1. Read and construct 10 questions with Correct answers on food safety below The questions and answers that you provide should be written in the correct “jeopardy” format-answers first and questions second. The purpose of the assignment is to demonstrate an understanding of the course content.

Foodborne Illness in the United States When certain disease-causing bacteria, viruses or parasites contaminate food, they can cause foodborne illness. Another word for such a bacteria, virus, or parasite is “pathogen.” Foodborne illness, often called food poison- ing, is an illness that comes from a food you eat. • The food supply in the United States is among the safest in the world— but it can still be a source of infection for all persons. • According to the Centers for Disease Control and Prevention, 48 million persons get sick, 128,000 are hospitalized, and 3,000 die from foodborne infection and illness in the United States each year. Many of these people are children, older adults, or have weakened immune systems and may not be able to ght infection normally. Since foodborne illness can be serious—or even fatal—it is important for you to know and practice safe food-handling behaviors to help reduce your risk of getting sick from contaminated food. 2 • Your gastrointestinal tract, when functioning properly, allows the foods and beverages you consume to be digested normally. Diabetes may damage the cells that create stomach acid and the nerves that help Food Safety: It’s Especially Important for You As a person with diabetes, you are not alone—there are many people in the United States with this chronic disease. Diabetes can affect various organs and systems of your body, causing them not to function properly, and making you more susceptible to infection. For example: • Your immune system, when functioning properly, readily ghts off harmful bacteria and other pathogens that cause infection. With diabetes, your immune system may not readily recognize harmful bacteria or other pathogens. This delay in the body’s natural response to foreign invasion places a person with diabetes at increased risk for infection. your stomach and intestinal tract move the food throughout the intestinal tract. Because of this damage, your stomach may hold on to the food and beverages you consume for a longer period of time, allowing harmful bacteria and other pathogens to grow. Additionally, your kidneys, which work to cleanse the body, may not be functioning properly and may hold on to harmful bacteria, toxins, and other pathogens. A consequence of having diabetes is that it may leave you more susceptible to developing infections—like those that can be brought on by disease-causing bacteria and other pathogens that cause foodborne illness. Should you contract a foodborne illness, you are more likely to have a lengthier illness, undergo hospitalization, or even die. To avoid contracting a foodborne illness, you must be vigilant when handling, preparing, and consuming foods. Make safe food handling a lifelong commitment to minimize your risk of foodborne illness. Be aware that as you age, your immunity to infection naturally is weakened. 3 Major Pathogens That Cause Foodborne Illness Symptoms and Potential Impact • Fever, headache, and muscle pain followed by diarrhea (sometimes bloody), abdominal pain, and nausea. Symptoms appear 2 to 5 days after eating and may last 2 to 10 days. May spread to the bloodstream and cause a life-threatening infection. Symptoms and Potential Impact • Watery diarrhea, dehydration, weight loss, stomach cramps or pain, fever, nausea, and vomiting; respiratory symptoms may also be present. • Symptoms begin 7 to 10 days after becoming infected, and may last 2 to 14 days. In those with a weakened immune system, including people with diabetes, symptoms may subside and return over weeks to months. Symptoms and Potential Impact Associated Foods • Untreated or contaminated water • Unpasteurized (“raw”) milk • Raw or undercooked meat, poultry, or shell sh Associated Foods/Sources • Swallowing contaminated water, including that from recreational sources, (e.g., a swimming pool or lake) Eating uncooked or contaminated food Placing a contaminated object in the mouth Soil, food, water, and contaminated surfaces Associated Foods/Sources • Many outbreaks result from food left for long periods in steam tables or at room temperature and time and/or temperature abused foods. • Meats, meat products, poultry, poultry products, and gravy Associated Foods • Improperly reheated hot dogs, luncheon meats, cold cuts, fermented or dry sausage, and other deli-style meat and poultry Unpasteurized (raw) milk and soft cheeses made with unpasteurized (raw) milk Smoked seafood and salads made in the store such as ham salad, chicken salad, or seafood salads Raw vegetables • Onset of watery diarrhea and abdominal cramps within about 16 hours. The illness usually begins suddenly and lasts for 12 to 24 hours. In the elderly, symptoms may last 1 to 2 weeks. Campylobacter Cryptosporidium Clostridium perfringens • Complications and/or death occur only very rarely. Listeria monocytogenes Can grow slowly at refrigerator temperatures Symptoms and Potential Impact • Fever, chills, headache, backache, sometimes upset stomach, abdominal pain, and diarrhea. May take up to 2 months to become ill. Gastrointestinal symptoms may appear within a few hours to 2 to 3 days, and disease may appear 2 to 6 weeks after ingestion. The duration is variable. Those at-risk (including people with diabetes and others with weakened immune systems) may later develop more serious illness; death can result from this bacteria. Can cause problems with pregnancy, including miscarriage, fetal death, or severe illness or death in newborns. 4 Associated Foods • Undercooked beef, especially hamburger Unpasteurized milk and juices, like “fresh” apple cider Contaminated raw fruits and vegetables, and water Person-to-person contact Associated Foods • Shell sh and fecally- contaminated foods or water • Ready-to-eat foods touched by infected food workers; for example, salads, sandwiches, ice, cookies, fruit Associated Foods • Raw or undercooked eggs, poultry, and meat Unpasteurized (raw) milk or juice Cheese and seafood Fresh fruits and vegetables Toxoplasma gondii Associated Foods/Sources • Accidentalcontactofcatfeces through touching hands to mouth after gardening, handling cats, cleaning cat’s litter box, or touching anything that has come in contact with cat feces. • Raw or undercooked meat. Vibrio vulni cus Associated Foods • Undercooked or raw seafood ( sh or shell sh) Symptoms and Potential Impact • Severe diarrhea that is often bloody, abdominal cramps, and vomiting. Usually little or no fever. • Can begin 1 to 9 days after contaminated food is eaten and lasts about 2 to 9 days. • Some, especially the very young, may develop hemolytic-uremic syndrome (HUS), which can cause acute kidney failure, and can lead to permanent kidney damage or even death. Symptoms and Potential Impact • Nausea, vomiting, and stomach pain usually start between 24 and 48 hours, but cases can occur within 12 hours of exposure. Symptoms usually last 12 to 60 hours. • Diarrhea is more prevalent in adults and vomiting is more prevalent in children. Symptoms and Potential Impact • Stomach pain, diarrhea (can be bloody), nausea, chills, fever, and/or headache usually appear 6 to 72 hours after eating; may last 4 to 7 days. • In people with a weakened immune system, such as people with diabetes, the infection may be more severe and lead to serious complications including death. Symptoms and Potential Impact Escherichia coli O157:H7 One of several strains of E. coli that can cause human illness Noroviruses (and other caliciviruses) Salmonella (over 2,300 types) • Flu-like illness that usually appears 10 to 13 days after eating, may last months. Those with a weakened immune system, including people with diabetes, may develop more serious illness. • Can cause problems with pregnancy, including miscarriage and birth defects. Symptoms and Potential Impact • Diarrhea, stomach pain, and vomiting may appear within 4 hours to several days and last 2 to 8 days. May result in a blood infection. May result in death for those with a weakened immune system, including people with diabetes, cancer or liver disease. 5 Eating at Home: Making Wise Food Choices Some foods are more risky for you than others. In general, the foods that are most likely to contain harmful bacteria or viruses fall into two categories: • Uncooked fresh fruits and vegetables • Some animal products, such as unpasteurized (raw) milk; soft cheeses made with raw milk; and raw or undercooked eggs, raw meat, raw poultry, raw sh, raw shell sh and their juices; luncheon meats and deli-type salads (without added preservatives) prepared on site in a deli-type establishment. . . . about Particular Foods: KEEP YOUR FAMILY SAFER FROM FOOD POISONING If you are not sure about the safety of a food in your refrigerator, don’t take therisk. Interestingly, the risk these foods may actually pose depends on the origin or source of the food and how the food is processed, stored, and prepared. Follow these guidelines (see chart at right) for safe selection and preparation of your favorite foods. If You Have Questions . . . . . . about Wise Food Choices: Be sure to consult with your doctor or health care provider. He or she can answer any speci c questions or help you in your choices. When in doubt, throw it out! Wise choices in your food selections are important. All consumers need to follow the Four Basic Steps to Food Safety: Clean, Separate, Cook, and Chill. Check your steps at FoodSafety.gov 6 CLEAN SEPARATE CHILL CLEAN WASH HANDS AND SURFACES OFTEN SEPARATE SEPARATE RAW MEATS FROM OTHER FOODS CHILL REFRIGERATE FOOD PROMPTLY oF COOK TO THE RIGHT TEMPERATURE Common Foods: Select the Lower Risk Options Type of Food Higher Risk Lower Risk Meat and • Raw or undercooked • Meat or poultry cooked to a Poultry meat or poultry safe minimum internal tem- perature (see chart on p. 10) Tip: Use a food thermometer to check the internal temperature on the “Is It Done Yet?” chart on page 10 for speci c safe minimum internal temperature. Seafood • Any raw or undercooked sh, or shell sh, or food containing raw or undercooked seafood e.g., sashimi, found in some sushi or ceviche. Refrigerated smoked sh • Partially cooked seafood, such as shrimp and crab • Previously cooked seafood heated to 165 °F • Canned sh and seafood • Seafood cooked to 145 °F Milk • Unpasteurized (raw) milk • Pasteurized milk Eggs Foods that contain raw/undercooked eggs, such as: At home: • Homemade Caesar salad dressings* • Homemade raw cookie dough* • Homemade eggnog* • Use pasteurized eggs/egg products when preparing recipes that call for raw or undercooked eggs When eating out: • Ask if pasteurized eggs were used *Tip: Most pre-made foods from grocery stores, such as Caesar dressing, pre-made cookie dough, or packaged eggnog are made with pasteurized eggs. Sprouts • Raw sprouts (alfalfa, bean, or any other sprout) • Cooked sprouts Vegetables • Unwashed fresh vegetables, including lettuce/salads • Washed fresh vegetables, including salads • Cooked vegetables Cheese • Soft cheeses made from unpasteurized (raw) milk, such as: — Feta — Brie — Camembert — Blue-veined — Queso fresco • Hard cheeses • Processed cheeses • Cream cheese • Mozzarella • Soft cheeses that are clearly labeled “made from pasteurized milk” Hot Dogs and • Hot dogs, deli meats, and • Hot dogs, luncheon meats, and deli meats reheated to steaming hot or 165 °F Tip: You need to reheat hot dogs, deli meats, and luncheon meats before eating them because the bacteria Listeria monocytogenes grows at refrigerated temperatures (40 °F or below). This bacteria may cause cause severe illness, hospitalization, or even death. Reheating these foods until they are steaming hot ho destroys these dangerous bacteria and makes these foods safe for you to eat. Deli Meats luncheon meats that have not been reheated Pâtés • Unpasteurized, refrigerated pâtés or meat spreads • Canned or shelf-stable pâtés or meat spreads 7 Taking Care: Handling and Preparing Food Safely Foodborne pathogens are sneaky. Food that appears completely ne can contain pathogens—disease-causing bacteria, viruses, or parasites—that can make you sick. You should never taste a food to determine if it is safe to eat. As a person with diabetes, it is especially important that you—or those preparing your food—are always careful with food handling and preparation. The easiest way to do this is to Check Your Steps – clean, separate, cook, and chill – from the Food Safe Families Campaign. Four Basic Steps to Food Safety 1. Clean: Wash hands and surfaces often Bacteria can spread throughout the kitchen and get onto cutting boards, utensils, counter tops, and food. To ensure that your hands and surfaces are clean, be sure to: Wash hands in warm soapy water for at least 20 seconds before and after handling food and after using the bathroom, changing diapers, or handling pets. Wash cutting boards, dishes, utensils, and counter tops with hot soapy water be- tween the preparation of raw meat, poultry, and seafood products and preparation of any other food that will not be cooked. As an added precaution, sanitize cut- ting boards and countertops by rinsing them in a solution made of one tablespoon of unscented liquid chlorine bleach per gallon of water, or, as an alternative, you may run the plastic board through the wash cycle in your automatic dishwasher. Use paper towels to clean up kitchen surfaces. If using cloth towels, you should wash them often in the hot cycle of the washing machine. Wash produce. Rinse fruits and vegetables, and rub rm-skin fruits and vegetables under running tap water, including those with skins and rinds that are not eaten. With canned goods: remember to clean lids before opening. 8 2. Separate: Don’t cross-contaminate Cross-contamination occurs when bacteria are spread from one food product to another. This is especially common when handling raw meat, poultry, seafood, and eggs. The key is to keep these foods—and their juices—away from ready-to-eat foods. To prevent cross-contamination, remember to: • Separate raw meat, poultry, seafood, and eggs from other foods in your grocery shopping cart, grocery bags, and in your refrigerator. • Never place cooked food on a plate that previously held raw meat, poultry, seafood, or eggs without rst washing the plate with hot soapy water. • Don’t reuse marinades used on raw foods unless you bring them to a boil rst. • Consider using one cutting board only for raw foods and another only for ready-to-eat foods, such as bread, fresh fruits and vegetables, and cooked meat. 3. Cook: Cook to safe temperatures Foods are safely cooked when they are heated to the USDA-FDA recommended safe minimum internal temperatures, as shown on the “Is It Done Yet?” chart (see next page). To ensure that your foods are cooked safely, always: • Use a food thermometer to measure the internal temperature of cooked foods. Check the internal temperature in several places to make sure that the meat, poul- try, seafood, or egg product is cooked to safe minimum internal temperatures. Cook ground beef to at least 160 °F and ground poultry to a safe minimum internal temperature of 165 °F. Color of food is not a reliable indicator of safety or doneness. Reheat fully cooked hams packaged at a USDA-inspected plant to 140 °F. For fully cooked ham that has been repackaged in any other location or for leftover fully cooked ham, heat to 165 °F. Cook seafood to 145 °F. Cook shrimp, lobster, and crab until they turn red and the esh is pearly opaque. Cook clams, mussels, and oysters until the shells open. If the shells do not open, do not eat the seafood inside. Cook eggs until the yolks and whites are rm. Use only recipes in which the eggs are cooked or heated to 160 °F. Cook all raw beef, lamb, pork, and veal steaks, roasts, and chops to 145 °F with a 3-minute rest time after removal from the heat source. 9 3. Cook: Cook to safe temperatures (cont.) Bring sauces, soups, and gravy to a boil when reheating. Heat other leftovers to 165 °F. Reheat hotdogs, luncheon meats, bologna, and other deli meats until steam- ing hot or 165 °F. When cooking in a microwave oven, cover food, stir, and rotate for even cooking. If there is no turntable, rotate the dish by hand once or twice during cooking. Always allow standing time, which completes the cooking, before checking the internal temperature with a food thermometer. Food is done when it reaches the USDA-FDA recommended safe minimum internal temperature. Is It Done Yet? Use a food thermometer to be most accurate. You can’t always tell by looking. 4. Chill: Refrigerate promptly Cold temperatures slow the growth of harmful bacteria. Keeping a constant refrigerator temperature of 40 °F or below is one of the most effective ways to reduce risk of foodborne illness. Use an appliance thermometer to be sure the refrigerator temperature is consistently 40 °F or below and the freezer temperature is 0 °F or below. To chill foods properly: • Refrigerate or freeze meat, poultry, eggs, seafood, and other perishables within 2 hours of cooking or purchasing. Refrigerate within 1 hour if the temperature outside is above 90 °F. Never thaw food at room temperature, such as on the counter top. It is safe to thaw food in the refrigerator, in cold water, or in the microwave. If you thaw food in cold water or in the microwave, you should cook it immediately. Divide large amounts of food into shallow containers for quicker cooling in the refrigerator. Follow the recommendations in the abridged USDA-FDA Cold Storage Chart (see page 11). The USDA-FDA Cold Storage Chart in its entirety may be found at www.fsis.usda.gov/Fact_Sheets/Refrigeration_&_Food_Safety/index.asp. USDA-FDA Recommended Safe Minimum Internal Temperatures Beef, Pork, Veal, Lamb Steaks, Roasts & Chops 145 °F with 3-minute rest time Fish 145 °F Beef, Pork, Veal, Lamb Ground 160 °F Egg Dishes 160 °F Turkey, Chicken & Duck Whole, Pieces & Ground 165 °F 10 USDA-FDA Cold Storage Chart These time limit guidelines will help keep refrigerated food safe to eat. Because freezing keeps food safe inde nitely, recommended storage times for frozen foods are for quality only. Product Refrigerator (40 °F) Freezer (0 °F) Eggs Fresh, in shell 3 to 5 weeks Don’t freeze Hard cooked 1 week Don’t freeze well Liquid Pasteurized Eggs, Egg Substitutes Opened 3 days Don’t freeze well Unopened 10 days 1 year Deli and Vacuum-Packed Products Egg, chicken, ham, tuna, & macaroni salads 3 to 5 days Don’t freeze well Hot Dogs Opened package 1 week 1 to 2 months Unopened package 2 weeks 1 to 2 months Luncheon Meat Opened package 3 to 5 days 1 to 2 months Unopened package 2 weeks 1 to 2 months Bacon & Sausage Bacon 7 days 1 month Sausage, raw—from chicken, turkey, pork, beef 1 to 2 days 1 to 2 months Hamburger and Other Ground Meats Hamburger, ground beef, turkey, veal, pork, lamb, & mixtures of them 1 to 2 days 3 to 4 months Fresh Beef, Veal, Lamb, Pork Steaks 3 to 5 days 6 to 12 months Chops 3 to 5 days 4 to 6 months Roasts 3 to 5 days 4 to 12 months Fresh Poultry Chicken or turkey, whole 1 to 2 days 1 year Chicken or turkey, pieces 1 to 2 days 9 months Seafood Lean sh ( ounder, haddock, halibut, etc.) 1 to 2 days 6 to 8 months Fatty sh (salmon, tuna, etc.) 1 to 2 days 2 to 3 months Leftovers Cooked meat or poultry 3 to 4 days 2 to 6 months Chicken nuggets, patties 3 to 4 days 1 to 3 months Pizza 3 to 4 days 1 to 2 months Check Your Steps Check “Sell-By” date Put raw meat, poultry, or seafood in plastic bags • Buy only pasteurized milk, soft cheeses made with pasteurized milk, and pasteurized or juices that have been otherwise treated to control harmful bacteria. • When buying eggs: – Purchase refrigerated shell eggs – If your recipe calls for raw eggs, purchase pasteurized, refrigerated liquid eggs • Don’t buy food displayed in unsafe or unclean conditions Is It Done Yet? You can’t tell by looking. Use a food thermometer to be sure. USDA-FDA Recommended Safe Minimum Internal Temperatures Beef, Pork, Veal, Lamb Steaks, Roasts & Chops 145 °F with 3-minute rest time Fish 145 °F Beef, Pork, Veal, Lamb Ground 160 °F Egg Dishes 160 °F Turkey, Chicken & Duck Whole, Pieces & Ground 165 °F Ordering “Smart” When Eating Out Higher Risk: ✘ Cheese made from unpasteurized (raw) milk. ✘ Raw or undercooked seafood. ✘ Cold hot dogs. ✘ Sandwiches with cold deli or luncheon meat. ✘ Raw or undercooked fish, such as sashimi or some kind of sushi. ✘ Soft-boiled or “over-easy” eggs, as the yolks are not fully cooked. Lower Risk: ✔Hard or processed cheeses. Soft cheeses only if made from pasteurized milk. ✔Fully cooked smoked fish or seafood. ✔Hot dogs reheated to steaming hot. If the hot dogs are served cold or lukewarm, ask to have the hot dogs reheated until steaming, or else choose something else. ✔Grilled sandwiches in which the meat or poultry is heated until steaming. ✔Fully cooked fish that is firm and flaky; vegetarian sushi. ✔Fully cooked eggs with firm yolk and whites. Clip out these handy Info Cards and carry them for quick reference when shopping, cooking, and eating out! In the Know: Becoming a Better Shopper Follow these safe food-handling practices while you shop. • Carefully read food labels while in the store to make sure food is not past its “sell by” date. (See Food Product Dating • Put raw packaged meat, poultry, or seafood into a plastic bag before placing it in the shopping cart, so that its juices will not drip on— and con taminate—other foods. If the meat counter does not offer plastic bags, pick some up from the produce section before you select your meat, poultry, and seafood. Buy only pasteurized milk, cheese, and other dairy products from the refrigerated section. When buying fruit juice from the refrigerated section of the store, be sure that the juice label says it is pasteurized. Purchase eggs in the shell from the refrigerated section of the store. (Note: store the eggs in their original carton in the main part of your refrigerator once you are home.) For recipes that call for eggs that are raw or undercooked when the dish is served—homemade Caesar salad dressing and ice cream are two examples—use either shell eggs that have been treated to destroy Salmonella by pasteurization, or pasteurized egg products. When consuming raw eggs, using pasteurized eggs is the safer choice. • Never buy food that is displayed in unsafe or unclean conditions. When purchasing canned goods, make sure that they are free of dents, cracks, or bulging lids. (Once you are home, remember to clean each lid before opening the can.) Purchase produce that is not bruised or damaged. When shopping for food, it is important to read the label carefully. on page 13) 12 Food Product Dating Read the “Safe Handling Label” for food safety information on raw foods. Types of Open Dates Open dating is found primarily on perishable foods such as meat, poultry, eggs, and dairy products. A “Sell-By” date tells the store how long to display the product for sale. You should buy the product before the date expires. A “Best If Used By (or Before)” date is recommended for best avor or quality. It is not a purchase or safety date. A “Use-By” date is the last date recommended for the use of the product while at peak quality. The date has been determined by the manufacturer of the product. CHICKEN SAMPLER PACK SELL BY JAN 13.06 576 PRICE/LB NET WT LB 270567 005093 BEST IF USED BY 1.99 2.56 lb MEAT DEPT. $5.09 TOTAL PRICE P—7903 “Closed or coded dates” are packing numbers for use by the manufacturer. “Closed” or “coded” dating might appear on shelf-stable products such as cans and boxes of food. Transporting Your Groceries Follow these tips for safe transporting of your groceries: • Pick up perishable foods last, and plan to go directly home from the grocery store. Always refrigerate perishable foods within 2 hours of cooking or purchasing. Refrigerate within 1 hour if the temperature outside is above 90 °F. In hot weather, take a cooler with ice or another cold source to transport foods safely. 13 10 NOV 06 Eating out can be lots of fun—so make it an enjoyable experience by following some simple guidelines to avoid food- borne illness. Remember to observe your food when it is served, and don’t ever hesitate to ask questions before you order. Waiters and waitresses can be quite helpful if you ask how a food is prepared. Also, let them know you don’t want any food item containing raw meat, poultry, sh, sprouts, or eggs.

