also worsened the overdraft
in the theatre accounts, with consequent ongoing interest charges.

762 SHEFFIELD THEATRES TRUST

()nce the shock of the fraud was over. it emerged that box office sales had
once again fallen drastically. and in 1995-96 the average capacity ll across all
performances was only $7 per cent. The 1994/95 accounts showed a decit of
5l8,l)()l), and 1995/96 showed at .553.()()() decit: considerably worse than
the gure suggested in the shock headlines of |99l.
Fonunatcly the charity has a major asset in the form of the Crucible building
(the Lyceum building is leased). Nevertheless. the accumulated decit \vas
such that there began to be some doubt as to whether the company \vas in fact
a going concem. lf. in fact. the company continued to trade while knowingly
insolvent. the board members would lose the benets of limited liability. and
would end up personally accountable for any continued losses. For each year
since then the accounts have contained a special note reviewing the going
concem basis. ln the worst year. 1996/97. the accottnts showed the company
to have net assets of iust l()_U()(l. made of up a building worth 9(i9.()ll(l less
accumttlated decits of .99.o0o.'
(Irisis meetings were held in summer I996 and a recovery plan agreed.
which involved drastic cost-cutting. Productions were greatly slimmed back.
and key members of the pcnnanent production staff were made redundant and
offered purely seasonal contracts (the posts were eventually restored in I999).
The result was that artistic morale was extremely low and long~tcrm planning
seemed impossible: in order to control cash flow, budgets for each production
could only be agreed once the outcome of preceding productions was known.
The output began to be chamctcristzd by plays such as Iizltusaling Rilll which
could be mounted with two actors and rt onc~room set.
As a result. the reputation of the Crucible began to fall. with weak reviews
and audiences less willing to tntvel to the theatre. resulting in even lower
attendances. In its best year (I995). Sheffield Theatres had achieved com-
bined attendances across all three stages of 450.000; by I996 this had fallen
to 2-i(),(N)0: no better than the hest gures achieved in some years with the
Crucible and Studio alone. before the reopening of the Lyceum. The problems
were compounded by a couple of poor Lyceum performances with box office
sales below the level of the minimum guarantee given to the touring company.
ln such cases. the theatres had to make a net payment to the touring company:
had they known in advance. it would have been cheaper to have kept the
Lyceum dark in such weeks!
A N EW STRATEGY
Until 1996. the board of the theatres was chaired by at Shefeld City Councillor.
but the pressure for further change led to Norman Adsetts being asked to take
The severity of this was softenctl on a day-|tH.lay basis, hecatlse theatres
receive signicant cash
front ticket sales in advance of productions. At Shcflield Theatres this applies
both for their own
productions and for tickets sold l'or others; moreover, grant aid is often received
in advance of
when it is used. 50 in fact. provided the theatres remained a going eoncem. it
was possible to cover
2 cumulative decit of nearIy.'.lm with a net bank overdraft oi just
under5.200.000. But if closure
had been considered all the advance cash would have to be repaid to third
parties.
SHEFFIELD THEATRES TRUST 163
over as chair of the board in summer 1996. A prominent business leader in the
city, and the former chair of governors of Shefeld Hallam University, Norman
Adsetts (subsequently Sir Norman) brought a new emphasis on strategy and
business planning.
Stephen Barry left in December 1996 for a new role in Edinburgh; he sadly
died in autumn 2000 while his vision of a single site theatre complex in
Shefeld was still being taken forward by others. The new chief executive,
Grahame Morris, took up his post in September 1997 and immediately had the
task of presenting a new business plan for approval by the board. He brought
with him experience from Plymouth of combining production and touring
theatre: one of the few other UK locations to work on that basis.
The 1997 business plan, which was prepared with the support of an outside
consultant, sought to unravel the various problems that the theatres had faced,
and in particular stressed the need to distinguish between the historic decit
and the need to generate at least a small surplus for the years ahead. The busi-
ness plan, which was agreed with the various funders, proposed many modest
but signicant changes over a three-year period to make the complex more
protable, by developing the marketing further, increasing the number of co-
productions with other theatres, strengthening the protability of the catering
function, and giving greater opportunities to the senior management team to
manage the theatres as a single venture.
in the light of this. by 1998/99 a major decision was made to reverse the
decline of the previous years, and to invest in more signicant productions
which would attract better audiences. This was a fundamental shift of thinking
in that the artistic quality and nancial prudence were no longer to be seen as
competing forces: commitment was obtained from the board and from funders
to a policy which recognised that the only way the theatres would succeed
would be to have output of a standard that would attract the audiences needed.
This bore fruit in the I998 production of Bmssed Off at the Crucible (based
on the lm of the same title) which was the most successful Sheffield produc-
tion ever, generating excellent box ofce sales, subsequently transferring to
the National Theatre, and then touring the UK (coming back. on tour, to the
Lyceum as a touring production). Such spin-offs generate substantial revenue
to Shefeld Theatres well beyond their life in Shefeld.
In early 2000, a new nance director, Kay Ford, took up ofce: she had pre-
viously been nance director of the London Symphony Orchestra, and was
fully supportive of this new nancial strategy. Commenting on the relationship
between the nancial aims and the charitys objects, she said. It's all about pro-
ducing output of the highest quality - if youre not doing that. theres no point
in being here.
Deborah Paige left in 2000 and the post of artistic director was not replaced,
but there had already been a policy of using freelance directors for some pro-
ductions. One of these, Michael Grandage, created a highly successful produc-
tion of Twelfth Night at the Crucible in late 1998, and in 1999 he was made
associate (artistic) director. with a brief to develop the range and scale of pro
ductions. By 2000, a production schedule was planned and costed for a whole
year ahead, enabling the theatres to market performances with long leadtimes
and to invest in high quality casts including well-known actors.