Please read the article and answer about questions.

International Strategies

When you are struggling to get through that first year of business, international sales are about the last thing on your mind. The U.S. Department of Commerce, however, indicates that large compa- nies account for only about 4 percent of all exporters, meaning the other 98 percent of the exporters in 2010 were small businesses.22

Entrepreneurs typically fall into three categories. There are those who realistically will never go international (for example, a restaurant owner or dry cleaner working from a single site). There are those who intentionally start international businesses23 (for example, import-export businesses), such as Peter P., the director of procurement for a Russian trading company, who saw a trading opportunity with the opening up of Eastern Europe and the former Soviet Union. Educated in the United States, he is of Ukrainian descent and speaks both Russian and Ukrainian.24 Last, there are those who think international business might be something they’ll do someday way off in the future. This section is primarily for the last two categories.

Thanks to the Internet, once a company has a website, it is essentially an international business, a whole new breed of firms known as born internationals.25 Potential foreign customers see the website and before you know it—or before you are prepared—the first international order rolls in. Even “website–free” companies aren’t exempt. A foreign visitor comes across your products and sees a need for it in his or her country, and here comes that order.

Some international orders aren’t all that difficult to handle. If the order is small enough, if the product or service is not highly regulated domestically, and if the country is one with which the United States has rather liberal trade such as Canada, the order processing may offer few or no head- aches. The customer may use a credit card or international money order, and the product ships in the mail without much more effort than figuring the extra postage. That’s okay for the occasional order, but more complex situations will require more time and effort on the part of the entrepreneur. The ideal situation is to consider and prepare an international strategy before it becomes a hit-and-miss method that is too cumbersome or before serious and costly mistakes are made.

Entrepreneurs have available to them the same options as large companies including wholly owned subsidiaries, joint ventures, licensing, franchising, and exporting. For most, though, an ex- port strategy is sufficient and is all that is covered in this section. It’s usually inexpensive, quick to start, easy to change, and less risky than other ventures. It has the additional advantage of allowing the entrepreneur the opportunity to learn about doing business abroad in case the company reaches the point of moving further. For U.S. entrepreneurs, the U.S. government offers detailed and useful help for exporters, including seminars and other training, export assistance, websites and reports, financing, insurance, and legal and collection assistance.

Putting together an export strategy involves answering three questions:

1. Are we ready? 2. Where should we go? 3. Whom do we contact over there?

There are many sources for assistance in answering these questions, and many good ones are free or almost free. One excellent resource is the U.S. Commerce Department’s report entitled, “A Basic Guide to Exporting” that can be found at www.unzco.com/basicguide.

Question 1: Are you ready to export? Exporting requires a different kind of thinking and prepa- ration from selling locally or even nationally. Are you going to target one country, a region, or the whole world? Do you know what customers want? Do you know what the import requirements are? What aspects will you handle, and which ones will you contract out? Are you ready for the costs and headaches of exporting? To see how you are coming along, you can check your readiness online at the U.S. government’s exporting site www.export.gov/, which provides extensive exporting basics, including a “readiness test” at www.fas.usda.gov/agexport/exporttest.asp.

Consider your product as well. Will your U.S. designed product fit an international lifestyle or needs? Clothing sizes are different—both in how they are numbered and what the sizes mean. A woman’s medium in the United States is an XXL in mainland China. Electrical currents are

different, as are various other safety and product standards, and the United States is one of only two countries that’s not on the metric system.27

There are several ways you can export. One is to use online services such as eBay. Approximately one-fifth of eBay’s sales are out of country.28 If you’re handling your international business this way, a lot of the rest of this section isn’t really for you until you want or need to change methods. Another is to work from personal contacts gained through school, travel, or family. Most exporting small businesses start with countries where they have had personal experience or support.29 These two methods are called direct exporting, since you are selling directly to foreign buyers or distributors.

If you want to use outside experts, there are three intermediaries who can help. With indirect exporting, you use agents, export management companies, or export trading companies as inter- mediaries to handle most of the exporting process. Direct exporters can also get help from freight forwarders. Freight forwarders are specialists in export-related activities including tariff sched- ules, shipping, insurance, packing, transportation arrangements, customs clearing, and other export details. (By the way, many agents, export management companies, export trading companies, and freight forwarders are themselves small businesses. They know exactly what problems you’ve faced and are much easier to approach than some megacompany.) The Small Business Administration’s Export Assistance Center can help you find one.

Question 2: Where should we go? The United Nations has 193 member countries in the world; chances are not all of them are right for your product. Even if your product should have wide appeal, it makes good sense to pick one or two as first markets. One of the safest bets is to consider countries that are similar to the United States—Canada, United Kingdom, Australia, for example. In those countries, you have few language issues, the culture is pretty close, the governments and economies are stable, and the people there are likely to want or need about the same kinds of products as people in the United States do. Should you decide to go further afield, those are the same sorts of things you want to look for—language and culture issues, government and legal situations, economic situ- ations, and peoples’ wants and needs. Here’s a good time to use those personal contacts mentioned earlier; if they live there, they are likely to be able to tell you if the product makes sense or not.

International marketing research isn’t cheap and can be difficult to do. Contacts are a valuable resource. Additionally, the U.S. government and world trade centers can give a lot of free or low-cost assistance. See Table 11.1 for a list of some of the major ones.

TABLE 11.1   Sources of Export Assistanc Question 3: Whom do we contact over there? You may already have international contacts through school, friends, travel, or other methods. If so, you’re ahead of the game. Even if they cannot help you with specific questions, they probably know someone who can. On the other hand, if you do not have any contacts, a lot of the government services you have already used can provide lists of poten- tial intermediaries or end users. In addition to the free services available, U.S. Commercial Services (www.export.gov) provides a number of levels of fee-based customized services. For $500, they offer their International Partner Search service, which will identify up to five potential businesses to work with you as licensees, agents, distributors, or strategic partners, and prequalify them based on your criteria. The government’s www.export.gov site offers a database of sales leads that can be searched for free by industry, region, or country. They also are the point of contact for catalog exhi- bitions which can get your product or service catalogs into the hands of potential buyers in specific markets (or at specific trade shows) overseas.

Other good ways to make international contacts are to participate in trade shows and trade mis- sions. In a trade mission, a U.S. government official takes a small group of business owners to dif- ferent foreign countries in order to help establish relationships and promote exporting. There are not a lot of these missions, and they are usually specific to a particular type of business and region of the world, so they are not always appropriate. At an international trade fair, similar to domestic trade fairs, you have a booth displaying your products or services and the opportunity for exposure to thousands of potential clients. Again, some fairs are industry-specific, while others are more general. The U.S. government often has a U.S. pavilion featuring export-oriented companies. These companies often have the opportunity to tie into other U.S. government services such as meeting with local U.S. embassy officials, prearranged meetings with qualified customers, market research information, trade barrier information, transportation and customs information, and assistance and access to U.S. trade show experts. Even if you can’t exhibit in the fair, attending the fair may give you a chance to meet the sort of people you need to know.

The U.S. government through www.export.gov also provides such services as printed and video catalogs, online databases, and personalized (fee-based) contact services. The U.S. Commercial Service will also assist a company in arranging private promotional activities, including exhibitions, press releases, and receptions when appropriate.

Still another way is to look for foreign companies with a resident representative in the United States, a type of private importing agent. Often these representatives are interested in bringing U.S. products back to their home countries and will already have a good idea if your product is right, and how to promote and distribute it.30 To find these resident representatives, try a Google search with the terms “resident representative” US, importing-site:.gov.

The next step is to export your products. But there are a few other things to consider first. Pricing becomes complicated as you need to cover transportation, the additional documents you may need,

possible tariffs (taxes on incoming goods), potential currency valuation changes, the cost of convert- ing currencies, and the additional packaging necessary to ship abroad. The importer usually covers foreign taxes, tariffs, additional shipping charges, port handling fees, and the like, but this must be carefully spelled out in your contracts in order to avoid potential differences of opinion.

Shipping documentation and other paperwork are very specific to the product and the country to which it is going. The International Trade Administration (www.ita.doc.gov) provides extensive information about tariffs, taxes, specific country information, and other general exporting informa- tion. The U.S. Country Commercial guides also provide some assistance in this area, as do some country government websites. The Bureau of Export Administration (www.bxa.doc.gov) provides information about when export licensing is necessary and also information on exporting of politi- cally sensitive products. In addition, companies such as NetShip (www.netship.net) have arisen specifically to handle shipping and documentation issues for e-commerce.31

There are a variety of payment procedures available. The easiest for you is to require up-front cash payment prior to shipment (or credit card if appropriate). This eliminates your risk, but puts the customer at risk. Providing credit to your customers reverses the risk, and puts it all on you. Both of these are possible methods of receiving payments, but less often used. More typical meth- ods include letters of credit or documentary drafts. In both cases, the payment procedure now includes four parties—you, your customer, and both of your banks—and payments are made upon proper presentation of certain documents, including the letter of credit or draft, bills of lading, and other paperwork. Although the system is somewhat complex, it provides a lower level of risk for all parties than cash in advance or an open account. You can find assistance about these methods at your current bank.

Financing and insurance become important because of the length of time it may take for interna- tional payments to be processed and the risk of default, as well as the difficulty of recovery in case of default in international transactions. The Small Business Administration (www.sba.gov), the Ex-Im Bank (www.exim.gov), and the Overseas Private Investment Corporation (www.opic.gov) provide loans and insurance to cover exporting. In some cases, these loans may also be used to finance trade show participation, to translate brochures and catalogs for international distribution, to renovate or expand existing facilities necessary to produce products for export, to set up lines of credit for potential customers, to provide export working capital, and to provide funding for developing an export program.

Last is the consideration of conflict resolution. Although the possibility exists for pirating, prod- uct misuse, and other unfortunate occurrences, the primary areas for conflict resolution include nonpayment and contract default issues. There is no universal court of law that can handle these situations. The U.S. Department of Commerce can provide advice and offer reputable local coun- sel, but only for sizable losses, typically several thousand dollars or more. The U.S. Council of the International Chamber of Commerce (www.iccwbo.org) provides international arbitration services and offers some other suggestions, but arbitration, too, is costly and probably not worthwhile un- less the loss is significant. This difficulty in international dispute resolution underscores the need to carefully select partners and to do a thorough job of prescreening. This is an area in which various government agencies can help you. The U.S. Commerce Department, for example, prequalifies potential customers in many cases prior to recommending them; you should check the particular program specifics to verify. Ex-Im Bank provides credit information on potential customers and, as mentioned earlier, many agencies provide insurance for export payments.

Importing

Importing strategy is similar to exporting, but with the buyers and sellers reversed. Instead of cus- tomers to buy your products, you are looking for sources to sell products to you (which, of course, you’ll eventually resell). If you have the opportunity to travel abroad, look for products that are selling well in the country you’re visiting and aren’t available in the United States or products that are considerably cheaper than similar ones found in the United States (labor and manufacturing costs are often cheaper in other countries than the United States). Trade mission and domestic and international trade shows are also good sources. If you can’t travel, ask your international contacts for this information. Next, find out who manufactures them and write the manufacturer a letter, introducing yourself and your company and the potential you see in your market for its product. You’re selling yourself, so be sure to tell the producer why you are the best person or company to be representing the product (i.e., experience in that product or in importing, contacts and distribution systems already in place, familiarity with the market, etc.). International mail can be painfully slow, so a fax or e-mail letter is probably best. Also, avoid slang terms (e.g. “your product is da bomb!”) and idiomatic expressions (like “break the ice”) that are likely to be misunderstood. Since English is rapidly becoming the language of business, a translation is usually not necessary. Follow up with a phone call or visit in which you can pitch the specifics of your marketing plan for the product.32 One way to conduct international calls for free is to register for Skype, an Internet service which lets you use a broadband connected computer to call other Skype users for free (www.skype.com). If you and the overseas company both use Skype, having long conversations to get an understanding of each other will not pose a financial problem. Along the same lines, it is worthwhile these days to check to find out whether an overseas company has video capabilities. Video cameras for PCs are inexpensive, and videoconferencing services are often available on campuses or at commercial locations such as FedEx Kinko’s for low costs.

With importing, many of the paperwork and insurance details will be your source’s responsibil- ity. Import buying works the same way as export selling, that is, the same sorts of paperwork and procedures are followed only in reverse.

Concluding Thoughts on International Business

One of the major mistakes commonly made by U.S. businesspeople (entrepreneurs or major compa- nies) is being insensitive to cultural differences. You’re likely to make some mistakes, but take time to learn at least the basics about the culture you’re dealing with to avoid the biggest errors. Travel guides and U.S. government country reports often offer brief cultural assistance as do books such as Kiss, Bow or Shake Hands and a plethora of “doing business in ———” guides.33

Although international business might seem a little daunting with all the paperwork and regula- tions, small businesses just like yours do it every day. There’s a lot of free or very inexpensive help out there; make use of it.

Location

When you ask real estate agents the best three things to look for in a house, they will tell you, “Loca- tion, location, location.” The same holds true in your business. What location—in particular, good location—means for your business is highly dependent on what your business is, the amount of money you can afford to budget for it, your particular business philosophy, and the marketing niche you are seeking. Let’s start with some general information about location, then move onto specific issues for services (including retailing) and manufacturing businesses. We then discuss some spe- cific choices such as site selection and layout and the buy, build, or lease option.

The first choice, and often only choice, for many entrepreneurs is their hometown because it offers convenience and a familiar setting, and it eliminates a lot of possible family issues. There may also be valid business reasons for this choice: The local banker knows you and is more likely to loan you money; you know your market—the potential customers in the area—and understand their wants and needs; you have seen an unmet need that you can fill; and, for many entrepreneurs, friends and family (usually local) are often the first customers and are great at spreading the word about your business. (Remember that word-of-mouth is often the first method of getting to your customers.)

There may also be some compelling reasons to consider a different location. What are the busi- ness laws like in your area? Local zoning ordinances specify what sorts of businesses are allowed and not allowed in specific locations.34 Certain types of businesses—usually those deemed hazard- ous or that produce foul odors—may be banned or severely restricted. State and local pollution standards, worker’s compensation, wage rates, and other such legislation might increase the cost of doing business to the point that other locations become much more favorable. State and local taxes in particular vary considerably from state to state. For example, Wyoming has no personal or corpo- rate income tax, while California has relatively high rates. On the other hand, certain locations often offer attractive incentives for new businesses ranging from tax credits to low-interest loans, from favorable business laws to business incubators (discussed later). Most of this information can be found on the Internet. Try the state or city business development office (a good place to start is the Federation of Tax Administrators’ state list at www.taxadmin .org/fta/rate/tax_stru.html) or the local chambers of commerce (look in the phone book or at www.uschamber.com/chambers/directory/default to find your local Chamber affiliate). There is also information by state available for your state at business.USA.gov, and the Small Business Ad- ministration offers links to state-based resources at www.sba.gov/category/navigation-structure/ counseling-training. Site Selection Magazine’s website (www.siteselection.com) has a number of tools that can help you find the right location. Many of these require being a registered user, but registration is free.

Other reasons to consider other locations are tied to your customer. Your hometown may not be the best place for you to find your target market customers. Are you close to the people who will use your product or service? Other considerations include population growth or decline (especially in your target sector), income levels, and predicted increases or decreases in income. Is the location expanding economically or slowly dying? Perhaps the best source for this infor- mation is the US Census Bureau. State and local municipality business development offices may also carry such information, but they are likely to be slanted toward attracting new businesses. Being positioned to benefit your customer can also be key. Zappos’s primary distribution hub was placed in Louisville, Kentucky, to be close to a major UPS air cargo hub in order to speed delivery.

Also consider the type of business you are planning. Do you need skilled labor? If so, what areas will provide you with the necessary employees? Do you need to be near raw materials or particular methods of transportation? These issues will help determine your choices. Where are your competitors? Certain industries tend to be clustered in certain regions where they can make efficient use of services and employees. Think of California’s Silicon Valley or the financial district of New York City.

Doing business in your hometown may be perfectly appropriate; however, the cost of moving a company—whether across town or across the country—can be very expensive. It pays to plan ahead.

Service Firms

There are three typical locations for services: at the client’s location, at a mutually accessible loca- tion, and at your firm’s location. Traditionally, services may have been tied to one or another of these, but marketing niches have been carved out by people daring to be different. Typically, dry cleaning and restaurant dining are services provided at a place accessible to both parties, but some dry cleaners now offer pick up and delivery from the client’s home, and not only pizza restaurants offer delivery these days. Thanks to the Internet, video rental like Netflix.com and other services are handled electronically, and the customer and service provider may never meet face to face. Whatever innovative niche you select, there are a few things to keep in mind.

At the Client’s Location

Typically, these services include things such as house or office cleaning, pest control, remodeling, lawn and gardening services, carpet cleaning, and similar services which must be performed at the client’s location. Business headquarters can be a home office with enough room to store and maintain any necessary equipment used in the service. Reliable transportation, preferably modified to organize and store tools efficiently, is imperative. More importantly, the range of your client’s locations must be planned to prevent transportation times from being unmanageable. For example, facing a one-hour drive to a client’s location might mean you have tied up two hours in commuting. If you cannot charge for travel and do not have other clients nearby, it means you have two hours in which you cannot make any money that day.

If you’ve done your homework carefully, you already know the geographic area(s) most likely to use your service. Certain services may be organized into a rotating schedule. For example, a house cleaning service may clean a certain set of neighborhoods on Monday, different set on Tuesday, and so on. In other cases, more remote clients may be charged a transportation fee. In some cases, a mile- age fee may be appropriate for your business (delivery services, for example).

As the firm grows, it may outgrow its home-based headquarters. As your clients seldom, if ever, visit you, you have more latitude in where you can be located and the ability to seek out low-cost space (see site selection section below). Reasonable distance to the clients and adequate storage room for your expanded fleet and equipment are key to choosing a site.

Mutually Accessible Location

Services using this approach often have too much specialized equipment to be readily transported and a need for at least some client involvement. Barbershops, dentist offices, video rental stores, and restaurants are services typically located at a site that is extremely convenient for the client and reasonably so for the owner and employees.

Even though your service may be traditionally located in a mutually accessible area, consider what you might do to make it home-based (see Chapter 5). Your watch repair shop might generate clientele by being located in a shopping center, but will the added sales be offset by the high cost of rent, utilities, insurance, and other payments? Can you offer pickup and delivery and do the work at

home? Your restaurant idea might work as a catering service. Instead of a specialized clothing shop, why not try mail order or Internet-based sales?

Remote Location

In this type of service, face-to-face meetings with the client are infrequent. Typical services that meet this criterion include medical transcription, data processing, fulfillment centers, and some consulting work. These services generally are ideal for home-based businesses. Certain services, for example, fulfillment centers, generally take more space—at the minimum, an attic, garage, or basement. The biggest advantage of these sorts of businesses is that they can be located anywhere in the world. U.S. hospitals, for example, use medical transcription services located in India. One such company, Infoflow/TSVI, operates from a U.S. sales base (which makes handling calls from U.S. hospitals easier) with transcription being done in India, managed there by a co-owner, who is a cousin and long-time friend of one of the two American owners (www.tsviinc.com).35 Other than perhaps some initial sales meetings, all business is transacted via phone, fax, electronic exchanges, or mail.

Manufacturers

What if you are selling a product and not a service? What are your considerations about location now? Where you make the product is really dependent on the product. Some products that do not require a lot of specialized or bulky equipment can be produced at home unless zoning ordinances forbid it. In addition to whatever office space is needed, adequate work space is also required. The basement, a garage, or a home workshop may be adequate for some time. As business expands and as you add employees, it will become awkward if not illegal to continue production at home (see Chapter 5).

Some products require bulky and specialized equipment, utility demands atypical of homes, or sizable warehousing requirements and are never suitable for home businesses. Certain production characteristics—for example, use of hazardous materials and materials with strong odors or noisy operations—may make a home-based business undesirable. Many cities have zoning ordinances prohibiting manufacturing in residential areas. When you start to hire employees, providing the amenities they will expect or that are required by law will usually require moving the business from your home.

Contract manufacturing might be a better option, at least for awhile. In this case, a firm with the capabilities to produce your product is contracted to manufacture it for you, usually for a flat per unit fee and a possible setup charge. Some firms will also assist in marketing and sales as well. Trade magazines in your field often list ads for contract manufacturers. An interesting possibility here is to use sheltered workshops to perform light manufacturing or assembly sorts of businesses. These workshops exist in nearly every state and offer very competitive pricing, often including tax benefits for the business.

Site Selection

Once you have determined the general location of your business, you need to determine the exact location for your operation. What you should look for falls into three main categories: home-based businesses (covered in Chapter 5), high customer contact (e.g., retail), and low customer contact (e.g., manufacturing). Each has certain criteria to be considered.

High Customer Contact Businesses

Businesses with high customer contact include such diverse operations as medical or legal offices, restaurants, retail establishments, dry cleaners, and other businesses that are highly dependent on being convenient to the customer. For these operations, there are three critical site selection consid- erations: traffic, customer ease, and competition.36

First of all, you want a site that is convenient to your target market and to enough of the customers to make you profitable. If you are considering a franchise, many will offer site criteria to help you make your selection. If you are going it alone, consider the population density of the area and how many of the people in the area meet your target market criteria. The U.S. Census Bureau website

and a number of free nongovernment sites like www.zipwho.com and www.city-data.com can be a good starting place for free information. See Skill Module 11.2 and the Online Learning Center. If plowing through the Census Bureau website doesn’t get you what you want, several commercial services mentioned in Chapter 10 including Prizm and ESRI will sell you data about the population in a particular zip code for several hundred dollars. More detailed and specific commercial infor- mation is also available and can range in price from several thousand dollars to over $100,000 and is probably not an option for most entrepreneurs.37 Again, the website of Site Selection Magazine (www.siteselection.com) mentioned above has tools and additional articles that can help. Another consideration is the presence of traffic generators in the area. These are other busi- nesses that draw customers to the area and may include supermarkets, office complexes, schools, and malls. If the customers are drawn there, for example, to grocery shop, might they not stop at your video store next door? Reflect on the type of customer you are seeking and the likelihood of these businesses in attracting them. If you want a teen customer, a location near a high school works well. If you are looking for evening clientele, offices that close at five aren’t the right traffic genera- tors for you. Drive around likely areas and locate possible sites. Visit during the hours you anticipate to be peak times for your business and evaluate foot and car traffic.38 Look at the crowds or lines in similar businesses and decide whether there is room for you. If most businesses seem empty, you probably will be too.

Intersections of major streets offer high automobile traffic, but because of divided roads and other barriers, they may not make it easy for your customers to get to you. Businesses along inter- states have high visibility, but the frontage roads can be so convoluted that the clients seek easier- to-get-to competitors. Even some malls and shopping centers have such tortuous access problems that customers avoid them when possible. Sometimes entry is easy, but getting out is difficult. For example, no signals for left turns when most of the traffic needs to head in that direction can turn off customers.

Parking is also an issue. Is it conveniently located to your place of business? Do customers need to cross busy streets to get to you? Is parking free or paid? Are parking areas well lit and safe? Are there wheelchair ramps or other accommodations for disabled customers?

Customers have strong ideas about how far they should have to drive for things. These vary some- what from major metropolitan areas to more rural towns and from one region of the United States to another. Generally convenience stores, fast-food restaurants, and gas stations need to be close to con- sumers. Grocery stores and banks can be somewhat farther away, but not much. Discount stores and midscale restaurants can be even farther away, while specialty stores, upscale restaurants, and malls can be relatively remote. Where does your business fit? How far are customers willing to drive to get to you?

Malls are great traffic generators, but space at malls is costly. If it is appropriate for your product, you might consider a kiosk or cart in the mall as a way of testing the market and location without making a large investment.39 Neighborhood shopping centers (those anchored by a supermarket, drugstore, or major retailer) or strip centers (shopping centers without major anchors) are more modestly priced, but lack the drawing power of malls.4 Generally, competition in the area can draw away valuable clients, but this is not true in every case. Many cities have a restaurant row, an antique district, or an automobile mile (as well as other business types) where many competitors cluster. Clients wish to comparison shop or have choices and are drawn to areas where they can see several similar businesses at one time. Locating far from these will mean that you are free from competition, but this benefit may easily be offset by the cost of at- tracting customers to a different place. Additionally, you can capitalize on competitive advertisements that bring potential customers to the area. Your competitor’s high-budget TV ad might get customers to the neighborhood, but the “sale” sign in your window may get them to stop at your place instead.

Another instance when you want to be near competitors is when your business provides a strong contrast to the competition in the area. Do you offer better assistance, additional services, unique advantages, or other benefits that can easily be seen by customers? They may be drawn to the area by a well-known competitor’s name, but they may select your establishment instead because of what you offer that differentiates you.

Low Customer Contact Businesses

Generally low customer contact businesses are manufacturing businesses, the headquarters of client location-based services, or remote location services. Customer access is relatively unimportant. More critical are access for your employees, reasonable cost, and the space necessary to do your business. Certain manufacturing operations will need adequate utilities and specialized transportation too. Unless you plan to use some of this space as a high-traffic showroom, commercial space in a business park or light industrial park might be appropriate. These parks are located near major transportation routes, often have rail spurs, and are designed for industrial utilities; that is, they have adequate electricity, gas, water, waste water treatment, and the like. Frequently, support businesses will be located in or near the park such as warehousing, shipping firms, copy centers, and office supply stores. Industrial or business park space tends to be cheaper in smaller cities and rural towns than in major metropolitan areas. If distribution to customers can be arranged, these locations are certainly cost-effective.

Some major metropolitan areas offer empowerment zones. These zones, often in economically depressed areas, offer businesses low-cost space and tax advantages for locating there. For more information, see www.rurdev.usda.gov/BCP-EZEC-Home.html or www.siteselection.com.

A third possibility is a business incubator. The National Business Incubator Association (www .nbia.org) shows over 1,400 business incubators in North America sponsored by government, uni- versities, or private investment groups. These business incubators are specifically designed for the entrepreneur, and, in addition to relatively low cost space, they offer a multitude of small business support services. These services range from copy machines, faxes, and conference rooms to ac- counting, finance, and consulting services. Since the building is populated by other entrepreneurs, it’s a great place to talk to others who might have had some of the same problems or to brainstorm new ideas. Most incubators require a stake in your company in exchange for their assistance— maybe as much as 50 percent—and often have quite a bit to say about how you run your business. Opinion is mixed on how much real help a company can get; just like all businesses, there are better and worse incubators, so do your homework.42

General Comments on Site Selection

How do you go about finding potential sites? Looking for “for sale” and “for rent” signs is a start, but not all space will be advertised that way. Just as a good real estate agent can warn you about the pro- posed freeway project going through the backyard of the house you are considering or let you know about houses not yet listed but likely to be, an experienced real estate broker will also be able to assist you in your search for your business location. Many have relationships with landlords that can work to your benefit. They are also likely to have at least some of the market statistics you may need to help you decide if the location is right for your business.43 Level with them about what you can spend. You have your business plan and know the cost per square foot you can afford and be profitable. If you are looking at property more expensive than that, you’ll need to cut corners elsewhere.44

Leasing

It is rare that a small business start-up buys its first location. The reason is financial. It takes a lot of money to buy a place, and beyond that a long-term commitment to pay for it. For most small busi- nesses, it is not a worthwhile risk. It makes more sense to rent or lease your facility to leave more money for other aspects of the business. But leasing is one of the most complex of the issues an entrepreneur faces when starting a business.

In reality, most landlords (especially those from big national commercial real estate and mall companies) have fairly standard contracts which they don’t like to change. These typically start out as very pro-landlord. That said, in many cases they are also likely to accept certain standard clauses that are more tenant-friendly. However, it is unlikely they will offer those. You will need to ask for them. In this section you will learn about the major types of tenant-friendly clauses you might want to seek. However, it makes tremendous sense to get a real estate lawyer involved to help you. They should be able to tell you what kinds of clauses are typical, and who else offers them in your area, and if there are any other likely traps in the lease. You can learn how to choose a lawyer in Chapter 18.

You should start the leasing process by looking for locations. You can start using the local news- paper’s or business journal’s classified ads for commercial real estate. If you know of a great loca- tion, but there is no “for rent” or “for lease” on it, consider asking the owner or current renter about subleasing a portion of the location. If your product or service complements the current tenant, you could find a home. Local real estate websites may also have listings, and there are national websites like LoopNet.com which compile listings from a variety of sources. There is a how-to video for

using LoopNet on the Online Learning Center. You may contact a real estate agent with commercial experience to help you, but make sure you know how the agent is making his or her money. You want the agent to work in your best interests.

It helps to have two or three possibilities identified before you begin negotiating leases. This is a use of the idea of the power of rivalry from Chapter 7. This gives you a basis for comparison, and an alternative for leasing when negotiating. But note that the more alike the properties, the greater your power at the negotiating table. Also, if you are opening a franchised operation, you will want to contact your franchisor before you start looking for locations. Most franchisors have specifications for locations, and advice on costs and other features. They often have a lease review department to help you with this process.45

The best way to start thinking about the clauses is to separate them into those clauses related to choosing a property, day-to-day operations, and endings. In reality, though, all of these clauses will get negotiated when you and the landlord discuss the lease agreement.

There are several issues that could pop up as you are narrowing your choices and trying to decide which location and deal is the best for you. These are:46

?          “As is” versus compliant property: If the location has problems, who should fix them? The landlord would like to have you do it, and will try to push you to accept the property “as is.” You, of course, want the landlord to fix it before you move in, so you would ask the property to be “in compliance with all applicable laws, rules, and regulations.” Realize that the landlord will get back the money paid for repairs eventually, through fees or higher rents, but it can save you money on the front end.

?          HVAC: This is the commercial jargon for “heating, ventilation, and air conditioning.” It can be the most expensive type of repair, and since it is mechanical, one of the types most likely to go wrong. The landlord wants it to be your responsibility. You want it to be the landlord’s. This is particularly important if the location has a central air system so everyone shares the same air conditioner and heating equipment. This type of equipment needs to be the landlord’s responsibility. For any type of equipment, you want the landlord to at least guarantee the first year of operation.

?          Signs: Called “signage” in the business, it can be on the street, on the building, or around the door. You probably have ideas for your signs. If you are a franchise, you face signage require- ments from the franchisor. You want a landlord who will work with you on the size, place- ment, and visibility of signs. Make sure you have written

agreement on the signs and, if possible, a clause that says approval cannot be unreasonably denied for future changes.

There are other benefits possible if you know to ask for them. Often these are called concessions. Examples include “leasehold improvements,” which are permanent changes made to the loca- tion to fit your business’s needs. You cover these by seeking a “tenant improvement allowance” or “construction allowance” which are rent dollars (typically $5 to $25 a square foot) they agree to let you put into improving your location.47 This amount should be based on a firm estimate from a construction profes- sional. Another concession is a “rent-free use period” which cov- ers the time while you prepare your location prior to opening.

As you start thinking about how you would operate day-to- day, there will be several different issues you will face. These include:

?          Hidden charges: Many leases include charges that do not have to be listed in the term sheet given you for the prop- erty. An example is a monthly operating expense. This may be justified. You may be leasing a thousand feet of space, but there are also common areas, restrooms, parking and the like that the landlord keeps up for everyone. Ask spe- cifically for a list of all expenses or charges for which you will be liable, and compare to other locations. Also make sure to learn the conditions under

which you can lose all or part of your security deposit. ?     Use of premises: You specify in the lease what you will sell or do at the leased location, but

too exact a description could prevent you from expanding the products or services you offer. Try to add the clause “and related goods and services” to any description you give to provide reasonable flexibility.

?          Noncompete: If you have a pet store in a strip mall, you’d like to be the only one there. For many types of businesses, you negotiate a clause limiting the landlord’s ability to lease to a competing business. This can be just for your facility or for a radius. You should expect to pay for the exclusivity and the farther you want it, the more it will cost. Note that competition in terms of different types of restaurants, or another store selling some of your products, is still likely.

?          Hours of operation: Mall landlords want stores open the same hours and days, and landlords of other types of properties may have some of the same desires. You need to negotiate times that fit your business model. Look for stores in the landlord’s properties that match your hours. Precedence helps here.

?          Rent default: When you are late paying rent, all sorts of penalties and problems emerge. It also hurts your credit rating. Some leases require the renter to keep track. Ask to change the lease to specify the landlord needs to alert you immediately on the rent due date in written or telephonic (usually fax) form, and get the 5–10 day default period for paying rent before default starts from that notice.

?          Moves and remodels: There may be a clause that gives the landlord the right to move your business elsewhere, at their discretion. If this is to update or repair an area, fine, but what if it is to get a higher-paying tenant in your space? Set time limits and return rights on any forced move. Similarly, if the landlord decides to remodel, you should not have to pay for it.

As an entrepreneur negotiating a lease, you need to prepare for the good and the bad as time moves along. The good is the prospect your business grows and you need more space. The bad is that your business doesn’t do well, and you need to get out of your lease before the end of the term. Dealing with these issues is like worrying about a prenuptial agreement while you are taken with the romance of getting married. It might be painful to imagine, but it is important to keeping what is yours.

If your business falters, you are obligated to continue paying your monthly rent and fees for the duration of the lease. A landlord has the power to let you out of a lease, but he or she is only likely to do this if a better tenant is lined up. Once you tell your landlord you may need to vacate the prem- ises, she or he is supposed to look for a replacement tenant, but not all do, or do a good job of it. If you can find a replacement tenant, it can help this process along, but you need to make sure there is a clause that lets you sublease the property, and further, that the landlord can’t unreasonably deny the sublease. If your pet store is closing, finding a dress shop is probably reasonable (as long as it doesn’t violate some other tenant’s noncompete clause), but finding an adult book store is probably not a reasonable replacement.

Three other ways to handle an early termination are to set up a short-term (e.g., 6 months) lease initially, ask for a bailout clause, or for a “cap” or limit on how long you need to continue paying rent. The bailout clause lets you out of the lease if sales do not meet an agreed-to level. You negotiate this with the landlord up front. To understand a cap, think about a three-year lease. If you close down after only six months, you are still obligated to pay 30 more months’ rent. With a one-year cap you are only obligated to pay 6 months’ more rent. This is like a type of insurance, and like insurance policies, you will probably have to pay a slightly higher rent from the start to cover this possibility.

Realize there can be problems you face caused by the property itself. What if you move into a mall with a major chain like Sears, Penny’s or Macy’s, or a strip mall with a major supermarket or discount store. Part of what you are paying a premium for is the traffic and reputation these anchor stores bring. What if they leave? Your location’s quality could dramatically drop. To get out of your lease under these unfortunate circumstances, you want to ask for a cotenancy clause.

Although we’ve segmented a renter’s concerns by stage of the leasing process, all of these issues need to be negotiated at the start when crafting a lease. Although landlords often start with a lease they call “standard,” nearly everything about it can be negotiated. But be fair; the space may mean a lot to you, but it is a drop in the bucket to large commercial realtors. You can learn more about negotiating in general in Chapter 18, but there are some special considerations for lease negotia- tions. Because so many aspects are potentially negotiable and areas have different norms for what are typical tenant-friendly clauses, work with a real estate lawyer of your own to help you in the negotiation and phrasing of the lease terms.

Layout

Since so much of this is particular to the type of business you are in, what you’ll read below is a general guide. Check out competitors or similar types of businesses to see what you like and don’t like, what seems to work well, and what seems to cause a lot of problems. In addition, certain categories—restaurants and retailing, for example—have numerous books from college textbooks to do-it-yourself books, like the “For Dummies” series. Try your local library or bookstore.

The layout of a potential site must be considered carefully. Is the building setup appropriate for your use? A restaurant will have different needs than a retail area or a manufacturing plant. The amount of area allocated to the “front room” (e.g., eating or retail areas) versus “back room” (storage, kitchen, warehouse, and office areas) needs to be adequate for the purpose of your business. If you are operating a restaurant or retail operation, how important is space in the front room? A coffee shop or fast-food restaurant squeezes in more customers per square foot than a gourmet restaurant. Do you need specialized areas, such as a kitchen or laboratory that are expensive to retrofit into existing buildings? Is there adequate storage area? How much dock space is appropriate for your business? A manufacturing firm usually needs more dock space and storage than a retailer or a restaurant, while a service company may need very little of either. Retail operations need display windows, while manufacturers do not. For restaurants or other services, this need varies. Is there room for expansion should the business grow? Remember: Moving can be expensive. A good strategy is to rough out the desired layout of your operation on graph paper to get a basic idea of the square footage needed and how it should look. What exactly you want may not be out there, but you’ll be able to see what’s close and what’s impos- sible to live with.