SHEFFIELD THEATRES TRUST

In 1997/98 the nancial position recovered to show a small 10,000 surplus
on the year, and in 1998/99 a very respectable surplus of87,000 was achieved
- well beyond the basic aim of a charity which is usually to break even.
i999/2000 also showed a surplus ofl9,000, so taking the three years together
a major tumround had been achieved. But by autumn 2000 there was further
disappointment that the rst Crucible performance of the key 2000/01 season
had achieved attendances well below expectations, and the visiting company
programme was also showing disappointing sales, with intemal accounts pre-
dicting a signicant decit for 2000/O1. For once, no major cuts were made,
but as Grahame Morris commented, The resolve of the board to stick to its
new strategy was severely tested.
STRUCTURES
ln the early days, all the work of the Crucible was handled by one Trust board.
Then from 1987 a separate Lyceum Trust was established, and a further
management company was formed, providing the common support functions
to both theatres. It was clear that very few people (certainly very few board
members) understood the overall nancial situation. It was also found that
grant aid might be increased to one company whilst being withdrawn from
another.
So in 1995, after extensive debate, it was agreed to transfer overall legal
responsibility for the work of both theatres to one body, the Shefeld Theatres
Trust. Sheffield Theatres Trust is a registered charity and a company limited by
guarantee (with permission to omit the word LiJnited' from its title). Its chari-
table objects, as stated in its Memorandum of Association, are:
0 To promote, maintain, improve and advance education, particularly by the
production of educational plays and the encouragement of the arts of drama,
mime, dance, singing and music . . .
0 To receive, educate and train students in drama, dancing, music, and other
arts, and to promote the recognition and encouragement of special merit in
students. . . .
The Lyceum Trust continues, but it employs no staff. lt leases the building to
Shefeld Theatres Trust for use as a theatre for a payment of 90,000 per year
most of this money goes into a long-term building fund to cover future repairs
and maintenance.
As with most charitable organisations of any size, it is necessary to have a
trading subsidiary company to undertake non-charitable activities such as the
sale of food and drink and commercial sponsorship: this is the role of Offstage
Ltd. Offstage is wholly owned by Shefeld Theatres Trust, and at the end of
each year, Offstage undertakes a gift aid payment to transfer all its prots to
Shefeld Theatres Trust - this means no corporation tax is paid, and the theatres
get the full benet of all associated activities undertaken on their premises.
The board of Sheffield Theatres now operates in effect as one organisation,
with overall responsibility for management of the whole complex - the board
membership is shown in Appendix 2. The board members are both directors

SHEFFIELD THEATRES TRUST 1

of the company and trustees of the charity; as such they are unpaid. The full
board takes responsibility for the entire work; the only subcommittees are an
audit committee and a nominations committee (which seeks out new trustees
to replace those retiring). Staff of the two theatres. from the chief executive
downwards, are employees of the board: they are not actually directors of the
company even if the job title director is used.
GRANT FUNDING
Since the beginning of subsidised theatre in Sheffield in 1960-61, income
had shifted from purely commercial sources towards a heavy dependence
on grants, primarily from the Arts Council of Great Britain and the local author-
ities. By 1977 some 65 per cent of the income was in the form of grants; this
declined to about 55 per cent by the 19805. to 40 per cent in I989, and to
27 per cent by 1995. though with some oneoff grants for specic initiatives
the grant funding rose slightly to 51 per cent in Z000 (post-1990 gures are
based on hoth theatres together).
The Arts Council does not give grants to touring theatres. but instead gives
grants to certain touring companies towards the cost of their productions.
However, Shefeld City Council makes grants towards both theatres (in the
case of the Lyceum, this is simply to cover lease payments back to the Council
for the Lyceum site).
The polity on public funding of the arts had changed substantially over the
years. In 1985 there was an attempt to build up genuine centres of excellence
in the regions, and the Crucible was one of thirteen regional theatres selected
as a major beneciary. Another important policy change in the late 1980s was
the introduction of parity funding, by which the Arts Council aimed that the
total public funding of any theatre should be shared equally between them-
selves and the local authority. However, Sheffield City Council was unable to
reach agreement with the Arts Council on this issue. David Patmore. Director
of Arts for Sheffield City Council in 1992. stated that much of the problem was
due to the internal structures of the Arts Council. which treated producing
theatre and touring venues completely separately. As a result, the substantial
money which the City Council was contributing to the Lyceum project was not
recognised by the Arts Council in calculations of overall parity. From our point
of view, he stated, 'wed prefer to talk to the Arts Council about our theatre
policy as a whole but their structure gets in the way of this. The net effect
was that the Crucible lost out substantially in the overall pecking order of Arts
Council grants, compared with other large provincial repertory theatres.
In the early 19905, the Arts Council moved to a regional structure, which
meant that most of the giant to Shefeld Theatres came from Yorkshire Arts
Board rather than direct from the Ans Council of England (ACE). though the
latter has continued to make grants for certain one-off projects (such as the
How Much? study, described below). This change meant that the Crucible
was no longer in direct competition for funds with as many other theatres
as previously (there being only one other producing theatre in Yorkshire of
comparable size), but it also meant that the scope for Arts Council grants was