Consider the amenities that are already there. Carpeting may be appropriate for a retail area and perhaps the office or dining area of a restaurant, but not appropriate for manufacturing or cooking areas. What about the walls? What sort of ceilings and lighting is appropriate? Again, a visit to the competition will help you decide what works and what doesn’t, as well as where you want to be different.

Check the exterior, too. Is the building attractive and inviting? Are the sidewalks and landscaped areas in decent shape? Is parking adequate, well lit, and safe? Is employee parking separate from customer parking? What about handicap accessibility? The 1990 Americans with Disabilities Act (ADA) specifies that businesses (with few exceptions) must accommodate persons with disabilities. Many buildings have been brought up to code, and all new construction should meet the require- ments of this act, but keep your eyes open.

Once the building has been selected, how you lay out the interior also needs to be considered. While retailers, restaurants, offices, and manufacturers all have different layout needs and consider- ations, two facts hold true: (1) layouts need to be designed so as to eliminate unnecessary and exces- sive employee movement, and (2) the layout says something about who you are to your customers, employees, and visitors. In retailing, this last factor is called atmospherics. While the opportunities for variation are limitless, let’s consider the major types of retail and manufacturing layouts as well as what atmospherics might mean to a business.

Traditionally, manufacturing processes are laid out in one of two formats: production line layout and process layout displayed in Figure 11.2. In the production line layout, material flows in on one side of the operation and continues to the other end of the operation. Most assembly manufacturing is done this way, often with conveyors moving subassemblies from one station to another. Although a rather rigid flow, it works well for mass production and high-volume manufacturing. The second method, process layout, groups similar machines/or functions together, not unlike a typical machine shop. This format is much more appropriate for lower-volume, flexible manufacturing.

There are also two traditional layouts for retail operations, which are shown in Figure 11.3. The first one, the grid layout, has aisles running from the front of the store to the back like the typical grocery, discount, or convenience store. It’s a very efficient and organized layout although it lacks some visual impact. The second layout, the free-form layout, alleviates this problem. In this layout, the store is laid out in sections with aisles that angle or meander through the store. This is the layout more typically found in upscale department stores, clothing stores, and the like.

Atmospherics include all the ambiance items that might be considered in your business. An up- scale women’s clothing store is likely to have wider aisles, deep carpeting, soft “elevator music,” indirect lighting, and, perhaps, a lightly perfumed aroma. These are appropriate atmospherics for the target market. A shop catering to edgy teen fashions may be done in black and chrome with loud rock or alternative music and strobe or black lights. Both of these send a message about whom the store is likely to appeal to. Restaurants use atmospherics, too. Compare a family restaurant to a gourmet restaurant to an ethnic restaurant. Services and the office and public areas of manufacturing firms do this as well in their choice of colors, furniture styles, and background music.48

Build, Buy, or Lease49

Ultimately, there are three choices available to the business: build, buy, or lease. Building has the advantage of having the perfect layout in the perfect location and the street appeal of a new build- ing, but it is costly and slow. Buying something already in existence shortens the time and may be

somewhat cheaper, but any remodeling or retrofitting that needs to be done may overshadow any time or money savings. In both cases, though, business owners have an asset that they can leverage, as well as the depreciation tax advantage. They have the flexibility to make the changes they need and know what the long-term costs will be.

Leasing, which we detailed earlier in the chapter, is an option with a considerably lower initial cash outlay, and it is often the only feasible choice for new businesses. Lease expenses are deduct- ible business expenses. One of the main downsides of leasing is that you are usually limited in the renovations you can do. Another one is that leases tend to get higher with each renewal contract, and your landlord may choose not to extend a lease, forcing you to move before you are ready to do so.

The issues of location and distribution are decisions that business owners make only occasion- ally. Many businesses operate from the same location for their entire existence. Distribution deci- sions may come up more often. For example, a business started on eBay develops its own website, and then grows into a store in the city’s commercial center. Regardless of how often these decisions are made, they are central to the success of the small business, because placing a business in the right location and equipping it with the right channels of distribution are essential to finding and connecting with customers. Done right, managing the issues of location and distribution can turn an average firm into a major success.

1. According to this chapter, what are three key considerations in determining the location of your business?

2. According to this chapter, what are the typical locations for service businesses?

3. What are the advantages and disadvantages of buying, building or leasing your business’ facility?

In the ZZZZ Best case, explain the kinds of evidence that the auditors gathered and how the auditors failed. just write one or two paragraph to support

ZZZZ Best Case

On May 19, 1987, a short article in the Wall Street Journal reported that ZZZZ Best Company, Inc., of Reseda, California, had signed a contract for a $13.8 million insurance restoration project. This project was just the most recent of a series of large restoration jobs obtained by ZZZZ Best (pronounced “zee best”). Located in the San Fernando Valley of Southern California, ZZZZ Best had begun operations in the fall of 1982 as a small door-to-door carpet cleaning operation. Under the direction of Barry Minkow, the extroverted 16-year-old who founded the company and initially operated it out of his parents’ garage, ZZZZ Best experienced explosive growth in both revenues and profits during the first several years of its existence. In the three-year period from 1984 to 1987, the company’s net income surged from less than $200,000 to more than $5 million on revenues of $50 million.

When ZZZZ Best went public in 1986, Minkow and several of his close associates became multimillionaires overnight. By the late spring of 1987, the market value of Minkow’s stock in the company exceeded $100 million, while the total market value of ZZZZ Best surpassed $200 million. The youngest chief executive officer in the nation enjoyed the “good life”, which included an elegant home in an exclusive suburb of Los Angeles and a fire-engine red Ferrari. Minkow’s charm and entrepreneurial genius made him a sought-after commodity on the television talk show circuit and caused the print and visual media to tout him as an example of what America’s youth could attain if they would only apply themselves. During an appearance on The Oprah Winfrey Show in April 1987, Minkow exhorted his peers with evangelistic zeal to “Think big, be big” and encouraged them to adopt his personal motto, “The sky is the limit.”

Less than two years after appearing on Oprah, Barry Minkow began serving a 25-year sentence. Tried and convicted on 57 counts of securities fraud, Minkow had been exposed as a fast-talking con artist who swindled his closest friends and Wall Street out of millions of dollars. Federal prosecutors estimate that, at a minimum, Minkow cost investors and creditors $100 million. The company that Minkow founded was, in fact, an elaborate Ponzi scheme. The reported profits of the firm were nonexistent and the large restoration contracts, imaginary. As one journalist reported, rather than building a corporation, Minkow created a hologram of a corporation. In July 1987, just three months after the company’s stock reached a market value of $220 million, an auction of its assets netted only $62,000.

Unlike most financial frauds, the ZZZZ Best scam was perpetrated under the watchful eye of the Securities and Exchange Commission (SEC). The SEC, a large and reputable West Coast law firm that served as the company’s general counsel, a prominent Wall Street brokerage firm, and an international public accounting firm all failed to uncover Minkow’s daring scheme. Ultimately, the persistence of an indignant homemaker who had been bilked out of a few hundred dollars by ZZZZ Best resulted in Minkow being exposed as a fraud.

How a teenage flimflam artist could make a mockery of the complex regulatory structure that oversees the U.S. securities markets was the central question posed by a congressional subcommittee that investigated the ZZZZ Best debacle. That subcommittee was headed by Representative John D. Dingell, chairman of the U.S. House Committee on Energy and Commerce. Throughout the investigation, Representative Dingell and his colleagues focused on the role the company’s independent auditors played in the ZZZZ Best scandal.

The ZZZZ Best prospectus told the public that revenues and earnings from insurance restoration contracts were skyrocketing but did not reveal that the contracts were completely fictitious. Where were the independent auditors and the other that are paid to alert the public to fraud and deceit?

Like many other daring financial frauds, the ZZZZ Best scandal caused Congress to reexamine the maze of rules that regulated financial reporting and served as the foundation of the U.S. system of corporate oversight. However, Daniel Akst, a reported for The Wall Street Journal who documented the rise and fall of Barry Minkow, suggested that another ZZZZ Best was inevitable. “Changing the accounting rules and securities laws will help, but every now and then a Barry Minkow will come along, and ZZZZ Best will happen again. Such frauds are in the natural order of things, I suspect, as old and enduring as human needs.”

The Early History of ZZZZ Best Company

Barry Minkow was introduced to the carpet cleaning industry at the age of 12 by his mother, who helped make ends meet by working as a telephone solicitor for a small carpet cleaning firm. Although the great majority of companies in the carpet cleaning industry are legitimate, the nature of the business attracts a disproportionate number of shady characters. There are essentially no barriers to entry: no licensing requirements, no apprenticeships to be served, and only a minimal amount of start-up capital is needed. A 16-year-old youth with a driver’s license can easily become what industry insiders refer to as a “rug sucker,” which is exactly what Minkow did when he founded ZZZZ Best Company.

Minkow quickly learned that carpet cleaning was a difficult way to earn a livelihood. Customer complaints, ruthless competition, bad checks, and nagging vendors demanding payment complicated the young entrepreneur’s life. Within months of striking out on his own, Minkow faced the ultimate nemesis of the small business person: a shortage of working capital. Because of his age and the fact that ZZZZ Best was only marginally profitable, local banks refused to loan him money. Ever resourceful, the brassy teenager came up with his own innovative ways to finance his business: check kiting, credit card forgeries, and staging of thefts to fleece his insurance company. Minkow’s age and personal charm allowed him to escape unscathed from his early brushes with the law that resulted from his creative financing methods. The ease with which the “system” could be beaten encouraged him to exploit it on a broader scale.

Throughout his tenure with ZZZZ Best, Minkow recognized the benefits of having an extensive social network of friends and acquaintances. Many of these relationships he developed and cultivated at a Los Angeles health club. After becoming a friend of Tom Padgett, an insurance claims adjuster, Minkow devised a scheme to exploit that friendship. Minkow promised to pay Padgett $100 per week if he would simply confirm over the telephone to banks and any other interested third parties that ZZZZ Best was the recipient of occasional insurance restoration contracts. Ostensibly, Minkow had obtained these contracts to clean and do minor remodeling on properties damaged by fire, storm, or other catastrophes. Minkow convinced the gullible Padgett that the sole purpose of the confirmations was to allow ZZZZ Best to circumvent much of the bureaucratic red tape in the insurance industry.

From this modest beginning, the ZZZZ Best fraud blossomed. Initially, Minkow used the phony insurance restoration contracts to generate the paper profits and revenues he needed to convince bankers to loan him money. Minkow’s phony financial statements served their purpose, and he expanded his operations by opening several carpet cleaning outlets across San Fernando Valley. Minkow soon realized that there was no need to tie his future to the cutthroat carpet cleaning industry when he could literally dictate the size and profitability of his insurance restoration “business.” Within a short period of time, insurance restoration, rather than carpet cleaning became the major source of revenue appearing on ZZZZ Best’s income statements.

Minkow’s “the sky is the limit” philosophy drove him to be even more innovative. The charming young entrepreneur began using his bogus financial statements to entice wealthy individuals in his ever-expanding social network to invest in ZZZZ Best. Eventually, Minkow recognized that the ultimate scam would be to take his company public, a move that would allow him to tap the bank accounts of unsuspecting investors nationwide.

Going Public with ZZZZ Best

Minkow’s decision to take ZZZZ Best public meant that he could no longer completely control his firm’s financial disclosures. Registering with the SEC required auditors, investment bankers, and outside attorneys to peruse ZZZZ Best’s periodic financial statements.

ZZZZ Best was firm subjected to a full-scope independent audit for the 12 months ended April 30, 1986. George Greenspan, the sole practitioner who performed that audit, confirmed the existence of ZZZZ Best’s major insurance restoration contracts by contacting Tom Padgett. Padgett served as the principal officer of Interstate Appraisal Services, which reportedly contracted the jobs out to ZZZZ Best. By this time, Padgett was an active and willing participant in Minkow’s fraudulent schemes. Minkow established Interstate Appraisal Services and Assured Property Management for the sole purpose of generating fake insurance restoration contracts for ZZZZ Best.

In testimony before the congressional subcommittee that investigated the ZZZZ Best scandal, Greenspan insisted that he had properly audited Minkow’s company. Greenspan testified that while planning the 1986 audit he had performed various analytic procedures to identify unusual relationships with ZZZZ Best’s financial data. These procedures allegedly included comparing ZZZZ Best’s key financial ratios with industry norms. Regarding the insurance contracts, Greenspan testified that he had obtained and reviewed copies of all key documents pertaining to those jobs. However, Greenspan admitted that he had not inspected any of the insurance restoration sites.

Congressman Lent: Mr. Greenspan, I am interested in the SEC Form S-1 that ZZZZ Best Company filed with the SEC….You say in that report that you made your examination in accordance with generally accepted auditing standards and accordingly included such tests of the accounting records and other auditing procedures as we consider necessary in the circumstances….You don’t say in that statement that you made any on-site inspections.

Mr. Greenspan: It’s not required. Sometimes you do; sometimes you don’t. I was satisfied that these jobs existed and I was satisfied from at least six different sources, including payment for the job. What could you want better than that?

Congressman Lent: Your position is that you are an honest and reputable accountant.

Mr. Greenspan: Yes, sir.

Congressman Lent: You were as much a victim as some of the investors in this company?

Mr. Greenspan: I was a victim all right….I am as much aghast as anyone. And every night I sit down and say, why didn’t I detect this damned fraud.

Retention of Ernst & Whinney by ZZZZ Best

Shortly after Greenspan completed his audit of ZZZZ Best’s financial statements for fiscal 1986, which ended April 30, 1986, Minkow dismissed him and retained Ernst & Whinney to perform the following year’s audit. Apparently, ZZZZ Best’s investment banker insisted that Minkow obtained a Big Eight accounting firm to enhance the credibility of the company’s financial statements. At approximately the same time, and for the same reason, Minkow retained a high-profile Los Angeles law firm to represent ZZZZ Best as its legal counsel.

The congressional subcommittee asked Greenspan what information he provided to Ernst & Whinney regarding his former client. In particular, the subcommittee wanted to know whether Greenspan discussed the insurance restoration contacts with the new auditors.

Congressman Wyden: Mr. Greenspan, in September 1986 Ernst & Whinney came on as the new independent accountant for ZZZZ Best. What did you communicate to Ernst & Whinney with respect to the restoration contracts?

Mr. Greenspan: Nothing. I did—there was nothing because they never got in touch with me. It’s protocol for the new accountant to get in touch with the old accountant. They never got in touch with me, and its still a mystery to me.

Representatives of Ernst & Whinney later testified that they did, in fact, communicate with Greenspan prior to accepting ZZZZ Best as an audit client. However, Ernst & Whinney did not comment on the nature or content of that communication. (Greenspan was not recalled to rebut Ernst & Whinney’s testimony on this issue.)

The engagement letter was signed by Ernst & Whinney and Barry Minkow in September 1986. The engagement letter outlined four services that the audit firm intended to provide ZZZZ Best: a review of the company’s financial statements for the three-month period ending July 31, 1986; assistance in the preparation of a registration statement to be filed with the SEC; a comfort letter to be submitted to ZZZZ Best’s underwriters; and a full-scope audit for the fiscal year ending April 30, 1987. Ernst & Whinney completed the review, provided the comfort letter to ZZZZ Best’s underwriters, and apparently assisted the company in preparing the registration statement for the SEC; however, Ernst & Whinney never completed the 1987 audit. The audit firm resigned on June 2, 1987, amid growing concerns that ZZZZ Best’s financial statements were grossly misstated.

The congressional subcommittee investigating the ZZZZ Best fraud questioned Ernst & Whinney representatives at length regarding the bogus insurance restoration contracts—contracts that accounted for 90 percent of ZZZZ Best’s reported profits. Congressional testimony disclosed that Ernst & Whinney repeatedly insisted on visiting several of the largest of these contract sites, and that Minkow and his associated attempted to discourage such visits. Eventually, Minkow realized that the auditors would not relent and agreed to allow them to visit certain of the restoration sites, knowing full well that none of the sites actually existed.

To convince Ernst & Whinney that the insurance restoration contracts were authentic, Minkow plotted and carried out a series of sting operations that collectively cost millions of dollars. In the late fall of 1986, Larry Gray, the engagement audit partner for ZZZZ Best, told client personnel that he wanted to inspect a restoration site in Sacramento on which ZZZZ Best had reported obtaining a multimillion-dollar contract. Minkow sent two of his subordinates to Sacramento to find a large building under construction or renovation that would provide a plausible site for a restoration contract. Gray had visited Sacramento a few weeks earlier to search for the site that Minkow had refused to divulge. As chance would have it, the building chosen by the ZZZZ Best conspirators was the same one Gray had identified as the most likely site of the insurance restoration project.

Minkow’s two confederates posed as leasing agents of a property management firm and convinced the supervisor of the construction site to provide keys to the building one weekend on the pretext that a large, prospective tenant wished to tour the facility. Prior to the arrival of Larry Gray and an attorney representing ZZZZ Best’s law firm, Minkow’s subordinates visited the site and placed placards on the walls at conspicuous locations indicating that ZZZZ Best was the contractor for the building renovation. No details were overlooked by the two co-conspirators. They even paid the building’s security officer to greet the visitors and demonstrate that he was aware in advance of their tour of the site and its purpose. Although the building had not been damaged and instead was simply in the process of being completed, the sting operation went off as planned.

Congressional investigators quizzed Gray regarding the measures he took to confirm that ZZZZ Best had a restoration contract on the Sacramento building. They were particularly concerned that he never discovered the building had not suffered several million dollars in damages a few months earlier, as claimed by ZZZZ Best personnel.

Congressman Lent: Did you check the building permit or construction permit?

Mr. Gray: No, sir. That wouldn’t be necessary to accomplish what I was setting out to accomplish.

Congressman Lent: And you did not check with the building’s owners to see if an insurance claim had been filed?

Mr. Gray: Same answer. It wasn’t necessary. I had seen the paperwork internally of our client, the support for a great amount of detail. So, I had no need to ask—to pursue that.

Congressman Lent: You understand that what you saw was not anything that was real in any sense of the word?....You are saying you were duped, are you not?

Mr. Gray: Absolutely.

Before allowing Ernst & Whinney auditors to visit a bogus restoration project, Minkow insisted that the firm sign a standard confidentiality agreement. Members of the congressional subcommittee were troubled by the following stipulation of the confidentiality agreement: “We will not make any follow-up telephone calls to any contractors, insurance companies, the building owner, or other individuals involved in the restoration contract.” This restriction effectively precluded the auditors from corroborating the insurance restoration contracts with independent third parties.

Resignation of Ernst & Whinney

Ernst & Whinney resigned as ZZZZ Best’s auditor on June 2, 1987, following a series of disturbing events that caused the firm to question Barry Minkow’s integrity. First, Ernst & Whinney was alarmed by a Los Angeles Times article in mid-May 1987 that revealed that Minkow had been involved in a string of credit card forgeries as a teenager. Second on May 28, 1987, ZZZZ Best issued a press release, without consulting or notifying Ernst & Whinney, that reported record profits and revenues. Minkow intended this press release to restore investors’ confidence in the company—confidence that had been shaken by the damaging Los Angeles Times story. Third, and most important, on May 29, Ernst & Whinney auditors discovered evidence supporting allegations made several weeks earlier by a third-party informant that ZZZZ Best’s insurance restoration business was fictitious.

The informant had contacted Ernst & Whinney in April 1987 and asked for $25,000 in exchange for information proving that one of the firm’s clients was engaging in a massive fraud. Ernst & Whinney refused to pay the sum, and the individual recanted shortly thereafter, but not until the firm determined that the allegation involved ZZZZ Best. (Congressional testimony disclosed that the individual recanted because of a bribe paid to him by Minkow.) Despite the retraction, Ernst & Whinney questioned Minkow and ZZZZ Best’s board of directors regarding the matter. Minkow insisted that he did not know the individual who had made the allegation. On May 29, 1987, however, Ernst & Whinney auditors discovered several cancelled checks that Minkow had personally written to the informant several months earlier.

Because ZZZZ best was a public company, the resignation of its independent auditor had to be reported to the SEC in an 8-K filing. This requirement alerts investors and creditors of circumstances that may have let to the change in auditors. At the time, SEC registrants were allowed 15 days to file an 8-K auditor change announcement. After waiting the maximum permissible time, ZZZZ Best reported the change in auditors but, despite Ernst & Whinney’s insistence, made no mention in the 8-K of the fraud allegation that had been subsequently recanted.

The SEC requires a former audit firm to prepare a letter to be filed as an exhibit to its former client’s 8-K auditor change pronouncement. That exhibit letter must comment on the 8-K’s accuracy and completeness. In 1987, formed audit firms had 30 days to file an exhibit letter, which was the length of time Ernst & Whinney waited before submitting its exhibit letter to the SEC. In that letter, Ernst & Whinney revealed that ZZZZ Best’s insurance contract might be fraudulent.

The congressional subcommittee was alarmed that 45 days had passed before the charges of fraudulent misrepresentations in ZZZZ Best’s financial statements were disclosed by the public. By the time the SEC released Ernst & Whinney’s exhibit letter to the public, ZZZZ Best had filed for protection from its creditors under Chapter 11 of the federal bankruptcy code. During the period that elapsed between Ernst & Whinney’s resignation and the public release of the 8-K exhibit letter, ZZZZ Best obtained significant financing from several parties, including $1 million from one of Minkow’s close friends. These parties never recovered the funds invested in, or loaned to, ZZZZ Best. As a direct result of the ZZZZ Best debacle, the SEC shortened the length of time that registrants and their former auditors may wait before filing auditor change documents.

The congressional subcommittee also quizzed Ernst & Whinney representatives regarding the information they disclosed to Price Waterhouse, the audit firm that Minkow retained to replace Ernst & Whinney. Congressman Wyden wanted to know whether Ernst & Whinney had candidly discussed its concerns regarding Minkow’s integrity with Price Waterhouse.

Congressman Wyden: I am going to insert into the record at this point a memo entitled “Discussion with successor auditor,” written by Mr. Gray and dated June 9, 1987. Regarding a June 4 meeting, Mr. Gray, with Dan Lyle of Price Waterhouse concerning the integrity of ZZZZ Best’s management, you stated that you had no reportable disagreements and no reservations about management integrity pending the results of a board of directors investigation. Then you went on to say that you resigned because, and I quote here: “We came to a conclusion that we didn’t want to become associated with the financial statements.”   Is that correct?

Mr. Gray: That is correct.

Mr. Wyden: …Mr. Gray, you told the committee staff on May 29, 1987, that when you uncovered evidence to support allegations of fraud that you decided to pack up your workpapers and leave the ZZZZ Best audit site. How did your leaving without telling anybody except the ZZZZ Best management and board of directors the reasons for leaving help the public and investors?

A final twist to the ZZZZ Best scandal was an anonymous letter Ernst & Whinney received one week after the firm resigned as ZZZZ Best’s auditor. At that time, no one other than Ernst & Whinney and ZZZZ Best’s officers was aware of the firm’s resignation. The letter contained several allegations suggesting that ZZZZ Best’s financial statements were fraudulent. According to the congressional testimony, Ernst & Whinney forwarded this letter to the SEC on June 17, 1987.

Collapse of ZZZZ Best

The Los Angeles Times article published in mid-May 1987 that disparaged Barry Minkow ultimately doomed the young entrepreneur and his company. Several years earlier, a homemaker had fallen victim to Minkow’s credit card forgeries. Minkow had added a fraudulent charge to a credit card slip the woman had used to make a payment on her account. Despite her persistence, Minkow avoided repaying the small amount. The woman never forgot the insult and tracked down, and kept a record of, individuals who had been similarly harmed by Minkow. At the urging of this woman, a reporter for the Los Angeles Times investigated her allegations. The woman’s diary became the basis for the Los Angeles Times article that, for the first time, cast doubt on the integrity of the “boy wonder” that was the talk of Wall Street.

The newspaper article triggered a chain of events that caused ZZZZ Best to collapse and disappear less than three months later. First, a small brokerage firm specializing in newly registered companies with suspicious earnings histories began short-selling ZZZZ Best stock, forcing the stock’s price into a tailspin. Second, Ernst & Whinney, ZZZZ Best’s law firm, and ZZZZ Best’s investment banker began giving more credence to the allegations and rumors of financial wrongdoing by Minkow and his associates. Third, and most important, the article panicked Minkow and compelled him to make several daring moves that cost him even more credibility. The most critical mistake was his issuance of the May 28, 1987, press release that boldly reported record profits and revenues for his firm.

EPILOGUE

Among the parties most vilified for their role in the ZZZZ Best scandal was Ernst & Whinney. The transcripts of the congressional testimony focusing on the ZZZZ Best fraud included a list of 10 “red flags” that the audit firm had allegedly overlooked while examining ZZZZ Best’s financial statements. Ernst & Whinney officials flatly rejected assertions that their firm was even partially to blame for the ZZZZ Best fiasco. In his congressional testimony, Leroy Gardner, the West Coast director of accounting and auditing for Ernst & Whinney, maintained that when all of the facts were revealed, his firm would be totally vindicated:

The ZZZZ Best situation proves at least one thing: a well-orchestrated fraud will often succeed even against careful, honest, hard-working people…The facts that have begun to emerge establish that Minkow, along with confederates both inside and outside ZZZZ Best went to extraordinary lengths to deceive Ernst & Whinney. For example, Thomas Padgett, an alleged conspirator, revealed in a recent televised interview that Minkow spent $4 million to deceive Ernst & Whinney during a visit to one of ZZZZ Best’s job sites….Ernst & Whinney never misled investors about the reliability of ZZZZ Best’s financial statements. Ernst & Whinney never even issued an audit opinion for ZZZZ Best….We are not part of the problem in this case. We were part of the solution.

In one of the largest civil suits stemming from the ZZZZ Best fraud, a court ruled that Ernst & Whinney was not liable to a large California bank that had extended ZZZZ Best a multimillion-dollar loan in 1986. The bank alleged that in granting the loan, it had relied upon the review report issued by Ernst & Whinney on ZZZZ Best’s financial statements for the three-month period ending July 31, 1986. However, an appellate judge ruled that the bank was not justified in relying on the review report since Ernst & Whinney had expressly stated in the report that it was not issuing an opinion on the ZZZZ Best financial statements. “Ernst, because it issued only a review report, specifically declined to express an opinion on ZZZZ Best’s financial statements. The report expressly disclaimed any right to rely on its content.”

In the late 1980s, ZZZZ Best’s former stock-holders filed a class-action lawsuit against Ernst & Whinney, ZZZZ Best’s former law firm, and ZZZZ Best’s former investment banker. An Internet publication reported in March 1996 that this lawsuit had been settled privately. The defendants reportedly paid the former ZZZZ Best stockholders $35 million. However the contribution of each defendant to the settlement pool was not disclosed.

Barry Minkow was released from prison in late 1994. Minkow secured the reduction in his 25-year prison sentence for “good behavior and efforts to improve himself.” These efforts included earning by correspondence bachelor’s and master’s degrees in religion from Liberty University. Shortly after being paroled, Minkow married a young woman introduced to him by a fellow inmate. That inmate was a former subordinate of Charles Keating, the principal architect of the massive Lincoln Savings and Loan fraud.

In early 1995, Minkow began serving as the associate pastor of an evangelical church in a community near his hometown of Reseda. Two years later, Minkow was appointed the senior pastor of a large nondenominational church in San Diego. Besides his pastoral duties, Minkow serves as the spokesperson for an Internet company, the Fraud Discovery Institute, which markets various fraud prevention and detection services.

Minkow regularly presents lectures and seminars across the United States that focus on his “experience” with corporate fraud. He has spoken to groups of CPAs, educational institutions, and, most notably, the FBI Academy at Quantico, Virginia. Minkow, who typically delivers his lectures while dressed in an orange prison jumpsuit, often chastises he accountants and auditors in his audience. During one presentation, Minkow noted that, “CPAs are creatures of habit. You’re interested in making tick marks and footnotes, not in thinking outside the box.” Minkow also chides auditors for being overly willing to accept weak forms of audit evidence, such as client representations. He warns auditors “Don’t give up objectivity for convenience.”

Journalists frequently interview Minkow and ask for his views on corporate fraud and related issues. In January 2005, Minkow gave the following response when he was asked by CFO Magazine whether the Sarbanes-Oxley Act of 2002 would likely serve to mitigate or deter corporate fraud: “Let me tell you why this legislation is brilliant. Sarbox hit a common denominator of corporate fraud: bypassing systems of internal control. I would not have been able to perpetrate the ZZZZ Best fraud if I had not been able to bypass the internal controls.”

Ten Red Flags that ZZZZ Best’s Auditors Allegedly Overlooked.

1. The amounts called for by the insurance restoration contracts were unrealistically large.

2. The number of multimillion dollar insurance restoration contracts reportedly obtained by ZZZZ Best exceeded the number available nationwide during the relevant time period.

3. The purported contracts failed to identify the insured parties, the insurance companies, or the locations of the jobs.

4. The contracts consisted of a single page which failed to contain details and specifications of the work to be done, such as the square yardage of carpet to be replaced, which were usual and customary in the restoration business.

5. Virtually all of the insurance restoration contracts were with the same party.

6. A large proportion of the ZZZZ Best insurance restoration contracts occurred immediately and opportunistically, prior to a planned offering of stock.

7. The purported contracts provided for payments to ZZZZ Best or Minkow alone rather than to the insured or jointly with ZZZZ Best and the insured, contrary to the practice of the industry.

8. The purported contracts provided for payments by the insurance adjustor contrary to normal practice in the industry under which payments are customarily made by the insurance company directly to its insured or jointly to its insured and the restorer.

9. ZZZZ Best’s purported gross profit margins for its restoration business were greatly in excess of the normal profit margin for the restoration industry.

10. The internal controls at ZZZZ Best were grossly inadequate.

.

Descriptive information and graphical displays of the top three reasons coming to the university (use Statcrunch)

[GO to Stat, Tables, Frequency, Select columns (use SHIFT Key to choose the block of variables).

Select Statistics: Choose all five (use Ctrl key), Compute]. You see the output. Look for the top three reasons to report in (a).

Use table to summarize the frequency of ‘reasons’ for choosing the university. What are the top three reasons:

      [1: Yes, and 0: No]

For the top reason you found in (a), fill the follow table to find out the frequency and % of males and females students chose this top reason:

[GO to Stat, Tables, Frequency, select the Top Reason Column, Group by ‘Gender’, Compute]. Report your results in (b)

Draw a Bar Graph for the Reason ‘Right_Distance’ for Female and Male, separately, but, on the same graph. Copy and Paste the graph here.

[Graph, Bar Plot, With Data, Select Column ‘Right Distance’, Group by ‘Gender’ , Grouping options: Split bars’, Type: Relative Frequency’, Check Display Value above bar, Check ‘Use Same Y-axis’, Compute]. On the resulting plot, left-upper corner, click on options to ‘Copy’ the graph. Ctrl+Alt+V, choose ‘Device Independent Bitmap, Ok.]

How many % of females choose ‘Right_Distance (‘Yes’ (=1) ) as their reason: _________________

How many % of males chooses ’Right_distance’ as their reason: _______________

Draw a Pie graph for the ‘Grade’ variable to see the % of students in each grade level.

Copy and paste the graph here.

[Graph, Pie Chart, With data, Select Gender, Display both Count and Percent of Total, Compute]. Copy and paste the chart below.]

What is the % of Senior students in this data? ____________________

Prior to answer the remaining questions, check if there are unusual distance data by conducting a Dot Plot of the variable ‘Miles’.

You should notice there are some cases with distance over 3000 miles. It is clear they are international students.

Let’s copy and paste the ‘Miles’ into a new column and delete the Miles over ‘1000’ miles. The new variable is named as ‘Miles_1’.

[Use StatCrunch to create Miles_1: Go to Edit, Columns, Duplicate, Select column: Miles, Compute. On the data sheet (move the cursor to the most right column: DUP(Miles), Change the name to Miles_1, Go through the data values of Miles_1 variable to delete the Miles_1 > 1000. (Note: after the clean up, the maximum is 996).]

Construct a histogram of the variable Miles_1 for male and female, separately, on the same graph in different panels and paste them here.

[Go to Graph, Histogram, Select column Miles_1, Group by ‘Gender’, Choose the Type: Relative Frequency, Check ‘Value above bar’, For multiple graph: Columns per page: 2, check ‘Use same Y-axis’. Compute]. To copy and paste the graph: Click on ‘Options’, Copy, Right-click , Copy Image. Move cursor to your Word File: Ctrl+Alt+V , Choose Device Independent Bitmap, OK to paste the image.

Compare the shapes of the distributions for the Miles_1 between Female and Male students:

Which one is more skewed (Female or Male distribution): ________________

(c ) Which distribution (Male or Female) of Miles_1 shows larger variation: _________________

Please answer the following Case analysis questions

1-What has New Balance’s management done to implement and execute the strategy? What policies, practices, support systems, and management approaches underlie New Balance’s strategy execution efforts?

2-To what extent has the New Balance Executional Excellence initiative impacted the firm’s performance?

3-What are the chief elements and characteristics of New Balance’s culture? What mechanisms does New Balance use to nurture and reinforce this culture? In what way, if at all, does the company’s private ownership impact the company’s culture?

New Balance Athletic Shoe Inc

On a pleasant August evening in 2005, Jim and Anne Davis enjoyed what was meant to be a relaxing dinner at home. As they fin­ished their meal , however, they could not help but turn their attention to a headl ine in that morning's Boston Globe, a copy of which sat on their kitchen ta ble: "Adid as to buy Reebok."For over 30 years, the Davises had been the sole owners of New Balance Athletic Shoe Inc., one of the top five producers of athletic footwea r in the world. Given their experi­ ence i n the industry, they had suspected for some time that an Ad idas-Reebok transaction might be in the works. Neverthe less, the formal announcement caused them to wonder about the implications of this deal for New Balance. By bringing together Adidas and Reebok-the second- and third-largest  produc­ ers of athletic footwear, respectively-this transac­ tion would create ajuggernaut that would rival Nike, the largest competitor in the industry. Although the Davises did not have to answer to Wall Street con­ cerning their competitive plans,they knew that many in the industry-including their own  employees­ would soon be asking for their response. Lately, the Davises had focused significant atten­ tion on an initiat ive cal led New Balance Executional Excellence (N B2E), the goal of which was to in­ crease the quality and efficiency of the company's operational processes through the application oflean manufacturing. Started less than one year earlier,

NB2E already had provided evidence of early im­ provement, and the Davises did not want to lose the growing enthusiasm for this initiative among New Balance 's 2,600 associates. Further,they realized the importance of staying true to the private company's uniq ue operating philosophy, strategy, culture, and history.Nonetheless, they could not help but wonder whether New Balance's priorities needed to be ad­ justed in light of the shi fting competiti ve landscape.

THE U.S. ATHLETIC SHOE INDUSTRY'

The United States was the world's largest mari<et for athletic shoes and apparel, accounting for roughly 50 percent of the $32 billion spent globally each year. Between 2004 and 2009, the number of pairs of ath­ letic footwear sold in the United States was expected to grow ata 6.3 percent annual growth rate (8.4 percent growth among women who accounted for 58 percent of all pairs purchased), reaching 530 million pairs in 2009. Industry trade group Sporting Goods Intelligence projected that the $9 bi llion branded-shoe market in the United States would grow by 8 percent in 2005. Growth was slowing in part because of a maturation in consumer interest in sports and fitness activities.

ln recent years, manufacturers moved to com­ bine fashion and comfort to appeal to a broader range of consumers, namely those who wore athletic shoes for casual purposes. Concurrently, a combi­ nation of technological developments and style im­ provements in athletic footwear helped drive growth. While leather continued to be the most popular ma­ terial for athletic footwear uppers, some firms, such as Adidas-Salomon (Adidas), had developed shoes with so-called "smart textiles" and microchips that adjusted fit based on the wearer's activity, height, weight, and running terrain. Nike maintained a comfortable lead ahead of its competitors with 43 percent of the total global market for athletic shoes and apparel (see Exhibit I for sales and financial data for leading firms in the industry). Within the U.S. footwear market, Nike accounted for 36 percent of the market, while Adidas, Reebok and New Balance held on to a variable 8-12 percent each (Exhibit 2). Appendix A provides a brief description of each of the top competitors in the industry. The acquisition of Reebok by Adidas would cre­ ate a firm that rivaled Nike in terms of size and would boost Adidas 's share to roughly 20 percent of the U.S. footwear market. Though the Adidas-Reebok transaction was notable for its size, it reflected a broader recent trend of consolidation in the ath­ letic footwear industry. In July 2003, Nike acquired Converse, a Massachusetts based manufacturer of court and casual shoes, for $305 million. In June 2005, Stride Rite-the maker of casual footwear brands Keds and Sperry Top Sider-announced its intention to acquire Saucony, a $I 70 million manu­ facturer of specialty running shoes and apparel based in Peabody, Massachusetts. With respect to worldwide marketing, Nike out­ spent its rivals, spending $213 mi Ilion in measured media in 2004, compared to Adidas' $89 mill ion and Reebok 's $42 million.2 For the first JO months of 2005, for example, New Balance total advertising expenditure was $17.3 million.3 For all companies , a large portion of worldwide media expenditure was geared toward the marketing of footwear brands in the United States (Exhibit 2).

In addition to spending more on marketing than New Balance, most of its competitors produced their shoes outside of the United States, largely because the manufacturing of athletic footwear was highly l.abor intensive and required relatively low levels of worker skill. As a result,China had become the larg­ est manufacturer of athletic footwear for the U.S. market, commanding 85 percent of the category.4 The U.S. trade deficit in shoes was expected to con­ tinue to deepen, as more manufacturers shifted pro­ duction offshore. The deficit had increased about 7 percent per year since 1999, reaching 379 million pairs in 2004. Overall,Americans purchased 2.2 bil­ lion pairs of shoes and boots in 2004, enough to give each man, woman and child there 7.7 new footwear options that year.5

Distribution Channels

In 2005, the American sneaker market was divided i.nto several discrete retai I channels catering to pe­ riodically overlapping demographics that defined themselves by distinctive tastes, buying patterns, and price elasticity. Foremost among these were the "big box" chains such as Wal-Mart, Target, and Sears which together sold an estimated $12 billion in ath- 1.etic apparel and equipment per year.6 The second­ Largest group by sales volume included national sellers such as Foot Locker, The Sports Authority, Finish Line, and The Athlete's Foot. Next were smaller urban chains that maintained strong ties to tastemakers and arbiters of fashion. These chains typically either sold brands at heavy discounts to younger consumers or catered to high-end custom­ ers with very specific needs (e.g., high-performance running). The leading sneaker manufacturers, such as Nike and Adidas, also maintained showcase stores that featured new products in lavish displays accom­ panied by TV screens and music.These branded out­ lets were less retail stores than museums to the sneak­ ers of tomorrow and the "classics" made legendary by the likes of Pele, Chuck Taylor, and Michael Jordan.