SHEFFIELD THEATRES TRUST

influenced heavily by the initial split of the 'cake into regional slices. over
which t.he theatre had relatively little influence. 'lhe funding from Yorkshire
Arts remained virtually static at around 650,000 from 1994 to 2000 - effectively
a cut each year after allowing for inflation.
But in 2001, a major shift of government policy towards the arts began to
emerge. with new policies to support excellence in regional theatres. and
in 2001 Yorkshire Arts announced an extra award to Shefeld Theatres of
247,500 for 2002/05, and 4"0.000 for 2005/04, as a reward for innovative
output. This meant that over just two years the Trust was due to receive a
massive 72 per cent increase in its Yorkshire Arts core funding.
Shefeld (liry Council has continued to see the theatres as vital to the city,
and relationships between the theatres and the Council are seen as good. Grant
funding has been largely maintained despite heaty cuts elsewhere in the city's
arts budgets: in 1999/00 the (Zity Council grant was worth $685000 to Sheffield
Theatres (excluding amounts related to the lease-back of the Lyceum site).
However, with small cuts and the effects of inflation, the theatres continue to
face yearon-year reductions in the net value of this support, and nancial sup-
port from two other neighbouring local authorities (Rotherham and Bamsley)
together worth around 25000 was also withdrawn during the late 1990s.
However, the launch of the National Lottery in 1994 meant a new possible
source of support from the Arts Lottery Fund from around 1996 (though only
for specic initiatives. usually of a capital nature); this is administered by ACE
but separately from the government ans funding. Then with the election of
the Labour govemment in I997. some changes began to emerge in national
policies towards support of the arts through the new Department of Culture.
Media and Sport (DCMS).
These initiatives enabled Sheffield Theatres to secure emergency funding
from ACE of .l00.000 per year for 1997-99, and a oneoff grant of 300,000
for audience development work and the research project on ticket pricing.
Then in 1999 ACE announced the launch of its Stabilisation Programme, aimed
at helping major arts bodies such a Shefeld Theatres to get on a stable footing,
both in their nancial structures and in their artistic output. It was recognised,
for example, that whilst good management would allow the theatres to balance
their budgets each year and perhaps make a small surplus, there is no way they
would recover the cumulative historic decit which was still around 790,000
in 2000 and looked set to grow again by 2001.
Conrmation was received in summer 2000 that Shefeld Theatres had been
accepted on to the programme, and by spring 2001 a total award of 1 .7m was
conrmed: the largest single injection of funds to Sheffield Theatres since the
opening of the Lyceum. lm of this would completely wipe out the historic
cumulative decit, 150,000 was for a new stage lighting system andl40,000
for new IT infrastructure for the theatres, with the balance available as revenue
funding up to 2003/04 to develop the artistic programme and educational
work.
This was received with great optimism, but further funds would also be
needed. The cuts of the preceding years meant that the Crucible building and
much of the production equipment were in desperate need of repair or
replacement, with the age of the building now approaching 50 years. Although

v
SHEFFIELD THEATRES TRUST 151
funding was received to replace the erratic stage lighting system. the auditorium
chilling system (vital for audience comfort to attract patrons during the sum-
mer months) had completely failed a year previously; and a new stage surface
was required. Urgent refurbishment of the front of house was needed. and
certain extemal maintenance was needed. Grahame Morris estimated that a
minimum of 750,000 was required for emergency capital works. with as
much as.81Om needed to bring the Crucible fully up to the standard needed
for the Zlst century.
AUDIENCES, PRICING AND MARKETING
The largest part of Shefeld Theatres revenue is dependent on tickets sold at
the box ofce. and this money must meet all the remaining costs not met by
grants or ancillary income. Budgeting for this is dependent upon the three
issues of how seats are priced. what proportion of seats for any production are
sold. and to what extent seats are sold at concessionary prices.
Seats in the Crucible (without concessions) were normally priced in the
range 12 to 17, including VAT. in autumn 2000. In the Lyceum. prices
varied widely according to the production, but prime seats could be as much
as 28 for a major touring musical or even 40 for opera. Seats in the Studio
theatre were normally priced at 10 for the theatres uwn productions, but
the Studio also hosts many musical concerts and smaller outside production
companies. The theatres offer a range of discounts for regular theatre-goers
who belong to certain membership schemes (over 2.400 households belong
to one of these - they have the advantage of providing the company with a
certain amount of regular committed income). Concessions were also available
to those over (>0, children. students. registered unemployed. disabled people
and their carers. Standby seats at 5 were also widely sold on the day of each
performance.
After deducting VAT from the prices. and allowing for concessions, the aver-
age yield per seat in 2000 (i.e. the net revenue to the theatres accounts) was
around 7.50 for Shefeld productions. and around 9.50 for performances
mounted by visiting companies.
ln the case of the visiting productions (mostly at the Lyceum) the revenue
from ticket sales is distributed between Shefeld Theatres and the touring
company according to a contract which is negotiated individually for each
production. However. the shape of the Lyceum can be somewhat limiting in
terms of revenue: with 1.100 seats it is not quite sufficient to attract the very
largest touring companies. and over 500 of the seats are in the balcony, where
visibility is limited.
ln some cases quite complex formulae can he used to allocate the box ofce
sales for visiting productions, but a typical split is for 70 per cent of revenue to
go to the touring company and 30 per cent to be retained by the theatre.
However, it is not uncommon for the touring company to have a rst call on
all sales up to a certain level, or even a minimum guarantee (as mentioned
above) which the theatres have to commit before the touring company will
agree to come to Sheffield. In terms of minimising risk, the best arrangement