With 4,000 stores around the world, Foot Locker was widely recognized as the world's leading retailer of athletic shoes and apparel. Foot Locker contribut­ ed slightly less than I0 percent to Nike's annual sales, but Nike products represented as much as 50 percent of sales for Foot Locker. The Sports Authority had 400 U.S. stores, but maintained a broader product base, selling workout equipment, basketball gear, sneakers and sports apparel. Finally, with 598 stores in the United States, Finish Line, originally started in the early 1980s as a discounter whose primary business was in "closeout" sales, prided itself in of­ fering prices that were typically $5 less than other retailers. Although beholden to the vagaries of fashion and manufacturers' ability to design hit products that would drive traffic into their stores, larger re­ tailers held a great deal of sway over the fortunes of the sneaker companies. For example, even though Converse sneakers were sold through many retail and on-line outlets nationwide, Foot Locker accounted for roughly 20 percent of all Converse sales. Any decision by Foot Locker about Converse's product placement thus could have a material impact on the brand's sales. In another case, a 2003 dispute over promotional practices for Nike shoes caused a costly one-year rift between the manufacturer and Foot Locker.

THE MAKING OF NEW BALANCE

New Balance was founded in Boston in 1906 as New Balance Arch 7 by William J. Riley, a 33-year-old British emigre who committed himself to helping people with problem feet by making arch supports and prescription  footwear  to improve shoe  fit. In I 934, Riley went into partnership with his leading salesman, Arthur Hall. In 1954, Arthur Hall sold the business to his daughter and son-in-law, Eleanor and Paul Kidd. Arch supports and prescription fool:\vear remained the cornerstone of the business until 1961, when they manufactured the Trackster, the world 's first performance running shoe made with a ripple sole and available in multiple widths.

Du.ring the 1960s, New Balance's reputation for manufactu.ring innovative performance footwear available in multiple widths grew through word of mouth and grassroots promotions. When Jim Davis bought the specialized shoe man ufacturer from the Kidds on the day of the Boston Marathon in I 972, he committed himself to  uphold the  company's founding va lues of fit, performance , and manufac­ turing . He recalled: I wanted to buy a company, I wa  young and single. I didn't have anything. so I had nothing to lose. [ looked at it a year before I bought ii.Al the time, I was in electronics. 1 pa. ed. because l knew noth­ ing about footwear and not much about spotting goods.other than what I knew from doing spotts in college. I got a pair of the hoes.statted running in them,and peoplewould come up lo me and comment that I must be a good runner. Unable to put a deal together in elect1-onics.with the company still avail­ able. I went back,and t he guy was desperate losell it. We paid $100,000 for the company; we put $10,000 down, and the rest of the $90,000 was generated from lowering im•ento1y.

At the time N ew Balance was primarily a mail­ order business with only a handful of U.S. retail­ ers. Jim Davis started traveling around the country to expand reta il distribution , and sales grew from $ I 00,000 to around $300,000 over a two-year pe­ riod. Anne, who wou l d marry Jim in 1984, joined New Balance in 1978 and focused on bui lding a dis­ tinct culture for New Balance associates and those who would do business with the company around the globe. Indeed, N ew Ba l ance's first international sales office and first European manufacturing facility both opened in 1978 in Europe. Since then the brand had expanded from Europe and Asia to the Middle East, Latin America, and Africa.

In the early 1980s New Balance set up new manufacturing facilities in New England and signed on international distributors. In 1982, the company reached the $60 million mark and debuted the well­ received 990 running shoe, the first athletic shoe priced at $ 100.1 Jn the 1990s, the company unveiled its New Balance Suspension System to telegraph its emphasis on cutting-edge R&D and its dedication to meeting the needs of performance-oriented runners. The company 's commitment to multiple sneaker widths remained a sell ing point that was reflected in the brand 's iconic marketing logo of three differently sized feet.9 Being Different Herb Spivak, executive vice president of opera­ tions and a 12-year veteran of the company, provid­ ed a picture of New Balance's un ique features. He observed: Ow·values have been very, very con istent and re­ inforced continuously by J im and Anne Davis. We do not endorse athletes, as an example. We aim to make every one of ow·shoes a pc1fo1mance product as opposed lojusl a fashion product. We sell eve1y shoe that we make in multiple width . because we believe that fit is a critical pe1fo 1mance charac1e1is­ tic. We maintain a great percentage of our product in inventory for replenishment. so that dealers can con­ tinually get fill-ins when they sell and when they need ce1tain sizes and widths. In con1ra 1. competitors pretty much tell retailers. "OK. tell us six months in advance what you 're going lo want lo buy and we'll deliver it. But it's fixed. and we don't plan on having future invenlo1y.'·These basic factors, combined with the maintainin g of our domestic factories all come together to describe what makes us unique.

Because the company had remained private,Jim Davis felt that he and his colleagues could act more nimbly and be more socially responsible than their more well-heeled competitors. "I f we were a pu b­ lic company, I am sure the shareholders would say, cclose your factories and make the product abroad because you will make more dough for me and my quarterly dividend,"' Davis told the Boston Globe in 2004.'0 Davis also felt that the company had prod­ ucts capable of providi ng sol id margin s needed to generate the cash flow required  to finance growth. As such, the company's balance  sheet  remained very strong with a seven-to-one ratio of assets to Liabilities.

Beyond financial flexibility, other aspects of the company's operations and strategy suggested that it was somehow different from competitors. President and Chief Operating Officer Jim Tompkins noted: One thing that sets us aprui and that is we a1-e manu­ factun:rs. But "e at'C mediocre marketers by design. Our marketing spend as a percent of net revenue is much lower than our competitors.The message that we talk about in the marketplace i different from our competitors' message. And that's what makes the company unique-ii is that we are manufacturing­ and operations-based. not marketing-based.

Jim Davis emphasized this distinction: In the early lo mid- l 980s. Nikeand Reebok wem both becoming major players. and eve1ybody said, "You ought to really do this because Nike and Reebok are doing it." Well , we tried a cou ple limes with product and programsand whatever, and we failed. drastically. So then l woke up one moming and I said, "We're not any good at that. We're really good at this ." So we concentrated on doing this instead of that, and thus differentiated ow-selves. Culture Similar to its unique business model, New Balance's corporate culture developed over time. Teamwork was a critical component. "When you 're young and starting up," Jim Davis recalled, "you don't really think in terms of a culture. You just sort of do things a certain way. One day we realized that we're very team-oriented, and that we empower people. When we got to a certain size and maturity, we realized that that's basically what we were all about."Further, New Balance developed a long-standing commitment to social responsibility that, according to Anne Davis, "made people feel good about deal ing with the com­ pany." For example, after the 2004 Asian Tsunami, New Balance declared that it would match whatever its associates donated. Then retailers wanted to par­ ticipate, so New Balance decided to match their con­ tributions for a total contribution of $1 million. The company also promised to donate another $1 million if 100 pen;ent participation was reached among as­ sociates. In the end, every person in the organization contributed something.

The company's culture was also very entrepre­neurial, starting with the owners' willingness to take risks and encourage others to do the same. Anne em­ phasized that this culture of change and challenge extended to the factory, noting thatmatmfacturing em­ ployees, mostly organized in cross-functional teams, represented one of the greatest forces for change in the company.This spirit was also reflected across New Balance's senior managers. Chief Financial Officer John Withee observed, "Continuous improvement is a mantra here. Do the best you can, work cross­ functionally, and work towards a common goal." As an example of a major risk taken relatively early on by the company, Jim Davis pointed to the introduction of the 990 series running shoe in the 1980s, the first $I 00 shoe at a time when athletic shoes were retai ling for about $50. "People said we were nuts;' Jim mused, "but we couldn 't make them fast enough. People learned from that and be­ came more confident in pushing the envelope."As of 2005, the 990 series still represented the top-selling product for New Balance, accounting for roughly 3.5 percent of the company's sales.

Endorsed by No One

In an industry dominated by endorsement deals and large print and TV campaigns featuring celebrity ath­ letes, New Balance put its energies and investment into research, design, and domestic manufacturing, and let the resulting products speak for themselves. New Balance felt it could eschew celebrity endorse­ ments and position itself as a brand for performance­ oriented runners less swayed  by  fashion  trends and popular personalities. New Balance extended its product-focused strategy to its branding efforts in 1992 with its "Endorsed by No One" campaign despite holding only 3 percent of the U.S. market for athletic shoes at the time."

New Balance introduced edgier iterations of the campaign that culminated with an anti-endorsement ad message that actually chided professional athletes for losing sight of the game and focusing dispropor­ tionately on endorsement deals. With slightly older core customers (between 25 and 49), New Balance concluded it could afford to take this irreverent tone in commercials. The "For Love or Money" campaign was unveiled in February 2005.12 The slogan felt "nat­ural to us because it was something that only New Balance can stand in front of;' said Paul Heffernan, executive vice president of global marketing. "Jt's all about everyday athletes playing for the love of the game."13 By contrast, Reebok introduced a new ad campaign of its own that same month featuring bas­ ketball icon Yao Ming, Olympic gold medalist Kelly Holmes, actress Lucy Liu, and tennis player Andy Roddick, with the tagline "I Am What I Am.'*

The New Balance campaign featured a you ng basketball player admonishing "some of the pros out there," for their swagger and potentially un­ sportsmanlike conduct on and off the court that had become accepted behavior in some quarters. Most notably, a game-ending brawl during a Detroit Pistons game in Auburn Hills, Michigan, on November 19, 2004, that erupted after Indiana Pacers' forward Ron Artest leapt into the stands to retaliate against a spectator who had lobbed a cup of beer at players from the stands. The New Balance campaign took a direct approach with an unassailable jibe: "Is fight­ ing in sports everjustified?" In addition to 30-second TV spots, the campaign included print, billboard, and onl ine ads that posed a series of questions about athletes'-and by exten­ sion, their fans'--core values: "Can a losing coach still be a good coach?" and "Which teaches a player more, winning or losing?"Yet another New Balance ad from the same series was even more direct and confrontational: "Just in case you forgot, this is what a pass looks like. . . . This is what a Aoor burn looks like." New Balance was reportedly planning to spend $21 million on its 2006 advertising campaign, which was close to its entire promotional budget for the year.16

PRODUCT DESIGN

According to Paul Heffernan, New Balance's focus on width sizing and fit had  historically  dictated the design of many of the company's products. He explained: A 15-year-old who wants a pair of Nike Air Jordans might curl his toes or put on six pairs of socks to make that shoe fit. tn that case, purchases are made based on how a shoe looks rathe1·whether it really fits well. The market that is interested in width sizing and fit is a little bit older and more mat u.re; those custom­ ers demand a product that is a bit more conservative in its presentation and style.They tend to like a prod­ uct and buy it again and again and again. It 's Like a white button-down shirt. I own a white button-down, it wears out, I buy another white button-down.

New Balance had approximately 60 people in product design and development who were involved with efforts on two fronts. One was incremental de­ velopment of existing models. The second involved the incorporation of new technologies such as Absorb EX-a premium, visible-cushioning techno logy­ and Zip, a patented responsive-cushioning technol­ ogy scheduled to debut in 2006. Both technologies were oriented toward a younger customer base.

Despite New Balance's desire for long-lived products, Heffernan knew that the company had to remain capable of delivering prod ucts to the shorter­ cycle, fashion-oriented segments of the market. He noted:The 991 series-our franchise shoe of 25 years­ stays in line three years. With t hree ye;us to update that shoe, we can afford lo lake our time and be more thoughtful. But the more fashion-oriented products often need to chw·n every 60 to 90 days. which cre­ ates a completely different model for prod uct design. The fashion segment cares !es about widths and more about time to market, so we need to work under tighter timelines for these product .

Jim Davis felt that in the past five or six years, New Balance had "dropped the ball in a few places, and design is one of them." He added:

Right now. we are emphasizing design more tha n we have in the past and are raising the level and tature of design within the organization. Design is going to become more impo1tant as time goes on. a much larger foclor than it has been. We tend to be a little bit more conservative with design than our competition and stay within a ce1tain real.m for a relatively long pe1iod oftime. Then we find that we might have hit a wall. o we have to come back and reinvent ourselves a little bit and move forward. The manufact uring folks do that every day. The rest of the company is so11 of playing catch-up there, and we have to re­ invent ou1-i;e lves a little bit more often than we have in the past.

SALES AND DISTRIBUTION

New Balance had focused more on smaller retailers, running specialty shops, and family footwear shops. John Withee explained, "We are heavi ly focused on supporting the smaller type of service-oriented cus­ tomer." New Balance sold its products through ap· proximately 3,500 retailers representing over 12,000 sites, commonly referred to as "doors." Its largest retai I customer was Foot Locker, a major chain that, on its own, accounted for over 3,000 doors in the United States. New Balance divided its retai lers into two groups-key accounts and specialty dealers (see Exhibit 3). Key accounts were further divided into six strategic accounts and 49 other key accounts. Specialty retai lers were subdivided into three major channels: elite ru nning stores (i.e., specia lty stores for serious runners); independently owned and op­ erated New Balance stores; and other independent dealers, which were primarily family shoe stores.

Fran Allen, executive vice president for sales and service, noted that strong relationships with both small and large retailers were critica l for New Balance. "The importanc.e of independent, specia lty retai lers to the image of our brand far exceeds their 25 percent share of our sales volume. Obviously, large accounts are  extremely  important  in  terms of their sales volume. Consequently, we give both groups a lot of attention and work hard to give each what they need to be successful."

In contrast to competitors, New Balance relied on a sales force that was composed of independent agents. Allen noted, "In the sporting goods industr there is an unwritten rule-or maybe it isjust natural selection-that as you get to a certain point in sales volume, you grow out of an independent sales force. You bring the sales organization in house. At New Balance, we do not have any in-house accounts. We prefer using independent, dedicated sales agencies with an entrepreneurial mindset." Indeed, all the company's sales agents were independent of-but exclusive tNew Balance. These sales agencies were compensated through a sales-based commission. Under this system, new salespeople might earn $40,000 to $50,000 per year (from which they would cover their own expenses) whi le the most experienced salespeople could make several hundred thousand per year. Large retail ac­ counts were managed by a total of 10 head sales agents, 6 of whom were strategic account managers (SAMs). Specialty accounts were managed by ap­ proximately 100 agents, who worked for independ­ ent sales agencies, but were managed by five regional managers employed by New Balance (see Exhibit 4). New Balance was investing in a sales force automa­ tion system to increase the agents' productivity.

Despite the fact that these agents were not direct employees of New Balance, Allen-who had been with New Balance 15 years as sales manager-not­ ed that the company was not concerned about these relationships that were u nique to the industry. "We have a loyal group of salespeople, and their longev­ ity of service provides us with a distinct edge over our competitors," he explained, attributing this loy­ alty to the strength of New Balance 's leadership and culture. He added: In 1991, my first year at New Balance, the company sold $84 million in footwear in the United States; last year, we did a little over $1 billion. One of the reasons Jim Davis liked this sales organ'ization was that he had head sales agents who had been with him for 15 or 20 years before [ got here and had gone through some difficult times and stuck with the company.

For smaller, privately owned retailers, New Balance had historically paid an independent sales representative to take product orders and either key them into the New Balance order system or fax them to New Balance's corporate sales office at company headquarters in Allston, Massachusetts. To speed the ordering process, the company had recently invested in what Chief Financial Officer John Withee termed a "state-of-the-art" ilistribution center and was us­ ing technology to leverage this resource, support its retailers, and strengthen its retail relationships. In terms of information technology, a new sales force automation system enabled sales representatives to place direct orders remotely, access New Balance's inventory information, and check on delivery sta­ tus business-to-business (B2B). A B2B application promised to enable retailers-particularly smaller retailers-to do the same without intervention by the sales representative. Withee added, "This appli­ cation helps manage the flow of product through the supply chain and is about as vital as you can get in determining our performance."

Going forward, Withee explained, the B2B ap­ plication would help reta.ilers directly manage basic ordering, thereby freeing up the sales representative to engage with the retailer and make recommenda­ tions about new items to carry or options for reduc­ ing inventory levels. Concerning retailers, Jim Davis explained: If you've been selling New Balance shoes for  the last I 0 years, to sell 1,000 pairs you  had  400 pairs in inventory. Assuming you are selling all domestic product, which some of our accounts do, we would say: "We think we can increase your sales next year and lower your invento1y at ihe same time. We will ship to you the  day after you order the product, so yom inventoties can be decreased dramatically. Rather than canying 400 pairs, you can cru..-y 200 pairs, and sell maybe 1,200 pairs instead of 1 ,000.And your mru·kdowns ru·e negligible, because your inven­ tory's so low:' And we think ihat's a very compelHng argument. We ru·e taking all the risk when we do that.

By shipping quickly and accurately, New Bal­ ance offered retailers the ability to build loyal cus­ tomers of their own. Indeed, according to Jim Davis, New Balance had far the greater consumer loyalty than any of its competitors. "That translates well for the retailer, especially if that retailer's able to satisfy the customer with that 13EEEE, because that cus­ tomer always wants that 13EEEE. He or she will generally go back to that same retailer to get that product.. And retailers lmow that!'

SUPPLY CHAIN AND  MANUFACTURING

Jn contrast  to  Nike and  Reebok, who outsourced nearly all  of  their  production  to As.ian manufac­ turers, New Balance used  outsourcers  for only 75 percent of its U.S. volume. For the remaining 25 per­ cent,final product assembly took place in one of New Balance's five factories in  the Northeastern United States. One-third of these domestically  assembled shoes were  referred  to  as "cut through assembly" product. For these shoes, New Balance would import finished soles and the raw materials for the upper from Asian suppliers. The uppers would then be ful­ ly manufactured and attached to soles in the United States. The remaining two-thirds of New Balance's domestic product was referred to as "sourced up­ per." For sourced-upper shoes, New Balance would import finished  uppers  and  soles  from  Asia and would complete the assembly by attaching the appro­ priately sized uppers and soles at its U.S. factories. The more time-intensive cut-through-assembly prod­ uct was manufactured at New Balance's factories in Lawrence, Massachusetts; Skowhegan , Maine; and Norridgewock , Maine. Sourced-upper shoes were as­ sembled at these three sites,as well as another factory in Norway, Maine.17 Exhibit 5 provides an overview of the manufacturing network and supply chain.

Foreign Suppliers

New Balance sourced the soles for most of its shoes from two suppliers in China (suppliers A and B in Exhibit 5). Depending on the shoe, these two firms also supplied either finished uppers or kits contain­ ing a significant portion of the materials required to stitch uppers in the United States.18 Finally, these firms provided a limited amount of fully assembled shoes. These firms shipped to New Balance's three materials warehouses , two in Skowhegan, Maine, and one in Lawrence, Massachusetts.

Historically, it would take approximately one week for New Balance to place a purchase order for components (e.g., soles, uppers, or kits) and have it accepted by the appropriate supplier in China. It would then take roughly six weeks for the supplier to manufacture the required components and an ad­ ditional five weeks to ship them by boat across the Pacific and transfer them to cross-country transport for delivery to the designated warehouse. Until the early 2000s, New Balance tended to place orders for a particular sole on a monthly basis in batches as large as 20,000 pairs. For a single type of sole, each order would include roughly 20 different SKUs, re­ flecting different shoes' lengths and widths such as 90, J OY,E, and 12EEE.

John Wilson, vice president for manufacturing, noted that the company had taken several steps in recent years to reduce the lead times from Asian suppliers. First, New Balance had shifted to placing smaller orders of between 2,000 and 10,000 pairs on a weekly basis. Jn addition, New Balance made ar­ rangements with these suppl iers to enable them to "pre-buy" their own raw materials on behalf of the company, thereby reducing the lead time required to produce an order. Based on the above initiatives and other efforts to reduce lead time, the average time from placing a component order with a suppl ier to having those items available at the New Balance materials warehouses fell from 12 weeks to approxi­ mately 9 weeks by 2005.

New Balance also contracted with two other Chinese manufacturers who were  responsible  for 75 percent of New Balance's foreign final product assembly. These firms shipped finished shoes to several of New Balance's smaller international divi­ sions, but most were bound for the United States and were sent via ship directly to New Balance's product distribution centers in Lawrence, Massachusetts, or Ontario, Cal ifornia. The order-to-delivery lead time 25 percent of the total, while materials accounted for the remaining 50 percent. Estimates of the total cost for a cut-through-assembly pair of shoes assembled in the United States was approximately $13 greater than a similar product fully man ufactured in Asia. For "sourced upper" pairs, this difference was thought to be about $0.50, due to import duties placed on fin­ ished goods entering the United States.

In 200 I, the average lead time for a cut-through­ assembly batch (typically consisting of 12 pairs of shoes) through a New Balance plant-measured from arrival of the raw materials to loading on the truck as finished product-was roughly 8.5 days. By 2005, the company had reduced  this time to 2.5 days through significant attention to process improvement and work-in-process reduction within the plants. Wilson and his colleagues believed that further reductions in manufacturing lead time were attainable. Following production, domestically assembled pairs were transported via truck either directly  to the retai ler (in the case of large strategic accounts) or to inventory in the Lawrence or Ontario distribu­ tion center. Each of those sites received and filled orders from smaller retailers. Combined, these two distribution centers held roughly 6.4 million pairs of finished shoes. The Ne"v Balance Workforce­ A Key to Operations l111prove1nent

The Davises believed that improving the produc­ tion process at New Balance req uired widespread initiative and involvement from the company's front line workers. Before joining the New Balance team, these manufacturing employees went through a lengthy selection process. New Balance screened potential employees for their professional or per­ sonal experience in team-based environments. For example, the company often looked for employ­ ees who had played team sports in high school or college. New hires were paired up with an experienced employee, known as a "buddy;' and were placed in a training team for six to eight weeks u ntil they were comfortable enough to go on a regular production team. "As soon as new employees come in, we train them in the fow1dations of associate involvement, continuous improvement, and leadership," Anne Davis explained, "but we don't want to put them immediately into an existing team and have them intimidated by the skills that the more experienced members already have." Another important  feature  of  the  company's U.S. workforce was that it was not unionized. Some employees performed two or three jobs on teams-a feature that would not be possible under a strict job classification system. "If one area of the factory is slow and the other one is loaded up," Anne Davis explained, "people willingly go to the next area to make their numbers for the day,and we would not be able to do that if they were unionized." "It's a flexibility issue. The factories are always changing," Jim Davis explained. "The folks on the factory floor are always pushing us to change things so they can do it better. We would n't be able to do that if we were unionized." He added: Annie and l are constantly amazed at how flexible these folks are, and how engaged they are in what they're doing. They go home, and they come to work the next day thinking, "How can 1 do things better? How can [ be more productive?" And what we're trying to do is get the whole company to think that Beyond the organization of the workforce, compensation also played a key role in the abil­ ity of New Balance's management to leverage em­ ployee knowledge and initiative. A few years ago, New Balance briefly moved from individ ual-based hourly wages to team-based piece rates, but then quickly moved back to the hourly system. Jim Davis explained:

Teammates put too much pressure on each other under the team-based compensation system. If one person was out of work because she had a sick child at home, there would be too much pressure on the rest of the team to perfo1m, and she came in feel­ ing guilty the next day. So we have also a culture of mutual respect here, and we sat down with ow· supervisors and we talked about how we might bet­ ter accommodate these people, and one of the things that we came up with was hourly pay. We did a pilot run for a month or so, and we found that the produc­ tion when we were compensating them on an how·Jy basis was equal lo if not better than under the team­ bai;ed piecework system.

Anne Davis added that the maintenance of hourly compensatio n helped gain support for con­ tinued training of the workforce. "Under the team­ based rate, many supervisors saw training as another project, as taking their people away from the job;' she said. '•With hourly pay they were more willing to send poople to training, and by doing training early on, people know right away whether or not they fit in the company."

LEAN MANUFACTURING ­ NEW BALANCE EXECUTIONAL EXCELLENCE (NB2E)

In 2004, New Balance began New Balance Execu­ tional Excellence (NB2E) to apply the principles of the Toyota Production System (TPS) to shoe produc­ tion. One of the key goals of NB2E was to further reduce the lead time from a retailer's order to its delivery. Tompkins clearly stated his objective for NB2E:

Our goa l is I 00 percent delivery of requested prod­ uct within 24 hours. It may be impossible, but we are going to\\ ork toward something very, very close to that-to a position "here, for that two or three percent that \\ e can't deliver within 24 hours-we can ce11ainly replenish within. say, four days al the most. And that would be only for the worst-case scenario where we got completely surprised by an order.

According to Tompki ns, an essential component of NB2E would be to move the company's manu­ facturing plants from batch production to single-pair flow. He added:

Over a period of time I would like to know that when a part of an u pper gets cut to what pair of shoes that part is heading. . ..And we might be making several different models in a given factory on a given day, but we would still know that that pru·t right there and the one in the ot her factory over there are going to end up in a shoe that is put on tliat trailer heading to that cu tomer.Thal is where I would like lo get to.

Before NB2E, to improve product availabi lity, New Balance was required to resort to what Spivak called "brut e force" by greatly increasing finished goods inventory. For the compa ny's flagship shoe, the 991 , inventory was doubled to ensure availability for all colors, sizes, and widths. Though there was a significant increase in sales of the 991,the inventory cost was very high.

If N B2E were to be successful-approaching Tompkin s' goal of I 00 percent availabi lity within 24 hourswhile reducing inventory levels-manufacturing cycle times would need to be dramatically reduced. These changes required complete realignment of factory operations. Spivak observed:

0lll' factory had a classk a1rn ngement with a cutting, an embroidery. a stitching, and an assem bly depait­ ment. Each department did their particular tasks for all styles, and t he factory worked on a batch basis. To 1ealign that under NB2E would require a big change. Instead of moving a day's worth of production, we needed to move toward a more continuous flow. Doing this would require us lo reduce work in proc­ ess significantly and get the line associates and su­ pe1visors to embrace that change. The real challenge would be lo keep making shoes every day while this transformation \Va ongoing.

THE MARATHON

G limpsing the brilliant evening sun outside their kitchen window, the Davises could not imagine a more fitting time for reflection. Though New Balance traditionally had competed on the basis of its manu­ facturing, service to retai lers, and its ability to build loyalty among a core set of customers for its high­ margin, long-lived shoe models, 2005 had not been a stellar year mostly beca use of operational issues. "We did a very poor job of executing i n the first half of the year," J im Davis noted. "We had a lot of qual­ ity problem s, late del iveries, late samples, which in­ hibited the effectiveness of our salespeople." To Jim Davis, the answer to the company's problems was "basically doing everything we've always done be­ fore, only doing it better."Yet as New Balance grew well beyond $ I billion in revenue, the question of scalability came up.

Please answer the following Case analysis questions

1-What do you see that is impressive about New Balance? What aspects of New Balance do you find less impressive? What accounts for New Balance’s success since the early 1980’s? IS it great strategy, sound strategy, implementation and execution, great leadership, or just plain good luck?

2-What are the key elements of new Balance’s strategy? Which of the five generic strategies is the company employing?

3- Are New Balance’s functional strategies well aligned with its business level strategy? Why or why not?

On a pleasant August evening in 2005, Jim and Anne Davis enjoyed what was meant to be a relaxing dinner at home. As they fin­ished their meal , however, they could not help but turn their attention to a headl ine in that morning's Boston Globe, a copy of which sat on their kitchen ta ble: "Adid as to buy Reebok."For over 30 years, the Davises had been the sole owners of New Balance Athletic Shoe Inc., one of the top five producers of athletic footwea r in the world. Given their experi­ ence i n the industry, they had suspected for some time that an Ad idas-Reebok transaction might be in the works. Neverthe less, the formal announcement caused them to wonder about the implications of this deal for New Balance. By bringing together Adidas and Reebok-the second- and third-largest produc­ ers of athletic footwear, respectively-this transac­ tion would create ajuggernaut that would rival Nike, the largest competitor in the industry. Although the Davises did not have to answer to Wall Street con­ cerning their competitive plans,they knew that many in the industry-including their own employees­ would soon be asking for their response. Lately, the Davises had focused significant atten­ tion on an initiat ive cal led New Balance Executional Excellence (N B2E), the goal of which was to in­ crease the quality and efficiency of the company's operational processes through the application oflean manufacturing. Started less than one year earlier,

NB2E already had provided evidence of early im­ provement, and the Davises did not want to lose the growing enthusiasm for this initiative among New Balance 's 2,600 associates. Further,they realized the importance of staying true to the private company's uniq ue operating philosophy, strategy, culture, and history.Nonetheless, they could not help but wonder whether New Balance's priorities needed to be ad­ justed in light of the shi fting competiti ve landscape.

THE U.S. ATHLETIC SHOE INDUSTRY'

The United States was the world's largest mari

ln recent years, manufacturers moved to com­ bine fashion and comfort to appeal to a broader range of consumers, namely those who wore athletic shoes for casual purposes. Concurrently, a combi­ nation of technological developments and style im­ provements in athletic footwear helped drive growth. While leather continued to be the most popular ma­ terial for athletic footwear uppers, some firms, such as Adidas-Salomon (Adidas), had developed shoes with so-called "smart textiles" and microchips that adjusted fit based on the wearer's activity, height, weight, and running terrain. Nike maintained a comfortable lead ahead of its competitors with 43 percent of the total global market for athletic shoes and apparel (see Exhibit I for sales and financial data for leading firms in the industry). Within the U.S. footwear market, Nike accounted for 36 percent of the market, while Adidas, Reebok and New Balance held on to a variable 8-12 percent each (Exhibit 2). Appendix A provides a brief description of each of the top competitors in the industry. The acquisition of Reebok by Adidas would cre­ ate a firm that rivaled Nike in terms of size and would boost Adidas 's share to roughly 20 percent of the U.S. footwear market. Though the Adidas-Reebok transaction was notable for its size, it reflected a broader recent trend of consolidation in the ath­ letic footwear industry. In July 2003, Nike acquired Converse, a Massachusetts based manufacturer of court and casual shoes, for $305 million. In June 2005, Stride Rite-the maker of casual footwear brands Keds and Sperry Top Sider-announced its intention to acquire Saucony, a $I 70 million manu­ facturer of specialty running shoes and apparel based in Peabody, Massachusetts. With respect to worldwide marketing, Nike out­ spent its rivals, spending $213 mi Ilion in measured media in 2004, compared to Adidas' $89 mill ion and Reebok 's $42 million.2 For the first JO months of 2005, for example, New Balance total advertising expenditure was $17.3 million.3 For all companies , a large portion of worldwide media expenditure was geared toward the marketing of footwear brands in the United States (Exhibit 2).

In addition to spending more on marketing than New Balance, most of its competitors produced their shoes outside of the United States, largely because the manufacturing of athletic footwear was highly l.abor intensive and required relatively low levels of worker skill. As a result,China had become the larg­ est manufacturer of athletic footwear for the U.S. market, commanding 85 percent of the category.4 The U.S. trade deficit in shoes was expected to con­ tinue to deepen, as more manufacturers shifted pro­ duction offshore. The deficit had increased about 7 percent per year since 1999, reaching 379 million pairs in 2004. Overall,Americans purchased 2.2 bil­ lion pairs of shoes and boots in 2004, enough to give each man, woman and child there 7.7 new footwear options that year.5

Distribution Channels

In 2005, the American sneaker market was divided i.nto several discrete retai I channels catering to pe­ riodically overlapping demographics that defined themselves by distinctive tastes, buying patterns, and price elasticity. Foremost among these were the "big box" chains such as Wal-Mart, Target, and Sears which together sold an estimated $12 billion in ath- 1.etic apparel and equipment per year.6 The second­ Largest group by sales volume included national sellers such as Foot Locker, The Sports Authority, Finish Line, and The Athlete's Foot. Next were smaller urban chains that maintained strong ties to tastemakers and arbiters of fashion. These chains typically either sold brands at heavy discounts to younger consumers or catered to high-end custom­ ers with very specific needs (e.g., high-performance running). The leading sneaker manufacturers, such as Nike and Adidas, also maintained showcase stores that featured new products in lavish displays accom­ panied by TV screens and music.These branded out­ lets were less retail stores than museums to the sneak­ ers of tomorrow and the "classics" made legendary by the likes of Pele, Chuck Taylor, and Michael Jordan.

With 4,000 stores around the world, Foot Locker was widely recognized as the world's leading retailer of athletic shoes and apparel. Foot Locker contribut­ ed slightly less than I0 percent to Nike's annual sales, but Nike products represented as much as 50 percent of sales for Foot Locker. The Sports Authority had 400 U.S. stores, but maintained a broader product base, selling workout equipment, basketball gear, sneakers and sports apparel. Finally, with 598 stores in the United States, Finish Line, originally started in the early 1980s as a discounter whose primary business was in "closeout" sales, prided itself in of­ fering prices that were typically $5 less than other retailers. Although beholden to the vagaries of fashion and manufacturers' ability to design hit products that would drive traffic into their stores, larger re­ tailers held a great deal of sway over the fortunes of the sneaker companies. For example, even though Converse sneakers were sold through many retail and on-line outlets nationwide, Foot Locker accounted for roughly 20 percent of all Converse sales. Any decision by Foot Locker about Converse's product placement thus could have a material impact on the brand's sales. In another case, a 2003 dispute over promotional practices for Nike shoes caused a costly one-year rift between the manufacturer and Foot Locker.

THE MAKING OF NEW BALANCE

New Balance was founded in Boston in 1906 as New Balance Arch 7 by William J. Riley, a 33-year-old British emigre who committed himself to helping people with problem feet by making arch supports and prescription footwear to improve shoe fit. In I 934, Riley went into partnership with his leading salesman, Arthur Hall. In 1954, Arthur Hall sold the business to his daughter and son-in-law, Eleanor and Paul Kidd. Arch supports and prescription fool:\vear remained the cornerstone of the business until 1961, when they manufactured the Trackster, the world 's first performance running shoe made with a ripple sole and available in multiple widths.

Du.ring the 1960s, New Balance's reputation for manufactu.ring innovative performance footwear available in multiple widths grew through word of mouth and grassroots promotions. When Jim Davis bought the specialized shoe man ufacturer from the Kidds on the day of the Boston Marathon in I 972, he committed himself to uphold the company's founding va lues of fit, performance , and manufac­ turing . He recalled: I wanted to buy a company, I wa young and single. I didn't have anything. so I had nothing to lose. [ looked at it a year before I bought ii.Al the time, I was in electronics. 1 pa. ed. because l knew noth­ ing about footwear and not much about spotting goods.other than what I knew from doing spotts in college. I got a pair of the hoes.statted running in them,and peoplewould come up lo me and comment that I must be a good runner. Unable to put a deal together in elect1-onics.with the company still avail­ able. I went back,and t he guy was desperate losell it. We paid $100,000 for the company; we put $10,000 down, and the rest of the $90,000 was generated from lowering im•ento1y.

At the time N ew Balance was primarily a mail­ order business with only a handful of U.S. retail­ ers. Jim Davis started traveling around the country to expand reta il distribution , and sales grew from $ I 00,000 to around $300,000 over a two-year pe­ riod. Anne, who wou l d marry Jim in 1984, joined New Balance in 1978 and focused on bui lding a dis­ tinct culture for New Balance associates and those who would do business with the company around the globe. Indeed, N ew Ba l ance's first international sales office and first European manufacturing facility both opened in 1978 in Europe. Since then the brand had expanded from Europe and Asia to the Middle East, Latin America, and Africa.

In the early 1980s New Balance set up new manufacturing facilities in New England and signed on international distributors. In 1982, the company reached the $60 million mark and debuted the well­ received 990 running shoe, the first athletic shoe priced at $ 100.1 Jn the 1990s, the company unveiled its New Balance Suspension System to telegraph its emphasis on cutting-edge R&D and its dedication to meeting the needs of performance-oriented runners. The company 's commitment to multiple sneaker widths remained a sell ing point that was reflected in the brand 's iconic marketing logo of three differently sized feet.9 Being Different Herb Spivak, executive vice president of opera­ tions and a 12-year veteran of the company, provid­ ed a picture of New Balance's un ique features. He observed: Ow·values have been very, very con istent and re­ inforced continuously by J im and Anne Davis. We do not endorse athletes, as an example. We aim to make every one of ow·shoes a pc1fo1mance product as opposed lojusl a fashion product. We sell eve1y shoe that we make in multiple width . because we believe that fit is a critical pe1fo 1mance charac1e1is­ tic. We maintain a great percentage of our product in inventory for replenishment. so that dealers can con­ tinually get fill-ins when they sell and when they need ce1tain sizes and widths. In con1ra 1. competitors pretty much tell retailers. "OK. tell us six months in advance what you 're going lo want lo buy and we'll deliver it. But it's fixed. and we don't plan on having future invenlo1y.'·These basic factors, combined with the maintainin g of our domestic factories all come together to describe what makes us unique.

Because the company had remained private,Jim Davis felt that he and his colleagues could act more nimbly and be more socially responsible than their more well-heeled competitors. "I f we were a pu b­ lic company, I am sure the shareholders would say, cclose your factories and make the product abroad because you will make more dough for me and my quarterly dividend,"' Davis told the Boston Globe in 2004.'0 Davis also felt that the company had prod­ ucts capable of providi ng sol id margin s needed to generate the cash flow required to finance growth. As such, the company's balance sheet remained very strong with a seven-to-one ratio of assets to Liabilities.

Beyond financial flexibility, other aspects of the company's operations and strategy suggested that it was somehow different from competitors. President and Chief Operating Officer Jim Tompkins noted: One thing that sets us aprui and that is we a1-e manu­ factun:rs. But "e at'C mediocre marketers by design. Our marketing spend as a percent of net revenue is much lower than our competitors.The message that we talk about in the marketplace i different from our competitors' message. And that's what makes the company unique-ii is that we are manufacturing­ and operations-based. not marketing-based.

Jim Davis emphasized this distinction: In the early lo mid- l 980s. Nikeand Reebok wem both becoming major players. and eve1ybody said, "You ought to really do this because Nike and Reebok are doing it." Well , we tried a cou ple limes with product and programsand whatever, and we failed. drastically. So then l woke up one moming and I said, "We're not any good at that. We're really good at this ." So we concentrated on doing this instead of that, and thus differentiated ow-selves. Culture Similar to its unique business model, New Balance's corporate culture developed over time. Teamwork was a critical component. "When you 're young and starting up," Jim Davis recalled, "you don't really think in terms of a culture. You just sort of do things a certain way. One day we realized that we're very team-oriented, and that we empower people. When we got to a certain size and maturity, we realized that that's basically what we were all about."Further, New Balance developed a long-standing commitment to social responsibility that, according to Anne Davis, "made people feel good about deal ing with the com­ pany." For example, after the 2004 Asian Tsunami, New Balance declared that it would match whatever its associates donated. Then retailers wanted to par­ ticipate, so New Balance decided to match their con­ tributions for a total contribution of $1 million. The company also promised to donate another $1 million if 100 pen;ent participation was reached among as­ sociates. In the end, every person in the organization contributed something.