SHEFFIELD THEATRES TRUST

with visiting productions is hire only where the touring company simply pays
a xed fee for use of the theatre, regardless of ticket sales - but then if such
productions prove to be very successful, Shefeld Theatres has no share in the
prots beyond the hire fee agreed.
Even with the in-house productions, since 1998 increasing emphasis has
been placed on plays which are originated at Shefeld Theatres but then trans
ferred elsewhere (as with Brassed Off mentioned above), giving royalty
income back to the company. or co-productions with other regional theatres
where production costs are shared. However, the unique shape of the Crucible
stage makes such transfers relatively difcult; it becomes more viable if pro-
ductions are originated for the Lyceum. For the same reason, the Lyceum is
much more suitable than the Crucible for most touring companies.
From 1996 a marketing director. Angela Galvin, was added to the senior man-
agement team, and the roles of marketing, publicity, box ofce, and
development
(fundraising) are now managed on an integrated basis. which was not always
the case in the past (see stmcture in Appendix 1). A more systematic approach
to marketing has seen attendances rise compared with the dire situation on
1996, though inevitably there are variations from year to year depending on
whether a given season included any overwhelmingly successful productions.
Both the Trust and its funders have long been concemed to extend the reach
of the theatres to a wider audience. By 2000, the theatres had built a database
of ticket purchasers running to some 250,000 names, but surveys in the past
had found that around 70 per cent of all seats were sold to a core of around
20,000 regular theatre attenders, drawn largely from those living in certain
middle class suburbs of Shefeld.
To help understand the audience issues more clearly. and especially to
implement one of the Labour govemments aims of making theatre more attrac-
tive to young people. Sheffield Theatres successfully obtained a 500,000 Arts
Council grant in I998 for a two-year project entitled How Much?. Theatre
audience are often dominated by middle aged and older people: the obvious
scope for audience growth is to attract more young people. Nationally, only
16 per cent of theatre audiences come from the 16-24 age group, and in
Shefeld the gure was iust 7 per cent, despite a large student population in
the city. It was generally supposed that young people are cautious about
theatre as a leisure activity. because of the twin problems of the cost of seats
and unexciting productions (cinema being much more attractive). The How
Much? grant enabled the company to tackle this directly: 21 productions
were publicised under the How Much? banner with seat prices as low as
3.50 for those aged 16-24. Several new productions specically tackled
issues seen as relevant to young people, and others were marketed directly to
them with headlines such as Sex . . . Violence , . . Brilliance . . . Shakespeare
. . . all for 5.50. With the support of the two universities in Shefeld, How
Much? was tackled as a major research project. also involving studies on
non-theatreattenders.
The net effect was a massive increase in seats sold to young people: for these
21 productions, 41 per cent of the audience was in the 16-24 age group, and
overall, 29 per cent of the audience for these productions were new attenders.
The box ofce coded all sales according to how the purchaser said they had

7_
SHEFFIELD THEATRES TRUST
heard of the production, so the marketing director knew exactly which sales
came from which promotional media.
The results were seen as very exciting, but without further special giants,
the theatres cannot continue to offer such low prices to young people (though
student discounts and standby seats continue to apply); there was also the
problem that these productions were less attractive to some of the more tradi-
tional audience. Whether productions are in-house or touring. it remains a real
challenge to ll 2,500 seats of theatre capacity, across the three stages. Some
local commentators have felt that Shefeld was simply unable to support this
capacity of professional theatre (although there was no attempt to use all three
stages for productions for S2 weeks per year). But capacity ll remains the
fundamental issue in achieving sufcient box ofce revenue. Appendix 3 gives
more details of attendances.
OTHER INCOME
In addition to the grant and box ofce income, Sheffield Theatres has worked
hard. particularly since 1990, to generate other forms of income.
The most long-standing source of external income has been from hosting the
World Snooker Championships, and to many people in the UK the Crucible
became synonymous with the World Snooker Championships, which have
been held there over three weeks every April/May from 1977. under the
sponsorship of a tobacco company (which itself caused some controversy in
the early days). Although the snooker brought in substantial revenue (including
extra catering prots as well as the basic hire charge), this decision was not
without its critics. One of the board members commented in 1996: I don't like
snooker. l really object to my theatre being used as a snooker hall and it breaks
up the theatre season. But it does mean that ve or six times a day the Crucible,
Sbeflield is mentioned on prime time TV. And we do need the money!
Although the net revenue from hosting the snooker has fallen over the years
(particularly on the catering side, due to changes in the arrangements), the
overall view of the board has been that the Crucible needed the income. and
in 2000, Shefeld Theatres were negotiating to continue hosting the
Championships.
The prots of the restaurant, bars and gift shop form an important source
of additional income, which is generated via the trading subsidiary Offstage
Ltd. Signicant steps were taken from 1997/98 to increase the protability of
this side of the work, by altering the stafng levels. opening hours. menus and
prices. However, one of the longer-term aims of the major capital investments
proposed for the Crucible will be a complete redesign of the front of house
areas (at present the bar and coffee shop are not on the natural circulation
route, and access to these areas for disabled people is very difcult). So
although the late 1990s saw improvements in catering revenues, for the time
being there is little scope to go further.
By the mid-1990s, Shefeld Theatres became increasingly successful in
attracting sponsors for many Shefeld productions (and for some touring
productions, too, if not already sponsored through the touring company); in
SHEFFIELD THEATRES TRUST
particular, from 1997/)8 they received support through the DCMS-promoted
Arts and Business Pairing Scheme, and a further sponsor supported the educa-
tion work. However. such income can be vulnerable in Limes of recession,
as sponsorship of the arts is an obvious area for companies to reduce in times
of difculty.
The total prots of such commercial activities (catering and sponsorship)
contributed about 500,()00 to theatre funds in I998/99, but this fell to
225,000 in 1999/00 (and it should be noted that the Trust docs not charge
Offstage a full rental for the space used by bars ctc.).
in addition, as a charity. Sheffield Theatres has been active in various forms
of fundraising over the years. A Programme Development Fund generated
around 100,000 over four years in the mid-19905. from individuals supporting
the development of new Crucible productions. A number of charitable trusts
make occasional grants to the theatres. but such grants are usually only for one-
off projects.
Certain capital projects have also been supported by fundraising - in particu-
lar in 1994, 400,000 was raised for enlargement of the Studio Theatre from
250 to 400 seats and improved auditorium access for disabled people. But the
need for major upgrading of the Crucible building means that a new fundrais-
ing project. possibly for up to 10m. might soon be launched, with a view to
completion by 2004.
EMPLOYEES
ln 2000. Sheffield Theatres employed 161 staff on ongoing contracts: 65 in sell-
ing and front of house, 45 technical (stage crews etc.), 24 in maintenance and
security, and I4 administrative and secretarial. A further S6 were employed by
Offstage Ltd in catering and retailing. Actors and production staff are taken on
individually for each production - the average number in post at any one time
was l5.
ISSUES FOR THE EARLY 20005
For Shefeld Theatres, the principal challenge as the Crucible approached
its 50th birthday in Z001 remained the ongoing requirement to maintain and
develop the quality of output on the three stages, whilst attracting sufficient
revenue from a combination of grants and box ofce sales to make this possi-
ble. Building new audiences remained crucial.
The major injection of funds won in 2001 meant that the Trust would soon
see the historic decit wiped away, giving it the long-sought nancial stability
(plus a big saving in interest charges). The new revenue grants from Yorkshire
Arts meant that for the rst time in many years the management could think
about expanding the investment in productions.
Sheffield Theatres Trust recovered from the near-disastrous situation of 1997
when the company almost became insolvent, but even by 2000 the general
fund remained 788,000 in decit, the net assets were only.-113.000, and the

SHEFFIELD THEATRES TRUST

decit was expect to worsen by 2001. Charity Conunission guidance suggests
that charities should have adequate reserves over and above their xed assets
to cover a reasonable period of expenditure (three months is often suggested):
it would need ai-2m increase in ctu"rent assets for the charity to reach this level
of nancial security, and even with all the new funding agreed, the theatres
would still be below this level.
However, there was real encouragement that new government policies
towards the Arts were creating a potential where, for the rst time in many
years, Shefeld Theatres might really be able to move forward in the quality of
its artistic output, though huge amounts management time were devoted to
securing these funds, and much of the extra funding was in the form of special
one-off grants so the longer-term revenue funding remained uncertain. More-
over, most of the new funding would take up to two years to come on stream,
and as well as meeting the running costs, major capital investment was also
urgently required to carry out urgent repairs. and in due course to bring the
Crucible building up to the standards of a top-class theatre for the 21st century.
The company was moving forward in response to a comprehensive business
plan, based on high levels of artistic investment, detailed research on ticket
pricing. and a more strategic approach to maximising other income. There was
a sense amongst staff that the new willingness to invest in larger and higher
quality in-house productions was beginning to bear fruit. But ct strategy of high
investment in production quality can only succeed in the long term if it leads
to higher levels of attendance. Sadly. due to a combination of apparently unre-
lated issues, attendances in 2000/01 were disappointing hoth for in-house and
visiting productions.
The key question which remained was whether or not, on a long~term
basis, the output of the theatres could be translated into a level of sales at
the box ofce that could give the nancial stability which Shefeld Theatres so
desperately needed

SHEFFIELD THEATRES TRUST

APPENDIX 1 MANAGEMENT STRUCTURE, FEBRUARY 2001
Sheffied Theatre Organisational Chart
Chief Associate
Executive Director
Grahame Morris Michael Grandage
Marketing
Director
Finance
Director
Angela Galvin Kay Ford
Manager
Boxoice lMarketing |Deve|opment Personnel vroduction liducation 'Theatre
,Catering
Manager
Manager Manager Manager Director Manager Manager
Accounts Shop
Supervisor Manager
APPENDIX 2 SUMMARY OF BOARD MEMBERSHIP,
FEBRUARY 2001
Directors/Trustees (12 persons):
Nominated by Sbejeld Cit) Council - three members (two councillors and
one other).
Elected - nine members including the chair (Sir Norman Adsetts). These
members serve for periods of three years after which they may be re-elected
for one further three-year period. The board elects its own successors.
Observers:
Sbeflield City Council Arts Department - two observers (ofcers of the
Council).
Yorkshire Arts Board - one observer.
Officers in attendance:
Chief Executive
Associate Director
Finance Director
Marketing Director

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No one loves you, baby:

The Child Support Agency
Alex Murdock
77.19 Child Supjmrr A_eemj]' (('SA) is rm e.\'nmpIe of the ])rr1bIem.t (but can
occur" Ll/.70" (1 new public sector ngemjr t'.\ created. The case slurtr (lemon-
slrates bow zIl]]icult it cm! he for ml myznzisutimi ll/J('H there are ltmltijfle
stakeljolzlers um! competing and nflen unclear olijeclires. 7720 (All. as a
mltiomrl agency. attracted more polilicul and media ulleuliun Ibml [Hill/it
sector organisations u'ln'eIJ are more localir oriented. The bisllnjy of Ibe
creation of (ISA also shuuls the mnjllcl between stated goals and ex];/ici!
targets (rerlm:ing the cos! Io the public purse of child mnintenmzce) zritb
itnplicit social polic1"gtmIs I betlter sup/mrt for single-/mrenlfamilies}.
In August 2000 the London Times published the story of u policeman who
gassed himself in his car. His ancee hlamcd the Child Support Agency for driv-
ing him to suicide. She said that he killed himself ht-cause of the lntpossible
demands matle of him by the agency which asked him to pay.l.217 a month
from his salary of 1798 towards the maintenance of his teenage children hy
a previous relationship. He was happy to support his children but the amount
asked for was just impossible for him. she said. The campaign group NACSA
(National Association for Child Support Action) believed that 42 suicides and
eight murders can be laid at the agency's door.
That same month Faith Boardman, chief executive of the Child Support
Agency. resigned to take up ti senior job in local govemmcnt. The new chief
executive of the Child Support Agency. Doug Smith. may have reflected that
he was the rst man to occupy the role - the previous three having been
women. Would he be able to make the agency both widely accepted and
respected . 4 . and possibly cvcn liked?
In the last annual report of his predecessor, Doug Smith would have found
the comments:
l am very conscious that the service we provide to our customers is still not as
good
as we wish it to bc. But we have made considerable progress over the last three
years
and l believe we are now on the right track.
(Foreword: Child Support Agency Annual Report 200i)/2001)
This case was prepared by Alex Murdock, South bank University Business School.
lt is
intended as a basis for class discussion and not as an illustration of either good
or bad
management practice. O A. Murdock, 2001. Not to be reproduced or quoted
without
permission.
N0 ONE LOVES YOU, BABY: THE CHILD SUPPORT AGENCY "5
However, earlier the influential Public Accounts Committee of the UK Parlia-
ment had been forthright in its criticism of the Child Support Agency. lt stated
that the agency had got itself into a position where nearly one-third of its cur-
rent maintenance assessments were wrong and the proportion of non-resident
parents who paid an incorrect amount was very nearly 50 per cent and there
was no sign of any improvement. Indeed, the situation was actually getting
worse with the large number of errors being made each year simply adding to
the agencys legacy of error.
BACKGROUND TO THE CHILD SUPPORT AGENCY (CSA)
The Agency came about following a debate about what role the state should
play in maintaining single parents and their children. In 1990 Margaret Thatcher,
the then prime minister, summed up the concem when she observed that
Nearly four out of ve mothers receive no maintenance from the fathers. No
father should be able to escape his responsibility. Over the period l9"l-91
there had been a vefold increase in single parents - mostly women.
This had been associated with a large increase in expenditure of state welfare
benets to support single parents. The legal system was regarded as inefcient
and ineffectual in securing maintenance from the liahle but absent parent and
hence single parents had increasingly come to rely on state welfare benets.
indeed, divorce settlements often presumed that the parent with care of chil-
dren would receive such welfare benets. The govemment Benets Agency.
which paid out welfare benets, did not regard assessing absent parents as its
prime task. A large number of absent parents. who might have been liable to
contribute to the support of their children, had been able to avoid doing so.
The legislation to set up the Child Support Agency was not opposed by
any of the major political parties. There was widespread agreement with the
principle that absent parents should pay to support their children. The implica-
tions of the changes were described in a Parliamentary report as the most far
reaching social changes to be made for 40 years. The assumption that in broken
marriages or partnerships taxpayers should assume nancial responsibility for
the
rst family is, at long last, being challenged. The prime responsibility is placed
where we believe it has always rested until recently i.e. with natural parents.
WHAT WAS UNUSUAL ABOUT THE CSA
The Child Support Agency was unusual not only in terms of its brief to taclde
the problem of child support. lt was also a newly created agency. The chief
executive was on a ve-year contract and was given specic targets to meet.
The person appointed was Ros Hepplewhite whose background was from the
voluntary sector. She was used to dealing with the media and was seen as
someone who would be able to bring a high level of energy and commitment
to making the CSA a success.
The functioning of the Agency brought it into contact with other govem-
ment agencies. It had obvious links with the Benets Agency, "a section of

NO ONE LOVES YOU, BABY: THE CHILD SUPPORT AGENCY

which had previously undertaken the role of assessing parental liability. It also
linked to the inland Revenue, the agency responsible for assessing and collect-
ing tax.
The Agency had to recruit staff and set up an operational structure. Many of
the staff recruited had little experience of the sort of work involved. Even
though Ros Hepplewhite sought to downplay this aspect of the CSAs role,
there was a general impression fostered by some politicians that much of the
role of the CSA was to track down fecldess fathers.
THE EARLY HISTORY
The CSA found problems almost from the outset. The complexity of the assess-
ment process meant that few were processed through to completion. The staff
were new to the work and for the system to work efficiently it required that
both parents with care and absent parents complied with :1 complex adminis-
trative process.
The legislation provided for a set formula for assessing liability. This formula
did not take into account remarriage or children arising from new relation-
ships. It did not take account of costs of access where there was a signicant
geographic distance between absent parent and children.
The Agency found that it was falling behind in its targets to complete main-
tenance assessments and bring in contributions. The response was to focus
upon the easier cases which were those where there was already a record of
maintenance being paid and where the absent parent was easier to track down
and assess. Typically such parents were mature men in stable and well-paid
jobs who had second marriages and mortgages. They were not at all like the
'feckless fathers.
Another problem was that parents with care who were receiving state
benets did not gain from the CSA assessment process. Maintenance from the
absent parent went to the govemment unless the parent with care came off
benet. A study commissioned by the Child Poverty Action Group was highly
critical of this. its title, Putting the Treasury First. was a clear reference to its
conclusion that the CSAs implicit (if not explicit) task was to reduce social
security costs rather than to put more resources into the hands of the caring
parent.
STAKEHOLDERS
A number of groups had been affected by the creation and operation of
the CSA. Single-parent organisations expected that the Agency would deliver
more child maintenance for their members. They had been very supportive of
the Agency, seeing it as representing a positive step towards addressing the
inadequacies and problems inherent in the court-based system. The govern-
ment had also expectations of the Agency to deliver against its targets and also
implicitly to bring about changes in the nature of parental behaviour. However,