The company's culture was also very entrepre­neurial, starting with the owners' willingness to take risks and encourage others to do the same. Anne em­ phasized that this culture of change and challenge extended to the factory, noting thatmatmfacturing em­ ployees, mostly organized in cross-functional teams, represented one of the greatest forces for change in the company.This spirit was also reflected across New Balance's senior managers. Chief Financial Officer John Withee observed, "Continuous improvement is a mantra here. Do the best you can, work cross­ functionally, and work towards a common goal." As an example of a major risk taken relatively early on by the company, Jim Davis pointed to the introduction of the 990 series running shoe in the 1980s, the first $I 00 shoe at a time when athletic shoes were retai ling for about $50. "People said we were nuts;' Jim mused, "but we couldn 't make them fast enough. People learned from that and be­ came more confident in pushing the envelope."As of 2005, the 990 series still represented the top-selling product for New Balance, accounting for roughly 3.5 percent of the company's sales.

Endorsed by No One

In an industry dominated by endorsement deals and large print and TV campaigns featuring celebrity ath­ letes, New Balance put its energies and investment into research, design, and domestic manufacturing, and let the resulting products speak for themselves. New Balance felt it could eschew celebrity endorse­ ments and position itself as a brand for performance­ oriented runners less swayed by fashion trends and popular personalities. New Balance extended its product-focused strategy to its branding efforts in 1992 with its "Endorsed by No One" campaign despite holding only 3 percent of the U.S. market for athletic shoes at the time."

New Balance introduced edgier iterations of the campaign that culminated with an anti-endorsement ad message that actually chided professional athletes for losing sight of the game and focusing dispropor­ tionately on endorsement deals. With slightly older core customers (between 25 and 49), New Balance concluded it could afford to take this irreverent tone in commercials. The "For Love or Money" campaign was unveiled in February 2005.12 The slogan felt "nat­ural to us because it was something that only New Balance can stand in front of;' said Paul Heffernan, executive vice president of global marketing. "Jt's all about everyday athletes playing for the love of the game."13 By contrast, Reebok introduced a new ad campaign of its own that same month featuring bas­ ketball icon Yao Ming, Olympic gold medalist Kelly Holmes, actress Lucy Liu, and tennis player Andy Roddick, with the tagline "I Am What I Am.'*

The New Balance campaign featured a you ng basketball player admonishing "some of the pros out there," for their swagger and potentially un­ sportsmanlike conduct on and off the court that had become accepted behavior in some quarters. Most notably, a game-ending brawl during a Detroit Pistons game in Auburn Hills, Michigan, on November 19, 2004, that erupted after Indiana Pacers' forward Ron Artest leapt into the stands to retaliate against a spectator who had lobbed a cup of beer at players from the stands. The New Balance campaign took a direct approach with an unassailable jibe: "Is fight­ ing in sports everjustified?" In addition to 30-second TV spots, the campaign included print, billboard, and onl ine ads that posed a series of questions about athletes'-and by exten­ sion, their fans'--core values: "Can a losing coach still be a good coach?" and "Which teaches a player more, winning or losing?"Yet another New Balance ad from the same series was even more direct and confrontational: "Just in case you forgot, this is what a pass looks like. . . . This is what a Aoor burn looks like." New Balance was reportedly planning to spend $21 million on its 2006 advertising campaign, which was close to its entire promotional budget for the year.16

PRODUCT DESIGN

According to Paul Heffernan, New Balance's focus on width sizing and fit had historically dictated the design of many of the company's products. He explained: A 15-year-old who wants a pair of Nike Air Jordans might curl his toes or put on six pairs of socks to make that shoe fit. tn that case, purchases are made based on how a shoe looks rathe1·whether it really fits well. The market that is interested in width sizing and fit is a little bit older and more mat u.re; those custom­ ers demand a product that is a bit more conservative in its presentation and style.They tend to like a prod­ uct and buy it again and again and again. It 's Like a white button-down shirt. I own a white button-down, it wears out, I buy another white button-down.

New Balance had approximately 60 people in product design and development who were involved with efforts on two fronts. One was incremental de­ velopment of existing models. The second involved the incorporation of new technologies such as Absorb EX-a premium, visible-cushioning techno logy­ and Zip, a patented responsive-cushioning technol­ ogy scheduled to debut in 2006. Both technologies were oriented toward a younger customer base.

Despite New Balance's desire for long-lived products, Heffernan knew that the company had to remain capable of delivering prod ucts to the shorter­ cycle, fashion-oriented segments of the market. He noted:The 991 series-our franchise shoe of 25 years­ stays in line three years. With t hree ye;us to update that shoe, we can afford lo lake our time and be more thoughtful. But the more fashion-oriented products often need to chw·n every 60 to 90 days. which cre­ ates a completely different model for prod uct design. The fashion segment cares !es about widths and more about time to market, so we need to work under tighter timelines for these product .

Jim Davis felt that in the past five or six years, New Balance had "dropped the ball in a few places, and design is one of them." He added:

Right now. we are emphasizing design more tha n we have in the past and are raising the level and tature of design within the organization. Design is going to become more impo1tant as time goes on. a much larger foclor than it has been. We tend to be a little bit more conservative with design than our competition and stay within a ce1tain real.m for a relatively long pe1iod oftime. Then we find that we might have hit a wall. o we have to come back and reinvent ourselves a little bit and move forward. The manufact uring folks do that every day. The rest of the company is so11 of playing catch-up there, and we have to re­ invent ou1-i;e lves a little bit more often than we have in the past.

SALES AND DISTRIBUTION

New Balance had focused more on smaller retailers, running specialty shops, and family footwear shops. John Withee explained, "We are heavi ly focused on supporting the smaller type of service-oriented cus­ tomer." New Balance sold its products through ap· proximately 3,500 retailers representing over 12,000 sites, commonly referred to as "doors." Its largest retai I customer was Foot Locker, a major chain that, on its own, accounted for over 3,000 doors in the United States. New Balance divided its retai lers into two groups-key accounts and specialty dealers (see Exhibit 3). Key accounts were further divided into six strategic accounts and 49 other key accounts. Specialty retai lers were subdivided into three major channels: elite ru nning stores (i.e., specia lty stores for serious runners); independently owned and op­ erated New Balance stores; and other independent dealers, which were primarily family shoe stores.

Fran Allen, executive vice president for sales and service, noted that strong relationships with both small and large retailers were critica l for New Balance. "The importanc.e of independent, specia lty retai lers to the image of our brand far exceeds their 25 percent share of our sales volume. Obviously, large accounts are extremely important in terms of their sales volume. Consequently, we give both groups a lot of attention and work hard to give each what they need to be successful."

In contrast to competitors, New Balance relied on a sales force that was composed of independent agents. Allen noted, "In the sporting goods industr there is an unwritten rule-or maybe it isjust natural selection-that as you get to a certain point in sales volume, you grow out of an independent sales force. You bring the sales organization in house. At New Balance, we do not have any in-house accounts. We prefer using independent, dedicated sales agencies with an entrepreneurial mindset." Indeed, all the company's sales agents were independent of-but exclusive tNew Balance. These sales agencies were compensated through a sales-based commission. Under this system, new salespeople might earn $40,000 to $50,000 per year (from which they would cover their own expenses) whi le the most experienced salespeople could make several hundred thousand per year. Large retail ac­ counts were managed by a total of 10 head sales agents, 6 of whom were strategic account managers (SAMs). Specialty accounts were managed by ap­ proximately 100 agents, who worked for independ­ ent sales agencies, but were managed by five regional managers employed by New Balance (see Exhibit 4). New Balance was investing in a sales force automa­ tion system to increase the agents' productivity.

Despite the fact that these agents were not direct employees of New Balance, Allen-who had been with New Balance 15 years as sales manager-not­ ed that the company was not concerned about these relationships that were u nique to the industry. "We have a loyal group of salespeople, and their longev­ ity of service provides us with a distinct edge over our competitors," he explained, attributing this loy­ alty to the strength of New Balance 's leadership and culture. He added: In 1991, my first year at New Balance, the company sold $84 million in footwear in the United States; last year, we did a little over $1 billion. One of the reasons Jim Davis liked this sales organ'ization was that he had head sales agents who had been with him for 15 or 20 years before [ got here and had gone through some difficult times and stuck with the company.

For smaller, privately owned retailers, New Balance had historically paid an independent sales representative to take product orders and either key them into the New Balance order system or fax them to New Balance's corporate sales office at company headquarters in Allston, Massachusetts. To speed the ordering process, the company had recently invested in what Chief Financial Officer John Withee termed a "state-of-the-art" ilistribution center and was us­ ing technology to leverage this resource, support its retailers, and strengthen its retail relationships. In terms of information technology, a new sales force automation system enabled sales representatives to place direct orders remotely, access New Balance's inventory information, and check on delivery sta­ tus business-to-business (B2B). A B2B application promised to enable retailers-particularly smaller retailers-to do the same without intervention by the sales representative. Withee added, "This appli­ cation helps manage the flow of product through the supply chain and is about as vital as you can get in determining our performance."

Going forward, Withee explained, the B2B ap­ plication would help reta.ilers directly manage basic ordering, thereby freeing up the sales representative to engage with the retailer and make recommenda­ tions about new items to carry or options for reduc­ ing inventory levels. Concerning retailers, Jim Davis explained: If you've been selling New Balance shoes for the last I 0 years, to sell 1,000 pairs you had 400 pairs in inventory. Assuming you are selling all domestic product, which some of our accounts do, we would say: "We think we can increase your sales next year and lower your invento1y at ihe same time. We will ship to you the day after you order the product, so yom inventoties can be decreased dramatically. Rather than canying 400 pairs, you can cru..-y 200 pairs, and sell maybe 1,200 pairs instead of 1 ,000.And your mru·kdowns ru·e negligible, because your inven­ tory's so low:' And we think ihat's a very compelHng argument. We ru·e taking all the risk when we do that.

By shipping quickly and accurately, New Bal­ ance offered retailers the ability to build loyal cus­ tomers of their own. Indeed, according to Jim Davis, New Balance had far the greater consumer loyalty than any of its competitors. "That translates well for the retailer, especially if that retailer's able to satisfy the customer with that 13EEEE, because that cus­ tomer always wants that 13EEEE. He or she will generally go back to that same retailer to get that product.. And retailers lmow that!'

SUPPLY CHAIN AND MANUFACTURING

Jn contrast to Nike and Reebok, who outsourced nearly all of their production to As.ian manufac­ turers, New Balance used outsourcers for only 75 percent of its U.S. volume. For the remaining 25 per­ cent,final product assembly took place in one of New Balance's five factories in the Northeastern United States. One-third of these domestically assembled shoes were referred to as "cut through assembly" product. For these shoes, New Balance would import finished soles and the raw materials for the upper from Asian suppliers. The uppers would then be ful­ ly manufactured and attached to soles in the United States. The remaining two-thirds of New Balance's domestic product was referred to as "sourced up­ per." For sourced-upper shoes, New Balance would import finished uppers and soles from Asia and would complete the assembly by attaching the appro­ priately sized uppers and soles at its U.S. factories. The more time-intensive cut-through-assembly prod­ uct was manufactured at New Balance's factories in Lawrence, Massachusetts; Skowhegan , Maine; and Norridgewock , Maine. Sourced-upper shoes were as­ sembled at these three sites,as well as another factory in Norway, Maine.17 Exhibit 5 provides an overview of the manufacturing network and supply chain.

Foreign Suppliers

New Balance sourced the soles for most of its shoes from two suppliers in China (suppliers A and B in Exhibit 5). Depending on the shoe, these two firms also supplied either finished uppers or kits contain­ ing a significant portion of the materials required to stitch uppers in the United States.18 Finally, these firms provided a limited amount of fully assembled shoes. These firms shipped to New Balance's three materials warehouses , two in Skowhegan, Maine, and one in Lawrence, Massachusetts.

Historically, it would take approximately one week for New Balance to place a purchase order for components (e.g., soles, uppers, or kits) and have it accepted by the appropriate supplier in China. It would then take roughly six weeks for the supplier to manufacture the required components and an ad­ ditional five weeks to ship them by boat across the Pacific and transfer them to cross-country transport for delivery to the designated warehouse. Until the early 2000s, New Balance tended to place orders for a particular sole on a monthly basis in batches as large as 20,000 pairs. For a single type of sole, each order would include roughly 20 different SKUs, re­ flecting different shoes' lengths and widths such as 90, J OY,E, and 12EEE.

John Wilson, vice president for manufacturing, noted that the company had taken several steps in recent years to reduce the lead times from Asian suppliers. First, New Balance had shifted to placing smaller orders of between 2,000 and 10,000 pairs on a weekly basis. Jn addition, New Balance made ar­ rangements with these suppl iers to enable them to "pre-buy" their own raw materials on behalf of the company, thereby reducing the lead time required to produce an order. Based on the above initiatives and other efforts to reduce lead time, the average time from placing a component order with a suppl ier to having those items available at the New Balance materials warehouses fell from 12 weeks to approxi­ mately 9 weeks by 2005.

New Balance also contracted with two other Chinese manufacturers who were responsible for 75 percent of New Balance's foreign final product assembly. These firms shipped finished shoes to several of New Balance's smaller international divi­ sions, but most were bound for the United States and were sent via ship directly to New Balance's product distribution centers in Lawrence, Massachusetts, or Ontario, Cal ifornia. The order-to-delivery lead time 25 percent of the total, while materials accounted for the remaining 50 percent. Estimates of the total cost for a cut-through-assembly pair of shoes assembled in the United States was approximately $13 greater than a similar product fully man ufactured in Asia. For "sourced upper" pairs, this difference was thought to be about $0.50, due to import duties placed on fin­ ished goods entering the United States.

In 200 I, the average lead time for a cut-through­ assembly batch (typically consisting of 12 pairs of shoes) through a New Balance plant-measured from arrival of the raw materials to loading on the truck as finished product-was roughly 8.5 days. By 2005, the company had reduced this time to 2.5 days through significant attention to process improvement and work-in-process reduction within the plants. Wilson and his colleagues believed that further reductions in manufacturing lead time were attainable. Following production, domestically assembled pairs were transported via truck either directly to the retai ler (in the case of large strategic accounts) or to inventory in the Lawrence or Ontario distribu­ tion center. Each of those sites received and filled orders from smaller retailers. Combined, these two distribution centers held roughly 6.4 million pairs of finished shoes. The Ne"v Balance Workforce­ A Key to Operations l111prove1nent

The Davises believed that improving the produc­ tion process at New Balance req uired widespread initiative and involvement from the company's front line workers. Before joining the New Balance team, these manufacturing employees went through a lengthy selection process. New Balance screened potential employees for their professional or per­ sonal experience in team-based environments. For example, the company often looked for employ­ ees who had played team sports in high school or college. New hires were paired up with an experienced employee, known as a "buddy;' and were placed in a training team for six to eight weeks u ntil they were comfortable enough to go on a regular production team. "As soon as new employees come in, we train them in the fow1dations of associate involvement, continuous improvement, and leadership," Anne Davis explained, "but we don't want to put them immediately into an existing team and have them intimidated by the skills that the more experienced members already have." Another important feature of the company's U.S. workforce was that it was not unionized. Some employees performed two or three jobs on teams-a feature that would not be possible under a strict job classification system. "If one area of the factory is slow and the other one is loaded up," Anne Davis explained, "people willingly go to the next area to make their numbers for the day,and we would not be able to do that if they were unionized." "It's a flexibility issue. The factories are always changing," Jim Davis explained. "The folks on the factory floor are always pushing us to change things so they can do it better. We would n't be able to do that if we were unionized." He added: Annie and l are constantly amazed at how flexible these folks are, and how engaged they are in what they're doing. They go home, and they come to work the next day thinking, "How can 1 do things better? How can [ be more productive?" And what we're trying to do is get the whole company to think that Beyond the organization of the workforce, compensation also played a key role in the abil­ ity of New Balance's management to leverage em­ ployee knowledge and initiative. A few years ago, New Balance briefly moved from individ ual-based hourly wages to team-based piece rates, but then quickly moved back to the hourly system. Jim Davis explained:

Teammates put too much pressure on each other under the team-based compensation system. If one person was out of work because she had a sick child at home, there would be too much pressure on the rest of the team to perfo1m, and she came in feel­ ing guilty the next day. So we have also a culture of mutual respect here, and we sat down with ow· supervisors and we talked about how we might bet­ ter accommodate these people, and one of the things that we came up with was hourly pay. We did a pilot run for a month or so, and we found that the produc­ tion when we were compensating them on an how·Jy basis was equal lo if not better than under the team­ bai;ed piecework system.

Anne Davis added that the maintenance of hourly compensatio n helped gain support for con­ tinued training of the workforce. "Under the team­ based rate, many supervisors saw training as another project, as taking their people away from the job;' she said. '•With hourly pay they were more willing to send poople to training, and by doing training early on, people know right away whether or not they fit in the company."

LEAN MANUFACTURING ­ NEW BALANCE EXECUTIONAL EXCELLENCE (NB2E)

In 2004, New Balance began New Balance Execu­ tional Excellence (NB2E) to apply the principles of the Toyota Production System (TPS) to shoe produc­ tion. One of the key goals of NB2E was to further reduce the lead time from a retailer's order to its delivery. Tompkins clearly stated his objective for NB2E:

Our goa l is I 00 percent delivery of requested prod­ uct within 24 hours. It may be impossible, but we are going to\\ ork toward something very, very close to that-to a position "here, for that two or three percent that \\ e can't deliver within 24 hours-we can ce11ainly replenish within. say, four days al the most. And that would be only for the worst-case scenario where we got completely surprised by an order.

According to Tompki ns, an essential component of NB2E would be to move the company's manu­ facturing plants from batch production to single-pair flow. He added:

Over a period of time I would like to know that when a part of an u pper gets cut to what pair of shoes that part is heading. . ..And we might be making several different models in a given factory on a given day, but we would still know that that pru·t right there and the one in the ot her factory over there are going to end up in a shoe that is put on tliat trailer heading to that cu tomer.Thal is where I would like lo get to.

Before NB2E, to improve product availabi lity, New Balance was required to resort to what Spivak called "brut e force" by greatly increasing finished goods inventory. For the compa ny's flagship shoe, the 991 , inventory was doubled to ensure availability for all colors, sizes, and widths. Though there was a significant increase in sales of the 991,the inventory cost was very high.

If N B2E were to be successful-approaching Tompkin s' goal of I 00 percent availabi lity within 24 hourswhile reducing inventory levels-manufacturing cycle times would need to be dramatically reduced. These changes required complete realignment of factory operations. Spivak observed:

0lll' factory had a classk a1rn ngement with a cutting, an embroidery. a stitching, and an assem bly depait­ ment. Each department did their particular tasks for all styles, and t he factory worked on a batch basis. To 1ealign that under NB2E would require a big change. Instead of moving a day's worth of production, we needed to move toward a more continuous flow. Doing this would require us lo reduce work in proc­ ess significantly and get the line associates and su­ pe1visors to embrace that change. The real challenge would be lo keep making shoes every day while this transformation \Va ongoing.

THE MARATHON

G limpsing the brilliant evening sun outside their kitchen window, the Davises could not imagine a more fitting time for reflection. Though New Balance traditionally had competed on the basis of its manu­ facturing, service to retai lers, and its ability to build loyalty among a core set of customers for its high­ margin, long-lived shoe models, 2005 had not been a stellar year mostly beca use of operational issues. "We did a very poor job of executing i n the first half of the year," J im Davis noted. "We had a lot of qual­ ity problem s, late del iveries, late samples, which in­ hibited the effectiveness of our salespeople." To Jim Davis, the answer to the company's problems was "basically doing everything we've always done be­ fore, only doing it better."Yet as New Balance grew well beyond $ I billion in revenue, the question of scalability came up.