NO ONE LOVES YOU, BABY: THE CHILD SUPPORT AGENCY

the experience of the Agency operations was generally disappointing. Delays,
mistakes and bureaucracy meant that cases were not being progressed. Also,
some parents who had concems about issues such as domestic violence felt
pressured by the CSA to complete forms which might put them at risk of
further violence or intimidation from ex-partners. ln some cases this demon-
strably occurred when. as a result of the CSA inquiries. women at risk of
violence were tracked down by violent former partners.
The Treasury, the govemment department responsible for allocating re-
sources, had a clear ftnancial interest in the success of the Agency. They
expected to improve on the collection rate of the previous section of the
Department of Social Security. The targets set for the Agency in this respect
were initially seen by the Treasury as reasonable and attainable.
Many divorced men with court-agreed nancial settlements were shocked
to nd themselves the subject of the Agency. The failure of the formula to take
account of second families meant that new partners (and their children) of
divorced or separated men also were negatively affected by the Agency in
a way they had not expected. The operations of the Agency - in particular
where mistakes of attributing parenthood were made caused great distress
and brought about highly negative publicity.
REACTlONS
Organisations rapidly sprang up to oppose the operation of the Child Support
Agency. Divorced and separated men (and their new partners) made common
cause and were joined even by feminist groups opposed to the CSA. A letter-
writing campaign swamped politicians in-trays. Advice lines and support
groups appeared, often using the Internet. lnformation was rapidly dis-
seminated on ways to delay or obstruct the CSA. Some organisations whose
members incomes were relatively easy for the CSA to access, such as
reghters and police officers. campaigned even more vociferously. The
!~ire!-igbters' Magazine was soon devoting a substantial portion of each issue
to attacking the CSA.
Some of the opposition took more direct forms. CSA ofces were picketed.
Staff of the CSA were abused and in some cases threatened. Unpleasant and
sometimes dangerous substances and materials were sent to the CSA in the
post. CSA staff became liable to be treated as social outcasts, nding it difcult
to book venues for social events. The press picked up on the issue very quickly
and highlighted tragedies such as suicides of fathers confronted with sudden
and apparently impossible demands for maintenance. Mistakes made by CSA
staff - often in misattributing patemity - were rapidly seized upon and heavily
publicised. Staff at the Agency felt under siege.
The parents with care also complained that the Agency was taking an
inordinate time to complete assessments and deliver on maintenance. There
was a perception that mothers receiving benet were being pressured to com-
plete CSA forms even when there might be a history of domestic violence.
Examples where violent ex-partners had been able to trace former partners as
a result of the CSA process gave rise to understandable conceFns.'

NO ONE LOVES YOU, BABY: THE CHILD SUPPORT AGENCY

CSA RESPONSE
The CSA confronted a particular problem with the rigidity and complexity of
the formula it was supposed to apply. Many people, unhappy with the nature
of the assessment made by the CSA. complained to their Member of Parliament
(MP). The avalanche of MP5 letters to the CSA led to often anodyne or pro
forma responses which infuriated MPs. The Parliament Social Security Select
Committee conducted some highly critical and televised investigations on the
operation of the CSA and the legislation.
The lack of success in meeting its targets - particularly in completing
assessments - led to an exercise called closing the gap. This involved target-
ing the easiest cases - liable parents who were already paying maintenance and
who had stable homes and regular employment. However, although this raised
more revenue, the CSA was seen as punishing the most responsible parents
whilst letting the feckless' ones get away.
The costs of second families also became a major issue effectively exploited
by CSA critics. The retrospective element of the legislation was seen as particu-
larly pernicious because it unravelled divorce settlements. The nature cf the
legislation gave the CSA little option in this regard.
The chief executive of the CSA. Ros Hepplewhite. adopted a highly visible
role and went on the media frequently to defend the CSA and the spirit of the
legislation.
The CSA annual report for 1993 -94 on its rst two years of operation showed
it had failed to meet targets for an-anging maintenance (31 per cent against a
target of 60 per cent) and for making benet savings (418 million against a tar-
get of 530 million). However. it was successfully operating within its budget.
Ms Hepplewhite blamed the shortfalls on difculties in setting up the new
system and the campaigns against the Agency. However. she also acknowl-
edged the distress that had been caused to many divided families and publicly
apologised for this. in September 1994 (18 months before the end of her con-
tract) she resigned as chief executive and was replaced by Ann Chant, a career
civil servant from a government agency.
SUBSEQUENT HISTORY
Ann Chant took a much lower public prole than her predecessor. She focused
upon addressing the operational shortcomings. However. the overall per-
forrnance of the Agency continued to be disappointing, despite changes made
in the Child Support Act 1995. Though the number of assessments made
increased, this was in part linked to a reduction of the inflow of new applica-
tions. The backlog still remained substantial. Press coverage. although less
vociferous, was still negative and critical. Although the opposition to the CSA
became less vigorous, it had by no means gone away.
ln 1997 Ms Chant was replaced by Faith Boardman - another career civil
servant. The Conservative government lost the election and New labour took
office determined to manage government efciently and effectively. However.
in February 1998 the Observer newspaper commented:

NO ONE LOVES YOU, BABY: THE CHILD SUPPORT AGENCY 779

the agency seems to have established itself as the single most ridiculed.
overworked
and unsuccessful branch of the govemment machine. Organisations have been
set up with the sole purpose of getting it abolished It is by far the biggest cause
of constituents complaints to MP5 and has been accused of simply acting as a
collection agency for the Social Security Department, rather than acting to
support
children.
The Agency staff voted in favour of strike action and Barry Reamsbottom, the
union general secretary, stated: Morale is very low. Its not the fault of our
members that the Agency was set up in the most cack-handed way. with undue
haste. lt has been battered by review after review. and the fact that our mem-
bers have voted for strike action is symptomatic of how they have become
brassed off.
The media coverage continued to be critical and - perhaps signicantly -
highlighted that opposition had grown amongst parents with care (usually
mothers) who would be normally viewed as potential allies of the Agency. Ann
Perkins. an infomied and sympathetic observer of the (ISA. writing in the
Guardian on 21 April 1998. noted:
An increasing number of women deserted by their husbands are refusing to co-
operate with the CSA because they are haffled by the complex formula it uses to
work out claims. A minister revealed . . . that "0 per cent oi" women on benet
now declined to reveal the name of their ex-partner - citing fear of violence. That
represents an increase of 15 per cent on last year - a gure which ministers link
to
disillusionment with the Ap,encys workings ntthcr than a genuine rise in
violence.
The CSA and the government recognised that the focus of their approach had
to change:
Our agenda changed and we have moved away from numeric targets to a more
balanced approach, concentrating rst and foremost on the overall service \ve
provide to our customers.
(Faith Boardman. (ISA Annual Report 1998)
Faith Boardman also set up a panel so that those who use the service can
make suggestions as to how it can be improved. Gingerbread (an organisation
campaigning for one-parent families) accepted a place on the panel which
Ms Boardman chaired. The National Association of Child Support Action
(NACSA) was not offered a place.
This seemed to have had some eifect as shown in the report of the
Independent Case Examiner - an office set up to respond to customer
complaints:
l see measurable improvements in the recognition of complaints; of mttch
improved
apologies; explanations offered and redress volunteered. Furthermore this
improve-
ment is not conned to specialised complaints handling teams alone and I have
seen
energetic and enthusiastic staff seeking to resolve complaints on the front line.
The
year was marked by improved co-operation between my ofce and the Child
Support
Agency, which recognises ottr mutual interest in responding well to customer
com-
plaints. This is reflected in a jointly agreed framework for improvements in
standards
of service to my clients.
(independent Case Examiner, Annual Report 1999-2000)

NO ONE LOVES YOU, BABY: THE CHILD SUPPORT AGENCY

The labour govemment introduced legislative proposals to replace the
complex formula of the CSA with a simpler one using a xed percentage
of earnings based upon the number of children. This has generally been
Welcomed. However, no account was to be taken of the mother's income
(where the mother has care) and in a situation where an increasing number
of women eam more than their partners this is predicted to cause problems.
Indeed, some commentators used the prime minister, Tony Blair, and his wife
(a highcarning lawyer) as an example of the inequity that could arise.
The operations of the CSA continued to be the subject of ongoing concem.
The head of the National Audit Ofce, the government body entrusted with
examining the accounts of the CSA, noted in his report:
the Agencys poor perfonnanee has left a legacy of error. The results of both my
audit
and of the Agency's intcmal performance measuring unit indicate that there has
been
no discernible improvement in the Agencys perfomtance in i999-2000.
Doug Smith, the new chief executive. was no stranger to working in agencies
with critical or unfriendly stakeholders. He had previously spent 57 years in the
Inland Revenue, the agency responsible for collecting taxes. In his new agency
he had to confront a range of stakeholders with divergent and possibly oppos~
ing interests. They were very aware of the Agency's troubled history and
watchful of its progress.
The govemment plans required him both to implement a new set of child
maintenance rules and. at the same time, introduce a major new computer
system to the Agency which was just beginning to feel a sense of stability after
its difficult and eventful rst eight years.

NO ONE LOVES YOU, BABY: THE CHILD SUPPORT AGENCY 751

APPENDIX A FURTHER INFORMATION
Useful CSA-related links
www.nacsa.org.uk/
National Association of Child Support Action. This site describes itself as the
denitive website for people affected by the United Kingdoms Child Support
Agency (CSA), who want good advice intelligent discussion and to Wise up to
the truth that lies behind government doubletalk'. The NACSA has been set up
to represent those adversely affected by CSA decisions, and its site provides a
forum for criticisms of the Agency.
www.nacsanews.org.uk/BodEntrance.htm
NACSA, using :1 US-hosted website. publishes this macabre site which com-
memorates all those whom NACSA claim have died as a result of the CSA. It
does. however, give an idea of the depth of feeling associated With the CSA.
www.spig.clara.net
SPIG (Shared Parenting Information Group) - a group which indicates the com-
plexity of modern family relationships
www.gingerbread.org.uk
Gingerbread - Support group for lone parents which is regarded as a key stake-
holder hy the (ISA.
www.fnf.org.uk
FNF (Families Need Fathers) - 21 lobbying and campaigning group which has
sought to present itself as balanced in its comments on the CSA.
Political Parties
0 Website of the UK Labour Party - wWw.labour.org.uk
0 Website of the UK Conservative Party - www.conservative-party,org.uk
0 Website of the UK Liberal Democratic Party - www,libdems.org.uk
Government
Houses of Parliament - vwwv.par|iament.uk
A key source site for political comment by politicians and which gives access
to the working of parliamentary committees.

NO ONE LOVES YOU, BABY: THE CHILD SUPPORT AGENCY

Department for work and pensions - www.dss.gov.uk
Child Support Agency and Benets Agency website.
Inland Revenue www.in|andrevenue.gov.uk
The govemment agency responsible for collecting tax.
Social Security and Child Support Commissioners -
vwv.hywe|s.demon.co.uk/commrs
A site for the Agency which handles CSA appeals.
NACAB www.nacab.org.uk
National Association of Citizens Advice Bureaux: u voluntary influential and
widely respected independent organisation which advises people on a range of
issues.
General CSA Information
0 Child Support Guide (www.dss.gov.uk/csa/csaguidehtm) provided by the
Child Support Agency (www.dss.gov.uk/csa/).
0 National Audit Ofce (www.nao.gov,uk) for the CSAs accounts.
0 Independent Examiners Report on the CSA (wwwjnd-case-exam.org,uk).